Non-traditional Life Insurance

Products/Unit Linked Products

(ULIP’s)
 Chapter 4
 Marked pages 61-78
 Concentrate more on Examples in Presentation
(compared to coursepack)
 Unit Linked Insurance Plan (ULIP)
 Life Insurance products have significant
“Savings” component
 In traditional products (WLP, Endowment) not
possible to gauge return on investment
 Also no control on investment avenues
 Pressure started to build up over time to
separate protection and savings components
for greater transparency
 Unbundled (ULIP) version started in 50’s but
more popular in 80’s & 90
 In Pakistan, private sector mainly ULIP’s
 Main Characteristics of ULIP’s

1. All fees/charges known to policyholders

2. All premiums net of all charges invested in
funds of policyholder’s choice
3. Value of policy fluctuates with underlying
investments (investment risk borne by
policyholder)
4. Generally offers variety of investment choices
5. Generally does not work well for small
premium amounts
 Working of ULIP
 Policyholder deposits premium
 Company deducts charges in a transparent manner
to meet expenses
 Company also deducts mortality charge to pay
death benefits
 Remaining premium paid into 1 or more “Unit
Fund(s)” and Units purchased a prevailing unit
price
 Investment management charge deducted from
Fund (generally implicitly through unit price)
 Savings component operates like investment in
mutual fund
 Working of ULIP
 Value of these units generally increases with
time
 Fund Value + agreed amount (or higher of 2)
paid out at death (2 options)
 Fund Value paid on maturity
 Fund Value less Surrender Charges paid on
early withdrawal
Typical flow of ULIP
Initial No. Initial Fund Premium
of Units Value
+

-
Expenses Updated
Charges
-
Fund Value
Cost of
Insurance

Final Fund Purchase Total Units = Initial

Value No. of New Units + New Units
Units Purchased
 Terms and Formulae related to Unit
Linked Insurance Plans
1. Sum Assured (SA) or Death Benefit – benefit
payable on death
2. Level SA – uniform benefit payable on death
regardless of timing
3. Increasing SA – Level SA plus Policy Value
(explained below)
Comment : In this case, SA will generally increase due
to increase in Policy Value over time.
4. Policy Value (PV) or Fund Value– Amount of
money in the investment account (or
accumulated savings + returns)
 Terms and Formulae related to Unit
Linked Insurance Plans
5. Surrender charge (SC) - Charge that insurer levies
(generally in first 1-2 years) to recover initial
expenses if policy lapses early.
6. Surrender Value (SV) or Cash Surrender Value (CSV)
= Policy Value less Surrender Charge
7. Sum At Risk (SAR) for Level SA= SA – Policy Value
before cost of insurance (subject to min SAR of Zero)
8. SAR for Increasing SA = Level SA
9. Cost of Insurance = SAR x Mortality rate at that age
 Terms and Formulae related to
Unit Linked Insurance Plans
10. Unit Price (Investment Fund)=

11. Offer Price – Price at which units can be bought from

the investment fund (same as Unit Price)
12. Bid Price – Price at which Units can be redeemed
(sold) to the investment fund
13. Bid/Offer Spread – Percentage difference between
buying & selling price of units
or Bid/Offer Spread = x 100
 Terms and Formulae related to
Unit Linked Insurance Plans
14. For a Level Death benefit structure, the Policy
Value increases at a faster rate than Increasing
Death benefit structure (as Cost of Insurance is lower
for Level Death benefit).
15. Cover Multiple = at start of policy.
 Typical Charges of ULIP
A. Insurance Related charges
i. Percentage of premium charge
ii. Policy Fee / Initial charges
iii. Admin / Maintenance fee
B. Investment Related charges
i. Bid/offer spread
ii. Fund management fee
iii. Fund switching charge
iv. Surrender charge
C. Cost of Insurance (COI) or Mortality Charge
 Flow of typical ULIP
Typical ULIP example
Product Feature Assumptions
i. % of Premium charge 20%
ii. Policy Administration Fee 20 per annum
iii. Cost of Insurance Deducted on Sum at Risk
Other Assumptions
iv. Age of policyholder 40 years
v. Annual Premium beginning of year 1,000
vi. Sum Assured 15,000
vii. Mortality rate at age 40 2 per thousand age 40
viii.Offer Price of Unit Fund at beginning of 10 per unit
year
vi. Timing of deduction of charges beginning of year
vii. Beginning Fund Value Nil
 Flow of typical ULIP
Working of typical ULIP Premium
1. Initial No. of Units = Nil
2. Initial Fund Value = 0
3. Premium = 1,000
4. Percentage of premium = (200)
Charge (0.2 x Premium)
5. Policy Admin fee = (20)
6. Premium after Expense Charges = 780
(Premium – Percentage of
Premium Charges – Policy Fee)
7. Updated Fund Value = 780
(Beginning Fund Value +
Premium - Expense charges)
 Working of typical ULIP
8. Amount at risk = 14,220
(SA/DB less Updated Fund Value)
9. Cost of Insurance = 28.44
(Mortality Rate x Sum At Risk)
  
