INTRODUCTION TO INSURANCE

Humans have always sought security. This quest for security was an important
motivating force in the earliest formations of families, tribes, and other groups. The
groups have been the primary source of both emotional and physical security since
the beginning of humankind. Humans today continue their quest o achieve security
and reduce uncertainty. We still rely on groups for financial stability.

With industrialization our physical and economic security has diminished.

Mankind is exposed to many serious hazards, which cause stoppage of income.
The biggest worry any human being has is the economic worry. He is always
thinking of tomorrow and the days to come and he will be planning to meet the
demands of his family, his business and that of his own needs. The economic
worries may arise due to stoppage of income. Our income dependent, wealth-
acquiring lifestyle renders us and our families more vulnerable to environmental
and social changes over which we have no control. There may be accidents,
sickness disability, or due to premature death of the breadwinner. It is impossible to
prevent such calamities. But it is always possible to provide against the loss of
income that may result out of such these perils.

Risk is defined as uncertainty of financial loss. If the event were certain to happen,
then there is no loss If the event were certain not to happen, then also there is no
loss. It is the uncertainty about the time of loss that worries the mankind.

There are two types of RISKS namely PURE RISK and SPECULATIVE RISK.
In pure risk there is always loss only. by happening of the event, the person is
certain to have an economic loss. In speculative risk, there can be loss or gain.
Trade risk is a speculative risk.

Whereas speculative risks are managed by management techniques, RISK

MANAGEMENT manages pure risk. The following are the risk management
methods.

Avoidance: Here the risk is altogether avoided.

E.g.: Do not get a motorcycle to young boy.
Prevention: being very careful prevents Risk.
Eg: Proper maintenance of the vehicle.
Reduction: Again by proper maintenance of the vehicle, loss can be reduced.
Retention: Where the loss is minimum and can be met by own resources,
Transfer: When the person is not in a position to manage the loss by anyone of the
above methods, the risk is transferred to someone else.

Here comes the concept of Insurance. It is the function of Insurance, to enable

individuals to protect such losses. In Insurance language, RISK means financial
loss only

Individually every person irrespective of his financial status cannot provide against
all the losses he may incur. It is not only costly but also speculative. Hence all the
individuals who are exposed to same type of risk or common risk come together
and transfer their loss to an organization or a corporate body. This is done by a co-
operative endeavor. All people contribute towards a common fund. It is not
possible to predict as to which individual suffers the loss. But it is always possible
to forecast the quantum of loss the entire group may suffer. The loss of few is
compensated by the contribution of many individuals.

The characteristics of pure risk or insurable risk;

The risk may be one that may or may not happen

The risk must be pure and not speculative. This is because of the fact that it is not
possible to know various factors which may result in trade loss
The loss caused must be capable of being measured in terms of money only
Risk should not be of illegal nature E.g.: stolen property cannot be insured
Risk should not be opposed to any public policy.
Risk should not be catastrophic in nature

Risks can be further divided into the following groups:

Dynamic risk: This results from the changes in economics like demand and
supply, changes in consumer tastes. But such risks benefit the society over a long
term.

Static risk: These arise due to dishonesty of few individuals. They cause unequal
distribution of wealth, asset or possession of property.

Fundamental risk: These are not personal in nature. These come out of political
and social phenomenon like unemployment, wars etc.,
Particular risk: Here the loss is due to individual events like fire, accidents etc.,
.The solution lies in going for insurance.

NATURE OF INSURANCE:

Sharing of risk: Insurance is a social devise to share the financial loss, which may
befall individuals due to many events. Whereas it is not possible to share deaths,
accidents or sickness, it is always possible to share the economic losses, which
come out of these events. All persons who are exposed to similar risks come
together and share the loss.

Co-operative endeavour; in every type of Insurance, large number of persons are

brought together to share the loss. They have a common goal viz., to plan the
economic future. Such people come together voluntarily or through publicity or
through soliciting. It is the Insurer who compensates the loss of few from the
contributions received from many.

