FINA 442 Hartwig - Exam 1
elasticity of demand
(% change in Qd)/(% change in price) if the elasticity of between o and -1 = inelastic if the absolute value > 1 = elastic
participating policies and dividends
-"par" -are entitled to share via non-guaranteed policy elements in any distribution of the insurer's surplus that it decides to make under those policies -"participating" in life insurance company's good fortunes if it does well
pure premium - annual renewable term
-(the premium associated with the risk of death only; insurer expenses not included) is determined by the mortality rate at each attained age -example: $1000 face amount $100,000 in coverage at age 40 the pure premium is (100 x $3.02) = $302
cash value life insurance: (ordinary) whole life
-a cash value policy that provides lifetime protection (idea is that protection is provided throughout your "whole life") -fixed premium or policy will terminate -a stated amount is paid to a designated beneficiary when the insured dies, regardless of when death occurs -legal reserve: the excess premiums paid during the early years are used to supplement the inadequate premiums paid during the later years of the policy. legal reserve is a liability
economically non-productive period
-begins at retirement -ends at deaht
policyholder loans
-borrow against cash value of the policy
managing moral hazard
-charging more for tobacco usage to convince people to live healthier lifestyles -delta airlines charging more for people who are not vaccinated
cash-value life insurance
-combines term insurance (death benefit) and internal savings component called "cash value" -investment earnings build up on a tax-deferred basis
advantages of universal life insurance
-flexibility -cash withdrawals are permitted -favorable federal income tax treatment
universal life insurance
-flexible premium policy -lifetime protection -after first premium, policyholder decides amount and frequency of payments
cash value life insurance
-higher upfront premiums than with the term -policyholder "prepays" part of the cost of future death benefit -premiums generally do not increase over time even though the probability of dying is increasing -life time protection -cash values are a by-product of the level premium
interest credit rating
-if the insurer can earn above interest return, they can translate this into more interest credited to cash values -higher cash values, which reduces net amount risk -allows company to charge lower prices for their policies
second-to-die life insurance
-insures 2+ lives -pays death benefit upon the death of the second or last insured -often used to provide financial security for a disabled child
advantages of term life insurance
-less expensive than cash value -provides more coverage for the same amount of money -all the money goes toward the death benefit policy -simple to understand -does exactly what its meant to do
taxation of life insurance
-life ins proceeds paid in a lump sun to a designated beneficiary are generally received income-tax free -the interest component of periodic payments is taxable as ordinary income -premiums are generally not tax deductible -dividends are not taxable, but interest on dividends retained is taxable -if a policy is surrendered for its cash value, any gain is taxable as ordinary income -proceeds from a life insurance policy are included in the gross estate of the insured for a federal estate-tax purposes if: the insured has any ownership interest, they're payable to the estate, 2020 federal tax exemption -proceeds maybe be removed from the gross estate if the policyholder makes an absolute assignment of the policy to someone else -policy owner must make the assignment more than 3 years before death -federal estate tax is payable if the decedents taxable estate exceeds certain limits
mortality-based policies: 2 categories
-life insurance: pays a death benefit on the death of the insured -annuity contracts: policies that promise to make payments through the systematic liquidation of principal and interest for a fixed period or over the annuitant's lifetime
single-premium whole life
-lifetime protection with single, large premium paid at policy inception
advantages of policyholder loan
-loan with no credit check like a bank would require -no fixed payment schedule
ordinary life is not always the best solution
-may cause person to be underinsured -lifetime protection may not be priority
disadvantages of term life insurance
-more expensive with age -if insured outlives policy there is no death benefit -only provides protection for selected period of time
cash value life insurance: surrender charges
-most cash value has this -amount assessed against the policy's cash value as a type of penalty for early termination of policy -allows insurer to recoup some of the costs of policy issuance and maintenance without penalizing policyholders who do not surrender policies -usually declines over time and eventually disappears, but can be significant in the early years
disadvantages of policyholder loan
