Insurance ProcessInsurance Process

Kamal JindalKamal Jindal

Client Submits Proposal

Validation of the Proposal

Underwriting the Proposal

Premium Calculation

Issuing the Policy

The Data Flow diagram for New Business

New Business

POLICY SERVICING

Issuing a New Life Policy to a client is known as known as New Business. The following are the tasks to be carried out.

Proposal Underwriting Premium Calculation Policy Issue

Contd…..

Schedule / Declarations

What is covered, Who is insured, Period of policy, Policy limits, premium amount. Declaration states all facts about the parties and the contract.

Conditions

Sets out the rights duties and responsibilities of both parties

Pricing of Life Pricing of Life Insurance ProductsInsurance Products

Kamal JindalKamal Jindal

Pricing of Life Insurance Pricing of Life Insurance ProductsProducts

In a life insurance contract the price of the In a life insurance contract the price of the contract is the total premium payments paid by contract is the total premium payments paid by the policyholder. Three main factors are used the policyholder. Three main factors are used to calculate life insurance premiums:to calculate life insurance premiums:

Rate of mortalityRate of mortality

Investment incomeInvestment income

ExpensesExpenses

  

Rate of MortalityRate of Mortality

In non-life insurance it is difficult to predict how In non-life insurance it is difficult to predict how much the claims cost will be due to the variability much the claims cost will be due to the variability in claims incidences and costs. However, in the in claims incidences and costs. However, in the case of life insurance it is much easier to predict case of life insurance it is much easier to predict this cost because there are reliable mortality this cost because there are reliable mortality tables based on past mortality statistics.tables based on past mortality statistics.

Life insurance policyholders pay premium into a Life insurance policyholders pay premium into a common fund. From this fund all claims are paid common fund. From this fund all claims are paid out. The mortality risk premium is decided based out. The mortality risk premium is decided based on expected mortality.on expected mortality.

Mortality/ Morbidity TablesMortality/ Morbidity Tables

They are based on life insurance companies’ They are based on life insurance companies’ historical statistics on the people they have historical statistics on the people they have insured.insured.

Typically mortality tables will vary by age and Typically mortality tables will vary by age and gendergender

Also, as a general rule, as age increases, so Also, as a general rule, as age increases, so does the mortality rate.does the mortality rate.

The exception to this rule is found in the early The exception to this rule is found in the early years of life and, for men, in their late teenage years of life and, for men, in their late teenage years.years.

Mortality/ Morbidity Tables Mortality/ Morbidity Tables (contd.)(contd.)

A morbidity table shows the rates of sickness and A morbidity table shows the rates of sickness and injury accruing among given groups of people. They injury accruing among given groups of people. They are categorised by age, gender and other criteria such are categorised by age, gender and other criteria such as occupation.as occupation.

Normally, morbidity tables show both the probability of Normally, morbidity tables show both the probability of becoming sick – the inception rate- and the rates at becoming sick – the inception rate- and the rates at which insured people recover from sickness – the which insured people recover from sickness – the termination rate.termination rate.

Actuaries in order to arrive at the concept of an Actuaries in order to arrive at the concept of an `average’ or `standard’ life use mortality and morbidity `average’ or `standard’ life use mortality and morbidity tables. This decides the risk premium.tables. This decides the risk premium.

Mortality/ Morbidity Tables Mortality/ Morbidity Tables (contd.)(contd.)

However, such tables are not foolproof. They are However, such tables are not foolproof. They are also country and culture specific. Actuaries also also country and culture specific. Actuaries also have to take into possible future developments.have to take into possible future developments.

Finally, such tables are based on `selected lives’. In Finally, such tables are based on `selected lives’. In the general population, mortality and morbidity the general population, mortality and morbidity rates – the `ultimate rates’ - will normally be higher.rates – the `ultimate rates’ - will normally be higher.

The Mortality and Morbidity Investigation Bureau The Mortality and Morbidity Investigation Bureau (MMIB), promoted by the Life Insurance Council (MMIB), promoted by the Life Insurance Council and the Actuarial Society of India, will prepare new and the Actuarial Society of India, will prepare new mortality as well as morbidity tables. Presently mortality as well as morbidity tables. Presently decade old LIC mortality table used.decade old LIC mortality table used.

Investment IncomeInvestment Income

When actuaries calculate the price of When actuaries calculate the price of insurance, they estimate the amount of money insurance, they estimate the amount of money the life insurance company expects to earn on the life insurance company expects to earn on the investments.the investments.

