LIFE INSURANCE PRODUCTS

LIFE INSURANCE PRODUCTS
K K Jindal Managing Director Global Management Services New Delhi

Life Non-Life (General)
Insurance Life Non-Life (General) Individual Group Fire Marine Miscellaneous Cargo Hull Motor Liability Engineering Others Employers liability Construction phase Burglary Ins. Public liability Operation phase Fidelity Ins. Product liability Money Ins. Professional liability BaggageIns Director’s & Off. Liability AviationIns Satellite Ins.

Poor health Death longevity
LIFE RISKS Poor health Death longevity In life insurance, insurable risks fall into three streams

Insurance Products The risk of poor health The risk of death
The risk of longevity Health Insurance Life Insurance Annuity

Life Insurance Products are known as PLANS
[I] ……………. Individual Insurance (a) Term Insurance (b) Pure Insurance (c) Whole Life (d) Endowment (e) Annuity (f) Riders (g) ULIPs

[II]…… Group Insurance
(a) Group Term (b) Gratuity (c) Pension

Insurable Risks/ Types of Insurance Covers
In life insurance, insurable risks fall into three categories: The risk of poor health The risk of death The risk of longevity Poor Health: Health Insurance Premature Death: Life Insurance Outliving Resources: Annuity

Insurable Interest In order for a life insurance contract to be valid the policy owner must have an insurable interest in the life of the proposed insured when the policy is issued. A person has an insurable interest in the life of the insured if the person is: likely to benefit if the insured continues to live, or likely to suffer some loss or detriment if the insured dies. People are automatically assumed to have an insurable interest in their own lives.

life insurance plans TERM ASSURANCE PURE ENDOWMENT

Two Broad Types of Policies
Those with profit participation and those without. Non-profit policies provide the policyholder with a guaranteed benefit but no link with the life ins. co.’s performance. As both the policy’s benefits and premiums are guaranteed, the life ins. co. bears all the investment risk - the risk of earning enough money to meet the liabilities. There are two ways in which policyholder benefits can be linked to the life insurance company’s financial performance: a with profits policy or a unit linked policy.

Types of Policies (contd.)
A `with profit’ policy is one where the policyholder’s benefits are indirectly linked to the insurance company’s financial performance. The life insurance company carries out a regular valuation of the assets and liabilities of the life fund. This will normally reveal a profit or surplus. A part of this profit can be allocated to the `with profits’ policyholders, in the form of an addition to the sum insured, called a bonus.

Types of Policies (contd.)
Bonuses can be normal or terminal. They can be calculated on a simple interest basis or compound basis. Bonuses do not accrue under non-profit or unit linked policies. Premiums for with profits contracts are always higher than those for the corresponding non-profit contracts for the same sum insured, since they reflect the higher benefits that will be paid out.

Unit Linked Policies Unit linked policies are policies where the values are directly linked to the investment performance of a set of assets specifically chosen for the set of policyholders. The values of the units directly reflect the values of the underlying assets of the fund, and fluctuate according to the performance of the fund.

Unit Linked Policies (contd.)
Life Ins. Cos. offer a variety of funds to which a policy can be linked. For example: Equity or ordinary share funds Fixed interest funds Property funds International and regional funds Cash or money market funds Index linked funds The life insurance company may also offer a switching facility.

Surrender Values Some policies can be cashed in early at surrender values. The value of the savings accumulated to date, less the expenses incurred in running the policy and the costs of the risks borne. The return on surrender tends to be low, especially during the initial years. In the case of term insurance polices, surrender values are typically zero throughout the term of the policy.

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

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

Paid-up Policies Other options:
Borrow money from the insurance company against the security of the policy, and Converting the policy into a fully paid-up policy in which case no more premiums are paid and future benefits will be based on the value of the policy when it is paid-up.

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 1.5% Rs 0.55 Balance Rs 35.00 Balance X SA=35X25= Rs Add DAB+EPDB Rs Total Rs Half yly prem Rs

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

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

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.

