1. PREMIUMS AND BONUSES
CHAPTER 4
PREMIUMS
Premium is the Price that the policy- holder has to pay in order to get the benefits under the Insurance Policy.

2. Premium can be paid in following ways
One Time Payment – Single Premium
Once in a Year – Yearly Premium
Twice in a Year – Half Yearly Premium
Four Times in a Year – Quarterly Premium
Monthly Premium
Directly from salary – Salary Saving Scheme

3. Single Premium is not very common
Generally people prefer to pay yearly, Half Yearly, Quarterly and Monthly premiums. If one premium is not paid the policy will be treated as lapsed and the policy holder will not get the expected benefits from the policy.
There is one more scheme called Salary Saving Scheme wherein the premium is directly deducted from salary and hence default in premium is avoided.
For calculating above premiums, insurance companies provide a table. This table contains planwise, agewise, termwise premiums per thousand sum assured.

4. Premium is calculated as follows
Risk premium
Less : interest
net premium
Add : loadings office premium
Less: rebate for large sum assured
Less: rebate for mode of payment
Add : extra premium
premium paid by policy holder per thousand S.A.
( each component explained in further slides)

5. Risk premium
The cost to meet the risk of death for one year at a particular age is called risk premium.
Mortality tables give the data related to death at various ages. This mortality table is used by insurance offices to calculate risk premium.
The risk premium is adequate to pay the claims if all the policies were term assurance policies for one year.

6. EXAMPLE OF MORTALITY TABLE
In this example you will find that the rate of death upto age 5 is high, then it reduces upto age 15, at age 20 again it is high, then it continuously rises till last age of 100 years. This happens because the rate of infant death in India is high. At age 15 to 20 the bad habits of smoking etc increases the death rate.

7. RISK PREMIUM UNDER ENDOWMENT POLICIES
In the case of endowment policies the claims are paid on survival after some years.
So the premium is more than risk premium to pay the survival benefit.
Here also mortality table is used to estimate the number of persons at particular age, surviving at the end of the term.

8. Interest
Insurance companies calculate risk premium on the basis of deaths for one year as per mortality table. But the actual experience of death may be different.
Some portion of the risk premium is kept for payment of survival benefit.
The balance is invested and the interest on such investment is earned by insurance companies.
To the extent of expected interest earnings the premium is reduced. Such reduced premium is called
Net Premium

9. Rebate for large sum assured
For large sum assured the administrative cost as a proportion of premium would be less, because many expenses like clerical cost, printing cost etc remain constant. So the insurers give rebate on large sum assured
e.g. Rs – Rs Re.1/- Rs – Rs Rs.1.50 Rs and above Rs.2/-
This rebate is deducted from the premium, for the given age, quoted in the tables given to agents.

10. Rebate for mode of payment
If the mode of payment is yearly the cost of printing premium notice, premium notice and other costs will be once in a year only. This again reduces the administrative cost of the insurer.
But if the mode of payment is quarterly the cost will be four times than the cost of yearly premium. Hence no rebate is given for quarterly mode.
Similarly, extra will be charged for monthly premium as the cost will be 12 times

11. Loadings
Loadings means expenses.
Administrative expenses – The salary to the clerk, printing of policy, cost of paper, stamps, other office expenses etc. are the administrative expenses.
Contingencies – some unexpected events like earthquake, epidemic, riots, war can raise the number of death claims than normal. To meet these contingencies premiums are loaded suitably.
When above expenses are added to the net premium we get the office premium, which is given in the tables provided to agents by insurance companies.

12. Extra Premiums
In addition to the basic benefits under the policy, extra benefits such as accident benefit or premium waiver benefit is given by the insurance companies. For such extra benefit extra premium is charged.
Similarly, if the life to be insured is not healthy, his job is risky, his habits are such that he is prone to bad health then the extra premium is charged as the risk is more than normal man of that age.
Extra premium is added to the office premium which is to be paid by the policy holder.

13. Calculation of age
The premium changes as the age changes. So at lower age the premium will be lower as the risk of death at lower age is less. The risk of death at higher age is more, hence the premium is more.
The age is always calculated at the start of the policy (at the commencement of the policy). The age calculated in complete years and not in months and days. The methods to calculate the age are
Age last birthday
Age next birthday
Age nearest birthday

14. Example of Age Calculation
The policy starts on st June, 2004
The date of birth of a person is 29th December, 1971
The actual age calculates to
Less :
(start calculating from days, then months, then years)
The actual age of the person is 32 years, 5 months and 2 days. In this case Age last birthday is 32 years
2.Age next birthday is 33 years
3.Age nearest birthday is 32 years