Value of risk: The risk or financial loss is measured in terms of money before
insuring. This is done by means of past experience of the Insurer. This will enable
him to collect the cost of Insurance in adequate measure.

Payment at contingency: The payment of sum assured is made on the happening

of the event, which is insured. It may be premature death or end of the term in Life
Insurance. In non-life, it may be the happening of the event.
Amount of payment: In Life Insurance the amount is fixed at the beginning of the
contract and full amount is paid at death or end of term. But in other types of
Insurance the amount of loss only is paid.

Large number of persons: To make the cost of Insurance cheaper, it should

involve large number of persons. This will enable the Insurer to spread the loss.

Insurance is not gambling:Though an amount of chance is involved, Insurance is

not gambling. The uncertainty of financial loss is changed into certainty of
payment of amount on the happening of event

FUNCTIONS OF INSURANCE:

The function of insurance is to safeguard against such misfortunes by having

contributions of the many pay for the losses of the unfortunate few. This is the
essence of insurance- the sharing of losses and, in the process, the substitution of a
certain, small “loss” called the premium for an uncertain, large loss.

From an economic perspective, insurance is a financial intermediation function by

which individuals exposed to a specified contingency each contribute to a pool
from which covered events suffered by participating individuals are paid.
Insurance then is a contingent claim contract on the pools assets.

From a legal perspective, insurance is an agreement, the insurance policy or

insurance contract, by which one party, the policy owner, pays a stipulated
consideration called the premium to the other party called the insurer, in return for
which the insurer agrees to pay a defined amount of money or provide a defined
service if a covered event occurs during the policy term.

The person whose life, health or property is the object of the insurance policy is
referred to as the insured. Insurance provides certainty of payment of sum assured
at the happening of the event. Since no one can predict the happening of the event
in advance, it is not possible to compensate against the loss. There is an uncertainty
about the time of the event happening. We will not be also sure about the quantum
of loss. Under life insurance policies, the person to whom the payment is made on
the insured’s death is the beneficiary

Provides assistance to business: Large capital investments on buildings and

machinery can be protected against loss by Insurance. The cost of Insurance will be
very small compared to the total loss.

Provides financial stability to commerce and industry: When material damage

takes place due to peril, there will be stoppage in production resulting in reduction
in profit. Loss of profit Insurance can take care of the loss in net profits in addition
to loss of machinery.

Insurance serves as a basis of credit: Industry and commerce approach banks and
financial institutions for financial assistance to develop their business. A collateral
security may be necessary to secure against the finance advanced. Insurance
policies can provide against such advances.
Insurance plays a role in reduction of losses. Insurance companies render advice as
to how losses can be minimized by using various safety measures because of their
experience.

Insurance provides fund for investment: The Insurer will have huge funds
collected from Insured by way of premiums. These funds are not kept idle, but
invested in nation building activities.

Insurance earns foreign exchange: Indian Insurance companies have branches in

different countries, where large volume of business is transacted. This will fetch
huge amount in foreign currency.

TYPES OF INSURANCES:
Insurance sector has divided itself into companies that sell on the person, known as
life insurance, and those that sell insurance to protect property, referred to as non-
life insurance, property/ casualty insurance, and general insurance.

Life Insurance: On human life, which includes premature death, old age
provisions, disability benefits, Annuities and Super annuation.
Death: usually called life insurance or life assurance.
Living a certain length of time: called endowments, annuities, and pensions.
Incapacity: called disability and long term care insurance.
Injury or incurring a disease: called health insurance, accident insurance, and
medical insurance.

Non Life Insurance, which can be classified as follows:

On property: Buildings, machinery marine etc.,
On person: Like personal accident, health, sickness etc.,
On interest: Like fidelity guarantee, personal indemnity etc.,
On liability: Like third party liability.

Difference between Life and Non life Insurance:

a). Risk is certain to happen in Life Insurance, either premature death or
survival to a particular age. But in Non life Insurance risk may or may not happen
b). Life Insurance is a long-term contract
Non-life contracts are usually renewable every year.
c). It is very difficult to assess the value of human life
It is easy to value a property.
d). General Insurance is contracts of Indemnity.
Life Insurance is not contracts of indemnity.

