Risk Management & Insurance Chapter -5- Life & Health Insurance Policies

CHAPTER FIVE

LIFE AND HEALTH INSURANCE POLICIES

5.1. LIFE INSURANCE

Life insurance is financial tools that can help individuals accomplish a variety of financial goals. The

most common use of life insurance is to provide for dependent family members in case of premature

death.

The main purpose of life insurance is financial protection, i.e., to provide dependents of the insured

with financial compensation amounting to the sum assured if the insured faces premature death

while the policy is in force. The sum assured is, then, used by the widow (widower) to bring up the

family. The insurance money, therefore, supplements the family income; it gives the family financial

security for a certain period. This is the case, particularly, in whole life, term and endowment

insurance policies.

A person may also purchase life insurance with other objectives in mind. For example, a person may

buy life insurance policy to cover personal loans and other debts. If he dies before settling his debt,

the insurer will pay the outstanding amount to the creditors. The family of the insured and the

creditors will then be protected from loss of money. In other situation, a person may buy life

insurance policy to accumulate an educational fund that could be used to pay tuition fees for

children when they join higher education.

Life Insurance are engaged in selling protection and encourage saving. This protection is against

financial difficulty and is acquired for a consideration called a premium. The premium is the price

that keeps the policy in force. Normally Insurers charge level premiums, i.e., the same amount of

premium paid annually throughout the term of the contract. The protection given by the insurer is

death benefits to the beneficiary of the insured, or in the case of survival of the insured, other

financial benefits in accordance with the policy contract.

The following points are worth considering in life insurance covering death of the insured:

(A) The benefit is determined in advance. The insured decides for him the amount of insurance

protection he needs. The insurer will then decide on the reasonableness of the amount of coverage

and sets the corresponding premium.

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(B) The amount of money required to pay the death benefits in a given period are to be collected in

advance so that there should not be shortage of funds to pay claims as they occur.

(C) Each insured in the group must be charged an appropriate premium, which reflects the amount

of risk he brings to the group. In other words, losses are to be distributed among the group of

insured in an equitable manner.

(D) The probability of claim increases with the passage of time since insured exhibit deteriorating

health condition, as they grow old.

(E) Another aspect in life insurance is that the insured and the policy owner may be different. For

example, an individual may insure the life of another person. This happens when the proposer

have a financial interest (insurable interest) in the proposed insured’s death or survival.

Consequently, a creditor may apply for an insurance policy on the life of the loans he made to the

debtor. Similarly, an employer may purchase a noncontributory group life insurance for his

employees. The employer becomes the policy owner, and the employees become the insured.

5.2. BASIC TYPES OF LIFE INSURANCE CONTRACTS

There are Three types of basic life insurance contracts offered by Ethiopian Insurance Corp.

1. Whole Life Insurance 2. Term Insurance 3. Endowment Insurance

- Straight Life - Level Term Insurance
- Limited –pay - Convertible
- Single- pay - Nonconvertible
- Renewable Term
- Decreasing Term

1. WHOLE LIFE INSURANCE

Whole life is a type of life insurance contract that provides insurance coverage of the contract holder

for his or her entire life. Upon the inevitable death of the contract holder, the insurance payout is

made to the contract’s beneficiaries. These policies also include a savings component, which

accumulates a cash value. This cash value is one of the key elements of whole life insurance.

This policy provides protection to the dependents of the insured upon the event of his death i.e., the

sum assured is payable only upon the death of the insured.

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One option is that the insured pays annual premiums as long as he lives. The second option is that

premiums are made for a specified number of years or up to a certain age limit normally up to the

age of retirement. Premium payment after retirement is discontinued because of a decline in the

income of the assured. The policy provides permanent protection to the insured’s departments in the

case of death. Besides this protection, whole life insurance allows for the accumulation of savings

over the life of the insured. In essence, the policy encourages saving.

