How do insurance companies carry out rate making?

Rate making is yet another important operation of insurers. Rate is defined as the price per each unit of protection or exposure of insurance. The rate is the cost of production and its value is known only when the policy period is over. The premium paid at first should be sufficient for the claims and other expenses. If it is inadequate, then the insurer will be in loss. Insurance rates are subjected to government regulations. Government allows rates which are not too high and which are not biased. The rate and premium determination is the function of insurance actuaries. To determine the rates for life insurance, an actuary has to study the statistical data of births, deaths, marriages, employment, retirement, illnesses, and so on. The basic goal of an actuary is to determine the best premium for policies, such that there is a profit for the company, and the company can effectively compete with other insurance companies.

Insurance premium
Insurance premium is the product of rate and the number of units of protection purchased. It involves the cost of the policy, requirements, benefits and the cost of writing the insurance. The insurance premium depends upon two factors, loss expected (Pure premium), and cost required for the business (Loading). The insurer calculates the pure premium by dividing the total expected loss by the total number of exposures. Loading is calculated as the sum of the agent’s fee, insurance expenses, tax and other fees. The gross premium is the sum of pure premium and the loading amount. The first year insurance premium of some life insurers for the period of September 2010 is given below in the table 
 Rate making guidelines
The basic rate making guidelines are: 
  • The rate should be just enough to cover the losses, but should not be in excess. 
  • The rate should allocate equal cost burden to the insureds without any biasness. 
  • The rates should encourage the insureds to do loss control. 
  • The rates should be revised and updated often.
The guidelines seem to be simple, but have to be maintained strictly. If the rate is high, then it is easy to cover the losses, but it will be challenging to compete in the insurance market. If the rates are calculated incorrectly, then it cannot be bargained again. The cost is assigned differently in different situations. For example in life insurance, the rates are fixed after considering the occupation, income and expenditure, marital status, and so on.
How do insurance companies carry out rate making? How do insurance companies carry out rate making? Reviewed by enakta13 on December 14, 2019 Rating: 5

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