A Primer in Claims-Made Step Factors

The following mini-lesson on claims-made step factors in context of professional liability insurance is brought to us by ETHOS Insurance Partners, Inc., in Duvall, Washington.

What Are Claims-Made Step Factors?

Claims-made step factors are the actuarially determined mechanism that increases a claims-made policy's premium to reflect the increase in exposure associated with the provision of professional services by an insured over time.

In the first year of a claims-made policy, the only professional services provided by an insured that could result in a claim are those services provided in the first year. However, the next year's claims can result not just from the professional services provided in the first year but also from professional services provided in the second year. This increase in exposure requires an increase in premium. In the following year, there are now 3 years of professional services provided by an insured that could result in a claim, and the premium must increase yet again.

All else being equal, the premium for a claims-made policy will typically increase until new exposures being added under the current policy period are balanced out with exposures dropping off from earlier policy periods that are far enough in the past that they are no longer statistically likely to result in claim activity, at which point the premium is considered "mature."

Understanding Claims-Made Step Factors

Below is a chart reflecting a common series of claims-made step factors found in healthcare professional liability policies.

Calculating the projected premium increase percentage from one year to the next is straightforward. You simply divide the step factor increase by the previous year's step factor. For example, moving from the first- to second-year claims-made step means a step factor increase of .3 (.65–.35). Dividing .3 by .35 gives you 85.71 percent. So, a first- to second-year claims-made step using the factors above will result in a premium increase of 85.71 percent, again without consideration of other risk factor changes. This works the same way with the subsequent steps as well.

You can validate this calculation by using actual premiums for any particular risk. Let's say a physician risk generates a mature premium of $10,000. The first-year premium will be $10,000 multiplied by .35, which equals $3,500. Using the same approach, the second-year premium, all else being equal, will be $10,000 multiplied by .65, which equals $6,500. The percentage increase in premium moving from the first to the second year is 85.71 percent—just as the above table states. No matter what mature premium you use, the same claims-made step factors will result in the same premium increase percentages, again all else being equal.

Keep in mind that if an insured's risk profile changes during the policy term, the renewal premium will be different than what is dictated strictly by the claims-made step factor change, which is just one of the components used to derive a final premium. This is because the applicable exposures have changed and/or something else has caused a modification to the factors (debits/credits) being applied. Of course, a rate change will have the same effect.