CHAPTER FIVE

LIFE AND HEALTH INSURANCE

5.1. LIFE AND HEALTH INSURANCE
Definition
Life insurance is a contract where by the insurance for certain sum of money or premium proportionate to
the age, health, profession and other circumstances of the person whose life is insured engage that, if such
person dies with in the period specific (limited), the insurer will pay the amount specified by the policy
according to the term thereof to the person in whose favor the policy was entered to.

Life insurance can also be defined as a social and economic device by which a group of persons may
cooperate to ameliorate the loss resulting from the premature death of members of the group. The insuring
organization collect contributions from each member, invest this contribution, grants both their safety and a
minimum interest return and distribute benefits to the estates of the members who die.

The main purpose of life insurance is financial protection to the dependents of the insured upon the
premature death of the insured. The sum assured is, then, upon the death of the insured will be paid to the
beneficiaries. The financial compensation will provide security for a certain period of time.

Unique Characteristics of Life Insurance

Life insurance is a risk pooling plan economic device through which the risk of premature death or
superannuation is transferred from the individual to the group. However, the contingency insured against
has certain characteristics that make it peculiar; as a result, the contract insuring against the contingency is
different in many respects from other types of insurance.
i. The benefits are determined in advance
- The insured decides for himself the amount of insurance protection he needs. The insurer will then
decide on the corresponding reasonableness of the amount of coverage and sets the
corresponding premium.
ii. The amount of money required to pay the death benefits in a given period are to be collected in advance
so that there should not be shortage of funds to pay claims as they occur.

iii. Each insured in the group should be charged an appropriate premium, which reflects the amount of risk
he brings to the group. In other words, losses are to be distributed among the group of insured in an
equitable manner.
iv. The probability of claim increases with the passage of time since insured exhibit deteriorating health
condition as they grow old.

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v. In addition to protection against uncertainty, life insurance has the function of accumulation (saving).
 Saving==> premium will accumulate with interest till the date of maturity of the policy.
Life insurance is not strictly a contract of indemnity. it is impossible to place a value on human life. The
provision of life insurance is a quite different process from the provision of non-life insurance. The main
distinction is that in life insurance the event being assured is either certain to happen, in the case of those
policies paying on death, or scientifically calculable, in the case of policies not paying a benefit of death.

Life insurance contracts 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 months contracts, which may be terminated by either party.
In addition to these, there are number of special features, which are worth mentioning at this stage:
a) Premium Payments
Life insurance premium are payable by level amounts throughout the period of the policy. This means that
each person pays the same amount throughout, that amount being determined by his age on effecting the
policy. Premium can be paid annually, half-yearly, quarterly or monthly. It is also possible for the insured to
pay premiums for a specified period of time or even a single payment at lump sum at the time the policy is
purchased.

b) Surrender Values
When a person no longer wants his policy, or for some reason cannot continue the premiums, he can ask
for the surrender value.

c) Investments
We have already identified the life insurance industry as being of considerable size by considering the
number of policies in force and value of premiums paid each year. These vast amounts of money are held
by companies to meet future liabilities and are termed life insurance funds. These funds do not lay dormant
waiting for claims to come in; rather they are invested to provide income for the companies and so assist
policyholders and shareholders.

3.7.1. BASIC TYPES OF LIFE INSURANCE CONTRACTS

Not all people need exactly the same kind of protection from life insurance. Their ages differ; their incomes
and financial obligations differ. To provide all the different types of protection that are needed, insurance
companies offer a variety of policies. The basic types of contracts are:
1) Term Insurance
2) Whole life insurance
3) Endowments insurance and
4) Annuities

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1) Term Insurance
The insurance scheme provides compensation to the beneficiary if the insured dies within the stated period
mentioned in the policy. If the insured survives beyond the specified time limit in the policy, the policy will
expire and there will be no payment made by the insurer.

