Introduction To Insurance

INTRODUCTION TO INSURANCE

Humans have always sought security. This quest for security was an important motivating force in the earliest formations of families, tribes, and other groups. The groups have been the primary source of both emotional and physical security since the beginning of humankind. Humans today continue their quest o achieve security and reduce uncertainty. We still rely on groups for financial stability.

With industrialization our physical and economic security has diminished. Mankind is exposed to many serious hazards, which cause stoppage of income. The biggest worry any human being has is the economic worry. He is always thinking of tomorrow and the days to come and he will be planning to meet the demands of his family, his business and that of his own needs. The economic worries may arise due to stoppage of income. Our income dependent, wealthacquiring lifestyle renders us and our families more vulnerable to environmental and social changes over which we have no control. There may be accidents, sickness disability, or due to premature death of the breadwinner. It is impossible to prevent such calamities. But it is always possible to provide against the loss of income that may result out of such these perils.

Risk is defined as uncertainty of financial loss. If the event were certain to happen, then there is no loss If the event were certain not to happen, then also there is no loss. It is the uncertainty about the time of loss that worries the mankind.

There are two types of RISKS namely PURE RISK and SPECULATIVE RISK.

In pure risk there is always loss only. by happening of the event, the person is certain to have an economic loss. In speculative risk, there can be loss or gain. Trade risk is a speculative risk.

Whereas speculative risks are managed by management techniques, RISK MANAGEMENT manages pure risk. The following are the risk management methods.

Avoidance: Here the risk is altogether avoided. E.g.: Do not get a motorcycle to young boy. Prevention: being very careful prevents Risk. Eg: Proper maintenance of the vehicle. Reduction: Again by proper maintenance of the vehicle, loss can be reduced. Retention: Where the loss is minimum and can be met by own resources, Transfer: When the person is not in a position to manage the loss by anyone of the above methods, the risk is transferred to someone else.

Here comes the concept of Insurance. It is the function of Insurance, to enable individuals to protect such losses. In Insurance language, RISK means financial loss only

Individually every person irrespective of his financial status cannot provide against all the losses he may incur. It is not only costly but also speculative. Hence all the individuals who are exposed to same type of risk or common risk come together and transfer their loss to an organization or a corporate body. This is done by a cooperative endeavor. All people contribute towards a common fund. It is not

possible to predict as to which individual suffers the loss. But it is always possible to forecast the quantum of loss the entire group may suffer. The loss of few is compensated by the contribution of many individuals.

The characteristics of pure risk or insurable risk;

The risk may be one that may or may not happen The risk must be pure and not speculative. This is because of the fact that it is not possible to know various factors which may result in trade loss The loss caused must be capable of being measured in terms of money only Risk should not be of illegal nature E.g.: stolen property cannot be insured Risk should not be opposed to any public policy. Risk should not be catastrophic in nature

Risks can be further divided into the following groups:

Dynamic risk: This results from the changes in economics like demand and supply, changes in consumer tastes. But such risks benefit the society over a long term.

Static risk: These arise due to dishonesty of few individuals. They cause unequal distribution of wealth, asset or possession of property.

Fundamental risk: These are not personal in nature. These come out of political and social phenomenon like unemployment, wars etc.,

Particular risk: Here the loss is due to individual events like fire, accidents etc., .The solution lies in going for insurance.

NATURE OF INSURANCE:

Sharing of risk: Insurance is a social devise to share the financial loss, which may befall individuals due to many events. Whereas it is not possible to share deaths, accidents or sickness, it is always possible to share the economic losses, which come out of these events. All persons who are exposed to similar risks come together and share the loss.

Co-operative endeavour; in every type of Insurance, large number of persons are brought together to share the loss. They have a common goal viz., to plan the economic future. Such people come together voluntarily or through publicity or through soliciting. It is the Insurer who compensates the loss of few from the contributions received from many.

