How is the pure premium calculated?

The method for calculating pure premium involves dividing total incurred losses by the number of exposure units, which accurately reflects the risk associated with providing insurance. In this context, an exposure unit can refer to various metrics, such as the number of homes insured or vehicle miles insured, depending on the type of insurance. The pure premium is a fundamental concept as it focuses solely on the cost of coverage excluding administrative costs and profit margins.

Calculating pure premium this way allows insurers to determine the amount of premium required to cover the expected losses from claims within a given period. This straightforward calculation provides a foundational basis for pricing insurance policies, ensuring that premiums are fair and aligned with the actual risk posed to the insurer.

If total incurred losses were divided by the number of insured homes, it could provide a measure specific to that market but would not reflect the broader concept of exposure across all units, which makes the more general calculation using exposure units preferable. Total premium collected divided by the number of policyholders, while related to profitability, does not provide the same insight into expected losses as pure premium does. Lastly, calculating total claims made divided by the number of insurance representatives lacks relevance to insurance pricing and risk assessment.