Risk Loading (Risikozuschlag)
Risk loading is a margin added to the expected-value-based net premium, through which an insurer is compensated for the uncertainty of the loss estimate and the volatility of the risk assumed.
Concept
Risk loading is the component of the insurance premium that goes beyond the pure expected value of the insured loss (the net premium) and provides the insurer with compensation for bearing the uncertainty surrounding that expected value. It reflects, in particular, the fact that the actual loss experience of a portfolio can deviate from the statistically expected value.
Factors Influencing the Amount
The amount of the risk loading depends significantly on the dispersion and skewness of the underlying loss distribution, the size of the insured collective, and the degree of correlation between individual risks: the smaller the collective, or the more strongly the risks are correlated with one another – as with accumulation risks from natural catastrophes – the greater the relative fluctuation of the actual loss cost, and consequently the higher the appropriate risk loading.
Distinction from the Risk Margin under Solvency II
The actuarial risk loading used in premium calculation is conceptually related to the risk margin used under Solvency II and IFRS 17, which, as an additional component of technical provisions, compensates for the cost of providing risk capital to bear non-diversifiable risk; both concepts serve the purpose of appropriately pricing, or valuing, the uncertainty risk assumed.