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Insurance Rate Methods


The price of insurance depends ultimately on the risk the insurer is taking on on behalf of the customer. 
Simply put, this will depend on the chance of the insured event occurring, and the likely cost of the outcome. 
The way insurers calculate this risk, and quantify the amount of the premium, is through the use of what is 
known as actuarial science. Using certain probability and statistical mathematical models, the insurance 
company can predict with a fair degree of accuracy, the approximate cost of future claims. 

For example, supposing a someone wishes to insure their $100,000 home against fire. For argument’s 
sake, lets assume that 1 in a 1000 homes in this area burn down every year. This would mean that just 
to break even, on the mathematical model, the insurance company would have to charge $100 a year for 
the premium. What the insurance company will in fact do is charge something more than $100, say $120. 
This extra $20 will cover the overhead costs of the insurance company’s operation. It will also cover an 
amount for profit of the insurance company. The only other way the insurance company generates profits 
is by investing all the policy premiums it is paid. That way, all the premiums earn interest, or investment 
returns, while they are in the possession of the insurance company. While this method represents a 
significant income for the insurance company, the majority of insurance company’s funds do actually 
come from the payment of premiums. 

It has been argued that those who pay premiums and do not have to make a claim lose out by effectively 
wasting their unused premium. In this sense, the insurance industry can not be held to produce any net 
gain for society, and therefore, the huge profits they generate are unwarranted. Defenders of insurance 
companies however claim that the peace of mind they offer to all their customers is a significant societal 
benefit which they provide. Simply knowing that you will be compensated if disaster strikes you is worth 
something to people, even if the disaster never strikes. 

The funds the insurance company holds, from premiums that have not been claimed for payouts, 
is called its float. Massive profits can be generated from the float alone. While losses are just as 
possible as gains with all investments, the profits made from insurance company floats, for the 
five years ending 2003, was $68.4 billion. In the same period, insurance companies paid out $142.3 
billion in insurance claims. Some do not believe that the insurance industry will be able to sustain 
itself for ever on profits generated by the float and so predict large premium rises for the future.







About the author:
Joseph Kenny is the webmaster of the insurance site http://www.insure121.com/ where you will find 
information, news and links to the leading providers of car insurance in the UK.






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