Premium

Learning outcomes
After this discussion, you shall be familiar with :
• Definitions of premium & renewal premium
• Components of premium
• Types of premium
• Premium calculation
• Valuation
• Bonus
• Life fund
 What is premium ?
• Premium – consideration against insurance contract
• First premium – consideration for contract to
COME into force
• Subsequent premia - for contract to REMAIN in
force
• Insurance policies priced first, cost of production
known later
• Calculation is very complex involving statistical
and actuarial principles.
 Components of premium
• Interest
• Expenses
• Mortality
• Benefits under contract
• Bonus loading
• Taxation
• Inflation
 Types

• Risk premium - covers risk of death

• Net or pure - Risk premium plus interest

• Office premium – Net premium plus

management expenses
 Risk Premium
• Risk premium adequate to pay claims if all
policies were term policies for one year
• Risk premium based on probability of death
at various ages , using mortality tables
containing data for such probabilities.
• In Endowment cases, claims to be paid on
survival after some years
• Actual premium collected would have to be
more than risk premium
 Net premium
• Premium collected are not utilised every year
for payment of claims
• Reasons -
Real experience may not be exactly as per
mortality tables
Premiums collected in Endowment plans will
be much higher initially than required since
company has to cover risk & pay survival
amount if policyholder survives term.
 Contd……
• Hence premium should provide for the Pure
Endowment part of the policy also.
• Excess premium collected, in either case, is
invested by insurer
• This belongs to policyholders and will be
passed on to them
• Co assumes a certain rate of interest, based
on its experience, while computing premium
rates.
 Contd…..
• Since life insurance contracts are very
long-term contracts, investments made by
company also will be long-term.
• Higher the interest earned, lower will be
premium
• Premium based on combination of
mortality rate and interest factor is Net
Premium
 Office Premium
• If co was to charge only NP, then no
provision for expenses, hence certain
loadings to NP.
• In life insurance, expenses of procuring
business very high
• Cost of maintaining a policy is low
• Lesser RP goes towards expenses
• Uneven distribution of expenses in FYP & RP
 Contd…..
• Expenses of a life insurance company
Salaries
Commission
Medical fee
Stamp duty
Printing & stationary
Postage
Advertisement/publicity
 Contd….
• Establishment charges
Legal fees
Consultancy/training
Taxation
• When expenses are loaded, the premium
arrived at is the office premium.
This premium is now ready for use.
Is printed in promotional literature/ brochures
 Level premium
• Insurers spread risk premium uniformly
throughout term of policy
• Premium remains same throughout term
• This is level premium
• Implies that premium collected in early years of
policy would be more than necessary for risk and
less than necessary towards latter part of policy
• If premia were to increase with age, difficult
for policyholders to continue.
 Premium calculation
• Calculate age ( less/more than 6 mos )
• Find correct tabular premium per Rs
1000 SA
• Rebate/adjustment for mode ( subtract for
Yly/Hly , no rebate for Qly/Mly )
• Arrive at balance
• Allow high SA rebate
• Multiply balance by SA & divide by 1000
 Contd….
• Add rider premiums by multiplying with
SA/ ltd SA & divide by 1000
• Add extra premium like HE/OE
• Add above to get annual premium
• Calculate instalment premium (Yly/ Hly …..)
• Round off to nearest rupee
 Life fund
• Insurance contracts are long-term
• Profit determined only after contract ends
• Premiums are yet to be paid, liability
continues & insurer has to keep aside funds
• Practice of level premium implies that part
of a premium collected in any year is meant
to cover higher risks of future years &
kept till such risks arise
 Life fund
• Hence, all income from life insurance
business , including earnings from investments,
are kept aside in a LIFE FUND to exclusively
meet liabilities
• IRDA stipulates this requirement
• Life fund used only to pay claims & the
expenses of running the business
• It represents the RESERVE for life
insurance policies
 Valuation
• Premium is calculated considering likely future
experiences in respect of mortality, interest &
expenses
• These are assumptions or expectations
• Reality could be different from expectations
• If expectations conform, business properly funded
• If experience is worse ( mortality/expenses are
more or interest earnings are less ), premium
would be inadequate & problems for co.
 Contd…..
• All insurers check validity of these
assumptions annually to ensure business is
on sound footing .
• Process called ACTUARIAL VALUATION
• In any valuation actuary estimates liabilities
of insurer in respect of business in it’s books
& estimates amount of premia receivable
• Difference between the two is the fund
insurer must have to remain solvent.
• Data compared to existing life fund.
• If present fund more, insurer solvent.
• Method of valuation very complex.
• Each co to have full-time actuary.
 Bonus /types
• If valuation shows fund is more than
estimated liabilities, insurer has a SURPLUS
• Valuation surplus is distributed to
policyholders through BONUS
• Participating policyholders pay extra premium
due to “bonus loading”
• Simple reversionary bonus – Bonus plus SA
• Compound reversionary bonus – Bonus plus
(SA plus bonus)
 Types
• Vesting bonus – payable only when claim
arises, not if policy terminated for other
reasons.
• Terminal / final additional bonus – one-time
bonus for policies in force for at least 15
years
• Interim bonus - payable only to policies
maturing between a declared valuation &
valuation next year i.e mid-year
THANK
YOU !