Life insurance

nitesh sudan Pooja shukla Nidhi Neha Deepika Amit beniwal

Introduction
Life insurance contract may be defined as a contract , whereby the insurer in consideration of a premium undertakes to pay a certain sum of money either on the death of the insured or on the expiry of a fixed period.

Features of life insurance

1) Nature of general contract According to section 2(h) and section 10 of Indian contract act, the valid contracts must have the following essentialities:
a)Agreement (offer and acceptance) b)Competency of parties c)Free consent of parties d)Legal consideration e)Legal objective

2) Insurable interest Insurable interest arises out of pecuniary relationship that exists between the policy holder and the life assured so that the former stands to loose by the death of the latter and/or continues to gain by his survival. If such relationship exists than the former has the insurable interest in the life of latter. Loss should be monetary or financial.

Insurable interest
Owns life Others life

Proof is not required

Proof is required

Business relation

Family relation

3) Utmost good faith Both the parties must make full and true disclosure of the facts material to the risks. Material facts Duty of both parties Full and true disclosure Legal consequence

4) Warranties Warranties are an integral part of the contract. These are the bases of the contract between the proposer and the insurer and if any statement, whether material or immaterial, is untrue the contract shall be null and void and the premium paid by him may be forfeited by the insurer. Warranties may be of two types: Informative the proposer is expected to disclose all the material facts to the best of his knowledge and belief. Promissory-these are statements about expectations and intention.

5) Proximate cause
The effective or efficient cause which causes the loss is called proximate cause. If the cause of loss is insured the insurer will pay ;otherwise the insurer will not compensate. In life insurance the doctrine of causa proxima (proximate cause) is not applied because the insurer is bound to pay the amount of insurance whatever may be the reason of death. But in the following cases the proximate causes are observed in life insurance War risk Suicide Accident benefit

6) Return of premium 7)Assignment and nomination

Other features
Aleatory contract(depends on chance) Conditional contract Contract of adhesion(terms of contract cannot be negotiated) Indemnity contract is not applied.

Selection of Risk
The function of the selection of risk is to determine whether the degree of risk presented by applicant for insurance is commensurate with the premium established for persons in his category or some additional premium should be charged or the applicant should be rejected the insurance.

Purpose of selection
Determine whether the proposal should be accepted or not Determine the rate of premium to be charged, which depends on the amount of risk To avoid any discrimination on the part of the lives insured To avoid adverse selection

Factors affecting risk

Factors affecting risks are usually those factors which are affecting the mortality; they are also called factors affecting the longevity of a person. Age- premium is determined at every year of completion of age Build- it refers to physique of the proposed life and includes height, weight, chest expansion etc. Physical condition- it includes sight, hearing, heart, lungs, teeth etc. Family history- the certain diseases of the parents will be relevant factors for determining the degree of risk of the applicant

1.

2.
3.

4.

5. Personal history- it would reveal the possibility of death to the life insured. It can be connected with Health record(any past operations, recent injuries and illness) Past habits(drugs or alcohol addiction) History of occupation(hazardous or unhealthy occupation) 6. occupation- it is the most important factor which includes; hazardous nature of work, chemical effect, excessive mental and nervous strain

7. Resident- the risk will be lesser in a good climate area and more in a bad climate 8. Race and nationality- in India, persons of high, race or caste are expected to live longer than the scheduled castes or tribes 9. Economic status- it is important to examine the family and business circumstances of the applicant so as to justify the amount of insurance applied for 10. Sex- mortality among females sex is generally higher than that of male sex, because of the physical hazard of maternity in females.

Sources of risk information

1) The proposal form: it can be divided into two parts
Application form- it includes questions pertaining to home, address, term of insurance, sum to be assured, mode of payment, name of the nominee, previous insurance history etc Personal statement- it can be filled by (1) either the life to be assured or (2) the agent, writing at the dictation of the life to be assured. This statement mentions name of the life to be assured, family history, information about serious disease, operations

2) Medical examiners report: such examiner has to identify the applicant to avoid case of impersonation. It basically includes general appearance questions.
3) Agent report: the agent is required to state whether the life to be assured , is insurable or not. He has to disclose the financial and social position of the propose and also all the unfavorable information of the life proposed 4) The inspection report: the insurers generally verify the information obtained by an independent agency. The main advantage is that the inspector provides fair and frank information

5) Attending physicians: the attending or the family physician can give better records of health, history of the proposed life and his family. Family physician provide information after charging some fees.

