CHAPTER FIVE

LIFE AND HEALTH INSURANCE

5.1. LIFE INSURANCE

“The human life value, expressed in dollars, should be carefully appraised for life and health
insurance purposes.” S.S. Huebner, the Economics of Life Insurance

A human life has economic value to all whom depend on the earning capacity of that life,
particularly to two control economic groups- the family and the employer. To the family, the
economic value of a human life a probably most easily measured by the value of the earning
capacity of each of its members. To the employer, the economic value of human life is measured
by the contributions of an employee to the success of the business firm. If one argues that in a
free competitive society a worker is paid according to the worth and is not exploited, the
worker’s contribution again is best measure by earning capacity. It develops the earning capacity
probably the only feasible method of giving measurable economic value to human life.

There are four main perils that can destroy wholly or partially, the economic value of a human
life. These include “premature death, loss of health, old age and unemployment”.

For many people, the risk management tool that is most appropriate for dealing with the
exposure of premature death is “Life Insurance”. Every person faces two basic contingencies
concerning life; he may die too soon, or he may live too long, to suit himself, it means that he
may outlive his financial usefulness or his ability to provide for his needs. The first category is
physical death. The second is economic death. A man, who is forced to retire at 58 from his job,
unless he has substitute income, is financially dead. Economic death may also occur at early
ages if the person becomes too disabled or ill to work. Life insurance is designed to provide
protection against these two distinct risks premature death and superannuation. Thus, life
insurance may be defined as a special and economic devise by which a group of people may co-
operate to ameliorate (make better) the loss resulting from the premature death or living too long
the members of the group.

5.1.1. CHARACTERISTICS OF LIFE INSURANCE

A. The event insured against is an eventual certainty. No one lives forever or maintains his
economic value. Yet we do not violate the requirements of an insurable risk in the case of life
insurance for it is not the possibility of death itself that we get insured against, but rather
untimely death. The uncertainty surrounding the risk in life insurance is not whether the
individual is going to die, but when.

B. Life insurance is not a contract of indemnity. The principle of indemnity applies on a

modified form in the case of life insurance. In most lines of insurance, an attempt is made to put
of individual back in exactly the same financial position after a loss as before the loss. For

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obvious reasons, this is not possible in life insurance the simple fact of the matter is that we
cannot place a value on a human life.

C. Insurance as a legal principle, every contract of insurance must be supported by an insurable

interest, but in life insurance the requirement of insurable interest is applied somewhat
differently than in property and liability insurance. When the individual taking out the policy is
also the insured, there is not legal problem concerning insurable interest. The important question
of insurable interest arises when the person taking out the insurance is someone other than the
person whose life is concerned. In such cases, the law required than an insurable interest exists
at the time the contract is taken out. There are many relationships, as stated earlier, than provide
the basis for an insurable interest.

D. Life contract are long-term contracts. Nearly all life policies are intended to continue until the
insured’s death or at least for several years. Other forms of insurance policies may be renewed
many times, but are usually twelve-month contracts, which may be terminated by either party.

E. Finally, the question of over insurance is immaterial in life insurance contracts.

5.1.2. TYPES OF LIFE INSURANCE CONTRACTS

From a generic viewpoint, life insurance policies can be classified as either Term insurance or
cash-value life insurance. Term insurance provides temporary protection, while cash-value life
insurance has a savings component and builds cash values. Numerous variation and
combinations, of these two types of life insurance are available today.

5.1.2.1. TERM INSURANCE

Term insurance provided protection only for a definite period (term) of time. A term insurance
policy is contract between the insured and the insurer where by the insurer promises to pay face
amount of the policy to a third party (the beneficiary) should the insured die within a given
period of time. If the insured does not die during the period for which the policy was taken, the
insurance company is not required to pay anything. Protection ends when the term of years
expires. In other words, term life insurance look like automobile insurance, fire insurance, and
the like, this is always term insurance. Term insurance is sometimes called temporary insurance.
Common types of term life insurance are 1 year term, 5 year term, 10 years term, 20 years term,
and term to age 60 to 65.

