Understanding your commercial insurance premium
When you pay for commercial insurance, the biggest (and often only) line item on your invoice is the premium. But what is an insurance premium, and how is it calculated? Briefly, it’s how much your insurance costs – but to be more precise, insurance premium is the money you pay in exchange for an amount of coverage, for a certain risk, over a period of time. There is a lot to unpack from that description, so let’s get into it!
Amount of coverage
Your insurance premium is calculated in part based on how much insurance you’re buying. For example, it makes sense that your commercial insurance premium cost is higher for $1,000,000 in Replacement Cost coverage for a building than for $10,000 to replace a single piece of equipment, but how is that amount determined? Most often, the insurance underwriters who decide on the premium will apply a rate to the limit of coverage they’re offering. As we will see below, insurance premiums are also determined by the type of risk they’re taking on. So once the underwriters have an idea of the scope of their risk, they can scale that up based on the amount of money at stake.
Risk assessment
No matter what you’re insuring, when it comes down to it, the underwriters promise to pay an amount of money if the policy conditions are triggered. For them, insurance premium is a calculation of how much money they need to collect in order to pay those claims, pay their operating expenses, and make a profit. But underwriters also know that they’re working with much larger numbers than just your commercial insurance premium. That’s why they rely on enormous amounts of historical and actuarial data to develop their rates. Based on thousands upon thousands of insurance policies over the years, they know roughly how much money they will pay per $100 of insurance that they offer for certain risk categories.
Underwriters take into account all sorts of things. Here are some examples of how they determine insurance premiums for property insurance:
The materials and construction of buildings: A wood frame is more flammable than a fire-resistive apartment building, but it could also withstand an earthquake better.
Occupancy of buildings: It’s a lot cheaper to insure a warehouse than an airplane manufacturer; 30-story residential buildings have a lot of water damage claims and water runs downhill; etc.
Protection of buildings: Does the building have a 24-hour monitored fire and burglar alarm? Does the jewelry shop have bars on its windows?
Exposure of buildings: Is it on a flood plain? Is that airplane factory next door?
And here are just a few examples of how they determine insurance premium for Third-Party Liability insurance risks:
Sales revenue: A business that makes $1 million selling widgets is selling a lot more widgets than one making only $100,000 – and each widget is a possible claim!
Payroll: A company with 1000 employees is going to cost more to insure than a mom-and-pop shop with just a few staff members.
Operations: What your business sells or the services it provides will impact how much you pay for insurance, depending on the risk you’re exposed to.
Once your risk is categorized, the underwriter can apply a rate to the amount of insurance you’re buying, and that is how most commercial insurance premium costs are generated.
When you’re covered: Your policy term
The other thing to consider when you pay your insurance premium is that you aren’t just buying an amount of coverage, you’re buying it for a specific timeframe. The amount of time that an underwriter is eligible to pay a claim is called the time on risk, and unless you cancel partway through the contract, it is also the policy term. Most insurance policies have a term of one calendar year, but many types of insurance are issued on a shorter or longer term depending on the needs of the buyer:
- Construction insurance premium is calculated on a monthly rate rather than an annual rate, since not very many projects start and finish exactly on a 12-month timeline.
- Special event policies for things like festivals, fundraisers and sporting events are priced for as little as a single day of coverage!
The longer the period of coverage, the more risk an underwriter accepts that they may need to pay out. That’s why insurance policies are limited to certain timeframes, and when they expire, you need to pay a new insurance premium to buy another policy.
Other things to know when it comes to your commercial insurance premium
Insurance policies can have different types of premiums, and costs that aren’t premiums – and premium isn’t the only thing to think about when choosing an insurance product.
Some policies include a minimum and retained insurance premium, which means that even if you cancel partway through the insurance contract, the minimum and retained amount is non-refundable.
In some circumstances, underwriters and brokers can both include policy fees, which are meant to offset the operational costs of providing services to their clients. These aren’t insurance premiums, because they aren’t related to the risk of paying a claim.
And last but certainly not least: the lowest premium isn’t always the best choice! If you have a few options for the insurance product you’re buying, it’s worth considering why one might cost more than another. Not all policies are created equal, and a good broker will use their experience and expertise to help you understand what the right premium is for you.
Despite the special name, commercial insurance premium isn’t unlike most other prices you pay for products – it represents the cost of doing business plus a margin for the seller. In the simplest terms, insurance premium is the cost you pay for the amount of insurance you need.
Your broker is the best person to talk to about your insurance premium. They can help you understand where it comes from, why it changes from time to time, and whether the premium offered by an underwriter is good value. If you’d like to get a better understanding of commercial insurance premium costs, get in touch with Westland!