6) Neighbors and business associates: 7) Private friends report: in some situations confidential reports of the friends of the proposer are considered. Since friends are more close they are in a better position to provide information.

Non medical business

Non medical life insurance, sometimes referred to as no exam life insurance Lives insured without undergoing medical examinations They can be of two types : Non medical general scheme- a special report is formed which replaces the medical report. Classes of lives acceptable: male lives not more than 40 years Maximum sum assured: 7500 Types of policy: only endowment, double endowment, educational annuity Maximum age: maximum age at maturity is 60 nearer birthday and maximum policy term is 25 years

 Non medical special scheme : available to males who are literate, not more than 45 years and are employed in special types of employment such as government office, quasi government offices. Types of policy: it covers only limited payment life, endowment, double endowment, money back Maximum sum : 20000

Classes of risk
Uninsurable risk: A hazard or condition that has either a high likelihood of loss, or in which the insurance would be considered against the law Condition or situation that fails to meet the requirements of an insurable risk, such as where a loss is inevitable (as the death of a patient suffering from a terminal illness) or where the damage is gradual (as corrosion or rusting of metals).

 Factors determining uninsurable risk

A risk is uninsurable when an insurance company cannot calculate the probability of the risk and therefore cannot work out a premium that the business must pay Risk is too widespread, for example, when there is a war in the country. When the loss is incurred due to your own deliberate actions, it cannot be insured.

 Insurable risk: these risk are those which after the selection process can be carried out by an insurer although there can be different terms and conditions for different policy holders. Such risk can be divided into: Standard risk related to normal life where there is no much or less risk. It involves majority of people. Sub- standard- risk which are higher though insurable than the standard risk. They are above the standard risk and below the uninsured risk Super standard- they are present where there is lesser risk than the standard risk.

Methods of risk classification

1) Judgment method The individual decisions of experienced persons, in medical , in actuarial and other departments are combined. These people are qualified and permitted to take decision This method is Used: where a single factor is to be considered or where the decision for acceptance or rejection is to be taken Where numerical rating fails to decide

Disadvantage:
Personal direction may be biased This method is not very scientific

2) Numerical rating method Based upon the principle that a large number of factors enter into the composition of a risk and that the impact of each of these factors on the longevity of the risk can be determined by statiscal study of lives possessing that factor It assumes that a standard risk has a rating of 100 Favorable factors are assigned negative values called credits while unfavorable factors are assigned positive values called debits

 The particular percentages are added or deducted for each factor The algebraic summation of the debits and credits added to the per value of 100 represents the numerical value of risk. The degree of risk on the basis of each factor is evaluated in terms of percentage. If it is more than 100, i.e., if the risk is more than the standard the extra percentage will be debited (+) and if the degree of risk expressed in percentage is less than the 100, the lesser percentage will be credited (-) up to the difference.

Mortality Table
A table that shows the rate of deaths occurring in a defined population during a selected time interval, or survival from birth to any given age.
It records the past mortality and is put in such form as can be used in estimating the course of future data.

 Features:

observation of generation: persons of a generation are

selected and they are observed upto death. Start from a point: it starts from a point which depends on the requirement of the insurer and will continue upto the point all of them has been dead Yearly estimation: it records the yearly death or survival rate Mortality and survival rates: any table giving mortality rates only is not mortality table, unless mortality rate of a generation is calculated every year.

TREATMENT OF SUB STANDARD RISKS

TYPES OF SUB STANDARD RISKS

(a) Increasing Extra-Risk:- In this category, the extra mortality increases as the life assured grows older. For example patients of diabetes, overweight etc. (b) Decreasing Extra-Risk:- In this category, the extra hazard decreases with increase in age. For example, persons of defective past history. (c) Constant Extra-Risks:- In this category, the extra hazard remains at the same level throughout the life-time of the assured. For example, blindness, or loss of limb, deafness, etc.

Treatment of Sub-standard risks

Increase in premium, Decrease in death, benefits Change in class and period of assurance, Any combination of the above-mentioned methods, and Postponement of risk.

