What Is an Actuarial Rate?

An actuarial rate is an estimate of the expected value of the future losses of an insurance company. Usually, the estimation is predicted based on historical data and consideration of risk involved. Accurate actuarial rates help protect insurance companies against the risk of severe underwriting losses that could lead to insolvency.

Key Takeaways

  • Actuarial rates are estimates of future losses, generally based on historical loss.
  • Actuarial ratemaking is used to determine the lowest premium that meets all the required objectives of an insurance company.  
  • Rates are expressed as the price per unit of insurance for each unit of exposure. 
  • Actuarial rates are reviewed and adjusted periodically.

How Actuarial Rates Works

Actuarial rates are expressed as a price per unit of insurance for each exposure unit, which is a unit of liability or property with similar characteristics. For instance, in property and casualty insurance markets, the exposure unit is typically equal to $100 of property value, and liability is measured in $1,000 units. Life insurance also has exposure units of $1,000. The insurance premium is the rate multiplied by the number of units of protection that are purchased.

Generally, during a review of a rate, it's first determined whether the actuarial rates need to be adjusted. A projected loss experience gives the insurance companies the ability to determine the minimum premium required to cover expected losses.

Requirements for Actuarial Rates

The primary purpose of actuarial ratemaking is to determine the lowest premium that meets all of the required objectives of an insurance company. A successful actuarial rate must cover losses and expenses plus earn a profit. But insurance companies must also offer competitive premiums for a given coverage. In addition, states have laws that regulate what insurance companies can charge, and thus, both business and regulatory pressures are taken into consideration during the ratemaking process.

A major component of the ratemaking process is to consider every factor that might impact future losses and set a premium pricing structure that offers lower premiums to low-risk groups and higher premiums to high-risk groups. By offering lower premiums to low-risk groups, an insurance company can attract those individuals to buy its insurance policies, lowering its own losses and expenses, while increasing the losses and expenses for competing insurance companies (who must then vie for business from higher-risk pools of individuals). Insurance companies spend money on actuarial studies in order to ensure they're considering every factor that can reliably predict future losses.

Actuaries focus on performing statistical analyses of past losses, based on specific variables of the insured. Variables that yield the best forecasts are used to set premiums. However, in some cases, the historical analysis does not provide sufficient statistical justification for setting a rate, such as for earthquake insurance. In such cases, catastrophe modeling is sometimes used, but with less success.