How do insurance companies calculate exposure?
Different insurance companies will have their own ways of calculating risk exposures and it will vary for different types of insurance. Most of this actuarial information is complex, proprietary, and not generally available to the public. The actuaries at large insurers use complicated risk models and many factors to determine exposure. With that said, I can still give you a general run-down of their techniques and the kinds of factors they consider when calculating exposure.
First, let's go over what we mean when we say "exposure." Exposure is used by insurance companies to calculate our premiums and, simply put, it measures our level of risk. Throughout our lives, we are all under some amount of risk, whether we're driving a car or simply walking from the living room to the kitchen to get a glass of water. However, some actions entail more risk than others. If you drive a car more often, you face more exposure to car accidents or automobile-related death or injury. You will, therefore, have to pay a higher premium if you are a frequent driver, commensurate with your higher loss exposure.
Risk is calculated by multiplying the impact or "value" of a loss with its frequency or probability of occurring. An occurrence with a high impact but low frequency may have the same level of "risk" as a low impact occurrence that happens more often. This is a very simplistic way of looking at it but it forms the theoretical foundation of risk assessment in insurance.
In practice, an underwriter, with the help of a sophisticated algorithm, will look at certain things like the detachment of a building or its occupancy to gauge the level of risk or exposure that building is likely to experience. From this, they derive the premium you end up paying (to learn more about exposure and your insurability, see How an Insurance Company Decides to Insure You).
Written by Jacques Wong
Jacques grew up around the insurance industry and began actively participating in 2013. Since then, he has gotten a Level 2 license, won Insurance Council of BC awards in 2015 and 2020 for academic excellence in the insurance licensing courses. He educates insurance professionals through PNC Learning and as a Thought Leader at ReFrame Insurance.
In his day job as an insurance broker, he helps businesses with creative risk management solutions and strategic advice when it comes to insurance.
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