A. INCREASE IN PREMIUM

Rating up of age:-Under this method, the

life assured is assumed to be a number of years older than his real age. The premium rate is calculated according to the assumed higher age. The extra no. of years to be added is determined according to the extra risk involved with the life assured. Premium once decided cannot be changed so this method is not suitable to decreasing risk.

 Flat Extra Premium:-Under this method a flat annual extra premium

of so many rupees per thousand sum assured per year is charged. Thus, a Constant additional premium is added to standard premium. Extra premium is also charged for certain defects and deformity like imputed arms and legs, partial or total blindness, deafness, etc., or in the case of standard imprepairments. This extra rating mostly vary from Rs.2/- to Rs6/- per thousand of sum assured per annum.

Extra Percentage Plan:- There are certain classes of sub-standard

risks which are determined by numerical rating system. For each class of extra risk, a certain percentage of the standard premium is charged. This extra percentage is added to the standard premium and is charged along with the standard premium.

B. Decrease in Death Benefits:

The death benefits may be reduced in two ways: Lien Method; and Restrictive Clause.

 Lien Method:- The amount payable under this method would be the sum assured less the outstanding lien at the particular time of the policy. The lien is for a fixed number of years. If the life assured dies within this period, the amount of lien is deducted from the policy amount and rest is paid to the beneficiary but if the life assured survives the period of lien, the whole of the policy amount is paid at the claim. For example, a reducing lien of Rs. 500 per Rs. 1,000 sum assured for 10 years would mean that the sum payable would be reduced by Rs. 500 if death occurs in the first year, by Rs. 450 if in the second year, and Rs. 400 if in the third year and so on, so that the full sum assured will he paid if death occurs only after the expiry of 10 years.

 Restrictive Clause :-

Under this clause, the extra hazard is accepted with a restrictive clause which limits death benefit under certain circumstances. Such a clause usually states that the amount payable under this policy will be on a reduced basis which any be surrender value or return of premiums paid, in case death occurs due to the specified extra hazard. For example first pregnancy clause or aviation clause.

C. Change in the Class and Period of Assurance

The life assured is not given all types of insurance and for a longer period. There is neither a lien on the policy nor any extra premium by way of flat nor rating up to ages. The policy is given at standard premium but all types of policies are not issued. The types of policies to which the choice is restricted are those which carry a higher rate of premium such as ordinary endowment policy.

D. Any Combination of the above-mentioned Methods E. Postponement :

Consideration of proposal is postponed for a period, when the initial risk is so heavy that there is little hope of offering insurance immediately and the proposal is postponed. Postponements in different type of risk are different. It has been observed that the postponement vary from 3 months to 3 years.

THE RESERVE
Reserves is a liability which is to be met by the insurer at and when it arises. It must be adequately met. Prospective definition:-The reserve is that fund, which, together with future premiums and interest, will be sufficient to pay the future claims Retrospective definition:-The reserve is considered as the accumulation at interest of the difference between the net premiums received in the past and the claims paid out.

Origin of reserve
The reserve in any group of policies originates in the excess of premium receipts over payment of claims . The premium receipts are more than the payments in the beginning and less after a point . The excess receipts are accumulated at the assumed rate of interest and build up the 'Reserve.

Need for reserves

I. To Meet the Amount of Claims:- The reserve is required to meet the amount of claim whenever the given event takes place. The insurer must have sufficient amount to meet the claims. Therefore, the reserve is essential to meet these claims. II. To Build up Funds:-the 'reserve' is also useful to build up funds that can be invested for long period to earn at least assumed rate of return. The invested funds help not only to the insurer to obtain a required amount of return but are also helpful for the economic development of the country.

Sources of reserves
PREMIUN
o Assessment Premium PLAN- members of a group contributes to a fund which can be utilised to settle the claim at the time of death of any assured.In this case there is no need to accumulate the amount for payment of the claim. Natural Premium Plan -rate of premium increases as the insured grows older.

