International Styles

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 rate-making, 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 rate-making. Certain arbitrary rules used in rate computations must also be stated. To this twofold task the present chapter is devoted.

Sections in Chapter 12.

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