2.insurance risk management

7/31/2019 2.Insurance Risk Management

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2. INSURANCE CONTRACTSInsurance and Risk Management

INSURANCE is like SAND when it is

bought and GOLD when it is realized


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Elements Of Valid Contract

Sec (10) of the Indian Contract Act, 1872:

GENERAL:

Offer: There must be an offer

Acceptance: Offer must be accepted

Consideration:

Consensus ad idem: Parties must concur on identity

Object: must me legal, not opposed to public policy.


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SPECIAL: Utmost good faith: There should not be concealment of

material facts.

Indemnity: No profit out of insurance, insured to be placedin same position before loss.

Subrogation: Any recovery from TP should go to insurer andnot the insured.

Contribution: Double insurance will result in sharing oflosses among insurers (gen insurance)

Insurable Interest: must have legal interest in the property.

Proximate cause:


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Is Insurance A contract?

Offer and Acceptance

Legal consideration

Parties competent to contract Free consent

Legal object


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PRINCIPLES OF INSURANCE

Principles of utmost good faith

Principles of Insurable interest

Principles of proximate cause Principles of indemnity

Principles of subrogation

Principles of contribution


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Unilateral contract

A contract in which only one party makes an

express promise, or undertakes a performance

without first securing a reciprocal agreement

from the other party.


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Premium

Premium = Expected cost of benefit payment

+ Profit + expenses.

For ex: No. of persons= 10000; Age = 25 years;

Sum assured = Rs 10000; Mortality table =

0.0011 for 25 year aged persons;

How much is the premium?

11 persons will die out of 10000 persons;

11x10000=110000;


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Premium = 110000/10000 = Rs.11

This premium arrived after mortaility table

calculation is called PURE premium or

Natural premium


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Example

Term Insurance for 5 years;

Mortality rate increases So Premium also increases. Itis called as STEPPED PREMIUM arrangement

Age (x) No.of persons

living at age X and

share claims (Ix)

No. of claims by

death ( probability)

(Dx)1

Pure / Natural

premium = S.Ax

(Dx)/(Ix)

25 10000 11 11.00

26 9989 15 15.02

27 9974 20 20.05

28 9954 25 25.11

29 9929 29 29.21


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Level Annual premium

Equal for all years


living at age X and

share claims (Ix)

No. of claims by

death ( probability)

(Dx)1

Cost of benefit

payment

25 10000 11 110000

26 9989 15 150000

27 9974 20 200000

28 9954 25 250000

29 9929 29 290000

Total cost 1000000


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0

5

10

15

20

25

30

35

Category 1 Category 2 Category 3 Category 4 Category 5

Stepped

Level


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Net premium Calculation

Taking interest factor into consideration.

Present values

For example : interest factor is 6% Sum assured and premiums should be

converted into present values.


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For Example

P.v of cost of benefit payment is 819925


living at age X

and share

claims (Ix)

No. of claims

by death (

probability)

(Dx)1

Cost of benefit

payment

P.V of benefit

payment

25 10000 11 110000 103774

26 9989 15 150000 133500

27 9974 20 200000 167424

28 9954 25 250000 19802229 9929 29 290000 216705

Total cost 1000000 819925


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living at age X and

share claims (Ix)

PV @ 6% PV of Rs.1 of each

surviving policy

holder

25 10000 1.0000 10000

26 9989 0.9434 9423.62

27 9974 0.89 8876.86

28 9954 0.83962 8357.58

29 9929 0.79209 7864.66

Total benefit 44522.72


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Level premium after considering Interest

factor = PV of cost of benefit payment/PV of

Benefit

= 819925 / 44522.72

=18.42;

Lower than pure premium.


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Valuation And Distribution Of Bonus

Surplus: Is generated from favorable experience that areanticipated on the parameters of ,.

--Mortality

--Interest earned and expenses incurred.-- Different methods are used for fair distribution of surplus.

Life insurance policies can be classified into

Nonparticipating or Participating.


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Sources of Surplus

Net premiums = Claims + loading interest

earned.

A life insurance can derive surplus from three

principle sources:

A higher return on investments than the rate assumed for

premium and reserve computations.

Lower death rate than indicated by mortality table A saving in the loading expenses because total expenses are

less than total loadings.


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Approaches to distribution Of Surplus

Increase In benefits approach

Revalorization method

Contribution method


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Issues considered Before Distribution

of BONUS

Deferring the distribution of surplus

Meeting policy holders reasonable

expectations

Equity between generations and categories

Future business plans, investment strategy

and solvency.


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Increase in Benefits Approach

Regular reversionary bonuses, addedthroughout the term of contract.

(Simple reversionary bonus method, Compound

reversionary bonus method, Super compoundreversionary bonus)

A special reversionary bonus, added as a oneoff from time to time.

A terminal bonus, paid when the contractexits from the books of insurer due to deathmaturity or surrender.


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Revalorization Method

means To change the valuation of (assets)

The benefit under the contract and the

premium payable by the policy holder are

then increased by the same amount.

Usually surplus from the interest component

only will be distributed to the policy holder.

The mortality profit might be retained by the

company for distribution to shareholders.


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The interest component surplus for a

particular policy can be represented as:

( i i) t+1 V

i is the interest earned on assets

i is the expected rate on the assets

t+1 V represents the reserve at the end of theyear.


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Advantages

It is simple in approach

This system predefines the method of

distribution of surplus or profit.

Protects policy holders from ungenerous life

insurance companies


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Disadvantages

No discretion for the company for distribution

of surplus.

There is little scope for companies to invest in

risky assets.


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Contribution method

The bonus is declared in proportion to

contribution made by the policy to the

surplus.

The common term for bonus in this method is

dividend.

Dividend = Interest contribution + mortality

profit contribution + expenses contribution


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Three ways of paying dividend in this method:

Cash dividend

Dividend in reduction of premium Increase in benefits of the policy.

2.insurance risk management

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