Types of Term Insurance:

A wide variety of term insurance products are sold today. They include the following:
 Yearly renewable term 5-,10-,15- or 20 year term
 Term to Age 65
 Decreasing term
 Reentry term

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Yearly renewable term: Yearly renewable term insurance is issued for a one-year period, and the
policy owner can renew for successive one year periods to some stated age without evidence of
insurability. Premiums increase with age at each renewal date. Most yearly renewable term
policies also allow the policy owner to convert to a cash-value policy.

5-, 10-, 15- or 20 year term: Term insurance can also be issued to 5, 10, 15, or 20 years, or for
longer periods. The premiums paid during the term period are level, but they increase when the
policy is renewed.

Term to Age 65: A term to age 65 policy provides protection to age 65, at which time the policy
expires. The policy can be converted to a permanent plan of insurance, but the decision to covert
must be exercised before age 65. For example, the insurer may require conversion to a
permanent policy before age 60. Because premiums are level, the policy develops a small
reserve that is used up by the end of the period.

Decreasing term insurance: Decreasing term insurance is form of term insurance where the face
amount gradually declines each year. Although the face amount declines over time, the premium
is level (same) throughout the period. In some policies, the premiums are structure so that the
policy is fully paid for a few years before the coverage expires. For example, a 20 year
decreasing term policy may require premium payments for 17 years. This method avoids paying
a relatively large premium for only a small amount of insurance near the end of the term period.
Finally, decreasing term insurance can be written as a separate policy, or it can be added as a
rider to an existing contract.

Reentry term insurance: Reentry term also called revertible term is another important term
insurance product. Under a reentry term policy, renewal premiums are based on selected
mortality (death) rates if the insured can periodically demonstrate acceptable evidence of
insurability.

Uses of Term Insurance

 If the amount of income that can be spent on life insurance is limited, term insurance can
be effectively used.
 Term insurance is appropriate if the need for protection is temporary.
 Term insurance can be used to guarantee future insurability.

Limitation of Term Insurance

 Term insurance premiums increase with age and eventually reach prohibitive levels.
 Term insurance is inappropriate if you wish to save money for a specific need.

5.1.2.2. WHOLE LIFE INSURANCE

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In contrast to term insurance, which provides short term protection, whole life insurance is a
cash-value policy that provides lifetime protection. From a historical or traditional perspective;
the following two types of whole life insurance:

 Ordinary Life Insurance

 Limited – Payment Life Insurance

Ordinary Life Insurance: Ordinary life insurance also called straight life and continuous premium
whole life provides lifetime protection to age 100, and the death claim is a certainty. If the
insured is still alive age 100, the face amount of insurance is paid to the policy owner at that
time.

In addition, premiums do not increase from year to year but remain level throughout the
premium paying period. Under an ordinary life policy, the policy owner is overcharged for the
insurance protection during the early years and undercharged during the later years when
premiums are inadequate to pay death claims. Ordinary life insurance also has an investment or
saving element called a cash surrender value. The cash values are due to the overpayment of
insurance premiums during the early years.

Limited Payment Life Insurance: A limited payment policy is another type of traditional whole
life insurance. The insurance is permanent, and the insured has lifetime protection. The
premiums are level, but they are paid only for a certain period. For example Girma, age 35 may
purchase a 20 year limited payment policy in the amount of 25,000 Birr. After 20 years, the
policy is completely paid, up, and no additional premiums are required even though the coverage
remains in force. A paid up policy should not be confused with one that matures. A policy
matures when the face amount is paid as a death claim or as an endowment. A policy is paid up
when no additional premium payments are required. The most common limited payment
policies are for 10, 20, 25 or 30 years. A policy can paid up at age 65 or 70 is another form of
limited payment insurance. An extreme form of limited payment life insurance is single
premium whole life insurance, which provides lifetime protection with a single premium.
Because the premiums under a limited payment policy are higher than those paid under an
ordinary life policy, the cash values are also higher.

