What is Estimated Maximum Loss? Definition & Examples.
by Adam Bishop on February 3, 2011
As part of our ongoing insurance glossary series we continue to explore the terminology and practices used in the Insurance world.
Today we will be looking at Estimated Maximum Loss as follows:
What does Estimated Maximum Loss mean ?
As its name would suggest this is an estimate only based on experience, there is no exact formula that Insurers use to arrive at this figure.
It is an estimate of the maximum probable loss that can develop from an Insured peril – generally speaking the perils involved will be those relating to material damage of a property or the consequential loss that follows.
An alternative term commonly used is Probable Maximum Loss.
What factors effect Estimated Maximum Loss ?
In considering the maximum loss that they may incur Insurers will take into account both the good features of a risk and the bad.
Good features may involve a wide range of fire protection systems, automatic sprinklers, portable extinguishers and the proximity of the property to the neares fire station.
Bad features may include combustible construction of the building (timber floors, thatched roof), storage of flammable liquids, limited fire protection systems, no local fire station, location near to a river with a known flood history.
It is the balance of these two factors that will help Insurers to determine the maximum loss that they are likely to incur.
A risk with a high Estimated Maximum
Loss will normally attract a premium loading.
Insurers surveyors may suggest a means that can be adopted by the policyholder to help reduce the risk and if these requirements are adopted a rating discount may be available.
How do Insurers use Estimated Maximum Loss to control their business ?
An Insurer would clearly not want to have too many risks where there was a 100% Estimated Maximum Loss but in some cases this is unavoidable due to the circumstances of the risk and a large number of bad features.
This does not mean to say that Insurers will not cover the risk but they may in the case of a very large risk seek to re insure some of the cover with other Insurers so that they can spread a serious loss betwen them.
Insurers can use the Estimated Maximum Loss figures that they have to determine a worst case scenario, and then set their rating accordingly for this overall class of business. This is possible as two factors are known, the premium income and the Estimated aximum that they may have to pay on claims.
Insurers will also seek to avoid a number of risks with a high Estimated Maximum Loss in the same area, this is referred to as accumulation which will be covered in a future topic.
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