Premium discounts are described as which of the following?

Premium discounts are described as which of the following?

• A. It reduces the policyholder's payroll
• B. It reflects that expenses rise with premium at an increasing rate
• C. It reflects that expenses increase at a decreasing rate as premium increases
• D. It is only for large policies

Answer: (C)

Premium discounts reflect economies of scale in how an insurer’s costs behave as the policy premium grows. Some expenses she the insurer incurs to issue and manage a policy are fixed, not tied to the size of the premium. When the premium is small, these fixed costs represent a larger portion of total expenses; as the premium increases, those same fixed costs are spread over a much larger premium, so total expenses don’t rise in step with the premium. That means the rate at which expenses increase slows down as premium goes up, which is why the relationship is described as expenses increasing at a decreasing rate with higher premiums. This is why the option saying expenses increase at a decreasing rate as premium increases is the best description. It’s not about payroll costs, it’s not about expenses rising faster with premium, and it’s not limited only to large policies, though larger policies often reveal this effect more clearly.

Premium discounts reflect economies of scale in how an insurer’s costs behave as the policy premium grows. Some expenses she the insurer incurs to issue and manage a policy are fixed, not tied to the size of the premium. When the premium is small, these fixed costs represent a larger portion of total expenses; as the premium increases, those same fixed costs are spread over a much larger premium, so total expenses don’t rise in step with the premium. That means the rate at which expenses increase slows down as premium goes up, which is why the relationship is described as expenses increasing at a decreasing rate with higher premiums.

This is why the option saying expenses increase at a decreasing rate as premium increases is the best description. It’s not about payroll costs, it’s not about expenses rising faster with premium, and it’s not limited only to large policies, though larger policies often reveal this effect more clearly.