TOPIC 2: LIFE INSURANCE PRODUCTS

Topic 2 constitutes lesson units 3, 4 and 5. It discusses life insurance products such as life
policies, retirement annuities and healthcare, as well as other products offered to
individuals and businesses.

Lesson Unit 3: Life Insurance – Product Introduction

Content
3.1 Principles of life insurance
3.2 How a premium is determined
3.3 Valuations

Learning outcomes

When you have completed studying this lesson unit, you should be able to

• describe the three essential types of life insurance: term, whole life and endowment
• describe mortality tables and the determination of a life insurance premium
• discuss the impact of Aids on future mortality rates
• identify the main elements to consider when a life insurance premium is being
determined
• explain the purpose of a valuation, and briefly describe the two methods of doing a
valuation
• list and briefly describe the possible sources of a surplus when a valuation is undertaken
• describe how with-profit policy owners can share in the surplus established after a
valuation
• briefly describe how the owners of linked policies share in the investment returns of an
insurer
• describe, in some detail, how the universal life concept works
• describe the main supplementary or risk benefit life policies

Key concepts
1

Open Rubric
Credit life insurance
Decreasing term insurance
Endowment
Linked policies
Morbidity tables
Mortality tables
Prospective method
Retrospective method
Risk policy
The universal concept
Whole-life insurance
With-profit policy

Introduction
The products offered by life insurance companies are intended to mitigate the risks or
consequences of risks such as death, disability, critical illness, unemployment and
retirement. This lesson unit not only outlines the products which are available, but also
demonstrates how these products are priced in the market. Lesson Unit 3 presents the life
insurance products offered in the life insurance industry, and offers detailed discussions of
the types of life insurance products and how they are used in practice. For example, credit
life insurance is taken up to mitigate the risks associated with a failure to fulfil debt
obligations such as home loans, personal loans, etc.

Lesson Unit 3 discusses how premiums are determined, how insurance reserves are
calculated, as well as the subject of valuation – which is critical in the operation of life
insurance. Valuation is not only done to meet the requirements of the regulator, but also to
ensure the sustainability of the business of the life insurer. Lastly, Lesson Unit 3 discusses
the types of risk benefits that the life industry provides.

Remember: this lesson unit will not repeat the content of the prescribed book, but provides
activities and, where necessary, an explanation of the subject covered. The activities are
designed to help you apply the principle or rule.

Overview
When studying Lesson Unit 3, you must distinguish between risk policies and investment
policies. You must also understand whether or not a policy is a term policy. This lesson unit
consists of three subjects (excluding the revision and written questions), namely principles
of life insurance, how a premium is determined and valuations.

Page 2 of 11
3.1 Principles of life insurance

Study the following sections in the prescribed book:

3.1.1 Understanding insurance

Also refer to the Insurance Act 18 of 2017, which provides definitions for insurance
business and insurance policy. Understand these definitions, as they will enhance your
understanding of insurance.

3.1.2 Types of life insurance

Learn about, and understand, the following products of life insurance:

• Term insurance
• Decreasing term insurance
• Whole life insurance
• Pure endowments
• Endowment insurance
• Reinforced endowments

Benfield (2013:36) mentions the following funding structures which are applicable to all life
policies and endowments:

(i) Non-profit contracts

• This structure has a fixed premium and benefits structure which does not provide
for the policy owner to participate in the profit experience of the insurer.
• This structure is also known as a without-profit or non-participating business.

(ii) With-profit contracts

• Read this section together with section 3.3.4 – with-profit policies.

• This structure entitles the policy owner to share in the declared profits, through
declared bonuses, of the insurer.
• Contracts have an extra premium loading to pay for the right of the policy owner to
participate in the insurer’s profits.
• The following are types of bonuses used in this structure:
a. Reversionary bonuses – once declared, they form part of, and are payable at
the same time as, the sum assured. They also form part of the calculations of
3
 loans or surrender values.
b. Terminal bonuses – they are only paid at the claim stage, arising from death,
disability or maturity. They do not form part of the calculations of loans or
surrender values.

(iii) Investment-linked contracts

• Read this section together with section 3.3.4 – linked policies.

• This structure provides for a systematic allocation of the premium paid between
investment, risk and allocations.
• They are also known as unit-linked contracts.
• No extra premium charge is paid for participating in the growth achieved.
• Where a guaranteed minimum maturity value is provided, a small charge is applied.
• It is exposed to various management charges before the net performance is
established.

(iv) Universal whole life and universal endowment contracts

• Read this section together with section 3.3.4 – universal policies.

• Universal life contracts provide for the unbundling of the component parts of the
life product.
• A policy owner is free to select her/his own mix as a proportion of the total
premium paid.
• The unbundling has an effect on the cash value that accrues to the policyholder.

Activity 3.1

Describe the endowment products used in the life insurance industry.

Feedback on activity 3.1

Pure endowments do not have a life cover, but have a fixed period. There are two
categories, namely with profit and without profit.

Page 4 of 11
Activity 3.2

Explain how the fact that a person may have a heart condition will result in him/her having
to pay a higher life insurance premium than the average person.

