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Morbidity is the incidence or probability of sicknesses or accidents within a given group of people. Morbidity rates indicate the average number of people who can be expected to become disabled each year due to accident or sickness, and can help insurers project annual claim costs.
The insurer collects the mortality charge to pay the policy face amount if an insured dies. Since the insurer earns interest on the premiums it collects, the expected interest is subtracted from the mortality cost to arrive at the net premium. Then, the insurer adds its expected operating costs (underwriting, overhead, and commissions) to calculate the gross premium that the insured pays.
Another way to view this formula is net premium plus expenses (loading) equals the gross premium.
Assume that the mortality cost is $500 and interest is $100, producing a net premium of $400. If the operating cost is $200, the gross premium equals the $400 net premium plus the $200 operating cost, or $600.
Because premiums are paid before claims are incurred, insurance companies invest a large portion of the premiums in an effort to earn interest on these funds (invested in bonds, stocks, or mortgages). The interest earnings help insurers reduce the premium rates for policyowners.
The probationary (waiting) period provision states that a period of time must lapse before coverage for specified conditions goes into effect. This provision is most commonly found in disability income policies. In group health insurance, the probationary period also applies to new employees, who must wait a certain period of time before they can enroll in the group plan. The purpose of this provision is to avoid unnecessary administrative expenses in cases of employee turnover.
The elimination period is a type of deductible that is commonly found in disability income policies. It is a period of days that must expire after the onset of an illness or occurrence of an accident before benefits will be payable. The longer the elimination period, the lower the cost of coverage.