PREMIUM BASIS (A.K.A. 'EXPOSURE BASIS')

Premium Basis – An Assessment System for Insurance Policies

In plain language: Premium basis, which is also known as exposure basis, is the method employed by insurers to decide how much they will charge clients for their insurance policies. 

Technical definition: Premium basis or exposure basis is the foundational measurement used by an insurance company to determine rates in an insurance policy. This term is frequently encountered in declarations, endorsements, and exclusions. It typically applies across a myriad of policy forms and lines of business. The determination of premium basis or exposure basis often varies according to state regulations and specific carrier policies. 

Did you know that incorrect usage or misunderstanding of premium basis could lead to an exponential increase in your client's premium and a corresponding increase in your agency's E&O exposure? 

TL;DR

Premium basis, or exposure basis, is a criterion for setting insurance premium 

Recognizing its importance is vital in day-to-day agency work 

Often, it gets misunderstood or misapplied, leading to increased costs and risks 

An effective practice is to review and verify exposure basis data regularly 

What Is Premium Basis in Insurance?

A policy's premium bears relevance to an agency's work as it determines how much a client pays for insurance coverage. The way that premium basis or exposure basis works is that the insurer takes an underlying exposure unit - such as square footage of a property, payroll, or sales for general liability - and applies a rate. The rate is determined through evaluating multiple factors such as risk characteristics, claim frequency, accident severity, and loss experience. 

The exposure base units can differ significantly based upon the type of policy. For instance, the payroll figure is used for workers compensation and workmen's compensation while sales may be used for general liability and public liability insurance. 

Key Related Terms to Know

Exposure Unit: A quantifiable basis for setting the insurance premium. Examples include total square footage or payroll per $1,000. 

Experience Rating: A method of setting premiums based on the claim history of the insured. 

Claims-Made Policies: These are policies that cover claims made during the policy period. 

Premium Collections: The total amounts of premium collected by an insurance company. 

Aggregate Limits: The maximum amount an insurer will pay for all claims during the policy term. 

Common Questions About Premium Basis

What is the difference between exposure basis and exposure base? 

Exposure basis refers to the standards used for evaluating an insurance risk and setting premium. On the other hand, exposure base refers to the specific units of measurement, such as square feet, man-hours, or number of admissions, used for premium calculation. 

What's the difference between premium basis and written exposure? 

While premium basis refers to the criterion used for determining insurance premiums, written exposure refers to the unit of exposure covered by an insurance policy at a given time. 

What factors influence the premium basis? 

Several factors, such as the risk size, the amount of coverage, the value of product, the claim severity, and expected losses, affect the determination of premium basis. 

How is premium basis related to claim frequency and severity? 

Higher claim frequency and severity increase the chances of loss for the insurer, and this is taken into account in the premium basis. 

Premium Basis vs. Experience Rating

Distinguishing between premium basis and experience rating is critical, as both influence the cost of an insurance policy yet function differently.  

Real Claim Examples Involving Premium Basis

Scenario 1: A company insuring their building failed to include recent expansions in their property's square footage during a policy renewal. The insurer based premiums on outdated exposure basis, resulting in underinsurance. When a fire later devastated the building, the recovery amount fell substantially short of the actual losses. 

Scenario 2: A restaurant extended their hours of operation without updating their policy, which was underwritten based on their operating hours. When a liability claim occurred during the extended hours, the insurer denied the claim due to temporal mismatch between the actual operations and the documented exposure. 

Scenario 3: A construction company's insurance policy had premiums calculated based on the workforce strength reflected in their payroll exposure. Due to some payroll errors, the company accidentally paid higher premiums for non-existent employees. It was only revealed during an audit which led to an adjustment in premiums.

Limitations and Common Mistakes

Misjudgment of exposure units may lead to premium errors 

Not updating changes affecting exposure and premium basis to the insurer leads to policy incongruities 

Overstated premium basis could result in higher premiums, while understated basis may lead to inadequate coverage 

Incorrect classification codes can distort the premium basis calculation 

Failing to understand the differences in premium basis calculation based on policy types like automobile liability and general liability 

How to Explain Premium Basis to Clients

Personal Lines client Premium basis is how your insurance cost is calculated. It's like the ingredients in a recipe - the type and quantity of each ingredient (exposure) affect the final dish (your premium). 

Small Business owner Your business insurance premium is based on your exposure basis. If your sales or payroll – the factors we use to decide your insurance cost – change, please let us know so we can adjust your premium accurately. 

CFO or Risk Manager Premium basis, or exposure basis, forms the essence of your policy's rating. It measures your company’s exposure to potential losses. Regular review and adjustment ensure alignment with your operational realities, ensuring optimal insurance expense and adequate coverage.