Endowment insurance

Endowment insurance is another traditional form of life insurance. An endowment policy pays
the same amount of insurance if the insured dies within a specified period; if the insured survives
to the end of the endowment period, the face amount is paid to the policy owner at that time. For
example, if Stephanie, age 35, purchased a 20-year endowment policy and dies any time within
the 20-year period, the face amount would be paid to her beneficiary. If she survives to the end
of the period, the face amount paid to her.

5.1.2.3. VARIATIONS OF WHOLE LIFE INSURANCE

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Some important variations of whole life insurance include the following:

Variable Life Insurance: Variable life insurance is fixed premium policy in which the death
benefit and cash surrender value vary according to the investment experience of a separate
account maintained by the insurer. The entire reserve is held in a separate account and is
invested in equities or other investments. The cash surrender values are not guaranteed.

Universal Life Insurance: Universal life insurance is another variation of whole life insurance.
Theoretically, universal life can be viewed as a flexible premium policy that provides life time
protection under a contract that separates the protection and saving components. Universal life
insurance has the following features:

 Unbundling of protection, savings, and expense components

 Two forms of universal life insurance
 Pays a level death benefit during the early policy years.
 Provides for an increasing death benefit.
 Considerable flexibility.
 Cash withdrawals permitted.
 Favorable income tax treatment.

Variable Universal Life Insurance: This is similar to universal life insurance with two major
exceptions. First, the cash values can be invested in a wide variety of investments. Second,
there is no minimum guaranteed interest rate, and the investment risk falls entirely on the policy
owners.

Current Assumption Whole Life Insurance: Current assumption whole life insurance is a
nonparticipating whole life policy in which the cash value is based on the insurer’s current
mortality, investment, and expense experience. An accumulation account is credited with a
current interest rate that changes over time.

Common Features

Although current assumption whole life products vary among insurers they share some common
features summarized as follows:

1. An accumulation account is used to reflect the cash value under the policy. The accumulation
account is credited with the premiums paid less expensive and mortality charges plus interest
based on current rates.

2. If the policy is surrendered a surrender charge is deducted from the accumulation account. A
surrendered charge that declines over time, such as 10 to 20 years, is deducted from the
accumulation account to determine the net cash surrendered value.

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3. A guaranteed interest rate and current interest rate are used to determine cash value. The
minimum cash values are based on the guaranteed interest rate such as 4 or 4.5 percent.
However, the accumulation account is credited with a higher interest rate based on current
market conditions and company experiences.

4. A fixed death benefit and maximum premium level at the time of issue are stated in the policy.
( however under the low-premium version discussed next both are subjected to change)

An Indeterminate Premium Whole Life Policy: This is a policy that permits the insurer to
adjust premiums based on anticipated future experience. The initial premiums are guaranteed for
a certain time period and can then be increased up to some maximum limit. The maximum
premium that can be charged is stated in the policy. The actual premium paid when the policy is
issued is considerably lower and may be guaranteed for some initial period, such as three to five
years. The intent is to have the actual premium paid reflect current market conditions. After the
initial guaranteed period expires, the insurer can increase premium up to the maximum limit if
future anticipated experience with respect to mortality, investments and expenses is expected to
worsen. However the premium may not change if future experience is expected to be similarly to
past experience. Conversely, if future experience is expected to improve, then the insurer can
further reduce the premium if it desires to do so.

Modified Life Policy: Modified life policies are whole life policy in which premiums are lower
for the first three to five years and are higher thereafter. There are several variations of the
modified life policy. Less than one version, the premium increases only once at the end of three
or five years, and dividend is paid that can be used to offset most or all of the premium
increase. Under another version the premiums gradually increase each year for five years and
remain level thereafter. Finally terms insurance can be used for the first three to five years which
automatically converts into an ordinary life policy at a slightly higher premium than for a regular
ordinary life policy issued at the same age.

The major advantage of a modified life policy is that insured can purchase permanent insurance
immediately even though they cannot afford the higher premiums for a regular whole life policy.
Modified life insurance is particularly attractive to persons who expect that their incomes will
increase in the future and those higher premiums will not be financially burdensome.