Whole life policy acquires Cash Value after two or three years of premium payment. The Cash Value

gradually grows to equal the sum assured upon maturity or at the time insured attains age 100.

If the insured, for some reasons, discontinues premium payment after the policy accumulates Cash

Value, then the Cash Value can be used to keep the policy in force under the Automatic Premium

Loan provision (to be discussed later). Moreover, the insured can apply for loans when the policy

acquires cash value.

Depending on the manner of premium payment, Whole Life Insurance contracts are classified as:

Straight Life, Limited- pay and Single-pay policies.

Straight Life Insurance

It is also called Ordinary Life Insurance. Under this policy premiums are to be paid at regular

interval until the death of the insured or until the achievement of a specified age limit, 100 years. It

gives permanent protection at the lower cost.

Limited-Pay Life Insurance

Under this insurance scheme, premiums are paid for a definite period of time, which is determined

in advance. That is for 10, 15, 20, 25, 30 years or up to age 65. After the expiration of the specified

time, the policy is said to be paid-up, which means that no more premiums are to be paid to keep the

policy is in force until the time of death of the assured at which time compensation amounting the

face value of the initial policy is to be made to the assureds beneficiary. This policy is desirable when

one intends to stop premium payments after reaching a given age level, usually upon retirement, but

wants to continue with the insurance protection till the end of his life. Since premiums are to be paid

for a limited period, they are usually higher than those under the straight life insurance. Similarly,

the Cash Values under the limited- pay whole life policy are higher than that of the straight-line

policy.
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Single Payment Life Insurance

Here premium payment is made in one lump- sum at the time of purchase of the whole life

insurance. In most cases, insurance buyers do not prefer this type of arrangement (mode of

payment).

2. TERM INSURANCE

This insurance scheme provides compensation (death benefit) to the beneficiary if the insured

person dies within the stated period mentioned in the policy. If the insured survives beyond the

specified time limit in the policy, the policy will expire and there will not be any payment made by

the insurer. Term policy gives only temporary protection and there is no saving element involved.

Since the policy is taken for a specified period to deal with premature death, the cost of this policy is

relatively low. It is a form of temporary life insurance.

Term policies do not provide the insured with loans, cash surrender or non-forfeiture options.

Insurance coverage terminates at the end of the period unless it provides an option for conversion

into other insurance schemes.

The EIC currently issues 10-year term, 15-year term and 20-year term policies to individuals; 1-year

term policies in the case of Group Mortgage protection Insurance.

Term policies can be single premium policy or Level Promotion Policy Single Premium Policy is

policy, which requires the payment of the entire premium in a lump sum at the time the term policy

is issued level premium policy requires the payment of an equal amount of premiums at definite

intervals. In the case of the EIC, Single Premium policies are very rare. Most of the term policies are

level premium. More appropriately, term contracts can be classified as: level term, renewable term

or decreasing term.

1. Level Term Policy

Level term policy provides a constant sum assured throughout the term of the policy. For example,

under a 15-year term policy of Birr 30,000, the amount of payment to the insured will be Birr 30,000

if the insured dies at any time during the policy period. Level Term policies can be convertible or

nonconvertible.

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A. Convertible Term Policy

Convertible Term Policy is a term policy that gives the policyholder the option to convert his term

policy into the other types during the tenure of the term policy. No new evidence of insurability

(medical certificate, etc…) is required upon conversion. If conversion is not made, the policy lapses

at the end of the term. The term contract can be converted into whole life of endowment insurance.

Conversion may be effected using either the attained age at the time of conversion of the term policy

or using the date of the initial term policy issued. In the case of the latter premiums are calculated

retroactively, and the insured would be required to make up the difference in premiums, including

interest, through lump-sum payment at the time of conversion.

To eliminate anti-selection problem, the following requirements are to be met upon conversion.

1. There will not an increase in the sum assured.

2. The option will have to be exercised with in a specified period. In the case of the EIC the time

periods are given as follows:

- 10-year policies, during the first seven years.

