Unique Characteristics of Life Insurance

1. Unique Characteristics of Life Insurance • 1. The event insured is an eventual certainty and the probability of loss increases from year to year. • 2. Life insurance does not violate requisites of an insurable risk; it is not the possibility of death that is insured, but of untimely death. • 3. There is no possibility of partial loss. Therefore all policies are cash payment policies.

2. Types of Life Insurance • Term Insurance Cash Value InsurancePure Protection Insurance and Savings • Term Insurance Whole Life Insurance • Endowment Insurance • Universal Life Insurance • Adjustable Life Insurance • Variable Life Insurance

3. Rationale for Different Forms • 1. Simplest form of life insurance is yearly renewable term. • Provides coverage for one year only • Permits insured to renew for successive years at higher premium • Increasing mortality produces increasing rates as the insured grows older

4. Rationale for Different Forms • 2. Premium eventually becomes unaffordable for person who wants to continue coverage: • age 21 $1.07 • age 30 1.35 • age 40 2.42 • age 50 4.96 • age 60 9.47 • age 70 22.11 • age 80 65.99 • age 90 190.75 • 3. Insurers developed the principle of the level premium as a practical method of providing lifetime insurance.

5. Comparison of Term & Whole Life Premiums $1,000 Increasing term premium Level premium

6. Increase in Reserve on Whole Life Policy $1,000 Decreasing Amount of Protection Increasing Saving Element Insured’s Age 100

7. Tax Treatment of Life Insurance • Life insurance policies are granted favorable tax treatment in two ways: • 1. Amounts payable to beneficiary at the death of the insured are not generally included in taxable income. • 2. Income earned on the cash surrender value is not taxed until the policy is terminated and the gain is received. • 3. Further, the cost of life insurance is deductible as part of the basis in computing taxable gain.

8. Tax Treatment of Life Insurance • Favorable tax treatment is allowed only for contracts that meet the Internal Revenue Code definition of Life Insurance. • 1. Internal Revenue Code establishes two tests to determine if a contract is “life insurance.” • 2. If the contract fails to meet one of the two tests, earnings on the cash surrender value are currently taxable to the insured.

9. Current Life Insurance Products • Term Insurance • 1. Renewable term: guarantees the insured the right to continue coverage for a number of additional periods. • 2. Convertible term: guarantees the insured the right to exchange the policy for some type of permanent insurance. • 3. Advantages and disadvantages of term: • provides greatest amount of protection for given dollar outlay • temporary protection only

10. Current Life Insurance Products • Whole Life • 1. Straight whole life provides protection for insured’s entire lifetime (until age 100) with premiums payable for lifetime. • 2. Limited-pay whole life provides protection for entire lifetime (until age 100) with (higher) premiums payable for a shorter time.

11. Current Life Insurance Products • Universal Life • 1. Introduced in 1979 by subsidiary of stock brokerage firm, E.F. Hutton. • 2. Subject to specified limitations, premium, cash value, and level of protection can be adjusted up or down to meet insured’s needs. • 3. Premiums are credited to a fund, which is credited with policy’s share of investment earnings. • 4. Fund provides source of funds to pay cost of pure protection (term) under the policy.

12. Current Life Insurance Products • Variable Life Insurance • 1. A whole life contract in which insured has the right to direct how cash value will be invested. • 2. Insured bears the investment risk in the form of fluctuations in cash value and amount of protection. • 3. Amount of premium is fixed, but cash value and face amount vary, subject to a minimum.

13. Current Life Insurance Products • Adjustable Life Insurance • 1. Allows the buyer to adjust face amount of the policy and premium over time. • 2. Relationship between premium and amount of protection determine the cash value. • 3. Based on this relationship, an adjustable life policy may be term or whole life. • 4. When premiums paid exceed the cost of protection, the cash value increases. • 5. When cost of protection exceeds premium, cash value or face amount decreases.

14. Current Life Insurance Products • Endowment Life Insurance • 1. Endowment contracts no longer meet the Internal Revenue Code definition of life insurance. • 2. Endowment policies are issued for a term period such as 10 or 20 years. • 3. Endowment policies promise to pay face amount if the insured dies during the policy period and also to pay the face amount if the insured survives the policy period.

