Chapter 5

LIFE AND HEALTH

INSURANCE POLICIES

03/15/24
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5.1. LIFE INSURANCE

 Life insurance is a financial tool that can help individuals
accomplish a variety of financial goals.
 The most common use of life insurance is to provide for dependent
family members in case of premature death.
 The main purpose of life insurance is financial protection, i.e., to
provide dependents of the insured with financial compensation
amounting to the sum assured if the insured faces premature death
while the policy is in force.
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Cont,
 The sum assured is, then, used by the widow (widower) to bring up
the family.
 The insurance money, therefore, supplements the family income; it
gives the family financial security for a certain period.
 A person may also purchase life insurance with other objectives in
mind. For example, a person may buy life insurance policy to cover
personal loans and other debts. If he dies before settling his debt,
the insurer will pay the outstanding amount to the creditors.
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Cont,
 The family of the insured and the creditors will then be protected
from loss of money.
 In other situation, a person may buy life insurance policy to
accumulate an educational fund that could be used to pay
tuition fees for children when they join higher education.
 Life Insurance are engaged in selling protection and encourage
saving.
 This protection is against financial difficulty and is acquired for a
consideration called a premium.
 The premium is the price that keeps the policy in force.

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Cont,
 Normally Insurers charge level premiums, i.e., the same amount
of premium paid annually throughout the term of the contract.
 The protection given by the insurer is death benefits to the
beneficiary of the insured, or in the case of survival of the
insured, other financial benefits in accordance with the policy

contract.

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The following points are worth considering in

life insurance covering death of the insured

A. The benefit is determined in advance. The insured decides for

himself the amount of insurance protection he needs.

B. 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.

C. Each insured in the group must be charged an appropriate

premium, which reflects the amount of risk he brings to the group.

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Cont,
D. The probability of claim increases with the passage of time since
insured exhibit deteriorating health condition, as they grow old.

E. Another aspect in life insurance is that the insured and the policy
owner may be different.
 For example, an employer may purchase a noncontributory group
life insurance for his employees.
 The employer becomes the policy owner, and the employees
become the insured.
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5.2. BASIC TYPES OF LIFE INSURANCE

CONTRACTS
 There are Three types of basic life insurance contracts
offered by Ethiopian Insurance Corp.
1. Whole Life 2. Term Insurance 3. Endowment
Insurance Insurance

- Straight Life - Level Term Insurance

- Limited –pay - Convertible
- Single- pay - Nonconvertible
- Renewable Term
- Decreasing Term

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1. WHOLE LIFE INSURANCE

 Whole life is a type of life insurance contract that provides
insurance coverage of the contract holder for his or her entire life.
 Upon the inevitable death of the contract holder, the insurance
payout is made to the contract’s beneficiaries.
 These policies also include a savings component, which
accumulates a cash value.
 This policy provides protection to the dependents of the insured
upon the event of his death i.e., the sum assured is payable only
upon the death of the insured.
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Cont,
 One option is that the insured pays annual premiums as long as
he lives.
 The second option is that premiums are made for a specified
number of years or up to a certain age limit normally up to
the age of retirement.
 Premium payment after retirement is discontinued because of a
decline in the income of the assured.
 The policy provides permanent protection to the insured’s
dependents in the case of death.

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Cont,
 Besides this protection, whole life insurance allows for the
accumulation of savings over the life of the insured. In essence, the
policy encourages saving.
 Whole life policy acquires Cash Value after two or three years of
premium payment.
 The Cash Value gradually grows to equal the sum assured upon
maturity or at the time insured attains age 100.
 If the insured, for some reasons, discontinues premium payment
after the policy accumulates Cash Value, then the Cash Value can
be used to keep the policy in force under the Automatic Premium
Loan provision.

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Cont,
 Automatic Premium Loan provision, is an insurance policy
provision that allows the insurer to deduct the amount of
outstanding premium from the cash value of the policy when
premium is due. Moreover, the insured can apply for loans when
the policy acquires cash value.
 Depending on the manner of premium payment, Whole Life
Insurance contracts are classified as: Straight Life, Limited- pay
and Single-pay policies.