Basics of Life Insurance Products

Term Policies Term insurance consists of policies which are taken out as a means of insuring against the possibility of death within a specific period, the policy’s term. Benefit is a lump sum payable in the event of death during the term of the policy. Premiums are usually payable on a regular basis through the term of the policy. Term policies are relatively inexpensive. The sum insured remains constant (level term) during the term of the policy and once it has expired the policy has no value.

Variations in Term Policies
Return of premium term Renewable term ins.: without evidence of health Convertible term insurance – convertible to a whole life or endowment policy without further evidence of health of the life insured. Useful for those who expect their incomes to rise in future. Decreasing term insurance – useful for house purchase mortgage. Increasing term insurance – to take care of inflation. Could also be inflation index-linked. Profit participation

HDFC Standard Term Policy
Premiums on a Rs.6 lakh policy for a 15 year term Age (Years) Half-yearly Yearly Single Premium 20 862 1566 11970 25 914 1662 13110 30 979 1782 15726 35 1074 1956 18216 40 1473 2688 26400

Whole Life Policies Provides cover for the insured’s whole life (or sometimes until a specific age) Accumulates a surrender or cash value during the insured’s lifetime This type of policy can be designed to pay death duties Whole life policies can be written for both single and joint lives. When the first person dies, the policy benefits are paid

Variations in Whole Life Policies
Whole life policies can be with profits, non-profit and unit linked. Universal life insurance, which is characterised by: (1) sum insured flexibility, (2) premiums which go up or down with the cover and fund performance, and (3) an unbundled price structure.

In cash, left to accumulate
Whole Life Policies Max MNYL LIC ING Bajaj Allianz Tata AIG Type WL Par WL WL + Money Back WL + Annuity Entry Age - Min 00 13 18 - Max 70 65 49 60 50 Maturity Age 100 85 80 Premium Paying Pd. Till maturity Single, years 16/20/24 years 12 years Sum Assured 100,000 200,000 150,000 50,000 50,000,000 No limit Underwriting Surrender Yes Bonus In cash, left to accumulate Reversionary Riders

Riders A rider is a special addition to an insurance policy that increases the cover provided by the policy. Some of the most common riders include: waiver of premium for disability riders and accidental death benefit riders Disability Insurance: Two main types of disability insurance are critical illness insurance and permanent health insurance.

Critical Illness Critical illness insurance pays out a cash lump sum on diagnosis of certain specified medical conditions. Some critical illness policies may have an option which covers the loss of independent existence after retirement age.

Critical Illness (contd.)
A cash sum can have a variety of uses: (1)It can be used to pay off a mortgage or other debts (2)Provide income to the policyholder and family during the period of serious illness (3)Enhance a pension plan or provide early retirement (4)Pay for specialist care A variation can be waiver of premium in case of being off work for a time due to ill health.

Permanent Health Insurance
Permanent health insurance (PHI) which provides a regular income when the insured’s own income stops or reduces significantly due to illness or injury. It is `permanent’ in the sense that there is no limit to the number of claims which can be made under the policy. PHI is usually marketed as an income protection plan. Because the focus is on protection of the insured’s level of income, policies are usually written to expire on retirement date at the latest.

Permanent Health Insurance (contd.)
The level of income protection will usually be up to 75% of the insured’s annual income if self-employed. This is to encourage the insured to return to work when possible. Any other benefits received by the insured (eg. social security payments, sick pay and benefits from other income protection plans) will be taken into account As the risk of illness and injury during work varies according to occupation, the client’s occupation will affect the premium level.

