Insurance companies should be given kudos for being responsible for offering services that help protect individual and assets from unforeseen circumstances and mitigating risks. Their effect on the economy cannot be relegated to the background. The insurance policies they offer is as a result of their calculated risks and also the Premiums they set is based on certain factors.
This article talks about how insurance companies assess risks and set Premiums behind the Scenes.
How Insurance Companies Assess Risks and Set Premiums
To understand how insurance companies set Premiums and asses risks, the following subheadings need to be explained;
Understanding Risk Assessment
Simply put, risk assessment refers to the process of identifying, evaluating and analyzing potential risks that might affect the individual or business. There are some factors that need to be considered when assessing risks. Such factors include; the likelihood of risks arising and the extent to which the damage can be done. In the case of insurance companies, Risk assessment is vital to understand the impending risk a policyholder could be faced with. Also, risk assessments help to determine the insurance quotes and claims that are likely to be made in future. The main reason why Insurance companies assess risks is to be sure that they can cover costs whenever uncertainties or unforeseen circumstances arise. To ensure their financial stability, they set Premiums.
Factors influencing Risk Evaluation
There are numerous factors that affect the way insurance companies evaluate risks. Such factors include;
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Demographic Information
Demographic Information includes; age, gender, occupation, location etc. These factors can affect risk assessments in so many ways. For example, a younger driver may pay for more auto insurance because based on statistics, they are likely to engage in more accidents than older drivers with more experience.
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Historical Loss Experience
When insurance companies assess risks, they can do so by checking the policyholder’s history of losses and claims. By doing so, they can set the appropriate Premium for them.
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Lifestyle and Behaviour
Lifestyle choices and behaviour can influence risk assessments. For instance, a policyholder who smokes will likely face a higher premium due to the medical risks he is prone to.
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Occupational Hazards
The nature of the policyholder’s job influences risk evaluation and assessment because there are some jobs that are riskier than others. Riskier jobs tend to pay more Premiums in case of claims in the future.
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Environmental Factors
This factor can influence risk assessment based on certain conditions of a geographical location such as; natural disaster, crime rates, climate, proximity of water level etc. This influences risk assessment for casualty and property insurance.
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Financial Stability
This is one major factor considered by insurance companies. They check their intending policyholder’s financial records to see if they will be able to pay Premiums and afford deductibles.
There are so many factors that influence the risk assessment insurance companies take into consideration. Although, the important ones have been listed and explained, in addition to them, we have more factors like; policy coverage and limit, regulatory and legal considerations, etc.
Statistical Modelling and Actuarial Science
Statistical Modelling and Actuarial Science are vital components of risk evaluation, risk assessment, and risk management employed by insurance companies in setting Premiums for policyholders.
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Statistical Modelling
This Modelling involves employing mathematical techniques in analyzing historical data and predicting the future. Insurance companies use the statistical model to identify patterns and trends and to predict the likelihood of unforeseen circumstances like accidents, illnesses and the like. This model helps them calculate and evaluate the value of risks.
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Actuarial Science
Actuarial Science on the other hand focuses on managing and assessing financial risk in the field of insurance. It is responsible for setting prices for products, risk analysis and setting aside reserves to cater for claims in the future.
Data Collection and Analysis
Another way insurance companies assess risks and set Premiums is by collecting data and analysing them. They do this so as to make informed decisions, assess risks and set Premiums. Below is how insurance companies use data Collection and Analysis in arriving at their insurance quotes:
- Data Collection
- Data Storage and Management
- Data Analysis
- Risk Assessment
- Fraud detection
It is a whole lot of rigorous process but it is worth it.
Pricing Strategies and Premium Setting
The pricing Strategies and Premium settings are very crucial aspect of the insurance industry. Arriving at prices for insurance policy isn’t magic. There were steps taken to arrive at such quotes. Here are some of the steps;
- Underwriting Guidelines
- Risk Segmentation
- Claim history and loss experience
- Competitive pricing
- Regulatory Compliance and
- Adjustment factors
Regulatory Considerations
The whole essence of Regulatory Considerations in insurance companies is to ensure order and fairness. Also, to protect customers and to stabilize the insurance market. Some aspects of regulation of insurance companies include;
- Licensing and Registration
- Rate Regulation
- Market Conduct Regulation
- Financial Regulation
- Consumer Protection
- Privacy and Data Security
- Anti-Fraud Measures
Challenges and Future Trends in Risk Assessment
There is no doubt that the challenges and future trends in Risk Assessment of insurance companies is shaped by technological advancements, Regulatory changes and dynamic changes in consumer behaviour. Taking for instance, the area of Data availability and quality, the major challenges the insurance industries face is obtaining data that are far from high quality, inaccurate and incomplete. In the nearest future, we believe that there will be advanced technologies that will help collect high quality data such as the telematics.
To conclude, you can see that a whole lot goes on behind the scenes before insurance companies arrive at their quotes.
