DEFINITION of 'Guaranteed Cost Premium'

Premiums charged for an insurance policy that are not adjusted for loss experience. Guaranteed cost premium represents a flat fee that the insured pays for coverage over a policy period.

Most policyholders are familiar with the guaranteed cost approach to determining the premiums that they pay for insurance. An individual or business purchases a policy to cover a specified peril for a specified period of time, and is charged a flat rate for the duration of the policy. While the insurance company does take into account the type of peril, the potential severity and frequency of claims, and the riskiness of the insured, the premium is not adjusted once it has been published.

BREAKING DOWN 'Guaranteed Cost Premium'

Most small and mid-sized businesses are comfortable with guaranteed cost premiums because they are predictable, and don’t adjust over the course of the policy period. These premiums are not dependent on claims made against the policy, which means that a sudden increase in claims will not lead to the insured seeing rate increases during the policy period.

Larger businesses may choose a loss sensitive approach to premium calculations, which take into account the loss experience of the individual business. This approach typically carries a lower up-front cost, but also higher deductibles and variable rates. If a company determines that it is 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 are also able to absorb higher deductibles better than smaller businesses.

Guaranteed cost premiums are likely to cost more than loss sensitive premiums, but because of their relatively lower deductible, the insured will shoulder a lower portion of losses stemming from claims. Insurers, however, may find guaranteed cost premiums less attractive because they have lower deductibles, which increases the portion of liabilities covered solely by the insurer.

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