Level Premium Plan - in the initial years the premium paid is more than the actual cost which result in accumulation of reserves which makes up deficiency out of lower premium in later years. INTEREST

Methods of calculating reserves:Reserves

retrospective method

Prospective Method

Group

Individual

Group

Individual

INVESTMENT OF FUNDS
While calculating premium it has been assumed that the accumulated premiums are invested. The funds are invested to earn at least assumed rate of interest. The needs of investment of funds are given here in brief. Payment of claims To avoid financial deficit National interest

Sources of funds
Premiums Interest Capital gains Savings in expenses Non payment of claims

Problems of investment
1) To preserve the interest of policy holders : to maintain the trusteeship ,it is essential that the fund must be invested in safe and secured securities. 2) Payment of the claimed amount : the insurer must have sufficient funds to pay the claims. 3) The asset should be protected from any element of fluctuation : insurer must earn sufficient amount to pay the expenses and the earning should be constant along the market price of the security. 4) There should be complete good faith of public in the insurers management of funds.

Principles of investment
Safety (no speculative investments) Profitability(highest return along with safety) Liquidity Diversification Increasing of life business(life funds should be invested in sectors which are going to benefit the business in the return. for eg. financing housing, sanitation ,medical and education.)

Surrender Value
Meaning:
When the insured wishes to surrender his policy or fails to pay his premium, reserve(premiums received by the insure; are accumulated with a certain rate of interest) is no longer accumulated and the insured, generally, is given a surrender value. The surrender value will not be equal to the accumulated reserve because certain expenses or losses are involved in payment of surrender values. No surrender value is paid if the policy lapses within two or three years of its issue . There are two bases of calculating surrender values:I. Accumulation Approach II. Saving Approach.

I.

The Accumulation Approach :

surrender value is the accumulation of overcharges in the net premium, which upon the surrender of the policy is no longer required to pay the amount of claims. very scientific because it allows surrender values to all types of policies, whereas, in practice surrender values on the term policies and pure endowment policies are not allowed . regards reserve for policy as the basis of distribution of surrender values. The reserve is calculated in this case on gross premium. So the expenses are also deducted from the premium received. Thus, the reserve would be equal to all the premiums paid and interest earned thereon minus shares of death claims and of over all expenses of the insurer. The full amount of reserve to a particular policy cannot be given as a surrender value because there are certain expenses and loss because of surrendering the policies. Thus, Surrender Value = Full Reserve-Surrender Charges

Surrender Charges: The surrender charges are those expenses and losses which occurred on account of a surrender or causation of policy. The surrender charges are discussed below:

(i) Initial Expenses : In the beginning of the contract, certain expenses are involved for processing the proposals, payment of commission to agents and medical officer, correspondence and issuing of policy.
(ii) Adverse Financial Selection : During the period of business depression, the surrendering of policies weaken the financial standing of the insurer . In such cases the policyholders should not be allowed to receive surrender values more than the realized values of the invested funds.

(iii) Adverse Mortality Selection : the persons in extremely poor health are not likely to surrender their policies. Those who do surrender are expecting longer lives than those who do not surrender. Consequently at every surrender, the average or actual mortality tends to increase more than the assumed mortality. (iv) Contribution to Contingency Reserve : While calculating gross premium a small amount for contribution to contingency reserve is charged from the policyholders to meet the sudden and accidental rise in claims due to wars and epidemics. If the policy is surrendered in the beginning, the contribution is left unrealised. (v) Contribution to Profits : The policy is expected to contribute a fund towards the profit. If the policy surrendered, the expectation is lost. So this contribution should also be treated as surrender charges while permitting surrender of policy. (vi) Cost of Surrender : The insurer will incur a certain amount of expenses in processing the surrender of policies. Sometimes, the cost of surrender is like other expenses, spread over the premium paying period.

II. Saving Approach : An insurer is responsible for payment of claims whenever it may arise; but if a policy is surrendered, the insurer is relieved of its obligation for payment of the assured sum.

Thus, where the insurer is relieved of the responsibility of payment of claims, he is in a position to return some amounts to the insured.
For example, in Term Insurance and Pure Endowment policies. the surrender value is paid in lieu of the claim amount. Here it is to be understood that the amount of saving in non-payment of claim can be calculated only after considering various transactions from the inception of the policy up to its surrender and from the date of surrender up to the maturity or deaths.

