Understanding Insurance Series: Risk-based Pricing and Premiums

What is risk-based pricing?

When you take out an insurance policy with us, we will consider the risk of accident or loss so we can more accurately price for the risk. This process is known as risk-based pricing, which affects your premiums.

Risk-based pricing is a way of calculating the cost to insure against accidents, loss, and events if they were to occur. The cost of your premium is higher if the risk of accident or damage is higher.

What is risk?

Risk refers to anything that may cause accidental loss or damage, or increase the extent of damage suffered.

For example, theft rates for cars are often higher in cities and towns. This means there is more risk for a car as it could be more likely to be stolen.

Similarly, the different environmental risks across the country are reflected in the price you pay for your home cover. Some parts of the country are riskier to live in, and therefore cost more to insure, than others. Natural perils pose a great risk to homeowners in New Zealand. If you were living in Wellington, for example, earthquakes are identified as a high risk of occurring.

What are premiums?

A premium is the amount you pay for your insurance.

Premiums are usually paid either fortnightly, monthly or annually, depending on your insurer.

How are premiums formulated?

Premiums are calculated based on the potential risk, and a number of characteristics relevant to the item being insured.

Some characteristics we consider include:

• Location – where is your car, home, contents or business located?
• Age – for car insurance, drivers under 25 pay higher premiums because they are not considered to have as much driving experience
• Car make and model – some cars are higher value and pricier to repair
• Market factors – the rising costs of building materials or car parts
• Sum insured – the higher your sum insured amount, the higher your premiums may be

From year to year, your premium is likely to change due to changing market conditions as well as your personal circumstances. For example, your sum insured amount may be re-evaluated or you may move to a new address.

Reinsurance

Reinsurance is insurance for insurers. Because our country is exposed to risks that can be catastrophic, such as earthquakes or cyclones, we purchase reinsurance to ensure we can financially cover all our customers’ claims if a catastrophic event were to occur.

Without capital and a good amount of reinsurance cover, we wouldn’t be able to pay out for claims when a major event hits.

We pay premiums on our reinsurance and the cost of those premiums is going up due to global events and the increase in wild weather disasters. In turn, the premium that you pay on your house, car or belongings will also go up.

The nitty gritty

Government levies, such as the Natural Hazards Commission Toka Tū Ake and FENZ (Fire and Emergency New Zealand) levies, and GST, also contribute to the cost of your premiums.

The opposite of risk-based pricing is community pricing, where every customer pays the same amount regardless of whether they face more or less risk than others. NHCover is the specific cover provided by the Natural Hazards Commission Toka Tū Ake, and is priced on a community-based pricing model - every home owner pays the same rate for the NHCover, regardless of where in New Zealand they live.