1. Presented By Ian Jones Divisional Manager Aon Risk Services Australia Limited “An Understanding of How Premiums are Calculated and Alternatives” Australasian Universities Risk & Insurance Management Society Conference 2005

2. How Premiums are Calculated Property and Business Interruption General Liability Motor Vehicle

3. The role of insurance in society is to increase financial certainty in the case of catastrophic loss

4. Market Conditions 12 Profits maximised. Prices stable. Everyone happy.. 1 Reinsurance availability increases. Prices start to drop. 2 Companies preserve market share. New marketing initiatives. Prices drop further. 3 Underwriting disciplines slacken. Profits reduce significantly. Prices continue to suffer. 4 Cover widens at reduced prices. Cheap reinsurance. Underwriting losses - profits from investment income. 5 Losses exceed income. Companies chase premium to outrun losses. 6 Reinsurers results suffer. Pricing bottoms out. 7 Insurers reunderwrite. Producers in turmoil. 8 Capacity crisis. Reinsurance shrinks. Prices start to rise. 9 ROE still unacceptable. Prices increase sharply. 10 Surplus lines flourish as capacity shrinks. Captives return to popularity. 11 Insurers return to profit. Prices start to peak.

5. The 21 st Century World Trade Centre Ray Williams - HIH Hurricanes Concorde

6. Market Cycle YearsTime 199519991 O’clock to 5 O’clock 200020046 O’clock to 12 O’clock 2005?1 O’clock to ?

7. Property and Business Interruption Portfolio premium Actuarial advice on –Expected claim levels –Administrative expenses –Desired level of reserves –Profit margin Technical rating –Risk types –Location –Construction –Protection

8. Property and Business Interruption Risk TypeRate (Example Only) Large Abattoir (Highly Protected)$0.45% Extruded Plastics Factory$0.25% Manufacturing$0.15% Educational Institutions$0.10% Hospitals$0.08% Office Buildings (CBD)$0.05%

9. Property and Business Interruption Loadings –Inferior construction –Cyclone / earthquake zones –Lack of physical protection –Claims history Discounts –High asset values –Strong risk management protocols –Sprinklers, hoses, etc –Attractive risks

10. Property and Business Interruption Rate applied to declared Property and Business Interruption values. Example 0.10% x $125,000,000 = $125,000 (plus GST / FSL / Stamp Duty as applicable)

11. General Liability Public and Products Liability Long Tail Liability Concepts Rating Factors Impact of Tort Law Reform

12. Concept of the Long Tail of Liability Claims Public Liability is considered a form of long-tail insurance.

13. Concept of the Long Tail of Liability Claims Whilst Public & Products Liability claims are not all that frequent, when they do happen the cost is substantial when compared to consumer claims such as private motor vehicle. Source: Suncorp

14. What makes up a Liability Premium?

15. Breakdown on Premium Components

16. What makes up a Liability Premium? How are Public & Products Liability Insurance Premiums calculated? The key influences to calculating Public & Products Liability insurance premiums are as follows: –The type of organisation / industry and its activities –Current or proposed Risk Management practices –The amount of Turnover –The number of employees / volunteers –Past Claims history

17. Impact of Tort Law Reforms Tort Reforms are focused on three main objectives To clarify and define the rules of negligence, looking at such issues such as obvious risk, recreational activities and volunteers; To reduce the number and cost of small low value claims through early notification and reduce legal costs for small claims with caps; To maintain damages for economic loss as well as full compensation for large claims.

18. Impact of Tort Law Reforms Reforms were aimed at reducing the frequency of small claims……… Source: ICA

19. Impact of Tort Law Reforms What about those that are catastrophically injured?

20. Motor Vehicle Types of Premium Rating methods Unit Cost basis – Motor fleets “Burning Cost” basis

21. Motor Vehicle Unit Cost Basis –Type of vehicle –Modifications –Principal drivers –Area garaged –Previous convictions –Claims history

22. Motor Vehicle Unit Cost Basis –Base rate per vehicle, say $400 per unit –Number of vehicles in fleet, say 150 vehicles –Annual premium calculation $400 x 150 = $60,000 (Plus GST and Stamp Duty as applicable) –Claims experience discount

23. Motor Vehicle Burning Cost basis –Annual Premium Calculation, say $60,000 –Minimum & Deposit Premium, 75% = $45,000 –Adjustable on claims paid and incurred –Claims, say $40,000 –Adjustment factor 100/70 –$40,000 x 100/70 = $57,143 –Less Deposit of $45,000 = $12,143 –Maximum Premium – 125%

24. Methods for Reducing Premiums Retain more risk –Higher deductibles / excesses –First loss sums insured Reduce coverage –Fire & perils instead of physical loss –Motor vehicle third party only instead of comprehensive Retain certain classes of insurance –Machinery breakdown –Fidelity Guarantee

25. Risk Financing Options Traditional expense management Corporate internal fund Discretionary mutual fund Captive insurance company / protected cell captive

26. Insurance Decision Framework RESIDUALRISK Loss Value ($) SHOULDTRANSFER CANTRANSFER MUSTRETAIN Probability of loss Markets won’t Insure or will charge excessive premium Earnings & Equity Capital cannot stand losses in this range Earnings & working capital can sustain losses in this range Equity holders may be willing to chance a loss in this range Insurable Risk Tolerance Level Insurable Risk Confidence Level Risk Retention StrategyRisk Transfer Strategy

27. Allocation of Premiums and Other Costs Costs –Premiums –Administration –Fees –Deductibles / Excesses –Legal –Uninsured / Self-Insured Risks

28. Allocation of Premiums and Other Costs Provide incentives for loss control Distribute risk financing costs equitably throughout the organisation Reflect loss experience Stability Maintain data and documentation

29. Questions