INTRODUCTION TO LIFE INSURANCE

In any activity of life there is a possibility that a desired event may fail to occur and that

pecuniary (financial) loss may arise. In adventures by sea the ship may fail to make the port;

or the cargo may be damaged or lost. In the adventure of life itself, the life may fail and

death may occur, causing suffering to dependants. Death comes to all sooner or later, and it

is the only truth in this world. So if death is the only truth, then why do we ignore the

implications of the event? Because of the nature of its permanence, and all pervasive; death

requires understanding the financial implications on the dependents. Life insurance is

therefore the most important of all forms of insurance. Its significance pales the other forms

of not just insurance but also all investment instruments. The theory of insurance, in general

terms, may be expressed to mean that the good fortune of the many compensates for the

misfortune of the few. The consequences of such misfortunes cannot be in many instances

borne by the individual, and so the insurance company is prepared to shoulder the burden of

these consequences in exchange for an assessed payment for the risk undertaken. Those who

avail themselves of this service know that such misfortunes will occur but do not know to

whom, and when, and they are willing to make such contributions to a common fund to buy

the right to be compensated of misfortunes if they should befall them.

The insurance company is concerned with any factor that may affect normal longevity, and

once the contract is entered into, and premiums are regularly paid by the policyholder, the

company is at a risk on a permanent contract which it cannot break. From the collation of a

vast amount of data, an assessment can be made of the rate of mortality or the likelihood of

death occurring at each age. Numbers can be quoted, but which individuals will die at each

age cannot be stated. Consequently, all who pay life insurance premiums to the common

fund do so with the same willingness that the fund shall be used to compensate the estates of

those contributors at whatever age in life they may die, within their respective contract

period. This is the basic theory of life insurance. However increasing emphasis on

investment aspects has tended to overshadow the primary purpose of protection against

premature death.

Life Insurance-The Contract:

Definition of the Life Insurance Contract:

There are various definitions of the Life Insurance Contract, as there can be wordings

intrinsic to the contract. Some of these are following:

As defined by Bunyon (UK), in Law of Life Assurance: A Contract of Life Insurance is

one in which one party agrees to pay a given sum upon the happening of a particular

event contingent upon the duration of human life, in consideration of the immediate

payment of a smaller sum or certain equivalent periodical payments by another. According to the Indian Contract Act 1872, A contract is an agreement between two or more parties to do or to abstain from doing an act. It is intended to create a legally binding

relationship. A contract is an agreement but an agreement cannot be called a contract. It is the legal binding intention that raises an agreement to the level of a contract.

Essentials of a valid contract are as follows:

1. Offer and acceptance 2. Consideration 3. Capacity to contract 4. Consensus ad idem (genuine meeting of the minds)

5. Legality of purpose 6. Possibility of performance 7. Intention to create legally binding relationship

In a contract to life insurance there are two parties, viz., the Insurer and the Insured. The

insured is generally called the life assured. In a life insurance contract the life assured undertakes to pay an agreed sum as premium to the insurer at stipulated intervals called the

Mode during the selected term. According to the nature of the contract and the type of life insurance cover purchased by the assured, the insurer is required to pay the contracted sum

to the legal heirs or to the nominee of the assured if death occurs during the currency of the

contract or to the assured on the expiry of the selected term if the contract so provides.

Normally, the premium remains uniform, but according to the nature of the plan, there could

be variations.

The method of paying the premium is called the Mode of Premium Payment. The assured is required to pay the premium on the date of the policy anniversary covering the ensuing

one year. In practice, to facilitate policyholders in the payment of premium, and also to

ensure the retention of the business in their books, companies offer half yearly, quarterly

and monthly payment modes or frequencies.

In India, a contract of life insurance draws its legal authority from the Indian Contract Act

1872. It should be noted that each policy is a separate contract and is treated accordingly.

Though the contract of life insurance is governed by the Indian contract Act, it has certain

peculiarities that set it apart from the other legally enforceable contracts. Some of the

distinguishing features are:-

Life insurance is a contract of utmost good faith or Uberrima fides. This means that both parties to the contract have to disclose all information for the fruition of the

contract.

