Claims-Made Step Factors 101

Updated December 5th, 2023

When I first penned this article in 2018, the 15-year softening market cycle applicable to the healthcare professional liability (HPL) arena was finally coming to an end. Today, at the tail end of 2023 and after only about 3 years of a moderate firming trend, we're beginning to see the E&S market reverse course and begin softening once again. However, this time we do not expect such a long or extreme softening phase for various reasons, and so E&S underwriters are not likely to disregard basic rating methodology such as the application of claims made step factors as they did in the past. As such, it’s a good time for retail agents and their production support staff to brush up on claims made step factors so they can better manage the expectations of their clients.

What are Claims-Made Step Factors?

Claims-made step factors are the actuarially determined mechanism that increases a claims-made policy’s premium to reflect the increase in exposure associated with the provision of professional services by an insured over time. In the first year of a claims-made policy, the only professional services provided by an insured that could result in a claim are those provided in that first year. However, the next year claims can result not just from the professional services provided in that first year, but those provided in the second year as well. This increase in exposure requires an increase in premium. The following year there are now three years of professional services provided by an insured that could result in a claim, and so the premium must increase again.

In fact, the premium for a claims-made policy, all else being equal, will typically increase until the new exposures being added under the current policy are balanced out with exposures dropping off on the back end because they are so far in the past that they are no longer statistically likely to result in claim activity. At that point, the premium is considered “mature”.

Understanding Claims-Made Step Factors

So, what do typical healthcare professional liability claims-made step factors look like and how do they impact a policy’s premium from year to year?

Below is a chart reflecting a common series of claims-made step factors found in healthcare professional liability policies:

Calculating the projected premium increase percentage from one year to the next is straightforward. You simply divide the step factor increase by the previous year’s step factor. For example, moving from the first to second-year claims-made step means a step factor increase of .3 (.65 – .35). Dividing .3 by .35 gives you 85.71%. So, a first to second-year claims-made step using the factors above will result in a premium increase of 85.71%, all else being equal. It works the same way with the other steps as well.

You can validate this calculation by using actual premiums for any particular risk. Let’s say a physician risk generates a mature premium of $10,000. The first-year premium will be $10,000 multiplied by .35, which equals $3,500. Using the same approach, the second-year premium, all else being equal, will be $10,000 multiplied by .65, which equals $6,500. The percentage increase in premium moving from the first to the second year is 85.71% - just as the above table states. No matter what mature premium you use, the same claims-made step factors will result in the same premium increase percentages, again all else being equal.

Keep in mind that I make a point of stating “all else being equal” above because if an insured’s risk profile changes during the policy term the renewal premium will be different than that dictated strictly by the claims made step factor change. This is because the applicable exposures have changed, and/or something has caused a modification to the credits/debits being applied. Of course, a rate change will have the same effect.

Using What You've Learned

Managing your clients’ expectations about future healthcare professional liability premiums will be challenging as the market cycle ebbs and flows between a hard and soft market. Understanding how claims-made step factors impact premiums year-to-year will make that part of your job much easier.