Insurance Pricing

Major Determinants of Fair

Premium
• Principle of Insurance Pricing-Premium collected should
be sufficient
– To fund expected claim costs and administrative cost
– To provide an expected profit to compensate for the cost of capital.

Fair insurance
Premiums

Expected claim Investment Administrative Fair Profit

costs income costs Loading
 Business objective
• Simplicity
• Stability
• Responsiveness
• Encouragement of loss control
 Rating Terminology
• Insurance prices are called premiums.
Premiums are based on rates and rates are
based on per unit of exposure.
• Rate is the price per unit of insurance.
• Exposure units are quantitative units used in
insurance pricing.
• Loading refers to the amount that must be
added to pure premium for other expenses,
profit and margin for contingencies.
Rate making in property and liability
insurance
• Judgment rating
• Class rating
• Merit rating
– Schedule rating
– Retrospective Experience rating
 Rate making in Life Insurance
• All claims are paid at the end of one year
P(1+r) = claim payment
Or P= claim payment/(1+r)
• Therefore P would be lower for a higher
rate of interest.
• All claims are paid at the end of two years
P= claim payment/(1+r)2
 Term Insurance
• Calculation of Net single premium
• Yearly renewable
Probability X Amount of Insurance X P.V factor
• Five year term insurance policy
– Death claim payable if the insured dies at any time within the five years
– Death claim paid at the end of year in which the event occur, not at the
end of five years.
– Consequently, the cost of each year’s mortality must be computed
separately and then added together to determine the net single
premium.
– For exam, if as per mortality table out of 10 million males alive at age
zero, 9,210,289 are still alive at the beginning of age 45. of this 41,907
will die during this year. Therefore, the probability that a person at the
age of 45 will die during the year is 41907/9210289. If at the age of
46,47,48,49 and 50 the number of people dying is 45,108, 48,536,
52,089 and 56,031. Calculate the amount of premium for Rs.1000 policy
assuming interest rate to be 5%.
 Whole life insurance
• Similar calculations to be carried out to the
end of mortality table.
 Net Annual Level Premium- whole
life policy
• If premiums are paid annually, the net single
premium must be converted into a net annual
level premium, which must be mathematical
equivalent of the net single premium.
• The mathematical adjustment for the loss of
premium and interest is accomplished by
dividing the net single premium by the present
value of an appropriate life annuity due of Rs.1.
NALP= NSP/PVLAD of Re 1 for the premium
paying period
 Net Annual Level Premium- term
insurance policy
• Going to the previous example the net annual level
premium for a five year term insurance policy at the age
of 45 is 22.74.
• This sum must be divided by present value of five year
temporary life annuity due of Rs.1.
• For the first year, Re.1 is payable immediately.
• Age 46 9168382/9210289*1*.9524=.948
• Age 47 9123274/9210289*1*.9070=.898
• Age 48 9074738/9210289*1*.8638=.851
• Age 49 9022649/9210289*1*.8227=.806
• PVLAD of Re.1= 4.503
• NALP = NSP/ PVLAD of Re.1 = 22.74/4.50 = 5.05
 Gross Premium
• Net annual level premium plus
• All operating expences.
• Margin for contingencies
• In case of stock life insurers, a contribution
to profits.
Reserves
 Reserves in Property & Liability
Insurance
• Unearned Premium Reserve
– the amount of premium estimated as required to cover the risk during the balance policy
period falling after the balance sheet date (Unearned or Unexpired Premium Reserve -
UPR)
– As per the IRDA regulations, UPR would be 50 per cent of the net (of reinsurance) premium
for all classes of business except the marine hull business, for which it is 100 per cent.
• Loss Reserve
– the amounts expected to be paid in future in respect of the claims already reported by the
balance sheet date.
– As per the IRDA regulations where the amounts of outstanding claims of insurers are
known, the amount is to be provided in full, and
– where the amount of outstanding claims could be reasonably estimated according to the
insurer, he may follow the case-by-case method, after taking into account the explicit
allowance for changes in the settlement pattern or average claim amount, expenses and
inflation.
• Reserve for the amount expected to be paid in future in respect of claims that might
have occurred but could not be reported to the insurer till the balance sheet date
(Incurred But Not Reported - IBNR),
– To be determined using actuarial principles
• Reserve for the direct expenses expected to be normally incurred for the settlement
of the above two classes of claims, and
• Reserves required to be held on a prudent basis towards catastrophe losses or a
single incident giving rise to multiple claims.
Investments
 Objectives
• Generally, under life insurance policies,
premiums are received in advance and
after providing for acquisition and
management expenses, the current cost
of claims and other outgo, the balance of
premium is available for investment.
• liquidity,
• safety and
• optimisation of yield
 Life Business
• Government Securities -25%,
• Government Securities or other approved securities (including (I)
above) -Not less than 50%,
• Infrastructure and Social Sector-Not less than 15%
• Others to be governed by Exposure/ Prudential Norms -Not
exceeding 20%
• Other than in Approved Investments to be governed by Exposure/
Prudential Norms -Not exceeding 15%
• Pension and General Annuity Business
• Government securities, - not less than 20%
• Government Securities or other approved securities inclusive of (i)
above, - not less than 40%
• Balance to be invested in Approved Investments as specified and to
be governed by Exposure/ Prudential Norms -Not exceeding 60%
 General Business
• Central Government Securities being not less than
20%
• State Government securities and other Guaranteed
securities including (i) above being not less than 30%
• Housing and Loans to State Government for Housing
and Fire Fighting equipment, being not less than 5%
• Infrastructure and Social Sector- Not less than 10%
• Others to be governed by Exposure/ Prudential Norms
-Not exceeding 30%
• Other than in Approved Investments to be governed by
Exposure/ Prudential Norms - Not exceeding 25%