15. Participating & Non-Participating Life Insurance • 1. Participating policies pay dividends • 2. Originally issued only by mutual insurers • 3. Dividend varies from margin built into premium

16. General Classifications of Life Insurance • 1. Ordinary life - 60.6% of insurance in force • 2. Industrial - less than 1% (0.2%) today, compared with 10% at one time • 3. Group life - 37.5% of life insurance in force. • 4. Credit life insurance - about 1.8% • Total life insurance in force exceeds $13 trillion

17. Life Insurance Premium Computation • 1. Mortality - 1980 CSO Table (separate tables for male/female) • 2. Interest - time value of money • 3. Loading - for insurer expenses, taxes, profit

18. Commissioners 1980 Standard Ordinary Mortality Table Males Females Deaths Life Deaths Life Age Per 1000 Expectancy Per 1000 Expectancy 30 1.73 43.24 1.35 47.65 31 1.78 42.31 1.40 46.71 32 1.83 40.46 1.45 45.78 33 1.91 39.54 1.50 44.84 34 2.00 38.61 1.58 43.91

19. One Year Term Policy • Alive at age 21 9,810,509 • Number who will die: 10,497 • 1 year term policy without interest: • $10,497,000 9,810,509 = $1.07 • 1 year term policy with interest • $10,497,780 X 0.956994 9,810,509 = $1.02

20. Annual Term for Five Years • Age 21$10,497,780 X 0.956994= $1.02 9,810,509 • Age 22$10,682,000 X 0.95694= $1.04 9,800,012 • Age 23$10,866,000 X 0.95694= $1.06 9,789,330 • Age 24$11,147,000 X 0.95694= $1.09 9,778,464 • Age 25$11,330,000 X 0.95694= $1.11 9,767,317

21. Net Single Premium: 5 Year Term Policy • Amount Present ValueYear Deaths of Claims Discount of Claims • 1 10,497 $10,497,000 0.95694 $10,044,999 • 2 10,682 10,682,000 0.91573 9,781,828 • 3 10,866 10,866,000 0.87630 9,521,876 • 4 11,147 11,147,000 0.83856 9,347,428 • 5 11,330 11,330,000 0.80245 9,091,890 • $47,787,890 • 5 year term net single premium • $47,787,890 9,810,509 = $4.8710

22. Net Single Premium: 5-Year Annuity Due • Present Number Value Age Alive Claims Discount of Claims • 21 9,810,509 $1 due now $1.000 $9,810,509 • 22 9,800,012 $1 due in 1 year 0.95699 9,378,023 • 23 9,789,330 $1 due in 2 years 0.91573 8,694,383 • 24 9,778,464 $1 due in 3 years 0.87630 8,568,868 • 25 9,767,317 $1 due in 4 years 0.83856 8,190,481 • $44,912,264 • 5-year annuity due premium • $44,912,264 9,810,509 = $4.5779

23. Net Single Premium: Whole Life Policy • Amount Present ValueAge Deaths of Claims Discount of Claims • 21 10,497 $10,497,000 0.95694 $10,044,999 • 22 10,682 10,682,000 0.91573 9,781,828 • 23 10,866 10,866,000 0.87630 9,521,876 • ** ***** ****** ***** ***** • 99 30,698 30,698,000 0.03087 947,647 • $1,052,972,752 • Whole Life net single premium • $1,052,972,752 9,810,509 = $107.33

24. Net Level Premium Conversion • $4.5779 is the actuarial equivalent of $1 now and a $1 payment every year for 4 years • Therefore, $4.5779 : $4.8710 = $1 : X • X = $1.064

25. Reserve on Life Insurance Policies • Present Value Present ValueRESERVE = of Future __ of Future Benefits Premiums

26. $1000 Net Single Premium 20-pay life 30-pay life $ 108 Paid-up at 65 Whole life 0 25 35 45 55 65 75 85 95 100

27. Benefit Certain Contracts • Benefit Certain Contracts are those under which, if the insured persists in premium payments, the policy will eventually mature and benefits will be payable. • 1. Cash value policies, under which benefits are payable whether the insured lives or dies are benefit certain contracts. • 2. Ignoring the interest on premiums paid, the net single premium on benefit certain policies equals the face of the policy.

28. Benefit Uncertain Contracts • Benefit uncertain contracts are those under which, if the insured persists in premium payments for the entire policy period, the insurer may or may not be obligated to make payment.