Insurance Premium, Insurance Policy

The size of the claim is based in large part on the amount available for settlement, or the policy limit. For example, say you knock down your neighbor's wooden fence, at a cost of $100 to repair. You might reasonably expect your liability insurance to pay your neighbor $100 in insurance settlement. If, however, your liability policy allows for exact replacement valued at up to $1 million, you might be surprised to discover that your neighbor's fence—fashioned of unusually aged wood and adorned with certain attractive knots and artfully crackled layers of antique paint—is by far his most prized and valuable asset. Remember the woman who sued McDonalds over hot coffee? Heaven help the insurance company that goes before a jury!

In any case, so far as premium pricing is concerned, the point is that even well-established products may not have accumulated a long enough list of successfully closed files to take the guesswork out of the pricing process.

Investment income certainly has an impact on premium levels. Simply put, the more money the carrier makes by investing your premium, the more they can reduce your rate. Medical Malpractice is a good example: most cases are litigated over years, and the effects show up in the insurance premiums.

The bottom line is that, even though it is perfectly valid to draw a connection between an insurer's corporate expenses or investment returns and its product premium pricing, the impact of such connections is minor when compared with those of underwriter pricing estimates and a product's established loss history.
Losses and Premium Levels

We have seen that premium levels are pretty much a guess for new products. For older products—and most insurance products are very old—the premium level is determined by expected loss levels. As we discussed, though, the real costs of a loss remain unknown until the insurance claim is settled and the file closed, which in our highly litigious society can take many years. As a result, loss levels as well are in many cases no more than SWAGs.