What is the risk premium primarily intended to cover?

The risk premium is primarily intended to cover the expected loss that an insurer anticipates will arise from providing coverage. This expected loss is based on actuarial data and historical claims experience, as it quantifies the anticipated payouts that the insurer must make in the event of covered claims.

While it may incorporate elements that relate to administrative costs, profit margins, and potential investment income, its fundamental role is to account for the risk associated with the insured entities. It reflects the likelihood and severity of potential losses from the insurance policies underwritten, thus ensuring that the insurer has sufficient funds reserved to meet these future liabilities.

In contrast, administrative costs cover the operational expenses related to managing the insurance policies, while profit for the insurer represents the financial gain after all expenses have been deducted. Investment income refers to the returns made on the funds that the insurer holds, which may supplement the total revenue but is not the primary focus of the risk premium itself. Understanding the expected loss concept helps clarify how the insurer sets premiums to maintain solvency and risk management effectively.