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Straight Life Insurance

 It is also called 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, 100 years.
 It gives permanent protection at the lower cost.

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Limited-Pay Life Insurance

 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, 30 years or up to age 65.
 After the expiration of the specified time, the policy is said to be
paid-up, which means that no more premiums are to be paid to
keep the policy is in force.

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Cont,
 This policy is desirable when one intends to stop premium payments
after reaching a given age level, usually upon retirement, but wants to
continue with the insurance protection till the end of his life.
 Since premiums are to be paid for a limited period, they are usually
higher than those under the straight life insurance.
 Similarly, the Cash Values under the limited- pay are higher than that

of the straight-line policy.

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Single Payment Life Insurance

 Here premium payment is made in one lump- sum at the time of
purchase of the whole life insurance.
 In most cases, insurance buyers do not prefer this type of
arrangement (mode of payment).

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2. TERM INSURANCE
 This insurance scheme provides compensation (death benefit) to
the beneficiary if the insured person 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 not be any
payment made by the insurer.
 Term policy gives only temporary protection and there is no
saving element involved.
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Cont,
 Since the policy is taken for a specified period to deal with
premature death, the cost of this policy is relatively low.
 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.

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Cont,
 Term policies can be single premium policy or Level premium
Policy.
 Single Premium Policy is policy, which requires the payment of
the entire premium in a lump sum at the time the term policy is
issued level premium policy requires the payment of an equal
amount of premiums at definite intervals.
 In the case of the EIC, Single Premium policies are very rare.
Most of the term policies are level premium.
 More appropriately, term contracts can be classified as: level
term, renewable term or decreasing term.
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1. Level Term Policy

 Level term policy provides a constant sum assured throughout the
term of the policy.
 For example, under a 15-year term policy of Birr 30,000, the
amount of payment to the insured will be Birr 30,000 if the insured
dies at any time during the policy period.
 Level Term policies can be convertible or nonconvertible

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A. Convertible Term Policy

 Convertible Term Policy is a term policy that gives the
policyholder the option to convert his term policy into the other
types during the tenure of the term policy.
 No new evidence of insurability (medical certificate, etc…) is
required upon conversion.
 If conversion is not made, the policy lapses at the end of the
term. The term contract can be converted into whole life of
endowment insurance.
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Cont,
 Conversion may be effected using either the attained age at the time
of conversion of the term policy or using the date of the initial term
policy issued.
 In the case of the latter premiums are calculated retroactively,

and the insured would be required to make up the difference in

premiums, including interest, through lump-sum payment at the
time of conversion.
 To eliminate anti-selection problem, the following requirements are

to be met upon conversion.

1. There will not an increase in the sum assured.
2. The option will have to be exercised with in a specified period.


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B. Nonconvertible Term Policy

 Under this scheme, the term policy cannot be converted into other
forms of life insurance contract. The policy terminates upon
maturity. However, it could be renewed.
2. Renewable Term Policy
 This is a term policy, which can be renewed upon expiration.
 No new evidence of insurability is required, but the premium
charges are adjusted to reflect the standard premium at the
attained age.
 Accordingly, yearly renewable term policies require renewable
every year. Similarly, a 5-year term policy may be renewed upon its
maturity. In most cases, group policies fall under this category

