HOW INSURANCE COMPANIES SET THE PREMIUM AMOUNT AND SELECTS THE INSURANCE SCHEME/PLAN

HOW INSURANCE COMPANIES SET THE PREMIUM AMOUNT AND SELECTS THE INSURANCE SCHEME/PLAN

• At the most basic level, initial ratemaking involves looking at the frequency and severity of insured perils and the expected average payout resulting from these perils

• Thereafter an insurance company collects historical loss data, bring the loss data to present value, and compare these prior losses to the premium collected in order to assess rate adequacy

• Loss ratios and expense loads are also used

• Rating for different risk characteristics involves at the most basic level comparing the losses with "loss relativities"—a policy with twice as many losses would, therefore, be charged twice as much

• More complex multivariate analyses are sometimes used when multiple characteristics are involved and a univariate analysis could produce confounded results

• Other statistical methods are also used in assessing the probability of future losses
• Upon termination of a given policy, the amount of premium collected minus the amount paid out in claims is the insurer's underwriting profit on that policy
• Underwriting performance is measured by something called the "combined ratio"  which is the ratio of expenses/losses to premiums
• A combined ratio of less than 100 percent indicates an underwriting profit, while anything over 100 indicates an underwriting loss
• A company with a combined ratio over 100% may nevertheless remain profitable due to investment earnings
• Insurance companies earn investment profits on "float"
• Float, or available reserve, is the amount of money on hand at any given moment that an insurer has collected in insurance premiums but has not paid out in claims
• Insurers start investing insurance premiums as soon as they are collected and continue to earn interest or other income on them until claims are paid out
• float method is difficult to carry out in an economically depressed period
• Bear markets do cause insurers to shift away from investments and to toughen up their underwriting standards, so a poor economy generally means high insurance premiums
• This tendency to swing between profitable and unprofitable periods over time is commonly known as the underwriting, or insurance cycle