- 15-year policies, during the first 10 years.

- 20-year policies, during the first 15 years.

B. Nonconvertible Term Policy

Under this scheme, the term policy cannot be converted into other forms of life insurance contract.

The policy terminates upon maturity. However, it could be renewed.

2. Renewable Term Policy

This is a term policy, which can be renewed upon expiration. No new evidence of insurability is

required, but the premium charges are adjusted to reflect the standard premium at the attained age.

Accordingly, yearly renewable term policies require renewable every year. Similarly, a 5-year term

policy may be renewed upon its maturity. In most cases, group policies fall under this category.

3. Decreasing Term Policy

In a Decreasing Term Policy, the sum assured (amount of claims to be paid to the insured) decreases

periodically (monthly, quarterly, semi-annually, yearly, etc…).

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These policies are usually, issued to cover the outstanding claims (debts) of a creditor (debtor) in the

event of accidental death of the debtor. The outstanding claims (debts) diminish periodically as

installment payments are made by the debtor at regular intervals.

These types of policies provide financial protection to the policy holder (creditor) and to the family

(dependents) of the debtor. The dependents of the Insured are saved from raising funds or selling

certain property in order to pay the outstanding loans.

3. ENDOWMENT INSURANCE

This policy pays face amount of insurance if the insured dies with in a specified period; if the

insured survives to the end of endowment period, the amount is paid to the policy owner at that

time.

This policy provides payment if the insured manages to live till the end of the endowment period

specified in the policy, or upon his death at any time during the term of the policy whichever occurs

first. The period of this policy is shorter then that for Whole Life Insurance, and hence the premiums

are higher for the same age level. The shorter the endowment period, the higher the premium.

The insured can surrender the policy at any time and collect the cash value in a lump sum. The cash

value normally becomes positive after two or three years. The policy, therefore, has dual purpose –

protection against a peril and permitting savings. It is a powerful means of accumulating funds for

possible contingencies in the future with an added advantage of covering the beneficiaries against

risk of death of the insured. In fact, the giving element is considered more important.

Another advantage is that the policy provides the insured with loan facility after the policy-acquired

cash value. The insured can have the option of returning the loan to the insurer or retain it, in which

case the loan including the interest is to be deducted from the final settlement upon the termination

of the policy. If, for some reasons, the insured discontinues payment of premiums, the cash value

can be used to keep the policy in force under the automatic premium loan provision provided the

insured agreed to the effect of this provision at the time of policy purchase.

Currently, the EIC issues 10-year, 20-year, 25-year and 30-year endowment policies. The other

arrangements are endowment at age 55, at age 60 and at age 65.

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ENDOWMENT ANNUITY

This is a policy that provides retirement income to the holder. It also incorporates protection during

the term of the policy up to the age of retirement. However, the annuity feature is given more

emphasis. EIC currently issues such a policy to a retirement age of 55, 60 or 65.

Specifically, the policy provides the following benefits to the holder:

1. Monthly income of Birr 10 for each Birr 1000 of the face amount for the remaining life of the

holder, after maturity, with the guarantee that 120 monthly payments be made even if the

holder dies within that period; or

2. Instead of monthly payment, a single cash payment equal to the maturity proceeds, or a

combination of paid-up Whole Life insurance and cash payment.

Upon maturity, the Cash Value of Endowment Annuity is larger than the Sum Assured. Normally,

after a certain point of premium payment, but before maturity time, the Cash Value will exceed the

Sum Assured, Consequently, if the insured dies at or after this point, the amount of death benefit

payable to his beneficiary with be the Cash Value.

Another aspect of this policy is that premiums on policies, issued to female insured are higher than

those premiums for male insured’s. This is because the Corporation expects to make annuity

payments to female insured’s relatively for a longer period as females are generally expected to live

longer than do males.

