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.
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
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:
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.
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
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.