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3. Decreasing Term Policy

 In a Decreasing Term Policy, the sum assured (amount of claims
to be paid to the insured) decreases periodically (monthly,
quarterly, semi-annually, yearly, etc…).
 These policies are usually, issued to cover the outstanding claims
(debts) of a creditor (debtor) in the event of accidental death of the
debtor. The outstanding claims (debts) diminish periodically as
installment payments are made by the debtor at regular intervals .
 This types of policies provide financial protection to the policy
holder (creditor) and to the family (dependents) of the debtor.
The dependents of the Insured are saved from raising funds or
selling certain property in order to pay the outstanding loans.
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3. ENDOWMENT INSURANCE
 This policy pays face amount of insurance if the insured dies
with in a specified period; if the insured survives to the end of
endowment period, the amount is paid to the policy owner at that
time.
 This policy provides payment if the insured manages to live till the
end of the endowment period specified in the policy, or upon his
death at any time during the term of the policy whichever occurs
first.
 The period of this policy is shorter then that for Whole Life
Insurance, and hence the premiums are higher for the same age
level.
 The shorter the endowment period, the higher the premium
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cont,
 The insured can surrender the policy at any time and collect the
cash value in a lump sum.
 The cash value normally becomes positive after two or three years.
 The policy, therefore, has dual purpose – protection against a
peril and permitting savings.
 It is a powerful means of accumulating funds for possible
contingencies in the future with an added advantage of covering
the beneficiaries against risk of death of the insured.
 In fact, the giving element is considered more important.

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Cont,
 Another advantage is that the policy provides the insured with loan facility after
the policy-acquired cash value.
 The insured can have the option of returning the loan to the insurer or retain it,
in which case the loan including the interest is to be deducted from the final
settlement upon the termination of the policy.
 If, for some reasons, the insured discontinues payment of premiums, the cash
value can be used to keep the policy in force under the automatic premium loan
provision provided the insured agreed to the effect of this provision at the time
of policy purchase.
 Currently, the EIC issues 10-year, 20-year, 25-year and 30-year endowment
policies. The other arrangements are endowment at age 55, at age 60 and at age
65.

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ENDOWMENT ANNUITY
 This is a policy that provides retirement income to the holder. It also
incorporates protection during the term of the policy up to the age of retirement.
 EIC currently issues such a policy to a retirement age of 55, 60 or 65.
 Specifically, the policy provides the following benefits to the holder:
 1. Monthly income of Birr 10 for each Birr 1000 of the face amount for the
remaining life of the holder, after maturity, with the guarantee that 120
monthly payments be made even if the holder dies within that period; or
 2. Instead of monthly payment, a single cash payment equal to the maturity
proceeds, or a combination of paid-up Whole Life insurance and cash payment

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Cont,
 Upon maturity, the Cash Value of Endowment Annuity is larger
than the Sum Assured.
 Normally, after a certain point of premium payment, but before
maturity time, the Cash Value will exceed the Sum Assured,
Consequently, if the insured dies at or after this point, the amount of
death benefit payable to his beneficiary with be the Cash Value.
 Another aspect of this policy is that premiums on policies, issued to
female insured are higher than those premiums for male insured’s.
 This is because the Corporation expects to make annuity payments
to female insured’s relatively for a longer period as females are
generally expected to live longer than do males.

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5.3. PREMIUM DETEMINATION

 A difference must be made between the following types of
premiums:
 Net Premium
 This is a premium rate determined on the basis of mortality
rate and interest rate only.
 It does not include the operating costs charged by the insurer.
 Net premium provides the insurer only with the amount of money
required to pay death claims.

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Net Single Premium

 When the total net premiums of an insurance policy are to be paid
as a single sum at the beginning of the contract, it is called the Net
Single Premium.
Net Level Premium
 This is a premium charge that does not change from year to year
throughout the term of the policy.
 In other words, the policyholder pays the same amount of
premium each year.

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Gross Premium
 When a portion of all the insurer’s costs of running the business
are added to the Net Premium, the resultant premium is called
the Gross Premium.
 The Gross Premium is the amount the policyholder pays to the
insurer to keep the policy in force.
 In insurance terminology, the addition of the insurer’s costs of
doing business to the Net Premium is called Loading.
 These costs include operating expenses, commissions,
advertisement expenses etc.

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Net Single Premium

 The following information is required to
determine the net single premium.
 - Age and sex of insured’s.
 - Mortality rate.
 - Interest rate.
 - Amount of insurance policy.