-not required to pay back loan, so cash value could be permanently reduced and amount owed could exceed cash value if CV falls
morbidity-based insurance: medical expense insurance
-offered on a group or individual basis -can be sold as guaranteed renewable or nonrenewable -market is undergoing huge changes due to ACA -large scale consolidation
term life insurance
-pays policy face amount of the insured dies during the policy term -provides temporary protection -life insurance that provides a specific amount of coverage for a designated period of time
private insurance
-person whose L/H is the object of the policy -purchase may be voluntary (life ins) or compulsory (auto) -premiums are determined actuarially
life insurance contractual provisions: ownership clause
-policy owner possesses all contractual rights while insured is living -rights include naming beneficiaries and surrendering the policy for cash value, receive dividends, elect settlement options -policy owner can designate a new owner by filing an appropriate form -possible owners: insured, beneficiary, third party
endowment insurance
-policy pays a face amount if insured dies within a specified period -if the insured survives to the end of the endowment period, the face amount is paid to the policy owner -impacted by deficit reduction act of 1984 -new endowment policies no longer meet tax definition of life insurance -caused most life insurers to discontinue sale of new endowment policies -not very common anymore
3 pricing objectives: economic feasibility
-premiums must be priced so that they are affordable -rates must not be excessive -premiums vary widely
3 pricing objectives: adequacy
-premiums must be sufficient to fund benefits promised -inadequate rates can lead to financial problems for the insurer and even insolvency if severe enough -in L/H, life insurance rates are generally not regulated while health is -life insurance is indirectly regulated through minimum reserve requirements
social insurance
-provided by governments -many forms: unemployment, health, disability, retirement (diff for all countries) -often compulsory with government mandated premiums -price may be subsidized; goal might be income redistribution
types of term life insurance: level
-provides a designated face amount of coverage for the entire period of the policy -premiums don't increase
term life in depth
-provides a specific amount of life insurance coverage for a designated time period -if insured dies during period, money is paid to the beneficiary -simplest form of life ins -does not build any cash value -often one of the least expensive types of insurance -three key factors considered with life insurance 1. face amount: protection or death benefit 2. premium: to be paid-cost to the insured 3. length of coverage: term period
limitations of universal life insurance
-rates of return may turn out to be less than policyholder had assumed based on insurer assertions -cash-value and premium-payment projections developed during period of high interest rates could lead to results that fall below expectation -insurers can increase the current mortality charge to recoup expenses -policy may lapse bc policy owner does not have a firm commitment to pay premiums
3 pricing objectives: equity
-rates should be commensurate with expected losses and other expenses associated with each policyholder brings to the risk pool -insureds will be classified into similar groups -life insurance underwriting is more refined that health
insurable interest
-requirement for making an insurance contract -must exist at time of inception, does not need to exist at payout
factors influencing life insurance demand: political & legal factors
-stable political environment positively influences insurance demand -generous gov benefits structures can lower life ins demand -gov regulation of insurance influences supply
an economically productive period of life
-starts when a person leaves the family and its authority (emancipated) -enters work force -beings to earn income and save -ends at retirement
mortality charges
-the charge associated with the probability of paying a death claim -the amount charged for a given year is that year's NaR and the mortality charge Cost of Insurance (COI), adjusted for the policyholder's age, sex, and other underwriting factors example: (face value - cash value) x (pure premium rate per $1000 coverage) (1M - 200k) = 800k x ($2 rate per $1000 coverage) = $1600
net amount of risk (NaR)
-the difference between the legal reserve and the face amount of coverage -NaR decreases as cash value (legal reserve) increases
types of term life insurance: renewable
-the insured has the option to renew the contract without proof of insurability -every time the policy is renewed, the premium increases to reflect the current age of the insured
exceptions to the incontestable clause
-the insurer can contest a claim after expiration of the period in limited circumstances involving egregious behavior -in this case, the insurer might argue that the incontestable clause should not apply and coverage should be voided -ex: lack of insurable interest at policy's inception, another person taking the medical exam