IMPORTANT DEFINITIONS

Risk: Risk is uncertainty of financial loss

Peril: It is defined as anything, which may cause the economic loss like fire,
sickness, and accident
Hazard: It is the state or condition, which brings out the peril
Insurance: Insurance or Assurance is a guarantee to pay prescribed sum on the
happening of the event.
Proposer: Proposer is the person who seeks the coverage of risk of the subject
matter of Insurance
Insured: Insured is the person whose subject matter of risk is covered by the
Insurer.
Insurer: It is a corporate bode or an organization who undertake to cover the risk
Proposal: A proposal form is an application, which is given by the proposer giving
details about the subject matter of risk to be covered.
Premium: It is the periodical or a lump sum payment or price paid by the Insured
as cost of risk to be covered.
Sum assured: It is the amount agreed upon by the Insurer, which is paid, on the
happening of the event, which is insured against.

The words Insurance and Assurance are interchangeable. Assurance means a

promise or a guarantee. This word applies more in case of Life Insurance, since the
Insurer guarantees to pay the full sum assured on premature death or survival. But
in other types of Insurances, the Insurer indemnifies the insured to the extent of
loss only if the event were to occur.

INDIVIDUAL AND FAMILY USES OF LIFE INSURANCE:

The primary purpose of Life Insurance is to provide the financial security against
the loss of income arising out of the insured peril. The loss of income to the family
in case of premature death of the life assured is neutralized by the sum assured,
which the Insurer pays.

Insurance encourages savings: By the very nature of Life Insurance contract, the
insured develop the habit of savings over a long period of time. Any other savings
program apart from insurance can yield only a small amount at the start, whereas
an insurance policy guarantees the full face value or other benefit from its
beginning, and thus, it can hedge the policy owner against failure through early
death or incapacity to have sufficient working time to save adequately through
other means.

Insurance affords peace of mind: The wish of financial security is the prime
motivating factor. If this wish is not satisfied, lot of tension is created. By taking
out a policy of Life Insurance we can have the mental satisfaction that the family
has been provided against any eventuality.

Furnishes an assured income in the form of annuities: Annuities can prove

valuable to those older persons who have succeeded in savings only a limited
amount of capital, and who have no one to whom they particularly can transfer this
sum on death.

Insurance eliminates dependency: At the death of the breadwinner, the income

stops and the standard of life of members of the family come down. By insuring
the life of the person and in case of premature death, the amount may be used to
maintain the standard to a greater extent. The family need not depend on the mercy
of others.

Profitable and safe investment: Savings in insurance is safe in the hands of the
Insurer. The Life funds are invested by the Insurer in safe securities as per the
directives of the Government and are safe. The Assured will also take part in the
profits of the Insurer if he has opted for a with profit policy.

Insurance protects mortgaged property: If the property is owned by an

individual is mortgaged, in case of premature death of the owner, the property is
taken over the lender and the family looses the property,
If the life of the individual is insured and in case of the premature death of the
assured, the sum assured so obtained can be paid towards the loan outstanding and
the property retained by the family.
BUSINESS USES OF LIFE INSURANCE:
a) Key man Insurance: It happens that in many organisations, the growth of
. the company depends on the skills and intelligence of one person. If the
Company loses him by death the company finds difficulty.

b). In finding an alternative person. Even if such persons are found, it

takes time and money to train him .By taking an Insurance policy on the
life of such a Keyman; the company can over come the vacuum created
by the death of the keyman

Partnership: Insurance: more than one person runs many business ventures. The
business interest can be insured by two methods. One by taking a Joint life policy
on the lives of all partners and the second method by taking policy on individual
life and sum assured payable to the company. In case of death of any one of them,
the capital investment by each is protected and business can continue.

Welfare of employees: As a welfare measure, employers can take Insurance on the

lives of employees in a group and on death of any employee while in service, the
family helped. This serves as an incentive and motivation to the employees to
perform better.

