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 ?
- What factors effect Estimated Maximum Loss ?
- How do Insurers use Estimated Maximum Loss to control their business ?
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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{ 22 comments… read them below or add one }
what about the disadvantages of using EML for writing business
Hi Francis,
I cannot really think of any disadvantages – EML is just a business tool that is used to determine a maximum possible risk – the more factors like this that can be calculated the better as they give the insurer a better understanding of their exposures.
Colin
advantages of eml
Hi Benson,
EML allows the insurer to quantify their maximum exposure on a risk or group of risks and set aside necessary reserves to cover claims payments.
Colin
the above research work is too general.i wanted to know EML in detail,that is its relevance in writing business as well as factors that are considered for a particular risk eg. under a fire policy
Hi Enard,
The article shows the main factors that an Insurer could use in determining an EML on a Fire Policy – these would be sprinklers, proximity of nearest fire station, construction, extinguishing appliances etc.
EML is a tool used so that Insurers can calculate their maximum possible exposure on a risk – without this they would not be able to quantify the risks that they are exposed to.
Colin
the above research work is kinda general.i need a detailed analysis of EML including its practical relevance in writing insurance business as well as factors that determine EML for a particular risk undertaking eg.under a fire policy
Hi Enardie,
The article shows the main factors that an Insurer could use in determining an EML on a Fire Policy – these would be sprinklers, proximity of nearest fire station, construction, extinguishing appliances etc.
EML is a tool used so that Insurers can calculate their maximum possible exposure on a risk – without this they would not be able to quantify the risks that they are exposed to.
Colin
WHAT ARE THE EFFECTS OF WRITING A BUSINESS BASED ON EML
Hi Junior,
EML is a very useful tool for Insurers to gauge the maximum amount that they may have to pay out on a claim on a given policy.
The accumulated total of all of these EML’s can be used to set aside reserves within the Insurers accounts and hence calculate their potential profitability.
Colin
how is EML used in writing businesses,what are its merits and demerits
You said that EML has no exact formula and its value is estimated on experience. So this experience you reffering to is past events and the costs that rsulted from those past events? I’m battling to understand how you arrive at a value for EML that is quite accurate even though its an estimate…can you perhaps help?
Hi Rochelle,
Yes it would be based on many years of experience and analysing data from similar types of losses.
Key facts in here are construction and fire prevention methods
Although an estimate previous trends on certain types of buildings would be pretty accurate. For example timber construction with few fire appliances and a long distance from fire service would most likely result in a total loss.
There is no exact formula but insurers would tend to look at the worst case scenario
Hi, I was wondering if someone could help me.
I’m busy doing an assignment about how a ship sank and the qestion basically asks me to draw up a risk profile. The did not include in the case study any past eventsa. They only told us how the ship sank. I have to calculate the EML, the probability and annual cost for the different types of loss or damamge. I can’t seem to figure out how to calculate the EML. The Question also gave me a replacement value, a contribution to profit, the time period it will take to recover and the estimated cost of a human life.
I see that colink wrote (above) that there is no exact formula, so how am I supposed to calculate it?
Help, please.
Hi
I was given the same or almost the same assignment as Izzy, so an answer for her will benefit me too..
Please help if you can ASAP..
Thanks
what is difference b/w maximum probable loss and maximum loss limit.
Hi Alex,
Maximum Loss limit is the maximum limit that a policy will pay out to, maximum probable loss is an estimate of what the biggest claim is likely to be – a payout would not be limited to this figure
EML is conducted by a consultant Engineer (or risk surveyor) hired by an insurance company or a broker. He should visit and inpect the insured’s site, and select about Top Tisk. Top risk is considered in severity of a consequantal event, not frequency. Inspection report must describe detail information of EML (or PML) because it is most important to underwriter in order him or her to decide how much of risk retention and rating of the property. In other words, EML of the insured property is high, the underwriter would decide to keep its risk as little as possible or reject. Therefore, underwriters like to have low EML properties.
what is the difference between EML and MPL?
Hi Maria,
They are different terms for the same thing – this is quite common in insurance which does make it a little complicated !
The calculation would be carried out in exactly the same way
Colin
Hi,
Can the EML be applied on a fidelity Guarantee insurance survey?
if, yes how would it defined. i have seen that MPL’s and EML calculations are majorly used on material damage scenarios. Is it possible to assign an EML to a fraud/theft /embezzlement scenario and how would it be calculated?
Nick
EML is calculated by estimating the extent of a fire damage during normal working conditions e.g. normal office hours. Yuo first must identify the top location(target risk). For example if we have a fire in one room of three equivalent buildings, the EML may be calculated as follows;
The total insurance sum limit = 100%
Loss per target building 100%/3 = 33.3%
Basing on the enginers estimation, there will be a loss percentage say about 70% damage in the room. This estimation depends on contents in the room, their flamablity e.g. metal may not be damaged but fuel will all be lost, smoke damage etc.
This is multiplied by loss per target building i.e. 0.7 x 33.3% = 23.3% which is our EML