Standard Premium – The Base Cost before Any Discounts or Surcharges
Standard premium, a fundamental part of insurance economics, is often center-stage when it comes to misunderstanding. Sure, insurance professionals are aware of it. But do they know enough to explain it accurately?
TL;DR
- Standard premium is the base cost of an insurance policy before factors such as discounts or surcharges are applied.
- It matters in day-to-day agency work as it is the starting point for determining policy premium price.
- A common pitfall is confusion with the final premium, which can include various discounts or surcharges on top of the standard premium.
- Quick win: Be clear in client communication when distinguishing between standard and final premium.
What Is Standard Premium in Insurance?
To a client, you could say, “the standard premium is the initial price determined by your insurance company before they account for discounts or rate increases.”
From a more technical aspect, standard premium is the premium at the manual rate for each exposure unit on a policy. It’s the starting point in premium calculation, calculated based on the appropriate rate for a given risk before any modifications. Standard premium is commonly applied in multiple lines of insurance such as workers compensation, general liability insurance, commercial property, personal lines, and commercial auto. Basic premiums are found on policy declarations and can be adjusted by modifiers like experience rating or retrospective rating.
Key Related Terms to Know
- Exposure Unit – A way to measure risk for insurance pricing. One exposure unit could be $1,000 of business income for a restaurant, a whole building for a commercial property policy, or each vehicle for a fleet in commercial auto insurance.
- Manual Rate – The rate that comes directly from the insurer’s rate book, before applying individual risk factors or discounts.
- Experience Rating – A method to calculate premium prices where the insurance company uses historical loss data to determine the likelihood of future losses.
- Retrospective Rating – A form of risk financing. After the policy term, the premium can increase or decrease based on actual losses.
- Premium Developed – This is the final premium price after all adjustments to the standard premium, like experience modification and schedule rating.
Common Questions About Standard Premium
Why is the standard premium important in the insurance industry?
The standard premium is vital because it serves as the benchmark for insurers when they price their products. It’s the starting point before any discounts or surcharges are applied based on the insured’s individual risk characteristics. For instance, a standard premium in a workers compensation policy might be modified by experience rating, resulting in new premium prices.
How is standard premium calculated?
The standard premium is calculated by multiplying the exposure unit by a manual rate, which is determined by statistical data and industry benchmarking. For example, in commercial property insurance, the standard premium is calculated by multiplying the property value (exposure unit) by the manual rate per $100 of coverage. When proper exposure unit usage and the appropriate rate are applied, the standard premium is developed.
Where does continuing education come in when dealing with standard premium?
Continuing education in the insurance sector helps professionals stay updated on changes in premium pricing methods and policy terms. This, in turn, fosters accuracy in standard premium calculation and strengthens risk management processes within agencies.
Does standard premium apply to all types of insurance, or is it specific to certain lines?
The standard premium applies to both commercial and personal lines, including specialty lines. Whether it’s workers compensation, general liability insurance, commercial property, or personal auto insurance, the standard premium acts as the basis upon which the final premium is calculated.
Standard Premium vs. Pure Premium
While both employ statistical data in their calculation, the standard premium is the initial cost before modifications whereas the pure premium represents the portion of the standard premium that covers expected losses and does not account for underwriting expenses, profits, or contingencies.
Comparison Area | Standard Premium | Pure Premium
|
Primary use case | Base for pricing insurance products | Used in actuarial studies and rate making |
Coverage / concept type | Applies to various insurance coverages | Applied mainly in liability and workers’ compensation lines |
Typical exclusions | No common exclusions unless individual risk factors are considered | Does not include elements of insurer’s overhead or profit |
Who is most affected by errors | Insured, insurer, agents | Mostly insurers and actuarial professionals |
Common mistakes | Misunderstanding with final premium | Misinterpretation as actual premium |
Real Claim Examples Involving Standard Premium
Scenario 1: A small business owner with a fair claim record recently had his workers compensation policy renewed. He noticed that his starting premium was much higher than the previous one. Upon contacting his insurance agent, he learned that the standard premium had increased due to a rise in the manual rate.
Scenario 2: A commercial property owner made a claim after a fire incident. At policy renewal, her standard premium had significantly increased. The increase was due to the fact that the insurance company had modified the manual rates to account for increased fire risk in her area, which resulted in a higher standard premium.
Scenario 3: An operator of a commercial fleet experienced a drastic increase in his insurance premium. Upon inquiry, he found out that the standard premium was affected by a modification in the exposure unit due to the additional vehicles added to his fleet.
Limitations and Common Mistakes
- Standard premium does not reflect the final premium, as it is subject to experience rating and other modifiers.
- Overlooking the fact premiums shown in declarations might not be the final premium.
- Failing to annually review premium calculations can leave errors undetected.
- Agency personnel may lack continuing education on premium components, leading to miscommunication to clients.
How to Explain Standard Premium to Clients
Personal Lines client: Think of the standard premium as the sticker price for a new car. It’s a starting point, and discounts or add-ons change the final cost.
Small Business owner: Your standard premium is the initial number we start with when determining your insurance costs, kind of like a base salary before tax and bonuses.
CFO or Risk Manager: The standard premium for your policies acts as a foundational figure. It’s established before we factor in your individual risk characteristics, loss history, or any discounts your company might qualify for.