life insurance contractual provisions: incontestable clause
-the insurer cannot contest the policy after it has been in force for 2 years during the insured's lifetimes -protects the beneficiary if the insurer tries to deny payment of the claim years after policy was issued -insurer has 2 years to detect fraud
life insurance contractual provisions: entire contract clause
-the life of the ins policy and attached application constitute the entire contract between the parties -prevents the insurer from making amendments without the policyholder's knowledge -prevents insurer form rescinding the policy -protects the agent from oral claims that are not stated in the policy - an agent does not have binding authority in life insurance, they need permission of the insurer to make changes
limited-payment whole life insurance
-type of whole life -lifetime protection -premiums are level but only paid for a certain period of time rather than lifetime of policy
factors influencing life insurance demand: inflation
-usually detrimental to insurance demand -during inflation, customers prefer shorter term, more liquid investments -on the supply side, inflation causes uncertainty for insurers in terms of long-term planning and investments
loading charges
-variously called loading charges, expense charges, fees and policy loads -unbundled policies contain guaranteed max loading charges (typical of variable life) -bundled policies contain no guaranteed max charged
modified life policy
-whole life -premiums are lower for first 3-5 years and higher after -besides lower premiums in beginning, basically identical to ordinary life
limited payment policy
-whole life policy -premiums are payable for a limited number of years -then policy becomes paid up for its face amount (paid up = no more premiums owed; policy remains in force)
riders or additional benefits for term life insurance
1. cost of living adjustment (COLA): provides for the increase of the term life ins policy's death benefit in an amount equal to the increase in the general cost of living 2. return of premium: provides that if the insured keeps the policy for the term period, at the end of the period, the life insurance company returns all of the premiums paid 3. waiver of the premium: if the insured becomes totally disabled, the premiums on the life insurance policy and any riders will be waived for the duration of the disability
requirements for insurable risk
1. large number of independent and homogenous exposure units 2. accidental and unintentional loss 3. losses easily determinable as to time, amount, and type 4. economically feasible premium
financial planning assumes that individuals should:
1. maximize the accumulation of assets during their productive working years 2. rationally liquidate assets during retirement to achieve the desired level of self-sufficiency
requirements for an informal contract
1. mutual assent of meeting of the minds 2. legally adequate consideration 3. lawful purpose 4. contractual capacity
to avoid adverse financial consequences of death, resources must come from one or more of these sources:
1. relatives 2. savings/investment 3. employer-provided death benefits 4. individual life insurance
options/key features for term insurance
1. renewability: the most common option on term policies is the right to renew the policy 2. conversion: the right to convert a term policy into a permanent policy without any new evidence of insurability 3. re-entry provision: the insurance company can ask the insured to undergo a medical exam before it will renew the policy after the term expires
dividend options: apply toward premium payment
Dividend is credited toward premium payment for the current year, thereby reducing cost to policyholder
dividend options: Purchase One Year Term
Dividend used to purchase 1-year term insurance. Two options: (i) used to buy as much term insurance as possible; (ii) purchase term insurance in the amount of the policy's cash value, with any excess dividend paid as one of the other 4 options
dividend options: Accumulate at Interest
Dividends are held "at interest" by the insurer. Insurer guarantees a minimum crediting rate (i.e., rate of return) on dividends earned. Accumulated sums can be withdrawn at will. When policyholder dies, policy pays face amount of policy plus dividend accumulations
dividend options: Purchase Paid Up Additional Insurance (often referred to simply as "Paid Up Additions"):
Most popular option. Dividend applied to the purchase of as much whole life insurance as possible. Thus when the policyholder dies, the payout is equal to the face amount of the policy plus accumulated PUAs. PUAs can be par or non par. If par, additional dividends will accumulate and can increase cash value of policy over time. Form of compounding.
insurance
a legal contract where the policyholder agrees to pay a premium to the insurer in exchange for a defined sum or service if specified contingencies (death, injury) occur during term of the policy.