SAVINGS IN LIFE INSURANCE:

Every form of legal savings has to be encouraged. The following are considered as
good savings;
Shares: shares and stocks represent ownership in a business in a very small way. It
is inherently speculative. Not everyone is qualified to make selection of good
shares. They do not induce compulsory savings. The profit of the company does
not depend on the shareholder but on how efficient the management of the business
is.

Bank deposits; to accumulate any money in a bank it takes time. There is always a
tendency to withdraw. The amount we get is our contribution and small interest.

Post Office savings: They are similar to Bank deposits but are absolutely safe.
There is temptation to withdraw.

Mutual funds: These are meant for small investors and if managed with skill by
the fund managers, they are good investments

Compared to these savings, investment in Life Insurance has the following distinct
advantages.

Capital is built the moment first premium is paid and the Insurer goes on risk
Premature withdrawal is not permitted due to the terms of the contract.
Savings are not time consuming. An estate is built moment the Insurer goes on
risk
 The investment is safe because the Insurer is governed by strict rules as to where
he has to invest his fund
LIFE INSURANCE PRODUCTS

It is the earnest desire of every individual to own property. Any one who is in
possession of something tangible feels secure. But very few people have adequate
income to own something of their own. It is just they FAILED TO PLAN and not
PLANNED TO FAIL. It is always desirable that we identify our financial needs
and buy an instrument rather than buy the instrument and try to fit in our needs.
Financial planning has become more complex because of greater economic
uncertainty, constantly changing tax laws and varieties of options

It is very difficult to prepare a list of all financial needs. But it can be divided into
Capital needs like emergency funds, education needs, marriage needs and income
needs like family income, retirement needs. Life Insurance has been recognized as
one of the best instruments of family financial program. Usually people look at
investment in Life Insurance as
Risk cover/ investment, combination of both the above, adequately long term, safe
investment, moderate yield and tax savings

The need levels of individuals in Life Insurance naturally depend on the age group.
Every one of us have the following Insurance needs at every point of our life. But
the degree of need depends on age. The recognized needs are
Protection for self and family, Children needs, Retirement needs, Special needs like
health and housing
Now let us study the various products that are available in the Insurance Industry
with reference to the above need levels

BASIC PLANS OF LIFE INSURANCE

There are only TWO basic plans of Life Insurance. They are TERM
ASSURANCE and PURE ENDOWMENT. In term assurance the sum assured is
paid only in case of death of the assured within the term of the contract and
nothing is paid in case of survival to end of the term. But in Pure endowment, the
sum assured is paid only in case the assured survives to the end of the term.
Nothing is paid in case of death of the assured within the term. Remember these
are the TWO BASIC plans. Any number of plans can be devised by combination of
these two plans.

Now let us study various products available in the Insurance market in India about
the four needs 1. Death 2. Living to a certain length of time, 3. Incapacity, 4. Injury
or incurring a disease.. They are the major needs and occupy prominent position in
our Life Insurance planning. Any other need can be a sub division of these.

NEED FOR FAMILY

A). Term assurance:

Term assurance is the cheapest form of Insurance. As explained above, this plan of
Insurance is just a RISK COVER plan. Young people who cannot afford high
premiums can go in for this policy and obtain substantial cover at a very moderate
cost. This term assurance has gone tremendous modification like

1.Term assurance: Here sum assured is paid only in case of death of the assured
within the term of the contract. Nothing is payable if the assured survives the end
of the term

2. Term assurance with return of premiums: In this plan, the sum assured is paid
in case of death within the term. But if assured survives the term of the contract, all
the premiums paid is returned

3. Term assurance with return of premiums and loyalty additions: If the

assured survives the term, in addition to return of premiums, loyalty additions are
given. Such additions may be a percentage of premiums

4. Term assurance with return of premiums & loyalty additions and extended
cover: In this plan in additions to the benefits under (3) the, contract does not
come to an end, but the insurer extends term assurance cover for a further period
after the end of term. In case of death of the assured during the extended period,
the Insurer pays full or part of the sum assured. This is ideal plan, whereby the
assured can have risk cover at an age when he may not be eligible for Life
Insurance at all.