The proponent has to complete a questionnaire designed by the insurer called the Proposal form to enable the insurer to evaluate the risk and decide whether to accept the risk or decline it or accept the same subject to certain conditions.

The proposer for the life insurance has to disclose all the material information, which has relevance to his/her health and longevity, and also about his/her habits, however

insignificant the proposer may consider them to be.

In the event of any suppression of the information material to the contract, the insurer will be within his rights to declare the contract null and void, and forfeit all the

premiums paid or decline to settle the claim in the event of death.

Similarly the insurer is also required to disclose:-

All the product features of the plan presented to the proponent for consideration without distorting the product attributes.

If a plan for insurance is sold by any misrepresentation or if a different package is offered to the proponent without his/her consent in lieu of the one asked for by the

proponent, the proponent will be well within his rights to terminate the contract and

demand for the repayment of the premium paid by him.

Life insurance protection comes in many forms, and not all policies are created equal, as

you will soon discover. While the death benefit amounts may be the same, the costs,

structure, durations, etc. vary tremendously across the types of policies. The basic types of

life insurance policies are as under:

1. Whole Life Insurance: A term insurance plan with an unspecified period is called a whole life plan. Some plans also have a savings element to them. The insurance

company declares bonuses for these plans based on the returns earned on

investments. As the name of the plan specifies, this plan covers the individual

throughout their entire life. On the death of the life insured, the nominee/beneficiary

is paid the sum insured along with the bonuses accumulated up until that point in

time. During the individuals lifetime they can make partial withdrawals to meet emergency requirements. An individual can also take out loans against the policy.

Although, in case of Whole Life Plans, sum assured is payable only on death, some

insurers pay the sum assured when life insured completes a certain age. For example,

80 years, 90 years, 100 years, etc.

2. Endowment Life Insurance: An endowment insurance offers death cover if the life insured dies during the term of the policy and also offers a Survival benefit if the life

insured survives until the maturity of the policy.

Some of the key features of an Endowment insurance plan are -

If the life insured survives the entire term of the plan, then a specified amount is paid to him/her on maturity of the plan

If the life insured dies before the maturity of the plan, then the death cover benefit is paid to the nominee/beneficiary

Savings element: After deducting the death cover charges & administration charges from the premium, the remaining amount is invested by the insurance

company. The returns earned are later paid back to the life insured in the form of

bonuses.

Goal-based investment: Helps in accumulating money for specific plans like a childs higher education or marriage, etc.

Some insurance companies also allow partial withdrawal or loans against these policies

There are different variants under this plan

Higher death cover than the maturity benefit

Maturity benefit is double the death cover, known as a double endowment insurance plan

3. Annuity Life Insurance: Pure savings and Pension plans address the risk of living too long. In the age of medical advancement where the mortality rates have declined

and life span has increased significantly, it is important that the individual saves

enough to meet his financial needs during the age when his earning capacity

diminishes. In the Indian context, with the growth of the Indian economy, the nuclear

family system is fast spreading and therefore old aged parents are left to fend for

themselves. In order to mitigate the risk of not being able to meet financial needs

during such old age, the savings and pension plans are effective tools.

These plans should be looked at two parts:

Savings or accumulation stage- Deferred Annuity Plans. Under the deferred annuity

plan, the policyholder contributes a small amount on a monthly/quarterly/ annual

basis and on maturity; the sum assured is used to buy a pension plan (immediate

annuities) that will provide a monthly income throughout retirement. These plans are

best when bought at a young age as the corpus depends upon the period of

accumulation.

The term of the policy is called deferment period. During this period, the insurance

company will invest the lump sum amount on behalf of the policyholder and earn

returns on it. The maturity of the policy is called vesting where the accumulated

corpus will be used to pay a regular annuity to the policyholder.

At the time of vesting the policyholder can decide whether to buy the immediate

annuity plan from the same insurance company or some other life insurer of his

choice. This option to choose the pension provider is known as the open market

option.

At the time of vesting the policyholder will also have the choice of selecting the type

of annuity plan that he would like from the annuity options available to him. The

annuity payout will depend on the type of annuity chosen and the rates prevailing at

the time of vesting.

The deferred annuity plans are available both in traditional and ULIP forms. In India

the deferred annuity plans are largely driven by tax benefits.

