The rate fixation in fire insurance is not as scientific as in life insurance. The physical hazard can be estimated satisfactorily but the moral hazard, being varied and unknown, cannot be ascertained so correctly. While calculating the premium, various relevant factors of both the hazards are properly estimated and evaluated.
The premium must be adequate enough to provide for full payment of claims including catastrophic losses, expenses of management and a margin of profit. The tariff offices follow the collective system of tariff rating.
After nationalisation of general insurance businesses, the tariff rating is applied. The basic principles of premium rating are physical hazard, classification of risk, past loss experience, discrimination differentiates, industrial and non industrial risks.
The actual process of rating consists of three steps: 1. Classification, 2. Discrimination and 3. Fixing rates or schedule rating.
Properties to be insured are of various nature and risk. Since the premium is fixed in relation to the class of risk, the properties are classified accordingly. Properties are generally divided into three main classes, viz., (i) common or ordinary, (ii) hazardous and (iii) doubly hazardous.
Different premium rates are fixed for each class. These classifications do not hold good for a long time because of varied nature of risk. Now the risks are classified into various classes according to factors affecting fire risk.
(i) Construction or Structure:
The construction of the building has always been of great importance in rating. Building made of brick will be sounder than the building made of wood. Today, the construction of building is divided into two types of structure. First fire-proof building and second, building without fireproof.
The height of the building, the area, the number of unprotected floor openings, construction of walls, floors, roof, etc., is considered in calculating the fire hazard.
The risk considerably varies according to the nature of occupancy, i.e., the use to which the building is devoted. One building may be used as a dry goods store or hardware store, or furniture-store or for residential purposes.
The building may have different risks because of the different substances and processes which they contain and the different uses to which they are put. There is inherent connection between the building and its contents. It is essential for companies to change their rates to meet changing business conditions.
Rate making in fire insurance does not present constant factors. Justice demands that the insurer should recognise the important changes. A building occupied as a residence or an office is a better risk than a retail shop.
A storeroom used for the storage of highly combustible goods is more hazardous from a fire insurance viewpoint than a grocery shop. The process of manufacture, the nature of raw materials used, the type of machinery are important factors to influence the physical hazard,
(iii) Nature of Flooring:
The nature of flooring influences the risk to a greater extent. Existence of wooden floors in the building introduces an additional physical hazard. Wooden floor becomes a fuel in the event of fire. It may collapse easily causing damage to property.
The risks inspection in based upon general features, lighting, heating and power; process of manufacture, exposures appliances, management and supervision and so on. A risk inspection report must satisfy three essential requirements of clarity, conciseness and completeness. The report must be free from ambiguities.
The height adds difficulty in fighting a fire on the upper floors. There may be risk of water damage to property on the lower floors when water is used to extinguish a fire on the upper floors. The floors involve heavy risk of collapse of the upper floors.
(v) Floor and wall opening:
Openings in the floor for lifts and belts constitute higher physical hazard. It may cause greater chances of ignition of fire and difficulty of extinguishing the fire.
The chances of risk may differ from property to property according to the degree of exposure. A building or property may be situated in a congested conflagration locality involving greater danger to the property. Exposure stands second as a cause of fire and is more than the occupancy hazard.
(vii) Lighting, Heating and Power:
The fire may occur due to short-circuit. Combustion can also arise from faulty installation and dampness. The lighting system e.g. by gas or oil, leakage of fuel and naked flames cause more hazard to property.
(viii) Place or Situation:
The location of the property, nature of adjoining premises, the distance from a fire brigade station or the source of water supply, the degree of congestion in the area are some of the important factors to influence the degree of risk.
The availability of protection against fire influences the degree of risk. The protection facilities may be public or private. When protection facilities are available the fire may be extinguished in its incipiency.
The fire extinguishing apparatus, water supply, police system, etc. can reduce the degree of risk. Smaller premium is charged where modern devices for preventing and extinguishing fires are present. It would be injustice to charge the same rate for all types of risk.
The time of loss must be kept into consideration. The annual loss ratio is by no means uniform every year. So, the rate fixation must account for good or bad years to determine approximately the real loss. Therefore, a long period of time is taken into consideration while calculating the premium.
The differentiation of the rates for individual risks in a particular class is known as discrimination. Each additional feature of risk is charged extra premium. The better types of risks are encouraged and attracted by the insurer. Lesser premium is charged where fire extinguishing appliances or fire-resisting construction are present.
The tariff system is based on the law of average and graded schedule is formulated where different rates are ascertained for the different types of risks. Thus, the different risks are put in a specified class, and are differentiated from each other according to the merits and demerits of the individual risk.
It aims at a more equitable basis of rating. For example, dwelling house is a class and, therefore, all the dwelling houses are put in the same class. Since the dwelling houses are of different type, the class may be sub divided into several classes according to the degree of hazard.
An appropriate discount could be given for those houses which have fire extinguishing appliances, nearness to fire brigade station and absence of exposure in the vicinity. There are Non- manufacturing risks. Industrial/Manufacturing risks, Utilities located outside the industrial, manufacturing risks, storage risks and Tank farms risks
3. Schedule Rating:
It is a plan by which hazards with respect to any particular risk are measured. It is defined as,” an empirical standard for the measurement of relative quantity of fire hazard.
Schedule rating takes into consideration the various items influencing the peril of fire. It is based on the theory that the aggregate fire hazard of any risk is capable of ultimate analysis into its component factors to each of which could be assigned an appropriate charge.
A standard or average premium is determined as a base for calculating the premium. The average premium rate for a class of risk is determined taking into account the total loss and the sums assured during a period of year. The period should be such that the experience of good as well as bad years may be taken into account.
A large number of items, as far as possible, are taken so that the law of average may apply. Larger the number, the more representative will be the rate of premium.
Where L represents the losses and V represents the values of insured amount. The rate arrived at will be net premium which is just sufficient to meet all the losses in that particular risk.
This basic or net premium is loaded with expenses of management, commission, rents and a margin for profit to arrive at the gross premium or office premium. .
The rate so calculated is called ‘normal rate’ or average rate for the particular group. In each group, risks may differ from one another and in order to maintain equity between different types of risk and between the insurer and the insured, it is necessary to apply the principle of discrimination, i.e., differentiation, of individual risks in a group taking into account their particular features.
Extra rates are provided for bad features, i.e., for inferior construction, timber flooring, height, situation in a congested area and discounts are granted for good features, i.e., for fire extinguishing appliances, automatic sprinklers etc. The rebate will be allowed taking into account the efficacy of the means adopted.
The schedule contains name and address of the proposer, brief description of the property insured, sum insured, period of insurance, perils covered, rates of premium and the serial number of the cover note.