INTRODUCTION

PRINCIPLES AND PRACTICES OF LIFE INSURANCE

Gitanjali Singh
Assistant Professor
IBM - UG
GLA University
 BBAE 0401 Principles & Practices Of Life Insurance
course content- Module-I
• Life Insurance Introduction:
– Concept, features, significance,
– Difference between life insurance and other forms of insurance,
– Parties to the Insurance contract and their Rights and Duties,
– Insurance Documents,
– Principles of life insurance and its Application
– Recent trends in life insurance.
• Life Insurance Risk:
– Selection and Classification of risks
– Methods of calculating/evaluating risk in life insurance
– Elements in computation of Assurance premium,
– Steps of Calculating Premium
– Factors governing Sum Assured (to continued in Mod II also)
 Course Objectives

 To acknowledge the fundamentals of insurance applicable

in India

 To enable the students in getting an outlook of how general

insurance businesses operates on day-to-day basis.

 To enable the students in getting insight regarding how

policies are formed and purchased.
 Learning Resources
• Text Books / Cases:
• Mishra, M. N. Insurance Principles and Practice. New Delhi: S.
Chand & Company.
• Gulati, N. C. Principles of Insurance Management. New Delhi: Excel
Books.

• Reference Books:
• Ganguly, A. Insurance Management. New Delhi: New Age
International.
• Panda, G. Principles and Practice of Insurance. New Dellhi: Kalyani
Publishers.
• Sreenivasan, N. M. Principles of Insurance Law. Lucknow: Eastern
Book Company
 I Intended Course outcome
On completion of the course, student will be able to

 Understand about insurance fundamentals & its importance

in today’s business world.
 Understand the main principles of insurance.
 Build a theoretical basis upon which students will develop
their knowledge and it will help in taking decision to
purchase insurance policies.
 Contractual definition of Insurance
• Insurance may be defined as consisting of One party (the insurer), who agrees to
pay the other party(the insured) or his beneficiary a certain sum of money(
claim) upon the occurrence of given contingency (Risk) against which insurance
is bought .

PREMIUM

INSURER INSURED/PROPOSOR

CLAIM (Happening of risk)

 Functional definition of insurance

• Insurance is a co-operative device to spread the loss

caused by a particular risk over a number of persons
who are exposed to it and who agrees to insure
themselves against the risk.
……Prof. R.S. Sharma
The insurance can be expressed as a group of people feeling similar kind of risk
come together and decide to make contribution towards formation of pool of
funds to be used in case of crises arisen out of uncertain happenings.
 Features/characteristics of Insurance
• It is sharing of risk
• It is a Co-operative device
• Payment of claim is made on happening of contigency (risk)
insured
• Amount of claim payment depends on the value of loss occurred
due to particular risk
• If Large no. of persons are insured persons- loss will be spread
smoothly . Hence, lesser will be premium
• It is neither Charity nor Gambling
• Calculations of risk are done in advance
 Significance of Insurance

• Safety
• Protection against financial losses and is superior to ordinary saving plan
• Encourages compulsory saving
• Loan can be availed up to the policy term
• Investment
– Better return
• A lot of Insurance products presently provide good returns which could be a beneficial
way for saving necessary funds for retirement years

– Insurance policies can help secure the future of children • For college /
educational purposes
– Tax rebate
 Different Forms of Insurance
• From Business point of view, Insurance can be classified as Life, General and
social insurance.
• Life insurance is different from other insurances in the sense that subject matter of
insurance is life of a person/his dependents. It provides protection on premature
death, and when income stops.
• General insurance offers financial protection for assets of life of a person against
loss, damage, theft, and other liabilities.
• Social insurance offers protection to the weaker section of society who are unable
to pay premium for adequate insurance. It is obligatory duty of the nation.
From risk point of view, Insurance can be classified as
• Personal Insurance –Life insurance, personal accident insurance, health insurance.
• Property Insurance- Marine, Fire, Automobile, Cattle, Crop, Theft insurance
• Liability Insurance- Third party, Employees
• Fidelity Insurance-Credit,