Term insurance provides protection only for a definite period (term) of time. A term insurance policy is a
contract between the insured and the insurer where by the insurer promises to pay face amount of the
policy to a third party (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 resembles
automobile insurance, fire insurance, and like which are always term insurance.

Term insurance is sometimes called temporary insurance. Common types of term life insurance are 1-year
term, 5-years term, 10-years term, 20-years term, and term to age 60 to 65.

Term life policy gives temporary protection and there is no saving element involved.

Term policies do not provide the insured with loans, cash surrender or non-forfeiture options. Insurance
coverage terminates at the end of the period unless it provides an option for conversion into other
insurance schemes. Term life policies can be single or level premium policy.

There are different forms of term insurance available to the potential purchaser, namely, straight term
insurance, renewable term insurance, and convertible term insurance.

Straight term insurance: Is written for a year or for a specified number of years and terminates
automatically at the end of the designated period.

Renewable term insurance: Is a type of contract under which the insured may renew his policy before its
expiration date without making another medical examination or otherwise providing that he still is insurable.
If the policy is renewable, the insurer will renew the policy, regardless of the insurability of the insured, for
the number of times specified in the contract commonly to age 60 or 65.

Convertible term insurance: Is available from most life insurance companies. This insurance may be
converted at any time during a specific period into a permanent form of insurance without taking a physical
examination. Some insurance companies write a convertible term policy which provides that at the
expiration of certain period of time the term insurance policy automatically will be converted into a
permanent form of insurance. This is called automatic convertible term insurance. Most term insurances
are convertible into whole life or endowment insurance.

2) Whole Life Insurance

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It is a permanent insurance that extends over the lifetime of the insured. The sum insured is payable on
the death of the life insured whenever it occurs. In other words, whole life insurance protects the beneficiary
when the insured dies, since the contract can be continued in force as long as the insured lives.

Whole life insurance contracts may be placed in two categories, depending upon the premium payment
period:
i. Straight life insurance, and
ii. Limited payment life insurance

i. Straight Life Insurance

Under straight life insurance, the premiums are payable for the remainder of the insured’s lifetime.
It is also called as ordinary life insurance. Under this policy, premiums are to be paid at regular interval until
the death of the insured or until the achievement of a specified age limit, say 100 years.
==>Less premium than limited payment life insurance

ii. Limited Payment Life Insurance

Under this insurance, the premiums are payable for the remainder of the insured’s lifetime or until the
expiration of a specified period, if earlier.

A limited-payment life policy is one arranged so that the insured pays a higher premium than would be
required on the straight life contact. Thus, a definite termination date can be established beyond which no
further payments are due. Limited installment plans could be 20-payment life, 30-payment life, and life paid
up at age 65.

Note: Under this insurance scheme, premiums are paid for a definite period of time which is determined in
advance. That is for 10, 15, 20, 25 and 30 years or up to age 85. ==>Higher premium than straight
life insurance.

3) Endowment Insurance
Endowment insurance promises to pay a stated amount of money to the beneficiary at once if the insured
dies during the life of the policy called the “endowment period,” or to the insured himself if he survives to
the end of the endowment period. This is “ You win if you live and you win if you die ” contract. The
endowment policy is, in a sense, a saving plan, which also gives insurance protection.

Under this type of contract the sum insured becomes payable at a maturity date (on the expiry of a fixed
term, say 10 or 20 years) or at death before the date.

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Endowment insurance may be a useful way for some persons to accumulate a specified sum over a stated
period of time whether they live or die. The objective may be funds to finance a child’s college education, to
pay living expenses during retirement, or to retire a date.

4) Annuity Contracts
The annuity contract is true life insurance. It is insurance against living too long-against one’s ability to
provide an income for himself. They have been called “upside-down life insurance,” and in a sense they are
a reverse application of the law of large numbers as it is used in life insurance. While life insurance is a
method of scientifically accumulating an estate; an annuity is designed for the scientifically liquidation of an
estate.

