Transcript Section II - Bryant University

Unique Characteristics of Life Insurance
1. The event insured is an eventual certainty
and the probability of loss increases from
year to year.
2. Life insurance does not violate requisites of
an insurable risk; it is not the possibility of
death that is insured, but of untimely death.
3. There is no possibility of partial loss.
Therefore all policies are cash payment
policies.
12-1
Types of Life Insurance
Term Insurance
Pure Protection
Cash Value Insurance
Insurance and Savings
Term Insurance
Whole Life Insurance
Endowment Insurance
Universal Life Insurance
Adjustable Life Insurance
Variable Life Insurance
12-2
Rationale for Different Forms
1. Simplest form of life insurance is yearly
renewable term.
• Provides coverage for one year only
• Permits insured to renew for successive
years at higher premium
• Increasing mortality produces increasing
rates as the insured grows older
12-3
Rationale for Different Forms
2. Premium eventually becomes unaffordable
for person who wants to continue coverage:
age 21
age 30
age 40
age 50
age 60
age 70
age 80
age 90
$1.07
1.35
2.42
4.96
9.47
22.11
65.99
190.75
3. Insurers developed the principle of the level
premium as a practical method of providing
lifetime insurance.
12-4
Comparison of Term & Whole Life Premiums
$1,000
Increasing term
premium
Level
premium
12-5
Increase in Reserve on Whole Life Policy
$1,000
Decreasing Amount
of Protection
Increasing Saving
Element
Insured’s Age
100
12-6
Tax Treatment of Life Insurance
Life insurance policies are granted favorable
tax treatment in two ways:
1. Amounts payable to beneficiary at the
death of the insured are not generally
included in taxable income.
2. Income earned on the cash surrender value
is not taxed until the policy is terminated
and the gain is received.
3. Further, the cost of life insurance is
deductible as part of the basis in
computing taxable gain.
12-7
Tax Treatment of Life Insurance
Favorable tax treatment is allowed only for
contracts that meet the Internal Revenue Code
definition of Life Insurance.
1. Internal Revenue Code establishes two
tests to determine if a contract is “life
insurance.”
2. If the contract fails to meet one of the two
tests, earnings on the cash surrender value
are currently taxable to the insured.
12-8
Current Life Insurance Products
Term Insurance
1. Renewable term: guarantees the insured
the right to continue coverage for a number
of additional periods.
2. Convertible term: guarantees the insured
the right to exchange the policy for some
type of permanent insurance.
3. Advantages and disadvantages of term:
• provides greatest amount of protection
for given dollar outlay
• temporary protection only
12-9
Current Life Insurance Products
Whole Life
1.
Straight whole life provides protection for
insured’s entire lifetime (until age 100) with
premiums payable for lifetime.
2.
Limited-pay whole life provides protection
for entire lifetime (until age 100) with
(higher) premiums payable for a shorter
time.
12-10
Current Life Insurance Products
Universal Life
1. Introduced in 1979 by subsidiary of stock
brokerage firm, E.F. Hutton.
2. Subject to specified limitations, premium,
cash value, and level of protection can be
adjusted up or down to meet insured’s
needs.
3. Premiums are credited to a fund, which is
credited with policy’s share of investment
earnings.
4. Fund provides source of funds to pay cost
of pure protection (term) under the policy. 12-11
Current Life Insurance Products
Variable Life Insurance
1.
A whole life contract in which insured has
the right to direct how cash value will be
invested.
2.
Insured bears the investment risk in the
form of fluctuations in cash value and
amount of protection.
3.
Amount of premium is fixed, but cash value
and face amount vary, subject to a
minimum.
12-12
Current Life Insurance Products
Adjustable Life Insurance
1. Allows the buyer to adjust face amount of
the policy and premium over time.
2. Relationship between premium and amount
of protection determine the cash value.
3. Based on this relationship, an adjustable life
policy may be term or whole life.
4. When premiums paid exceed the cost of
protection, the cash value increases.
5. When cost of protection exceeds premium,
cash value or face amount decreases.
12-13
Current Life Insurance Products
Endowment Life Insurance
1.
Endowment contracts no longer meet the
Internal Revenue Code definition of life
insurance.
2.
Endowment policies are issued for a term
period such as 10 or 20 years.
3.
Endowment policies promise to pay face
amount if the insured dies during the policy
period and also to pay the face amount if
the insured survives the policy period.
12-14
Participating & Non-Participating Life Insurance
1.