Savings and Investment Products: Endowment Policies
Endowment policies are policies where the sum insured is payable on a fixed date – the maturity date – or on the life insured’s earlier death Policy terms are usually between years or until retirement age Premiums for endowments are generally more expensive than for whole life policies, because claim payments are generally made earlier. Endowment policies have options regarding cash-in or surrender value. Making a policy paid-up for a reduced sum insured will also be usually possible. However, the best yield is usually obtained by waiting until the maturity date. Non-profit endowment policies have level premiums and payout a fixed, guaranteed, sum insured on maturity, or earlier death

Endowment Policies (contd.)
A with-profits endowment policy pays a guaranteed sum assured, plus bonuses. Premiums are higher than in non-profit policies If the policy runs to maturity, bonuses will generally be higher than if there is a death claim because they will have accrued longer. Endowment policies are often used as savings schemes and mortgage repayment arrangements. Unit linked endowment policies are of two types: guaranteed and reviewable policies.

Endowment Policies (contd.)
With a guaranteed unit linked policy, the premium is fixed at the outset of the contract and buys a fixed sum insured payable on death during the term. If units do not perform well enough to maintain the life cover and payout at maturity, the life co. makes good any shortfall. If the units outperform the assumptions made in the policy pricing, the excess is paid to the policyholder. With a reviewable policy there will be regular reviews of unit performance. Premiums can go up or down during the term of the policy.

HDFC Standard Life Endowment Policy
In case of demise during the policy term, this participating (‘With Profits’) insurance plan will pay the family the ‘Sum Assured’ chosen. The plan receives simple Reversionary Bonuses, which are usually added annually. At the end of the term an additional Terminal Bonus may be paid depending on the performance of the underlying investment. Choice of 4 additional optional benefits: Critical Illness (CI): 6 critical illnesses covered Additional Term Benefit (ATB) Accidental Death Benefit (ADB) Waiver of Premium Term (WOP)

Age (Years) Basic Policy Premium for Rs.2 lakhs for a period of 20 yrs Additional Premiums for Optional Benefits (Rs.) CI ATB ADB WOP 20 9392 608 644 272 401 30 9520 884 776 288 492 40 10046 1850 1282 312 700

Basic Policy: Age of Entry: 12 yrs to 60 yrs Max. age of maturity: 75 yrs. Term period: 10 yrs to 30 yrs. If premiums are paid continuously for 3 years, then the policy acquires a guaranteed minimum surrender value. The guaranteed minimum surrender value is 50% of all premiums paid subsequent to the first year, excluding any extra premiums paid for increased mortality risk.

Elements in a ULIP Plan Term Open Ended / 10 – 30 years Age at Entry
Min. Premium Contribution Rs.10,000 p.a. Payment Mode Quarterly/ Half-yearly/Annually Investment Options Growth, Balanced, Bond Survival Benefits Value of units Death Benefits Higher of Sum Assured (less any withdrawals) in Policy Fund Withdrawal Benefits After 3 years Initial Charge (as % of annual premium) 1st yr:12-20%, 2nd yr:7.5%, 3rd yr: 4% Fund management charges 0.75% % Bid Offer Spread In some cases Switch Between Fund Usually free Riders Term, Critical Illness

IRDA Guidelines on ULIPs
For a single premium product, the death benefit should be at least 125% of the single premium paid. For regular premium products the death benefit should be higher of 5 times the annualized premium or 0.5 x term of the policy x annualized premium. Every ULIP product should have a minimum policy term of 5 years and that every ULIP will have a minimum lock in period of three years. This is in order to ensure that ULIPs are not sold as short-term products.