Feedback on activity 3.2

Refer to the prescribed book for the suggested solution.

3.2 How a premium is determined

Learn about, and understand, the following variables in life insurance:

• Mortality, expenses and interest are three dominant factors in the determination of a
premium.
• They form the elements of the life assurance equation, which is:

premiums + interest = mortality + expenses

Study the following sections in the prescribed book:

3.2.1 Application of mortality tables

• The actuary needs the following information, in order to determine the premium:
(i) The probability of a prospective insured living until his/her next birthday, from the
mortality tables
(ii) The number of proposals received
(iii) The sum assured for each proposal

5
• Once the actuary obtains the above information, s/he takes the following steps in order
to calculate the premium:
1. Determine the expected number of claims (mortality rate x number of proposals)
2. Determine the expected cost of claims (number of claims x sum assured)
3. Calculate the cost of all per proposal (expected cost of claims/number of proposals)
4. Ensure that the cost per proposal is equivalent to a minimum premium which the
insurer must charge to cover the cost of all proposals
5. Possibly add a discount or a loading to this cost per proposal

Activity 3.3

Apply the steps mentioned above to the example provided in section 3.2.1 of the prescribed
book. Do you understand how the premium rate was calculated in this example?

Feedback on activity 3.3

The premium rate is calculated as follows:

= sum insured x number of claims

number of proposals received and accepted

= R10 000 x 28

100 000

= R2.80 premium rate

Activity 3.4

Page 6 of 11
Suppose a life insurer receives 100 000 life cover proposals from persons who are all 25
years old. They all want life cover of R10 000 each. Assume that the actuary finds out that
the probability of a 25-year-old living until the age of 26 is 0.00018, by looking at the
mortality tables. The life insurer applies a loading of 80% to all substandard risks.

a How many death claims does the life insurer expect to receive for the proposals?
b What is the expected total claims amount for the proposals?

Feedback on activity 3.4

The premium rate is calculated as follows:

a. The number of expected death claims:

= number of received and accepted proposals x mortality rate

= 100 000 x 0.00018

= 18

b. The cost of claims or claims amount:

= number of claims x sum assured

= 18 x R10 000

= R180 000

3.2.2 Impact of Aids on mortality rates

Study section 3.2.2 in the prescribed book.

3.2.3 Expenses

Study section 3.2.3 in the prescribed book.

3.2.4 Investments

7
Study section 3.2.4 in the prescribed book.

3.3 Valuations

Study the following sections in the book:

3.3.1 Purpose of a valuation

Activity 3.5

Describe the factors that need to be taken into account when an actuary does a valuation,
and give reasons why it is necessary for a valuation to be done in the first place.

Feedback on activity 3.5

Refer to the solution in the prescribed book.

3.3.2 Reserves
Study the two methods of valuation, namely prospective and retrospective valuation.

Activity 3.6

List the variables you need, in order to calculate the reserves.

Page 8 of 11
Feedback on activity 3.6

Premiums, interest earned on premiums, claims and expenses.

3.3.3 Surplus
Study the four types of surplus, namely expense, investment earning, mortality and
surrender surpluses.

Activity 3.7

Discuss the types of actuarial surplus.

Feedback on activity 3.7

• An expenses surplus occurs when the actual expenses incurred in running the
business are less than the expenses assumed.
• An investment earnings surplus is the amount by which the interest actually earned
on the assets of the insurer is greater than the interest earnings assumed.
• A mortality surplus arises if the claims experience is less than assumed.
• A surrender surplus happens when policies are surrendered and the reserve
(liability) no longer needs to be held.

3.3.4 Distribution to policy owners

Learn about, and understand, the following products outlined in the prescribed book:

• With-profit policies
• Linked policies
• Universal concept

•
•
9
Activity 3.8

It has become common practice to alter a universal policy when more life insurance is
required, rather than to draw up a contract for a new policy.

Explain how the universal concept allows this trend to continue and expand.

•
•
•

Feedback on activity 3.8

Refer to the suggested solution in the prescribed book.

Activity 3.9

A policy owner has just been informed that his universal policy has been reviewed and he
needs to increase the premium on the policy by 12%.

Explain to the policy owner how it is possible that this could occur.

•
•
•
Feedback on activity 3.9

Refer to the suggested solution in the prescribed book.

3.3.5 Supplementary or risk benefit policies

Learn about, and understand, the following products which are outlined in the prescribed
book:

Page 10 of 11
• Accident benefits
• Disability or health insurance benefits
• Guaranteed insurability benefits (GIB)

Conclusion

Summary

This lesson unit has discussed fundamental aspects of life insurance, such as the principles
of insurance, the products of life insurance, the determination of premiums and the process
of valuation. Retirement annuities are discussed in the next lesson unit.

Sources consulted
Benfield, B. 2013. Life assurance company management. Bryanston: Primary Asset
Administrative Services.
Republic of South Africa. 2017. Insurance Act 18 of 2017. Pretoria: Government Printers.
Republic of South Africa. 2005. National Credit Act 34 of 2005. Pretoria: Government
Printers.

11