A Modern Approach to Insurance Premium Calculation


Insurance policies don’t have consistent prices, rather each insurance policy comes with a particular premium.

This is because each insurance premium is calculated using hundreds of factors: age, medical history, family history, occupation and hobbies, smoking, and tobacco use are only some of the variables that go into calculating premiums. 

Even though insurers follow the same principles, each carrier has its own way of calculating premiums.

Premiums and Rates

There is often confusion between the terms “rate” and “premium”, which leads to them being used interchangeably. An insurance premium is an amount a policyholder pays to the insurance provider for the coverage, which is typically paid monthly, quarterly, or annually.

Insurance rates, on the other hand, are the prices of a particular plan's benefits. A premium is set by adding together all the different elements of the rates.

Insurance Coverage

Since insurance companies collect premiums in advance, they need to be able to predict how much money is necessary to finance claims in the future. An accurate premium calculation means that the insurer has enough funds to cover all those potential claims.

Accurate predictions require large volumes of data, gathered over the course of many years. Underwriters synthesize data from hundreds (or even thousands) of sources to calculate insurance premiums. 

Let's take a quick look at some of the variables insurers take into account to calculate different types of insurance premiums.

Common Factors that Affect Insurance Premium Rates

Below are some variables that carriers get from their prospects when calculating insurance premiums:

  • Age: Insurers use an applicant's age because that's the most important factor to consider in health and life insurance. When it comes to health insurance, younger applicants pay lower premiums because they are statistically less likely to need expensive medical care. However, in auto insurance, young drivers are inexperienced, so their insurance premiums are more expensive.
  • Scope of Coverage: Comprehensive coverages cost more. For instance, basic auto insurance coverage that only covers liability is less expensive than a policy with collision, medical payments, and uninsured motorist coverage. 
  • Personal History: Based on the type of insurance policy, an insurance company may look at various factors including a prospect's claims history, medical history, driving record, health, lifestyle choices, and occupation.

These are the most generic variables used in insurance premium calculation. However, it's necessary to go into more detail to get the best results.

How Are Home Insurance Premiums Calculated

The location of the insured property is the most crucial variable. Carriers look at previous non-natural losses in the insured property's neighborhood, such as break-ins, vandalism, or theft. 

Quality of the Property

The way a property is built and the systems inside affect premiums, since some types of houses are more susceptible to damage than others.

Type of Construction

The way houses are built makes them more susceptible to certain types of losses. For example, houses with basements are more prone to flood damage, which is why they cost more to insure.

Also, the age of the property is a frequent factor; newer houses often have more sophisticated safety features such as emergency water shutoff devices or security systems.

Natural Disasters

Sources like flood maps and historical records help shed light on a property’s relative risk from each type of calamity.


The way an insured uses their home can also raise or lower premiums. For instance, vacant houses have more expensive premiums, since there's nobody to deal with issues that can spiral into serious damage.

Property Use

Premiums can also be affected if the insured property is a primary residence or a vacation home. Primary residences have the least amount of risk and therefore enjoy lower premiums. However, vacation homes are often empty most of the time, which increases the likelihood of break-ins.

Another variable affecting premiums is living with unrelated roommates, which is riskier than sharing a home with family members. Therefore, premiums are higher for properties when the occupants are not related.

How Insurers Calculate Premiums

Insurance providers employ actuaries who are business professionals that use mathematical calculations and statistics to assess risk and generate insurance premiums.

Many insurance companies use enterprise software to manage their premium calculation models. While these tools do allow for accurate pricing, insurers are limited to the methods already implemented in these software solutions.

They are very useful when an organization is in the early stages of growth because many of the models and settings are pre-defined. As a result, users don't have to worry too much about whether the premiums were properly priced.

However, after a while, as an insurance company gathers more data on various risks, actuaries and underwriters soon realize that there are other powerful methods that accurately calculate premiums but aren't available in these software tools. Insurers begin to uncover certain hidden connections and relations that need to be taken into account.

As insurers' underwriting and risk management teams become more seasoned, they will need to develop new models (typically using R or Python) to calculate insurance premiums.

insurance premium calculation

So, going beyond the restrictions imposed by ready-made solutions and achieving freedom in risk modeling is the key to gaining a competitive advantage in the market.

Therefore, incumbent insurers and ambitious insurance organizations that constantly need to adjust their premium calculations can't use these kinds of software tools to achieve their business goals.

There’s a strong tendency in the industry not to use models (e.g. linear regression) that come with the software acquired from vendors, but rather insurers want to construct their own models that would give them an edge over competitors. However, implementing these models in the software solution comes with a host of problems.

When building custom models, insurers need to quickly export the changes in models to software’s online calculators that affect sales premiums. Oftentimes, tariff models are embedded in the software, which means that insurers have to wait for help from their IT department to make necessary changes. As a result, insurers wait days or weeks until the department has time to release a new version of the software.

In order to speed up the process, sometimes insurers extract the tariff models into an external tool. Unfortunately, the usage of these tools is complex and only a few users in the entire organization would have the expertise to make changes. 

Whichever way you look at it, insurance companies are unable to implement instant changes.

By using Higson insurance companies can model their tariffs in a such way that enables them to quickly import the results of their working model, run a regression test to see the impact of the changes on their test wallet, and have it running in production with a few simple clicks. Of course, Higson keeps previous versions of tariff models so that insurers can finish serving those customers that were still in the sales process when the changes were made.

This also allows carriers to explain to regulators how a premium was calculated for a specific customer, should the need arise.

Insurance Companies Innovate with Higson

As a result, leading insurance providers are turning to Higson to achieve a competitive advantage in a highly-saturated market.

Higson is a hyper-efficient rules engine, which is a powerful software solution that empowers non-technical business users to make complicated changes to their premium calculations without relying on support from IT.

Business professionals can manage their pricing and scoring algorithms with a user-friendly graphical interface, without being confined to pre-built models.

To see how Higson can help your organization to innovate, then schedule a free call with one of our experts today.

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