Convertible term assurance: In this plan the assured has a choice of converting
the policy into an endowment or whole life at the end of the term. The option is to
exercise before 2 years from the expiry of the term and the Insurer will agree to
cover risk for a sum not exceeding the original sum assured. There is no need to
submit any proof of insurability.

B). Whole Life

Under whole life, by concept the Sum assured is payable on death only. Whereas in
Term assurance, the death should take place within the term of the contract, in
Whole life there is no fixed term and the Sum assured is paid on death at any time.
The following are the modifications that have taken place over a period of time.

1. Whole life: Here the Sum assured is paid on death and the premiums are to be
paid, as long the Life assured is alive.

2. Whole life Limited payment: In this, the assured has a choice of limiting the
premium payment period and the Sum assured however is paid on death only.
The Insurers thought the above two do not serve the need of many and decided that
the premium payment automatically stops after 35 annual premiums are paid or the
LA reaching 80 years of age, whichever is later and the Sum assured is also
payable on reaching age 100. Now this has also been modified and the sum assured
is payable on reaching 80 years of age.

3. Convertible Whole life: In this plan, the life assured has the option of
converting the policy into an endowment plan after 5 years from the date of
commencement. The premium will be less during the first 5 years and will increase
according to the term selected. If however the conversion is not exercised, the
policy will run as whole life limited payment with premiums ceasing at age 70 of
the assured and the sum assured payable on death

C). Endowment type: These are the most popular plans of Insurance as the very
definition of life insurance is found here. That is the sum assured is paid on the
event contingent upon the duration of human life, death or survival.

1. Endowment policy: The sum assured is paid on death or survival to the end of
term whichever earlier.

2. Endowment limited payment: Here the LA has choice of limiting the premium
payment period.

3. Endowment double or triple cover: In this policy, the sum assured payable on
death within the term will be two or three times the basic sum assured. But the sum
on maturity will be the basic amount only.

4. Marriage endowment: Here the sum assured is due only at the end of the term
and the payment of premiums stops at death of the assured. The objective of
insurance to provide for the marriage of daughter is met under the policy

D) Combination of whole life, endowment and money back

1. Endowment & whole life: In this policy, the sum assured is paid on survival to
the end of term and the contract does not end and another sum assured is paid at
death any time. If however the assured dies before the expiry of the term, sum
assured is paid
2. Money Back & whole life: Under this plan a percentage of sum assured is paid
every 5 years as long the assured is alive and full sum assured is paid on death at
any time irrespective of the survival benefits paid earlier.

E). Money Back Type:

1. Ordinary money back: These are fixed term policies where under, part of the
SA is paid at periodical intervals. Full SA is paid at death any time within the term
irrespective of the survival benefits paid.

2. Money back with increased cover: In this case, the survival benefits are as
above. But the death benefits will be increased SA depending on the duration of the
policy.
RETIREMENT PROVISION

One of the risks associated with human being is the risk of living too long. With
break of joint family systems, each one of us have to start providing for the days
after we cease earning. The added problem of the increased longevity has
multiplied the need to provide for retirement. Life Insurer is an organization, which
can organize schemes to meet this need. The following are some of them

ANNUITIES
Annuities are annual payments made by the Insurer to the Annuitant in return for a
lump sum or periodical payment made by the other. The annuities can be purchased
in two ways

1. Immediate annuity: here the purchaser pays a single one time payment to the
Insurer and desires that annuity to flow immediately
2. Deferred annuity: Here the purchase price is paid by the buyer in installments
and annuity starts after the corpus is built.

The annuitant can desire the payment of annuity in respect of the above in any of
the following ways:

1. Life Annuity: Here the Insurer pays annuity installments as long as the
annuitant is alive
2. Annuity certain: The annuity is paid for the selected number of years
irrespective whether the annuitant is alive or not.
3. Annuity certain and life thereafter: The annuity is paid for the selected
number of years and if the annuity is alive at the end of the term, it will continue
for the lifetime of the annuitant.

