Sound Rating

A sound premium is the amount required to return an appropriate profit after allowing for claims, expenses and earnings from investments.

Sound premium combines:
– the pure risk premium (or risk cost)
– expense loading
– profit loading

A basic formulaic approach to sound premium can be written as follows:

       Discounted Risk Premium * (1 + Claim Expense Rate) * (1 + Profit Loading)
      ————————————————————————————————————————
       1 – Commission Rate – Net Reinsurance Cost – Underwriting Expense Rate

Expense loadings:
– Underwriting expenses
    commissions, sales & marketing, selection, policy administration
– Policy alteration
    administrative details, risks covered, terms of cover, cancellations, lapses
– Claim handling
– Reinsurance
– Government charges
– General overheads

Profit loading:
Loading required to meet required RORBC. Capital required is the amount of capital held from the time a risk comes on the book to the time it fully expires. It can be calculated on the basis of the difference between the present value of notional transfers at the earned interest rate and the required rate of return.

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