Probability

is the measure of likelihood of an event to occur. Probability of an event to

occur lies between 0 and 1. The higher the probability, the likely the

occurrence of the event. A simple and a most common example of probability is

the tossing of a fair coin. The probability of a head or tail to occur in a

single event is ½ or 50%. The probability of heads or tails to occur is equal.

Applications of

probability:

Probability theory is

applied in everyday life for various tasks. It is particularly instrumental in

areas where decisions directly are based on the future. The insurance industry

and markets use probability for future decisions. Probability can be used to

analyze future trends of trade markets and financial markets. In addition to

financial institutions and markets, probability has a wide scope in the field

of natural sciences, engineering and biology. Many consumer products, such as

automobiles and consumer electronics, use reliability theory in product design

to reduce the probability of failure. Failure probability may influence a

manufacturer’s decisions on a product’s warranty.

Probability used in

insurance companies:

In our report, we are

going to focus in detail on the application of probability by the insurance

companies. Companies that provide probability and liability insurance use

probability to access risks. When you are getting anything insured, you analyze

different policies with the principle of probability and decide which policy to

buy depending upon the usage of a good or property. For example, a person

decides to buy insurance policy for his car based on the usage and probability

of it getting damaged or lost. The insurers use statistics to calculate and

manage risk when evaluating policy and setting premium rates.

Now we are going to determine,

how probability is used by different insurance policies:

1. Health Insurance:

Health

insurance companies use probability to evaluate policy options. Forexample,

policy holders who smoke have high probability to develop health problems.

Statistics show that this leads to increase health insurance claims. These

statistics are developed through probability. The applicants age and geographic

location also enables the insurance companies to predict further decisions and

future claims based on probability for the insurance.

For

example, the health insurance in

the Netherlands everyone is obliged to have basic health insurance and all

insurers are obliged to accept every applicant, at community-rated premiums.

Premiums can differ between insurers and typically amount to 100 euro per month

per person. Children below the age of 18 years are insured free of charge,

and without a (mandatory or voluntary) deductible.1

2. Life insurance and annuities:

Analyzing mortality rates, the insurer considers where the

policyholder lives and what socioeconomic factors affect policyholder’s current

age and health. This analysis helps the insurer determine rates and consider

various options for life insurance policies and annuities using probability

theory to predict the number of years a policyholder will live. Term life insurance is generally considered one of the

more inexpensive ways to secure a death benefit.

Because term life insurance will expire

when the policy holder reaches a certain age, it is important that policy-holders

ensure that renew the policy

when it expires. Term

life is popular with young families who need protection, but also need to keep

prices low. It is often intended for income-replacement needs.

For example, Umar has a term life

insurance policy that covers him financially in the event of death until the

age of 50. Should Umar somehow die before the age of 50, the terms of the

policy cover him and pay a financial benefit. If Bob lives past the age of 50,

however, his policy will not yield any financial

benefit. So in this case, both the analysis of the policy are calculated

through probability. He must renew the policy for another term under new

conditions.

3. Liability and property:

Companies that provide property and liability insurance use

probability to assess risks. Data show that the age and gender of the driver

plays a role in the likelihood of an auto accident. The type of vehicle

insured, the driver’s geographic location, the condition and model of the car

and the number of miles driven regularly are additional factors the insurer

considers when setting premium rates based on probability. The more miles a

policyholder drives, for example, the greater the probability he’ll be involved

in an accident. Setting rates for homeowners insurance also involves

probability. Factors considered include the type of heating system in the home,

the location and age of the property and any added security features it has.

Many people get their valuable assets like mobiles and jewelry insured and the

insurance companies determine the rate with the help of probability based on

the usage and risk factor.

1 https://link.springer.com/article/10.1007/s10645-015-9258-8