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Recitation 10

Recitation 10. Insurance Premiums. One way to deal with risk is to transfer it to somebody else You pay somebody (like the insurance company) to take on your risk How does the insurance company come up with the amount of the premium?

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Recitation 10

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  1. Recitation 10

  2. Insurance Premiums • One way to deal with risk is to transfer it to somebody else • You pay somebody (like the insurance company) to take on your risk • How does the insurance company come up with the amount of the premium? • How much should they charge you in exchange for taking on your risk?

  3. Insurance Pricing • Insurance companies employ actuaries whose job is to analyze mortality rates • Probabilities are calculated for living and dying during a certain amount of time for people with similar certain characteristics • These calculations eventually take the form of Mortality Tables

  4. Term Insurance • Term insurance is the most straightforward form of protection. You generally pay premiums on a monthly or annual basis and your family is protected for that "term“ • While premiums for these level term policies remain level for a set number of years, after this time period the premium increases significantly, making the policy cost prohibitive.

  5. 23 year old female, Indiana

  6. 33 year old female, Indiana

  7. 43 year old female, Indiana

  8. 53 year old female, Indiana

  9. 63 year old female, Indiana

  10. 73 year old female, Indiana

  11. 83 year old female, Indiana

  12. Mortality Table Example • 1980 Mortality Table : Male

  13. Procedure of Calculating Insurance Premiums • Find “Expected Claims” • Find present value of those expected claims • Up-front price of the policy

  14. Procedure of Calculating Insurance Premiums continued • Annual payment (monthly has to be adjusted for frequency)

  15. Insurance Example • If you were 35 years old and wanted to pay for a $10,000 5-year term policy up-front, how much would you pay? Assume 4% interest rate

  16. Solution • Age 35: • Age 36: • Age 37: • Age 38: • Age 39:

  17. Solution Continued • PV of Expected Claims • Age 35: • Age 36: • Age 37: • Age 38: • Age 39:

  18. Solution Continued • The up-front price

  19. More on pricing • Most people will set up a payment schedule rather than pay up front. • In the previous example, what would your annual payment be? • You need to find the probability of being alive to make a payment

  20. Solution Continued • Annual payment

  21. Solution Continued

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