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Example
 The following example will provide the basic insight as to the
techniques employed in premium determination.
 According to the 1980 Commissioners Standard Ordinary (CSO)
mortality table, out of an initial population size of 1,000,000 male
people 958,000 live at age 30.
 The number of people expected to die at the age is 1,657.
 This means that the probability that a person aged 30 will die
during that age will be 0.00173, (1,657/958,000).
 Probability= no. of dying
no. of living

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Cont,
 Assume that an Insurer issued one-year Term Insurance to all
these male individuals aged 30 (958,000 policies) for death benefit
of Birr 5,000 each.
 Assume also that the premium is to be collected at the beginning
of the policy issue, and the death benefit (policy amount) is to be
paid at the end of the year.
 Also assume that the interest rate is 10%.
 Each the insured persons are assumed to bring the same level of
risk to the group.
 The number of policyholders at age 30 is 958,000. The number of
expected deaths at age 30 is 1,657.
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Cont,
 Expected death claim= no. of dying* death benefit
 Accordingly, expected amount of death benefits becomes Birr
8,285,000, (1657*5000). This is the amount that the insurer
expects to pay for death claims at the end of the year, i.e. upon
maturity of the Term Policy.
 The cash needed for payment of death claims is obtained through
the collection of premiums from the insured’s.
 The insurer, however, will not collect Birr 8,285,000 from the
insured through equal distribution because the premiums collected
at the beginning will have to be invested at 10% to bring interest.

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Cont,
 Consequently, it is necessary to find the present value of Birr
8,285,000.
 Pv of death claim= Total death claim
 (1+i)n
 The present value of this sum is then Birr 7531818.18,
(8285000/1.10). This present value is, therefore, the amount that
should be collected from the insured at the beginning of the policy.

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Cont,
 This amount is, then, divided by the number of insured to arrive at
the NET SINGLE PREMIUM.
 NSP=Pv of death claim
no of insured
 NET SINGLE PREIMUM = 7,531,818.18/958,000 = Birr 7.862
 Every Insured will have to pay Birr 7.862 Net Single Premium
(NSP) at the beginning of the Term policy.
 The Insurer will, then, collect a total of Birr 7,531,818.18 which
will grow to Birr 828,500 in one year time at 10%. This amount
will be sufficient to pay the expected death claims at the end of
the year.
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TERM INSURANCE
 With the above example as a background, let us try to determine the
Net Single Premium for a Term policy. Consider the following
information:
 3- Year term policy for Birr 5,000 to be issued at the beginning of
the year.
 Number of policy holders 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
occurred.

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CSO, 1980 mortality rate

Year Age No. of living No. dying Probability of dying

1. 30 958,000 1,657 0.00173

2. 31 956,343 1,702 0.00171

3. 32 954,640 1,747 0.00183

Expected death claims in each of the years during the term of the
policy are shown in the table below. The Insurer expects to pay death
claims of Birr 828,500 in the first year, Birr 85,100,000 in the second
year, etc.
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Year Age No. dying Amount of policy Expected Death

Claim
1. 30 1,657 5000 8,285,000

2. 31 1,702 5000 8,510,000

3. 32 1,747 5000 8,735,000

Total Expected Death Claims 25,530,000

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Each year’s expected death claim is discounted at interest rate

(10%) to arrive at the present value of total claims.
 This present value is then divided by the number of insured to determine
the net single premium. The analysis is shown below.
1 2 3 4 5 6
Year Death PV Factor (2*3) No. of (4/5)
Claims at 10% PV of Insured Annual Net
Claims Premium
1 8285000 0.9091 7531893.5 958000 7.862
2 8510000 0.8264 7032664 958000 7.341
3 8735000 0.7513 6562605.5 958000 6.850
25530000 21127163 22.053
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Cont,
 The Net Single Premium is Birr 22.053. It can also determine by
dividing the total present value of death claims by the number
of Insured.
 NSP = 21127163/958000 = 22.053
 Each Insured will be required to pay a Net Single Premium of Birr
22.053 at the beginning of the policy.
 This premium will enable the insurer to meet the expected death
claims that occur in each year as shown on the table below.