BASIS FOR COMPARISON
Subject matter covered
Risk
What is it?
Term of contract
Savings and investment
Claim payment
Principle of Insurable interest
Principle of subrogation
Principle of indemnity
OTHER FORMS OF
LIFE INSURANCE INSURANCE
(GENERAL INSURANCE)
risk to Life of an individual is Risk of damage, theft to the assets
covered. of a person is covered
Loss due to risk is certain to happen Risk may or may not happen
It is a form of investment. It is a contract of indemnity.
Long term Short term usually 1 year
Has element of security and No investment, Fire, marine
investment insurance has financial protection
only
Insurable amount is paid, either on the Loss or liability incurred will be
occurrence of the event, or on repaid on the occurrence of
maturity. uncertain event only.
Must be present at the time of Present ,both at the time of contract
contract. and at the time of loss. In Marine-
only at loss
Not applicable Applicable
Not applicable Applicable
 Parties to Insurance Contract
• There are two parties to insurance contract:
– The Insured

– The Insurer

In an insurance contract , a right created for one party

represents a duty for other party.
• Insurer: is the party who assumes or accepts the risk of
loss and undertakes for a consideration to indemnify
the insured or to pay him a certain sum on the
happening of a specified contingency or event.

• Insured: is the person in whose favor, the contract is

operative and who is indemnified against, or is to
receive a certain sum upon the happening of a specified
contingency or event.
 Obligations/Duties of the Proposer/Insured

• Insured obligations Before buy of Life Insurance Policy

– Fill the proposal form correctly and truthfully.
– Insured will be responsible for any information in this document as it
bears his signature.
– Insured will disclose “all material information” about the risk insurer
want to cover.
– Select the term of the policy as per needs.
– Select the amount of premium Insured can afford to pay.
– Choose between Single Premium or Regular Premium.
– Choose your premium paying frequency such as annual, half-yearly,
quarterly or monthly
– Ensure to register nomination under policy.
– Fill the nominee’s name correctly
• After buy Life Insurance Policy

– Once the proposal is submitted, Insured should hear from the

insurance company in 15 days.

– Obligation to pay an insurance premium

– If any additional documents are asked for, comply immediately

– Once the proposal is accepted by the insurance company, the

policy bond should reach you within a reasonable amount of time

– When policy bond is received, check it and be sure that the policy is
the one that you wanted.

– Go through all the policy conditions and be sure that these are the
same that were explained to you by the intermediary/ insurance
company official at the time of sale.
 Rights of the Insured

1. Right to receive insurance payment upon the

occurrence of an insurance event
2. Modify the terms of insurance contract (e.g. mode of
payment, tenure, sum assured, etc.)
3. Early termination of the insurance contract
4. Receiving part of the insurance premium in case of
early termination of the contract, etc.
5. Nominee/assignee of an insurance policy has right to
claim the amount of death benefit of insured.
 Obligations/Duties of the Insurer

• The main responsibility of the insurer is the

– Performance of the insurance contract by providing insurance
coverage.
– To tell risk coverage, terms & conditions of the policy and
riders(benefits) available.
– Right to specify the rules and conditions that govern the
promise made under the policy.
– Follow instructions from IRDA from time to time.
 Rights of the Insurer

– Getting an insurance premium.

– The inspection of the insured property before the conclusion of the insurance
contract and after the occurrence of the insurance event to determine the
conditions for its occurrence and the amount of losses.

– Getting information about insurance risk and changing it.

– Changing the terms of insurance.

– Increasing the insurance premium with increasing insurance risk.