The investment yield the life insurance The investment yield the life insurance company attempts to earn is in turn determined company attempts to earn is in turn determined by the nature of the company’s current and by the nature of the company’s current and future liabilities and the company’s need to future liabilities and the company’s need to have enough income to meet those liabilities.have enough income to meet those liabilities.

Investment Income (contd.)Investment Income (contd.)

Techniques of investment management have Techniques of investment management have to take care of issues like duration matching, to take care of issues like duration matching, liquidity management and cash flow matching.liquidity management and cash flow matching.

Some types of policies like guaranteed Some types of policies like guaranteed annuities have given rise to serious problems annuities have given rise to serious problems for life insurance companies in a falling interest for life insurance companies in a falling interest rate regime.rate regime.

ExpensesExpenses

Costs can be subdivided in to 3 main Costs can be subdivided in to 3 main categories:categories:

Production (or acquisition) costsProduction (or acquisition) costs Administration costsAdministration costs Claims handling costsClaims handling costs Actuaries cannot just factor in today’s costs. Actuaries cannot just factor in today’s costs.

They must also make educated estimates of They must also make educated estimates of what the costs would be in future.what the costs would be in future.

Production costs include advertising and Production costs include advertising and marketing, commission, medical examinations, marketing, commission, medical examinations, policyholder documentation and other policyholder documentation and other acquisition expensesacquisition expenses

Expenses (contd.)Expenses (contd.) Administration costs include renewal Administration costs include renewal

commission, the cost of collecting premiums, the commission, the cost of collecting premiums, the day-to-day administration of contracts and the day-to-day administration of contracts and the administration of surrender payments and policy administration of surrender payments and policy loansloans

Claims handling costs include processing claims, Claims handling costs include processing claims, investigating claims and administrating the investigating claims and administrating the payment of claimspayment of claims

One of the most significant costs faced by an One of the most significant costs faced by an insurance company is the cost of generating new insurance company is the cost of generating new business – the so-called `new business strain’. business – the so-called `new business strain’. These costs include advertising, commissions These costs include advertising, commissions and other acquisition costs. and other acquisition costs.

PersistencyPersistency

The hardest element to predict and control is The hardest element to predict and control is the regular payment of premiums – the so-the regular payment of premiums – the so-called persistency factor – and policy lapses, called persistency factor – and policy lapses, where policyholders stop paying premiums.where policyholders stop paying premiums.

Further, as it is not usually possible to increase Further, as it is not usually possible to increase the premium after the policy has commenced, the premium after the policy has commenced, consequences of cost over-runs are serious.consequences of cost over-runs are serious.

PremiumPremium

In a contract of insurance, the insurer promises to pay the In a contract of insurance, the insurer promises to pay the policy holder a specified sum of money, in the event of a policy holder a specified sum of money, in the event of a specified happening.specified happening.

The policy holder has to pay a specified amount to the The policy holder has to pay a specified amount to the insurer, in consideration of this promise. Premium is the insurer, in consideration of this promise. Premium is the name given to this considerationname given to this consideration

Premium can be looked upon as the price of the insurance Premium can be looked upon as the price of the insurance policypolicy

Premium has to be paid regularly over a period or it can be a Premium has to be paid regularly over a period or it can be a one time paymentone time payment

A default in premium can endanger the continuance of the A default in premium can endanger the continuance of the policypolicy

The calculation of the premium is a complex technical The calculation of the premium is a complex technical process involves actuarial and statistical principles base on process involves actuarial and statistical principles base on future experience of Mortality, interest rates and expensesfuture experience of Mortality, interest rates and expenses

PremiumPremium

RISK PREMIUMRISK PREMIUM NET & PURE PREMIUMNET & PURE PREMIUM LEVEL PREMIUMLEVEL PREMIUM OFFICE/TABULAR PREMIUMOFFICE/TABULAR PREMIUM EXTRA PREMIUMEXTRA PREMIUM

PREMIUM CALCULATIONPREMIUM CALCULATION

STEP 1 STEP 1 Find out the Tabular premium i.e. Premium quoted in published Find out the Tabular premium i.e. Premium quoted in published

premium rates for given age [nearest, next or last birth day]This premium rates for given age [nearest, next or last birth day]This premium is usually stated as Rs . Per thousand SApremium is usually stated as Rs . Per thousand SA

STEP 2STEP 2 Deduct adjustment for large SA,if applicableDeduct adjustment for large SA,if applicable STEP 3STEP 3 Make adjustment for mode of payment of premiumMake adjustment for mode of payment of premium STEP 4 STEP 4 Multiply by SAMultiply by SA STEP 5 STEP 5 Add Extras. Occupational hazards, supplementary benefits, double Add Extras. Occupational hazards, supplementary benefits, double

accident benefits [DAB], extended permanent disability benefit accident benefits [DAB], extended permanent disability benefit [EPDB][EPDB]