10. Net Premium after expense & mortality = 751.56
charges (Premium – Expense Charges –
Cost of Insurance)
  
11. No. of units purchased with net cash = 75.16
flow at beginning of year
(Net Premium / Offer Price)
 
 Regular Premium Unit linked
Policy (Level Death Benefit)
Features of Policy
1. Annual Premium 50,000 uniform throughout
2. Percentage of premium 30% in Year 1, 10% in Year 2 and Nil
  charge thereafter
3. Policy Fee 1,000 in Year 1 and 500 in Year 2 & onwards
4. Sum assured / Death Benefit 500,000 (cover multiple of 10)
5. Mortality Rate 2 per thousand in Year 1 &
3 per thousand in Year 2 & onwards
6. Surrender charge 3% of Fund value (or Policy Value) in year
1 and Nil thereafter
 
 Regular Premium Unit linked
Policy (Level Death Benefit)
Other assumptions
1. Offer Price 100 in Year 1, 110 in Year 2 and 121 in
(beginning of year) Year 3
2. Bid Price 95 in Year 1, 104.5 in Year 2 and 114.95
(beginning of year) in Year 3
3. Beginning Fund / Nil
Policy Value
4. All charges are deducted at beginning of year  
Implied from above
1. Rate of return per year 10%
2. Bid/Offer spread 5.26% ( x 100)
 Regular Premium Unit linked
Policy (Level Death Benefit)
Year 1
1. Starting No. of Units Nil
2. Starting Fund/Policy Value Nil
3. Premium 50,000
4. Percentage of Premium 15,000
charge (.3 x 50,000)
5. Policy Fee 1,000
6. Fund Value after expense charges 34,000
(2. + 3. -4. -5.)
7. Sum at Risk 466,000
(500,000 – 6.)
8. Cost of Insurance 932
(7. x .002)
9. Net amount available for investment 33,068
(6. – 8.)
 Regular Premium Unit linked
Policy (Level Death Benefit)
10. No. of Units purchased at beginning of year 330.68
(9. / 100)
11. Policy Value at beginning of year 31,414.6
(10. x 95)
12. Policy Value at end of year 34,556.06
(10. x 104.5)
13. Cash Surender Value of end of year 33,519.38
(12. x .97)
14. Death Benefit / Sum Assured 500,000
during the year
 Regular Premium Unit linked
Policy (Level Death Benefit)
Year 2
1. Starting Fund/Policy Value at beginning of year 34,556.06
2. Premium 50,000
3. Percentage of Premium 5,000
charge (.1 x 50,000)
4. Policy Fee 500
5. Fund Value after expense charges 79,056.06
(1. + 2. -3. -4.)
6. Sum at Risk 420,943.94
(500,000 – 5.)
7. Cost of Insurance 1,262.83
(6. x .003)
8. Amount available for investment 43,237.17
From cash flows during the year
(2. – 3. -4. -7.)
 Regular Premium Unit linked
Policy (Level Death Benefit)
9. New units purchased beginning of the year 393.07
(8. / 110)
10. Units at beginning of year 330.68

11. Total units at end of year 723.75

(9. + 10.)
12. Policy Value at beginning of year 34,556.06
13. Policy Value at end of year 83,195.06
(11. x 114.95)
14. Cash Surrender Value at end of year (13. x 1) 83,195.06
15. Death Benefit / (Sum Assured) during the year 500,000
 Regular Premium ULIP
Increasing Death Benefit
 Same as earlier example except death benefit increases
each year.
 Increasing Death Benefit = Sum Assured (level) + Policy
Value
 Sum at Risk (Generally) = Sum Assured – Policy Value
 Therefore Sum at Risk
(for increasing death benefit) = Sum Assured (Level)
 Works in exactly the same way except Sum at Risk
remains the same (50,000 in previous example)
 Cost of Insurance in this case is higher
 As such, policy value is lower than level death benefit
structure
 Working of typical ULIP
 Investment amount will generally increase
with time
 Sum at risk will generally decrease (for level
SA)
 Fund value (FV) will increase with new
premiums and investment income
 On death, higher of SA or FV is payable
 On maturity, FV is payable
 On withdrawal, FV less any surrender charge
is payable
 Pros of ULIP
 Transparency
 Flexibility
 SA
 Investment option
 Top up premium facility
 Disadvantages of ULIP
 Difficult to gauge clear value of policy
although better than traditional products
 Generally complicated design
 Illustrations difficult to understand and
generally misleading (important to understand
various columns/rows)
 Investment risk fully borne by policyholder
Risks to Company and Policyholders

Risks to Policyholder
 Misunderstanding of Product

 Potential Misunderstanding of Value

 Investment risk

Risks to Company
 Greater expense risk than conventional

products
 Greater mortality risk

 Reputation risk (bancassurance)

 Summary
 Transparent version
 Has its pros & cons
 Very prevalent in most markets
 Main advantages of transparency and
investment options
 Main disadvantages of bearing full investment
risk and having complicated design