 Had, instead of surrendering the policy, the insurance continued, the insurer would have received the level premiums on the policy and have earned interest on invested amounts and would have occupied certain expenses. Thus, at the surrender of the policy, the insurer does not get certain income and has not to occur future expenses in relation to the policy. The incomes or expenses will continue up to the policy life. Therefore, the life expectancy is to be known while determining the saving in expenses or loss of income. So, at the time of surrender of the policy, it is expected that the policy would have continued up to the maturity or till the end of mortality table. The surrender value on a policy can be calculated as below: Surrender Value = (Sum assured + Accumulated value of future expenses + Future reversion ally bonus, if participating policy) - (Accumulated value of all future premiums + expenses incurred in processing the surrender value).

Forms of Payment of Surrender Values

The policy holder can get the surrender values in any of the following forms: 1. Cash Surrender Value The policyholder can get the value of surrender in cash. When the policyholder gets the cash, the contract comes to an end and the insurer has no further obligation to pay on that particular policy 2. Reduced Paid up Insurance In this case, the surrender value is not paid immediately, but the original amount of policy is reduced in certain proportion and the reduced amount is paid according to the term of Policy. .

non-forfeiture condition would apply to proposals completed on and after 1 -1 -1976: If the premiums under the policies have been paid for a period of five years or 1 /4 of the original premium paying period of the policy whichever is less but subject to the condition that minimum 3 years' premiums are paid.

The paid up value under the policy is not less than Rs. 250 excluding of attached bonuses for policies where under original sum assured is Rs. 1,000 or more and Rs. 100 exclusive of attached bonus where the original sum assured is less than Rs. 1,000. 3. Extended Term Insurance: The net cash value arisen at the time of surrender of a policy can be used for payment of as single premium for purchase of term insurance, where the sum assured will be paid only when death of the life assured occurs within the term of the policy.

4. Automatic Premium Loan : the surrender value is used for payment of future premium. The premiums continue to be paid until the surrender value is completely exhausted. The advantage of this scheme is that if the policyholder dies after surrender but before expiry of the surrender value, full policy amount minus the loan and interest thereon is paid.
5. Purchase of Annuity : The policyholder, with the surrender value, can purchase an annuity. Thus instead of taking surrender value in cash, the annuity is purchased from the available surrender value. The amount of annuity depends upon the amount of net cash value, the attained age of the policyholders and the type of annuity required.

Valuation
VALUATION is a process : 1. To determine the total net liabilities of the insurer & 2. Compare his liabilities with the available funds.

Objectives of the Valuation

(i) To determine the Solvency: The life insurer must find out whether he has sufficient funds to meet the current obligations or not. (ii) To determine the divisible Surplus: The excess of receipts over expenditures of a period cannot be regarded as profit of the year.

Calculation Process
The valuation involves calculation of : I. Calculation of Net Liabilities : The Net liabilities may be calculated with prospective method or retrospective method. Whatsoever method may be applied, the result will be the same provided the past assumptions are also applicable to future estimations.

Bases of Valuation of Net Liabilities :

(i) The Mortality Rate: The morality rate is assumed that which is likely to be experienced in future during the policy. The past mortality which is revealed recently is modified in the light of present conditions and future prospects of the mortality rates.

(ii) Rate of Interest: not depending upon the past assumed rate; base our valuation on such rates which may reasonably be anticipated. (iii) Rate of Expenses: expenses should be assumed. past expenditure ratios may not be the correct figure of valuation. the future expense may be unduly heavy, if businesses are expanding or vice versa.
(iv) Bonus Rate: Premiums on the participating policies are loaded with bonus extras. In exchange of the bonus loading, the participating policyholders are getting bonus.

2. Calculation of Life Insurance Fund : is obtained from the revenue account of the insurer. The previous fund is shown in the credit side of the revenue account in respect of life insurance. During the period, all incomes including premiums, interest, rents, etc., are credited to the revenue account and all payments, like policy claims, annuities, management expenses etc., are debited to the account. The difference of the two sides will disclose the Life Insurance Funds available to insurer at the end of the period. The excess of the incomes over the expenditures during the year will disclose the life insurance fund of the year. Life Insurance Fund is different from Life Insurance Reserve.