An annuity may be defined as a periodic payment to commence at a stated or contingent date and to
continue for a fixed period or for the duration of life or lives. The person whose life governs the duration of
the payments is called the annuitant. If the payments are to be continued for the duration of the designed
life or lives, the contract is called a life annuity. If payments are to be for a specified period but only as long
as the annuitant lives, the contract is known as a temporary life annuity. The basic function of a life annuity
is that of liquidating a principle sum, regardless of how it was accumulated, and it was accumulated, and it
is intended to provide protection against the risk of outliving one’s income.

Annuity may be classified in various ways:

- An annuity may be immediate, i.e., the first annuity payment due one payment interval from the
date of purchase or it may be deferred, i.e., there is a spread of several years between the date of
purchase and the beginning of the annuity payments.
- Annuities may be classified according to the method of premium payment. If the annuity is paid up
at once, it is called a single-premium payment. If it is paid for in installments, it is known as an
annual-premium annuity.

3.7.2. LIFE INSURANCE PREMIUMS

There are three primary elements in life insurance rate making:
1) Mortality
2) Interest
3) Loading
The first two (i.e. mortality and interest) are used to compute the net premium. The net premium plus an
expense loading (which includes unit expense factor, profit factor, etc) is the gross premium, which is the
selling price of the contract and the amount the insured pays.

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1) Mortality
The mortality 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.

For large number of people actuaries have developed mortality tables on which scientific life insurance
rates may be used. These tables which are revised periodically, state the probability of death both in terms
of deaths per 1,000 and in terms of expectation of life.

Table 6-1 illustrates the mortality experience in current use . It shows that a male age 20 has an
expectation of living 52.37 years. At age 20 only 190 men (105 women) in every 100,000 are expected to
die before they become 21. The probability of death at age 20 is thus 0.19%. At age 96 the death rate is
slightly over 38%, since 384 per 1,000 are expected to die during that year. At age 100 it is assumed that
death is certain. The probability of death expressed in a mortality table is based on insured lives and not
the whole population.

2) 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 some
time in the future, they invest this money and earn interest on it.

Thus, the present value (PV) of a future birr (1Br) is an important concept in the computation of premiums.
To simplify computation, the assumption is made that all premiums are collected at the beginning of the
year and all claims mature at the end of the year.

The future value (FV) formula with compound interest can be written as:

FV =PV [ 1+i ] n , Where n- No of years.

i – Interest rate
Examples:
[Link] want to invest $1000 at 7% compounded annually. What will be the amount after 10 years?

Solution:
Given: Required: FV

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PV = $1000

i = 7% FV =PV [ 1+i ] n =$ 1000 [ 1+7 /100 ]10 =$ 1000 x [ 1 . 07 ] 10

n = 10 years = $ 1967.20

2. If we invest Br. 0.97087379 at 3% compounded annually. What will be the amount at the end of the
year?

Solution:
n 1
PV =PV [ 1+i ] =Br . 0 .97087379 [ 1+3 % ] =Br 1 . 00

Thus, reading down the table, we can see that we should have to invest only about 55 cents at 3% to have
Br. 1.00 at the end of 20 years.

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.

The rate maker in life insurance makes two assumptions in calculating the necessary premium:
1. All premiums will be collected at the beginning of the year and hence it will be possible to earn
interest on the advance payment for a full year.
2. Death claims are not paid until the end of the year in question. In practice, of course, death
claims are paid whenever death occurs.
The formula for NSP is:

Face Value x Mortality x Discount = NSP

of policy rate factor

Example:
1. Give the following information and determine the NSP.
Reference to the CSO 1980 table of mortality reveals that the probability of death at age 20 for a male is
0.0019 (i.e. out of 100,000 men living at the beginning of the year, 190 will die during the year). If a 1,000
birr policy is issued to each of the 100,000 entrants, death claims of 190,000 birr (190 x 1,000 birr) will be
payable at the end of the year at an interest rate of 3%.

