DEFINITION of ‘Loss Constant’
An amount added to an insurance policy with a low premium designed to cover higher-than-expected loss experiences. The loss constant helps protect insurers from losses associated with small risks, and is most commonly used in workers’ compensation policies.
BREAKING DOWN ‘Loss Constant’
Insurance companies determine the premium to charge for a new policy by examining the risk associated with covering a specific peril. The historical severity and frequency of losses associated with the risk are built into the models that insurers use to calculate premiums.
Workers’ compensation policies are very different than other policies that an insurer may underwrite. This is because the perils that the insurer is underwriting coverage for are based off of the safety procedures and records of the company purchasing the policy. Large companies that have had workers’ compensation policies before are less likely to present as much of a risk as small companies, mostly because larger companies are more likely to have better safety procedures.
Underwriting policies for small businesses brings in lower premiums because fewer employees are being covered. At the same time, smaller companies may wind up with claims that lead to substantial losses by the insurer. Because of this, the insurer will include a separate charge with the policy premium. For example, insurers will add a loss constant if the premium subject to loss constant is less than $500, dependent on whether the state insurance regulator permits a loss constant being charged. The amount of loss constant charged is limited to what brings the total premium to the $500 limit.
In workers’ compensation policies, the standard policy provided to employers is modified depending on the amount of premium charged. Several modifications may be added, including an expense constant, which covers the insurer’s cost of issuing and servicing the policy, and the loss constant, which protects the insurer from losses that are higher than average.