Chapter 5 - Premiums for Life Insurance Policies

Equation of Value/Equivalence Principle (Net Premiums):

Consider a life insurance contract: we have benefits and premiums.
#
PV profit = PV premiums PV benefits →
cash inflow -
cash outflow
Note: - We are ignoring expenses at this stage.
- PVs depend on the basis (survival model and interest rate assumptions)
#

)
The Net Premium for the contract is the premium which makes
E[PV profit] = 0

-
! E[PV premiums] = E[PV benefits]
This is the Equation of Value and we say the premium is calculated using
the Equivalence Principle.
Note:

• ‘Net’ means ignoring expenses.

• The net premium depends on the terms of the contract and the basis.
raga
• Premiums cease when the policyholder dies.
• The premium paying term may be less than the policy term.
• Unless otherwise stated, premiums are calculated using the equivalence
principle.

Example 1 A whole life insurance has sum insured 100,000 payable at the end of
the year of death of (40). Let P be net premium payable each year.
Calculate P
p p p p P
one
lion Age
40 41 42 43 40+1140 40 +
Tyg 40-1440+7
° i t
100,000
Using equip valence principle

EPV of premiums =
EPV of benefits

P 100000 AGO
.
=

↳o

P =
1000001€
40
He

1
Example 2 Give the following:
 i  0.06
"

 10 E40  0.540 =
V
,oP4O
 1000 A40  168

 1000 A50  264

year -
term
Calculate the annual net premium for a ten-payment fully discrete life insurance of 1000 on (40).
#

× :n7
⇐
Ax :n7
let pyo be annual net premium
jam =

i-A×
Using equivalence principle ; d

EPV of premiums =
EPV of benefits

Pho ⑤
IoT 1000
Auto
.
=

no :
: 107
M Alto 10€40
+
: 107

Roof ) =

1000J Ano Mio Pao Aso )

-

a .
-
i
Iti lol Ayo

:::÷÷÷l=÷ig÷÷
% .

=
3.318
#

2
 Tai Px sofas annual net premium

Example 3 Calculate the net premium for a fully continuous, instantaneously increasing whole life
insurance with benefit bt  t . Premiums are level and fully continuous. Assume that  x t   and  t  
for all t  0 .

EPV of premiums = F. PV of benefits

tp, e-
Ith is
-
ds

Px Ex ( Itf )
=

.
=

,
let
=
e-

tax =

To e- Sto tr, dt =

To e-
St
.
e
-
at
dt =

g÷µ
( IA )
,
=

It .
e-
St
.

tr .

cent at =

To test e-at .

µ dt

It tdf by parts
' U' -

8)
=
µ . e-
Clean 8) t
Bet
-

U t du e dt
=

go
= -

I? I
"
u du at eius
-

+
at v
-
-
-

.
,

let 8

=
U
a P, = te
8-ill

3
 Example 4 For a fully discrete whole life policy of 1 on (95), you are given:
l95  1000
l96  900
l97  250 Bai pas =
annual net premium for ( 95
)
l98  0
v  0.90

Calculate the annual net premium.

EPV of premiums =
EPV of benefits

Pas .

as
=
A 95
×
⇐ A ×

as
=
1+0
Past 022 Past ↳ Pas "

O
Pqgt
+
↳ .
. .

f÷ .me#..ii+ee:I?i+eeE..o :
' O
-
-
+

. . .

1+0.9
(8%-1+0.9490506)
=

=
2.0125

Ax =
1 d
Flag
-
.

×
= > =
I -

d =
0.79875
as

UFO Ags 0495 9419g 032

=

"z , fast
'
-

Clas
+
,
,
+
V
. . .

to -feas¥ he:( e.se?.raijm+feraieae.ai)o .