Value of risk: The risk or financial loss is measured in terms of money before insuring. This is done by means of past experience of the Insurer. This will enable him to collect the cost of Insurance in adequate measure.

Payment at contingency: The payment of sum assured is made on the happening of the event, which is insured. It may be premature death or end of the term in Life Insurance. In non-life, it may be the happening of the event.

Amount of payment: In Life Insurance the amount is fixed at the beginning of the contract and full amount is paid at death or end of term. But in other types of Insurance the amount of loss only is paid.

Large number of persons: To make the cost of Insurance cheaper, it should involve large number of persons. This will enable the Insurer to spread the loss.

Insurance is not gambling:Though an amount of chance is involved, Insurance is not gambling. The uncertainty of financial loss is changed into certainty of payment of amount on the happening of event

FUNCTIONS OF INSURANCE:

The function of insurance is to safeguard against such misfortunes by having contributions of the many pay for the losses of the unfortunate few. This is the essence of insurance- the sharing of losses and, in the process, the substitution of a certain, small “loss” called the premium for an uncertain, large loss.

From an economic perspective, insurance is a financial intermediation function by which individuals exposed to a specified contingency each contribute to a pool from which covered events suffered by participating individuals are paid. Insurance then is a contingent claim contract on the pools assets.

From a legal perspective, insurance is an agreement, the insurance policy or insurance contract, by which one party, the policy owner, pays a stipulated consideration called the premium to the other party called the insurer, in return for

which the insurer agrees to pay a defined amount of money or provide a defined service if a covered event occurs during the policy term.

The person whose life, health or property is the object of the insurance policy is referred to as the insured. Insurance provides certainty of payment of sum assured at the happening of the event. Since no one can predict the happening of the event in advance, it is not possible to compensate against the loss. There is an uncertainty about the time of the event happening. We will not be also sure about the quantum of loss. Under life insurance policies, the person to whom the payment is made on the insured’s death is the beneficiary

Provides assistance to business: Large capital investments on buildings and machinery can be protected against loss by Insurance. The cost of Insurance will be very small compared to the total loss.

Provides financial stability to commerce and industry: When material damage takes place due to peril, there will be stoppage in production resulting in reduction in profit. Loss of profit Insurance can take care of the loss in net profits in addition to loss of machinery.

Insurance serves as a basis of credit: Industry and commerce approach banks and financial institutions for financial assistance to develop their business. A collateral security may be necessary to secure against the finance advanced. Insurance policies can provide against such advances.

Insurance plays a role in reduction of losses. Insurance companies render advice as to how losses can be minimized by using various safety measures because of their experience.

Insurance provides fund for investment: The Insurer will have huge funds collected from Insured by way of premiums. These funds are not kept idle, but invested in nation building activities.

Insurance earns foreign exchange: Indian Insurance companies have branches in different countries, where large volume of business is transacted. This will fetch huge amount in foreign currency.

TYPES OF INSURANCES: Insurance sector has divided itself into companies that sell on the person, known as life insurance, and those that sell insurance to protect property, referred to as nonlife insurance, property/ casualty insurance, and general insurance.

Life Insurance: On human life, which includes premature death, old age provisions, disability benefits, Annuities and Super annuation. Death: usually called life insurance or life assurance. Living a certain length of time: called endowments, annuities, and pensions. Incapacity: called disability and long term care insurance. Injury or incurring a disease: called health insurance, accident insurance, and medical insurance.

Non Life Insurance, which can be classified as follows:

On property: Buildings, machinery marine etc., On person: Like personal accident, health, sickness etc., On interest: Like fidelity guarantee, personal indemnity etc., On liability: Like third party liability.

Difference between Life and Non life Insurance: a). Risk is certain to happen in Life Insurance, either premature death or survival to a particular age. But in Non life Insurance risk may or may not happen b). Life Insurance is a long-term contract Non-life contracts are usually renewable every year. c). It is very difficult to assess the value of human life It is easy to value a property. d). General Insurance is contracts of Indemnity. Life Insurance is not contracts of indemnity.

