Insurance Overview PDF

Chapter – 1- Overview Any risk that can be quantified can be potentially be insured. There is an exhaustive lists of the many different types of insurance that exist. A single policy may cover risks in one or more of the categories set out below. For example, vehicle insurance would typically cove...

Chapter – 1- Overview Any risk that can be quantified can be potentially be insured. There is an exhaustive lists of the many different types of insurance that exist. A single policy may cover risks in one or more of the categories set out below. For example, vehicle insurance would typically cover both the property risk (theft or damage to the vehicle) and the liability risk (legal claims arising from an accident) A home insurance policy typically includes: Coverage for damage to the home  Consumer Insurance Lines Life Insurance Home Insurance Property Insurance Auto Insurance Health Insurance Business Lines of Insurance Liability Insurance Casualty Insurance  Fire, Theft, Accident, Natural Disaster Employee benefits  Health  Dental  Disability  Life  Personal, Group & Commercial Personal insurance is insurance that is purchased by individuals and families for their risk needs. Such insurance includes life, health, disability, auto, homeowner, and long-term care. Group insurance is insurance provided by the employer for the benefit of employees. Group insurance coverage includes life, disability, health, and pension plans. Commercial insurance is property/casualty insurance for businesses and other organizations. Private or Government Insurance Insurance is provided both by privately owned organizations and by state and federal agencies. Measured by premium income, the bulk of property/casualty insurance is provided by private insurers. Largely because of the magnitude of the Social Security program, however, government provides about one-third more personal insurance than the private sector.  Insurers’ Corporate Structure Stock insurers are organized in the same way as other privately owned corporations created for the purpose of making a profit and maximizing the value of the organization for the benefit of the owners. Individuals provide the operating capital for the company. Stock companies can be publicly traded in the stock markets or privately held. Stockholders receive dividends when the company is profitable. Insurers’ Corporate Structure Mutual insurers are owned and controlled, in theory if not in practice, by their policyowners. They have no stockholders and issue no capital stock. People become owners by purchasing an insurance policy from the mutual insurer. Profits are shared with owners as policyowners’ dividends. Company officers are appointed by a board of directors that is, at least theoretically, elected by policyowners. The stated purpose of the organization is to provide low-cost insurance rather than to make a profit for stockholders.  Financial Statements of Property and Casualty Insurers A balance sheet is a summary of what a company owns (assets) and what it owes (liabilities), and the difference between total assets and total liabilities (owners’ equity) Total Assets = Total Liabilities + Owners’ Equity Financial Statements of Property and Casualty Insurers (Continued) Assets Liabilities The primary assets for an Although the assets of an insurance company are insurance company are relatively financial assets. An insurance straightforward, the liabilities are company invests premium and more complex. An insurer is retained earnings in financial required by law to maintain certain assets. These investments reserves on its balance sheet. also provide an important Because premiums are paid in advance, but the period of source of income for an protection extends into the future, insurer. an insurer must establish reserves to assure that premiums collected in advance will be available to pay future losses. A General insurer’s balance sheet The balance sheet of a general insurance is a summary of the financial status of the company. Assets : 1- investments: these might be bonds, equities and property 2- fixed assets: i.e the office building and equipment. 3- Net current assets: Excess of currents assets over liabilities. Liabilities: 1- free reserves: i.e. the balancing item equal to the excess of assets over liabilities. 2- Technical reserves(insurance ): these are the amounts set a side in respect to expected claim payments to or on behalf of policy holders, plus related expenses. Exhibit 7.1 ABC Insurance Company  Financial Statements of Property and Casualty Insurers (Continued) A property and casualty insurer is required to maintain two principal types of financial reserves: – Loss reserves – Unearned Premium reserves  Financial Statements of Life Insurers The balance sheet – The assets of a life insurer have a longer duration, on average, than those of property and casualty insurers – Because many life insurance policies have a savings element, life insurers keep an interest- bearing asset called “contract loans” or “policy loans” – A life insurance company may have separate accounts for assets backing interest-sensitive products, such as variable annuities Financial Statements of Life Insurers (Continued) Liabilities –Policy reserves are the major liability item of life insurers. Under the level-premium method of funding cash-value life insurance, premiums paid during early years are higher than necessary to pay death claims, while those paid in later years are insufficient to pay death claims. –The excess premiums collected in early years of the contract must be accounted for and held for future payment as a death claim to the beneficiary. –Policy reserves are a liability item on the balance sheet that must be offset by assets equal to that amount Financial Statements of Life Insurers (Continued) – The policy reserves held by