Payout or annuity stage Immediate Annuity Plans- An annuity is a series of

regular payments from an annuity provider (insurance company) to an individual

(called the annuitant) in return for a lump sum (purchase price) or instalment

premiums for a specified number of years. Annuities are usually sold by life

insurance companies. They may be purchased by a single lump sum payment or

under a deferred annuity plan. The premium (purchase price) may be made by the

person who is to be the annuitant or another annuity purchaser such as the annuitants employer, other personal benefactor or a pension scheme.

4. Term Life Insurance: One of the most commonly used policies is term life insurance. Term insurance can help protect your beneficiaries against financial loss

resulting from your death; it pays the face amount of the policy, but only provides

protection for a definite, but limited, amount of time. Term policies do not build cash

values and the maximum term period is usually 30 years.

Premiums for term coverage are usually initially lower than other types of life

insurance because the policy only provides a death benefit for a defined period.

Later, some term insurance policies can be extended or converted into another type

of coverage.

Convertible term assurance policy: This policy meets the needs of those who are

initially unable to pay the larger premium required for a whole life or endowment

assurance policy but hope to be able to do so within a few years. It would also enable

such persons to take final decision at a later date about the plan suitable for their

future needs.

However, if you renew or convert your coverage, your new premium will probably

be higher than your previous coverage, and can continue to increase as you grow

older.

5. Joint life insurance: Joint life insurance policies are designed to cover couples or partnerships in the event of either partners death. Life insurance is designed to ensure that your dependents do not suffer financially in the event of your death, and

traditionally many policies were set up to cover the main breadwinner of the family.

As this person makes the most significant financial contribution to the running of the

household, this approach might appear to make sense. But the consequences of the

other partners death even if they dont earn as much, or have no income because they look after the children full-time can also be serious from a financial point of

view. This is why its worth considering taking out life insurance that covers either partners potential death. Advantages of joint life insurance:

The advantages of joint life cover are that it pays out regardless of which partner dies, and is cheaper than taking out two individual life insurance

policies. It may be good for young couples who are trying to save money on

premiums, or for business partners.

Joint cover offers extra protection over taking out just one individual policy for the main breadwinner. Even where one person may stay at home to look

after the kids, its usually worth having some cover for them as if they were to die, childcare costs could be a significant burden.

Where the salaries of each partner in the home are vastly different, it may be worth taking out two individual policies - one each. These can be tailored to

provide adequate cover for each person.

Taking out two individual policies of the same amount will cost more than the equivalent joint policy, but provides double the cover.

6. Unit Linked Insurance Plan: A Unit Linked Insurance Plan or ULIP as it is popularly known is basically a combination of insurance as well as investments,

similar to a protection cum savings plan. While a part of the premium paid is utilized

to provide insurance cover to the policy holder the remaining portion is invested in

various equity and debt schemes. A fund is created from a pool of premiums

collected from policyholders and the fund is used to invest in various market

instruments (debt and equity) in varying proportions similar to mutual funds. The

significant difference between a protection cum savings plan and a ULIP is that the

investment risk in a ULIP is borne by the policyholder (similar to a Mutual Fund),

whereas the risk is borne by the Insurance company in the other case. The Policy

holders can select the type of funds (debt or equity) or a mix of both based on their

investment need and risk appetite. ULIP policy holders are allotted units and each

unit has a net asset value (NAV) that is declared on a daily basis. The NAV is the

value based on which the net rate of returns on ULIPs are determined. The NAV

varies from one ULIP to another based on market conditions and the funds performance.

7. Group Life Insurance: 'Group insurance' is an insurance that covers a group of people, usually who are the members of societies, employees of a common employer,

or professionals in a common group. Group coverage can help reduce the problem

of adverse selection by creating a pool of people eligible to purchase insurance who

belong to the group for reasons other than for the purposes of obtaining insurance. In

other words, people belong to the group not because they possess some high-risk

factor which makes them more apt to purchase insurance (thus increasing adverse

selection); instead they are in the group for reasons unrelated to insurance, such as all

working for a particular employer. This is when a group of people have been named

under a single life insurance policy. It is popular for an employer or a company to

add employees under the same policy. Each member of the group has a certificate as

legal evidence of insurance.

