DEFINITION of ‘Basic Premium Factor’
The acquisition expenses, underwriting expenses and profit, as well as the loss conversion factor adjusted for the insurance charge for a policy. The basic premium factor is used in the calculation of retrospective premiums. It does not take into account taxes or claims adjustment expenses, which are instead covered in the other components of the retrospective premium calculation.
INVESTOPEDIA EXPLAINS’Basic Premium Factor’
The basic premium factor is determined after an insurer sets the standard premium. A policy’s retrospective premium is calculated as (basic premium + converted losses) x tax multiplier. The basic premium is calculated by multiplying the basic premium factor by the standard premium. The converted loss is calculated by multiplying the loss conversion factor by the losses incurred. The basic premium is less than the standard premium because of the basic premium factor.
The insurance charge adjustment allows the calculation to keep the retrospective premium between the minimum and maximum premiums, but does not take into account the severity of claims or the loss limit. The loss experience of an insurer depends on the frequency of claims and the severity of those claims. High frequency, low severity claims give the insurer a less volatile loss experience than low frequency, high severity claims. This is because an insurer is better able to predict through actuarial analysis what the losses from an insured will be if claims are frequently made. Insureds that bring high severity claims are likely to have higher premiums using retrospective premium calculations because they are more likely to hit the maximum premium.
Insurance companies typically use a schedule of estimated standard premiums when determining whether to recalculate the basic premium factor. If the standard premium is outside of the ranges provided in the table – typically a percentage above the estimated standard premium – then the basic premium factor is recalculated.