How is an insurance premium calculated?

The calculation of an insurance premium is based on the fundamental formula, which involves multiplying the number of units of insurance coverage by the rate per unit. This approach ensures that the risk associated with insuring a particular asset or person is accounted for effectively.

For instance, in the case of property insurance, an insurer evaluates the property and determines a rate based on the risk factors, including the likelihood of damage or loss. The number of units typically refers to the coverage amount or limit chosen by the policyholder. Therefore, the more coverage requested, or the higher the risk of claims, the higher the premium will be when multiplied by the set rate.

Other choices do not adequately capture the comprehensive method of premium calculation. Simply looking at the cost of claims or administrative expenses ignores the risk assessment and the underwriting process integral to determining premiums. Market value alone does not take into account the frequency or severity of potential claims, which are crucial in setting the premium.