Definition of "Rate making"
Process of calculating a premium so that it is adequate-sufficient to pay losses according to expected frequency and severity, thereby safeguarding against the insurance company becoming insolvent; reasonable-the insurance company should not be able to earn an excessive profit; and not unfairly discriminatory or inequitable. Theoretically, it can be said that each insurance applicant should pay a unique premium to reflect a different expectation of loss, but this would be impractical. Instead, classifications are established for applicants to be grouped according to similar expectation of loss. Statistical studies of a large number of nearly homogeneous exposures in each underwriting classification enable the projection of losses after adjustments for future inflation and statistical irregularities. The adjusted statistics are used to calculate the pure cost of protection, or pure premium, to which the insurance company adds on loads for agent commissions, premium taxes, administrative expenses, contingency reserves, other acquisition costs, and profit margin. The result is the gross premium to be charged to the insured.
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