Fundamental Principles Underlying Rate Making
By Bruce D. Mudgett.
To compute premium rates in life insurance the following facts must be
known: (1) the age of the insured; (2) the kind of policy to be issued and
its face value; (3) the mortality table to be used in measuring the incurred
risk; and (4) the maximum rate of interest which the company is willing
to guarantee on funds in its possession. For example, if a contract is issued
promising to pay the holder $1,000 should death occur within the following
twelve months, and if the chance of death within one year is measured by
the American Experience table of mortality and it is further known that
the person to be insured is forty years of age, all the facts are at hand
for determining the amount of money to be contributed by him in order to
cover the risk. At age 40 the table shows that his chances of dying are
9,794 in 1,000,000, or, expressed as a decimal, .009794. This decimal multiplied
by 1,000 represents the amount of money the insured must pay to receive
the protection promised, if it is assumed that the money is put away and
no use made of it until needed to pay losses. While the illustration is
exceedingly simple and makes no attempt to bring out many of the complicated
factors found in a more complete analysis of ratemaking, it contains the
essential features of any rate computation, viz, the determination of the
risk covered and the amount payable in case the risk occurs. But before
a fuller analysis can be undertaken it is necessary to explain certain peculiarities
of life insurance which differentiate it from insurance of other hazards
and which are fundamental to any discussion of ratemaking. Certain arbitrary
rules used in rate computations must also be stated. To this twofold task
the present chapter is devoted.
Sections in Chapter 12.
