What Is a Guaranteed Cost Premium?

A guaranteed cost premium is a flat fee for insurance coverage that’s not subject to adjustments based on loss experience, or the amount of loss an insured party experiences. The price is fixed and remains the same throughout the policy term, regardless of how many claims were filed and paid out within this timeframe.

Key Takeaways

  • A guaranteed cost premium is a fixed charge for an insurance policy that is not adjusted for loss experience.
  • In other words, a sudden increase in claims will not lead to a sudden spike in charges during the policy period.
  • The convenience of fixed pricing tends to come at a higher cost.
  • An alternative to guaranteed cost premiums are loss-sensitive premiums, where insurance charges fluctuate depending on losses experienced.

How a Guaranteed Cost Premium Works

The beauty of a guaranteed cost premium is you know exactly how much you’re required to spend for protection against financial loss and don’t have to worry about any sudden surprises.

An individual or business purchases an insurance plan to cover a specified peril for a specified period of time and is charged a flat rate for the duration of the policy. When pricing its policy, the insurance company takes into account the type of peril, the potential severity and frequency of claims, and the riskiness of the insured. There’s no going back on this: as soon as the premium has been determined, published, and agreed on with the policyholder, it can no longer be adjusted or modified.

Important

The only way the premium can feasibly be adjusted is when an audit reveals that the exposure base has changed.

The predictable nature of guaranteed cost premiums make them particularly popular among small and mid-sized businesses. These premiums are not dependent on claims made against the policy, meaning that a sudden surge in requests for compensation will not lead to the insured facing rate increases during the policy period.

Fixed pricing is convenient, and small businesses benefit from this convenience while minimizing their risk. In a guaranteed-cost program, all liabilities and administration costs are transferred to the carrier, with the insured paying an up-front premium to cover these expenses.

Guaranteed Cost Premiums vs. Loss-Sensitive Premiums

When a business grows, it may want to explore other options for financing and managing risk and secure greater flexibility. Loss-sensitive premiums, which, unlike guaranteed cost premiums, are subject to change based on the loss experience of the individual business, might tick this box.

This approach typically carries a lower up-front fee, but also higher deductibles—out-of-pocket costs that must be paid before insurance coverage kicks in—and variable rates. If a company determines that it’s less likely to see high frequency or high severity claims, it will be able to realize greater cost savings than if it had accepted a guaranteed cost premium. Larger businesses often prefer to take this path, and are also able to absorb higher deductibles better than smaller ones.

Guaranteed cost premiums usually cost more than loss-sensitive premiums. Lower deductibles increase the portion of liabilities covered solely by the insurer, so companies that issue guaranteed cost premiums must err on the side of caution and price them accordingly.

With loss-sensitive premiums, on the other hand, you generally pay for what you get, with the total cost depending substantially upon each policyholder's losses in the given time period. The insured is responsible for costs incurred up to a retention amount, and the carrier then foots the bill for any excess charges.