Bonus-Malus
Encyclopedia
The term bonus-malus is used for a number of business arrangements which alternately reward (bonus) or penalize (malus).
It is used, for example, in the call center and insurance industries.
, a bonus-malus system (BMS) is a system that adjusts the premium paid by a customer according to his individual claim history.
Bonus usually is a discount in the premium which is given on the renewal of the policy
if no claim
is made in the previous year. Malus is an increase in the premium if there is a claim in the previous year. Bonus-malus systems are very common in vehicle insurance. This system is also called a no-claim discount (NCD) or no-claims bonus in Britain and Australia.
The fundamental principle of BMS is that the higher the claim frequency of a policyholder, the higher the insurance costs that on average are charged to the policyholder. This principle is also valid in an insurance arrangement consisting of a high maximum deductible
which is common to all policyholders.
The most usual BMS divides drivers by classes, where each class has its own discount or surcharge that is applied to the basic premium. A claim-free year implies in a decline of one or more degrees on the Bonus/Malus class table on the anniversary of the contract. A claim entails an increase of a given number of degrees on the Bonus/Malus scale on the anniversary of the contract. Generally, one degree corresponds to a 5% discount or surcharge. The starting class may depend on the driver's age, sex, place of residence, the car's horsepower. Each country has a different legislation, which rules how many degrees an insurer may increase or decrease, the maximum bonus or malus allowed and which statistics insurers can use to evaluate the starting class of a driver.
A BMS usually has an effect on road safety statistics, as it stimulates drivers to be careful and avoid accidents that would lead to the loss of bonus.
, particularly at banks, bonus-malus refers to schemes where annual bonuses are held in escrow
(do not immediately vest
), and can be reduced retroactively (clawed back) in case of losses in future years.
The intention is to align incentives better and encouraging a long-term view in directors, by discouraging the taking of risks which may yield short-term profits (and hence bonuses in early years) but with long-term losses (which, under a traditional bonus system, would not be penalized).
Such a system was proposed by Raghuram Rajan
in January 2008.
In November 2008, UBS AG
announced a change to its executive compensation
scheme implementing such a system, which it dubbed a "bonus-malus" system.
It is used, for example, in the call center and insurance industries.
Call centers
In call centers, a bonus-malus arrangement is a section in the contract between the company buying the call center services (buyer) and the company providing the call center services (call center) allowing for a payment to be made from one company to the other. As part of the contract, both companies agree on a set of Key Performance Indicators (KPIs). These are measurements for how the call center is performing. If the call center is performing poorly, then there would be a malus payment (payment from the call center company to the buyer). If the call center is doing well, then there is a bonus payment from the buyer to the call center company. Bonus-malus payments are in addition to the normal cost of call center services.Insurance
In insuranceInsurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
, a bonus-malus system (BMS) is a system that adjusts the premium paid by a customer according to his individual claim history.
Bonus usually is a discount in the premium which is given on the renewal of the policy
Policy
A policy is typically described as a principle or rule to guide decisions and achieve rational outcome. The term is not normally used to denote what is actually done, this is normally referred to as either procedure or protocol...
if no claim
Cause of action
In the law, a cause of action is a set of facts sufficient to justify a right to sue to obtain money, property, or the enforcement of a right against another party. The term also refers to the legal theory upon which a plaintiff brings suit...
is made in the previous year. Malus is an increase in the premium if there is a claim in the previous year. Bonus-malus systems are very common in vehicle insurance. This system is also called a no-claim discount (NCD) or no-claims bonus in Britain and Australia.
The fundamental principle of BMS is that the higher the claim frequency of a policyholder, the higher the insurance costs that on average are charged to the policyholder. This principle is also valid in an insurance arrangement consisting of a high maximum deductible
Deductible
In an insurance policy, the deductible is the amount of expenses that must be paid out of pocket before an insurer will pay any expenses. It is normally quoted as a fixed quantity and is a part of most policies covering losses to the policy holder. The deductible must be paid by the insured,...
which is common to all policyholders.
Automobile insurance
Most insurers around the world have introduced some form of merit-rating in automobile third party liability insurance. Such systems penalize at-fault accidents by premium surcharges and rewards claim-free years by discounts, commonly known as a "no-claims discount".The most usual BMS divides drivers by classes, where each class has its own discount or surcharge that is applied to the basic premium. A claim-free year implies in a decline of one or more degrees on the Bonus/Malus class table on the anniversary of the contract. A claim entails an increase of a given number of degrees on the Bonus/Malus scale on the anniversary of the contract. Generally, one degree corresponds to a 5% discount or surcharge. The starting class may depend on the driver's age, sex, place of residence, the car's horsepower. Each country has a different legislation, which rules how many degrees an insurer may increase or decrease, the maximum bonus or malus allowed and which statistics insurers can use to evaluate the starting class of a driver.
A BMS usually has an effect on road safety statistics, as it stimulates drivers to be careful and avoid accidents that would lead to the loss of bonus.
Bonus hunger
There is a basic question under Bonus-malus system based on insurance customer’s point of view, that is, “Should an insurance customer carry an incurred loss himself, or should he make a claim to the insurance company?”. Hence, an insurance customer prefers to choose self-financing an occurred loss by carrying a small loss himself in order to avoid an increased future premium, instead of financing the loss by compensation from the insurance company. This strategy is called bonus hunger of the insurance customer. In this strategy, the insurance customer prefers the most profitable financial alternative, after a loss occurrence. A well-designed bonus-malus system must take bonus hunger into consideration.Executive compensation
In executive compensationExecutive compensation
Executive pay is financial compensation received by an officer of a firm, often as a mixture of salary, bonuses, shares of and/or call options on the company stock, etc. Over the past three decades, executive pay has risen dramatically beyond the rising levels of an average worker's wage...
, particularly at banks, bonus-malus refers to schemes where annual bonuses are held in escrow
Escrow
An escrow is:* an arrangement made under contractual provisions between transacting parties, whereby an independent trusted third party receives and disburses money and/or documents for the transacting parties, with the timing of such disbursement by the third party dependent on the fulfillment of...
(do not immediately vest
Vesting
In law, vesting is to give an immediately secured right of present or future enjoyment. One has a vested right to an asset that cannot be taken away by any third party, even though one may not yet possess the asset. When the right, interest or title to the present or future possession of a legal...
), and can be reduced retroactively (clawed back) in case of losses in future years.
The intention is to align incentives better and encouraging a long-term view in directors, by discouraging the taking of risks which may yield short-term profits (and hence bonuses in early years) but with long-term losses (which, under a traditional bonus system, would not be penalized).
Such a system was proposed by Raghuram Rajan
Raghuram Rajan
Raghuram Govind Rajan is currently the Eric J. Gleacher Distinguished Service Professor of Finance at the Booth School of Business at the University of Chicago. He is also an honorary economic adviser to Prime Minister of India Manmohan Singh and the current President of the American Finance...
in January 2008.
In November 2008, UBS AG
UBS AG
UBS AG is a Swiss global financial services company headquartered in Basel and Zürich, Switzerland, which provides investment banking, asset management, and wealth management services for private, corporate, and institutional clients worldwide, as well as retail clients in Switzerland...
announced a change to its executive compensation
Executive compensation
Executive pay is financial compensation received by an officer of a firm, often as a mixture of salary, bonuses, shares of and/or call options on the company stock, etc. Over the past three decades, executive pay has risen dramatically beyond the rising levels of an average worker's wage...
scheme implementing such a system, which it dubbed a "bonus-malus" system.