Insurance Premiums Explained
An insurance premium is the amount you pay an insurer for your insurance cover. It reflects what the insurer believes is the likelihood you will make a claim. It also includes the insurers’ costs and any discounts or bonuses they might offer you. In a hard insurance market it will also reflect the high demand for insurance and reduced supply. Insurers generally impose stricter underwriting guidelines, are less likely to negotiate terms and generally issue a more limited number of policies in a hard insurance market.
The amount you have to pay is shown on the policy schedule or tax invoice which is sent to you when the insurance is arranged. The final amount you pay also includes state and territory stamp duties and levies, and the Goods and Services Tax (GST).
Each insurer makes their own commercial decisions when deciding how much to charge each person who wants to cover certain risks. For example, when you insure your car for a comprehensive policy the insurer will decide how much that particular car is worth and what risks are worth insuring. Insurers often refer to data when making these decisions. If your car is kept in a suburb with higher rates of car theft, you will be given a higher level of risk (therefore paying a higher premium) than someone whose car is kept in a place where car theft rates are low. Insurers will also look at other elements like the driver’s age and sex as well as their claims history. That’s because some demographics are statistically more likely to make a claim. Something which also influences risk is the driver’s personal driving record. Most insurers will take into account whether you’ve been at fault in any accidents or whether you’ve been penalised for speeding, rink driving or other offences.
All of these factors influence your premium calculation.
Insurers also decide how much coverage will be offered and in some circumstances may not offer you cover if they believe the risk is too high. It’s up to you to agree to all the terms of the policy including the extent of cover and any terms and conditions. You may have a choice about some aspects of the policy, such as the amount of excess and optional extras.
Similar principles are used in calculating premiums for all types of insurance.
Why Premiums Change
Premiums can change from year to year even if your personal circumstances don’t. Premiums are affected by a range of factors including business costs and changes to the way the insurer assesses your risk. Sometimes premiums go up across the board and sometimes it’s an individual rate hike if your level of risk has increased. If you’ve done something to reduce your risk, this is also taken into account with a premium reduction.
Some of the reasons why premiums may change
- Changes in Govt taxes, duties or levies
- Reassessment of your individual risk especially following a claim or natural disaster
- The overall number of claims experienced in a particular sector of the insurance industry
- Large scale claims due to natural disasters
- Investment returns for the insurer to help ensure they have sufficient capital to pay future claims
- Regional or global changes that affect the price and availability of reinsurance
- The value and quantity of what you are doing may have changed i.e. your turnover may have increased or decreased
- The overall cost of the insurer doing business
An unusually high number of claims in the previous year for example following a natural disaster may prompt an insurer to increase their premiums to restore balance between the pool of funds available to pay claims and the risk.
Balancing Premium Pprices
Working out the correct price for insurance premiums is a complex process that balances the availability of funds, the likelihood of certain claims (the risk) and the availability for the pool of money from all insurance premiums to cover the cost of claims.
Insurers rely on a range of data including claims histories, statistics and probability calculations to plan potential claim payouts. They can also use information on certain risks like flood maps and seasonal weather forecasts.
No two insurers offer the same policy with the same terms and conditions which makes comparing policies very important. Policies and premiums can differ if insurers are using different information. Some insurers have enough information to look at and price the risks for an individual address while another insurer might rely on data for the whole postcode.
Insurers must meet strict regulatory requirements and ensure they hold sufficient funds to meet the prudential capital requirements of APRA so that there’s enough funds to pay many claims at once. The prescribed capital requirements of insurers amount to very large sums of money which are invested. These investments are owned by shareholders like superannuation funds and investment funds and are an important part of the Australian economy, supporting businesses, industries, large scale projects and the financial system as a whole.