Professional Documents
Culture Documents
Principles of Insurance
Insurable interest:
An insurable interest is necessary for the contract to be valid. It means a life or
limb, property, potential liability, or financial interest should be involved. The insured
should suffer loss due to the occurrence of the insured event. The loss should be
pecuniary. Loss should be recognised by law . e.g. Father has no insurable interest in the
event of death of the son, unless the father can prove that he has a financial dependency
on the son.
Indemnity:
It is the concept of ‘Exact financial compensation’ when a loss occurs. This
implies that the insured is placed in the same financial position before and after the event.
However, loss due to death of a person is linked to an extent to the income status
and potential of the person. Because such a loss cannot be exactly compensated, it is not
an indemnity but only a guarantee of a benefit. Hence we use the term ‘assurance’ for
life, whereas we use ‘insurance’ for motor and other non-life risks.
Subrogation:
On payment of claim, the insurer is entitled for any rights the insured might have
enjoyed before the claim.
Average Clause:
If a property is insured for a value lesser than the current value, the claim will also
be settled at a proportionately reduced value. This average clause is not applicable to life
or motor vehicles.
Life Assurance policies can be broadly classified into Term, Whole of Life and
Endowment Assurance.
Term assurance
In this case the life is assured for a fixed term. The Sum Assured is paid if death occurs
within the term. However, on survival of the term no benefit is payable to the insured.
Normally premiums will be low compared to other types as there are no benefits on
survival. In some contracts, however, premiums may be paid back with little or no
interest, on survival.
policy.
Premiums for With-profits policies are always higher than those for corresponding non-
profit contracts, since higher benefits are paid out.
Various flavours of whole of life and endowment assurance policies are structured based
on their investment linkage.
Endowment assurance :
Here again the life is assured for a fixed term, but benefit is payable either on earlier
death or at the end of the term. This type of assurance is usually taken for long terms such
as 20 or 30 years. Very often the maturity date is kept closer to the retirement date,
though not necessarily so. An endowment policy can be used as security in getting loans
because a return is assured. This is the most popular type of assurance in U.K.
All the variants of Whole of life policies are also available for Endowment assurance
policies.
Underwriting
This is a process performed by the insurer, on receipt of a proposal, to decide whether or
not to accept the risk, and if so, on what terms. An underwriter is the person authorised to
accept, reject or fix terms for accepting a risk. The underwriter looks for factors adversely
affecting the longevity of the life assured, such as health, occupation, industry and life
style.
The underwriter scrutinises the facts given in the medical part of the proposal. He can
also check in the alphabetical name index maintained by the life office to find out
whether the proposer has been offered an under-average rate for an earlier policy or has
been declined a policy previously. He will compare the sum assured and age with the
non-medical limits set by the life office, and also will examine whether the insurance
cover including earlier insurance is at a reasonable level and not too high.
Based on this the underwriter arrives at a decision on the risk. The various underwriting
decisions are :
Proposers being assessed by the underwriter as having a greater risk of death than implied
in the premium rates are termed sub-standard lives and they will be offered special terms.
Impose a rating :
By rating, the proposer’s age is hiked up by a few years. For example a person aged 50
with asthma may be rated as ‘plus 2’ and he will be charged the rates for a 52 year old
person.
Impose a debt :
A debt is a reduction from the sum assured. It will often decrease and become nil at the
end of the term. This may be offered if the proposer disagrees to pay the extra premium
quoted for the extra risk and the nature of risk is not of increasing type.
All agents are paid remuneration for business generated, which is called commission. The
two major types of commission are Initial commission - which is paid for getting the
policy and Renewal commission - which is paid for continuation of the policy. In general,
the first few premiums of any regular premium policy go towards initial commission
payments. Commission is paid based on preset rates for various products. However
preferential commission rates are negotiable by the agents. Companies usually have a
limit on the percentage of Premium that can be paid as commission. When agents operate
as a hierarchy the commission is also split across them.
Exits Processing
This term is collectively used to denote all processing that is done to handle the following
events
Cancellation / Lapse
Surrender
Paid - up
Death Claim
Maturity
In all the exits cases, computer records are updated to cease the process of premium
billing for the policy and also help in various MIS and acturial functions.
