The common query raised by clients with their insurance agent is: why does his insurance company charge more premium for the same cover and tenure? We have tried to address this query below.
Insurance is essentially a matter of sharing risk. A thousand people contribute a certain fixed amount (i.e. premium) and in future if something were to go wrong with any of the mass contributors, the lump sum collected as premiums is used to compensate for the loss.
The basis on which the insurance company decides the amount of premium to be paid by each person is determined mainly by three factors:
1. Mortality Tables:
All insurance companies refer to different mortality tables. These tables differ from country to country. The mortality table indicates the probability of a person dying in a particular age group.
For example, in an age group of 25-30 years, the probability might be just two, but this probability would increase for a higher age group of 45-50 years.
The Life Insurance Corporation with its long-standing presence has a mortality table, which is grossly outdated.
Some other insurance companies have got their own tables but they are more or less in line with that of LIC.
2. Expected Surplus:
The premiums collected by the insurer are invested in capital markets. There is a fixed investment pattern for the insurer.
Out of the surplus earned on the premiums invested, 95 per cent is distributed to the policyholders and the insurance company retains the balance 5 per cent.
If an insurer expects to earn more return on his investment then he would charge more premium to his investor. It also depends on the nature of return (compounded or simple) the insurer is planning to give to his policyholders.
A compounded return would mean higher premium for the life to be assured.
3. Expenses:
An insurance company has to incur expenses in the form of commission to agents, office expense, advertising expense, salaries to employees.
These expenses are to be managed by the company in the 5 per cent surplus earning which they earn as mentioned above.
In order to meet the above expenses the insurer has to collect more premium so that there is more surplus from which expenses can be met.
Therefore, even if an insurer's premiums are a bit higher compared to others it is justified for the security of its policyholders and basically for its survival in the long run.
