All rates are based on various risk exposures that insurance may face. However the rate for use through a manual begins with the basic exposure unit, e.g. a residential house. There can be various rating factors involved such as the type of construction, the age of construction, the height of the building, the proximity to other buildings, the nature of locality and so on.
The relevant elements that are used to add up the rates make the rating plan and the various specific elements in it are referred to as rating factors. These rating factors can help to reflect the identified differences in loss propensity. By ensuring that all the relevant rating factors are taken into consideration, it can be ensured that the rates are not inadequate, excessive or unfairly discriminatory as between risks of same type and quality.
If the risk betterment characteristics of a risk are not considered the insurer is said to be skimming the cream. If there is failure to consider the adverse features of a risk the rate will be too low. If the competing insurers factor in the negatives and the insurer’s underwriter does not, then the insurer falls prey to adverse selection.
While assessing the risk characteristics, the rating plan broadly looks at risks from two sides, i.e, on one side the frequency of losses and on the other the severity of losses. For example, the frequency of losses to residences may be noted in houses that store more combustible material or where the house construction and house maintenance is of low standard.
In case of floods, it is related to houses in low lying areas. In respect of severity persons having high value contents tend to have larger losses than those residences that have fewer contents and so on.
Courtesy : General Insurance Underwriting Book published by Sashi Publications