IMPORTANT DEFINITIONS

Risk: Risk is uncertainty of financial loss Peril: It is defined as anything, which may cause the economic loss like fire, sickness, and accident Hazard: It is the state or condition, which brings out the peril Insurance: Insurance or Assurance is a guarantee to pay prescribed sum on the happening of the event. Proposer: Proposer is the person who seeks the coverage of risk of the subject matter of Insurance

Insured: Insured is the person whose subject matter of risk is covered by the Insurer. Insurer: It is a corporate bode or an organization who undertake to cover the risk Proposal: A proposal form is an application, which is given by the proposer giving details about the subject matter of risk to be covered. Premium: It is the periodical or a lump sum payment or price paid by the Insured as cost of risk to be covered. Sum assured: It is the amount agreed upon by the Insurer, which is paid, on the happening of the event, which is insured against.

The words Insurance and Assurance are interchangeable. Assurance means a promise or a guarantee. This word applies more in case of Life Insurance, since the Insurer guarantees to pay the full sum assured on premature death or survival. But in other types of Insurances, the Insurer indemnifies the insured to the extent of loss only if the event were to occur.

INDIVIDUAL AND FAMILY USES OF LIFE INSURANCE: The primary purpose of Life Insurance is to provide the financial security against the loss of income arising out of the insured peril. The loss of income to the family in case of premature death of the life assured is neutralized by the sum assured, which the Insurer pays.

Insurance encourages savings: By the very nature of Life Insurance contract, the insured develop the habit of savings over a long period of time. Any other savings program apart from insurance can yield only a small amount at the start, whereas an insurance policy guarantees the full face value or other benefit from its beginning, and thus, it can hedge the policy owner against failure through early

death or incapacity to have sufficient working time to save adequately through other means.

Insurance affords peace of mind: The wish of financial security is the prime motivating factor. If this wish is not satisfied, lot of tension is created. By taking out a policy of Life Insurance we can have the mental satisfaction that the family has been provided against any eventuality.

Furnishes an assured income in the form of annuities: Annuities can prove valuable to those older persons who have succeeded in savings only a limited amount of capital, and who have no one to whom they particularly can transfer this sum on death.

Insurance eliminates dependency: At the death of the breadwinner, the income stops and the standard of life of members of the family come down. By insuring the life of the person and in case of premature death, the amount may be used to maintain the standard to a greater extent. The family need not depend on the mercy of others.

Profitable and safe investment: Savings in insurance is safe in the hands of the Insurer. The Life funds are invested by the Insurer in safe securities as per the directives of the Government and are safe. The Assured will also take part in the profits of the Insurer if he has opted for a with profit policy.

Insurance protects mortgaged property: If the property is owned by an individual is mortgaged, in case of premature death of the owner, the property is taken over the lender and the family looses the property,

If the life of the individual is insured and in case of the premature death of the assured, the sum assured so obtained can be paid towards the loan outstanding and the property retained by the family. BUSINESS USES OF LIFE INSURANCE: a) Key man Insurance: It happens that in many organisations, the growth of . the company depends on the skills and intelligence of one person. If the Company loses him by death the company finds difficulty.

b). In finding an alternative person. Even if such persons are found, it takes time and money to train him .By taking an Insurance policy on the life of such a Keyman; the company can over come the vacuum created by the death of the keyman

Partnership: Insurance: more than one person runs many business ventures. The business interest can be insured by two methods. One by taking a Joint life policy on the lives of all partners and the second method by taking policy on individual life and sum assured payable to the company. In case of death of any one of them, the capital investment by each is protected and business can continue.

Welfare of employees: As a welfare measure, employers can take Insurance on the lives of employees in a group and on death of any employee while in service, the family helped. This serves as an incentive and motivation to the employees to perform better.

