280IK Lesson 04

LOMA
LOMA 280
280
Principles
of
Insurance:
Life,
Health,
and
Annuities
LESSON
LESSON 44
Pricing Life Insurance
© 2005 LOMA All Rights Reserved LESSON FOUR 1

Lesson 4
Learning Objectives 1 and 2
Describe three methods

organizations have used to
fund life insurance, identify the
three factors life insurers use
to calculate insurance
premium rates under the legal
reserve system, and explain
how each factor affects
premium rate calculations.
© 2005 LOMA All Rights Reserved Press “Esc” to return to main menu LESSON FOUR 2
Lesson 4
Methods of Funding Life Insurance

Insurers use three primary methods to fund life insurance
benefits:
Mutual benefit method
Assessment method
Legal reserve system
Lesson 4
Mutual Benefit Method

An early funding method developed by mutual benefit societies in
which money was collected after the death of the person insured
Example: A society with 500 members required a $10 payment
from each surviving participant upon the death of a member. The
total amount collected—$4,990—minus administrative fees is paid
to the deceased member’s beneficiary.
Drawbacks
Societies often had problems collecting benefits.
The size of the group became smaller as members died or
resigned.
As members of the society grew older, the number of deaths
increased each year thus increasing the benefits paid by the
society and the amount of each member’s cost.
Lesson 4
Assessment Method
An early funding method in which the organization that offered
insurance coverage estimated its operating costs for a given period
and divided equally among the plan participants the total amount
needed to pay operating costs for the period
Example: At the beginning of the year, a society with 500 members
anticipated that 3 members would die in that year and that the
society would incur $500 in administrative expenses. The society
agreed to pay a $5,000 death benefit to each member’s beneficiary.
To cover costs, each member was assessed $31.
Calculation:
$15,000 - Expected death benefits payable ($5000 × 3 deaths)
+ 500 - Administrative expenses
$15,500 - Total needed to pay death benefits and expenses
÷ 500 - Number of members
$31 Amount required from each member
Lesson 4
Legal Reserve Method

A modern funding method based on laws requiring insurance
companies to establish policy reserves
The legal reserve system is based on the following premises:
The amount of benefit payable under a life insurance policy

should be specified or calculable before the insured’s death.
The money needed to pay policy benefits should be collected in
advance so the insurer will be able to pay claims as they occur.
The premium an individual pays for an insurance policy should be
directly related to the amount of risk the insurer assumes for that
policy.
Lesson 4
Premium Rate Calculations

A premium rate is a charge per unit of insurance coverage.
A coverage unit usually equals $1,000 of life insurance
coverage, and the premium rate is typically expressed as the
rate per thousand. The annual rate is calculated by multiplying
the premium rate by the number of coverage units.
Example: The annual premium rate for a $50,000 life insurance

policy is expressed as $3.50 per thousand.
Analysis: The annual premium amount for that policy would $175,
which is calculated as follows:
$3.50 - Premium rate = Price per unit ($1,000 of coverage)
× 50 - Number of units ($50,000 ÷ $1,000)
$175 Annual premium amount
Lesson 4
Factors Used in Premium Rate

Calculations
Insurers include the following factors in the calculation of
life insurance premium rates:
Cost of benefits
Investment earnings
Expenses
In performing premium rate calculations, actuaries make

actuarial assumptions, which are estimated values
used in life insurance and annuity pricing, concerning
each of these factors.
Lesson 4
Cost of Benefits
The cost of benefits for an insurance product equals all
of the insurer’s potential payments of benefit obligations
to customers multiplied by the expected probability that
each benefit will be payable.
The probability that policy proceeds will be payable in a
given year is measured by mortality statistics.
Mortality is the Mortality rate is the
incidence of death rate at which death
among a specified occurs among a
group of people. specified group of
people during a
specified period,
typically one year.
Lesson 4
Expected and Experience

