DEFINITION of Actuarial Equity
Actuarial equity is the calculation of an insurance premium based on crucial factors such as the applicant's age, gender, health, family history and the type of insurance coverage applied for. This is so insurers can to treat applicants fairly according to their estimated risk levels.
BREAKING DOWN Actuarial Equity
In automobile insurance, for example, insurers use age as a rating factor in determining individual premiums. Thus, because young people tend to have less favorable driving records as a group, these individuals are required to pay out more in premiums, which normally include the expected value of losses. Also known as risk-based pricing.
How Actuarial Equity Works
For example, an individual's life expectancy isn't just about how old they are. It's about their actuarial age, based on calculations and statistical modeling. Actuaries use mathematical and statistical computations to predict a person's life expectancy, or his or her actuarial age, to assist insurance companies with pricing, forecasting and planning. The actuarial age reflects factors such as health and serious medical conditions. Knowing a person's actuarial age will help determine the most appropriate payments from an annuity.
With auto insurance, actuarial equity is even more important. So insurers look at factors including driving record, type of car, where the vehicle is garaged or parked, type of vehicle, age of the driver, even credit scores, though many states have rules on whether some of these factors can be considered in underwriting policies.
The goal for insurers is, as much as possible, to have each person pay their fair share based on what's objectively known about them. But insurance is about spreading the risk over many people, so one might justifiably ask, why not just divide the bill evenly based on claims experience of the entire group and have everyone pay the same?
That's an approach that works well with playing the lottery because nearly everyone will be a loser and anyone who buys a ticket understands that. With insurance, an equal division would penalize people who are more mature, drive less-expensive to repair cars and live in neighborhoods with fewer thefts. Conversely, it would reward bad drivers and those who make a lot of claims. That in turn would drive up claims from the rewarded class, making insurance in turn more costly for everyone.
To be sure there are other ways to allocate cost in insurance than actuarial equity. One would be a social equity system where each person pays based on their ability to pay.