You are on page 1of 28

COMPUTATION OF

INSURANCE PREMIUM
Prepared BySavika Tayal
Roopam
Rajesh
Pooja Gupta
Sagar Shukla

DEFINITION
 Insurance is a practice of exchanging a contingent
claim for a fi xed payment called premium.
 Premium
is
the
consideration
money
that
a
policyholder has to pay in lieu of the benefi t that the
insurer promises to confer on the happening of the
scheduled eventuality
 Premium needs to be paid in advance and regularly to
keep the policy in force.
 The principle of assigning premiums according to the
underlying risk is an essential element of actuarial
science.

FUNCTIONS OF PREMIUM  It should produce total funds suffi cient to cover the insurer’s obligation.  It should distribute the cost of insurance fairly among insured persons .

quarterly or monthly.  For monthly mode. It can also be paid in instalments i. no extra is charged.e.MODES OF PAYMENT OF PREMIUM  The premium can be paid at one time.  Half–yearly. when it is called a single premium. an extra addition of 5% to the tabular premium is made before dividing the tabular premium by 12  Premium can also be paid through salary savings scheme which is in fact a monthly mode but for this. half–yearly. quarterly and monthly mode instalment is obtained by dividing the tabular premium by 2 or 4 or 12. . yearly.

.  Similarly rebate is also permitted for large sum assured and these rebates diff er from plan to plan.  Premium is always payable in advance.CONT.  Insurers allow some rebate on the premium for yearly and half–yearly mode because the insurer earns interest on the advance payment and also because the administrative expenses are reduced because of lesser frequency of issuing renewal premium notices and receipts and maintaining the record.

ELEMENTS IN PREMIUM COMPUTATION Mortalit y Expenses of management Inflation Expecte d yield in its premiu m .

MORTALITY  The mortality tables are prepared by the insurers on the basis of their experience over a number of years.  The small premium charged from the total group is used to pay a big sum assured to the unfortunate few who die early. .  This prediction or estimation of mortality is true for a very large group of insured people and not for any individual insured. occupation. all insurers charge a level premium which remains constant over the entire duration of the policy term.  The mortality rates depend on the age. lifestyle and medical history of the insured. It is also called pooling of resources. Insurance is also known to be a co–operative action.  Though the rate of mortality increases with the increase in age.

e.  Expense is also incurred for servicing of the policies. for payment of commission to the agent and other incidental expenses like preparation of policy document etc.  Huge expenses are incurred for procurement of new business. payment of Survival Benefi t and Death claim and Maturity Benefi t etc. . valuation to determine bonus payable.EXPENSES OF MANAGEMENT  Any insurer has to incur expenses for conducting the insurance business that keeps on changing due to infl ationary market conditions.g. collection of renewal premium.

 However. as the future yield cannot be determined exactly. .EXPECTED YIELD ON INVESTMENT  The expected yield on investment of the collected endowment component of premium goes to reduce the premium rate. it is necessary for a prudent insurer to keep a reserve to take care of unexpected fall in the rate of yield.

 For example. The idea is that the amount of the insurance payment should be reasonably related to the cost of resolving the damage at that future date. persistent infl ation grievously harms the insurance industry  Insurance is a contract in which money is paid today in expectation of return of a greater amount to cover a named risk at some uncertain future date. fi re insurance is paid when one’s house burns down. generally related to the amount it will cost at a future date to heal the damage related to that risk. .  That named risk has a value to the insured.INFLATION  High.

people stop buying insurance and the insurance business dries up.  In an environment of high infl ation.  The higher the expected rate of infl ation. the greater portion of current income must go to cover the future risk and the less certain that the coverage will be suffi cient.CONT.  At some point. the amount that would be necessary to cover the future risk will be much higher than in a non-infl ationary environment.  Longer term insurance is more vulnerable than short term insurance .

To ensure fairness in premium for customer To produce rates that includes an adequate provision for profit and contingencies The rating system must be consistent.OBJECTIVES OF PREMIUM COMPUTATION To maintain solvency in order to pay claims The rates should be reasonably stable. adaptive. simple and easy to understand by the customer The rate mechanism should promote the reduction of losses by providing incentives to the insured to prevent losses. . responsive to changes and should be able to satisfy the rate regulators.

CALCULATION OF PREMIUM  It involves the following Components of Premium  Risk Premium (Mortality)  Net Premium (Margin of Interest)  Offi ce Premium (Margin of Offi ce Expenses and exigencies)  Level Premium  Loading on the premium  Extra Premium .

COMPONENTS OF PREMIUM Risk Premiu m Net Premiu m Office Premiu m .

