Rate making, or insurance pricing, is the determination of rates charged by insurance companies. The benefit of rate making is to ensure insurance companies are setting fair and adequate premiums given the competitive nature.
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Fundamental rate-making definitions
The following are fundamental terms that are commonly used in rate making. A rate "is the price per unit of insurance for each exposure unit, which is the unit of measurement used in insurance pricing". The exposure unit is used to establish insurance premiums by examining parallel groups.
The pure premium "refers to that portion of that rate needed to pay losses and loss-adjustment expenses". The loading "refers to the amount of the premium necessary to cover other expenses, particularly sales expenses, and to allow for a profit". The gross rate "is the pure premium and the loading per exposure unit". Finally, the gross premium is the premium paid by the insured consisting of the gross rate multiplied by the number of exposure units.
Objectives in rate making
Rate making has several objectives under regulatory requirements regulated by the states and business objectives due to the goal of profitability: The goal of insurance regulation is to protect the public and three regulatory objectives are placed to meet certain standards:
The business objectives are set as a guide for insurers while designing the rating system. The rating system should meet each of the four objectives:
Rate making methods
In property and casualty insurance, there are three basic rate-making methods:
Rate making in life insurance
Life insurance actuaries determine the probability of death in any given year, and based on this probability determine the expected value of the loss payment. These expected future payment are discounted back to the start of the coverage period and summed to determine the net single premium. The net single premium may be leveled to convert to installment premiums. A loading for expenses is added to determine the gross premium. With determining life expectancy, age is the most important factor, other significant factors are sex of the individual and smoking. Thus, an actuary can reasonably estimate the average age of death for a group of 25-year-old males, who don't smoke.