In the current insurance industry scenario, where all insurers are under pressure to improve their underwriting results, fundamental principles like risk differentiation becomes an important tool to decide on the appropriate premium to be charged for a risk. This is more so, as most markets are now deregulated, giving insurers the freedom to explore product differentiation with the aim of creating a sound rating system that is socially and economically beneficial to all stakeholders.
Technical pricing ensures that a risk is adequately priced, based on the circumstances of the risk, underwriting information presented, scope of cover provided and assessment of the exposures. Each component that has an effect on the risk covered will have an impact on the price. If the underwriter’s knowledge of these components is limited, adequate technical price of the risk cannot be realised. The final rate calculated is still an estimate and is usually a benchmark for a negotiated deal.
In order to salvage the situation, restore sanity and protect the industry, markets have come up with price regulatory mechanisms. Underwriters hitherto used rating manuals alone to assess risks and charged the basic rates per occupancy, without adequately factoring in the additional scope of covers requested or inherent exposures such as high flood or earthquake risks. Consequently, insurers were putting substantial portions of their capacities at risk for free, as certain exposures were not charged. This means that the insurer is not building sufficient reserves for future expected losses. In case of claims resulting from these unpriced exposures, insurers will continue to bear the liability thus depleting their reserves owing to inadequate pricing of risks.