.RISK PREMIUM  The pure premium needed to cover the expected risks but with no allowance for expenses. refl ecting the experience of Indians.  Mortality studies. commission or contingencies is to be made. are made by Mortality and Morbidity Investigation Bureau (MMIB). set up jointly by the Life Insurance Council and the Actuarial society of India to help insurers. Thus the cost to meet the risk of death for one year at a particular age is known as risk premium. The risk premium is based on the probabilities of death at various ages.

Its calculation only allows explicitly for interest and mortality.NET PREMIUM  A net premium is the premium calculated on the basis of the valuation assumptions to provide the contractual benefi ts at outset. Net premium is always less than the risk premium. Thus the net premium covers the risk factor as well as interest earned on investment of fund by the insurers. .

.  The premium fi gures printed in the promotional literature and brochures are offi ce premiums.OFFICE PREMIUM  The premium arrived at after loading net premium is called offi ce premium.  Also known as tabular premium.

.  In view of this insurers charge a level premium and the cost is distributed evenly over the period during which premiums are paid. The premium remains the same. and is more than the actual cost of protection in the earlier years of the policy and less than the actual cost in the latter years.LEVEL PREMIUM  Premium keeps on increasing as the age increases and this is the natural premium paying system but it is impractical because the insurer cannot ask the insured to pay extra premium every year and moreover in the latter years the cost of insurance would become unaff ordable resulting in lapse of policies. The excess paid in the early years builds up the reserve.

LOADING  The amount added to the pure premium to cover the administrative expenses is known as loading. . When these expenses are added to the net/pure premium it becomes the gross premium/offi ce premium which is actually charged from the customer.

EXTRA PREMIUM  It is charged on case-to-case basis. . unique for every policy. Riders provide additional benefi t or premium waiver benefi t  Extra premium may also become chargeable because of decisions relating to the extent of risk in any particular case. This may happen because of grant of some extra benefi t in addition to the basic benefi ts under the plan like accident benefi t or premium waiver benefi t.

DETERMINATION OF PREMIUM IN PROPERTY AND LIABILITY INSURANCE Class Rating • Pure Premium Method • Loss Ratio Method Merit Rating • Schedule Rating • Experience Rating • Retrospective Rating Method .

and so the class rating method is sometimes called a  manual rating.  These rates are published in a manual.  Two methods to determine a class rated premium or to adjust it Pure premium method  Loss ratio method .CLASS RATING METHOD  Used when the factors causing losses can either be easily quantifi ed or there are reliable statistics that can predict future losses.

Then the loading charge is added to the pure premium to determine the gross premium that is charged to the customer.CONT. the pure premium is 1 s t  calculated by summing the losses and lossadjusted expenses over a given period.   In the pure premium method. and dividing that by the number of exposure units.  Pure premium=  Gross premium= Pure premium + Load .

  The loss ratio method is used more to adjust the premium based on the actual loss experience rather than setting the premium. then the premium is adjusted according to the following formula:  Rate change = .CONT.  If the actual loss ratio diff ers from the expected loss ratio. The  loss ratio is the sum of losses and loss-adjusted expenses over the premiums charged.

 Three methods to determine merit rating Schedule rating  Experience rating  Retrospective rating .   Merit rating is usually used when a class rating can give a good approximation. but the factors are diverse enough to yield a greater spread of losses than if the composition of the class were more uniform. depending on the actual losses of that customer.MERIT RATING METHOD  Merit rating is based on a class rating. but the premium is adjusted according to the individual customer.

.  Schedule rating uses a class rating as an average base. Some factors may increase the premium and some may decrease it —the fi nal premium is determined by adding these credits and debits to the average premium for the class.CONT. then the premium is adjusted according to specifi c details of the loss exposure.

CONT.  The adjustment to the premium is determined by the loss ratio method. as compared to the class average to determine the premium for the next policy period.  Experience rating uses the actual loss amounts in previous policy periods. then the premium is lowered. then the premium is raised. but is multiplied by a credibility factor to determine the actual adjustment  Experience rating is typically used for general liability insurance. and if losses were higher. typically the prior 3 years. If losses were less than the class average. . workers compensation and group insurance.

Part of the premium is paid at the beginning.CONT. such as for burglary insurance. limited by a minimum and a maximum amount that can be charged. . the amount of which is determined by the actual losses for that period. Retrospective rating is often used when schedule rating cannot accurately determine the premium and where past losses are not necessarily indicative of future losses.  Retrospective rating uses the actual loss experience for the period to determine the premium for that period. and the other part is paid at the end of the period.