It should be remembered that the annuity can be selected to made either yearly,
half yearly, quarterly or monthly. .
PENSION PLANS

The life insurance industry has come out policies, which serve the provision of
pension linked with risk cover. In this type, risk on the life of the assured is
covered on a notional Sum assured and such notional amount is made use to buy
annuity as explained above. But in case of death of the assured within the term, the
nominee will be entitled to family pension based on the notional sum assured.
There is an option of commutation also

Difference between annuity and Life Insurance:

Those who are afraid of living too long and Life Insurance by those who are
afraid of premature death purchase annuity.
In annuity there is self-selection by the annuitant and in Life Insurance there is
selection by the Insurer.
By concept wise in Life Insurance payments start at death and in case of annuity
the payments stops at death. Both works on the theory of large numbers.
Life Insurance is based on rate of Mortality and Annuity is based on probability
of survival.

GROUP INSURANCE

Group Insurance is a device by which members belonging to a homogeneous group

can be given insurance cover under a single contract. The development of Group
Insurance in India is of recent origin and now lot of emphasis is given on wide
coverage in view of its simplicity and affordable cost. The salient features of
Group Insurance are as follows:

The group should be homogeneous and the Insurer may prescribe minimum
number depending on the scheme.
 The contract is between the Insurer and the employer/group/association
A single policy called master policy is issued covering all the members and
spelling out the relevant terms and conditions
The group must have been formed other than for the purpose of taking out
Insurance & the group should already exist.
The scale of benefits is pre decided depending on the salary/grade of the
employee. The individual employee has no choice of selecting the sum assured.
At the inception of the scheme, an option is given for members to join the
scheme. But new entrants have to compulsorily join the scheme.
The selection is based on the average age of the group.
Minimum Insurance cover will be given without strict proof of insurability.
The premium may be contributory or non contributory.
The employer is eligible to treat the premium as expenses and claim tax
exemptions
The contract is renewable every year. At the time of renewal, based on the
previous years experience, the premium may get revised. This is called experience
rating
The named person of the employer will deal with the Insurer in all servicing
matters.

TYPES OF GROUP INSURANCE SCHEMES

One year renewable term assurance: Here the contract is for one year renewable
every year. In the event of death of any member of the group during the year, the
agreed sum assured is paid.
Group gratuity scheme: As per Gratuity Act 1972, an employer is legally bound
to pay Gratuity for all employees who put in a minimum service of 5 years.
Wherever the employer appoints not less than 10 people. The scale is at the rate of
15 days wages for every year service completed, subject to a maximum of
3,50,000. The employer has to therefore make provision in advance. The methods
may be
Make payments as when it arises called as pay as you go method.
Can create an internal reserve equal to the actuarial valuation of the liability.
Set up a gratuity fund with trustees to manage.
Set up a fund and transfer the same to Insurance Company under a Group
Gratuity scheme.

Of the above methods, the first two methods are quite risky in the sense that the
fund may be misused in terms of financial difficulties. The fourth method would be
very prudent, since an Insurer has a huge portfolio and can diversify his
investments and assure a guaranteed return. The Insurer has also qualified people
to calculate the liability accurately.

Group Gratuity linked with OYRTA

Under this provision, risk on the life of the members of the group are covered and
in case of premature death, the gratuity paid will be notionally calculated and we
would receive higher gratuity. The balance service of the deceased member is
considered and gratuity calculated.

Group Pension scheme. The benefit of pension has the advantages of retaining the
talented people with the organization; the employer is treated as a progressive and
the tax advantages enjoyed by both the employer and the employee. The employer
can find the same ways to provide for pension as discussed in the provision for
Gratuity. But the Insurance Company can provide actuarial, legal and taxation help
to the employer. Again by conjunction with OYRTA, the employee can be helped
to get a higher pension in case of premature death.

Group savings linked Insurance Scheme: Under this scheme, the benefits offered
include both death cover as well as savings. A part of the contribution goes towards
the cost of risk cover and in case of death of the employee; a certain fixed amount
is paid. On surviving to superannuating age, savings portion with interest is paid.

