What Exactly is an Insurance Premium?

An insurance premium is a calculation made by an insurance company based upon a specific business model or type of insurance that considers the likelihood of claims filed in order to properly price their products for purposes of generating profits. The calculation uses actuarial tables and methods to make assumptions and quantify associated risks. The process consists of underwriting and investment returns.

The underwriting process.
The first and most complicated determination of an insurance premium is derived from the underwriting process. This process involves the use of actuarial science that analyzes a wide assortment of data based on the product offered and the risk factors of the insured such as age, health. experience, education or other factors that are specifically related to the type of insurance offered. Insurers must determine the amount of risk that they are willing to assume and the price that they should charge. This computation also must take into account the probability of risks and overall exposures that the insurance company is willing to accommodate. An insured underwriting performance is measured by dividing claims and underwriting expenses by premiums. A ratio of 100% indicates a profit while anything over 100% indicates a loss. However, the inclusion of investment return discussed below will impact these ratios and can turn a loss into a profit. Nevertheless a ratio over 100% requires a good hard look at the underwriting assumptions.

The investment return.
The investment profits are based upon float which represents available reserves of money at hand that have been collected but not paid out as claims. These funds earn interest until they are needed. This represents an important aspect of the insurance premium computation.

Determination of profit for insurance premium computation.
The insurance business model for determining profitability and premium amounts is reduced to a simple formula, as follows: Profitability = collected premium + investment return – claims paid out – underwriting costs.

Final Determination of Insurance Premium.
Underwriting standards need to be constantly reviewed and adjusted. During periods of low interest rates, investment income may not offset losses from the underwriting ratio. Therefore, premiums and the amount of risk exposure that insurance companies are willing to accept may require an increase in premium as well as a reduction in the type of insurance product offered. For example, during the hurricane season in the U.S., many insurance companies lost a lot of money because the insurance premiums were too low.

Related posts:

  1. High Insurance Rates and Disputed Claims
    Homeowners’ insurance rates can be expensive and overwhelming. While all homeowners struggle to pay the large insurance rates that come with owning a home, most homeowners expect insurance companies to...
  2. How Motorcycle Insurance Rates are Determined
    A variety of factors will strongly influence motorcycle insurance rates. Many riders worry about excessive insurance costs. There are ways to lower motorcycle insurance rates. Here, we’ll look at the...
  3. 7 Steps to Lower Auto Insurance Rates
    There’s a science to securing the lowest car insurance rates on the market. While shopping around for car insurance rates can seem daunting, there are a few things you can...
  4. How Much Home Can You Afford?
    In determining your maximum mortgage amount, lenders use guidelines called debt to income ratios. This is simply the percentage of your gross monthly income (before taxes) that is used to...