What Is Insurance: The Risk Premium And The Continuing Policyholders
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. 0.10 Per Rs. 1000 SA. If a policy has a term of 20 years, the risk premium and therefore, the premium charged, would vary for each of the 20 years.
It would be increasing steadily from year to year. It would be difficult to administer annual changes in a continuing contract. Apart from that, the 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 premium remains constant for 20 years. Such uniform premium is called level premium. This implies that the 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.
There is another reason for level premium being charged. As mentioned already, it is possible that many policyholders would find the higher premium payable otherwise, towards the latter part of the policy, too burdensome, and drop out. The persons who drop out are likely to be healthier than those who continue. The relatively unhealthy ones may try to pay somehow and continue the insurance cover. This would work against the insurer, as the assumptions made in calculating the premium would be disturbed.
The continuing policyholders would not be of the same kind of population, as the mortality tables would have assumed. The mortality tables show the probabilities of death for a group of healthy persons, while in this case, the population of policyholders would have a larger than normal proportion of the unhealthy. This is referred to as Adverse Selection, because the result of the decisions of the healthier policyholders walking out of the group is adverse to the interests of the remaining community of policyholders. The calculations of the insurer and his experience would go awry. The practice of charging level premium, avoids such adverse selection.
#Pure Premium Is Called the 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 premium figures printed in the promotional literature and brochures are office premium. They are also referred to as the tabular premium.
The actual premium to be charged in any one case would require further adjustments, depending on the practice of the insurer. For example, the administrative costs are more if the premium is paid every quarter or month, instead of once in a year. The number of renewal notices and receipts to the mode.
If the mode is yearly, the probability of default in the insurer can utilize this amount for the entire year and earn more interest than if the premiums were paid in installments. Therefore, the premium rate would have to be slightly increased or decreased depending on the chosen mode of payment.
#Charge Extra Premium on Any Particular Policy
Extra premium may be charged on any particular policy. This 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 insurance plan, like accident benefit or premium waiver benefit. Riders (discussed in a subsequent blog) 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 health 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 premium otherwise chargeable.
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