universal life
a type of cash value life insurance that offers policy owner a flexible premium structure, current interest rates paid on cash values, and flexible death benefit amounts
asset share
accumulated assets arising from a group of policies are allocated to individual policies -surplus strain: if the policy is surrendered and its asset share is less than the cash surrender value, this imposes a cost on the insurer
factors influencing life insurance demand: demographic
age of marriage (-) aging population (+) urbanization and industrialization (+) education (+)
factors influencing life insurance demand: price
as the price of any product/service increases, demand falls
bargaining vs. adhesion
bargaining contracts: the parties are equal in setting the terms of the agreement contracts of adhesion: one party prepares the terms of the contract and it is accepted or rejected without negotiation, insurance
bilateral vs. unilateral
bilateral: both parties have mad enforceable promises unilateral: only one party makes enforceable promise, insurance is unilateral
3 types of informational asymmetry problems
buyer ignorance, adverse selection, moral hazard
whole life
cash value life insurance that provides guaranteed death benefits, guaranteed premiums and guaranteed cash value accumulation throughout the life of the policy
commutative vs. aleatory
commutative: one in which the parties enter an agreement about the values they will exchange in advance aleatory: one party provides something of value for conditional promise, life insurance
variable life insurance
fixed-premium policy in which death benefit and cash values vary according to the investment experience of a separate account maintained by the insurer -premium is level -if investment is favorable, the face amount of insurance is increased -cash surrender values are not guaranteed -policy owner has the option to invest the cash value in a variety of investments
life insurance contractual provisions: suicide clause
if insured commits suicide within two years of policy issuance: -face amount will not be paid -only refund of premiums will be made purpose: reduce adverse selection legal presumption against finding of suicide death normally considered act of unintentional death insurer has burden of proof to prove insured committed suicide
managing adverse selection
insurance applicants have an incentive to conceal and misrepresent the true risk they post in order to get lower rates. the purpose of underwriting is to deter and detect adverse selection
buyer ignorance
insurance buyers are unable or unwilling to evaluate or understand their contracts
annuities and pensions
insurance which pays while an insured is still alive
dividend options: cash
insurer pays dividend in cash to the policyholder each year
factors influencing life insurance demand: globalization
life insurers continue to expand into many developing markets around the world creating new products and sales strategies along the way
moral hazard
occurs when the presence of insurance changes loss prevention behavior. the insured become less risk averse because they know they have insurance.
classical/tradition life insurance
pays benefits to named beneficiaries on the death of the insured
morbidity-based insurance: long-term care insurance
pays for services when the insured is unable to perform specific duties of daily living without assistance
health and disability
pays in the event of loss of health, physical or mental disability/incapacity, medical expense ins, disability income, long term care, credit L/H, "Dread" Disease coverage (cancer), workers comp
adverse selection
people who are most eager to buy insurance are the most likely to use it
persistency
percentage of policies not terminated by lapse or surrender
the beneficiary
person or entity entitled to insurance death, disability, or health benefits in the event of a policy claim
the insured
person whose life/health is the object of the policy -usually the policyholder
type of exposure: longevity risk
possibility of outliving one's financial resources
type of exposure: morbidity risk
possibility that injury, disease, or incapacity creates unacceptable financial consequences
type of exposure: mortality risk
possibility that one's death causes negative financial consequences for others
types of term life insurance: annually renewable term
premium is paid for one year of coverage, but the policy is guaranteed to continue each year for a given period of years
morbidity-based insurance: disability income insurance
provides for monthly payments to replace some share of loss of income when the insured is unable to work to illness or injury
types of term life insurance: group
purchased typically by an employer or professional association that is intended to cover several people, usually resulting in reduced premiums and underwriting
factors influencing life insurance demand: social factors
sales are higher in countries where high personal savings rates are the cultural norm
contribution principle
surplus distributed to policies in same proportions as those in policies contributed to the surplus
lapse
termination of life insurance policy after the expiration of the grace period for failure to pay the premium necessary to maintain it in full effect
types of term life insurance: increasing
the face amount of the insurance rises during the policy period
types of term life insurance: decreasing
the face amount paid upon the insured's death is reduced gradually over the policy period
factors influencing life insurance demand: income & wealth
the higher the company's income, the more it spends on all types of insurance
types of term life insurance: convertible
the insured can convert the term policy into a cash value form of life insurance such as whole life or universal life ins without providing evidence of insurability
types of term life insurance: non-convertible
the insured can't switch the policy to another form
variable life
type of cash value life insurance that permits the policy owner to allocate the investment of his or her fixed premium payments among various investment options; variable life is regulated as a security
void contract vs. voidable contract
void: cannot be enforced by either party. the law treats a void contract as if it had never been formed voidable: is valid and can be enforced -usually only one party is bound to the contract terms, the unbound party (policyholder) is allowed to cancel the contract
surrender
voluntary termination of a life insurance policy by its owner for its cash surrender value