=
0.79875

Pay .
=
AI =
0.3969
⑤ 95 #

4
Equation of Value/Equivalence Principle (Gross Premiums):
Consider a life insurance contract allowing for the insurer’s expenses: the
insurance company’s cash flow is:
benefits (paid), expenses (paid) and premiums (received).
-
PV profit = PV premiums PV benefits PV expenses
Note: PVs depend on the basis (survival model, interest rate assumptions
and assumptions about future expenses).

The Gross (or Office) Premium for the contract is the premium which
makes
E[PV profit] = 0
! E[PV premiums] = E[PV benefits] + E[PV expenses]
This is the Equation of Value and we say the premium is calculated using
the Equivalence Principle.
Note:

• ‘Gross’ means including expenses.

• The gross premium depends on the terms of the contract and the basis.
• Premiums cease when the policyholder dies.
• The premium paying term may be less than the policy term.
• Unless otherwise stated, premiums are calculated using the equivalence
principle.

Types of Expenses:

• PER POLICY EXPENSES. Policy fees, settlement costs, issue costs, ...
• PERCENTAGE of GROSS PREMIUMS. Commission, ...
• PERCENTAGE of BENEFIT: Per $1000 of insurance. Underwriting
costs, ...

Timing of Expenses:

• INITIAL expenses
• RENEWAL expenses
• CLAIMS expenses

5
 Comments:

• The equation of value implies the expected PV of profit to the insurer is

zero.
• In practice the insurer will charge a premium which will give a positive
expected profit. To obtain a positive expected profit the insurer could:
– Calculate premiums using a Profit Criterion. For example, adding
an explicit profit loading to the gross premium, say 10%.
– Use a conservative estimate of interest: i.e. a low interest assumption
in the premium calculations, so that the interest actually earned is

7.
greater than assumed.
→– Use a conservative estimate of mortality: than expected
mortality for insurances, than expected for annuities.

Example 5 The expenses on life policies are assumed to be as follows:

of 1styear premium
0 of nd year premium
10 of rd th years premiums (inclusi e)
of each year s premium thereafter
- Other expenses amount to $10 at the beginning of each of the first two years
and $2 at the beginning of each subsequent year per $1,000 of sum insured.
- Cost of settlement of a claim is $5 per $1,000 of sum insured.
- Assuming death benefits are paid at the end of the year of death, determine the
annual gross premium $ payable at the beginning of each year for a whole life
policy with sum insured $100,000 issued to a life aged 45.
F- PV of premiums =
Go
us

premium G G G G G G G G G

Fifty
45 46 47 4g 4g 50 51 52 53 . . . 45-1

Benefit ; EPV of benefit =

100,000 Aus g
Expense 0.756 0.26 0.16 0.16 0.16 0.16 0.056 0.056
'

0.056 . . .

1000 1000 200 200 200 200 200 200 200 . . .

EPV of 0.75Gt 0.260

expense pas 0.16 tears
=

0.56 !
t
6%5
-
-

up :p +
site
-

--
-0.1621
61545 45,47
0-56 '

1000
4f°%P↳s
+
t 200
us :& +
500A 45
in6

20021 £45
 Comments:

• The equation of value implies the expected PV of profit to the insurer is

zero.
• In practice the insurer will charge a premium which will give a positive
expected profit. To obtain a positive expected profit the insurer could:
– Calculate premiums using a Profit Criterion. For example, adding
an explicit profit loading to the gross premium, say 10%.
– Use a conservative estimate of interest: i.e. a low interest assumption
in the premium calculations, so that the interest actually earned is
greater than assumed.
– Use a conservative estimate of mortality: than expected
mortality for insurances, than expected for annuities.

