4. Life Insurance: A. Introduction and B. Product Types

Question 1

Contract of life assurance

Answer 1

A contract providing for the payment of a specified sum on the happening of an event or events which are dependent on human life or lives.

Question 2

With what was life insurance - as known today - born

Answer 2

The establishment of the Equitable Society in 1762.

Question 3

What was James Dodson’s principle on which the Equitable society had been set out (5)?

Answer 3

• Membership of the Society should be open to anyone who could satisfy the Society’s medical requirements
• The assurances were to be subject to level annual premiums, with the benefits payable on death or survival, the member having the right to renew his contract or not.
• Additional premiums to be charged for people in certain occupations
• Members were to share in the profits - or bear the losses - of the Society
• Members were to have the option at the outset of without profits policies with no liability to share any losses.

Question 4

To what problems did the practical adoption of Dodson’s principles lead?

Answer 4

• It now became necessary to take interest into consideration. (Previously only consider one year at a time).
• In the past, if premium scales proved inadequate, the actual premiums could be increased. This was no longer the case - they were now fixed.

Question 5

Insurance legislation imply:

Answer 5

• Life insurance can only be effected on lives for which the policyholder has an insurable interest.
• A person has an insurable interest in the life of his or her spouse.
• Only policies of limited size can generally be taken out on the lives of children.
• Although insurable interest must exist at the outset, this need not be the case when a claim arises.

Question 6

Valuation

Answer 6

A process by which a value is placed on a company’s liabilities

Question 7

A life company’s profit

Answer 7

surplus

Question 8

Industrial Assurance

Answer 8

The business of effecting assurances upon human life, premiums in respect of which are received by means of collectors.
The premiums must be payable at intervals not exceeding two months. (The principle feature that distinguished this type of business from ordinary business was the weekly collection of premiums from the insured’s home)

Question 9

Pure endowment

Answer 9

A policy which provides a lump sum payment to the insured only if he/she survives to the end of a specified term/period.

Question 10

Term assurance

Answer 10

A policy which pays a lump sum to a beneficiary of the insured only if the insured dies during a specified term/period.

Question 11

Common term assurance policy requirements

Answer 11

• Policyholder must make a series of regular premium payments to the life office for the whole of the specified term.
• Alternatively, cover may be purchased by means of the payment of a single up-front premium.

Question 12

Endowment Assurance

Answer 12

A policy which pays a lump sum either on the death of the insured during a specified term or on the survival of the insured to the end of that specified term.

Question 13

Whole of life assurance

Answer 13

A policy which pays a lump sum to a beneficiary of the insured when the insured dies (regardless of when this is).

Question 14

Annuity

Answer 14

A policy which provides the insured with a regular payment while he/she is alive.
The payments may be monthly, annual etc.

Question 15

Temporary Annuity

Answer 15

An annuity that has a maximum term

Question 16

Immediate annuity

Answer 16

An annuity where payments start immediately. It is purchased by means of a single up-front premium paid by the annuitant.

Question 17

Deferred annuity

Answer 17

An annuity where payments start at some specified date in the future. It may be purchased by a single premium or by the payment of a series of regular premiums which normally cease just before the annuity benefit payments commence.

Question 18

Income Protection

Answer 18

A policy which pays the insured a regular monthly payment while the insured is unable to work due to illness or injury. (Sometimes called “long term sickness” or “permanent health insurance”)

Question 19

Deferred period specified with long term sickness insurance

Answer 19

The deferred period is the first period of an illness or injury during which no payment is made to the holder.
Thus the injury needs to last longer than the deferred period for the “beneficiary” to receive payment.

Question 20

Long term care insurance

Answer 20

A policy which pays a specified regular amount if the insured requires long-term nursing care.

Question 21

Critical illness insurance

Answer 21

A policy which pays a lump sum to the insured if he/she is diagnosed as having contracted one of a specified list of “critical illnesses”.

Question 22

Medical expenses insurance

Answer 22

A policy which indemnifies the insured for any medical expenses incurred.

Question 23

Surrender values

Answer 23

A cash value for which a whole of life or endowment assurance contract can be exchanged for (when terminated pre-maturely).

Question 24

Policy loan

Answer 24

A loan taken on the surrender value of an assurance contract.

Question 25

Three categories of insurance contracts

Answer 25

• Non-profit
• With profit
• Unit-linked

Question 26

Non-profit insurance contracts

Answer 26

Where the insured does not share in the profits of the insurer.