Preferred Risks

Many life insurers sell policies at lower rates to individuals known as preferred risks. These
people are individuals whose mortality experiences are expected to be lower than average. The
policy is carefully underwritten and is sold only to individuals whose health history, weight,
occupation, and habits indicate more favorable mortality than the average.

The insurer may also require the purchase of a minimum amount of insurance such as $100,000.
If an individual qualifies for a preferred rate, substantial savings are possible. A discount for

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non- smoker’s a current example of a preferred risks policy. Most insurers offer substantially
lower rates to non- smokers in recognition of the more favorable mortality that can be expected
of this group

Second –To-Die Life Insurance

Second –to-die life insurance (also called survivorship life) is a form of life insurance that
insures two or more lives and pays the death benefit upon the death of the second or last insured.
The insurance usually is whole life, but it can be term. Because the death proceeds are paid only
upon the death of the second or last insured, the premiums are substantially lower than if to
individual policies were issued. Second-to-die life insurance is widely used at the present time in
estate planning. As a result of an unlimited marital deduction, the deceased’s, enter estate can be
left to a surviving spouse free of any federal estate tax. However, when the surviving spouse
dies, a sizable federal estate tax may be payable. A second-to-die policy would provide the cash
to pay the state taxes.

Juvenile Insurance

Juvenile insurance refers to life insurance purchased by a parent or adult on the lives of children
younger than a certain age, such as age 14or 15. Insurers generally require the child to be at least
one month old before he or she can be insured. Some insurers, however, will insure a child as
young as one day old.

The major disadvantage in insuring children is that the family head may be inadequately insured.
Scarce premium dollars that could be used to increase the life insurance on the family head are
instead diverted to the children.

Arguments for life insurance on children are not convincing. One argument is that insurance on
children is less expensive because it is purchased at a younger age. This argument is deceptive.
Although insurance premiums on children are lower, they are paid over a much longer time
period. Premiums at the older ages are higher, but they are paid for shorter periods of time.
Moreover, when present values are taken into account, the child’s policy can be more expensive.
One study indicated that the present value of the premiums for a $20,000 life paid – up-at-age-65
policy issued by one insurer on a child at age 15 is $5584 at a 4 percent discount rate. However,
the present value of the premiums for the same type of policy issued by the same insurer at age
35 is only $3905 In short; a juvenile insurance policy may be no bargain when it comes to cost.

Another argument is that life insurance should be purchased to guarantee the future insurability
of the children. This argument has slightly greater validity, but only if the husband and wife are
adequately insured. Unfortunately, guaranteed insurability option cannot be purchased separately
but must be added to the permanent life insurance policy. Even if future insurability cannot be
guaranteed, the odds are that the children will still be able to purchase insurance in the future.
More than 90 percent of all new policies sold are issued at standard rates.

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Industrial Life Insurance

Industrial life insurance; (sometimes called debit insurance) is a class of life insurance that is
issued in small amounts, and the premiums, are payable weekly or monthly. In the past, the
premiums were collected at the insured’s home by an agent of the company. More than nine out
of ten such policies were cash-value policies.

In recent years, industrial life insurance has also been called home service life insurance,
reflecting the fact that individual policies are serviced by agents who call at the policy owner’s
home to collect the premiums. The amount of life insurance policy generally ranges from $5000
to $25,000. Home service life insurance is relatively unimportant and accounts for less than 1
percent of all life insurance in force.

Group Life Insurance

Group life insurance is as type of insurance that provides life insurance on a group of people in a
single master contract. Physical examinations are not required, and certificates of insurance are
issued as evidence of insurance. Group life insurance is important in terms of total life insurance
in force. Most group life contracts provide terms insurance coverage. In 2000, group life
insurance accounted for 40 percent of all life insurance in force in the United States.

5.1.3. ANNUITIES

An annuity maybe defined as a periodic payment to commence at a stated date and to continue
for a fixed period or for the duration of a life. The person whose life governs the duration of
payments is called the annuitant. Annuity is insurance against living too long-against outliving
ability to provide an income for oneself.