HDFC Standard Life Unit Linked Endowment Plan
Types of Funds: (i) Liquid Fund: 100% bank deposits and money market instruments (ii) Secure Managed Fund: 100% govt. securities and bonds (iii) Defensive Managed Fund: 70% to 80% - govt. securities and bonds, 15% to 30% equity (iv) Balance Managed Fund: 40% to 70% govt. securities and bonds, 30% to 60% equity (v) Growth Fund: 100% equity Term period: 10 to 30 years Age of Entry: 18 years to 60 years Maximum age at maturity: 75 years Life protection: 5 to 20 times of regular premiums

HDFC Standard Life Unit Linked Endowment Plan
Investment Content Rate (ICR) 1st & 2nd year 3rd year onwards Up to 1,99,999 73% 99% 2,00,000 to 4,99,999 80% 5,00,000 to 9,99,999 85% 10,00,000 and above 90% Fund management charge: 0.8% p.a. of the fund’s value Administrative charge: Rs.15 p.m. Fund switching: free Cancellation or surrender charges: 25% of outstanding premiums due for the remainder of the initial 3 years

Guaranteed Bonds A guaranteed income bond is a simple contract wherein in return for a single premium the bond provides a guaranteed income each year for a specified period and then on maturity returns the investor’s premium. The income is usually payable yearly and most bonds are for terms of up to five years. Basically, the standard income bond is an endowment with a fixed maturity date. Guaranteed growth bonds are similar to guaranteed income bonds except that income is not paid. The investor pays a single premium and is guaranteed a fixed capital sum in 3-5years’ time

Annuities An annuity is a contract where an insurer agrees to pay a set amount, the annuity, every year until death of the annuitant or life insured or for a specified fixed term. The annuity purchaser typically makes a single premium payment to the insurer – although this sum could be built up over a number of years, in say, an endowment savings plan. The life ins. co. then invests this sum in order to generate the income to pay the annuity. These payments are expressed as an annual sum but may be payable monthly, quarterly or annually.

Annuities contd. In order to take care of married couples, joint last survivor annuities have been developed, where contracts pay an annuity for the joint lifetimes of the two annuitants. Payments either continue in full after the first death or a percentage of the original annuity is payable to the surviving partner. Typically, life time annuities do not offer a surrender value. However, where the annuity is a term annuity, a surrender value may be payable if it is cancelled before the end of the term.

Immediate and Deferred Annuities
Annuities can be distinguished in terms of specific provisions of the annuity contract. With an immediate annuity, annuity income benefits begin one annuity period after the annuity is issued. In the case of deferred annuity, income benefit payments begin more than one annuity period after the annuity is issued. With a deferred annuity, the premiums have more time to earn interest before the income benefit payments begin. The time between the issue of a deferred annuity and the beginning of the income benefit payments is known as the accumulation period.

Single and Flexible Annuities
Annuities can also be classified according to whether the contract owner pays a single – lump sum- premium or a series of premiums. All immediate annuities are single premium annuities, or popularly known as single premium immediate annuities (SPIAs). A deferred annuity purchased with a single premium is called a single premium deferred annuity (SPDA). When deferred annuities are purchased with a series of premiums paid over a period of time, they are known as flexible premium deferred annuities (FPDAs).

Fixed and Variable Annuities
With a fixed annuity, the insurer guarantees to credit the annuity account value with a fixed rate of interest for a specific period of time. At the end of the initial period, the insurer sets a new interest rate (lower or higher) for the next period. However, there is usually a certain minimum interest rate which is guaranteed.

Fixed and Variable Annuities (contd.)
With a variable annuity, there are no investment guarantees and the contract owner’s investment earnings depend entirely on the performance of the investments. The contract owner can usually choose from a range of investment options. Variable annuities are becoming popular as they offer greater investment flexibility, more control over how the money is invested and the potential for greater investment returns. In many countries around the world, deferred annuities are used for retirement or pension planning.

Tax Benefits (Across All income Slabs)
Income Tax Section Tax Amount Saved Type of Plan Sec. 80C Up to Rs. 33,660 saved on investment of Rs. 1,00,000. All the life insurance plans. Sec. 80 CCC Up to Rs. 3,366 saved on Investment of Rs. 10,000. All the pension plans. Sec. 80 D* All the health insurance riders available with the plans.

Pricing of Life Insurance Products

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.

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.

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

Value of business 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.

LIFE INSURANCE PRODUCTS

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