Premiums and Bonuses

7/27/2019 Premiums and Bonuses

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In the case of endowment policies the claimsare paid on survival after some years.

So the premium is more than risk premium to pay

the survival benefit.

Here also mortality table is used to estimate the

number of persons at particular age, surviving at

the end of the term.

RISK PREMIUM UNDER ENDOWMENT POLICIES

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Interest

Insurance companies calculate risk premium on the

basis of deaths for one year as per mortality table. Butthe actual experience of death may be different.

Some portion of the risk premium is kept for payment of

survival benefit.The balance is invested and the interest on such

investment is earned by insurance companies.

To the extent of expected interest earnings the premiumis reduced. Such reduced premium is called ------

Net Premium


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Rebate for large sum assured

For large sum assured the administrative cost as a

proportion of premium would be less, becausemany expenses like clerical cost, printing cost etc

remain constant. So the insurers give rebate on

large sum assured

e.g. Rs.25000 Rs.49999 Re.1/-

Rs.50000 Rs.99999 Rs.1.50

Rs. 100000 and above Rs.2/-

This rebate is deducted from the premium, for the

given age, quoted in the tables given to agents.


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Rebate for mode of payment

If the mode of payment is yearly the cost of

printing premium notice, premium notice andother costs will be once in a year only. This again

reduces the administrative cost of the insurer.

But if the mode of payment is quarterly thecost will be four times than the cost of yearly

premium. Hence no rebate is given for quarterly

mode.

Similarly, extra will be charged for monthly

premium as the cost will be 12 times


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Loadings

Loadings means expenses.

Administrative expenses The salary to the clerk,printing of policy, cost of paper, stamps, other office

expenses etc. are the administrative expenses.

Contingencies some unexpected events likeearthquake, epidemic, riots, war can raise the

number of death claims than normal. To meet these

contingencies premiums are loaded suitably.

When above expenses are added to the net

premium we get the office premium, which is given

in the tables provided to agents by insurance

companies.


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Extra Premiums

In addition to the basic benefits under the policy,

extra benefits such as accident benefit or premium

waiver benefit is given by the insurance

companies. For such extra benefit extra premium

is charged.

Similarly, if the life to be insured is not healthy, hisjob is risky, his habits are such that he is prone to

bad health then the extra premium is charged as

the risk is more than normal man of that age.

Extra premium is added to the office premium

which is to be paid by the policy holder.


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Calculation of age

The premium changes as the age changes. So at

lower age the premium will be lower as the risk ofdeath at lower age is less. The risk of death at higher

age is more, hence the premium is more.

The age is always calculated at the start of the policy(at the commencement of the policy). The age

calculated in complete years and not in months and

days. The methods to calculate the age are

Age last birthday

Age next birthday

Age nearest birthday


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Example of Age Calculation

The policy starts on 1st June, 2004

The date of birth of a person is 29th December, 1971

The actual age calculates to 01.06.2004

Less : 29.12.1971

02.05.0032

(start calculating from days, then months, then years)

The actual age of the person is 32 years, 5 months and 2

days. In this case --- 1.Age last birthday is 32 years

2.Age next birthday is 33 years

3.Age nearest birthday is 32 years


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The insurance companies can follow separate method for

separate types of policies. E.g. for children policies the age

last birthday is considered. For pension plans and other

plans age nearest birthday is considered.

As we have seen earlier, the premium changes as the age

changes. So if a man takes the policy at the age of 20 for 15

years then, -----

At first year the premium will be lower.

After 15 years the premium will be higher as his age

will be 35.

The risk of death is almost doubled.

However the premium is charged in such a way that the

policyholder has to pay the same premium for all the 15

years.

This is called Level Premium


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There are two reasons for charging level premiums.

1. If the premium is changed every year as the age

changes, it will be very difficult for the policyholder

to administer his savings at later ages as thepremiums will be higher at later ages and may find

beyond his ability to pay.

So he may drop out when actually the risk of

death is more and the need of insurance is most.

