Rate making, or insurance pricing, is the calculation of rates charged by insurance companies.
The benefit of pricing is to ensure insurance companies are setting fair and adequate premiums given the competitive nature.
The concept has many factors to consider. For instance
- Premiums should be set so that the company can afford to pay the claims, even in the long run. This is why companies also should consider expenses, cost of capital etc.
- Premiums should be set so that policyholders to a reasonable level pays for their own risk. That is way the premium is higher on a Porsche than a Fiat.
- Preferably premiums are not changed too often or otherwise are volatile.
The most important for the calculation is how the long period that is covered. In many cases this is 1 year. Also important is what risk is covered. This may be for instance death.
For a middle-aged person the risk of dying during the next year is around 0.5%.
If say the amount paid on death is 1,000. Then the premium would be 1,000*0.5% = 5.
Including expenses, risk cost and the possibility for the company to make a small profit let’s say they charge 6.
If they have a 10,000 customers their business would look like this.
|Number of Claims||50|
|Cost of Claims||50,000|
In different customers would pay different premiums but the above concept still remains.