SAVINGS IN LIFE INSURANCE:

Every form of legal savings has to be encouraged. The following are considered as good savings; Shares: shares and stocks represent ownership in a business in a very small way. It is inherently speculative. Not everyone is qualified to make selection of good shares. They do not induce compulsory savings. The profit of the company does not depend on the shareholder but on how efficient the management of the business is.

Bank deposits; to accumulate any money in a bank it takes time. There is always a tendency to withdraw. The amount we get is our contribution and small interest.

Post Office savings: They are similar to Bank deposits but are absolutely safe. There is temptation to withdraw.

Mutual funds: These are meant for small investors and if managed with skill by the fund managers, they are good investments

Compared to these savings, investment in Life Insurance has the following distinct advantages.

Capital is built the moment first premium is paid and the Insurer goes on risk Premature withdrawal is not permitted due to the terms of the contract. Savings are not time consuming. An estate is built moment the Insurer goes on risk

The investment is safe because the Insurer is governed by strict rules as to where he has to invest his fund LIFE INSURANCE PRODUCTS

It is the earnest desire of every individual to own property. Any one who is in possession of something tangible feels secure. But very few people have adequate income to own something of their own. It is just they FAILED TO PLAN and not PLANNED TO FAIL. It is always desirable that we identify our financial needs and buy an instrument rather than buy the instrument and try to fit in our needs. Financial planning has become more complex because of greater economic uncertainty, constantly changing tax laws and varieties of options

It is very difficult to prepare a list of all financial needs. But it can be divided into Capital needs like emergency funds, education needs, marriage needs and income needs like family income, retirement needs. Life Insurance has been recognized as one of the best instruments of family financial program. Usually people look at investment in Life Insurance as Risk cover/ investment, combination of both the above, adequately long term, safe investment, moderate yield and tax savings

The need levels of individuals in Life Insurance naturally depend on the age group. Every one of us have the following Insurance needs at every point of our life. But the degree of need depends on age. The recognized needs are Protection for self and family, Children needs, Retirement needs, Special needs like health and housing

Now let us study the various products that are available in the Insurance Industry with reference to the above need levels

BASIC PLANS OF LIFE INSURANCE

There are only TWO basic plans of Life Insurance. They are TERM ASSURANCE and PURE ENDOWMENT. In term assurance the sum assured is paid only in case of death of the assured within the term of the contract and nothing is paid in case of survival to end of the term. But in Pure endowment, the sum assured is paid only in case the assured survives to the end of the term. Nothing is paid in case of death of the assured within the term. Remember these are the TWO BASIC plans. Any number of plans can be devised by combination of these two plans.

Now let us study various products available in the Insurance market in India about the four needs 1. Death 2. Living to a certain length of time, 3. Incapacity, 4. Injury or incurring a disease.. They are the major needs and occupy prominent position in our Life Insurance planning. Any other need can be a sub division of these.

NEED FOR FAMILY

A). Term assurance:

Term assurance is the cheapest form of Insurance. As explained above, this plan of Insurance is just a RISK COVER plan. Young people who cannot afford high

premiums can go in for this policy and obtain substantial cover at a very moderate cost. This term assurance has gone tremendous modification like

1.Term assurance: Here sum assured is paid only in case of death of the assured within the term of the contract. Nothing is payable if the assured survives the end of the term

2. Term assurance with return of premiums: In this plan, the sum assured is paid in case of death within the term. But if assured survives the term of the contract, all the premiums paid is returned

3. Term assurance with return of premiums and loyalty additions: If the assured survives the term, in addition to return of premiums, loyalty additions are given. Such additions may be a percentage of premiums

4. Term assurance with return of premiums & loyalty additions and extended cover: In this plan in additions to the benefits under (3) the, contract does not come to an end, but the insurer extends term assurance cover for a further period after the end of term. In case of death of the assured during the extended period, the Insurer pays full or part of the sum assured. This is ideal plan, whereby the assured can have risk cover at an age when he may not be eligible for Life Insurance at all.