8. Credit life insurance (Advance life insurance): Credit life insurance is a type of term insurance plan designed to pay the balance due on a loan, if the borrower dies

before the loan is repaid. Like mortgage redemption it is usually decreasing term

assurance. It is more popularly sold to lending institutions as group insurance to

cover the lives of the borrowers of these institutions. It may be also available for

automobile and other personal loans. The benefit under these policies is often paid

directly to the lender or creditor if the insured borrower dies during the policy term.

9. Bank-linked Life Insurance: Some banks offer personal accident and health insurance cover at a discount to account holders. What one needs to check is the

product and how much is the payable premium if one buys the same product in the

market. The insurance product is not bundled with the account, as these are co-

branded products, launched in association with general insurance companies offering

medical insurance. Some banks are offering personal accident or medical insurance

cover at a discount to their account holders. For instance, State Bank of India (SBI)

two years back introduced personal accident insurance to all its savings account

holders worth Rs 4 lakh for Rs 100 annual premium in tie-up with SBI General

Insurance.

Circumstances affecting Risk in life Insurance:

Since life insurance is a financial contract, and a long-term contract and that a contract

which may come to be executed when one of the parties to the contract may not exist and

may be called up to a court of law in case of dispute in future, it is essential that all the

terms and conditions of the contract must be clearly understood and put in writing legibly.

Looking at the importance of the contract combined with the raised expectation of a benefit

which is still in the womb of a promise, unstinted trust should be created in the mind of the

insured so that he remains confident of its benefit and continues to perform his part of the

duty during the continuance of the contract. In life insurance, the factors which may affect

the risk are usually those factors which are affecting the mortality; they are also called

factors affecting longevity of a person. The mortality is not the only risk but the capacity

and willingness of a person also influence the insurance decision. These factors are

discussed hereunder:

1. Age: The age of the life to be assured is the most important factor to affect mortality. Except for a few years of the childhood, the premium is determined at every year of the

completion of age. The corporation asks for the age nearer to birthdays.

The person below six months and the person above six months older of the age will be

treated of the same age. For instance, a person of 22 years 7 months and another person

of 23 years 5 months will be treated the age of 23 years.

The age proof is very essential for calculating premium rate. So, unless age is proved

payment of claim is not made if the age was not admitted at the time of proposal. Now it

has been the common practice that the age should be admitted at the time of proposal to

avoid dispute. On the basis of age, in future, if a misstatement is discovered after the

policy has become a claim; the amount of the claim is adjusted in accordance with the

rectification of age. Age proof is essential at the proposal if the policy is term insurance,

non-medical policies and immediate annuity or the insurance is taken at advance age or

for a child because they are maximum and minimum limits of age.

Minimum and Maximum limit of age: The maximum age limit is fixed to avoid adverse

selection. At advance age, the need for insurance is a doubtful proposition, i.e., the

chances of moral hazard are higher. The third reason for fixing maximum limit is the

medical examination will disapprove most of the proposal at that stage. Mortality is

certainly increased at that age. The minimum age limit is meant to avoid risk of infant

mortality.

2. Physical Condition: The physical condition of the age life proposed has a direct bearing on the mortality of the life. Insurers are, therefore, very particular about the conditions of

an applicants' sight, hearing, heart, arteries, lungs, tonsils, teeth, kidneys, nervous

system, etc. The experts in the field can assess the longevity or mortality of a person due

to impairment of certain organs.

The questions are also designed to elicit information on the physical status of the

applicant in the proposal form. The information is confirmed and supplemented by a

medical examination. The primary purpose of the medical examination is to detect any

malfunctioning of the vital organs of the body.

3. Personal History: The personal history of the life proposed would reveal the possibility of death to him. The history may be connected with the (i) health record, (ii) past habit,

(iii) previous occupation, (iv) insurance history.

(i) Health Record: The past health record is the most important factor under personal history because it

affects the longevity or mortality of a person to a greater extent. It includes any

operations of the life proposed. The medical examination may reveal these facts.

This information is also given by the applicant. Particular emphasis is placed on the

recent injuries and illness. It is customary to consult attending physicians.