Example 5 The expenses on life policies are assumed to be as follows:

of 1styear premium
0 of nd year premium
10 of rd th years premiums (inclusi e)
of each year s premium thereafter
- Other expenses amount to $10 at the beginning of each of the first two years
and $2 at the beginning of each subsequent year per $1,000 of sum insured.
- Cost of settlement of a claim is $5 per $1,000 of sum insured.
- Assuming death benefits are paid at the end of the year of death, determine the
annual gross premium $ payable at the beginning of each year for a whole life
policy with sum insured $100,000 issued to a life aged 45.
EPU of premiums = G. as

Premiums

!... para
G G

pasaruns district
Be
15 1 2 3
4 6
5 7 8 .....
เอ๋อ,
ออ ด
-
-

Benefits; EPU of benefits = 100,000 Acis

0.750 0.26 0.10 0.10 0.10 0.16 0.056 0.056 0.056 ...
Expenses
0.050 0.056 0.056 0.050 0.056 0.056 0.05G 0.856 0.05 0
settle of claim
0.056 0.056 0.0560-856 0.056 8.856
0.01 G 8.07 G
0.55 0 ↓
1,000 200 200 200 200 100 100 200...
1,000 500

ข้
EPU of expense = 0.750 + 0.26 P + 0.16 dick : # IP45 +0.56. s, VP +1,00015:11 +20047 - V :Pass +500 Aus
V

~ ↳
0.1 0.21 45: 200.2145
EPU of expense = 0.056045 10.05 0 45:4 10.1 6 15:27 +0.55G
+200 c5 + 80045:1 + 5004 5

Usingequivalenceprinciple; 6
EPU of expenses
EPU of benefits +
EPU of premiums =
 6. 45 - 100,000 Au5 + (0.05G + 200) 45 +0.05045:A
+(0.16 +800) 45:2 + 0.55 G + 500 Ans

tous + #
200Gus +800Gus:
=> 6:

Example 6 For a fully discrete level benefit whole life insurance, you are given:
 Expenses, incurred at the beginning of each year, are:

Type of Expense Expense

Fraction of premium 0.25
Per 1000 of insurance 2.00 => 50 per 25,000
Per policy 30.00
 G is the gross level annual premium for an insurance of 25,000.
 Ax  0.12 and d  0.04

<=> Ax
Calculate G.
EPU of expenses
EPU of benefits
t

EPU of premiums =
=- 25,000 A x + 0.250x + 30 ) + 30 )
GQx
expense
501)T-
6 - + ( %
Ax = 22

0.75 x

=280.41 8

7
Example 6 For a fully discrete level benefit whole life insurance, you are given:
 Expenses, incurred at the beginning of each year, are:

Type of Expense Expense

Fraction of premium 0.25
Per 1000 of insurance 2.00 so 50 per 25000

Per policy 30.00

 G is the gross level annual premium for an insurance of 25,000.
 Ax  0.12 and d  0.04

Calculate G.

EPV of premiums EPV of benefit

=
+ EPV of
expense

GI ,
=
25000A ×
+10.256 ×
t 50
×
+

305×1
25O00Axtl5Ot30lIx@7pp.p
G =

0.75
x
,y ,
-
= 22
d

=
288.48

7
 Example 7 For a fully discrete 10-year term life insurance policy on ( x) , you are given: pog-ieodg.gg/gjggg
 Death benefits are 100,000 plus the return of all gross premiums paid without interest. non baiter
-

 Expenses are 50% of the first year’s gross premium, 5% of renewal gross premiums and 200 per
policy expenses each year.
 Expenses are payable at the beginning of the year. Pai 8, sailors annual

÷:::;::÷ :*
 A1  0.17094


x:10

( IA) 1  0.96728
÷:
x:10 .
 ax:10  6.8865
u - n
IO w -
n
100000 106
Calculate the gross premium using the equivalence principle.
Y
0000
thx :
107
EPV of
premiums = EPV of ( benefit +
expense )

Cox
'

( a' ) Ai +0.56×+0.05 Cox

107 100000 +
Gx ( IA ) I
=

x :
: 107 ,oy
.
.
-

a
× :
+200
× : ,o7

-0.05 Gx
Cox × : 107 t 0.45

@ ×
=
100000A ! : 107 t
200
× :
to
-

0.95
× : ,o7
-

( I A) I : 107
-

0.45

=
3604
*