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Chapter Three

Premiums & Bonuses


Objectives of Learning
Understand the concept of premium
Factors affecting product pricing
Understand how profitability is built in the
pricing
Understand the concept of Bonus
Know different types of Bonuses
Know how to calculate the premium
WHAT IS PREMIUM
Premium is the amount which is paid by the insured
to the insurer for an insurance Contract

Insured pays the premium

Insurer
Policyholder
Frequency ofatPremium
Premium to be paid periodic interval.

Every year

Monthly Quarterly Half-yearly Yearly


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 Factor is the rate at which people may die

This Table
MORTALITY TABLE Is constructed
MALE FEMALE Based on past
AGE LIVING DYING LIVING DYING data

Shows how many people in


each age group are expected
to die in a given year
Risk Premium
The 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 Earnings
In 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 Premium
The premium worked out after taking into
account the interest is called the Net or Pure
premium

Interest Factor Net Premium


Risk Premium +
Expenses Factor
Expenses 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
Loadings
The administrative expenses have to be met
out of the premiums paid by the policyholders
These additions to net premium are called
Loadings
The loadings also provide for unexpected
contingency and fluctuations
Office or figure
The premium Gross arrived Premium
at after loading the net
or pure premium is called Office Premium

Office Premium
Net Premium + Expense Factor
Different Types of
Premium
 Risk 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
As per thePremium
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 Premium
Level Premium creates Reserves

 The premium collected is


more than necessary for
Risk Factor
risk coverage in the early
years.
 The extra premium is
Premium
Amount

invested and insurer


earns interest on them
 This is to offset against
the higher risk charges in
the later years
3
0
Age
Extra Premium
Extra 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
30 Days 12 months

03 2002
05
02 2001
04
(30+04=34 months) (12+2=14 months)

10 09 1980
-

Days Months
years

2001-
34-10 14-09
1980
=24 =05
=21

Solution = 24 Days,5 Months and 21 years


Age Nearer Birthday

21 years 0 2 4 6 8 10 12
22 years

Up to 5 months and 29 6 months and above


days age nearer b’day Age nearer b’day is same
same as age last b’day
as age next b’day
Age Calculation
Solution = 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 Calculation
Step 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 Calculation
Tabular Premium Calculate rider premium
36.55 (1/1000)*25000=25

Allow for Modal Rebate


36.55-0.55=36.00 Add Rider Premium
875 +25=900

Allow for large


S.A Rebate Get the Annual
36-1=35 Premium
900

Multiply by SA Get the modal premium


(35/1000)*25000=875
Half yearly Premium
(900/2) =450
Exercise: Premium
Calculation
Tabular Premium 28.40

Sum assured 50,000

High SA rebate 1.50

Health Rider 3.0

Mode Quarterly

Solution ????
Solution
Tabular Premium: Rs 28.40
Rebate for large SA: Rs 1.50
Adj for mode: nil
TP after all adj: Rs 26.90

Annual Premium: Rs (26.90Χ50)


= Rs 1345
Rider Premium: Rs (3Χ50) = 150
Total 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
The principles Fund?
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 Valuation
 Premium 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 Valuation
Fund > Liabilities = Surplus

Some amount is
Kept as reserve
Distributed
To Participating
POLICY
RESERVE Policy Holders
Bonus
Distribution of the valuation surplus to
policyholders is done through the declaration
of Bonus

Participating policies only are entitled to


Bonus
Types of Bonus
Bonus

Reversionary Terminal
Reversionary Bonus
Can be simple or compound

Simple Bonus Compound Bonus


Interest paid only on Interest paid on the
the original loan original loan amount
amount and on accrued
interest
Terminal Bonus
A 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 Learnings
 Life 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