Insurance Premium Pricing Model

Cover Page

Model overview with product line, effective dates, and navigation. Covers product and coverage details, rate effective dates and approval tracking.

Assumptions

Core pricing parameters including target loss ratio, expense ratios, and profit loads. Covers target combined ratio, investment income credit, trend factors and credibility parameters.

Risk Classification

Defines rating variables and class structures for segmenting the insured population. Covers rating variable definitions, class plan structure, relativities by class and territory factors.

Historical Loss Data

Organized historical claims and exposure data by year, class, and coverage. Covers accident year loss triangles, earned premium by year, claim count and severity and development patterns.

Loss Ratio Analysis

Analyzes historical loss ratios and projects expected future loss costs. Covers ultimate loss ratio by year, trend analysis, loss development factors and expected loss ratio projection.

Expense Loading

Allocates fixed and variable expenses to the premium rate. Covers commission rates, general & administrative expenses, acquisition costs and variable vs. fixed expense split.

Premium Calculation

Combines pure premium with expense and profit loads to calculate the final gross premium. Covers pure premium derivation, expense loading application, profit and contingency margin and final rate per unit of exposure.

Profit Margin

Models the underwriting profit margin under different scenarios. Covers underwriting income projection, combined ratio analysis, return on equity calculation and profit margin sensitivity.

Sensitivity

Tests rate adequacy under different loss ratio, expense, and growth scenarios. Covers loss ratio sensitivity, expense ratio changes, volume scenarios and combined ratio impact.

Summary Dashboard

Executive summary of the pricing analysis with key metrics and rate recommendations. Covers recommended rate level, rate change from current, projected combined ratio and key risk indicators.

Error Checks

Validates data integrity and formula consistency throughout the model. Covers data completeness checks, loss ratio reasonableness, balancing checks and formula verification.

Gross Premium

GP = Pure Premium / (1 − V − Q)

Where V = variable expense ratio, Q = profit & contingency loading. The fundamental insurance pricing formula.

Pure Premium

PP = Expected Losses / Exposures

The cost of claims per unit of exposure, before any expense or profit loading. The foundation of the rate.

Loss Ratio

LR = Incurred Losses / Earned Premium

The proportion of premium consumed by claims. The single most important metric in insurance pricing.

Combined Ratio

CR = Loss Ratio + Expense Ratio

Total cost ratio including claims and expenses. Below 100% indicates underwriting profit.

1.Organize Historical Loss Data and Exposure Measures

Insurance pricing starts with data. Compile historical policy data including premium collected, exposure measures (policy count, insured value, payroll), and claims data including loss amounts, claim counts, and loss adjustment expenses. Organize this data by coverage year, policy form, and rating class. The data must be at sufficient granularity to detect patterns — aggregate data hides important variation across segments. Clean the data for large losses (cap or exclude catastrophic events) to avoid distorting the underlying loss patterns that drive pricing.

2.Develop Loss Costs Using Actuarial Techniques

Loss development is the process of projecting immature loss data to its ultimate value, since insurance claims can take years to fully settle. Apply loss development factors (derived from historical triangles) to bring each accident year to an ultimate basis. Then trend the losses to the future effective period using loss trend factors that account for inflation, medical cost growth, or litigation trends. The developed and trended losses, divided by on-level earned premium, give you the expected loss ratio — the foundational building block for rate adequacy analysis.

3.Build Rating Factors by Risk Characteristic

Not all policyholders present the same risk. Analyze loss experience by rating variable — territory, class of business, vehicle type, coverage limit, deductible, building construction, and more. Use generalized linear models (GLMs) or pure premium methods to estimate the relativities between classes. The key principle is credibility: segments with large volumes of data can support finely tuned factors; segments with sparse data need to be grouped or supplemented with industry benchmarks. The resulting rating algorithm should charge premiums proportional to expected loss cost.

4.Load for Expenses, Profit, and Contingency

Pure loss cost is not the final premium — it must be loaded for the insurer's expenses and target return. Add expense provisions for acquisition costs (commissions, marketing), operating expenses (underwriting, policy admin, claims handling), and allocated loss adjustment expenses. Then add a profit and contingency margin that reflects the required return on allocated capital and provides a buffer for adverse deviation. The total indicated rate equals loss cost divided by the permissible loss ratio (1 minus the sum of expense ratio and profit margin).

5.Validate with Competitive Analysis and Regulatory Review

Before implementing rates, validate them against the competitive landscape and regulatory requirements. Compare your indicated rates against current market rates — dramatic departures from competitors may signal either a genuine pricing insight or an error in your analysis. Review rate filing requirements for your jurisdiction; many lines of insurance require regulatory approval before new rates can take effect. Document your methodology thoroughly, as regulators will examine your data sources, development methods, trend selections, and expense allocations. A well-documented filing accelerates approval and defends against regulatory challenges.