Chapter 10 – PRICING AND VALUATION IN LIFE INSURANCE
- The term premium denotes the price that is paid by an insured for purchasing an insurance policy.
- The rates that are printed in these tables are known as “Office Premiums”. They are typically level annual premiums which need to be paid every year. They are in most cases the same throughout the term and are expressed as an annual rate.
- The rebate for sum assured is offered to those who buy policies with higher amounts of sum assured.
- Rebate for mode of premium: Premiums can be on annual, half yearly, quarterly or monthly basis. More frequent the mode, more the cost of service.
- Half-yearly or yearly premiums thus enable a saving in administrative costs as compared to quarterly or monthly modes. In the yearly mode, the insurer can utilise this amount during the entire year and earn interest on it. Insurers encourage half yearly or annual premium payments by paying some rebate.
- Rebate is not a factor in determining life insurance premium
- Standard life: Group of insured individuals who are not subject to any significant factors that would pose an extra risk.
- Ordinary Rates: the rates charged on standard life individuals.
- Sub-standard life: If a persons suffering from certain health problems like heart ailments or diabetes, which can pose a hazard to the life.
- Extra charges: Insurers impose an extra premium by way of a health extra on substandard lives.
- Mortality is the first element in premiums. It is determined by using a “Mortality Table”, which gives us an estimate of the rate of mortality for different ages.
- Higher the mortality rate in the mortality table, higher the premiums would be. Higher the interest rate assumed, lower the premium
- Net Premium: The discounted present value of all future claim liabilities gives the “Net Single Premium”. From the net single premium, we can get the “Net Level Annual Premium”. It is the net single premium which is levelled out so as to be payable over the premium paying term.
- Gross premium is the net premium plus an amount called loading.
- Guiding Principles for determining Amount of Loading
- Adequacy : The total loading from all policies must be sufficient to cover the company’s total operating expenses.
- Equity: Expenses and safety margins etc. should be equitably apportioned among various kinds of policies, depending on type of plan, age and term etc. The idea is that each class of policy should pay for its own costs, so that to the extent possible, one class of policy does not subsidise the other.
- Competitiveness: The resulting gross premiums should enable the company to improve its competitive position. If the loading is too high, it would make the policies very costly and people would not buy.
Life insurers have to incur various types of operating expenses including:
Agents training and recruitment,
Commissions of agents,
Other miscellaneous etc.
The typical loading to a net premium would have three parts
- A percentage of premiums
- A constant amount for each ‘1000 sum assured’ (or face amount) which is added to net premium
- A constant amount per policy
- Lapse: Means that the policyholder discontinues payment of premiums.
- Withdrawals: The policyholder surrenders the policy and receives an amount from the policy’s acquired cash value.
- Lapses can pose a serious problem because they typically happen within the first three years with highest incidence being typically in the very first year of the contract. Life insurers incorporate a loading in anticipation of leakages that may arise as a result.
- Gross premium = Net premium + Loading for expenses + Loading for contingencies + Bonus loading.
- Surplus = Assets – Liabilities
- Bonus: Bonus is paid as an addition to the basic benefit payable under a contract.
- The most common form of bonus is the reversionary bonus. They are called ‘Reversionary’ bonuses because the policyholder only receives them when the contract becomes a claim by death or maturity.
- Simple Reversionary Bonus: This is a bonus expressed as a percentage of the basic cash benefit under the contract. In India for example, it is declared as amount per thousand sum assured.
- Compound Bonus: Here the company expresses a bonus as a percentage of basic benefit and already attached bonuses. It is thus a bonus on a bonus. A way to express it may be as @ 8% of basic sum assured plus attached bonus.
- Terminal Bonus: This bonus attaches to the contract only on its contractual termination (by death or maturity). The bonus is declared only for claims of the ensuing year without any commitment about subsequent years (as in case of reversionary bonuses). Thus the terminal bonus declared for 2013 would only apply to claims that have arisen during 2013-14 and not for subsequent years.
- Terminal bonuses depend on the time duration of the contract, and increases as the duration increases. Thus the terminal bonus for a contract that has run for 25 years would be higher than one which has run for 15 years.
- ULIP premium comprises of policy allocation charge, investment risk premium and mortality charge.