BU353 Lecture 7: Actuarially Fair Premiums
Document Summary
Fixed administrative costs imply that exposures with very small severity will have a high loading relative to expected claim costs, making the cost of insuring small losses on an individual basis unattractive to most people. To illustrate, consider two bicycles: one worth and the other worth ,000. Assume that the probability of each bike being stolen is 0. 05. Then the expected claim costs for full insurance would be ( x 0. 05) and (,000 x 0. 05), respectively. Assume that the fixed costs of paying employees to market, underwrite, and process an application for bike insurance are , that these are the only administrative costs, and that capital costs are sh. Then, ignoring investment income, the fair premiums would be for the bike and for the ,000 bike.
