How to Calculate Probable Maximum Loss

by Jackie Lohrey; Updated September 26, 2017
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Commercial insurance underwriters use probable maximum loss calculations to estimate the highest maximum claim that a business most likely will file, versus what it could file, for damages resulting from a catastrophic event. Although underwriters use complex statistical formulas and frequency distribution charts, the concepts involved are not difficult to understand. In fact, once you understand the basic formula, you can estimate your own PML and use this information as a starting point in negotiating favorable commercial insurance rates.

Calculate the dollar value of business property to establish the amount you stand to lose if a catastrophic event demolished your business. If you already have business property insurance, this is the amount of insurance coverage. Otherwise, add real property and business personal property to reach the valuation.

Identify risk factors that increase the chance a specific catastrophic event would demolish your business. For example, risks associated with a fire include combustible construction materials, clutter, flammable liquids or other substances used to operate or maintain your business, and distance to the nearest fire station. Risks associated with flooding include the business site, such as whether you are in a documented flood plain, construction materials and storage policies.

Identify risk mitigation factors that decrease the chance a specific catastrophic event would demolish your business. For example, risk mitigation factors associated with a fire include functioning protection systems such as alarms, automatic sprinklers and portable fire extinguishers. Also, consider elements in your emergency action plan that address emergency reporting procedures and policies for protecting business assets.

Conduct a risk analysis to estimate the degree to which risk mitigation factors decrease the chance a catastrophic event will demolish your business. The difference between these two factors determines the maximum loss your business is likely to incur. Insurance companies typically use percentages that increase incrementally by 1 percentage point. For example, an analysis might determine that risk mitigation decreases the chance of a total loss by 21 percent.

Multiply the property valuation by the highest expected loss percentage to calculate the probable maximum loss. For example, if the property valuation is $500,000 and you determine that fire risk mitigation reduces expected losses by 20 percent, probable maximum loss for a fire is $500,000 multiplied by .80 or $400,000.

Tips

  • Contact your insurance agent for help in assessing risk and risk mitigation factors. For a specific event, such as a fire, contact your local fire station or inspector for assistance.

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About the Author

Based in Green Bay, Wisc., Jackie Lohrey has been writing professionally since 2009. In addition to writing web content and training manuals for small business clients and nonprofit organizations, including ERA Realtors and the Bay Area Humane Society, Lohrey also works as a finance data analyst for a global business outsourcing company.

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