Insurance Documents for buying a Insurance Plan/
Proposal stage

Proposal form

Age proof

Address proof
Documents for buying a
Insurance Plan/ Proposal Photo identity proof:
stage

Recent passport size photograph

Income proof

Medical reports
Gitanjali singh
 Proposal form
• Proposal form: is the basic format (application for insurance)
which is filled in by the proposer who wants to take an
insurance policy. A proposal form has three portions.
– Ist Portion: Details about the proposer

– IInd Portion: Essential information

– IIIrd Portion: The declaration

Gitanjali singh
Details about the proposer
• Name, Address, Occupation,
• The name of the nominee
• The details about the type of
insurance wants to take
Essential information
(This is a detailed questionnaire)
• Details of the previous insurance
policy
• Present health conditions and the
personal history of his health,

Declaration
• The proposer:
• Affirms that he/she has not suppressed, misrepresented or
concealed any fact which may be material to the risk
• Agrees that this declaration along with the proposal form shall
form the basis of the contract and if any information is found to
be false the contract will be null and void thus reinforcing the
principle of utmost good faith.
• Agrees to take the insurance on the terms and conditions
decided by the insurer.
Gitanjali singh
Age Proof Address Proof

Utility bill

Pan card, Voter's

id, Passport, Passport,

Driving license, Voter's id

School/ college
certificate, telephone bill

Birth certificate. Ration card,

electricity bill

Bank a/c statement, letter from

Gitanjali singh
recognized public authority
Income Proof Photo identity Proof

Driving license,

Salary slip, Voter's id card,

letter from recognized public

Form 16,
authority/servant with
photograph verifying the identity
and residence,
ITR/ assessment
order/ employers
Passport
certificate.

pan card,

Aadhar card.
Gitanjali singh
 Insurance Documents after Proposal stage

• Cover note

• Issue of Insurance policy document/ certificate

of Insurance

• Issue of Duplicate policy

• First premium Receipt

• Claim form filling on happening of contigency

 Recent Trends in Life Insurance

1. Digitization

2. E-Insurance Account

3. Evolution of Alternative channels of Distribution

 Recent Trends in Life Insurance
Digitization
 Use of digital technology is gradually picking up in insurance sector.
 Insurers use digital channels like websites, apps, to reach out to
customers.
 In November 2020,LIC launched its first software application, ANANDA,
acronym for ‘Atmanirbhar Agents New Business Digital App’.
 Majority of people now do bulk of their initial research online ,using tools
such as search engines and comparison websites.

 Enables insurers to price the premium lower for safe drivers and higher to
those who have track record of accidents.
 In the first half of FY22, the life insurance industry recorded growth rate of
5.8% compared with 0.8% in the same period last year.
 E-Insurance Account (eIA)
• E-Insurance Account hold all insurance policies in electronic form by
opening a single e-insurance account with an Insurance repository.

• IRDA has granted the Certificate of Registration to the following four

entities to act as 'Insurance Repositories' that are authorized to open
e-Insurance Accounts.
– NSDL Database Management Limited

– Central Insurance Repository Limited

– Karvy Insurance Repository Limited

– CAMS Repository Services Limited

• Benefits of an eIA:

– No more physical policy documents/ completely paperless

– View and manage all life insurance policies under a single account

– Single KYC done for e-insurance account instead of each policy – reduces the

paper work.

– Changes in contact details get auto updated in all your policies across all life

insurers

– Opening eIA is free

– A customer buying policy online, pays insurance premium online, gets receipt

online and also gets credit of insurance policy account online and the claims

are settled by direct transfer of funds to the account of the

nominee/Policyholder.
Evolution of Alternative channels of
Distribution

1. Individual agency channel/Agents was the only mode

of distribution in LIC days (more than currently 20
lakh).
– Direct Marketing is a popular channel for reaching customers and
generating leads or selling through a telephone.
II. Corporate Agency system: Corporate entities
represent an insurance company and sell its policies.
– It was introduced in 2002 with IRDAI framing regulations (currently more than
428).

– Usually they are engaged in a particular business and sell insurance policies to
their existing customers based on the situation.

– When a bank becomes the corporate agent of an insurance company it is

referred to as a bancassurance arrangement or partnership.