It has been the practice not to accept the proposal form of the applicants who are

suffering from illness. If the applicant has suffered from certain serious disease or

operation during the past 5 years, he may be under the possibility of getting it again.

(ii) Past Habits: The insurers want to know the past habit the life proposed, for drugs or alcohol because

the cure may be only temporary. The past history is usually expected to be repeated.

Therefore, past history is very cautiously examined.

(iii) History of Occupation: If the proponent was employed in hazardous or unhealthy occupation, there is a

possibility that he may still retain ill-effects there from or may revert to such occupation.

An intimate association within a person suffering from a contagious disease may

influence the health of the life proposed. The past hazardous occupations generally

affects, health slowly occupational diseases are contacted. Inorganic dust may create

silicosis.

(iv) Insurance History: The previous amount of insurance may disclose the degree of risk of the applicant. If he

was refused insurance, it might be a suspicious factor of his insurability. If it was found

that the applicant was already insured for adequate amount this request for more

insurance is regarded with suspicions.

4. Family History: Like the personal history, family history also requires information of habit, health, occupation and insurance of other family members, particularly of the

parents, brother and sisters. The children's history of health is also required.

The certain diseases, like tuberculosis and insanity, etc., and longevity of the parents will

be relevant factors for determining the degree of risk of the proponents. The favourable

family history, however, is not considered for offsetting the adverse effect of the

personal history. The family history is considered significant to know the transmission

of certain, characteristics by heredity. Hearts, lungs, build, etc., follow family.

5. Occupation: Occupation is an important factor to affect the risk. It affects the occupation in various ways. Firstly, the nature of work may be hazardous because he

may suffer an accident at any time while at work.

Secondly, the morale of the workers may go down. They may be tempted to indulge in

intoxicating or liquor or other forms of immoral living.

Thirdly, the chemical effect may be poisonous. For instance, the workers may contact

poison while engaged in match or chemical factories.

Fourthly, the dusty or unventilated house, unhealthy or insanitary environments may

deteriorate the health of the workers.

Fifthly, in certain occupation, the occupational diseases are common.

Sixthly, excessive mental and nervous strain may cause financial worries, and lastly, the

lesser income may affect the health of the worker.

6. Residence: The residence also affects the risk. The risk will be lesser in a good climate area and more in a bad climate although the difference is narrowed down because of

better medical and sanitary facilities! Information about the previous residence is equally

important. The geographical location, atmosphere, political stability, climate,

construction of house, travel, etc., are important factor which may affect the risk.

7. Present Habits: The general mode of living of the proposer affects the risk. Drunkards and non-temperate persons cause increase in mortality. Similarly, temperate habits tend

to increase longevity of a person. Excessive and careless smoking tends to shorten the

life due to development of nicotine poisoning. The past habits are also considered

important. The intoxication affects the health of a person and consequently his mortality.

The general mode of living is also considered in habits.

8. Morals: It has been observed that the departure from the commonly accepted standards of ethical and moral conduct involve extra mortality. Infidelity and departure from the

code of sex behaviour are seriously regarded because these may affect the health.

Unethical conduct is considered to be another form of moral hazard. Insurance is not

generally given to bankrupt and reputed dishonest persons.

Consideration, of morals is essential to determine the moral hazard. There are two types

of hazards Moral and Physical hazards we have discussed factors affecting physical

hazards in the other sections. Moral hazard will be discussed only under this heading.

The moral hazard occurs due to intention of the insured whereas the physical hazard is

beyond his approach. The former is present where the policy is taken not with a view to

protect one-self against losses but to obtain gain through crooked means.

The moral hazard is judged by the reputation and fairness in dealings. The moral hazard

is expected to present where insurance is taken at advanced age, where person is

suffering from serious disease, proposal is on other's life and the proponent is engaged in

hazardous occupation.

9. Economic Status: It is essential to examine that the family and business circumstances of the proponents are such as to justify the amount of insurance applied for. This

investigation also reveals whether the income of the applicants bears a reasonable

relationship to the amount of insurance which he proposes to carry. The higher economic

status generally provides a better field for insurance due to various reasons. Educational,

financial and professional consciousness makes the proponent insurance minded. The

chance of death is also lower in higher strata of the society.

It is suggested to go through class notes also.