Thursday, 1 July 2010

Life Insurance Basic Principles (Part VI) - Determining Life Insurance Premiums

The Basic Principles of Life Insurance (Part VI)

Determining Life Insurance Premium

Mortality tables list different rates for men and women of different ages. The rate per $1,000 of benefit for women aged 35 is $1.65 in the 1980 Commissioners Standard Ordinary (CSO) table. The companies that issue policies to only the healthiest applicants will have rates significantly lower than those in the CSO tables. Even insurance companies issuing policies to applicants in average health usually offer rates lower than those listed in the CSO tables.

We will first examine how the premium for a yearly renewable term (YRT) insurance policy is calculated to demonstrate how the tables are used.

YRT is the simplest form of insurance offered by life insurance companies. It provides insurance for a period of one year and allows the policyowner to renew the policy for successive periods of one year each, paying just the mortality charges and administrative expenses for one year at a time, and no more. The interest component is minimal.

The mortality charge for YRT insurance is determined by the death rate for the attained age of the individual involved. Each premium purchases only one year of insurance protection. Each group of policy owners of a given age is considered to be a separate class for premium purposes; each group must pay its own death claims, the burden shared equally by the members of the group. Because the death rate increases with age, the premium for yearly renewable term insurance normally increases each year.

Because premiums are paid to the life insurance company in advance, the cost of the anticipated death claims would be distributed pro rata over the 100,000 policy owners, and a premium of $1.16 would be obtained from each policyowner. Note that:

• the premium is precisely the same as the death rate applicable to those insured

• those policyowners who, according to the mortality projection, will die during the year, contribute on the same basis as those who will survive

Each policyowner pays a share of his or her own death claim. This is a principle that underlies all life insurance contracts. The proportion, however, varies with the type of contract, age at issue, and duration of the protection.

If the 99,884 survivors of the original group of 100,000 policy owners were insured for another year, they would be exposed to the death rate for persons aged 26, or 1.19 per 1,000, which would theoretically produce 119 deaths and claims totaling $119,000. That sum, divided equally among the 99,884 participants would yield a share, or premium, of $1.19 per person. If the 99,765 women who survived the first and second year should desire insurance for another year, provision would be made for $122,000 in death claims, requiring a premium of $1.22 per person.

For the first several years, the premium would continue to increase slowly, being $1.35 at age 30, $1.65 at age 35, and $2.42 at age 40.

However, the premium would rise sharply thereafter, reaching $3.56 at age 45, $4.96 at 50, $7.09 at 55, $9.47 at 60, and $14.59 at 65. If the insurance should be continued beyond age 65, the cost would soon become prohibitive, soaring to $22.11 per $1,000 at age 70, $38.24 at 75, $65.99 at 80, and $116.10 at 85. The premium at 90 would be $190.75 per $1,000; at 95, $317.32. Finally, if a woman aged 99 should want $1,000 of insurance on the YRT basis, she would have to pay a premium of $1,000, since the 1980 CSO table assumes that the limit of life is 100 years and that a person aged 99 will die within the year (or at least the policy period will end).

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