Employees deposit linked insurance: All the employers have to provide for risk
cover to those who come under PF Act. This provision can be arranged with an
Insurance Company, whereby the Insurer will cover risk on the life of the
employee to the extent of balance of PF account on the date of death or up to
62,500/- whichever is lower.
SOCIAL SECURITY SCHEME: As per Article (41) of Indian Constitution, the
Central Government has to provide Social Security to vulnerable sections of the
Society. Life Insurance is one of the ways by which such security can be provided.
Now IRDA has also prescribed that each Insurer has to compulsorily cover certain
number of lives under such schemes. The scheme has to be financed either wholly
by the Insurer or with nodal agencies.

PREMIUM AND PREMIUM STRUCTURING

Premium is defined as the consideration, which flows from the Insured to the
Insurer. It is the cost of Insurance product. What we should remember is that Life
Insurance is a long-term contract and a voluntary contract. The terms and
conditions are decided at the beginning of the contract and can never be changed
during the currency of the policy. Hence lot of care is needed before a terms and
conditions are incorporated.

Actuary is the person who is responsible for devising the product and pricing them.
He is one of the most qualified people and has knowledge in Mathematics,
Statistics, Economics and expert in forecasting. An actuary has to be a Fellow of
Institute of Actuary, London or a Fellow of Actuarial Society of India. IRDA
prescribes that each Insurer should have an Actuary on his rolls. HE is also
responsible for Valuation, which is a statutory requirement.

ELEMENTS IN PREMIUM STRUCTURING

1. MORTALITY TABLE

One of the characteristics of pure risk is that it be measurable in terms of money

only. That means that the Insurer should know well in advance, the liability he is
taking by entering into contracts. He should know as to how many people are
going to die every year and over a period of time so that he will be able to pay sum
assured to all those who die during each year and also to those who live the entire
term of the contract.

Mortality table is a document, which provides information about the death rate at
each age. It can be defined as a tool in the hands of the Insurer to determine the
premium. It can be described as a picture of generation of individuals passing
through time. It shows a group of individuals entering at a certain age and traces
the history of the entire group year by year until all have died

It can be constructed from two sources. One is the census data, which is
enumerated once in ten years by the Government. The data is very vast and lot of
approximations is made while compiling the data. Age is a very important factor in
Life Insurance. But the age reporting is very casual in census because of the
tendency of people to report lower age. The other source is the Life Office data,
consisting of the information about the insured lives in Insurance Company. The
main differences between census and Life Office data can be summarized as
follows.

Census Life office data

1) Once in 10 years Data available at any point

2) Not homogeneous Very homogeneous
3) Consists of entire population Insured lives only
4) Age reporting is approximate Age is accurate
5) Deaths may not be reported at all Cause of death also reported
6) Includes uninsurable people also Selection has taken place

In view of the above, inaccuracies, the Insurer cannot base his premium on the
census data. He has to construct his own mortality table based on the insured lives.
But no mortality table can be constructed unless huge data available, so that law of
large numbers works out. The first mortality table on the Indian lives was
constructed by Oriental Insurance Company called O (25-35). The effort is
monumental, since in those days, no technological support was available. Before
this, the premium was charged on the basis of British Life Office Mortality table.
Naturally all Indian lives were charged extra premium. This was borrowed by LIC
when it was born in 1956. LIC constructed its own mortality table LIC (61-64)
which was later updated in (70-73) and the latest being in (94-96). These tables are
published documents and can be used by any one. Now the IRDA is planning to
construct a new table with the data made available by all Insurers in the coming
years.

When an Insurer constructs mortality table, 3 types can be constructed as follows

Select Mortality table: Here the Insurer will use or consider those lives which
have entered into his books of recent, say during the last 3 to 4 years and study the
mortality rate pertaining to those lives only. Usually the rate of mortality among
such lives will be lighter in view of the effect of selection.
Ultimate mortality table: Here the Insurer will omit those lives that have come
into his books recently and construct mortality table of the other data.
Aggregate Mortality table: In this no distinction is made as above and the Insurer
will include all the lives in his books and construct a mortality table.
Uses of Mortality table

It is used by the Insurer to determine the premium

It helps to verify the accuracy of assumptions against actual experience
It forms data for future use
Valuation results are compiled from this data
In view of the accuracy of Life Office data, many research organizations make
use of the data.

