Actuarial Science: Life Insurance An Overview
A policy of life insurance is the cheapest and safest mode of making a certain provision for one’s family ~ Benjamin Franklin
What is Life Insurance?
A Life insurance contract is an agreement between a policyholder, the insured and an insurer or assurer, the insurance company, where the insurer promises to pay a sum of money (death benefit) in exchange for a premium, upon the death of the insured person i.e. The policyholder. Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The policyholder typically pays a premium, either regularly or as one lump sum. Other expenses, such as funeral expenses, can also be included in the benefits.
How Life Insurance Works?
The Death benefit is the amount of money the insurance company guarantees to the beneficiaries identified in the policy upon the death of the insured. The insured will choose their desired death benefit amount based on estimated future needs of surviving heirs. The insurance company will determine whether there is an insurable interest and if the insured qualifies for the coverage based on the company’s underwriting requirements.
Premium payments are set using actuarially based statistics. The insurer will determine the cost of insurance (COI) which comprises the amount required to cover mortality costs, administrative fees, and other policy maintenance fees. There are eight factors besides medical history, the insured’s age that influences the premium calculation, some of them are occupational hazards, personal risk propensity, geographical location, education. The insurer will remain obligated to pay the death benefit if premiums are submitted as required. With term policies, the premium amount includes the COI. For permanent or universal policies, the premium amount consists of the COI and a cash value amount.
The policyholder pays a premium for a pre-determined fixed period of time (can continue till the death of the policyholder) in return for a sum of money, known as a death benefit, at the time of death of the policyholder. This is a basic life insurance works.
Similarly, there are health assurance schemes in which policyholder receives a sum of money for the treatment of certain diseases or contraction of a terminal illness.
There are certain basic forms of life insurance. The different types of life insurance policies include
Following are the most common life insurance myths:
- Insurance is for saving tax
Saving tax is just an added advantage of the insurance policy. The main objective of insurance is to provide protection to you and your family and to build an assured corpus for your future needs.
- Insurance will benefit only after my death
Insurance policies provide protection to you and your family. One of the main objectives of taking insurance is to provide a financial cushion to your family in case you are not around but it’s not the only objective. Insurance helps you to build a corpus for yourself; provides you with comfortable retired life and even takes care of your lengthy medical bills.
- My group insurance is adequate
Your group insurance might be adequate but what if you change the job? Once you change the job your group insurance will cancel off and you will not get any insurance benefit. So it is always advisable to take insurance other than the insurance offered by your employer.
- Only the Breadwinner of the family needs insurance
Every family member needs insurance. Your work profile changes the insurance needs but certainly does not eliminate them.
- I’m single and don’t have any dependents, therefore I don’t need any coverage
You might not need a life insurance policy where your nominee is taken care of but you certainly need the policy to take care of your health and retirement worries.
- Life insurance is far more important than health coverage
As the health costs are increasing by the day, taking a health insurance plan has become as important as a life coverage plan. Health plans, disability plans, and critical illness plans provide you with financial cushion and compensate for the financial loss you suffer in case you are not able to work because of illness.
What does life insurance mean for Actuaries and insurance companies?
The law underlying life insurance contracts is the law of large numbers. The basic principle in insurance is that the company ensures a diverse group of individuals and the probability of having to pay death benefit early for an insurer is low in that large group.
Policies are designed by actuaries. They estimate the mortality rate of the insured and calculate the appropriate gross premium to be charged. Profit- tests are run to decide an appropriate premium.
Actuaries also calculate reserves to be held by insurance companies to avoid financial problems at the time of payment of death benefits. In life insurance plans, actuaries take note of details like the premium structure, death benefit structure i.e. whether it is paid in the form of an annuity or lump-sum amount after the death of the insured. The premium that is collected is invested in securities to earn income for survival. Since there is no certainty of the time of death, market conditions, certain assumptions are used called experience basis, assumption basis. A way of looking at it is, they put a price on the death and time of death of an individual using basis and probability. There are in a position to do so because they have more information on mortality statistics than an individual.
There are many public and private insurance companies offering various plans with a detailed overview of their policy, which are readily available on their websites. One can also calculate the premium amount for different policies after specifying the requirements like the sum assured, age, term of the policy, premium payment frequency. These help in making smart decisions.