an insurer plus future premiums and future interest earnings will enable the insurer to pay all future policy benefits if the company’s experience conforms to the actuarial assumptions used in calculating the reserve. – Policy reserves are often called legal reserves because state insurance laws specify the minimum basis for calculating them. – The reserve for amounts held on deposit is a liability that represents funds that are owed to policyholders and to beneficiaries – The asset valuation reserve is a statutory account designed to absorb asset value fluctuations not caused by changing interest rates Financial Statements of Life Insurers (Continued) The income and expense statement for a life insurance company is similar to the statement reviewed earlier for a property and casualty insurance company. A life insurer’s net gain from operations (also called net income) equals total revenues less total expenses, policyowner dividends, and federal income taxes Life Insurance The purchase of life insurance is economically justified if the insured has earned income, and others are dependent on those earnings for part or all of their financial support. If a family head dies prematurely with dependents to support and outstanding financial obligations, the surviving family members are exposed to great economic insecurity. Life insurance can be used to restore the family’s share of the deceased breadwinner’s earnings. 1 AMOUNT OF LIFE INSURANCE TO OWN This is known as “sum assured” or the “coverage amount”. It will take the following forms:  Lump sum: it will be a large single amount paid out all at once when the insured dies. It is fixed amount for all insureds in a portfolio regardless of their job titles, their salaries, so It may be insufficient for some beneficiaries. 1 AMOUNT OF LIFE INSURANCE TO OWN  Category: the amount of coverage is classified into categories based on the insureds’ jobs and salaries (for example: some insureds can take L.E.100,000, other insureds can take 300,000, and so on). Although it can be perceived more preferable than the lump sum, it still may be insufficient for some beneficiaries  Multiple of salary : it is the most professional way of life insurance coverage. 1 AMOUNT OF LIFE INSURANCE TO OWN Where the total coverage amount is a multiple of the insured’s monthly earnings. Most companies offer (as a maximum) 60 months from monthly salary as a benefit, although some companies may offer higher than 60 months. 2 The main coverages of life insurance policies  Death for any cause.  Total Permanent disability (TPD)  Permanent partial disability (PPD)  Accidental death 2 Types of Life Insurance Life insurance policies can be classified in two general categories: – Term insurance provide temporary protection – Cash-value life insurance has a savings component and builds cash values (i.e. whole life – endowment policies) – There are many variations of both types available today Term Life Insurance Under a term insurance policy, protection is temporary; protection expires at the end of the policy period, unless renewed Most term policies are renewable for additional periods – Premiums increase at each renewal – To minimize adverse selection, many insurers have an age limitation beyond which renewal is not allowed Most term policies are convertible, which means the policy can be exchanged for a cash- value policy without evidence of insurability Types of Term Life Insurance Yearly-renewable term insurance is issued for a one-year period 5-, 10-, 15-, 20-, 25-, or 30- year term A term to age 65 policy provides protection to age 65, at which time the policy expires Decreasing term insurance policy, under which the face value gradually declines each year reentry term insurance policy, renewal premiums are based on select (lower) mortality rates if the insured can periodically demonstrate acceptable evidence of insurability (i.e., good health) Uses and Limitations of Term Life Insurance Term insurance is appropriate when: – The amount of income that can be spent on cover is limited – The need for protection is temporary – The insured wants to guarantee future insurability. i.e) inexpensive term insurance can be purchased, which can be converted later into a permanent cash-value policy without evidence of insurability. However, – Term insurance premiums increase with age at an increasing rate – Since term insurance has no cash values, it can’t be used for retirement or savings purposes. Whole Life Insurance Whole life insurance is a cash-value policy that provides lifetime protection – A stated amount is paid to a designated beneficiary when the insured dies, regardless of when the death occurs Types of whole Life Insurance Ordinary life Limited-payment life Types of Whole Life Insurance 1) Ordinary life insurance It is a level-premium policy that provides lifetime protection – Premiums are level throughout the premium-paying period – The policy develops an investment or saving element called a cash surrender value, which results from the overpayment of premiums during the early years. – policy is appropriate when lifetime protection is needed A major limitation is that some people are still underinsured after the policy is purchased Notes – The excess premiums paid during the early years are used to supplement the inadequate premiums paid during the later years of the policy. – The legal reserve is a liability item for an insurer that must be offset by sufficient financial assets. The fundamental purpose of the legal reserve is to provide lifetime protection. – The net amount at risk is the difference between the legal reserve and the face amount of coverage 2) The limited-payment life insurance: It is another traditional form of whole life insurance. The insured also has lifetime protection, but the premiums are paid only for a limited period, such as 10, 20, or 