S.N Corporate Agent Insurer

1 State Bank of India
2 ICICI BANK LIMITED
3 HDFC BANK LTD
4 4CITIBANK N.A
5 SIDBI BANK
6 Peerless Developers Limited
SBI LIFE INSURANCE COMPANY LIMITED
ICICI PRUDENTIAL LIFE INSURANCE
HDFC STANDARD LIFE INSURANCE CO LTD
ROYAL SUNDARAM ALLIANCE INSURANCE CO LTD
IDBI-FORTIS LIFE INSURANCE CO. LTD
IFFCO-TOKIO GENERAL INSURANCE CO. LTD.
III. Insurance Broking model allowed the entity to be a distributor

for multiple insurers (currently more than 370).

– An insurance broker sells, solicits, or negotiates insurance for

compensation

S.N Insurance Broking Firms

1 Aditya Birla Insurance Brokers Ltd.

2 Alliance Ins. Brokers Pvt. Ltd.

3 IIFL Insurance Brokers Limited

4 Muthoot Insurance Brokers Pvt. Ltd

5 Policywow Insurance Broking Private Limited

• Micro Insurance Agent channel to procure New
Business from rural and remote rural areas. (currently
more than 27,041)
– Micro insurance agents are appointed by and acting for an insurer,
for distribution of micro insurance products (and only those
products).

– Microinsurance is insurance with low premiums

– Example:
• Term life insurance
• Death insurance, disability insurance, and
• Insurance for natural disasters.
• Health insurance,
• Crop insurance and livestock/cattle insurance,
• Theft or fire insurance,
• Web Aggregators are online operators who provide choice of products to
customers online (currently more than16).
• ‘Insurance price index’ has been launched by policy X.com -Web aggregator. It
tracks changes & patterns in premium price rates so will help consumers to
have better understanding of insurance prices.

• Insurance Marketing Firms (IMF): The IRDA has allowed for the registration of
insurance marketing firms, so that entrepreneurs and insurance agents can
start their own insurance distribution company. (currently more than 81)
• As per the Registration of Insurance Marketing Firm Regulations, 2015, an
“Insurance Marketing Firm is defined as an entity registered by the IRDA to solicit
or procure insurance products, to undertake insurance service activities and to
distribute other financial products”.
• Common Service Centers (CSC): Encourage Rural Entrepreneurship to
take insurance to the remote areas through Village Level Entrepreneurs
(VLE). (currently more than 5373).

• CSCs are the service delivery points enabled with Information and
Communication Technology (ICT) for the delivery of various public and
private services to rural citizens of India.

• CSC is one of the programs of Government of India under the Digital India
Program.

• The government services delivered through the network of CSCs include

services in the area of:
– Education, agriculture, health,

– Utility payments

– Banking, Insurance, financial services etc.

 Insurance is Contract
• Life insurance contract may be defined as “The contract, whereby the insurer in consideration of
a premium undertakes to pay a certain sum of money either on the death of the insured or on the expiry
of a fixed period.” The definition of the life insurance contract is enlarged by Section 2(ii) of the
Insurance Act 1938 by including annuity business.

• Essentials of Insurance contract

According to Section 2(H) and Section 10 of Indian Contract Act, a valid contract must have the

following essentialities:

a) Agreement (offer and acceptance)

b) Competency of the parties

c) Free consent of the parties

d) Legal consideration

e) Legal objective
 a. Agreement (offer and acceptance):
• Offer and acceptance in life insurance is of typical nature. The Agents canvassing or
prospectus are invitation to offer because the public in general and individual in particular
are invited to make proposal for insurance. Submission of proposal along with the
premium is an offer and the dispatch of acceptance-letter is the acceptance. The risk will
start as soon as the acceptance letter/ cover note is dispatched by the insurer.

b. Competency of the Parties

• Parties to insurance must be legally competent to contract

– Age of majority and Of sound mind

• an intoxicated person cannot enter into a contract

– Not disqualified from contracting by any law

• A contract with an alien enemy is void.

