2. Definition – Insurance pricing
A rate is the price per unit of insurance.
An exposure unit is the unit of measurement used in insurance
pricing. It varies by line of insurance.
The pure premium refers to that portion of the rate needed to
pay losses and loss adjustment expenses.
Loading refers to the amount that must be added to the pure
premium for other expenses, profit and a margin for
contingencies.
The gross rate consists of the pure premium and a loading
element. Finally, the gross premium paid by the insured consists
of the gross rate multiplied by the number of exposure units.
3. Objectives of
Insurance Pricing or Rate Making
Regulatory Objectives
Business Objectives
Adequate Rates
Simplicity
Not Excessive
Stability
Not unfairly Discriminatory
Responsiveness
Encouragement of loss
control
5. Judgment Rating
Judgment Rating means that each exposure is
individually evaluated, and the rate is determined
largely by the underwriter’s judgment.
This method is used when the loss exposures are so
diverse that a class rate cannot be calculated or when
credible loss statistics are not available.
Eg: Ocean marine insurance.
6. Class Rating or Manual Rating
Class Rating means that exposures with similar
characteristics are placed in the same underwriting
class, and each is charged the same rate.
The rate charged reflects the average loss experience
for the class as a whole.
Class rating is based on the assumption that future
losses to the insureds will be determined largely by the
same set of factors.
7. Advantages of Class rating
Simple to apply.
Premium quotations can be quickly obtained.
Ideal for personal lines market.
8. Class rating is widely used in:
Home owner’s insurance
Private passenger auto insurance
Workers compensation
Life and health insurance, etc.
9. Methods of Class Rating
Pure Premium Method
Loss Ratio Method
10. Pure Premium Method
The pure premium can be determined by dividing the
amount of incurred losses and loss adjustment expenses by
the number of exposure units.
First step:
Pure premium =
Incurred losses and loss adjustment expenses
Number of exposure units
Final step:
Gross Rate = Pure Premium
1 – Expense Ratio
11. Illustration
Assume that in auto collision insurance, 500,000
automobiles in a given underwriting class generate
incurred losses and loss adjustment expenses of Rs.30
million over a one year period. Expenses ratio expected
to be 40%.
12. Illustration
Assume that in auto collision insurance, 500,000 automobiles in a
given underwriting class generate incurred losses and loss adjustment
expenses of Rs.30 million over a one year period. Expenses ratio
expected to be 40%.
First step:
Pure premium =
Incurred losses and loss adjustment expenses
Number of exposure units
= 30,000,000
500,000
= Rs. 60
Final step:
Gross Rate = Pure Premium
1 – Expense Ratio
= Rs. 60
1- 0.40
= Rs. 100
13. Loss Ratio Method
Under the loss ratio method, the actual loss ratio compared
with the expected loss ratio, and the rate is adjusted
accordingly.
The actual loss ratio is the ratio of incurred losses and loss-
adjustment expenses to earned premiums.
The expected loss ratio is the percentage of the premiums
that is expected to be used to pay losses.
Rate Change = A – E
E
where A= Actual loss ratio
E = Expected loss ratio
14. Illustration
A line of insurance has incurred losses and loss-
adjustment expenses in the amount of Rs.800,000 and
earned premiums are Rs.1 million. The actual loss
ratio is 80%. The expected loss rate to be 70%.
Calculate the rate.
15. Illustration
A line of insurance has incurred losses and loss-
adjustment expenses in the amount of Rs.800,000 and
earned premiums are Rs.1 million. The actual loss
ratio is 80%. The expected loss rate to be 70%.
Calculate the rate.
Rate Change = A – E
E
= 0.80 – 0.70
0.70
= 0.143 or 14.3%
where A= Actual loss ratio
E = Expected loss ratio
16. Merit Rating
Merit rating is a rating plan by which class rates
(manual rates) are adjusted upward and downward
based on individual loss experience.
Merit rating is based on the assumption that the loss
experience of a particular insured will differ
substantially from the loss experience of other insureds.
Thus class rates are modified upward and downward
depending on individual loss experience.
18. Merit rating - Types
1.
Schedule rating
Under a schedule rating plan, each exposure is individually
rated. A basis rate is determined for each exposure, which is
then modified by debits or credits for undesirable or
desirable physical features.
19. Merit rating - Types
2. Experience rating
Under experience rating , the class or manual rate
is adjusted upward or downward based on past
loss experience.
Insured’s past loss experience is used to determine
the premium for the next policy period.
20. Merit rating - Types
3. Retrospective rating
Under a retrospective rating plan, the insured’s loss
experience during the current policy period determines
the actual premium paid for that period.
Under this rating plan, a provisional premium is paid
at the beginning of the policy period. At the end of the
period, a final premium is calculated based on actual losses
that occur during the policy period.