30 years, or until age 65. A paid-up policy at age 65 or 70 is another form of limited- payment life insurance A single-premium whole life is an extreme form of the limited payment policy 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 pays the face amount of insurance if the insured dies within a specified period. If the insured is still alive at the end of the period, the face amount is paid to the policyholder Endowment insurance accounts for less than one percent of the life insurance in force Variations of Whole Life Insurance Variable life insurance is a fixed-premium policy in which the death benefit and cash values vary according to the investment experience of a separate account maintained by the insurer – The premium is level – The entire reserve is held in a separate account and is invested in common stocks or other investments – Cash-surrender values are not guaranteed and there are no minimum guaranteed cash values Variations of Whole Life Insurance Universal life insurance is a flexible premium policy that provides lifetime protection – After the first premium, the policyholder decides the amount and frequency of payments – Most policies have a target premium, but the policyowner is not obligated to pay it – a contract that separates the protection and saving components  There are two forms of universal life insurance: – Option A pays a level death benefit during the early years, and the death benefit increases in later years – Option B provides for an increasing death benefit which is equal to a constant net amount at risk plus the accumulated cash value Universal life provides considerable flexibility – Cash withdrawals are permitted – Policies receive favorable tax treatment  Limitations include: – Insurers advertise misleading rates of return – Cash-value and premium-payment projections can be misleading and invalid – Insurers can increase the mortality charge – A policy may lapse because some policyowners do not have a firm commitment to pay premiums Variable universal life insurance is similar to universal life insurance with two major exceptions. 1) the cash values can be invested in a wide variety of investments. 2) there is no minimum guaranteed interest rate, and the investment risk falls entirely on the policyholder. Variations of Whole Indexed universal Life Insurance life insurance is a variation of universal life insurance with certain key characteristics:  There is a minimum interest rate guarantee which is usually lower than the minimum interest rate guarantee on a regular universal life policy.  Additional interest may be credited to the policy based on investment gains of a specific stock market index  There is a formula for determining the amount of enhanced (additional) interest credited to the policy Variations of Whole Life Insurance Variable universal life insurance is an important variation of whole life insurance. Most are sold as investments Variable universal life insurance is similar to a universal life policy with two major exceptions: – The policy owner decides how the premiums are invested which provides considerable investment – flexibility. – The policy does not guarantee a minimum interest rate or minimum cash value – These policies have relatively high expense charges, including surrender charges, and investment management fees Variations of Whole Life Insurance Current assumption whole life insurance is a nonparticipating whole life policy in which the cash values are based on the insurer’s current mortality, investment, and expense experience – An accumulation account reflects the cash value under the policy – If the policy is surrendered, a surrender charge is deducted from the accumulation account – A guaranteed interest rate and current interest rate are used to determine cash values – A fixed death benefit and maximum premium level at the time of issue are stated in the policy  There are two forms of current assumption whole life products:  Low-premium products, with a low initial premium for a certain period and then the insurer to recalculate the premium after the initial guaranteed period expires If the new premium is higher than the initial premium, the policyholder generally has the option of paying the higher premium and maintaining the same death benefit. Alternatively, the policyholder can continue to pay the lower premium, but the death benefit is reduced.  High-premium products, with a provision that allows the policyholder to discontinue paying premiums after a certain time period such as 10 years. Exhibit 11.6 Comparison of Major Life Insurance Contracts Other Types of Life Insurance A modified life policy is a whole life policy in which premiums are lower for the first three to five years and higher thereafter Preferred risk policies are sold at lower rates to individuals whose mortality experience is expected to be lower than average (e.g., a non-smoker) Second-to-Die life insurance insures two or more lives and pays the death benefit upon the death of the second or last insured Other Types of Life Insurance Savings Bank Life Insurance (SBLI) is a type of life insurance that is sold by savings banks Industrial life insurance is a type of insurance in which the policies are sold in small amounts and an agent of the company collected the premiums at the insured’s home Group life insurance provides life insurance on a group of people in a single master contract  Ratemaking in Life Insurance Life insurance actuaries use a mortality table or individual company experience to determine the probability of death at each attained age Expected future payments are discounted back to the start of the coverage period and summed to determine the net single premium or level installment premiums The annual expected value of death claims equals the probability of death times the amount the insurer must pay if death occurs