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Amortization of net single premium

1 2 3 4=(2+3) 5 6=4-5
year Beginning Interest BB + Death Ending
balance at 10% interest Claim Balance
21126774* 2112677.40 23239451.40 8285000 14954451.4
1.
14954451.40 1495445.14 16449896.54 8510000 7939896.54
2.
7939896.54 793989.66 8733886.20 8735000 -1113.80*
3.
* Number of insured multiplied by Net Single
Premium.
** Difference due to rounding.
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ACTUARIAL NOTATIONS: -
 T = time (years)
 X = age
 Lx = number of people living during age x.
 (Lx – Lx +1) = dx = number of people dying during age x.
 (Dx/Lx) = px = probability of dying during age x.
 (Lx+1/Lx) = qx = Probability that an individual Survives
at age x.
.

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Number Number Dx/Lx Lx+1/Lx

Year Age Living Dying = = Px + qx
t x Lx Dx px qx

1 60 808592 13002 0.01608 0.98392 1

2 61 795590 13954 0.01754 0.98246 1
3 62 781636 15000 0.01919 0.98081 1
4 63 766636 16145 0.02106 0.97894 1
5 64 750491 17367 0.02106 0.97686 1
6 65 733124

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• The probability that a person aged 60 dies during age 60 is

0.01608.
• The probability that this individual survives age 60 is, then,
0.98392, (1-0.01608).
• Consider the 3- year Term Insurance discussed earlier. The
following notations are used:
T = policy term (3 years)
S = Sum assured (Birr 5000)
r = interest rate (10%)

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Formula to determine Net Single

Premium:

 or no. dying

NSP=sum of death benefit no of insured

1+i n

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Using this formula the Net Single Premium is

computed as follows:

Year Age Number Living Number dying

t x Lx dx

1 30 958000 1657
2 31 956343 1702
3 32 954640 1747

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NET LEVEL PREMIUM

 Suppose that instead of paying a single premium at the beginning of
the policy, the policyholders want to pay annual premiums of
equal size. Here there are two points to be considered.
 Firstly, not all the policyholders will pay the annual level premiums
since some of them are expected to die before the end of the term.
 Secondly, the insurer is now collecting limited amount of premiums
to invest at the very beginning of the policy.
 Accordingly, the total annual level premiums paid by a policyholder
under the level scheme will be greater than the single premium
paid at the beginning of the policy.
 This equal annual premiums paid by a policy-holder is then called
NET LEVEL PREMIUM.
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Cont,
 The calculation is shown below the approach is as follows:
 First we assume that each insured pays level premium of Birr
1 throughout the term of the policy.
 The present value of Birr 1 premium payment is determined.
 The total present value is then divided by the number of insured
to arrive at the present value of Birr 1 premium payment per
insured.
 Finally, the Net single Premium is divided by the present value of
Birr 1 premium payment per insured to determine the Net Level
Premium.

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No. of insured PV of $1 payable PV of $ 1

Year Age Paying Beginning of year Premium
premium

1 30 958000 1 958000
2 31 956343 0.9091 869411
3 32 954640 0.8264 788915
TOTAL PV 2616326

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PV of $ 1 premium total Pv of premium pmt

Payment per Insured = no. of insured
2612326/958000 = 2.731
Alternatively: The PV of $ 1 annual premium payment for three periods
becomes:
The PV of $ 1 annual premium payment for three periods becomes:
PV of Birr Premium payment =
(958000/958000) 1
+
(956343/958000) .9091
+
(954640/958000) .8234

= 2.731

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NET LEVEL PREMIUM = NET SINGLE PREMIUM

PV of $ 1 premium Payment per insured

= 22.053/2.731
=$ 8.075
The following table shows the amount of Net Level Premiums to
be collected and the expected death claims to be paid each year.

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Amortization of net level premium

1 2 3 4 = (3 + 5 6 7
Year Annual Total 7) B.B Death Ending
Level Premium Beginning Invested Claims Balance
Premium Collected Balance At 10%

1 8.075 7735850 7735850 8509435 8285000 224435

2 8.075 7722470 7946905 8741596 8510000 231596

3 8.075 7708718 7940314 8734345 8735000 -655*

* Difference due to rounding.

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th e
n d of
E
p t e r
c h a

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