.

Ratemaking - A rate "is the price per unit of insurance for each

exposure unit, which is the unit of measurement used in insurance
pricing".Rate making , is the determination of what rates, or
premiums, to charge for insurance. A rate is the price per unit of
insurance for each exposure unit, which is a unit of liability or
property with similar characteristics.The insurance premium is the
rate multiplied by the number of units of protection purchased.

Insurance Premium = Rate × Number of Exposure Units Purchased

Ratemaking Principle (CAS)

1. A rate is an estimate of the expected value of future costs.
2. A rate provides for all costs associated with the transfer of risk.
3. A rate provides for the costs associated with an individual ri ks t f
rans er.
4. A rate is reasonable and not excessive, inadequate, or unfair
disscriminatory
5. the rate structure should tend to encourage loss prevention among
those who are insured.
Objectives of rate marketing
Rate making has several objectives under regulatory requirements
regulated by the states and business objectives due to the goal of
profitability: The goal of insurance regulation is to protect the public and
three regulatory objectives are placed to meet certain standards:
 The first regulatory requirement is that rates must be adequate;
meaning the rates the insurers charge should be able to cover
expenses.
 The second regulatory requirement is that rates must not be
excessive; meaning rates should not be so high that policyholders are
paying more than the actual value of their protection.
 The third regulatory objective is the rates must not be unfairly
discriminatory; meaning exposures that are similar with respect to
losses and expenses should not be charged significantly different
rates.

Rate making methods

In property and casualty insurance, there are three basic rate-making
methods:

 Judgment Rating is used when the factors that determine potential

losses are varied and cannot easily be quantified. There are no
statistics regarding quantity of future losses and probability. This
means an underwriter rates each exposure individually.
 The second rate making method is class rating, or manual rating.
This rating means that exposures with similar characteristics are
placed in the same underwriting class, and each is charged the same
rate. The advantage of class rating lies with its easy application and
ability to quickly be obtained.
 The third rate making method is merit rating. This rating means a
plan which class rates, or manual rates are adjusted upward or
downward based on individual loss experience. Merit rating is based
on the assumption of loss experience will differ substantially from
other loss experiences.
Types of rating
1.class rating/manual rating: Class rating is used when the factors
causing losses can either be easily quantified or there are reliable
statistics that can predict future losses. These rates are published in a
manual, and so the class rating method is sometimes called a manual
rating. The class is defined through statistical studies as a group with
specific characteristics that reliably predict the insured losses of that
group. A class rating must be applied to a rate class that is large enough
to reliably forecast losses through statistical analysis but small enough to
maintain homogeneity so that the premium covers the loss exposure and
is competitive for each member of the class. A class rating is a grouping
of people with similar risk profiles for the purpose of issuing them an
insurance rate that roughly corresponds to their risk levels.
Class rates are the most common rate in insurance business. Insured
risks are classified on the basis of one or several important features and
all that belong to the same class are subject to the same rate per unit of
exposure. The rate charged reflects the claims experience for the class as
a whole. It is based on the assumption that future losses to insured will
be determined largely by the same set of factors. This type of rating is
also termed as manual rating because the various classifications and the
respective rates are in the form of printing manuals. Life insurance is
one of the line where class rates are used viz. rates based on age, gender,
healthiness, smoking and drinking habits etc. Class rating is also used
for homeowners insurance, automobile insurance, workers compensation
and health insurance.
The class rate may be determined by dividing the amount of incurred
losses and loss adjustment expenses by the number of exposure units.
Incurred losses include all losses paid during the accounting period, plus
amounts held as reserves for the future payment of losses that have
already occurred during the same period. Loss adjustment expenses are
the expenses incurred by the company in adjusting losses during the
same accounting period.
2. individual rating: Individual ratings are used when many factors are
used to predict the losses and those factors vary considerably among
individuals. Additionally, individuals can exercise loss control measures
that will reduce losses, so those individuals will pay a lower premium.
3. Judgment ratings:  are used when the factors that determine
potential losses are varied and cannot easily be quantified. Because of
the complexity of these factors, there are no statistics that can reliably
assess the probability and quantity of future losses. Hence, an
underwriter must evaluate each exposure individually, and use intuition
based on past experience. This rating method is predominant in
determining rates for ocean marine insurance, for instance.
4. Schedule rating: Under this plan, each exposure is individually rated.
In calculation of schedule rates the first step is to examine the risk (the
person or object insured) in order to identify the features that are likely
to cause losses or to prevent them. Then the risk is compared with the
average or standard risk of its type. Finally deductions are made from
the standard rate, for this risk's desirable features and additions are made
for its undesirable features, the resultant rate is rate that is tailored made
to reflect the characteristics of risk for which it is used. The scheduled
rating system (for a building) takes into account the following major
factors :
• Occupancy
• Construction
• Location
• Protection
• Maintenance
The various additions to and subtractions from the basic rate are based
upon the judgement of the person who develop the overall scheduled
rating system and important feature of this system is that it identifies the
factors entering into an Insurer's rate.
4. Experience rating:
This type of rating modifies the class rate on the basis of claim
experience of a particular exposure. The actual losses for a period
generally of two or three years are compared with the average risks in
the same class. The rate is reduced if the risk has a better record than the
average, it is increased if the record is worst than average. Experience
rating is used only for large risks viz. large enough to have many losses
each year reflecting a trend. Hence, this type of rating is generally
limited to larger firms that generate a sufficiently high volume of
premiums and more crEidible experience.
5. Retrospective rating
Contrary to experience rating retrospective rating modifies the
insurance cost on the basis of current experience. This is generally done
by making a provision in the policy contract that final rates will be
determined retrospectively. Generally a range indication maximum and
minimum is specified and the final premium is determined after the
policy expires and depends upon the amount of losses incurred during
the year. If the losses are very small the insured will pay the minimum
premium otherwise if they are very large the insured will be charged the
maximum premium. Usually the premium lies between maximum and
minimum premium. Retrospective rating increases the insured's
incentive to control losses, because the pay-off in premium savings can
be substantial. It is generally applied to large liability and workers
compensation policies.
Rate Making Entities
Professiontional Rate-making Organisations :
Professional rate making organisations are the specialists that perform
the rating work for the insurance companies. The reason for existence of
such organisations is that many companies do not have the sufficient
data of their own. By working together and pooling their premium and
loss data, they can develop a more reliable rating information. Co-
operative rate-making is also suitable for smaller companies.