– The insurer must have the license to carry on insurance business.

 c. Free consent of the parties:
• Consent is not free if it is obtained by Undue influence, Fraud or Misrepresentation/ mistake

d. Legal Consideration:
– The insurer must have some consideration(premium) in return of his promise to pay a
fixed sum(claim) at maturity or death. The first premium is consideration and
subsequent premiums are merely conditions to contract.

e. Legal Objective:

– The object of a legal life insurance contract is to protect oneself or ones family against

financial losses at the death of the insured.

– The objective will be legal only when there is insurable interest. Without having this

interest, the object of the contract would not be legal.

 Principles of Insurance
• To ensure the proper functioning of an insurance contract, the insurer and the
insured have to uphold the different principles of Insurances which have emerged
from economic, actuarial and legal domains are mentioned below :
• Principles of large numbers
• Insurable Interest
• Utmost Good Faith
• Loss Minimization
• Principles listed below are not applicable to life
insurance
• Proximate Cause
• Indemnity
• Subrogation
• Contribution
 Principle of Large Numbers

• Insurance companies must use a large sample size of the population

(insured people) to predict death rates.
• Probabilities for life insurance are represented in a mortality table.
• While no one single person's death can be predicted, the law of large
numbers allows insurers to predict death rates by looking at a large
group of people.
• A large sample size means that a probability can be predicted as a
percentage of the population.
 Principle of insurable interest

• Implication :The owner of a taxicab has insurable interest in

the taxicab because he is getting income from it. But, if he
sells it, he will not have an insurable interest left in that
taxicab. Ownership plays a very crucial role in evaluating
insurable interest. .
• Every person has an insurable interest in his own life
• Insurable interest in life insurance may be divided into
two categories:

Insurable Interest

Own life Others life

Proof is not required Proof is required

Business Relation Family Relation

• Insurable interest in own’s Life
– An individual always has an insurable interest in his own life. Bunyon

says:

“Every man is presumed to possess an insurable interest in his estate for

the loss of his future gains or savings which might be the result of his

premature death”.

– The insurable interest in own life is unlimited because the loss to the

insured or his dependents cannot be measured in terms of money

and, therefore, no limit can be placed to the amount of insurance that

one may take on ones own life.

• Insurable interest in other’s life: There are two types of
insurable interest in others life.
a) Where proof is not required and
b) Where proof is required.

• Proof is not required

– There are only two such cases where the presence of insurable
interest is legally presumed and therefore need not be proved.
– Wife has insurable interest in the life of her husband: It is presumed
and decided by Reed vs. Royal Exchange (1795) that wife has an
insurable interest in the life of her husband because husband is legally
bound to support his wife. The wife will suffer financially if the
husband is dead and will continue to gain if the husband is surviving.
– Husband has insurable interest in the life of his wife: It was decided in
Griffith vs. Fleming (1909) that the husband has insurable interest in
his wife‟s life because of domestic services performed, by the wife. If
the wife is dead, husband has to employ other person to render the
domestic services and other financial expenditures will involve at her
death which are not calculable..
• Proof is required : Insurable interest has to be proved in the following cases:
– Business Relationship:

– Example: a creditor may lose money if the debtor dies before the loan is repaid.
The continuance of debtor‟s life is financially meaningful to the creditor because
the latter will get all his money repaid at the former‟s survival.

– Family Relationship: The insurable interest may arise due to family relationship if
pecuniary interest exists between the policyholders and life assured.

– The interest must be based on value and not on mere sentiments.

– Thus a son can insure his fathers life only when he is dependent on him and the
father can take insurance policy on his son‟s life only when he is dependent on
his son.
 Principle of Utmost Good Faith
• The principle of utmost good faith says that:

– The parties, insured and insurer must be of the same mind at the time of contract
(because only then the risk may be correctly ascertained).

– They must make full and true disclosure of the facts material to the risk.

• Subject matter/ Material facts are age, income, occupation, health, habits,
residence, family history and plan of insurance.

