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How Premium Is Calculated?

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One of my friend was asking me "How is insurance premium calculated ?".

Ya.. I know. It is a very complicated process and I still tried to explain him.


Here it goes.


In different places it is calculated differently. I will tell you 2 basic differences taking two different countries.


Say for example in UK,

YOu can decide a premium for a particular person based on his characteristics. YOu can also add some extra amount to that person of you think he is very rich. The state laws allow you to do that, which is not the case with US.


Considering US,

YOu cannot come up with your own premium for a particular person. You can decide on premiums only based on segments example: He belongs to a segment of people whose annula income is > $100k and so for that segment the premium will be calculated in this way.


To help you understand it better.. everywhere the premium calculation is done by using the below formula.


Premium = Base Rate * Rating Factor 1 * Rating Factor 2 * RF3 * RF4


Rating Fators are basically, those metrics which will determine if you will have a higher or lower premium based on characteristics.


Below are some of the Rating Factors:


1. Age

2. IS Score

3. Your accident history

4. YOur History with prior insurance companies

5. YOur Premium Payment history

6. Number of cars you own

7. etc etc etc.



The above are some of the rating factors I have given you. But there are many. There will be a value associated with different segments and that will be multiplied with the base rate and that will give you your final premium.




1. Age -- If you are young/old, you are risky so RF value will be say 2. But if you are in the age between 30-40, you will be very careful and the RF value will be say 1.

2. Accident History - Say you had 2 accident in past 1 year, your RF for this segment will be 2.5 and if no accident it will be 1.5

3. Prior Insurance History - If your prior insurance history is good, you will have a low rating factor else it will be high



When you add this to your base rate, you will come up with the premium.


Your Premium = 100(Example) * 2 (RF for your age 23) * 1.5 (RF for your acc. history ie. no accident) = $300

Your Fathers Premium = 100(Example) * 1(RF of your fathers age - less because of his age, he will drive responsibly) * 1.5 (again, your father had no accident history) = $150


The above will be the premium if in case of US and they cannot do anything about it unless they can categorize. Say you are in UK, if they think you are a bad person, they can add some 20$ to your premium, just like that.


This is the overall calculation of the premium, but there are so many rating factors, segments where they classify you and try to get the right premium from you.


Hope this helps.

Thoughts/ ideas/ correction? please add them.


How does it work in your country?

Share it. I would love to know.

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