2. Another reason is, those who drop out may be

healthier than those who continue and they may

not find need for insurance.

So there are chances of adverse selection as the

policyholders who continue will be all unhealthy and

insurers calculation of claims may go wrong.


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ACTUARIAL VALUATION

The insurance business is based on some

assumptions of mortality, interest, expenses and

market conditions. If these assumptions go wrong

then there will be difficulty to run the business. Hence

there is a need to check the validity of these

assumptions periodically to make sure that thebusiness is on sound lines. This process is called

actuarial valuation.

This is a specialised job and done by the actuaries of

the insurance company. If the actuarial valuationshows that the funds with company are more than the

estimated liabilities, then this surplus is distributed

among policyholders as BONUS


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BONUS

The bonus is given to those policyholders who opt forwith

profit or participating policy. Those who opt for without

profit ornonparticipating policies do not get any bonus.

By paying little higher amount for bonus in the premium for

the existing benefits the policyholder is entitled to bonus.

The bonus is declared in such a way that the policieswhich have contributed more to the surplus (e.g. high sum

assured, long term, endowment policy etc.) get more

bonus.

There are three types Simple Reversionary Bonus,

Compound Reversionary Bonus,

Interim bonus.

Terminal or Final Additional Bonus


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In Simple Reversionary Bonus, the bonus is added to

the Sum Assured every year. E.g 50000+3000=53000,

53000+3000=56000

In Compound Reversionary Bonus, the bonus is

added to the total Sum Assured and the bonus of the

last year. E.g. 50000+3000=53000,53000+3180=56180

Interim Bonus is the bonus paid for the part of the

policy year from the date of commencement of the

policy to the date of claim.

Terminal or Final Additional Bonus is paid at the time

of claim settlement, in addition to the usual bonus,

where the policy is in force for 15 years.


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The bonus is actually paid to the policy holders in the

following ways.-----On a claim arising,

Only on maturity,

only for the policies that have been in the books forminimum years,

reduction in subsequent premium,

allowed to discount and encash the bonusimmediately


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LIFE FUND

In other businesses the income over the expenditure is

considered as profit. It is distributed among owners as

dividend for that particular year.

Unlike other business, in the insurance business the

contract is for many years. The part of the profit of every

year is accumulated to pay the liabilities in future when the

contract comes to an end. This process continues every

year.

Similarly, in level premiums we know that the premium

collected in a current year is meant to cover future risk andhence the part of the premium is to be kept until such risks

arise.


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Such kept aside fund is called LIFE FUND

This life fund can be used only for paying the

claims and for running the expenses of the

business


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EXAMPLE OF PREMIUM CALCULATION

1. PLAN & TERM =14-30 , SUM ASSURED = 25000

AGE = 35 , MODE = HALF YEARLY

DECISION BY UNDERWRITER = DAB + EPDB

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STEP 1

FOR ABOVE EXAMPLE, FIND OUT TABULAR PREMIUM

FROM TABLE FOR PLAN 14, TERM 30 YRS AND AGE 35 YRS.

(Rs.36.55)

STEP 2

FOR SUM ASSURED OF RS.25000 THE REBATE IS Re.1/-

STEP 3

FOR HALF YEARLYMODE THE REBATE IS 1.5% = 0.55

STEP 4

DAB + EPDB IS Re.1/- PER THOUSAND S.A. i.e. Rs.25/- FOR 25000 S.A.


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SO THE PREMIUM COMES TO

36.55 1.00 0.55 = 35.00

STEP 5

THIS PREMIUM IS FOR RS.1000/-

WE HAVE TO CALCULATE FOR RS.25000 35.00 X 25 =875.00

STEP 6For DAB + EPDB ADD Rs. 25/-

875 + 25 = 900.00

STEP 7

NOW Rs. 900/- IS YEARLY PREMIUM

FOR HALF YEARLY PREMIUM 900 / 2 = 450

SO HALF YEARLY PREMIUM IS Rs. 450.00


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