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How to Calculate Premiums
There are two elements in calculating a premium. These are the sum insured and rate.
The sum insured represents the value of the property or the subject that is to be insured, while the rate is the percentage or price that an insurer charges for the protection which is provided under the policy. The premium is the cost of insuring and is arrived at by applying the rate to the sum insured.
For example, if the sum insured of a house is $1,000,000 and the rate is 1%, then the premium will be $10,000 = $1,000,000 x 1%.
This is fairly straightforward but when calculating a motor premium, it may become necessary to apply various loadings. In such a case, the base premium must be determined and then multiplied by the load factor, the result of which is added to the base premium. When more than one loading applies the process is repeated.
For example, a motor vehicle is to be insured with a sum insured of $1,000,000 at a rate of 4%. The insured must to be loaded 20% for having a driver's licence for less than 1 year and another 20% for being under age twenty-five (25) years. The calculation would be:
| $1,000,000 x 4% |
= |
$40,000 (base premium) |
| Plus 20% licence loading |
= |
$40,000 x 20% = $8,000 |
| Total |
= |
$48,000 |
| Plus 20% underage loading |
= |
$48,000 x 20% = $9,600 |
| Total Premium |
= |
$57,600 |
If other loadings were applicable , the process as outlined is repeated. On the other hand, where there are different levels of discounts to be applied, the money value of discount is determined and deducted from the premium. Each discount is deducted from the remaining balance of the premium.
For example, let's assume the premium is $57,600 (from above), and there is now an "other vehicle" discount of 10% and a no claim discount of 20%. The premium calculation continues as follows:
| Premium already calculated |
= |
$57,600 |
| Less No Claim Discount 20% |
= |
$57,600 x 20% = $11,520 |
| Total |
= |
$46,080 |
| Less O/V discount 10% |
= |
$46,080 x 10% = $4,608 |
| Total Premium |
= |
$41,472 |
These are examples of premium calculations for property and motor insurance. The principle also applies to other classes of insurance, although in some cases the rate is applied to a company's annual turnover as is done for public liability policies, and in others on the estimated annual transit, such as for a money policy.
There are also instances when an Underwriter will charge a minimum or flat premium which relates to the Underwriter’s experience with the particular risk rather than referring to the formula that has been described. When this is done it is usually because the premium calculated is less than an acceptable minimum premium.
The Importance of Insurance in Financial Planning
Insurance Glossary
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