STEP 6STEP 6 Divide by frequency of paymentDivide by frequency of payment

Premium Calculation-Premium Calculation-examples examples

EXAMPLEEXAMPLE Plan Plan TermTerm

AgeAge TPTP SASA

[000s][000s]

ModeMode Other Other ridersriders

11 14-3014-30 3535 36.5536.55 2525 HYHY DABDAB

+EPDB+EPDB

22 5-355-35 3030 28.4028.40 5050 YY HealthHealth

ExtraExtra

Rs 3Rs 3

33 75-2075-20 3030 66.8066.80 3030 MM DABDAB

+EPDB+EPDB

Sum assured [SA]Sum assured [SA] RebateRebate

25,000-49,99925,000-49,999 Rs 1.00Rs 1.00

50,000-99,99950,000-99,999 Rs 1.50Rs 1.50

Rs 100,000Rs 100,000 Rs 2.00Rs 2.00

Mode of PremiumMode of Premium rebaterebate

Half yearlyHalf yearly 1.50%1.50%

yearlyyearly 2.00%2.00%

RebatesRebates

Example 1Example 1

Tabular premium Rs 36.55Tabular premium Rs 36.55 Less adjustmentLess adjustment [a] for SA Rs 1.00[a] for SA Rs 1.00 [b] for Hly mode@ 1.5% Rs 0.55[b] for Hly mode@ 1.5% Rs 0.55 Balance Rs 35.00Balance Rs 35.00 Balance X SA=35X25= Rs 875.00Balance X SA=35X25= Rs 875.00 Add DAB+EPDB Rs 25.00Add DAB+EPDB Rs 25.00 Total Rs 900.00Total Rs 900.00 Half yly prem Rs 450.00 Half yly prem Rs 450.00

Eample 2Eample 2

Tabular premium Rs 28.40Tabular premium Rs 28.40 Rebate for large SA Rs 1.50Rebate for large SA Rs 1.50

Balance Rs 26.90Balance Rs 26.90 Balnce X SA=26.90X50= Rs 1345.00Balnce X SA=26.90X50= Rs 1345.00 Add heath extra Rs 3 X 50= Rs 150.00Add heath extra Rs 3 X 50= Rs 150.00 Total Rs 1495.00Total Rs 1495.00 Qtly prem Rs 373.75Qtly prem Rs 373.75

Example 3Example 3

Tabular premium Rs 66.80Tabular premium Rs 66.80 Less adj for SA Rs 1.00Less adj for SA Rs 1.00 Rs 65.80Rs 65.80 Balance 65.80x30= Rs 1974.00Balance 65.80x30= Rs 1974.00 Add for DAB+EPDB Rs 60.00Add for DAB+EPDB Rs 60.00 Total Rs 2034.00Total Rs 2034.00 Monthly instt premium Rs 169.50Monthly instt premium Rs 169.50

Underwriting & ClaimsUnderwriting & Claims

Basic responsibility of an underwriter is to decide Basic responsibility of an underwriter is to decide whether or not an applicant’s anticipated whether or not an applicant’s anticipated mortality is in line with the assumptions used in mortality is in line with the assumptions used in the premium rates and, if not, what additional the premium rates and, if not, what additional premium should be charged. Underwriters have premium should be charged. Underwriters have to prevent anti-selection against the company.to prevent anti-selection against the company.

  The so-called standard rates have to cover a The so-called standard rates have to cover a broad spectrum of lives and most people need to broad spectrum of lives and most people need to be included in the list. Most others can be be included in the list. Most others can be accepted on amended terms.accepted on amended terms.

Underwriting & Claims (contd.)Underwriting & Claims (contd.)

Underwriters have four inter-related concerns when Underwriters have four inter-related concerns when they consider a proposal. They look at:they consider a proposal. They look at:

   The nature of the personThe nature of the person The particular risk to be coveredThe particular risk to be covered The chosen amount of coverThe chosen amount of cover The time periodThe time period The life ins. company will need to assess all risks The life ins. company will need to assess all risks

before guaranteeing a sum insured. They include:before guaranteeing a sum insured. They include: Age and gender, medical history, lifestyle, occupation, Age and gender, medical history, lifestyle, occupation,

hobbies and past timeshobbies and past times

The Financial Underwriting The Financial Underwriting ProcessProcess

The underwriter must ask four key questions?The underwriter must ask four key questions?

Is there an insurable interest?Is there an insurable interest?