15. The insurance companies can follow separate method for separate types of policies. E.g. for children policies the age last birthday is considered. For pension plans and other plans age nearest birthday is considered.
As we have seen earlier, the premium changes as the age changes. So if a man takes the policy at the age of 20 for 15 years then, -----
At first year the premium will be lower.
After 15 years the premium will be higher as his age will be 35.
The risk of death is almost doubled.
However the premium is charged in such a way that the policyholder has to pay the same premium for all the 15 years.
This is called Level Premium

16. There are two reasons for charging level premiums.
If the premium is changed every year as the age changes, it will be very difficult for the policyholder to administer his savings at later ages as the premiums will be higher at later ages and may find beyond his ability to pay.
So he may drop out when actually the risk of death is more and the need of insurance is most.
2. Another reason is, those who drop out may be healthier than those who continue and they may not find need for insurance.
So there are chances of adverse selection as the policyholders who continue will be all unhealthy and insurers calculation of claims may go wrong.

17. ACTUARIAL VALUATION
The insurance business is based on some assumptions of mortality, interest, expenses and market conditions. If these assumptions go wrong then there will be difficulty to run the business. Hence there is a need to check the validity of these assumptions periodically to make sure that the business is on sound lines. This process is called actuarial valuation.
This is a specialised job and done by the actuaries of the insurance company. If the actuarial valuation shows that the funds with company are more than the estimated liabilities, then this surplus is distributed among policyholders as BONUS

18. BONUS
The bonus is given to those policyholders who opt for ‘with profit’ or ‘participating’ policy. Those who opt for ‘without profit’ or ‘non participating’ policies do not get any bonus.
By paying little higher amount for bonus in the premium for the existing benefits the policyholder is entitled to bonus.
The bonus is declared in such a way that the policies which have contributed more to the surplus (e.g. high sum assured, long term, endowment policy etc.) get more bonus.
There are three types – Simple Reversionary Bonus, Compound Reversionary Bonus, Interim bonus Terminal or Final Additional Bonus

19. In Simple Reversionary Bonus, the bonus is added to the Sum Assured every year. E.g =53000, =56000
In Compound Reversionary Bonus, the bonus is added to the total Sum Assured and the bonus of the last year. E.g =53000, =56180
Interim Bonus is the bonus paid for the part of the policy year from the date of commencement of the policy to the date of claim.
Terminal or Final Additional Bonus is paid at the time of claim settlement, in addition to the usual bonus, where the policy is in force for 15 years.

20. The bonus is actually paid to the policy holders in the following ways
On a claim arising,
Only on maturity,
only for the policies that have been in the books for minimum years,
reduction in subsequent premium,
allowed to discount and encash the bonus immediately

21. LIFE FUND
In other businesses the income over the expenditure is considered as profit. It is distributed among owners as dividend for that particular year.
Unlike other business, in the insurance business the contract is for many years. The part of the profit of every year is accumulated to pay the liabilities in future when the contract comes to an end. This process continues every year.
Similarly, in level premiums we know that the premium collected in a current year is meant to cover future risk and hence the part of the premium is to be kept until such risks arise.

22. Such kept aside fund is called LIFE FUND
This life fund can be used only for paying the claims and for running the expenses of the business

23. EXAMPLE OF PREMIUM CALCULATION
PLAN & TERM =14-30 , SUM ASSURED = 25000
AGE = 35 , MODE = HALF YEARLY
DECISION BY UNDERWRITER = DAB + EPDB
STEP 1
FOR ABOVE EXAMPLE, FIND OUT TABULAR PREMIUM
FROM TABLE FOR PLAN 14, TERM 30 YRS AND AGE 35 YRS. (Rs.36.55)
STEP 2
FOR SUM ASSURED OF RS THE REBATE IS Re.1/-
STEP 3
FOR HALF YEARLY MODE THE REBATE IS 1.5% = 0.55
STEP 4
DAB + EPDB IS Re.1/- PER THOUSAND S.A. i.e. Rs.25/- FOR S.A.

24. SO THE PREMIUM COMES TO
36.55 – 1.00 – 0.55 = 35.00
STEP 5
THIS PREMIUM IS FOR RS.1000/-
WE HAVE TO CALCULATE FOR RS X 25 =875.00
STEP 6
For DAB + EPDB ADD Rs. 25/- =
STEP 7
NOW Rs. 900/- IS YEARLY PREMIUM
FOR HALF YEARLY PREMIUM / 2 = 450
SO HALF YEARLY PREMIUM IS Rs

25. THANK YOU. M. J. MALIK S. B. A. 836 B. O. AHMEDABAD D. O
THANK YOU M. J. MALIK S.B.A. 836 B.O. AHMEDABAD D.O