Mortality
Insurers have organized statistical information regarding
overall mortality experience into charts known as
mortality tables.
Expected mortality Mortality experience

refers to the number of refers to the number of
deaths that have been deaths that actually
predicted to occur in a occur in a given group of
group of people at a insureds.
given age according to a
mortality table.
Lesson 4
Mortality Tables
Mortality tables are used to Example: Mortality tables
show the mortality rates an show that, on average,
insurer may reasonably women live longer than
anticipate among a men.
particular group of insured
lives at certain ages.
Life insurers use mortality tables as a first step in determining

the premium rate to be charged for a block of life insurance
policies.
Mortality rates start high at birth and decrease dramatically at
age 1.
Mortality rates typically show separate rates for men and
women.
Lesson 4
Block of Policies
A block of policies is a group of policies issued to
insureds who are all the same age, the same sex, in the
same risk classification.
Example: An insurer may classify into one block all

term insurance policies issued to males age 35 who are
nonsmokers and have no significant medical history.
Lesson 4
Investment Earnings
Investment earnings is money
insurers earn by investing premium
dollars.
Premium dollars are

the primary source of
funds used to pay life
insurance claims.
Lesson 4
Effects of Earnings on Price

The effect of investment earnings on insurers and
policyowners is important in premium rate
calculations.
Investment earnings enable an insurer to charge
lower premium rates than would be possible if the
insurer considered only the mortality risk factor.
The longer a life insurance policy is in force, the
greater the effect investment earnings will have on
premium calculations.
Lesson 4
Simple Interest
Interest is money that is paid for the use of money. Investments
create earnings through interest.
Simple interest is interest paid on the original sum only.
Example: Susan Chen loaned Juan Bonitez $1,000 for one

year at an annual interest rate of 10 percent. If Ms. Chen
earned simple interest on the loan, at the end of the first year,
Mr. Bonitez would owe Ms. Chen $1,100.
Calculation: $1,000 × .10 = $100
$1,000 + $100 = $1,100
Lesson 4
Compound Interest
Compound interest is interest paid on the original principal sum
and on accrued interest.
Example: Assume that Ms. Chen earned compound interest on

her loan to Mr. Bonitez, and she allowed Mr. Bonitez to keep the
$1,000 loan for an additional year without paying the $100 of
interest for the previous year. At the end of the second year, Mr.
Bonitez would owe Ms. Chen $1,210.
Calculation: $1,000 × .10 = $100 - Interest at end of Year 1
$1,000 + $100 = $1,100
$1,100 × .10 = $110 - Interest at end of Year 2
$1,100 + $110 = $1210
Lesson 4
Expenses
A policy's net premium is the amount of money the
insurer needs to provide policy benefits. An insurer
must add an amount to the net premium to cover all
operating costs and provide itself some profit.
Loading is the total Gross premium is
amount added to the the net premium
net premium to with the loading
cover all of the added. This amount
insurer's costs of is the amount that
doing business. the insurer charges
to the policyowner.
Net premium + Loading = Gross Premium

Lesson 4
Explain how the level pricing

system operates and identify
two methods used to change
the price of a life insurance
policy after it has been issued.
Lesson 4
Level Premium Pricing System

The level premium pricing system is a life insurance pricing
system that allows the purchaser to pay the same premium
amount each year the policy is in force.
The leveling of premiums is possible because premium rates
charged for level premium policies are higher than needed to
pay claims and expenses that occur during the early years of
those policies. Excess premium dollars from these policies
are invested by the insurer.
At the time of purchase, a 1-year term insurance policy is

less expensive than a similar level premium, long-term
policy. As the insured's age increases, however, so does the
premium rate for a 1-year policy. The premium rate for a
level policy, on the other hand, does not increase after the
policy has been issued.
Lesson 4
Changing the Price of a Policy

Several types of life insurance policies provide that
the policy's price can change after the policy is
issued. Insurers primarily use two methods of
changing the price of a policy after it has been issued.
The first method is to reduce the price by

returning to policyowners a portion of premium
that was paid for the coverage. This premium
refund is called a policy dividend.
The second method consists of changing the

values of the pricing factors while the policy is in
force and, consequently, changing the amount
charged to the policyowner for the coverage.
Lesson 4
Paying Policy Dividends