Construction of Mortality table

A typical mortality table looks as follows

Age No.living No.dying Rate of Mortality Probability of

survival

X lx dx qx px

A mortality table can start at any age. Suppose we consider that the mortality table
starts at age 15,
X means age 15
lx means number living at age 15
dx means number dying before they reach age 16
qx means the chance of one person out of lx dying within one year
px means the probability of one person out of lx surviving till age 16
The relationship among various coloumns can be established as follows

Qx= number dying divided by number living

Dx divided by lx

Px = 1 - qx
Lx +1= lx - dx
Dx = lx x qx

Now let us see how an actuary uses the mortality table to structure the premium
Consider a group of 1 lakh people all aged 20. If as per mortality table, 120 people
die within one year and if the Insurer has agreed to pay Rs.1000/- to each one of
them, then the Insurer should have Rs.120 X 1000= Rs. 1,20,000 with him to meet
the liability. That means each one of 1 lakh people have to contribute Rs.1.20. This
is called as RISK PREMIUM, which can be defined as that premium which is
sufficient to cover risk for one year only.

Now consider another group of 1 lakh people say all aged 30. In this group, the
number of deaths will have to be naturally little more than the earlier age. Suppose
we consider 140 people die within one year. Then this group has to pay Rs.1.40 as
premium to cover risk for one year. This can be called NATURAL PREMIUM.
This is also risk premium but applicable for those aged 30 for a period of one year.

Now consider a situation hypothetically that if we can arrange Life Insurance

contracts to be renewable as General Insurance, then each one have to pay
increased premium every year when we come to renew the contract. After certain
period, we can start thinking of withdrawing from the insurance contract in view of
the increased premium.

It may so happen that the type of people who withdraw from the contract will be
very healthy people who no longer feel the need for insurance cover at increased
rate. That means that when all healthy people withdraw from the contract, only sub
standard people will be left with the Insurer. The mortality rate among such group
will be higher than the standard group and the insurer will not be able to meet the
liability. This system is called ASSESMENTISM and this is not the correct way of
structuring the premium. Hence the Insurer follows a LEVEL PREMIUM system
whereby the insured pays the same premium throughout the term of the contract
depending on age at entry.

This level premium is more than sufficient during the early years of the contract.
The excess premium accumulates with the Insurer as RESERVES. This is a
liability of the Insurer. The Insurer towards the cost of Insurance draws a part of
the reserves at higher ages towards risk coverage. Hence reserves can be defined as
that part of the premium set apart by the Insurer with a view to meet the future
contractual liability.

The reserves cannot be kept idle and hence invested by the Insurer as per the
Investment policy. The interest earned out from the investment goes towards
reducing the level premium to a small extent and this premium is called PURE
PREMIUM. This is also level premium but has taken into account, the interest
earned out of the reserves.
Now the Insurer has to load the pure premium with expenses. Such expenses of the
Insurer are distributed over the entire term of the contract. Pure premium loaded
with expenses will become OFFICE PREMIUM.

Office premium is moderated with a contingent loading to arrive at TABULAR

PREMIUM. This is quoted as per thousand Sum assured. It depends on the Term
and age of the proposer. For each plan of Insurance, the Insurer publishes the
Tabular premium, in his prospectus, manuals and brochures.

REBATES FOR SUM ASSURED AND MODE

The assured has choice of paying premium in 4 modes namely yearly, half yearly,
quarterly and monthly. Premium collection and accounting will cost more if the
mode is more frequent. Hence to encourage, lesser frequency, the Insurer may
allow rebates for yearly and half yearly modes. It depends on how the Insurer has
structured the premium.

Similarly the Insurer may allow rebates on large sum assured, since for the same
cost the Insurer will be receiving higher premium.

Both these rebates are not common for all Insurers. Each one of them follows
different methods. But many Insurers have been allowing such rebates. These are
to taken into account while calculating the installment premium.