life and Health Insurance - FIN-3660
Abu khaled
chapter444420420financial20design.pptxFinancial Design of Life Insurance Products
Life and Health Insurance FIN 3660
Chapter 4
Outline
The Legal Reserve System
Elements of a Product’s Financial Design
Level Premium System
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Insurance companies have traditionally referred to the financial design of products as “pricing.”
A premium is not a price.
Financial Design for a life insurance product consists of a set of values for the numerous elements of the product.
Actuaries are the employees most heavily involved in the financial design of products.
Financial stability requires revenues > expenses
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The Legal Reserve System
The system insurers use to set financial values for life insurance products.
Policy Reserves are liabilities that represent the amount the insurer estimates it needs to pay future benefits.
In insurance reserves are NOT assets, they are liabilities representing the amounts of money an insurer estimates it will need to pay its future obligations.
Policy reserves represent the largest portion of an insurer’s total liabilities.
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The Legal Reserve System
The Legal Reserve system is based on the following principles:
The amount of benefits payable should be specified or calculable in advance of then insured event.
Companies should collect in advance the money needed to fund a policy reserve so that the insurer will have sufficient funds available to pay claims and expenses as they occur.
The amounts a customer pays for a life insurance policy should be related to the amount of risk the insurance company assumes for that policy.
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Elements of a Product’s Financial Design
The primary elements in the financial design of a life insurance product are as follows:
1) the cost of benefits
2) the insurer’s investment earnings
3) the insurer’s operating expenses
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Cost of benefits
AKA Cost of insurance, the value of all benefits under a product.
Cost of Life Insurance Policy Benefits= Total Potential Benefit Obligations X Probability that Potential Benefits will be Payable
Primary benefit obligation under a life insurance policy is the death benefit payable.
Block of Policies- a group of policies issued to insureds who are all the same age, the same sex, and in the same risk classification.
Mortality Experience Table-compiled from a company’s own records, reflecting insureds’ actual mortality.
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Investment Earnings
The money the insurer earns from investing the funds it receives from customers.
Many investments earn money in the form of interest payments.
Simple Interest- is interest on the original principal only.
Compounding Interest- is interest on both the principal and accrued interest.
Rate of Return- the investment earnings expressed as a percentage relative to principal.
To pay benefits, the insurer uses (1) the premiums and charges it collects from customers and (2) its investment earnings.
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Operating Expenses
The expenses that arise in the normal course of the insurer’s operations.
In general, insurers pay considerably more on life insurance benefits than on operating expenses.
Lapse Rate- percentage of a specified group of policies in force at the beginning of a specified period, such as a year, that are terminated by the end of that period for reasons other than the death of the insured.
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Conservative Values in Financial Design
Because insurers face a risk of unexpected financial outcomes, they must make sure they hold funds in the amount that will be more than adequate to protect policy owners and beneficiaries.
Conservative values for a life insurance product are
Mortality rates that are higher than expected
Investment earnings that are lower than expected.
Operating expenses that are high than expected.
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Premium Rates
A premium rate is a charge per unit of insurance coverage.
For life insurance a premium rate is usually equal to $1,000 of coverage.
The premium rate is usually expressed as the rate per thousand per year.
Example: $500,000 life insurance policy is expressed as $4 per $1,000 of coverage.
Annual Premium amount=$4 x ($500,000/$1,000)= $2,000
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Level premium system
A life insurance premium system that allows a policyowner to pay the same premium amount each year a policy is in force.
Term life insurance (covered in chapter 5) increases yearly; however, the level premium system does not increase yearly.
Insurers expect to have few to no death claims during the early years of these policies; therefore, as customers grow older, they use the premiums from earlier years to pay for the claims.
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