Insurance: More scientific risk assessment

In the current insurance market, it has become crucial to assess risk using a more scientific approach. To maximise profits, companies need to re-evaluate the existing market analysis techniques to make this scientific approach possible.

The insurance cycle peaked in 2004 and robust competition drives companies in the insurance industry to look for ways to increase revenue and manage costs. Accurate, scientific risk rating will play a vital role in achieving these objectives and ensuring sustainability. The basic principles of quantifying short-term risk have changed dramatically, as a result of developments in the market and in analysis techniques.

"What is required is a more hands-on approach in the day to day risk assessment of business. Companies need to accurately identify all possible risks and scientifically calculate premiums. This approach is particularly useful for re-rating existing business," says Sandra Page, Managing Director of BrokerNet Risk Services.

"The availability and quality of data will determine the result of any risk analysis and assessment. Gathering and processing accurate data can be time-consuming and labour-intensive," says Page. "We believe in streamlining the gathered information and process requirements to enable us to apply a scientific approach in critical decision-making processes."

A thorough analysis requires data from active and non-active policies in the portfolio, as well as the claims information relating to all these policies. From this data, numerous risk variables must be extracted - including, for example, age, area and types of losses incurred in a claim.

The risk analysis further involves grouping similar risks and identifying the variables and factors that contribute to higher risk.

Once there is a clear understanding of the risk groups involved, the premium is calculated using experience rating. This method of rating bases the premium calculation on the claims experience and exposure of the individual risk. This results in each risk paying the correct premium based on its own past claims experience, expected claims for the next insurance period and its exposure.

This will determine if the current premiums justify the risk apposed for the coming year. With this method certain high-risk groups are identified. Premiums for these groups are adjusted accordingly.

The premiums can now be adjusted for these high-risk groups and also to allow for the increasing cost of claims and administration on all the policies. Another important benefit is that companies can protect the "good" risks in the portfolio against unnecessary premium increases, and so strengthen the loyalty of these desirable risks to the company.

In some cases the new premiums may not be in line with the market standard and a management decision is made to determine what increase will apply. This decision takes into account the number of policies that will default if the increase is too high for the less risk adverse clients in the group as well as the growth of the portfolio in the coming year.

"By applying these techniques and using accurate information, companies can identify and address problem areas. The company and its clients benefit from fair differentiation between risks, without discrimination. The result is optimal profitability for the portfolio and more accurate future assessment of the business," concludes Page.