Computation of premium, Annuity payments, Mortality Table

Computation of premium

Computation of premium is an important aspect of life insurance policies. It is the amount that the policyholder pays to the insurance company in exchange for the insurance coverage provided by the policy. The premium amount is determined based on various factors, such as the age, health, and occupation of the policyholder, the sum assured, the duration of the policy, and any additional benefits or riders selected by the policyholder.

Steps involved in the computation of premium for life insurance policies:

• Underwriting: The first step in computing the premium is underwriting, which involves assessing the risk profile of the policyholder. The insurance company evaluates the age, health, lifestyle habits, and occupation of the policyholder to determine the risk of mortality or morbidity.
• Actuarial calculations: The insurance company uses actuarial calculations to determine the premium amount based on the risk profile of the policyholder. Actuarial calculations are mathematical models that take into account the probability of the policyholder’s death or illness during the policy term.
• Sum assured: The sum assured, which is the amount that the policyholder will receive in the event of death or maturity of the policy, also affects the premium amount. The higher the sum assured, the higher the premium amount.
• Policy duration: The duration of the policy also affects the premium amount. Longer policy terms typically result in higher premiums, as the risk of mortality or morbidity increases with age.
• Additional benefits or riders: The policyholder may opt for additional benefits or riders, such as accidental death benefit, critical illness benefit, or disability benefit, which can increase the premium amount.
• Premium payment mode: The premium payment mode, such as monthly, quarterly, half-yearly, or annual, also affects the premium amount. The insurance company may offer discounts for annual premium payments, as it reduces the administrative costs for the company.

Once all these factors are considered, the insurance company computes the premium amount, which is communicated to the policyholder. It’s important for the policyholder to understand the premium computation process and carefully review the policy documents before making the premium payment.

Annuity payments

An annuity payment is a fixed periodic payment made to an individual, typically on a monthly basis, for a specified period of time or for the rest of their life. An annuity payment can be purchased by an individual from an insurance company or financial institution, and is often used as a means of providing a regular income stream during retirement.

Annuity payments can provide a reliable source of income during retirement and help ensure a comfortable standard of living. However, it’s important to carefully review the terms and conditions of any annuity contract before making a purchase, and to consider factors such as the annuity type, payment frequency, and tax implications when evaluating the suitability of an annuity for one’s financial needs.

Aspects of annuity payments:

• Types of annuities: There are different types of annuities, including immediate annuities and deferred annuities. Immediate annuities begin making payments to the annuitant immediately after the purchase, while deferred annuities start making payments at a future date, typically at the time of retirement.
• Payment frequency: Annuity payments can be made on a monthly, quarterly, semi-annual or annual basis, depending on the annuitant’s preference and the terms of the annuity contract.
• Guaranteed payments: Annuities can be structured to provide guaranteed payments for a certain period of time, regardless of whether the annuitant is alive or deceased. This is known as a period certain annuity. Alternatively, an annuity can be structured to provide payments for the lifetime of the annuitant, known as a life annuity.
• Joint and survivor annuities: Joint and survivor annuities are structured to provide payments for the lifetime of two individuals, typically a married couple. Payments continue to the surviving spouse after the death of the first annuitant.
• Tax implications: The tax treatment of annuity payments depends on the type of annuity, the source of the funds used to purchase the annuity, and the age of the annuitant. Generally, annuity payments are taxed as ordinary income in the year they are received.
• Annuity guarantees: Annuity payments may be guaranteed by the insurance company or financial institution that issues the annuity. These guarantees protect the annuitant from the risk of default or insolvency by the issuer.

Mortality Table

A mortality table, also known as a life table, is a statistical tool used by insurance companies and actuaries to estimate the probability of an individual’s death at a given age. A mortality table is based on data collected from a large group of people, typically from a specific population or demographic, and provides a standardized method for calculating life expectancies and insurance premiums.

Mortality tables typically include the following information:

• Age: The mortality table is broken down by age, typically in one-year increments.
• Number of individuals: The number of individuals in the population or sample used to construct the mortality table at each age.
• Deaths: The number of deaths that occurred in the population or sample at each age.
• Probability of dying: The probability of an individual dying at each age, typically expressed as a percentage or fraction.
• Life expectancy: The average number of years a person is expected to live based on the mortality table.

Mortality tables can be used to calculate insurance premiums by estimating the probability of an individual’s death at a given age. Insurance companies use mortality tables to determine the expected number of deaths in a given population or sample, which helps them calculate the premiums that must be charged to cover the expected costs of paying out benefits.

Mortality tables are also used by actuaries and other financial professionals to estimate the present value of future pension payments, as well as to assess the financial risk associated with various investment options. By understanding the probability of death at different ages, these professionals can make informed decisions about the level of risk they are willing to take on and the appropriate financial strategies to pursue.

Example:

Suppose a 30-year-old male purchases a 20-year term life insurance policy with a face value of $500,000. The premium for this policy is calculated based on the probability of the insured’s death during the 20-year term of the policy, which can be determined using a mortality table.

Assuming that the mortality table indicates that the probability of the insured’s death during the 20-year term is 0.05, the premium for the policy would be calculated as follows:

Premium = (Face value x Probability of death) / (1 + Interest rate) ^ Number of years

Premium = ($500,000 x 0.05) / (1 + 0.05) ^ 20

Premium = $3,303.72 per year

This means that the insured would need to pay $3,303.72 per year for 20 years to maintain the life insurance policy.

Now suppose that instead of purchasing a life insurance policy, the insured decides to purchase an annuity that will pay him a fixed monthly income for the rest of his life, starting at age 65. The annuity payments will be based on the mortality table, which will estimate the probability of the insured living to different ages.

Assuming that the mortality table indicates that the insured has a life expectancy of 85, and that the annuity will pay $1,000 per month, the present value of the annuity can be calculated as follows:

Present value = (Annuity payment x Present value factor)

Present value factor = 1 / (1 + Interest rate) ^ Number of years

Number of years = Life expectancy – Age at start of annuity

Present value factor = 1 / (1 + 0.05) ^ (85 – 65)

Present value factor = 0.268

Present value = $1,000 x 0.268

Present value = $268 per month

This means that the present value of the annuity is $268 per month, based on the estimated life expectancy of the insured.

In summary, the computation of premium, annuity payments, and mortality tables are all important components of the insurance and financial industries, and are used to estimate risk, calculate costs, and inform decisions about investment and financial planning.