Cancellation
According to statutory laws the policyholder has a right to cancel a policy, on its issue,
until a period of time called the ‘Cooling off’ period. A Cancellation Notice will usually
be sent along with the policy document. If the policyholder wishes, he may complete and
return this form within the cooling off period. The cooling off period is usually 14 days if
a cancellation notice is sent by the life office. Otherwise it is two years.
On receipt of a completed cancellation notice, the policy status is set to ‘Cancelled’ and
premiums received will be refunded in full, except in case of unit linked policies where
the unit price on date of cancellation will be used to calculate the amount to be returned.
Surrender
Any time after the cooling off period, and after the policy acquires a surrender value,
during the term of a policy the policyholder may wish to cash in the policy. Usually
during the first few years a policy will not achieve a surrender value as most of the
premium paid goes towards policy set up expenses, commission and charges.
On receipt of a surrender request, the life office will calculate the surrender value (SV) of
the policy. The surrender value will be in proportion to premiums paid. Since the life
office incurs high expenses initially in setting up the policy records and policy
procurement, it is usual to recover part of this loss while paying out the surrender claim.
The surrender value is calculated based on plan, either by using a formula or by an
explicit penalty as a percentage of premiums paid. The earlier the surrender, higher the
penalty and hence a lower surrender value. On calculation of SV, a letter will be sent to
the policyholder, listing the documents required and a Surrender Form. On receipt of the
completed surrender form and all required documents, the cheque for SV will be sent.
In case of with-profits policies, the policyholder is sometimes given the option of Partial
surrender, whereby he may encash only the bonus accrued. In this case the current value
of the bonus declared till date will be calculated as the Partial SV and paid out.
Paid-up (PUP)
If a policyholder can no longer afford to pay the premiums he may choose to make the
policy paid-up. This means that no further premiums are payable and cover continues at
an appropriately reduced level. Only whole of life and endowment policies which have a
surrender value can be made paid-up. A term assurance policy just lapses.
On receipt of a paid-up request the life office will calculate the reduced Sum Assured
based on the policy’s current value. A communication will be sent to the policyholder
detailing the reduced SA and proof required to make the policy paid-up. On receipt of
proof, the policy status will be set to Paid-up and the reduced SA will be in force. This
will usually be handled as an endorsement to the policy.
Death Claims
Normally a death claim will be initiated by the claimant or the solicitors of the deceased,
when the life assured dies. On receipt of a death claim, the life office will calculate the
amount payable. In case of with profits policies, this will include the bonuses declared till
date and also any terminal bonus. For Unit linked policies, it will be the higher of the
Guaranteed Minimum Death Benefit (GMDB) or the bid value of units held by the
policyholder.
A claim form, a letter stating the claim amount and request for documents required to
settle the claim will be sent. The main requirements are Proof of Death, Proof of
entitlement by the claimant, Proof of age (if not given at proposal time). On receipt of the
completed claim form and the required documents the cheque for the claim amount is
sent.
Maturity
All maturity processing starts a few weeks before the maturity date as life offices
endeavor to release the cheque so that it reaches the policyholder on maturity date.
Four to six weeks before the maturity date, the Maturity Value (MV) is calculated and a
letter is sent to the policyholder stating the amount, listing the requirements for payment
and enclosing a claim form. On receipt of the completed claim form and all required
documents the cheque will be sent out.
Annuities
An annuity is a contract to pay a given amount every month or quarter or such other
frequency chosen by the annuitant, whilst he is still alive. In this sense it is not a life
assurance policy. The annuitant buys the annuity from the life office by paying a lump
sum or regular premiums. Usually the annuity payments cease on the death of annuitant.
Annuities are usually expressed in terms of the annual amount payable. An annuity can
be payable in arrears or in advance. For example, where are annuity is effected on 1
January 1999, if the first payment is made on the same date it is called ‘in advance’, if it
is paid on 1 January 2000 and if the frequency chosen is yearly, it is called ‘in arrears’.
