Most insurance premiums are fixed for the duration of a policy, which is usually a single year. Risk details are provided to insurers before inception of the contract, and these normally include financial estimates.

Insurers use this risk information to determine the terms to apply, and the premium they need to charge. Once the policy has started, the premium applicable doesn’t normally change unless material facts of the risk insured change during the year. The premium charged is usually all that the insured needs to pay, and the balance owed to insurers at the policy end is therefore zero.

Yet that’s not always the case, which is where adjustable premiums come in. But what exactly are adjustable premiums? And do they impact how much you pay? In this guide, we’ll answer questions like this, and provide advice on dealing with such policies.

What are adjustable premiums?

Sometimes, insurance policies are provided on an adjustable basis which means the premiums charged at the outset are not full and final. Instead, the premium set out at the quotation stage is based on an estimate of the key financials used to calculate the premium. Examples of this include:

• Estimate of wages for Employers’ Liability insurance
• Forecasted annual sendings for a Marine Transit cover
• Anticipated attendee numbers for an Event Liability policy
• Expected annual production costs under a Producers’ Indemnity policy

At the end of the policy year, the insured company is obliged to provide insurers with a declaration as to the actual financials. Insurers then use that to calculate a final “adjustment” premium, which can result in a returned or additional premium being due.

The declaration

How often a declaration is needed depends on how the policy is set up. Some policies (such as motor fleet insurance) may be subject to quarterly declarations, whereas others (like film production insurance) may only require one policy declaration at the end of its term.

Similarly, the information required in a declaration itself varies massively depending on the type of insurance and the business concerned. For example:

Event insurance – The policy may be based upon an estimated number of events or attendee numbers, and also might attract different rates for domestic and overseas events. The declaration would include the actual events undertaken, where they took place, and how many people bought tickets. This type of declaration is usually provided annually at the end of the policy.

Fleet insurance – The policy premium is calculated using various factors, including the number and type of vehicles on cover at inception. A declaration would then be done quarterly to advise on the actual number of vehicles on cover, and a premium will be changed/refunded accordingly. Mid-term changes, such as the addition of younger drivers, would normally result in changes to terms outside the usual declarations.

Liability insurance – The premium here may be based on an estimated turnover, employee numbers, or wages for the forthcoming year. Just before policy renewal, a declaration would be requested by insurers to advise what the actual figures achieved were, and the premium will be adjusted accordingly.

Minimum and deposit premiums

Whilst in theory an adjustable premium can result in a return premium, that is actually relatively rare, with most adjustments being for additional premiums. Why? Because of minimum and deposit premiums.

Minimum and deposit premiums are used by insurers to guarantee a certain level of premium for a policy, and set the absolute minimum that needs to be paid. So when the estimates are provided at the quoting or renewal stage, they’re used to charge a minimum acceptable level of premium for the risk.

This premium is the minimum insurers will accept for the risk, and also what the insured will book as the annual premium. This can feel a little unfair, because if the insured has a bad year and suffers a dip in revenue, they wouldn’t get any of the premium paid back. Additionally, minimum and deposit premiums are usually non-refundable if the policy gets cancelled mid-term.

How to deal with year-end adjustments

Our two pieces of advice when dealing with policies on an adjustable basis are:

1. Be conservative with your estimates, whilst ensuring they remain reasonable. Give the financials you would to your board, not the ones you use on a pitch deck. This way, you won’t end up overpaying premium in a bad year due to the application of a minimum and deposit premium.
2. Budget for the year-end adjustment. Either allocate an additional amount in the insurance budget for year end, or keep track of how the relevant financials have increased to calculate an anticipated year-end premium.

What’s the purpose of adjustable premiums?

You may be wondering why insurers set a policy on an adjustable basis – surely it just opens the door to potential premium disputes and unnecessarily over complicates the insurance? This is a fair point.

However, adjustable premiums can play an important role where accurate estimates are difficult to provide, such as for production companies reliant on an unsteady flow of commissions, or start-up businesses that aren’t sure how quickly their products will gain traction.

When done correctly, benefits to the policyholder include: paying less initial premium, protecting cash flow, and having a premium charged tied directly to performance. It can also take the stress away from having to “predict the future” at the quoting stage, and reduce the administration burden, with less need to advise insurers of financial changes.

Drawbacks, though, include having a large, unexpected bill at the end of the policy. It can also make it more difficult to move insurers at renewal, as there can be a tendency to “waive” or reduce an adjustment premium providing the policy is renewed with the same carrier. This leaves the insured company back on an adjustable policy, and likely to be stuck in the same situation at the end of the following year.

Guidance from RiskBox

Our advice is to be aware if your premium is on an adjustable basis, and if it is, budget correctly for year end. One of the best ways to do that is to work closely with your insurance broker through the policy year to monitor growth, and how this could impact your final premium.

If you’d like support from RiskBox, or you have a question about something mentioned in this guide, get in touch with our team today. You can call us on 0161 533 0411 or fill in our contact form and we’ll get back to you.

Photo by Szabo Viktor on Unsplash