Annuities can be classified according to several characteristics. First, annuities can be classified
as immediate or deferred, depending upon whether the benefits are payable immediately after the
purchase of the contact. The rent of annuity can begin as soon as the annuity is purchased, in
which case the transaction is called an immediate annuity. Alternately, the rent can begin at
some future time in which case the annuity is called a deferred annuity. Often the rent begins at
retirement.

Second, annuities may be paid for by a single premium or by annual premiums. An annuity can
be wholly paid up in lump sum payment or it can be purchased in installments over a period of
years. If the annuity is paid up at once, it is called a single-premium annuity. If it is paid for in
installments, it is known as an annual premium annuity.

Third, annuities may cover one life or joint lives. If two or more lives are covered, the payments
may stop at the death of the first annuitant or at the death of the last annuitant. An annuity may
be issued on more than one life. For example, the agreement might be to pay a given rent during
the lifetime individuals, as long as either shall live.

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This is a very common arrangement, is known as a joint and last survivorship annuity, because
the rent is payable until the last survivor dies. The rent may be constant during the entire period
or may be arranged to be reduced by, say one third upon the death of the first annuitant. Thus, a
husband and wife both ages 65 may elect to receive the proceeds of the pension of a pension plan
on a joint and last survivor basis, with an income guaranteed as long as either shall live.

5.1.4. LIFE INSURANCE PREMIUMS

There are three primary elements in life insurance rate making:

 Mortality Charge.
 Interest Charge.
 Loading Charge.

Mortality: The morality table is simply a convenient method of expressing the probabilities of
living or dying at any given age. It is a tabular expression of the chance of losing the economic
value of human life. Since the insurance company assumes the risk of the individual, and since
this risk is based on life contingencies, it is important that the company know within reasonable
limits how many people will die at each age. On the basis of past experience actuaries are able
to predict the number of deaths among a given number of people at some given age.

Interest: Since the insurance company collects the premium in advance and does not pay claims
until the future date, it has the use of the insured’s money for some time, and it must be prepared
to pay interest on it. The life insurance companies collect vast sums of money, and since their
obligations will not mature until sometime in the future, they invest this money and earn interest
on it.

Loading Charge: When a life insurance policy is sold, the insurer incurs relatively high first year
acquisition expenses because of commissions, sales, and administrative expenses. Thus, the
premium charges must include a loading for expenses.

Net Single Premium (NSP): The net single premium is the amount the insurer must collect in
advance to meet all the claims arising during the policy period.

Net Level Premium (NLP): It would be impractical at attempt to collect a net single premium
from each member of an insured group. Few people would have the necessary funds for an
advance payment of all future obligations. Therefore, actuaries must calculate an annual
premium.

Gross Premium: Gross premium is the pure premium plus loading for the necessary expenses of
the insurer. The net level premium for life insurance represents the pure premium that is
unadjusted for the expenses of doing business. The pure premium is actually the contribution
that each insured makes the aggregate insurance fund each year for the payment of both death
and living benefits.

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Illustration;

Calculate the NSP and NLP for a 4 year term policy for birr 10,000 to be insured at the
beginning of the year with an interest rate of 8 %. The number of policy holders at age 26 is
964,591. The expected number of persons dying at age 26, 27, 28 and 29 are 1669, 1647, 1634
and 1641 respectively.

Solution

It will be observed that each person must pay in advance the sum of birr 0.0057 for 4 years of
protection.

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5.2. HEALTH INSURANCE

Health insurance may be defined broadly as the type of insurance that provides indemnification
for expenditure and loss of income resulting from loss of health. Health insurance is insurance
against loss by sickness or bodily injury. The loss may be the loss of wages caused by sickness
or accident, or it may be expenses for doctor bills, hospital bills medicine etc.