Where the payment is ‘in arrears’ it could be further classified as ‘with proportion’ or
‘without proportion’ depending on whether a proportionate amount is paid on death for
the period from last installment paid to date of death.
Annuity types
Immediate Annuity
An immediate annuity contract provides, in return for a single premium, an annual
payment starting immediately and continuing for the rest of the annuitant’s life. An
annuity payable for life is also called a life annuity. These are usually purchased by
people at the time of their retirement.
Deferred Annuity
A deferred annuity provides annuity at some future date. For the period between the
contract date and deferred date, called the deferred period, regular premiums are usually
payable. If the annuitant dies during the deferred period the office will usually return the
premiums paid, with or without interest. Often a cash option will be available on the
vesting date, in lieu of the annuity.
Temporary annuity
Here the annuity is payable for a fixed period or for the annuitant’s lifetime, whichever is
shorter.
Annuity certain
In this type, the annuity is payable over a certain period agreed in advance. It does not
depend on survival or annuitant.
Guaranteed annuity
The annuity is guaranteed to be payable over a fixed period of time say 5 or 10 years and
continued thereafter throughout the life of the annuitant.
Escalating annuity
In this type of annuity, the annuity installments payable are increased periodically by an
amount agreed at the outset. It is a simple form of protection against inflation.
Pensions
Occupational Pensions
These are pension schemes offered by the employer to their employees. In the state
operated scheme, pensions are paid out of the tax revenue. This approach is called ‘Pay
as you go’. Such schemes can be operated only when income at a future date is
guaranteed. In most companies, contributions are paid by the employer and employee
into an investment fund. The pensions are paid from the fund as and when they fall due.
The fund is usually set up as a trust fund, separate from the employer’s business and not
dependent on their future solvency. Tax recognition and relief are also available to such
schemes.
a. Define the benefits that are payable and pay sufficient contributions to provide those
benefits,
b. define the level of contributions and then provide benefits, based on the accumulated
amount available when the benefit falls due.
AVC
An additional Voluntary Contribution (AVC) is where the employee contributes more
than the standard amount towards his pension. The reasons to opt for an AVC are two
fold - When an employee wants to increase his own retirement benefits, above the levels
defined in the occupational pension scheme provided by the employer. The other reason
is the tax rebates available for an AVC. According to the law 15% of pensionable annual
income can be paid into a pension scheme. So, in cases where the employers scheme
takes out less than that, say 10%, the employee can choose to voluntarily contribute the
remaining 5%, thereby qualifying for tax benefits.
FSAVC
An AVC can be paid into the employers pension scheme itself or to a personal pension
plan. The latter is called a Free standing AVC (FSAVC). These are attractive because
certain types of perks which are not included as pensionable income under the Inland
Revenue rules are counted as pensionable for FSAVC. Moreover an early retirement age
can be specified for an FSAVC, so that the benefits become available immediately on
early retirement. In case of an employers pension scheme, the benefits will usuallly start
only at the specified retirement age, even if the employee takes an early retirement.
SunLife : The product PAVC (Personal AVC) is an FSAVC with single premium.
SERPS
This is a pension scheme run by the Government in the UK. The expansion is State
Employment Related Pension Scheme. By Inland Revenue law, all employed people
should pay a basic amount from their salary to this scheme. The amount paid as pension,
after retirement, depends upon the duration of the working -life for which the employee
has paid premiums. This is a cumbersome scheme, mostly used by employees not having
access to their employers schemes.
Where an employer offers pension schemes, the employees can ‘contract out’ of SERPS,
and avail premium rebates for doing so. In such cases the employer’s scheme has to
maintain separate accounts for the SERPS (called the Protected Rights) and non-SERPS
parts of the premiums and benefits.
Recent regulations have allowed employees to choose even FSAVCs for contracting out.
Such products are called Contracted Out Money Purchase Schemes (COMPS).
Personal Pensions
These originated as pension schemes for self-employed people. But from 1988 employees
have the right not to join an employers pension plan or opt out of it at any time. Hence
they are for anybody not covered by an employer’s scheme. Personal Pensions are
essentially investment contracts, where the money at retirement is used to purchase a
pension.