• Implication:
Jacob took a health insurance policy. At the time of taking insurance, he was a
smoker and failed to disclose this fact. Later, he got cancer. In such a situation,
the Insurance company will not be liable to bear the financial burden as Jacob
concealed important facts.

45
 Principle of Loss Minimization

• This principle says that as an owner, it is obligatory on the part of the insurer
to take necessary steps to minimize the loss to the insured property. The
principle does not allow the owner to be irresponsible or negligent just
because the subject matter is insured.

• Implication–
• If a fire breaks out in your factory, you should take reasonable steps to
put out the fire like making use of fire extinguishers etc. You cannot
just stand back and allow the fire to burn down the factory because
you know that the insurance company will compensate for it.
 Risk
• “Risk is circumstance or the possibility that a loss or injury will occur”.
• “Risk is danger, peril, hazard, chance of loss, amount covered by insurance,
person or object insured”.
• “The risk is an event or happening which is not planned but eventually
happens with financial consequences resulting in loss”. People generally
seek security and avoid uncertainty.
• The risk of death is unavoidable, and is especially an economic threat if
premature.
• “Risk is uncertainty”, The greater the uncertainty , the greater is the risk.
• Insurance provides a means for reducing the adverse impact of unexpected
losses.
 Classification of Risk

 Pure Risk
 Speculative Risk
 Fundamental Risk
 Particular Risk
 Static Risk
 Dynamic Risk.
 Pure Risk
• Pure risk is a situation that holds out only the possibility of
loss or no loss.
• It is Insurable. It can be classified as :
 Personal risk
 Property risk
 Liability risk Reach back to home with
damaged bike (LOSS)

When driving for University

by bike
Accident
Reach home safely
( (uncertainty) (No Loss)
 Speculative Risks

• Speculative risk is a situation that holds out the

prospects of loss, gain, or no loss no gain (break-
even situation).
• Common in business undertakings.

Successful
PROFIT
NEW
BUSINESS Fails
LOSS
 Different types of Risk
• Pure risk: Risk which has prospect of loss or no loss.
• Speculative risk : Risk which has prospect of bringing profit or loss.
• Fundamental risk: Risk which arises due to nature of the society & affects people
at large e.g Unemployment.
• Particular risk: Risk which affects a particular person or thing or asset.
• Personal risk: Risk to a person in the event of premature death, sickness etc.
• Fidelity risk: Risk of loss due to dishonesty of a person.
• Liability risk: Risk of loss due to negligence or carelessness of other person.
• Static risk : Risk of damage or loss to a property or entity that is caused by
dishonesty or human failure.
• Dynamic risk: Risk resulting from change in the economy e.g change in
technology leading to unemployment
• Financial risks: Risks where the outcome of an event can be measured in
monetary terms e.g. theft of a car
• Non-Financial risks: Risks whose outcome cannot be measured in monetary
terms e.g. wrong choice of a car
 RISK MANAGEMENT

• Risk management is defined as “the identification, analysis and

economic control of those risk which can threaten the assets or

earning capacity of an enterprise/ individual”.

 Risk Pooling
• Life insurance is based on a mechanism called risk pooling, or a group sharing of
losses.

• People exposed to a risk agree to share losses on an equitable basis. They transfer
the economic risk of loss to an insurance company. Insurance collects and pools the
premiums of thousands of people, spreading the risk of losses across the entire pool.
By carefully calculating the probability of losses that will be sustained by the members
of the pool, insurance companies can equitably (fairly) spread the cost of the losses to
all the members. The risk of loss is transferred from one to many and shared by all
insureds in the pool. Each person pays a premium that is measured to be fair to them
and to all based on the risk they impose.
 Risk Manager

 In insurance, the risk manager evaluate risks which endangers’ the company’s
funds or capacity to pay claims. Their work is done together with underwriters by
given the degree of risk the company can cover and profit realization on an
insurance application.

