2.5 - Premium Determination for Life Insurance

Question 1

Assumptions and Calculations

Answer 1

When calculating premium rates, life insurers assume that all:

• Premiums are paid in advance of the period of coverage
• Premiums will be invested and earn interest
• Claims will be paid by the end of a year

Question 2

Factors in Premium Determination for Life Insurance:

Premiums are based on expected mortality, interest, and expenses, and these factors are used by all insurers to determine premiums.

Mortality - Interest + Expenses = Total Premium paid to the insurer

Answer 2

A. Mortality

B. Interest

C. Expense

Question 3

Mortality - (Factors in Premium Determination for Life Insurance)

Answer 3

Mortality Tables are used to give the company a basic estimate of how much money it will need to pay for death claims each year. By using a Mortality Table, a life insurer can determine the average life expectancy for each age group, based on the year of birth. The mortality rate is taken from the Mortality Table, which shows life expectancy and the death rate per 1,000 people living in the United States. This table allows the insurer to rate policies using the law of large numbers, so accurate mortality predictions are extremely important. The higher the age group, the higher the mortality rate will be - translating to a higher premium. The Mortality Table also show that males have a higher mortality rate than females. Based on this statistic, males will pay a higher rate than females.

Question 4

Interest - (Factors in Premium Determination for Life Insurance)

Answer 4

Interest earnings are also used in calculating premium. Insurance premiums are paid in advance, and insurance companies invest these premiums and assume a certain rate of interest will be earned. The earned interest reduces the amount of premium paid.

Question 5

Expense - (Factors in Premium Determination for Life Insurance)

Answer 5

The amount charged to cover each policy’s share of expenses of operation (salaries, commission, and cost of doing business) is called expense loading. This can vary from company to company based on its operations and efficiency.

Question 6

Premium Concepts

Answer 6

A. Net Premium

B. Gross Premium

C. Reclassifications

D. Policy Reserves

Question 7

Net Premium - (Premium Concepts)

Answer 7

Takes into account interest and mortality factors only.

Mortality - Interest = Net Premium

Question 8

Gross Premium - (Premium Concepts)

Answer 8

Additional charges (expenses) are added to the net premium rate to enable an insurer to meet all costs under the contract.

Net Premium (Mortality - Interest) + Expenses = Gross Premium

Question 9

Reclassifications - (Premium Concepts)

Answer 9

When reviewing an application, the underwriter may find it necessary to reclassify the risk. This could either increase or decrease the premium.

Question 10

Policy Reserves - (Premium Concepts)

Answer 10

The net premiums paid plus interest earned; the policy reserves must also reflect possible contract obligations. A reserve is an amount, representing actual or potential liabilities, kept by an insurer to cover debts to policyholders. A reserve is usually treated as a liability.

Question 11

Premium Payment Mode

Answer 11

Mode reflects frequency of payment. Premium payments are made either monthly, quarterly, semiannually, or annually. Additional charges are included in modes other than annual to offset the lost interest earnings and increased administration costs. For this reason, the annual mode results in the lowest premium outlay. The more frequently the premiums are paid, the more expensive the mode of payment.