Convertible term assurance: In this plan the assured has a choice of converting the policy into an endowment or whole life at the end of the term. The option is to exercise before 2 years from the expiry of the term and the Insurer will agree to

cover risk for a sum not exceeding the original sum assured. There is no need to submit any proof of insurability.

B). Whole Life

Under whole life, by concept the Sum assured is payable on death only. Whereas in Term assurance, the death should take place within the term of the contract, in Whole life there is no fixed term and the Sum assured is paid on death at any time. The following are the modifications that have taken place over a period of time.

1. Whole life: Here the Sum assured is paid on death and the premiums are to be paid, as long the Life assured is alive.

2. Whole life Limited payment: In this, the assured has a choice of limiting the premium payment period and the Sum assured however is paid on death only. The Insurers thought the above two do not serve the need of many and decided that the premium payment automatically stops after 35 annual premiums are paid or the LA reaching 80 years of age, whichever is later and the Sum assured is also payable on reaching age 100. Now this has also been modified and the sum assured is payable on reaching 80 years of age.

3. Convertible Whole life: In this plan, the life assured has the option of converting the policy into an endowment plan after 5 years from the date of commencement. The premium will be less during the first 5 years and will increase according to the term selected. If however the conversion is not exercised, the

policy will run as whole life limited payment with premiums ceasing at age 70 of the assured and the sum assured payable on death

C). Endowment type: These are the most popular plans of Insurance as the very definition of life insurance is found here. That is the sum assured is paid on the event contingent upon the duration of human life, death or survival.

1. Endowment policy: The sum assured is paid on death or survival to the end of term whichever earlier.

2. Endowment limited payment: Here the LA has choice of limiting the premium payment period.

3. Endowment double or triple cover: In this policy, the sum assured payable on death within the term will be two or three times the basic sum assured. But the sum on maturity will be the basic amount only.

4. Marriage endowment: Here the sum assured is due only at the end of the term and the payment of premiums stops at death of the assured. The objective of insurance to provide for the marriage of daughter is met under the policy

D) Combination of whole life, endowment and money back

1. Endowment & whole life: In this policy, the sum assured is paid on survival to the end of term and the contract does not end and another sum assured is paid at

death any time. If however the assured dies before the expiry of the term, sum assured is paid 2. Money Back & whole life: Under this plan a percentage of sum assured is paid every 5 years as long the assured is alive and full sum assured is paid on death at any time irrespective of the survival benefits paid earlier.

E). Money Back Type:

1. Ordinary money back: These are fixed term policies where under, part of the SA is paid at periodical intervals. Full SA is paid at death any time within the term irrespective of the survival benefits paid.

2. Money back with increased cover: In this case, the survival benefits are as above. But the death benefits will be increased SA depending on the duration of the policy. RETIREMENT PROVISION

One of the risks associated with human being is the risk of living too long. With break of joint family systems, each one of us have to start providing for the days after we cease earning. The added problem of the increased longevity has multiplied the need to provide for retirement. Life Insurer is an organization, which can organize schemes to meet this need. The following are some of them

ANNUITIES

Annuities are annual payments made by the Insurer to the Annuitant in return for a lump sum or periodical payment made by the other. The annuities can be purchased in two ways

1. Immediate annuity: here the purchaser pays a single one time payment to the Insurer and desires that annuity to flow immediately 2. Deferred annuity: Here the purchase price is paid by the buyer in installments and annuity starts after the corpus is built.

The annuitant can desire the payment of annuity in respect of the above in any of the following ways:

1. Life Annuity: Here the Insurer pays annuity installments as long as the annuitant is alive 2. Annuity certain: The annuity is paid for the selected number of years irrespective whether the annuitant is alive or not. 3. Annuity certain and life thereafter: The annuity is paid for the selected number of years and if the annuity is alive at the end of the term, it will continue for the lifetime of the annuitant.