• Risk manager is said to be one who manages risk by:

– Assessing and quantifying business risk

– Taking into accounts control or measures to reduce them

– Advice on investment strategies and pricing on policies

 Risk management Team

Director- risk management

Risk management analyst

Safety, health & loss prevention Security manager

Insurance Manager Claim manager
Manager

Insurance
Insurance Clerk Supervisor Claim Supervisor
Administrator Industrial Administrator security
hygiene

Supervisor safety
 Selection of Risk/Underwriting the risk

• The selection of risk is:

– “process of accepting or rejecting risk”

– “a process whereby inferior lives are “weeded out”

– “a life insurer decides whether a proposal can be

accepted at standard rates of premium or on different
terms or be rejected”.
 Age

Build

Physical Condition

Personal History
Factors affecting
Selection & Family History
Classification of
Life insurance Risk
Residence

Morals

Race and Nationality

Gender
 Proposal form

Agent’s Report

Medical Examination Report

Sources of information
Friend’s Report
about the
(proposer )
The inspection Report
Life risk to be insured
Family Physician Report

Neighbours /Business Associates/

Colleagues

Associations( Commercial Credit

Investigation Bureau)
 Methods of rating Risk classification

• Two popular methods are adopted to overall rate the risk as

Standard Risk, Sub-Standard Risk & Super Standard Risk.
Judgement Method
Numerical Method
 Risk are divided in to three broad classes

Risk

Super Standard Risk

Standard Risk (Preferred)
(Normal) Sub-Standard
Risk
(High)
 Methods of Risk classification
 Numerical Method
 Rates the risk of individual by giving marks and ranks to the factors
affecting the longevity /mortality of an individual.
 Favourable factors are assigned negative values called credit.
 Unfavourable factors are assigned positive values called debit.
 Values are generally assigned ( on the basis of mortality expectation)
to the important factors like build, personal history etc.
 The degree of risk on the basis of each factor is evaluated in terms of
percentage.
 If degree of risk expressed in % is more than 100 then extra
percentage is debited(+)
 If degree of risk expressed in % is less than 100 then lesser
percentage will be credited (-) up to the difference.
 Numerical Method
of Risk classification

 It is in classifying applicants for life insurance according to certain demographic

factors and assigning weights to these factors. Factors include physical condition,
build, family history, personal history, habits, and morals.
 For example, if an applicant is 5 feet 8 inches and weighs 250 pounds/113 kg his
mortality expectation based on this height-weight ratio may be 160% of a standard
risk who weighs 150 pounds /68kg at that height. In this instance a debit of 60
percentage points would be listed next to the weight factor on the applicant’s
underwriting sheet. If the applicant has an excellent family history (no hereditary
diseases such as diabetes), his mortality expectation based on this factor is 90% of
the standard risk. Here a credit of 10 percentage points would be listed next to the
family history factor. Upon completion of the debiting/crediting process, debits and
credits would be totaled for a final rate, which would classify the applicant as
standard, substandard, or an uninsurable risk.
 Methods of Risk classification

Judgement Method
 Decision is based on Judgement of qualified & experienced
professionals like doctors, actuaries, underwriters etc.
 Helpful when factors are too much/ too less and numerical method
fails to give a fair decision.
Disadvantage:
 Personal decisions/ judgement may be biased or even taken by
inexperienced persons.
 It is not s scientific method
 Methods of risk classification/evaluation in life
insurance
• Numerical Method • Judgement Method
• Risk evaluation is based • Risk evaluation based on
on numbers. judgment of various people.
• Risk is rated in points. • No rigid rules/scales is
• Considers impact of large followed.
number of factors. • Considers impact of single
• It is scientific and time factor.
taking. • Personal decisions may be
quick , significant.
 PREMIUM
• Premium is the consideration money that a policyholder has to pay in lieu of the benefit
that the insurer promises to confer on the happening of the scheduled eventuality.

• It is important to note that, sometimes, insurance premiums quoted are slightly different
from the premiums charged.

• The amount of insurance premiums charged by the insurance companies is determined by

statistics and mathematical calculations done by the underwriting department of the
insurance company.

