Risk Management: Premium loading Q&A

On 9/24/18, 1:17 PM, "Finance 4335 Student" <Finance4335student@baylor.edu> wrote:

Dr. Garven,

What does the term “premium loading” mean? I’m familiar with many of the concepts in the problem set, but was unable to find this term and how to calculate it in class notes.

– Finance 4335 Student

Here’s my response to "Finance 4335 Student" on the topic of premium loadings:

It corresponds to the markup in the premium relative to the expected value of the claim (also commonly referred to as the expected value of the "indemnity"). In percentage terms, % loading = (premiumE(indemnity))/E(indemnity), and in dollar terms, $ loading = premiumE(indemnity), where E(indemnity) corresponds to the expected value of the indemnity. As we showed in class last Thursday, the expected value of the indemnity corresponds to the expected value of the loss only when full coverage is offered. Under a deductible policy, the indemnity in state s, indemnity(s) = Min(L(s) – Min(L(s), d)), where L(s) corresponds to the state-contingent loss and d corresponds to the dollar value of the deductible. Under a coinsurance policy, the indemnity in state s, indemnity(s) = L(s) – (1-a)L(s), where a corresponds to the coinsurance rate. Under an upper limit policy, indemnity(s) = Min(L(s), u), where u corresponds to the dollar value of the deductible. If you look at the “Insurance Payment Calculations” worksheet tab in the Coinsurance, Deductibles, and Upper Limits Spreadsheet, you’ll see that these are the equations used in order to determine the indemnity schedules under the various contracts listed there.

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