It should be remembered that the annuity can be selected to made either yearly, half yearly, quarterly or monthly. . PENSION PLANS

The life insurance industry has come out policies, which serve the provision of pension linked with risk cover. In this type, risk on the life of the assured is

covered on a notional Sum assured and such notional amount is made use to buy annuity as explained above. But in case of death of the assured within the term, the nominee will be entitled to family pension based on the notional sum assured. There is an option of commutation also

Difference between annuity and Life Insurance:

Those who are afraid of living too long and Life Insurance by those who are afraid of premature death purchase annuity. In annuity there is self-selection by the annuitant and in Life Insurance there is selection by the Insurer. By concept wise in Life Insurance payments start at death and in case of annuity the payments stops at death. Both works on the theory of large numbers. Life Insurance is based on rate of Mortality and Annuity is based on probability of survival.

GROUP INSURANCE

Group Insurance is a device by which members belonging to a homogeneous group can be given insurance cover under a single contract. The development of Group Insurance in India is of recent origin and now lot of emphasis is given on wide coverage in view of its simplicity and affordable cost. The salient features of Group Insurance are as follows:

The group should be homogeneous and the Insurer may prescribe minimum number depending on the scheme.

The contract is between the Insurer and the employer/group/association A single policy called master policy is issued covering all the members and spelling out the relevant terms and conditions The group must have been formed other than for the purpose of taking out Insurance & the group should already exist. The scale of benefits is pre decided depending on the salary/grade of the employee. The individual employee has no choice of selecting the sum assured. At the inception of the scheme, an option is given for members to join the scheme. But new entrants have to compulsorily join the scheme. The selection is based on the average age of the group. Minimum Insurance cover will be given without strict proof of insurability. The premium may be contributory or non contributory. The employer is eligible to treat the premium as expenses and claim tax exemptions The contract is renewable every year. At the time of renewal, based on the previous years experience, the premium may get revised. This is called experience rating The named person of the employer will deal with the Insurer in all servicing matters.

TYPES OF GROUP INSURANCE SCHEMES

One year renewable term assurance: Here the contract is for one year renewable every year. In the event of death of any member of the group during the year, the agreed sum assured is paid.

Group gratuity scheme: As per Gratuity Act 1972, an employer is legally bound to pay Gratuity for all employees who put in a minimum service of 5 years. Wherever the employer appoints not less than 10 people. The scale is at the rate of 15 days wages for every year service completed, subject to a maximum of 3,50,000. The employer has to therefore make provision in advance. The methods may be Make payments as when it arises called as pay as you go method. Can create an internal reserve equal to the actuarial valuation of the liability. Set up a gratuity fund with trustees to manage. Set up a fund and transfer the same to Insurance Company under a Group Gratuity scheme.

Of the above methods, the first two methods are quite risky in the sense that the fund may be misused in terms of financial difficulties. The fourth method would be very prudent, since an Insurer has a huge portfolio and can diversify his investments and assure a guaranteed return. The Insurer has also qualified people to calculate the liability accurately.

Group Gratuity linked with OYRTA

Under this provision, risk on the life of the members of the group are covered and in case of premature death, the gratuity paid will be notionally calculated and we

would receive higher gratuity. The balance service of the deceased member is considered and gratuity calculated.

Group Pension scheme. The benefit of pension has the advantages of retaining the talented people with the organization; the employer is treated as a progressive and the tax advantages enjoyed by both the employer and the employee. The employer can find the same ways to provide for pension as discussed in the provision for Gratuity. But the Insurance Company can provide actuarial, legal and taxation help to the employer. Again by conjunction with OYRTA, the employee can be helped to get a higher pension in case of premature death.

Group savings linked Insurance Scheme: Under this scheme, the benefits offered include both death cover as well as savings. A part of the contribution goes towards the cost of risk cover and in case of death of the employee; a certain fixed amount is paid. On surviving to superannuating age, savings portion with interest is paid.

