Insurance economic rating parameters

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Insurance economic rating parameters
Kailash Chandra Mishra, Member, Management Consultant, India

Competitive insurance pricing is a function of ten cost parameters.

Economic Parameters of Insurance Product Rating
Above the line costs (always positive costs):
1. Cost of Acquisition (COA)
2. Cost of Management (COM)
3. Cost of Insurance (Obligation) (COO)
4. Cost of Capital (COC)
5. Cost of Ruin (COR)
6. Cost of Interference (COI)
7. Cost of Perspective (Future scouting) (COP)
Below the line costs (Can be positive or negative):
8. Cost of Flows (COF)
9. Cost of Reinsurance (COR)
10. Cost of Ownership (COO)
1. Cost of acquisition is commission paid to source the premium through intermediaries or otherwise.
2. Cost of management is the administrative and regulatory compliance cost of insurance business
3. Cost of insurance is the cost of underwriting obligations, which is the major component of cost elements
4. Cost of capital is the opportunity cost of capital required to be deployed due to regulatory and prudential requirement of insurance; a threshold capital may be required at start up irrespective of business volume and thereafter capital may be required to be augmented due to required solvency margins.
5. Cost of ruin arises due to volatile nature of insurance obligations; insurers are to remain prepared for disaster or worst year phenomena not average obligation and a cost is incurred by way of ruin provision.
6. Cost of interference happens in any business and varies from country to country or place to place depending on corruption perception index; insurance business is more prune to such interference due to its push nature.
7. Cost of perspective results from ambition of insurance to grow in volume; growth requires prior effort when volume has not been acquired and next years result has a cost in the previous year without the volume being acquired.
8. Return from capital & calendar year cash flows; due to capital denudation former can be negative and capital appreciation can make the former positive; similarly calendar year cash flow can be negative on de-growth.
9. Net amount generated from risk transfers, which can as well be negative if for safety perception of balance sheet more reinsurance is ceded than obligation minus net commission of insurance
10.Cost of ownership dividend net of infusions, which is positive if infusion is more than required rate of dividend payout and negative otherwise.
This collectively exhaustive but mutually exclusive cost elements are determined taking insurance business entity concept.
The coefficients of these ten cost elements can be determined in time series of an existing business by regression and depending on availability of assorted market data, a cross sectional analysis can be done to find out corresponding market coefficients. This will facilitate to control the cost magnifications or return accentuations.

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