RESEARCH METHOD 6

Irina Kristela Sutarsa – 008201500011

Nathania Neysa – 008201500022
Reven Caroll Wijaya – 008201500026
Laura Alicia Tampubolon – 008201500060
Valencius Pangestu - 008201500130
What are the type of life insurance ?
There are many different types of life insurance products :
• Term life insurance (sometimes referred to as temporary life insurance) lasts a
predetermined number of years. If the policyholder dies during the life of the policy,
the insurance company makes a payment to the specified beneficiaries equal to the
face amount of the policy. If the policyholder does not die during the term of the
policy, no payments are made by the insurance company. The policyholder is required
to make regular monthly or annual premium payments to the insurance company for
the life of the policy or until the policyholder’s death (whichever is earlier).
• Whole life insurance (sometimes referred to as permanent life insurance) provides
protection over the whole life of the policyholder. The policyholder is required to make
regular monthly or annual payments until his or her death.
• Variable life (VL) insurance is a form of whole life insurance where the surplus premiums
discussed earlier are invested in a fund chosen by the policyholder. This could be an
equity fund, a bond fund, or a money market fund.
• The policyholder can usually switch from one fund to another at any time.
• Universal life (UL) insurance is also a form of whole life insurance. The surplus premiums are
invested by the insurance company in fixed income products such as bonds, mortgages,
and money market instruments. The policyholder can choose between two options. Under
the first option, a fixed benefit is paid on death; under the second option, the policyholder’s
beneficiaries receive more than the fixed benefit if the investment return is greater than the
guaranteed minimum. Needless to say, premiums are lower for the first option.
• Variable-universal life (VUL) insurance blends the features found in variable life insurance
and universal life insurance. The policyholder can choose between a number of alternatives
for the investment of surplus premiums. The insurance company guarantees a certain
minimum death benefit and interest on the investments can be applied toward premiums.
• Endowment life insurance lasts for a specified period and pays a lump sum either when the
policyholder dies or at the end of the period, whichever is first. The primary purpose of an
endowment policy is to build cash value that can be used as a way to set money aside for a
long-term goal, such as a college education. There are some policy in endowment life
insurance such as with-profits endowment life insurance policy, unit-linked endowment, pure
endowment policy.
• Group life insurance covers many people under a single policy. It is often purchased by a
company for its employees. The policy may be contributory where the premium payments
are shared by the employer and employee or noncontributory where the employer pays the
whole of the cost.
Explain the cost of whole life insurance
compared with annual premium.
70000

60000

50000

40000

30000

20000

10000

0
40 45 50 55 60 65 70 75 80
The graphic shows that the life insurance holders pay the annual
premium for 20000. In the year 0 until 60, the graphic shows surplus
because along that age, the life insurance holders do not use the
insurance yet. So, it is still considered as a surplus for them.
However, in the age of 60 above, the life insurance holders will use
the insurance. So that’s why, it is called as cost per year. In other
words, the cost per year is as same as the cost that the life
insurance will pay regarding to the claims of the insurance holders.
What are a) longevity risk and b)
mortality risk ?
• Longevity Risk, is the risk that advances in medical sciences and lifestyle
changes will lead to people living longer. Increases in longevity adversely
affect the profitability of most life insurance contracts (because the final
payout is either delayed).
• Mortality Risk, is the risk that wars, epidemics such as AIDS, or pandemics such
as Spanish flu will lead to people living a shorter time than expected. This
adversely affects the payouts on most types of life insurance contracts
(because the insured amount has to be paid earlier than expected), but
should increase the profitability of annuity contracts (because the annuity is
not paid out for as long).
Use the mortality table to calculate the minimum
premium an insurance company should charge for a $1
million two-year term life insurance policy issued to a
man aged 50. Assume that the premium is paid at the
beginning of each year and that the interest rate is 2%.
First term – life insurance
Probability of death in 1st term = 0.005512
Expected Payouts = 1000000 × 0.005512 = 5512
5512
Present Value = = 5403.92157
1.02
Second term – life insurance
Probability of death in 2nd term = 1 − 0.005512 × 0.006008 = ሺ0.994488 ×
Expected Payouts = ሺ1000000 × 0.00597488) = 5974.88
5974.88
Present Value = 2 = 5742.86813
1.02
Total PV = 5403.92157 + 5742.86813 = 11146.7897
𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦+𝑋
Suppose that the minimum premium is X, so 𝑋 + 𝑡
ሺ1+𝑟)
0.00597488+𝑋
=𝑋+ = 1.00574287𝑋
1.02 2
So that, 1.00574287𝑋 = 11146.7897 -> X = 11083.1407
So, the minimum premium payment is $11803.1407
Explain what is meant by “loss ratio” and “expense ratio”
for a propertycasualty insurance company. “If an
insurance company is profitable, it must be the case that
the loss ratio plus the expense ratio is less than 100%.”
Discuss this statement.
The loss ratio is the ratio of payouts to premium in a year, Loss ratios are typically in the
60% to 80% range. The expense ratio is the ratio of expense (example : sales commissions,
and expenses incurred in validating losses) to premium in a year, expense ratios in the
United States are typically in the 25% to 30% range and have tended to decrease
through time.
The statement is not true because investment income can be significant. Premiums are
received at the beginning of a year, and payouts on claims are made during the year or
after the end of the year. The insurance company is therefore able to earn interest on
the premiums during the time that elapses between receipt of premiums and payouts.
(Financial Institutions and Their Trading, 2015)
What is the difference between a defined benefit
and a defined contribution pension plan?
Defined benefit plan: A plan which the firm is responsible for
providing fixed benefits to the employee and this benefit is a future
financial commitment for the firm. Employees will receive a pre-
defined pension that based on their years of employment and
final salary. Defined contribution plan: A plan which the
contribution of each employee are kept in separate account and
invested for the employee. When they reach the retirement age,
the accumulated amount is converted into annuity.
Use the mortality table to calculate the minimum premium an insurance
company should charge for a $5 million three-year term life insurance contract
issued to a woman aged 60. Assume that the premium is paid at the beginning
of each year and death always takes place halfway through a year. The risk-
free interest rate is 3% per annum.

1st year probability: 0.006961 2nd E(p)= 5,000,000 x Total PV = 106,998.59

0.00757093 = 37,854.65
2nd year probability: (1-
0.006961) x 0.007624 = 3rd E(p)= 5,000,000 x 0.00820107𝑋
0.00757093 0.00820107 = 41,005.35 X+ = 1.00750514𝑋
ሺ1.03)3

3rd year probability: (1-

0.006961) x (1-0.007624) x 34,805 1.00750514𝑋 = 106,998.59
0.008322 = 0.00820107 1st PV = = 33,791.26
ሺ1.03)
37,854.65 X = 106,201.53
2nd PV = = 35,681.63
ሺ1.03)2 The minimum premium is
1st E(p) = 5,000,000 x 0.006961 $106,201.53
3rd PV = 41,005.35 = 37,525.70
= 34,805 ሺ1.03)3
During a certain year, interest rates fall by 200 basis
points (2%) and equity prices are flat. Discuss the effect
of this on a defined benefit pension plan that is 60%
invested in equities and 40% invested in bonds.

The value of a bond increases when interest rates fall. The value of the bond
portfolio should therefore increase. However, a lower discount rate will be used
in determining the value of the pension fund liabilities. This will increase the value
of the liabilities. The net effect on the pension plan is likely to be negative. This is
because the interest rate decrease affects 100% of the liabilities and only 40% of
the assets.