Chapter Three

Premiums & Bonuses

Objectives of LearningUnderstand the concept of premiumFactors affecting product pricingUnderstand how profitability is built in the

pricingUnderstand the concept of BonusKnow different types of BonusesKnow how to calculate the premium

WHAT IS PREMIUMPremium is the amount which is paid by the

insured to the insurer for an insurance Contract

Policyholder

Insured pays the premium

Insurer

Frequency of Premium

Every year

Monthly Quarterly Half-yearly Yearly

Premium to be paid at periodic interval.

WHAT IS PREMIUM Premium paid should be enough to

manage the insurance business and to pay the claim as they arise

Insurance Claim

Premiums are calculated by the Actuary

Key Factors in Premium calculation

1. Mortality Rates

2. Investment Earnings

3. Expenses

Mortality Factor

MORTALITY TABLEMALE FEMALE

AGE LIVING DYING LIVING DYING

Shows how many people in each age group are expected

to die in a given year

Mortality Factor is the rate at which people may die

This TableIs constructedBased on past data

Risk PremiumThe cost to meet the risk of death for one

year at a particular age is called the Risk Premium

The risk premium is based on probabilities of deaths at various ages

•Risk premium would be adequate to pay the death claims

Investment EarningsIn case of endowment policies claims have to be paid

after survival of some years

The actual premium collected has to be more than the risk premium

Investment Earnings

A part of the premium is invested

by the insurer to earn some interest When the investment earnings

are expected to be more, lower premiums are charged

Net or Pure PremiumThe premium worked out after taking into

account the interest is called the Net or Pure premium

Risk Premium Net Premium+ Interest Factor

Expenses FactorExpenses are like

Marketing,establishment,agent commission etc

A contingency factor is also provided as a safety margin to meet unforeseen events like earthquake or riots or epidemic

LoadingsThe administrative expenses have to be met

out of the premiums paid by the policyholdersThese additions to net premium are called

LoadingsThe loadings also provide for unexpected

contingency and fluctuations

Office or Gross PremiumThe premium figure arrived at after loading the net or pure premium is called Office Premium

Net Premium Office Premium Expense Factor+

Different Types of PremiumRisk premium: the amount required to purchase one

year of coverage.

Pure or Net premium: risk & interest factor in totality.

Office premium: administrative expenses + unexpected contingencies + fluctuation.

Tabular premium: Published premium rate table.

Level PremiumAs per the mortality table as the age increases the chargeable premium also increases

If the premium becomes too high in the later years the policy can lapse

The level premium system allows a person to pay the same premium throughout the term of

the policy

Level PremiumThe premium collected is

more than necessary for risk coverage in the early years.

The extra premium is invested and insurer earns interest on them

This is to offset against the higher risk charges in the later years

Prem

ium

A

mou

nt

30

Level Premium creates Reserves

Age

Risk Factor

Extra PremiumExtra premiums are charged for people with more than normal risk and may be charged due to any of the following reasons

Additional or supplementary benefits like accident benefit or premium waiver benefit

Underwriting Decisions because of risk perceived due to health,habits ,occupation etc

Age Calculation

Age nearer to birthday considered

Age up to 5 months 29 days is taken as

lower age

Age Calculation

0504

03 02

20022001

10 09 1980-

Days Months years

Solution = 24 Days,5 Months and 21 years

12 months30 Days

(12+2=14 months)

34-10=24

14-09=05

2001-1980=21

(30+04=34 months)

Age Nearer Birthday

0 2 4 6 8 10 1221 years 22 years

Up to 5 months and 29 days age nearer b’day same as age last b’day

6 months and aboveAge nearer b’day is same

as age next b’day

Age CalculationSolution = 24 Days,5 Months and 21 years

Age as on Last Birthday=21 years

Age as on next Birthday=22 years

Age nearer Birthday=21years

Rebate for Mode of Payment

- 3 % for yearly mode

- 1.5 % for half yearly mode

0 % for quarterly mode

+ 5 % for monthly mode

SSS- No mode extra charged

Rebate for Sum Assured

Per thousand Sum Assured

Rs 25,000 -Rs 49,999 - Rs 1

Rs 50,000 - - Rs 2

Premium CalculationStep 1 : Determine tabular premium depending on the Table-Term (Consider Age)

Step 2 : Allow for modal rebate

Step 3 : Allow for adjustment for Large Sum Assured

Step 4 : Multiply be number of Units

Step 5 : Add if any

•Accident extra

•Health extra

•Occupational extra

•Other extras

Step 6 : Get Annual Premium

Step 7 : Divide by 2-Semiannual, 4-Quarterly, 12 - Annual

Premium CalculationTabular Premium

36.55

Allow for Modal Rebate36.55-0.55=36.00

Allow for largeS.A Rebate

36-1=35

Multiply by SA(35/1000)*25000=875

Calculate rider premium(1/1000)*25000=25

Get the Annual Premium

900

Get the modal premiumHalf yearly Premium

(900/2) =450

Add Rider Premium875 +25=900

Exercise: Premium Calculation

Tabular Premium 28.40

Sum assured 50,000

High SA rebate 1.50

Health Rider 3.0

Mode Quarterly

Solution ????

SolutionTabular Premium: Rs 28.40Rebate for large SA: Rs 1.50Adj for mode: nilTP after all adj: Rs 26.90

Annual Premium: Rs (26.90Χ50)= Rs 1345

Rider Premium: Rs (3Χ50) = 150Total Annual Premium: Rs 1495

Quarterly Installment Premium: Rs 373.75

Life Fund

Premium

Life Fund

There is a need to keep aside income from life insurance business aside as life fund as a reserve

Why Life Fund?The principles of prudent life insurance management require that all the income from the life insurance business be kept aside in a life fund, embarked exclusively to meet the liabilities under life insurance policies.

The laws in India also stipulate this requirement

The life fund can be utilized only to pay the claims and expenses of running the business

The life fund represents the Reserves for life insurance policies

Actuarial ValuationPremium is calculated taking into account likely experiences in respect of mortality, interest and expenses.

These are assumptions or expectations.

If the reality is better than expectation, then business is said to be properly funded.

If experience worse than expectation then premium would be inadequate and business could run into difficulties.

What is Actuarial Valuation?Validity of assumptions needs to be checked periodically

This process is called actuarial valuation and they are done every year

Insurer estimates the liability:

Insurer estimates the premiums that are due as this will added to life fund

Liability – Life fund = Fund Required to be solvent

Actuarial ValuationFund > = Surplus

POLICY RESERVE

Liabilities

DistributedTo ParticipatingPolicy Holders

Some amount isKept as reserve

BonusDistribution of the valuation surplus to

policyholders is done through the declaration of Bonus

Participating policies only are entitled to Bonus

Types of BonusBonus

Reversionary Terminal

Reversionary BonusCan be simple or compound

Simple Bonus Compound BonusInterest paid only on the original loan amount

Interest paid on the original loan amount and on accrued interest

Terminal BonusA one time bonus declared for policies which

have been in force for 15 years or more

This is also known as final additional bonus

Interim Bonus

Are declared by actuaries to pay to policies which become claims between two valuations

Key LearningsLife Premiums depend on mortality, expenses

and interest earnings assumption

A favorable experience in these will result in surplus

Surplus is distributed to policy holders after annual valuation

Valuation is done by Actuary

Age nearer b’day is used for premium calculation

Premium Calculation Method

Thank You