Participating policies pay dividends
2.
Originally issued only by mutual insurers
3.
Dividend varies from margin built into
premium
12-15
General Classifications of Life Insurance
1. Ordinary life - 60.6% of insurance in force
2. Industrial - less than 1% (0.2%) today,
compared with 10% at one time
3. Group life - 37.5% of life insurance in force.
4. Credit life insurance - about 1.8%
Total life insurance in force exceeds $13 trillion
12-16
Life Insurance Premium Computation
1.
Mortality - 1980 CSO Table (separate tables
for male/female)
2.
Interest - time value of money
3.
Loading - for insurer expenses, taxes, profit
12-17
Commissioners 1980 Standard
Ordinary Mortality Table
Males
Females
Age
Deaths
Per 1000
Life
Expectancy
Deaths
Per 1000
Life
Expectancy
30
31
32
33
34
1.73
1.78
1.83
1.91
2.00
43.24
42.31
40.46
39.54
38.61
1.35
1.40
1.45
1.50
1.58
47.65
46.71
45.78
44.84
43.91
12-18
One Year Term Policy
Alive at age 21
9,810,509
Number who will die:
10,497
1 year term policy without interest:
$10,497,000
9,810,509
=
$1.07
=
$1.02
1 year term policy with interest
$10,497,780 X 0.956994
9,810,509
12-19
Annual Term for Five Years
Age 21
$10,497,780 X 0.956994
9,810,509
=
$1.02
Age 22
$10,682,000 X 0.95694
9,800,012
=
$1.04
Age 23
$10,866,000 X 0.95694
9,789,330
=
$1.06
Age 24
$11,147,000 X 0.95694
9,778,464
=
$1.09
Age 25
$11,330,000 X 0.95694
9,767,317
=
$1.11 12-20
Net Single Premium: 5 Year Term Policy
Year Deaths
1
2
3
4
5
Amount
Present Value
of Claims Discount
of Claims
10,497 $10,497,000
10,682 10,682,000
10,866 10,866,000
11,147 11,147,000
11,330 11,330,000
0.95694
0.91573
0.87630
0.83856
0.80245
$10,044,999
9,781,828
9,521,876
9,347,428
9,091,890
$47,787,890
5 year term net single premium
$47,787,890
9,810,509
=
$4.8710
12-21
Net Single Premium: 5-Year Annuity Due
Claims
Present
Value
Discount
of
9,810,509
$1 due now
9,800,012 $1 due in 1 year
9,789,330$1 due in 2 years
9,778,464$1 due in 3 years
9,767,317$1 due in 4 years
$1.000 $9,810,509
0.95699 9,378,023
0.91573 8,694,383
0.87630 8,568,868
0.83856 8,190,481
Age
Claims
21
22
23
24
25
Number
Alive
$44,912,264
5-year annuity due premium
$44,912,264
9,810,509
=
12-22
$4.5779
Net Single Premium: Whole Life Policy
Age
21
22
23
**
99
Deaths
Amount
Present Value
of Claims Discount
of Claims
10,497 $10,497,000
10,682 10,682,000
10,866 10,866,000
*****
******
30,698 30,698,000
0.95694 $10,044,999
0.91573
9,781,828
0.87630
9,521,876
*****
*****
0.03087
947,647
$1,052,972,752
Whole Life net single premium
$1,052,972,752
9,810,509
=
$107.33
12-23
Net Level Premium Conversion
$4.5779 is the actuarial equivalent of
$1 now and a $1 payment
every year for 4 years
Therefore,
$4.5779 : $4.8710 = $1 : X
X = $1.064
12-24
Reserve on Life Insurance Policies
Present Value
Present Value
RESERVE =
of Future __
of Future
Benefits
Premiums
12-25
$1000
Net Single Premium
20-pay life
30-pay life
$ 108
Paid-up at 65
Whole life
0
25
35
45
55
65
75
85
95
100
12-26
Benefit Certain Contracts
Benefit Certain Contracts are those under
which, if the insured persists in premium
payments, the policy will eventually mature and
benefits will be payable.
1. Cash value policies, under which benefits
are payable whether the insured lives or
dies are benefit certain contracts.
2. Ignoring the interest on premiums paid, the
net single premium on benefit certain
policies equals the face of the policy.
12-27
Benefit Uncertain Contracts
Benefit uncertain contracts are those under
which, if the insured persists in premium
payments for the entire policy period, the
insurer may or may not be obligated to make
payment.
12-28