Is there a genuine need for the cover?Is there a genuine need for the cover?

Does the sum insured match the financial loss Does the sum insured match the financial loss which could result in the event of the death of which could result in the event of the death of the life insured?the life insured?

Does the class and term of the policy match Does the class and term of the policy match the need for cover?the need for cover?

Performance Performance MeasurementMeasurement

Performance ManagementPerformance Management

Management will want to judge the performance Management will want to judge the performance of the business against performance criteria of the business against performance criteria which encourage the creation of value. Creating which encourage the creation of value. Creating value means maximising the return on capital.value means maximising the return on capital.

  Traditional life insurance business typically Traditional life insurance business typically involves paying level premiums for an increasing involves paying level premiums for an increasing risk – due to mortality increasing with age. This risk – due to mortality increasing with age. This means that during early durations of the policy means that during early durations of the policy the premium paid will be greater than the cost of the premium paid will be greater than the cost of the risk but later the premium paid will be less the risk but later the premium paid will be less than the cost of the risk.than the cost of the risk.

Role of ReservesRole of Reserves

This then leads to the concept of setting aside This then leads to the concept of setting aside part of the premium now to meet the expected part of the premium now to meet the expected shortfall in the future - `reserves’ are set up. shortfall in the future - `reserves’ are set up.

Typically, the cost of setting up initial reserves is Typically, the cost of setting up initial reserves is greater than the initial premium income. This is greater than the initial premium income. This is because the life insurance company has to because the life insurance company has to make cautious assumptions in setting up make cautious assumptions in setting up statutory reserves. Hence the company’s capital statutory reserves. Hence the company’s capital is required to meet the shortfall. This loss of is required to meet the shortfall. This loss of shareholder’s capital (hopefully temporary) is shareholder’s capital (hopefully temporary) is known as `Reserving Strain’.known as `Reserving Strain’.

New Business StrainNew Business Strain

In the case of a life insurance policy, most of In the case of a life insurance policy, most of the expenses are incurred at the inception of the expenses are incurred at the inception of the policy. This includes initial commission the policy. This includes initial commission expenses which are much more than running expenses which are much more than running expenses. As these initial expenses are usually expenses. As these initial expenses are usually greater than the initial premium income, the life greater than the initial premium income, the life insurance company must fund the balance. insurance company must fund the balance. This loss is termed as `Cash Flow Strain’.This loss is termed as `Cash Flow Strain’.

The sum of `Reserving Strain’ and `Cash Flow The sum of `Reserving Strain’ and `Cash Flow Strain’ is known as `New Business Strain”. Strain’ is known as `New Business Strain”.

Embedded ValueEmbedded Value

The amount of new business strain depends upon The amount of new business strain depends upon the local statutory rules for recognising income and the local statutory rules for recognising income and outgo. Therefore the statutory profile reflects a outgo. Therefore the statutory profile reflects a substantial loss in the first year which is recovered substantial loss in the first year which is recovered over a period of years finally leading to profits.over a period of years finally leading to profits.

  The statutory profit profile distorts the true The statutory profit profile distorts the true profitability of a company at any point of time. profitability of a company at any point of time. Taking into account expected future statutory profits Taking into account expected future statutory profits will provide a more realistic picture of a life will provide a more realistic picture of a life insurance company’s performance. This is known insurance company’s performance. This is known as the embedded value approach.as the embedded value approach.

Embedded Value (contd.)Embedded Value (contd.)

Embedded value (EV) = Net Asset Value (NAV) + Embedded value (EV) = Net Asset Value (NAV) + Value of Business in Force (VBF)Value of Business in Force (VBF)

WhereinWherein NAV is the market value of assets which could be NAV is the market value of assets which could be

immediately distributed to shareholders. immediately distributed to shareholders. NAV = Statutory Capital + Retained Statutory Profits + NAV = Statutory Capital + Retained Statutory Profits +

Unrealised Capital Gains (Losses) – Deferred TaxesUnrealised Capital Gains (Losses) – Deferred Taxes     

Embedded Value (contd.)Embedded Value (contd.)

VBF is the market value of assets which will be VBF is the market value of assets which will be eventually distributed to shareholders, but eventually distributed to shareholders, but cannot be immediately distributed because of cannot be immediately distributed because of legislation designed to protect the interests of legislation designed to protect the interests of policyholders or because the profit has yet to policyholders or because the profit has yet to be earned.be earned.

VBF is obtained by deducting the cost of VBF is obtained by deducting the cost of discounting and cost of solvency capital from discounting and cost of solvency capital from the value of future profits. the value of future profits.