5.2.1. TYPES OF HEALTH INSURANCE

There are two types of insurance in the generic term health insurance:

1. Disability Income Insurance and

2. Medical Expense Insurance

5.2.1.1. DISABILITY INCOME INSURANCE

Disability income insurance is form of health the insurance that provides periodic payment when
the insured is unable to work as a result of illness or injury. It may pay benefits only in the event
of sickness or only in the event of accidental bodily injury or it may cover both contingencies in
one contract. Benefit eligibility presumes a loss of income, but in practice this is usually defined
as the inability to pursue an occupation. The fact that the insured’s employer may continue his
or her wages does not reduce the insurance benefit. The disability must be one that prevents the
insured from carrying on the usual occupation. Most policies continue payment of the benefits
for only a specified maximum number of years, but lifetime benefits are available on some
contracts. However, under all loss of income policies, the benefits are terminated as soon as the
disability ends.

Certain types of accidents are excluded, for example, losses caused by war, suicide and
intentionally inflicted injuries, and injuries while in military service during wartime.

5.2.1.2. MEDICAL EXPENSE INSURANCE

Medical expense insurance provides for the payment of the cost of medical care that results from
sickness and injury. Its benefits help meet the expenses of physicians, hospital nursing the
related services, as well as medications and supplies. Benefits may be in the form of
reimbursement of actual expenses, up to a limit, cash payments or the direct provision of
services. The medical expense may be paid directly to the provider of the services or the
insured.

Medical expense insurance is divided into four major classes:

1. Hospitalization Expense Contract

2. Surgical Expense Contract

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3. Regular medical Expense Contract

4. Major medical Expense Contract

Hospitalization Expense Contract: The hospitalization contract is intended to indemnify the

insured for necessary hospitalization expense, including room and board in the hospital,
laboratory fees, nursing care, use of operating room, and certain medicines and supplies.

Hospitalization expense is usually written for a flat daily amount for a specified number of days
such 30, 120, or 365. The contract provides that costs up to the maximum benefit per day (say
50 birr, 60 birr, 70 birr etc.,) will be paid for the number of day specified, while the insured or an
eligible dependent is in the hospital.

The agreement may set birr allowance for the different items or may be on a service basis.
Typical contracts offered by insurance companies, for example may state that the insured will be
indemnified up to X birr per day for necessary hospitalization.

Exclusions under hospitalization contracts:

Like all insurance policies, hospitalization contracts offered by insures are subject to exclusions.
The following exclusions are typical of hospitalization contracts:

 Expenses resulting from war or any act of war.

 Expenses resulting from self-inflicted injuries.
 Expenses payable under worker’s compensation or any occupational disease law.
 Expenses incurred while on active duty with the armed forces.
 Expenses incurred for purely cosmetic purposes.
 Expenses incurred by individuals on an outpatient basis.
 Services received in any government hospital not making a charge for such services.

Surgical Contracts:

The surgical contract provides service allowances for different surgical procedures performed by
duly licensed physicians. In general, a schedule of operations is set forth together with the
maximum allowance for each operation. It reimburses the policyholder according to a schedule
that lists the amounts the policy will pay for a variety of operations.

Regular Medical Contract:

The regular medical expense insurance pays part or all of physicians’ ordinary bills, such as his
called at the patient’s home or at a hospital or a patient’s visit to his office. It is contract of
health insurance that covers physicians’ services other than surgical procedures. Normally,
regular medical insurance is written in conjunction with other types of health insurance and is
not written as a separate contract.

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Major Medical Contract:

The major medical expense insurance provides protection against the very large cost of serious
or long illness or injury. The major medical policy is not appropriate for the large medical
expenses that would be financially unaffordable for the individual. The contract is issued subject
to substantial deductible of different sorts and with a high maximum limit. Since this kind of
policy is designed to cover only serious illness or accidents, a deduction is used to eliminate
small claims. A major medical policy might have 5,000 birr maximum limit for any one accident
or illness, have a 200 birr deductible for any one illness, and contain an agreement to indemnify
the insured for a specified percentage of bills, such as 80% over and above the amount of the birr
deductible. This means the insurance company pays 80% of the loss in excess of the deductible,
and the insured pays the 20%. In the absence of the coinsurance clause, there would be no
incentive for the insured or the doctor to keep expenses within reasonable limits.

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