Employees deposit linked insurance: All the employers have to provide for risk cover to those who come under PF Act. This provision can be arranged with an Insurance Company, whereby the Insurer will cover risk on the life of the employee to the extent of balance of PF account on the date of death or up to 62,500/- whichever is lower. SOCIAL SECURITY SCHEME: As per Article (41) of Indian Constitution, the Central Government has to provide Social Security to vulnerable sections of the Society. Life Insurance is one of the ways by which such security can be provided. Now IRDA has also prescribed that each Insurer has to compulsorily cover certain

number of lives under such schemes. The scheme has to be financed either wholly by the Insurer or with nodal agencies. PREMIUM AND PREMIUM STRUCTURING

Premium is defined as the consideration, which flows from the Insured to the Insurer. It is the cost of Insurance product. What we should remember is that Life Insurance is a long-term contract and a voluntary contract. The terms and conditions are decided at the beginning of the contract and can never be changed during the currency of the policy. Hence lot of care is needed before a terms and conditions are incorporated.

Actuary is the person who is responsible for devising the product and pricing them. He is one of the most qualified people and has knowledge in Mathematics, Statistics, Economics and expert in forecasting. An actuary has to be a Fellow of Institute of Actuary, London or a Fellow of Actuarial Society of India. IRDA prescribes that each Insurer should have an Actuary on his rolls. HE is also responsible for Valuation, which is a statutory requirement.

ELEMENTS IN PREMIUM STRUCTURING

1. MORTALITY TABLE

One of the characteristics of pure risk is that it be measurable in terms of money only. That means that the Insurer should know well in advance, the liability he is taking by entering into contracts. He should know as to how many people are

going to die every year and over a period of time so that he will be able to pay sum assured to all those who die during each year and also to those who live the entire term of the contract.

Mortality table is a document, which provides information about the death rate at each age. It can be defined as a tool in the hands of the Insurer to determine the premium. It can be described as a picture of generation of individuals passing through time. It shows a group of individuals entering at a certain age and traces the history of the entire group year by year until all have died

It can be constructed from two sources. One is the census data, which is enumerated once in ten years by the Government. The data is very vast and lot of approximations is made while compiling the data. Age is a very important factor in Life Insurance. But the age reporting is very casual in census because of the tendency of people to report lower age. The other source is the Life Office data, consisting of the information about the insured lives in Insurance Company. The main differences between census and Life Office data can be summarized as follows.

Census

Life office data

1) Once in 10 years

Data available at any point

2) Not homogeneous

Very homogeneous

3) Consists of entire population

Insured lives only

4) Age reporting is approximate

Age is accurate

5) Deaths may not be reported at all

Cause of death also reported

6) Includes uninsurable people also

Selection has taken place

In view of the above, inaccuracies, the Insurer cannot base his premium on the census data. He has to construct his own mortality table based on the insured lives. But no mortality table can be constructed unless huge data available, so that law of large numbers works out. The first mortality table on the Indian lives was constructed by Oriental Insurance Company called O (25-35). The effort is monumental, since in those days, no technological support was available. Before this, the premium was charged on the basis of British Life Office Mortality table. Naturally all Indian lives were charged extra premium. This was borrowed by LIC when it was born in 1956. LIC constructed its own mortality table LIC (61-64) which was later updated in (70-73) and the latest being in (94-96). These tables are published documents and can be used by any one. Now the IRDA is planning to construct a new table with the data made available by all Insurers in the coming years.

When an Insurer constructs mortality table, 3 types can be constructed as follows Select Mortality table: Here the Insurer will use or consider those lives which have entered into his books of recent, say during the last 3 to 4 years and study the mortality rate pertaining to those lives only. Usually the rate of mortality among such lives will be lighter in view of the effect of selection. Ultimate mortality table: Here the Insurer will omit those lives that have come into his books recently and construct mortality table of the other data. Aggregate Mortality table: In this no distinction is made as above and the Insurer will include all the lives in his books and construct a mortality table.

