Insurance Process Kamal Jindal

The Data Flow diagram for New Business Client Submits Proposal Validation of the Proposal Underwriting the Proposal Premium Calculation Issuing the Policy The Data Flow diagram for New Business

POLICY SERVICING New Business Issuing a New Life Policy to a client is known as known as New Business. The following are the tasks to be carried out. Proposal Underwriting Premium Calculation Policy Issue Contd…..

Schedule / Declarations What is covered, Who is insured, Period of policy, Policy limits, premium amount. Declaration states all facts about the parties and the contract. Conditions Sets out the rights duties and responsibilities of both parties

Pricing of Life Insurance Products Kamal Jindal

Pricing of Life Insurance Products In a life insurance contract the price of the contract is the total premium payments paid by the policyholder. Three main factors are used to calculate life insurance premiums: Rate of mortality Investment income Expenses  

Rate of Mortality In non-life insurance it is difficult to predict how much the claims cost will be due to the variability in claims incidences and costs. However, in the case of life insurance it is much easier to predict this cost because there are reliable mortality tables based on past mortality statistics. Life insurance policyholders pay premium into a common fund. From this fund all claims are paid out. The mortality risk premium is decided based on expected mortality.

Mortality/ Morbidity Tables They are based on life insurance companies’ historical statistics on the people they have insured. Typically mortality tables will vary by age and gender Also, as a general rule, as age increases, so does the mortality rate. The exception to this rule is found in the early years of life and, for men, in their late teenage years.

Mortality/ Morbidity Tables (contd.) A morbidity table shows the rates of sickness and injury accruing among given groups of people. They are categorised by age, gender and other criteria such as occupation. Normally, morbidity tables show both the probability of becoming sick – the inception rate- and the rates at which insured people recover from sickness – the termination rate. Actuaries in order to arrive at the concept of an `average’ or `standard’ life use mortality and morbidity tables. This decides the risk premium.

Mortality/ Morbidity Tables (contd.) However, such tables are not foolproof. They are also country and culture specific. Actuaries also have to take into possible future developments. Finally, such tables are based on `selected lives’. In the general population, mortality and morbidity rates – the `ultimate rates’ - will normally be higher. The Mortality and Morbidity Investigation Bureau (MMIB), promoted by the Life Insurance Council and the Actuarial Society of India, will prepare new mortality as well as morbidity tables. Presently decade old LIC mortality table used.

Investment Income When actuaries calculate the price of insurance, they estimate the amount of money the life insurance company expects to earn on the investments. The investment yield the life insurance company attempts to earn is in turn determined by the nature of the company’s current and future liabilities and the company’s need to have enough income to meet those liabilities.

Investment Income (contd.) Techniques of investment management have to take care of issues like duration matching, liquidity management and cash flow matching. Some types of policies like guaranteed annuities have given rise to serious problems for life insurance companies in a falling interest rate regime.

Expenses Costs can be subdivided in to 3 main categories: Production (or acquisition) costs Administration costs Claims handling costs Actuaries cannot just factor in today’s costs. They must also make educated estimates of what the costs would be in future. Production costs include advertising and marketing, commission, medical examinations, policyholder documentation and other acquisition expenses

Expenses (contd.) Administration costs include renewal commission, the cost of collecting premiums, the day-to-day administration of contracts and the administration of surrender payments and policy loans Claims handling costs include processing claims, investigating claims and administrating the payment of claims One of the most significant costs faced by an insurance company is the cost of generating new business – the so-called `new business strain’. These costs include advertising, commissions and other acquisition costs.

Persistency The hardest element to predict and control is the regular payment of premiums – the so-called persistency factor – and policy lapses, where policyholders stop paying premiums. Further, as it is not usually possible to increase the premium after the policy has commenced, consequences of cost over-runs are serious.

Premium In a contract of insurance, the insurer promises to pay the policy holder a specified sum of money, in the event of a specified happening. The policy holder has to pay a specified amount to the insurer, in consideration of this promise. Premium is the name given to this consideration Premium can be looked upon as the price of the insurance policy Premium has to be paid regularly over a period or it can be a one time payment A default in premium can endanger the continuance of the policy The calculation of the premium is a complex technical process involves actuarial and statistical principles base on future experience of Mortality, interest rates and expenses

Premium RISK PREMIUM NET & PURE PREMIUM LEVEL PREMIUM OFFICE/TABULAR PREMIUM EXTRA PREMIUM

PREMIUM CALCULATION STEP 1 Find out the Tabular premium i.e. Premium quoted in published premium rates for given age [nearest, next or last birth day]This premium is usually stated as Rs . Per thousand SA STEP 2 Deduct adjustment for large SA,if applicable STEP 3 Make adjustment for mode of payment of premium STEP 4 Multiply by SA STEP 5 Add Extras. Occupational hazards, supplementary benefits, double accident benefits [DAB], extended permanent disability benefit [EPDB] STEP 6 Divide by frequency of payment

