Setting Premium Rates in Insurance Products

Premium in Insurance is the price paid by the insured in exchange for indemnity that the insurance company provides on happening of events mentioned in the insurance contract. A payment schedule specified in the contract describes how and when the premium is payable.
For every insurance policy, there is an equation of value.

• Price = Benefit or Indemnity provided by the product (Monetary or Non-Monetary) + Expenses (to be incurred for sales and service)

and

• The present value of premium(s) = Present value of Benefits or indemnity + Present value of expenses

Expenses included in pricing of an insurance product include:

• Procurement Expenses: A commission is normally paid which is related to premium
• Underwriting  Expenses: An underwrites needs to take a decision whether or not to grant insurance cover. Expenses may be involved in assessing the financial status and health condition of the insured.
• Administrative Expenses: Preparing policy documents, rendering service while collecting premium and settlement of claims and also payment of salaries to employees all constitute administrative expenditure.
• Legal Expenses: These include stamp duties and litigation costs
• Miscellaneous Expenses: These include advertisement, reinsurance and taxes.

Expenses are incurred during the first year and the renewal years.

• First Year Expenses = Procurement Costs + x% of first year premium towards expenses + constant expenses per policy towards sum insured + independent expenses per policy
• Renewal Expenses = y% of renewal premium + constant expenses + independent expenses
• The expenses would cease upon termination of the contract.

Cost of benefit is the expected value of benefit or indemnity in mathematical terms.

• Cost of benefit or indemnity = = The discounted value of ( The amount of benefit or indemnity * The probability that the benefit is payable at that point of time)