IC38 Chapter 11 Notes

CHAPTER 11

PRICING AND VALUATION IN LIFE INSURANCE

Premium :

Price for insurance.

Pricing refers to the process of calculating the rate of the premium that will be charged on insurance policy.

It is normally expressed as a rate of premium per thousand of Sum Assured

The policyholder can pay the premium in a number of ways:

  1. Single Premium Plan
  2. Level Premium Plan
  3. Flexible Premium Plan

Types of Premiums :Arriving at the rate is performed by an Actuary

  1. Office Premium : This rates printed in the tables of insurance companies.These are typically level premiums which need to be paid every year.
  2. Risk Premium : Premium is charged to meet the claim for the year.

Risk Premium = Mortality rate X Sum assured.

  1. Level Premium : Equal premium charge for entire term of the policy.
  2. Net Premium : The interest earned is also considered for the premium calculation.

Net Premium = premium – interest earnings.

Gross Premium :Net Premium + Loading for expenses + Loading for contingencies + Bonus Loading

  1. Higher the mortality rate, higher the premiums would be.
  2. Higher the interest rate assumed, lower the premium

Rebates :

Life insurance companies may offer certain types of rebates on the premium that is payable. Two such rebates are

  • For sum assured
  • For mode of premium.

Extra charges : ( Loadings ) :

Addition to net premium. Example: Administration charges, medical expenses, processing fees, profit margin bonus etc.

Components of premium :

  • Mortality
  • Bonus loading
  • Reserves
  • Expenses of management
  • Interest

 Guiding principles of Determining amount of loading :

  1. Adequacy :The total loading from all policies must be sufficient to cover the company‟s total operating expenses. It should also provide a margin of safety and finally it should contribute to the profits or surplus of the company.
  1. Equity :Expenses and safety margins etc. should be equitably apportioned among various kinds of policies, depending on type of plan, age and term etc.
  1. Competitiveness :The resulting gross premiums should enable the company to improve its competitive position.

 6.Determination of surplus and Bonus

Every Life insurance company is expected to undertake a periodic valuation of its assets and liabilities:

a) To assess the financial state of the life insurer , in other words to determine if it is solvent or insolvent.

b) To determine the surplus available for distribution among policy holders/share policyholders.

SURPLUS

Surplus is the excess of value of assets over value

of liabilities. If it is negative, it is known as strain.

Surplus = Assets – Liabilities.

  1. Assets are valued in one of the following three ways:

A)Book Value (Purchase value of the asset)

  1. B) Market value (Worth of the asset in market place)
  2. C) Discounted present value (Future income stream from various assets and discounting them to present)

Bonus :

Bonus is paid as an addition to the basic benefit payable under a contract.

Types of reversionary bonus :

a) Simple bonus

b) Compound Bonus

c) Terminal Bonus