The meaning of the words premium and bonus and surplus in life insurance. The significance of probability and mortality tables. How these are calculated. The rationale for the determination of all these. How these are different from price and profits in mercantile practice. The importance of life fund and actuarial valuation.
#What Is Insurance Premium
In a contract of insurance, the insurer promises to pay to the policyholder a specified sum of money, in the event of a specified happening. The policyholder has to pay a specified amount to the insurer, in consideration of this promise. Premium is the name given to this consideration that the policyholder has to pay in order to secure the benefits offered by the insurance contract.
It can be a onetime payment. That is not common. Often, it has to be paid regularly over a period of time. A default in premium can endanger the continuance of the policy. If that happens, the policy will be treated as lapsed and the expected benefits may not be available. The consequences of default are specified in the policy conditions.
The calculation of premium is a complex technical process, involving actuarial and statistical principles. Only trained professionals, called actuaries, do it. Tables of premium rates for each plan of insurance are made available by insurance companies for the use of agents, who are required to quote the premium for a particular policy being offered to a prospect. This insurance blog meant to make agents aware of the rationale behind the premium calculations.
#Risk Net And Pure Premium
→Examples were given to show how insurance works. The figure of Rs. 200 mentioned in Example 2 would be the cost of covering the risk of death of persons at age 50 for one year. This cost is for sum assured (SA) of Rs. 20000. This premium can also be expresses as Rs. 10 per thousand or 1% of SA. Such cost, to meet the risk of death for one year at a particular age, is called the risk premium.
→The risk calculated on the basis of an expectation as to how many persons are likely to die within a year in an age group. This expectation, regarding the number of persons likely to die within a year, at each age, is calculated by actuaries on the basis of past experience and made available as Mortality tables. Mortality tables prepared for use of insurance offices, contain data relating to such probabilities. If the mortality table shows that X% is the probability of death within one year for any age, (100-x)% persons are likely to be living at the end of one year, when they would all be one year older.
→This is a probability and not a certainty. It does not mean that x% will die. It means that over a long period of time, if large numbers of people at that age are observed, nearly x% may be dying within a year. Mortality studies, reflecting the experience of Indians, are made by the Mortality and Morbidity Investigation bureau (MMIB) set up jointly by the life insurance council and the actuarial society of India, to help insurers.
→The market risk premium would be adequate to pay the claims that would arise, if all the policies provided benefits only in the event of death within one year. Such policy is called term insurance policy. This premium will not be adequate for policy which provide also for amounts payable on the person surviving for some years, policy providing for benefits on survival, are called endowment policy, the actual premium collected in such policy would have to be more than the number of persons who may survive the specified periods of terms.
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