Premium Calculation-examples Plan Term Age TP SA [000s] Mode Other riders 1 14-30 35 36.55 25 HY DAB +EPDB 2 5-35 30 28.40 50 Y Health Extra Rs 3 3 75-20 66.80 M

Rebates Sum assured [SA] Rebate 25,000-49,999 Rs 1.00 50,000-99,999 Mode of Premium rebate Half yearly 1.50% yearly 2.00%

Example 1 Tabular premium Rs 36.55 Less adjustment [a] for SA Rs 1.00 [b] for Hly mode@ 1.5% Rs 0.55 Balance Rs 35.00 Balance X SA=35X25= Rs 875.00 Add DAB+EPDB Rs 25.00 Total Rs 900.00 Half yly prem Rs 450.00

Eample 2 Tabular premium Rs 28.40 Rebate for large SA Rs 1.50 Balance Rs 26.90 Balnce X SA=26.90X50= Rs 1345.00 Add heath extra Rs 3 X 50= Rs 150.00 Total Rs 1495.00 Qtly prem Rs 373.75

Example 3 Tabular premium Rs 66.80 Less adj for SA Rs 1.00 Rs 65.80 Balance 65.80x30= Rs 1974.00 Add for DAB+EPDB Rs 60.00 Total Rs 2034.00 Monthly instt premium Rs 169.50

Underwriting & Claims Basic responsibility of an underwriter is to decide whether or not an applicant’s anticipated mortality is in line with the assumptions used in the premium rates and, if not, what additional premium should be charged. Underwriters have to prevent anti-selection against the company.  The so-called standard rates have to cover a broad spectrum of lives and most people need to be included in the list. Most others can be accepted on amended terms.

Underwriting & Claims (contd.) Underwriters have four inter-related concerns when they consider a proposal. They look at:  The nature of the person The particular risk to be covered The chosen amount of cover The time period The life ins. company will need to assess all risks before guaranteeing a sum insured. They include: Age and gender, medical history, lifestyle, occupation, hobbies and past times

The Financial Underwriting Process The underwriter must ask four key questions? Is there an insurable interest? Is there a genuine need for the cover? Does the sum insured match the financial loss which could result in the event of the death of the life insured? Does the class and term of the policy match the need for cover?

Performance Measurement

Performance Management Management will want to judge the performance of the business against performance criteria which encourage the creation of value. Creating value means maximising the return on capital.  Traditional life insurance business typically involves paying level premiums for an increasing risk – due to mortality increasing with age. This means that during early durations of the policy the premium paid will be greater than the cost of the risk but later the premium paid will be less than the cost of the risk.

Role of Reserves This then leads to the concept of setting aside part of the premium now to meet the expected shortfall in the future - `reserves’ are set up. Typically, the cost of setting up initial reserves is greater than the initial premium income. This is because the life insurance company has to make cautious assumptions in setting up statutory reserves. Hence the company’s capital is required to meet the shortfall. This loss of shareholder’s capital (hopefully temporary) is known as `Reserving Strain’.

New Business Strain In the case of a life insurance policy, most of the expenses are incurred at the inception of the policy. This includes initial commission expenses which are much more than running expenses. As these initial expenses are usually greater than the initial premium income, the life insurance company must fund the balance. This loss is termed as `Cash Flow Strain’. The sum of `Reserving Strain’ and `Cash Flow Strain’ is known as `New Business Strain”.

Embedded Value The amount of new business strain depends upon the local statutory rules for recognising income and outgo. Therefore the statutory profile reflects a substantial loss in the first year which is recovered over a period of years finally leading to profits.  The statutory profit profile distorts the true profitability of a company at any point of time. Taking into account expected future statutory profits will provide a more realistic picture of a life insurance company’s performance. This is known as the embedded value approach.

Embedded Value (contd.) Embedded value (EV) = Net Asset Value (NAV) + Value of Business in Force (VBF) Wherein NAV is the market value of assets which could be immediately distributed to shareholders. NAV = Statutory Capital + Retained Statutory Profits + Unrealised Capital Gains (Losses) – Deferred Taxes  

Embedded Value (contd.) VBF is the market value of assets which will be eventually distributed to shareholders, but cannot be immediately distributed because of legislation designed to protect the interests of policyholders or because the profit has yet to be earned. VBF is obtained by deducting the cost of discounting and cost of solvency capital from the value of future profits.