The success of the competitive market depends on pricing. Basically, price is the value that sellers set on the products they offer for marketing.
Insurance pricing determines the premiums collected for an insurance contract. Insurance pricing is a difficult actuarial technique. In insurance, the sales price or premium is collected before specific services, such as claim payments are made. It is difficult for the insurers to decide the price of insurance products.
Insurers build a reserve from the premiums collected and invest it in financial markets according to the norms of the appropriate regulatory authority. Thus, insurance firms fulfills an important financial intermediary function.
The basic principle of insurance pricing is that insurers selling policies or insurance coverage must receive premiums that are enough to fund their expected claim costs and managerial costs,
and provide an expected profit to pay off for the cost of acquiring the investment necessary to support the coverage sale.
The base premium is calculated using the equivalence principle on the basis of expected claims distribution as,
P = E(s) + k + R Where, E(s) = Mathematical expectation of claims
k = Ongoing company running costs
R = Risk premium
The risk premium allows for coverage of unforeseen deviations in the claims amount to be paid, but still provides the company with the standard pricing methods. Within large, expanded and
identical underwriting securities, the claims payload should meet its expected value.
Insurance prices or premiums consist of three components. They are pure premium, operating expenses, and margins and other income.