Actuaries:
A person with expertise in the fields of economics, statistics and
mathematics, who helps in risk assessment and estimation of premiums
etc for an insurance business, is called an actuary.
Actuaries are the specialists in the mathematics of insurance, who carry
out the prime responsibility of the rate-making process either working in
companies or otherwise. An actuary is a professional who specialises in
the field of analysing financial risks by implementing statistical,
financial and mathematical theories. In insurance, actuaries aid in
assessing risks which help companies in the estimation of premiums for
their policies.    They make financial sense of the future by applying
mathematical models to problems of insurance and finance. Actuaries
are experts who perform actuarial analysis of insurance rates, rating
procedures, rating plans, and schedules of insurance companies. These
 are profeSSionals who are experienced in reviewing and analysing
insurance operations, reserves and underwriting procedures and provide
technical assistance regarding actuarial matters to policy examiners and
other technical staff.
They perform the following functions :
(a) Developing new forms of insurance to meet the changing needs of
consumers.
(b) Determining the reserves needed to meet the future obligations.
(c) Analysing the expenses and earnings and providing database for
distribution of surpluses.
(d) Conducting research studies on claims experiences, projecting future
claims and earnings.
(e) Communicating with the company officials, agents, policyholders,
and regulatory authorities about company policies and practices
Who can be Appointed as Actuaries for Insurance Companies?
As per the Appointed Actuary regulations put forth by the Insurance
Regulatory and Development Authority of India, any insurer or
insurance company should mandatorily appoint an actuary to manage
financial risks and uncertainty of the insurance business.
To be appointed as an actuary with any insurance company, an
individual has to fulfil the following criteria, as put forth under
regulations:
 He/she should be a resident of India.
 Should be a fellow member as per the Actuaries Act, 2006.
In the case of life insurance:
 He/she should have passed a specialisation subject related to life
insurance. Currently, specialisation refers to a Specialist Application
subject as put forth by the Institute of Actuaries in India.
 A prospective candidate should have at least 3 years of post-
fellowship experience pertaining to the annual statutory value of life
insurers.
 A minimum of 10 years’ experience in the life insurance industry,
out of which, at least 5 years should be that of the post-fellowship
experience.
 
In the case of general insurance:
 He/she should have passed a specialisation subject related to
general insurance. As per the Institute of Actuaries in India, currently,
specialisation refers to a Specialist Application subject.
 He/she should have at least 1 year of post-fellowship experience
pertaining to the annual statutory value of a general insurer.
 A minimum of 7 years’ experience in the general insurance
industry, out of which, at least 2 years should be that of the post-
fellowship experience.
 
In the case of health insurance:
 He/she should have passed a specialisation subject related to health
or general insurance. Similar to the above two categories, as per the
Institute of Actuaries of India, currently, specialisation refers to the
Specialist Application subject.
 He/she should have at least 1 year of post-fellowship experience
pertaining to the annual statutory value of a health or general insurer.
 A minimum of 7 years of experience in the general or health
insurance industry, out of which, there must be at least 2 years of post-
fellowship experience.
Apart from these, an individual can be eligible for the position of
Appointed Actuary with any insurance company if they comply with the
following criteria:
 Should be an employee of an insurance company.
 Is not already appointed as an actuary with any other insurance
company in India.
 Is not over the age of 65 years.
 Possesses a Certificate of Practice from the Institute of Actuaries in
India.
 Has not committed any professional breach or is not guilty of any
other misconduct.
Individuals satisfying the above criteria can be appointed as an actuary
for insurance companies by the IRDA.

Insurance business requires advanced statistical and analytical skills for

evaluation of risks and returns associated with each proposal. Insurance
companies employ these experts from the field of economics, statistics,
mathematics, risk assessment and management.

Actuaries play a crucial role in the operation and profitability of any

insurance business. They help the firm with their expertise in calculation
of premiums of various insurance policies, rating methods and reserves,
etc.
Pooling in Insurance:
Pooling of risks is the underlying feature of insurance. Insurance
companies try to make a group or pool of homogenous exposures with a
view to reduce the losses arising from that exposure. It is most
advantageous when the losses are uncorrelated. When the group agrees
to bear the losses in some proportion, the burden on a given member is
reduced. This has the effect of loss distribution for the group flatter and
flatter. The application of large numbers and pooling suggests that
normal curve becomes flatter any flatter when the members are added to
a grouplogically, because of reduction in the variance and likely
concentration towards mean.