Question 27

With profit insurance contracts

Answer 27

Where the insured shares in some way in the profits with the insurer.

Question 28

Reversionary bonus

Answer 28

A regular annual bonus which increases the sum’ assured on a contract each year.

Question 29

Terminal bonus

Answer 29

Applies only in the year of claim and further increases the sum assured.

Question 30

Distinctions between conventional and unit-linked business

Answer 30

• With conventional business, the benefits are either guaranteed or are dependent on bonuses declared by the life office.
• With unit-linked life insurance the value is determined by the performance of units whose value is linked to the performance of specific assets.
• With unit-linked business there is a range of explicit charges which are aimed at recouping the life office’s various expenses from each policy.

Question 31

The typical operation of a unit-linked life insurance policy

Answer 31

• Premiums paid, less any applicable charges made to cover expenses is invested in units (unit fund).
• The units belong to the policyholder
• On the appropriate contingency, the value of the units in the unit fund is passed to the claimant.
• The investment risk associated with the investment in units is geared by the policyholder
• The life office deducts a regular management charge from the unit fund to cover its investment related expenses.
• Commonly the benefit received on death will be guaranteed to be at least a certain amount. If the value of the unit fund exceeds the sum assured, it will be the value of the unit fund that is paid out.

Question 32

What do we mean when we speak of contingencies?

Answer 32

a future event or circumstance that is possible but cannot be predicted with certainty.
For example death, maturity or surrender of an assurance contract.

Question 33

Common unit types available:

Answer 33

• Local equities
• Overseas equities
• Property
• Fixed interest

Question 34

Living Annuity

Answer 34

A single premium that is invested in a unit account.
The policyholder decides what income he/she would like to receive.
This income is paid to him from investment income or the redemption of units.
Any investment income in excess of the annuity payment is reinvested.

Question 35

Unit-linked annuity

Answer 35

An annuity where payment is defined as a specified number of units paid until the death of the annuitant.
The actual amount paid to he policyholder depends on what the value of those units is at the time of the payment.

Question 36

Three primary points of office expense charges:

Answer 36

• Directly from the premium(s) before any units are purchased
• From the unit fund after units have been purchased
• From the final benefit at the time of a claim

Question 37

6 Explicit charges which the office can use

Answer 37

• Allocation rate
• Regular policy fee
• Bid-offer spread
• Regular management charge
• Switching fee for switching units into different unit funds
• Surrender penalty

Question 38

Allocation rate

Answer 38

The proportion of the premium allocated to the purchase of units

Question 39

Unallocated premium usage

Answer 39

The unallocated premium is retained by the life office to meet its expenses.

Question 40

Regular policy fee

Answer 40

A regular fee (e.g. R25 per month) which may be subtracted from each premium when received and before it is allocated to units, or it may be deducted from the unit account.

Question 41

Bid-offer spread

Answer 41

The bid-offer spread is the difference between the price at which the office sells units to the policyholders and the price at which it buys them back.

Question 42

The fact that most unit-linked contracts use a wide variety of charges has two effects:

Answer 42

1. The charges can match different types of expenses quite closely (for example: a monthly deduction of R25 to cover premium costs)
2. Policyholders get confused

Question 43

Possible approaches to recouping initial expenses on unit-linked policies are: (3)

Answer 43

1. Zero initial allocation of premiums to purchase units.
2. A level deduction from premiums throughout the term.
3. An extra management charge on the unit fund throughout the term.

Question 44

Explain Zero initial allocation of premiums to purchase units:

Answer 44

Under this method (also known as the Front End Load) none of the early premiums are allocated to the purchase of units until the initial expenses have been recouped.

Question 45

Explain A level deduction from premiums throughout the term:

Answer 45

Under this method (also known as a Reduced Level Allocation) instead of a low allocation followed by a high allocation of the premiums to purchase units, this method gives a medium allocation throughout (e.g. 95%)

Question 46

Explain An extra management charge on the unit fund throughout the term:

Answer 46

Units with an extra management charge (capital units) may be allocated for an initial period after which normal units (accumulation units) are allocated. The only difference between these units is the size of the management charge.

Question 47

Capital units may not be ideal for the office since: (2)

Answer 47

1. Initial expenses are only recouped slowly through the operation of these additional charges.
2. If future unit growth is poorer than expected the office will not recoup the expected amount from the extra management charge.

Question 48

What are benefit charges?

Answer 48

Explicit charges to cover mortality and any other insurance benefits.