The life insurance companies purchase actuarial tables. These are tables produced from various groups of the population and they list down how many people within a given age group died over a twelve month period.
The general rule is that those in a young age group have less chance of dying and those in a mature age group have a much greater chance of dying.
The insurance company will always try to use actuarial tables which match as close as possible the type of insurance they will have on their books or the type of insured they are hoping to insure going forward.
Age alone is not the only probability. Women general live to an older age then men. People in certain jobs or more exposed to serious work injuries. People in some jobs are more exposed to health risks such as high blood pressure.
Weight and smoking also play an important part in calculating our probability of death.
So the insurance company will select the factors they consider to be the most important and use those to calculate a base risk rate. The base risk rate is the premium rate required just to cover the basic risk before any additional factors are added. Insurance companies need to be commercial in regard to the number of question they can ask us. Who wants to complete a proposal form which is a hundred questions long?
Now we do not all purchase the same sum insured. Some of us want high levels of life cover and other are willing to accept lower levels of cover. Insurance companies need to balance their portfolio of business and therefore they may apply additional loadings to make cover less attractive for some areas and apply lower loading in other areas to make cover more attractive. This will help the insurer balance their portfolio.
If a person wants very high cover then the insurer may purchase reinsurance. That is a form of insurance taken out by insurance companies where they spread the very large risks with other insurance companies. That ability comes at a cost which may mean a load for the higher sums insured.
The insurance company can get the best feel for any risk by having either a medical questionnaire completed or a medical report done. Both of these cost time and money. So insurers will often only require these to be done if the major risk factors indicate that other risks may exist (heavy smoking or excessive over weight) or if the sum insured is high. Under those circumstances the insurance company can justify the additional cost.
Once the insurance company has worked out the actual risk premium they then need to add the cost of acquiring the business, whether this is commission to an agent or the cost of advertising or their own front of shop staff. Then there is the cost of issuing the policy documentation and premium collection.
When insures get the premium in they will invest it. The insurers may get many years investment income before they are called upon to pay a claim. The insurers can consider whether they will earn enough in investment income to allow a reduction in premium rate.
When all the above has been done the insurer needs to add a margin for profit and safety.
These calculations are done by very skilled staff called actuaries. The calculations are done on a regular basis to that the funds the insurers retain to pay future claims are held at a sufficient level.
The insurer must also take into account if the policy offers any additional cover extensions such as joint life cover, terminal illness or critical illness.
The author is Alan Knight who has over 35 years of experience in the financial and life insurance industries.