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Pricing of insurance products is typical in the sense that in insurance
transactions, the sales price (i.e. the premium) is collected before stipulated
Services namely claim payments , are duly provided.
A fundamental principle of insurance pricing, i.e. the insurer

receive premium that :-

1. Are sufficient to fund their expected claim costs and
administrative cost and
2. Provide an expected profit to compensate for the cost
of obtaining the capital necessary to support the sale
of coverage.
Actuaries generally calculate the base premium ,with help
following mathematical formula

P = E(S) + K + R
P = the base premium
E(S) = mathematical expectation of claims
K = ongoing company running costs
R = risk premium for unforeseen deviations in the claim
amount to be paid.
(still provide company with normal profit i.e. standard
pricing mechanism relies on the “law of large
Insurance premium

Pure premium Other income Operating

(expected losses) (income from investments) expenses Margins

Pure premium :-
based on actuarial calculations, it includes the amount needed to
cover expected losses and loss adjustment expenses.
Margin and Other incomes:-
it includes allowance for ,
• contingencies – this fund is required to meet the unexpected increase in the
number or size of benefit payments .
• Underwriting gain or profit – it is needed to fund for financing growth and
expansion .
Operating expenses -
it includes the sales commission ,other marketing cost ,taxes etc.
Rating terminology –
• insurance prices are called as premiums.
• rate is used synonymous with premium in insurance business.
• exposure unit are quantitave units used in insurance pricing .
• loading includes other expenses ,profit and margin for contingencies added to
pure premium.
Pricing objectives
1. Adequacy –
rate must be adequate to generate the premium income the
insurer needed to pay its claims and expenses.
it also should assure fair rate of return to investors and
continuing growth and expansion .
2. Reasonableness –
the rate must not be so excessive that allows insurance
companies to earn abnormal gains .
3. Fairness –
the rate must not be “unfairly discriminatory” means rate should
be same for homo-groups and differ for hetro-group .
4. Simplicity ,consistency and flexibility –
the pricing system should simple to understand and inexpensive
to use and must not change frequently .
Types of rating:-
A. Judgment rating
B. Class rating
C. Merit rating
I. schedule rating
ii. Experience rating
iii. Retrospective rating

A . Judgment rating –
 Risk is proposed to be bought with no similar statistical information
available .
 Rate is determined largely by underwriter’s judgment
 Each premium is unique here.
B. Class rating –
• most common rate in insurance business
•Insured risk is classified on the basis of one or several important features
•All that belongs to the same class are subject to same rate per unit exposure.
•Also called manual rating ,as various classifications and the respective rates in
the form of printing manuals .
• life insurance is one line where class rates are used viz. rates based on age
,gender ,healthiness etc.

C. Merit rating –
It is a modification of class rating .
I. schedule rating-
• Each exposure is individually rated
• first step for calculation of this rate is to examine the risk in order to find out the
features that are likely to cause losses or to prevent them.
• Then the risk is compared with the average or standard risk of its type.
•Finally deductions are made from the standard rate for this risk’s desirable
features and vice versa.
ii. Experience rating-
This type of rating modifies the class rate on the basis of experience of a
particular exposure .
iii. Retrospective rating –
• there is a range indication of minimum and maximum for premium
• it is determined after policy expires
• if the loss is less then the premium will be minimum and vice versa .
Life insurance vs. Non-life insurance pricing

Life ins. Non-life ins.

• Relatively simple. (age, sex) • Complicated as schedule
,experience and retrospective
rating is used.
• • Wide fluctuations. (operating
Do not change frequently .
environment and claims)
(mortality rate and administrative
• Exact calculation .(mortality • Rating is less precise .(losses and
expenses ,investment incomes) their amounts are uncertain)
Rate making entities
A. Professional rate making organisation
B. Actuaries (actuaries are the specialist in mathematics of insurance ,who
carry out the prime responsibility of rate making process)