Insurance companies use "exposure units" to calculate the premiums policyholders pay. Exposure units essentially measure the extent of the potential loss the insurer may have to cover. For example, a $1 million house destroyed by fire would cost five times as much to replace as a $200,000 home, so the $1 million home represents five times as many exposure units.
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Units and Types of Coverage
What constitutes an exposure unit depends on the kind of insurance being sold. For homeowners' hazard insurance, for example, one exposure unit might equal $1,000 worth of covered structure value. For auto collision insurance, one unit might equal $100 or $1,000 worth of the value of the vehicle; for auto liability, a unit might be 100 miles driven or one month of use. For workers' compensation insurance, a unit could be $1,000 worth of payroll. For liability coverage for a store, units might be expressed in terms of the number of customers. Each insurer can define units in the manner that suits it best.
Role in Setting Premiums
Insurers set premiums by multiplying the number of exposure units by the rate per unit. Say your auto insurer charges you $20 per unit for collision coverage, and each exposure unit is defined as $1,000 of vehicle value. If your car's worth $25,000, then your premium is $20 multiplied by 25, or $500. If something happens that causes your insurer to view you as a higher risk, such as an accident or a speeding ticket, it raises your rate per unit, and that leads to a higher premium.