Life insurance policies can be issued on either a participating or
nonparticipating basis.
A participating policy is one A nonparticipating policy is

under which the policyowner one in which the policyowner
shares in the insurance does not share in the insurer's
company's divisible surplus. divisible surplus.
The amount of surplus available for distribution to owners of

participating policies is called the divisible surplus and
policyowners share of this divisible surplus is called a policy
dividend.
Policy dividends are considered premium refunds and, unlike
dividends earned on shares of stock, are not considered taxable
income to the policyowner.
Lesson 4
Changing Pricing Factors

Policies that list cost elements separately usually
Guarantee maximum values for each cost element
Specify that more favorable values can be used
Example: A policy might guarantee a 4% interest rate but specify

that the insurer might pay a higher interest rate if market conditions
allow the insurer to earn a higher-than-predicted rate of return on
its investments. Paying a higher rate of return reduces the cost of
the policy.
Example: A policy might specify the maximum mortality charges
the insurer will assess. If the insurer's actual mortality experience
is lower than expected, the charges may be reduced. Reducing
mortality charges also reduces the cost of the policy.
In general, policies with variable pricing factors are issued on a

nonparticipating basis.
Lesson 4
Define policy and contingency

reserves and calculate the net
amount at risk for a given life
insurance policy.
Lesson 4
Policy and Contingency Reserves

Policy reserves are liabilities that represent the amount the
insurer estimates it will need to pay policy benefits as they
come due.
To calculate the amount needed for policy reserves, regulators
require insurers to use a conservative mortality table, which
is one that shows higher mortality rates than the company
anticipates for a particular block of policies.
Contingency reserves are reserves used to cover unusual
conditions that may occur. Loading sometimes includes an
amount to cover these unusual occurrences.
Contingency reserves provide a safety margin in case actual
mortality experience in any area—the cost of benefits,
investment earnings, or expenses—is worse than the insurer
expected.
Insurers typically establish contingency reserves for health
insurance policies.
Lesson 4
Net Amount at Risk

The difference between the face amount of a policy and the policy
reserve at the end of any given policy year is known as the insurer's
net amount at risk for the policy.
Net Amount at Risk = Face Amount - Policy Reserve
Example: If a $10,000 whole life insurance policy has a

reserve of $3,000, the insurer's net amount at risk is
$7,000.
Note that as a policy’s reserve increases, the net amount at risk

decreases.
Lesson 4
End of Lesson 4

280IK Lesson 04

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LOMA

Pricing Life Insurance

© 2005 LOMA All Rights Reserved LESSON FOUR 1

Learning Objectives 1 and 2

Describe three methods

Methods of Funding Life Insurance

Mutual Benefit Method

Legal Reserve Method

The legal reserve system is based on the following premises:

 The amount of benefit payable under a life insurance policy

Premium Rate Calculations

Example: The annual premium rate for a $50,000 life insurance

Factors Used in Premium Rate

In performing premium rate calculations, actuaries make

Expected and Experience

Expected mortality Mortality experience

 Life insurers use mortality tables as a first step in determining

Example: An insurer may classify into one block all

Premium dollars are

Effects of Earnings on Price

Simple interest is interest paid on the original sum only.

Example: Susan Chen loaned Juan Bonitez $1,000 for one

Example: Assume that Ms. Chen earned compound interest on

Net premium + Loading = Gross Premium

Learning Objectives 3 and 4

Explain how the level pricing

Level Premium Pricing System

 At the time of purchase, a 1-year term insurance policy is

Changing the Price of a Policy

 The first method is to reduce the price by

 The second method consists of changing the

Paying Policy Dividends

A participating policy is one A nonparticipating policy is

The amount of surplus available for distribution to owners of

Changing Pricing Factors

Example: A policy might guarantee a 4% interest rate but specify

In general, policies with variable pricing factors are issued on a

Learning Objectives 5 and 6

Define policy and contingency

Policy and Contingency Reserves

Net Amount at Risk

Net Amount at Risk = Face Amount - Policy Reserve

Example: If a $10,000 whole life insurance policy has a

Note that as a policy’s reserve increases, the net amount at risk

S-ar putea să vă placă și

The amount of benefit payable under a life insurance policy

Life insurers use mortality tables as a first step in determining

At the time of purchase, a 1-year term insurance policy is

The first method is to reduce the price by

The second method consists of changing the