June 9, 2022
If you upgrade your Ford Focus to a Mustang before your next auto insurance renewal, would you expect to pay more? After all, you still only have one car. I don’t think anyone would be surprised to pay more in this situation. So why then do design firms and contractors get surprised by a premium increase when their annual fees/revenues remain the same, but they are performing work in different disciplines or doing different kinds of projects than last year?
The year over year exposure change is more than just a change in the rating basis. It’s the change in the firm’s entire risk profile. As a dramatic example, suppose a firm does $10 million of civil engineering work one year, but the next year that same firm does $10 million of structural engineering work. The firm will pay more in year two simply because they are engaging in a discipline with more risk.
This is the basic underlying concept of what actuaries mean by exposure-adjusted rate change. If the premium charged in the second year only reflected the move from civil work to structural work, the exposure-adjusted rate change would be zero. We fundamentally need to charge additional premium for the type of work that is more likely to give rise to more severe claims simply due to the nature of the work.
(more…)