Superannuation
Current trend
Until recently, there was little provision made for them in the way of occupational
pension. Moreover, there was no regulation in place to preserve untouched, the
superannuation funds until retirement. And at retirement most of these funds could be
taken out as a lump sum. This resulted in a situation where most of the people were
dependant upon the Social security pension and even those who had saved for retirement
income squandered it easily.
To overcome this situation the Government has put in place legislation to provide for
compulsory superannuation requirements, to regulate superannuation funds and to
regulate the Superannuation industry.
Basics of superannuation
A superannuation fund is money set aside by an employee during his working years to be
taken out as income after retirement from active work. In many cases the employer is also
required to contribute towards an employees fund. Under the Superannuation Guarantee
(SG) law an employer is required to pay a minimum level of the employees earnings to
the superannuation fund.
Employed people usually have access to a superannuation fund operated by the employer
(Company Fund). In such a case, the employee becomes a member of the fund on
commencement of employment and both the employee (Ee) and employer (Er) contribute
towards the fund. In the normal course, on retirement the employee is paid a regular
income (pension) out of the superannuation fund accumulated.
In the above scenario, if the employee changes jobs, usually the employer will transfer
the fund to the new fund of the employee. This is called a rollover. It is necessary
because this money should be accessible only after retirement. And if the employee, in
his new job, does not have access to a company fund, this money will be held in an
Self employed do not have access to company funds and they need to set up their own
superannuation funds. Such funds are known as personal Superannuation funds and are
operated by Life Offices. Life offices also operate ADFs.
Superannuation Funds
The money set aside for Superannuation as funds is usually invested productively and
earnings accrue. The ADFs and comprehensive superannuation plans usually provide the
employee with a choice of unit trust funds in which the money can be invested. The Life
Office manages these funds which have a stated objective of investment and also a time
period for achieving it. When the benefits become payable, the units are cashed and used
to purchase an immediate annuity. At this point of retirement, the employee will have an
option to take part of the accrued benefits as a lump sum, subject to a maximum limit.
Superannuation Benefits
Benefits from a superannuation fund can be classified based upon when they can be
cashed. Any amount that can be cashed at any time by the employee is classified as
Unrestricted Non-preserved fund. Usually this is the employees own additional
contributions to a superannuation fund. In certain cases part of the benefits become
payable when an employee switches jobs. This is called restricted Non-preserved fund
and is usually the additional contributions that an employer makes towards the employees
fund. In this case the money can be moved to an ADF. The part of a superannuation fund
which does not come under the above two categories is classified as Preserved fund and it
can be taken only on reaching the retirement age. In extreme circumstances money can be
paid out earlier – in case of death or disablement.
Superannuation Surcharge
When premiums are paid by the employee and they are tax deductible or paid by the
employer for a Superannuation policy the surcharge applies. The surcharge can be up to
15% and it applies when the sum of the taxable income and surchargeable contributions
exceed $ 73, 220. This policyholder pays the surcharge to the fund, which in turn pays it
to the ATO.
When a death benefit is paid to the dependants of the policyholder, it will not be taxed
unless the benefit exceeds the Reasonable Benefit Limit (RBL) of the policyholder. If it
so exceeds, the excess will be taxed at the highest marginal rate which currently is 48%.
Business Functions
When premiums thus billed are received the Accounting process starts. Here the received
payment is tallied with the bill pending for the policy. On receipt of a premium payment
a record is created with status ‘Policy Suspense’, which is called a Suspense account
record. Then the premium dues for the policy for which payment has been received is
picked up and payments are allocated and ‘settled’. If premiums are received as cheques
and they bounce, the payment has to be ‘Unsettled’ where the old premium record is
canceled and a new premium record is created.
Endorsements
During the period when a policy is in force a lot of details can be changed by the
policyholder, with the consent of the insurer and as per the provisions laid out in the
policy contract. All changes to policy terms like additional benefits, additional premiums,
increased or decreased term, fund switches, indexation changes, date of birth change are
called policy endorsements.