3. Comparison of Net Liabilities with Life Insurance Fund : The insurance Act has provided that the valuation should be done once in a period of 3 years. However, the Life Insurance Corporation of India has taken a liberal attitude The comparison of net liabilities with Life Insurance Fund will disclose surplus or deficiency. a. Treatment of Deficiency : When deficiency arises, the insurer has to apply some drastic actions such as the expenses are curtailed, profitable investments are sought and bonus is not declared. The premium rates are increased , which causes reduction in business. b. Treatment of Surplus : distributed among the policyholders and shareholders only after certain provisions(General Contingency Fund, Dividend Equalisation Fund, Bonus Equalisation Fund, and Taxation Fund).

Sources of Surplus
1. Excess Interest :

The excess of actual interest over the assumed one gives rise to surplus. Sale of securities at more than the book value also contributes the surplus.
2. Savings from Mortality : The savings from mortality act in three ways to induce surplus. Firstly, lesser death causes higher amount of premium which shall be received from the persons more than the expected one. Secondly, lesser payment of claims on account of lesser death causes Surplus to a great extent. Thirdly, the extra-premium will not be required due to death less than the expected ones of actual interest over the assumed one gives rise to surplus

3. Savings from Loading : A certain amount is added to the net premium to obtain the office premium for meeting the expenses of the insurance-business. If this assumed loading is more than the actual expenses, surplus will arise. 4. Lapses and Surrenders : Early termination of policy during policy-life may give rise to surplus, if the surrender value given is less than the reserve accumulated or amount of surrender to be given. Actually, this is not surplus because the excess amount will be required to meet the losses on account of surrender. 5. Bonus Loading : On participating policies, bonus loading is added to declare at least a certain minimum rate of bonus. The unutilised portion of it along with interest thereon is added to surplus. Miscellaneous Sources : Saving in various types of annuity contract may give rise to surplus. Similarly in pure-endowment or Term insurance, some amount may remain unpaid, which will be taken as a surplus.

Methods of Distribution of Surplus

Uniform Bonus Plan : a uniform bonus rate is given to all policyholders of a particular type. The bonus rate is based on the policy amount. The bonus rate is determined simply by calculating the total amount of divisible profit and multiplying it with the amount of insurance of Rs. 1,000 and again dividing the whole sum by the amount of insurance under participating policies, at the time of valuation. Contribution Method : divisible surplus allotted to the various policies in proportion to the individual contribution of each policy to the surplus . Since there are several sources of surplus, contribution of each source should be analysed. For this purpose two things have to be taken into account. 1. The contribution of a particular type of policy to the total surplus. 2. Contribution of each source of surplus of a particular policy to the total surplus is to be determined. Then, on the basis of the contribution of each policy, the surplus is allocated. 'Three Factor Contribution Plan(The calculation has been made simple by taking only three sources of surplus viz. Mortality, Interest arid Expenses savings.)

Classification of Bonus
1. Bonus on the Basis of Calculation: There are two methods of calculation of bonus. uniform bonus :where the rate of bonus varies according to the policy amount. contributory bonus: where the contribution method is applied. 2. Bonus on the Basis of Vesting : Immediate bonus :when the bonus may vest as soon it is declared or after a period when the declared bonus is payable soon as it is declared Bonus is payable : when the bonus does not become a liability of the insurer as soon as it is declared, (only when particular conditions are fulfilled). 3. Bonus on the Basis of Results : bonus is determined on the basis of actual results or fixed on an abhor basis. When the actual valuation has taken place, the bonus declared is known Final Bonus, and the bonus declared before the actuarial valuation is known as Interim Bonus.

Bonus Options (Insurance)

1. Cash Bonus : Under this plan, the bonus when declared is paid to the assured in cash and the original sum assured alone is payable at claim and can be converted into other options of bonus. 2. Reversionary Bonus : Simple Reversionary Bonus Compound Reversionary Bonus 3. Reduction in Premium Bonus : When the bonus is not added to the assured sum but is utilised for permanent reduction in the future premium payable, it is called 'Reduction in Premium Bonus. 4. Accumulation at Interest Bonus : The bonus on the policy is kept in deposit with the insurer. The insurer gives a fixed rate of interest on the deposited amount and the insured at any time can withdraw the accumulated bonus or can use it for payment of future premiums.

5. Endowment Option : Under this option, the bonus is accumulated with a certain rate of interest and when the accumulated value of the policy becomes equal to the policy amount, the policy amount is paid in full before maturity.