UNIT 2

Life insurance Techniques - Basics and

Applications

Demographic Bases
Investment linked insurance plan
Insurance Products
Pensions & Annuities
Risks and solvency of Insurance
 Demographic Bases
• Demographics concern the measurement
of the population.
• Demographic segmentation involves
segmenting markets by age, gender,
income, ethnic background, and family
lifecycle. Other demographic descriptors
include educational level, occupation and
religion.
 INVESTMENT LINKED INSURANCE PLAN

• An investment-linked insurance plan is a life

insurance that combines investment and
protection.
• Your premiums provide not only a life insurance
cover, but part of the premiums will also be
invested in specific investment funds of your
choice.
• You get to choose how to allocate your
insurance premiums towards protection and
investment.
 Insurance Products
• Single Premium LIC
• Single Premium level term plan
• Occupational pension schemes
• Unit Linked Insurance
• Index linked Insurance
• Endowment Policy
 Single Premium LIC
• Single-premium life (SPL) is a type of life
insurance in which a lump sum of money
is paid into the policy in return for a death
benefit that is guaranteed to remain paid-
up until you die.
• With single-premium life insurance, the
cash invested builds up quickly because
the policy is fully funded.
 Example
• A 60-year-old female might use a $25,000
single premium to provide a $50,000
income-tax free death benefit to her
beneficiaries; whereas a 50-year-old
male's $100,000 single premium might
give a $400,000 death benefit.
Single Premium Level term plan
• Single Premium Term Assurance primarily
caters to the mortgage groups – like Banks and
Housing Finance companies.
• One Time Premium Payment -You can pay the
premium for the full term, to cover as many
clients as you wish, at one go. This way, you
save your administrative and financial managers
the recurring trouble of remembering to pay
premiums time and again.
 contd
• Guaranteed Premium Rate - Once you've paid
the premium, you can be rest assured the
premium rate is guaranteed throughout the
cover term. Your clients can feel safer and you
can save the effort of having to ever review the
rate.
• Under the plan, though the outstanding loan
amount decreases over a period of time,
protection under the plan remains constant to
the original loan amount granted. As your loan
decreases, so does your liability thereby giving
your clients additional protection.
 Pensions
• Pensions are generally a series of payments
made to a person after they retire. The
payments are made regularly and are for past
services with an employer. A pension is a means
for providing a secure income for life.
• There are pension plans specifically geared to
small businesses. The Simplified Employee
Pension (SEP) is designed for businesses with
no other pension plans in place. They are tax-
deferred accounts.
 Cont.d
• Saving Incentives Match Plans for Employees of
Small Employers (SIMPLE) are pension plans
for businesses with 100 or fewer employees.
• Employees put a portion of each paycheck into
an IRA. The employer matches the contribution,
and employees decide how to invest the money.
If the employee changes jobs, they still keep
their IRA account.
 Annuities
• An annuity is a series of fixed payments, which
can be paid over a fixed amount of years, over
the lifetime of an individual, or both. Insurance
companies provide annuities.
• A fixed period annuity allows an individual to
receive definite amounts at regular intervals for a
set period of time. The insurance company sets
an interest rate for one year at a time, and resets
the rate at their discretion. The interest
accumulates and is tax-deferred for most
people.
• Variable annuities combine the
advantages of a tax-deferral with
professionally managed investment
portfolios.
• An individual is allowed to select different
investment options with different
objectives to suit their needs. The rate of
return on the annuities will fluctuate.
 Occupational pension Scheme
• A pension scheme open to employees
within a certain trade or profession or
working for a particular firm. An
occupational pension scheme can either
be insured or self-administered.
• If it is insured, an insurance company
pays the benefits under the scheme in
return for having the premiums to invest.
• In a self-administered scheme, the pension-fund trustees
are responsible for investing the contributions
themselves.
• Occupational Pension schemes were first offered to
employees as an incentive to attract labor to businesses
that were in desperate need of workers.
• The government of that time offered taxation incentives
to employers who contributed to an employee's
retirement fund, and these contributions were offered to
employees as a benefit of employment in addition to
their remuneration.
• A pension fund is a pool of assets forming an
independent legal entity that are bought with the
contributions to a pension plan for the exclusive
purpose of financing pension plan benefits.
• Pension funds are important shareholders of
listed and private companies. They are
especially important to the stock market where
there are large institutional investors.
 Risk and Solvency of Insurance
Company
• Risk and solvency corresponds to its
ability to pay claims. An insurer is
insolvent if its assets are non adequate or
cannot be disposed of in time.
• Solvency depends upon whether technical
reserves have been set up and whether
the company has adequate capital as
security.
• Solvency margin is the amount by which
the assets of an insurer exceeds its liability
and will form part of the insurer’s
shareholder funds.
• For Life insurance business the minimum
solvency will be related to the policy
reserves as disclosed by the actuarial
valuation of the liabilities.
Mathematical basis of Insurance
• Probability - It refers to the chances of its
occurrence of the total set of possible
occurrences.
• The probability of the occurrence for a given
outcome can be accurately estimated and used
for decision making.
• Probability Distribution - It can either be discrete
or continuous. In insurance we use the three
popular variable distributions called Binomial,
Normal and Poisson
 Probability Distribution
• Binomial Distribution
Probability of occurrence of an event is p
Probability of an event will not occur is q
q = 1- p
We can also calculate how often an event will
happen.
• Normal distribution
If the number of observations increases, the
binomial distribution may be used to
approximate what is called normal distribution.
 contd
• Binomial distribution requires variables to
be discrete. With normal distribution the
variables may be continuous having
values from 0 to infinity. As a result,
normal distribution can be applied in more
situations and more realistic.
• Poisson distribution
Theoretical distribution that is useful in risk
management applications.
• P = Probability that an event n occurs
• R = No of events for which the probability
estimate is needed.
• M = mean (expected loss frequency)
• E = a constant, basis of natural algorithms.
 Life Reinsurance
• System whereby a life insurance company
(the reinsured) reduces its possible
maximum loss on either an individual life
insurance policy (facultative Reinsurance)
or a large number of life insurance policies
(automatic Reinsurance) by giving
(ceding) a portion of its liability to another
insurance company (the reinsurer).
• Method by which large groups of individuals
equalize the burden of financial loss from death
by distributing funds to the beneficiaries of those
who die.
• There are three basic types of life-insurance
contract.
• Term insurance is issued for a specified
number of years; protection expires at the end of
the period and there is no cash value remaining.
• Whole-life contracts run for the whole of
the insured's life and also accumulate a
cash value, which is paid when the
contract matures or is surrendered; the
cash value is less than the policy's face
value.
• Endowment contracts run for a specified
time period and pay their full face value at
the end of the period