5.3. PREMIUM DETEMINATION

A difference must be made between the following types of premiums:

Net Premium

This is a premium rate determined on the basis of mortality rate and interest rate only. It does not

include the operating costs charged by the insurer. Net premium provides the insurer only with the

amount of money required to pay death claims.

Net Single Premium

When the total net premiums of an insurance policy are to be paid as a single sum at the beginning

of the contract, it is called the Net Single Premium.

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Net Level Premium

This is a premium charge that does not change from year to year throughout the term of the policy.

In other words, the policyholder pays the same amount of premium each year.

Gross Premium

When a portion of all the insurer’s costs of running the business are added to the Net Premium, the

resultant premium is called the Gross Premium. The Gross Premium is the amount the policyholder

pays to the insurer to keep the policy in force. In insurance terminology, the addition of the insurer’s

costs of doing business to the Net Premium is called Loading. These costs include operating

expenses, commissions, advertisement expenses etc.

Net Single Premium

The following information is required to determine the net single premium.

- Age and sex of insured’s.

- Mortality rate.

- Interest rate.

- Amount of insurance policy.

The following example will provide the basic insight as to the techniques employed in premium

determination. According to the 1980 Commissioners Standard Ordinary (CSO) mortality table, out

of an initial population size of 1,000,000 male people 958,000 live at age 30. The number of people

expected to die at the age is 1,657. This means that the probability that a person aged 30 will die

during that age will be 0.00173, (1657/958000).

Assume that an Insurer issued one-year Term Insurance to all these male individuals aged 30

(958,000 policies) for death benefit of Birr 5,000 each. Assume also that the premium is to be collected

at the beginning of the policy issue, and the death benefit (policy amount) is to be paid at the end of

the year. Also assume that the interest rate is 10%. Each the insured persons are assumed to bring

the same level of risk to the group. The number of policyholders at age 30 is 958,000. The number of

expected deaths at age 30 is 1,657. Accordingly, expected amount of death benefits becomes Birr

8,285,000, (1657*5000). This is the amount that the insurer expects to pay for death claims at the end

of the year, i.e. upon maturity of the Term Policy.

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The cash needed for payment of death claims is obtained through the collection of premiums from

the insured’s. The insurer, however, will not collect Birr 8285000 from the insured through equal

distribution because the premiums collected at the beginning will have to be invested at 10% to

bring interest. Consequently, it is necessary to find the present value of Birr 8285000. The present

value of this sum is then Birr 7531818.18, (8285000/1.10). This present value is, therefore, the amount

that should be collected from the insured at the beginning of the policy. In other words, this is, then,

divided by the number of insured to arrive at the NET SINGLE PREMIUM.

NET SINGLE PREIMUM = 7531818.18/958000 = Birr 7.862

Every Insured will have to pay Birr 7.862 Net Single Premium (NSP) at the beginning of the Term

policy. The Insurer will, then, collect a total of Birr 7,531,818.18 which will grow to Birr 828,500 in

one year time at 10%. This amount will be sufficient to pay the expected death claims at the end of

the year.

TERM INSURANCE

With the above example as a background, let us try to determine the Net Single Premium for a Term

policy. Consider the following information:

- 3- Year term policy for Birr 5,000 to be issued at the beginning of the year.

- Number of policy holders at age 30 is 958,000

- Interest rate is 10%

- Single premium payment at the beginning of the year.

- Death claims to be paid at the end of the year in which the incident occurred.

- CSO, 1980 mortality rate.

CSO MORTALITY RATE, MALE, 1980

Year Age Number Living Number Dying Probability of Dying

1 30 958,000 1,657 0.00173

2 31 956,343 1,702 0.00171

3 32 954,640 1,747 0.00183

Expected death claims in each of the years during the term of the policy are shown in the table

below. The Insurer expects to pay death claims of Birr 828500 in the first year, Birr 85100000 in the

second year, etc.

