subject: Everything to Know about Insurance Premiums [print this page] Everything to Know about Insurance Premiums
Almost everyone has heard the term "insurance premium"and the vast majority of Americans make regular premium payments to one insurance company or another. But many people have no real understanding of what exactly a premium entails. Here is a brief explanation of the process.
An insurance premium is basically the amount a person pays for a certain level of insurance coverage. Insurance companies base their premium calculations on several factors that make up a business model. This model takes into consideration all of the factors that affect the likelihood of a claim being filed on a specific type of insurance. The end goal is a determination that protects the company while providing the lowest rates possible in order to attract clients.
Underwriting Process
The underwriting process is what determines the majority of a premiums cost. It is also the most complicated step. Specialized professionals called actuaries, who are trained in determining risk, analyze a great number of factors that are likely to play a role in claims. Depending on the type of insurance, factors such as location, age, health, education, experience and a long list of others are carefully weighed. Once the factors are determined and weighed, insurers then decide how much risk they are willing to assume. This in turn will affect the amount of money they will charge in return for taking that risk. The end numbers are determined by dividing the total of potential claims and operating costs by the premiums. The goal is a number that is 100% or less, which represents a profit to the company. Anything over this number could potentially lead to a loss.
Investment Return
Since the money an insurance company collects in premium payments is invested in other lucrative pursuits, a ratio over 100% might not actually lead to an overall loss. The difference in the money taken in as premiums and paid out as claims is called the float. This is the amount a company can invest and is an important factor in determining the overall premium rates.
Profit Determination
Insurance companies operate off a business model that is fairly simple. The company profit is determined by the formula
Since factors change regularly, including market competition, the premium rates must be constantly reviewed and revised. When interest rates are low or the market is in a slump, companies will take in less in the form of investment return. Therefore they may have to raise premiums to offset the loss. This is a careful ballet that must be perfectly choreographed to make sure the company doesn't put itself in a situation of owing more in claims than they have money to pay. This can lead to insolvency and bankruptcy. On the other hand, high premiums will mean the loss of customers and similar financial problems.
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