What is an Insurance Premium

What is an Insurance Premium: The Insurance Premium is calculated on the basis of assumptions relating to future experiences on mortality, interest rates and expenses. These assumption are based on the insurer's own experience in the past and therefore, not arbitrary. Yet, they are assumptions as far as the likely future experience is concerned. The margin for contingencies is provided because of the uncertainty that these assumptions will turn out to be valid, as the future unfolds.

Level Premiums

        If it is expected that out of 10,000 persons at a specified age, the probability is that one may die within one year, the mortality rate at that age is said to be 0.01%. The Risk Premium  chargeable  for persons at that age would be Rs 0.01 per Rs. 1,000 SA. If a policy has a term of 20 years, the risk premium and therefore, the Insurance Premium charged would vary for each of 20 years. It would be increasing steadily from year to year. It would be difficult to administer annual changes in a continuing contract. A part from that, the Insurance Premium at later ages, towards the end of the policy term, would be very high and people may find it beyond their ability to pay. 

         They will then be without the protection of insurance at times when they need it most. To offset this problem, insurers spread the Risk Premium  on a uniform basis, throughout the term of the policy. The Insurance Premium  remains constant for 20 years. Such uniform premium is called Level Premium. This implies that the Insurance Premium collected would be more than necessary for the risk in the early ages, and less than necessary towards the latter part of the policy.

Office Premium

          The premium figures arrived at after loading the Net Premium or Pure Premium, is called the Office Premium. They are now ready for use. The Insurance premium figures printed in the promotional literature and brochures and Office Premium. They are also referred to as the Tabular Premium.

Extra Premiums

          Extra Premiums may be charged on any particular policy.. This may happen because of the grant of some benefit in addition to the basic benefits under the plan, like accident benefit or premium waiver benefit. Riders provide additional or supplementary benefits. Extra Premium may become chargeable because of decisions relating to the extent of risk in any particular case. If the risk of the person to be insured is assessed as more than normal, because of healthy or because of occupation or habits, insurers may charge Extra Premium. These are usually stated as say, Rs.2 per thousand, and will be added to the Insurance Premium otherwise chargeable.

What is Premium

In a contract of insurance, the insurer promises to pay to the policy holder a specified sum of money, in the event of a specified happening. The policy holder has to pay a specified amount to the insurer, in consideration of this promise."Premium" is the name given to this consideration that the policyholder has to pay in order to secure the benefits offered by the insurance contract. It can be looked upon as the price of the insurance policy. It may be a one-time payment. That is not common. Ofter, it has to be paid regularly over a period of time. A default in premium can endanger the continuance of the policy. If that happens, the policy will be treated as "lapsed" and the expected benefits may not be available. The consequences of default are specified in the policy conditions.

The calculation of premium is a complex technical process, involving actuarial and statistical principles. Only trained professionals, called actuaries, do it. Tables of premium rates for each plan of insurance are made available by insurance companies for the use of agents, who are required to quote the premium for a particular policy being offered to a prospect.

The risk premium is calculated on the basis of an expectation as to how many persons are likely to die within a year in an age group. This expectation, regarding the number of persons likely to die within a year at each age, is calculated by actuaries on the basis of past experiences and made available as "Mortality Tables".

 The risk premium would be adequate to pay the claims that would arise, if all the policies provided benefits only in the event of death within one year. Such policies are called term insurance policies. This premium will not be adequate for policies which provides also for amounts payable on the person survival, are called Endowment Policies. The actual premium collected in such policies would have to be more than the risk premium. Here also, the mortality tables would be used to estimate the number of persons who may survive the specified periods or terms.

The premium collected by insurers every year are not utilised for payment of claims. This so for many reasons. One is the real experience may be different from the probabilities indicated by the mortality tables. Secondly, the portion of the premium is meant to meet the survival benefits and must be kept aside. The balance premium kept aside, after outgoes of various kinds, will be invested and will earn some interest. To the extent of these interest earnings, the premium charged can be reduced. The premium worked out after taking into account the interest likely to be earned, is called the Net premium or Pure Premium.