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Risk Management & Insurance Chapter -5- Life & Health Insurance Policies

Year Age Number Dying Amount of policy Expected Death Claim

1 30 1,657 5,000 8,285,000

2 31 1,702 5,000 8,510,000

3 32 1,747 5,000 8,735,000

Total Expected Death Claims 2,553,0000

Each year’s expected death claim is discounted at interest rate (10%) to arrive at the present value of

total claims. This present value is then divided by the number of insured to determine the net single

premium. The analysis is shown below.

1 2 3 4 = (2*3) 5 6 = (4/5)

Year Death Claims PV Factor at 10% PV of Claims No. of Insured Annual Net Premium

1 8,285,000 0.9091 7,531,893.5 958,000 7.862

2 8,510,000 0.8264 7,032,664 958,000 7.341

3 8,735,000 0.7513 6,562,605.5 958,000 6.850

25,530,000 21,127,163 22.053

The Net Single Premium is Birr 22.053. It can also determine by dividing the total present value of

death claims by the number of Insured.

NSP = 21,127,163/958,000 = 22.053

Each Insured will be required to pay a Net Single Premium of Birr 22.053 at the beginning of the

policy. This premium will enable the insurer to meet the expected death claims that occur in each

year as shown on the table below.

1 2 3 4 = (2 + 3) 5 6

Yr Beginning Bal Interest at 10% B.B + Interest Death Claims End Bal

1 21126774* 2,112,677.40 23,239,451.40 828,5000 14,954,451.4

2 14954451.40 1,495,445.14 16,449,896.54 8,510,000 7,939,896.54

3 7939896.54 793,989.66 8,733,886.20 8,735,000 -1113.80*

* Number of insured multiplied by Net Single Premium.

** Difference due to rounding.

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Risk Management & Insurance Chapter -5- Life & Health Insurance Policies
ACTURIAL NOTATIONS: -

T= time (years)

X= age

Lx = number of people living during age x.

(Lx – Lx +1) = dx = number of people dying during age x.

(Dx/Lx) = px = probability of dying during age x.

(Lx+1/Lx) = qx = Probability that an individual at age x.

Survives age x.

EXAMPLE

1980 CSO MORTALITY TABLE, MALE

Year Age Number Living Number Dying Dx/Lx Lx+1/Lx

t x Lx Dx = px = qx Px + qx
1 60 808592 13002 0.01608 0.98392 1
2 61 795590 13954 0.01754 0.98246 1
3 62 781636 15000 0.01919 0.98081 1
4 63 766636 16145 0.02106 0.97894 1
5 64 750491 17367 0.02106 0.97686 1
6 65 733124
The probability that a person aged 60 dies during age 60 is 0.01608. The probability that this

individual survives age 60 is, then, 0.98392, (1-0.01608).

Consider the 3- year Term Insurance discussed earlier. The following notations are used:

T = policy term (3 years)

S = Sum assured (Birr 5000)

r = interest rate (10%)

Formula to determine Net Single Premium:

S (dx / Lx) S (dx  1 / Lx s(dx  T  1 / Lx

NSP =    
(1  r ) (1  r )2 (1  r )T

⁄ ⁄
∑

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Using this formula the Net Single Premium is computed as follows:

Year Age Number Living Number dying

t x Lx dx
1 30 958,000 1,657
2 31 956,343 1,702
3 32 954,640 1,747

5000 (1657 / 958,000 ) 5000 (1702 / 958,000 )

NSP   )  5000 (1747 / 958000 )  Birr 22.053
1.10 (1.1)2 (1.1)3

NET LEVEL PREMIUM

Suppose that instead of paying a single premium at the beginning of the policy, the policyholders

want to pay annual premiums of equal size. Here there are two points to consider. Firstly, not all the

policyholders will pay the annual level premiums since some of them are expected to die before the

end of the term. Secondly, the insurer is now collecting limited amount of premiums to invest at the

very beginning of the policy. Accordingly, the total annual level premiums paid by a policyholder

under the level scheme will be greater than the single premium paid at the beginning of the policy.