Face Value Mortality Interest

NSP = of policy x rate x rate
= Br. 1,000 x 0.0019 x 0.9780==> Look table 6-2,the PV of Br.1.00 at 3% at

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 = Br.1.84 the end of a year
Thus, if each entrant pays 1.84 birr, the insurer will have sufficient funds on hand to pay for death costs
under the policy.

2. Give the following information and determine the NSP.

 3 years term policy for Br.5, 000 to be issued at the beginning of the year.
 No of policyholders at age 30 is 958,000
 Interest rate is 10%
 Single premium payment at the beginning of the year.
 Death claims to be paid at the end of the year in which the incident occur
 CSO 1980 mortality table for male shows the following.

Year Age No of Living No of Dying

1 30 958000 1657
2 31 1703
3 32 1747

Method 1

Face Value Mortality Discount

Age of policy x Rate x Factor (10%) NSP
30 5000 1657 0.90909 = Br.7.8618
958000
31 5000 1703 0.8265 = 7.3418
958000
32 5000 1747 0.7513 = 6.8497
958000
NSP = Br. 22.053

Alternatively the NSP payable by an individual entrant for Br.5000 policy of 3 years term could also be
computed as follows:
No of dying x Amount of Policy PV Expected
Year Age = Death Claims
1 30 1657 5000 8285000
2 31 1703 5000 8515000
3 32 1747 5000 8735000

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 Death PV factor PV of
Year Age Claims x at 10% = Death claims
1 30 8285000 0.9091 7531893.50
2 31 8515000 0.8264 7036796.00
3 32 8735000 0.7513 6562605.50
Total PV of death claims Br. 21131295.0

 NSP = Total PV of death claims

No of Entrants

Br .21131295 .0
=958000 ≈ Br. 22.053
Exercise:
Calculate the NSP for a 5-year term insurance 100,000 entrants of age 31 for a Br. 5,000 insurance policy
issued to each entrant at an interest rate of 10%.

CSO 1980 morality table shows the following. (Female)

Age No of Living No of Dying

31 100,000 178
32 183
33 191
34 200
35 211

Health Insurance
Health insurance may be defined broadly as the type of insurance that provides indemnification for
expenditures and less 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.

There are two types of insurance in the generic term health insurance:
1. Disability income insurance, and
2. Medical expense insurance

1. Disability Income Insurance

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Disability income insurance is a form of health insurance that provides periodic payments 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 accident bodily injury or it may cover both contingencies in one contract.

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

2. Medical Expense Insurance

Medical expense insurance provides for the payment of the cost of medical care that result from sickness
and injury. Its benefits help meet the expenses of physicians, hospital, nursing and related services, as
well as medications and supplies.

Medical expense insurance is divided into four major classes:

a. Hospitalization expense contract
b. Surgical expense contract
c. Regular medical expense contract
d. Major medical expense contract

a. Hospitalization Contract
The hospitalization contract is intended to indemnify the insured for necessary hospitalization expenses,
including room and board in the hospital, laboratory fees, nursing care, use of operating room, and certain
medicines and supplies.

Exclusions under hospitalization contracts:

i. Expenses resulting from war or any act of war
ii. Expenses resulting from self- inflicted injuries
iii. Expenses payable under worker’s compensation or any occupational
disease law.
iv. Expenses incurred while on active duty with the armed forces
v. Expenses incurred for purely cosmetic purposes
vi. Expenses incurred by individuals on an out patient basis
vii. Services received in any government hospital not making a charge for
such services

b. Surgical Contract

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 The surgical contract provides set 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.

c. Regular Medical Contract

The regular medical expense insurance pays part or physician’s entire ordinary bill, such as his calls at the
patient’s home or at a hospital or a patient’s visit to his office. It is a 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.

d. Major Medical Contract

The major medical expense insurance provides protection against the very large cost of a serious or long
illness or injury. The major medical policy is most appropriate for the large medical expenses that would be
financially unaffordable for the individual.

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