A lot of other details that do not affect the terms of the policy but alter data held for the
policy like bank account details, address details can also be altered when a policy is in
force. This is called general amendments.
Reinsurance
This is a method where the insurer takes insurance to cover the risks that he has
underwritten. It is an effective risk sharing method where a portion of the risk is
transferred to the reinsurer. All insurance companies assess the risks they underwrite and
reinsure based on their past experience on claims. Reinsurers also provide assistance to
insurance companies, particularly in the area of underwriting, when the insurers
Underwriter wants to have a second opinion on the life at risk. Some of the world largest
reinsurers are in the UK.
The process of determining the premiums that are commensurate with the risks covered is
called product pricing. Various factors considered in pricing are
Mortality
Morbidity/ Disability
Expenses
Investment Income and
Contingency and profit loading
Mortality:
In simple terms, mortality is the probability of a person surviving upto the given age.
This statistical information is published once in every period, say ten years, specifying
the number of persons per 1000, completing the age from 1 to 106 years or any other
upper limit as practical and applicable.Insurance companies hold this statistics in
mortality tables. Mortality rates at different ages are effected by factors such as race, sex
occupation, geographical area, industry, life-style etc. Companies often use more than
one table for different groups of policyholders. Some of these tables are favourable to the
insurer while some others are favourable to the insured. Premiums may thus be high or
low based on which table is used.
Morbidity:
Like mortality, the morbidity rates describe the statistics of disability and they are used in
evaluating the premiums payable for disability cover.
Expenses:
Every insurance company has marketing expenses, service exepnses and dividend to
stakeholders which will all be footed by the premiums paid by the policyholder. Thus a
lean company may be able to offer lower priced policies.
Investment Income:
The insurance company invests the collected premiums in properties, the stock market,
bonds and mortgages. A sound investment strategy will pay better returns, thereby giving
more money that can be used to settle payments. So premiums are indirectly linked to the
investment performance of the life office.
Contingency:
Every life office holds a certain portion of the premium collected as contingency margin.
A high contingency percentage will lead to a higher premium because this money will not
be invested in only short term instruments where the returns are low. And in most
countries, legislations specify the solvency exist for insurance companies to maintain
specified solvency margins.
calculations for premiums, investment, dividend etc. Every insurance company will have
its accounts inspeted by an Actuary once a year, at which time the company’s financial
worth will be calculated.
NTU - Not Taken Up. All policies where the life office offers to cover the risk and sends
a policy document, but not taken up by the policyholder are referred to as ‘Not Taken
Up’. These policies will lie dormant.
Extra Fund injection (Efi) - This is applicable to unit linked life assurance policies. By
this method the insurer pays back to the policyholder a portion of the money it took out
of the premiums paid towards capital units.
Premium Waiver Benefit (PWB) - This is an option wherein, the policyholder can stop
premium payments for a short period when a critical illness occurs or he is out of work.
Insurance companies usually account for it by raising the premium slightly.
Life assured – The Party whose loss of life is covered in the insurance policy.
Sum assured – The money that is payable by the insurer to the insured on the event of
the risk happening. It is the limit of insurer’s liability in a policy.
Index linking – The real value of money decreases over time as the retail price of various
commodities rise. If the premium is held constant, the value of a policy will decrease
with inflation. To overcome this the premium is increased by a rate proportionate to the
inflation. This is index linking. Usually the Retail Price Index (RPI) is linked with the
premium and a cap on the increase percentage is also fixed at the outset.
Maturity – The life assured has been alive for the term of an endowment policy and the
sum assured (along with the bonus, if any) will be payable to him.
Lapse - The premiums have not been paid regularly and the insurance policy is not
in force. When a policy lapses the insurer is automatically releived of his liabilities, in
case of the covered event happening. When a policy lapses no money is paid back to the
insured.
Direct debit (DD) - A payment method, where the Insurance company collects the
premium dues from the bank account of the policyholder automatically, when a premium
becomes due.
Market Value Adjuster (MVA) - A factor applied to the value of units, at the time of
encashment, if the insurer feels that the current bid price of units do not reflect the market
movements.