This equal annual premiums paid by a policy-holder is then called Net Level Premium. The

calculation is shown below the approach is as follows:

First we assume that each insured pays level premium of Birr 1 throughout the term of the policy.

The present value of Birr 1 premium payment is determined. The total present value is then divided

by the number of insured to arrive at the present value of Birr 1 premium payment per insured.

Finally, the Net single Premium is divided by the present value of Birr 1 premium payment per

insured to determine the Net Level Premium.

No. of insured PV of $ 1 payable PV of $ 1

Year Age Paying premium Beginning of year Premium
1 30 958,000 1 958,,000
2 31 956,343 0.9091 869,411
3 32 954,640 0.8264 788,915
TOTAL PV 2,616,326

PV of $ 1 premium Payment per Insured =

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Net Level Premium =

Net Level Premium =

The following table shows the amount of Net Level Premiums to be collected and the expected death

claims to be paid each year.

1 2 3 4 = (3 + 7) 5 6 7

Annual Level Total Premium Beginning B.B Invested Death Ending

Year Premium Collected Balance at 10% Claims Balance

1 8.075 7,735,850 7,735,850 8,509,435 8,285,000 224,435

2 8.075 7,722,470 7,946,905 8,741,596 8,510,000 231,596

3 8.075 7,708,718 7940314 8734345 8735000 -655*

* Difference due to rounding.

The PV of $ 1 annual premium payment for three periods becomes:

PV of Birr Premium payment =

(958000/958000) 1 + (956343/958000) .9091 + (954640/958000) .8234 = 2.731

5.4 PERSONAL ACCIDENT POLICY

Personal Accident Policy provides compensation for death or bodily injuries caused by violent,

accidental, external and visible means. The injuries shall be the direct cause of death, loss or

disablement. In the event of death of the insured, the benefit is to be given to his representative.

Death or disablement should occur within 12 calendar months from the date of the accident.

In the Schedule the insured specifies his occupation or profession; and the policy remains valid for

exposure to risk associated with the stated occupation or profession. If the insured engages himself

in any occupation which greater risk may prevail without informing the insurer, the policy becomes

void and no compensation would be paid. Occupational changes may necessitate premium

adjustment and hence should be communicated to the Corporation. Moreover, the accident is bound

to take place within the geographical limit specified in the Schedule.

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Personal Accident Policy is issued to individuals or a group of individuals on named basis. If

requested, Group Personal Accident Policy can be issued on unnamed basis. Under this scheme,

premiums are calculated based on the estimated annual wage payment, which at expiry, is adjusted

to reflect the actual wages paid. And, the benefits will be based on 5 years salaries/ wages without

exceeding Birr 100000 for any one person and medical expenses limited to Birr 1000 per person.

Group Personal Accident policy can also be provided to cover employees from off-duty accidents

and can be extended to include illness (payment of medical expenses only) and BSG under the age of

14 or over 65 years. However, the policy can be renewed up to the age of 70 under certain

conditions.

5.5 WORKER’S COMPENSATION POLICY

This policy indemnifies the insured against all sums for which he is to be liable to pay compensation

for any worker who sustains death or bodily injury by an accident or occupational diseases arising

from his work and during the time of his work. The worker should be employed by the insured, and

the category of work assigned to him and the place of work should be specified in the Schedule.

The policy does not provide compensation for death or disablement resulting from suicide

attempted suicide or intentional self-injury. Other exceptions for which no compensation is paid by

the insurer include: accidents occurred while the insured is in a state of insanity, or is under the

influence of intoxicants or drugs. Moreover, the policy does not cover accidents suffered by the

insured resulting from his criminal acts like provoked assault, dueling or fighting. In the case of

women, the policy does not cover accidents originating from pregnancy on childbirth.

The premium is based in the estimated amount of wages, salaries and other earnings. The estimated

total earnings would include the value of food, fuel, living quarters and other benefits the worker is

entitled to receive.

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