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Unformatted text preview: Insurance Pricing Risk pooling principles tell us: E(X) = E(X) Var(X) gets small as more people added to pool So, with large numbers of identical and independent risks, insurers best guess of average claim payout per policy is E(X) For this reason, insurance pricing starts with E(X) and builds on that number Insurance Premiums (Pricing) Determinants of Insurance Premium Expected Claim Costs Timing of Claims Payments Expected Investment Income Administrative Costs Profit Loading Pricing Example $100,000 with prob. 0.02 Loss = $20,000 with prob. 0.08 $0 with prob. 0.90 Find Competitive Insurance Premium if: Policy provides full coverage of losses Underwriting expenses = 20% of expected loss (undiscounted) Claims are paid at the end of one year Interest rate (discount rate) = 8% Claim processing costs = $5,000 per claim Profit = 5% of expected loss (undiscounted) Pricing Example Expected claims = $3,600 PV of expected claims = $3600/1.08 Underwriting costs + profit = (0.20+0.05)($3,600) = $900 Expected claim processing costs = ($5,000)(0.10) = $500 PV of expected claim processing costs = $500/1.08 Premium = ($3600+$500)/1.08 + $900 = $4,696 Determining Expected Claims Costs In class examples, we have assumed that the insurer knows the probability distribution of losses for each individual policy holder Insurer sells policies to a large number of buyers with the same (known) probability distribution of losses In practice: Insurers apply statistical techniques to large loss databases to predict E(F), E(S) and outliers based on observed characteristics of policyholders Group consumers into risk pools with similar predicted values of expected loss...
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 Spring '07
 TENNYSON

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