Uses of Mortality table

It is used by the Insurer to determine the premium It helps to verify the accuracy of assumptions against actual experience It forms data for future use Valuation results are compiled from this data In view of the accuracy of Life Office data, many research organizations make use of the data.

Construction of Mortality table

A typical mortality table looks as follows

Age

No.living

No.dying

Rate of Mortality

Probability of survival

X

lx

dx

qx

px

A mortality table can start at any age. Suppose we consider that the mortality table starts at age 15, X means age 15 lx means number living at age 15 dx means number dying before they reach age 16 qx means the chance of one person out of lx dying within one year px means the probability of one person out of lx surviving till age 16

The relationship among various coloumns can be established as follows

Qx= number dying divided by number living Dx divided by lx

Px = 1 - qx Lx +1= lx - dx Dx = lx x qx

Now let us see how an actuary uses the mortality table to structure the premium Consider a group of 1 lakh people all aged 20. If as per mortality table, 120 people die within one year and if the Insurer has agreed to pay Rs.1000/- to each one of them, then the Insurer should have Rs.120 X 1000= Rs. 1,20,000 with him to meet the liability. That means each one of 1 lakh people have to contribute Rs.1.20. This is called as RISK PREMIUM, which can be defined as that premium which is sufficient to cover risk for one year only.

Now consider another group of 1 lakh people say all aged 30. In this group, the number of deaths will have to be naturally little more than the earlier age. Suppose we consider 140 people die within one year. Then this group has to pay Rs.1.40 as premium to cover risk for one year. This can be called NATURAL PREMIUM. This is also risk premium but applicable for those aged 30 for a period of one year.

Now consider a situation hypothetically that if we can arrange Life Insurance contracts to be renewable as General Insurance, then each one have to pay

increased premium every year when we come to renew the contract. After certain period, we can start thinking of withdrawing from the insurance contract in view of the increased premium.

It may so happen that the type of people who withdraw from the contract will be very healthy people who no longer feel the need for insurance cover at increased rate. That means that when all healthy people withdraw from the contract, only sub standard people will be left with the Insurer. The mortality rate among such group will be higher than the standard group and the insurer will not be able to meet the liability. This system is called ASSESMENTISM and this is not the correct way of structuring the premium. Hence the Insurer follows a LEVEL PREMIUM system whereby the insured pays the same premium throughout the term of the contract depending on age at entry.

This level premium is more than sufficient during the early years of the contract. The excess premium accumulates with the Insurer as RESERVES. This is a liability of the Insurer. The Insurer towards the cost of Insurance draws a part of the reserves at higher ages towards risk coverage. Hence reserves can be defined as that part of the premium set apart by the Insurer with a view to meet the future contractual liability.

The reserves cannot be kept idle and hence invested by the Insurer as per the Investment policy. The interest earned out from the investment goes towards reducing the level premium to a small extent and this premium is called PURE PREMIUM. This is also level premium but has taken into account, the interest earned out of the reserves.

Now the Insurer has to load the pure premium with expenses. Such expenses of the Insurer are distributed over the entire term of the contract. Pure premium loaded with expenses will become OFFICE PREMIUM.

Office premium is moderated with a contingent loading to arrive at TABULAR PREMIUM. This is quoted as per thousand Sum assured. It depends on the Term and age of the proposer. For each plan of Insurance, the Insurer publishes the Tabular premium, in his prospectus, manuals and brochures.

REBATES FOR SUM ASSURED AND MODE

The assured has choice of paying premium in 4 modes namely yearly, half yearly, quarterly and monthly. Premium collection and accounting will cost more if the mode is more frequent. Hence to encourage, lesser frequency, the Insurer may allow rebates for yearly and half yearly modes. It depends on how the Insurer has structured the premium.

Similarly the Insurer may allow rebates on large sum assured, since for the same cost the Insurer will be receiving higher premium.

Both these rebates are not common for all Insurers. Each one of them follows different methods. But many Insurers have been allowing such rebates. These are to taken into account while calculating the installment premium.