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.
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