• Statistics used must include sufficiently large group of individuals to ensure data
reliability as well as application of “The law of Large Numbers.”

• Premium payment can be made in different frequencies: A lump sum payment( single
premium), Yearly, Half yearly, Quarterly, Monthly.

• Age of insured person, health status, occupation, Policy type and term are the various
factors affecting the premium amount paid by insured.
• Net premium: Premium designed to cover the benefits of the
insurance policy only. Net premium is calculated based on
– Mortality &

– Interest rate

• Gross premium: Gross premium calculation is based on

– Mortality

– Interest rate

– Expenses &

– bonus loading

Loading is the amount that must be added to the pure premium for
expenses, profit and margins for contingencies etc
• Single premium: The premium can be paid at one time, when it is called a

single premium.

• Level premium: Premium which remains same throught out the term of the

policy. Premium can also be paid in instalments i.e.,

– Yearly

– half–yearly

– quarterly or

– monthly.

• Single premiums are rare except in pension plans. Tabular premiums are given in yearly mode.
Half–yearly, quarterly and monthly mode instalment is obtained by dividing the tabular premium by 2

or 4 or 12. However before going for this division, one has to allow for certain rebates which are

allowed at different rates for different modes under different plans.

Insurers allow some rebate on the premium for yearly and half–yearly mode. However this rebate varies

from plan to plan.

Important elements in computation of Assurance
Premium

Important elements to be considered in the

computation of premium in life insurance
policy

Expenses incurred by Expected profits on its

Mortality
insurance company investment.
 Mortality
• Mortality is the probability of the insured dying in any given year.
• Mortality rate is expressed in units of number of deaths per 1,000
individuals per year. Mortality rate = no. of deaths/ 1000.
• The mortality tables are prepared by insurers based on past
experiences and indicate the number of deaths that may be expected
to take place at different ages in future years.
• Though, the rate of mortality increases with the increase in age, all
insurers charge a level premium which remains constant over the entire
duration of the policy term.
 Mortality

• The mortality tables are prepared by the insurers on

the basis of their experience over a number of years.

• Though, the rate of mortality increases with the

increase in age, all insurers charge a level premium
which remains constant over the entire duration of the
policy term.
Mortality Table –A glimpse
 Expenses of management
• Any insurer has to incur expenses for conducting the insurance business.

• These expenses are not of constant nature. They keep on increasing due to inflationary

market conditions.

• Huge expenses are incurred for

– Procurement of new business(recruitment & training of new sale executives),

– Payment of commission to the agent and

– Incidental expenses like preparation of policy document etc.

– Servicing of the policies, e.g.

• Collection of renewal premium,

• valuation to determine bonus payable,

– Payment of Survival Benefit and Death claim and Maturity Benefit etc.
 Expected yield on investment

• As the above two elements go to increase the premium rate, the

expected yield on investment of the collected endowment
component of premium goes to reduce the premium rate.

• In case Higher rate of interest on investment is earned by insurers

lesser will be the premium.

• However, as the future yield cannot be determined exactly, it is

necessary for a prudent insurer to keep a reserve to take care of
unexpected fall in the rate of yield.
Assumptions underlying Rate Computation
Steps of calculating premium
Steps of calculating premium
Example/ Practical Problem
Example/ Practical Problem
Present value of Claims
Present value of the first year
 SUM ASSURED
 Sum assured is also known as the cover or the coverage and is the
total amount you are insured for.

• Sum assured is “the guaranteed amount insured will receive”.

• On the event of death, the Sum Assured will go to the nominee or
insured beneficiary as per the policy.

• Sum Assured is the reason why an insured pays premium.

 Factors Governing Sum Assured
• Sum Assured depends on many factors such as:

– Insured total net assets,

– Insured family’s current fixed annual income

– Insured family’s current fixed annual expenditure

– Insured age

– The age of insured dependents,

– Current health condition and health history

– Lifestyle and hobbies

– Driving Record

– Any loans or liabilities due