Insurance Premiums

Actuaries base traditional life insurance premiums on all of the following factors, EXCEPT: sales projections mortality (or morbidity) interest rates expenses

sales projections

Premium tax

A premium tax is a tax levied on insurance companies when they receive premiums. It is imposed by only a few states. Most companies pass this tax on to their policyowners in some way, either directly or indirectly.

Premium payment methods

In calculating gross level premiums, actuaries make two key assumptions: Premiums will be paid once each year (annually). Premiums will be paid at the beginning of the policy year. In other words, insurers assume they will have the full premium for the full year to earn interest. There's just one catch: Many consumers prefer to spread their premiums out and pay them more frequently than once a year. To accommodate that preference, insurers offer policyowners the ability to use any of the following premium modes: monthly quarterly semiannually annually For those policyowners who do choose a premium mode other than annual, insurance companies add a modest cost to reflect lost earnings on the portion of the premium not paid at the beginning of the coverage year; and the increased administrative cost resulting from the need to send more frequent premium notices. For example, a policy that has an annual premium of $1,200 might charge the following rates for those who choose to pay more frequently than once a year: a monthly premium of $108, for an annualized premium of $1,296 a quarterly premium of $318, for an annualized premium of $1,272 a semiannual premium of $624, for an annualized premium of $1,248 In each case, the total yearly premium paid in excess of $1,200 offsets the insurer's increased billing costs and lost interest.

Premium factors

Insurance premiums are individually assigned to each policy as part of the underwriting process. While they are assigned by the insurer's underwriters, premium rates are developed by the company's actuaries (i.e., insurer mathematicians). Actuaries base life insurance premiums on three factors: mortality, interest, and expenses: Mortality is the risk of death posed by the applicant. It is a charge. Interest is the amount the insurer can expect to earn on invested premiums. It is a credit. Expenses represent the insurer's costs of doing business. It is a charge. Taxes and fees may also be added to the net premium in addition to the expense charge to yield the gross premium charged to the policyowner.

2001 CSO Table

Life insurance companies today use the 2001 CSO table. In fact, policies issued since 2009 are required to base their mortality charges on the 2001 CSO table. Prior to that, the 1980 CSO table was the standard, and policies issued before 2009 may continue using that table as the basis of their mortality charges. The 2001 CSO rates reflect the mortality experience of the entire U.S. population for every age beginning at birth and concluding at age 120. (The 1980 CSO rates ended at age 100.) Through underwriting, insurers expect to realize much better mortality experience than the CSO table would predict, and this is reflected in rates that are lower than they would be if based solely on the CSO table. Insurers use the CSO mortality tables as a minimum standard in determining mortality rates. With their extensive experience underwriting life insurance, the largest life insurers base their premium rates on their past experience. An insurer must adjust the rates to ensure a margin of safety. With life insurance pricing, this means increasing the mortality rates by some factor. With annuity pricing, the mortality adjustment causes the insurer to decrease the mortality factor to recognize the chance that an annuitant might live (and thus receive payments) longer than expected.

Maintenance fee

Some variable life insurers charge a maintenance fee to cover the costs of managing the complex investment element of the contract. Separate account management is far more complicated than general account management, and this is generally reflected in the gross annual premium of variable insurance contracts.

Interest

The interest that insurers earn on their general account investments is an important factor in determining the premium rates it charges policyowners. The more interest the insurer can earn through its investments, the less premium it needs to charge. Actuaries add an interest factor to their premium calculations to recognize the company's investment earnings. The interest factor works as a credit; the higher the assumed rate, the lower the premium. This also means a higher premium must be charged if assumed interest rates decrease.

Mortality

The mortality factor reflects the insured's risk of death. At its base, the mortality factor is drawn from mortality statistics compiled by the National Association of Insurance Commissioners (NAIC) into a set of rates called the Commissioners Standard Ordinary (CSO) table.

Which of the following most accurately describes the basic function of a life insurance policy's net single premium? The net single premium represents the insurer's mortality and expense factors and is used to help actuaries determine the proper mortality charge. The net single premium is the sum of the present values of all the expected benefits payable under the policy. The net single premium is the amount an individual actually pays to provide all the benefits promised in the policy regardless of premium mode. The net single premium is the amount actually charged to the policyowner who wants to purchase the policy with a single premium payment.

The net single premium is the sum of the present values of all the expected benefits payable under the policy.

Which of the following statements generally guides insurance companies in determining "loading"? Total loading from all policies should meet industry averages. Total loading from all policies should cover total operating costs, provide a safety margin, and contribute to profits or surplus. The resulting net premiums should help the company maintain or improve its competitive position. Expenses should be divided primarily among the company's most profitable plans and lowest mortality experience.

Total loading from all policies should cover total operating costs, provide a safety margin, and contribute to profits or surplus.

Expenses

An expense factor (sometimes called a load factor) is worked into the premium calculation. The load factor reflects the costs (other than mortality) that the insurer expects to incur on the policy. These operational costs include the insurer's expenses for rent, salaries, benefits, commissions, and field expenses. The insurer also accounts for a margin of profit it wants to earn on its operations. In determining its load factors, insurers are generally guided by three objectives: cover total operating costs provide a safety margin contribute to profits or surplus

Net vs. Growth Premium

The process of determining the premium that is actually charged involves several steps by the insurer's actuaries: Calculate net single premium, using the factors of mortality and interest. This is the theoretical amount, excluding the load factor, which would be needed to fund the face amount for the duration of the policy with a single premium payment. Calculate the net level premium by applying a factor to the net single premium that essentially spreads out the premium for the duration of the premium-paying period. Calculate the gross premium that is actually charged for the policy by adding the expense load to the net single premium or net level premium. Applicants who are purchasing a single premium life insurance policy will pay a gross single premium, while those who will spread premiums out over a number of years will pay a gross level premium (also called a gross annual premium).

Actuaries begin the process of calculating life insurance premium rates by using mortality tables, which help predict future experience but not with 100 percent certainty. How do actuaries compensate for this uncertainty when determining the gross premium charged to the policyowner? They assume a higher rate of interest than actually expected, which provides a safety margin by increasing the gross premium. They assume there will be fewer deaths than their past mortality experience would predict, which provides a safety margin by increasing the gross premium. They add an expense load, which includes a safety margin factor, to the net premium to produce the gross premium. They add a safety margin load to the mortality charge, increasing the net premium.

They add an expense load, which includes a safety margin factor, to the net premium to produce the gross premium.

Level vs. Flexible premium payments

Depending on the policy, a life insurance policyowner may have the choice of paying the premium on a fixed level basis or on a flexible basis. Under a level premium payment plan, the premium is fixed and remains level over the policy's term. The policyowner pays the same premium amount each time it is due for as long as the policy is in force. This payment amount does not change even though the risk to the insurer increases over time as the insured ages. Policies that use the level premium method include whole life insurance and variable life insurance. Under a flexible premium payment plan, the policyowner can change the premium payment amount at will, after the first payment, within a range set by the insurer. Depending on the policy, the policyowner can change the payment amount or frequency of payment. The policyowner can also choose to stop payments for a while and then restart them. Policies that use the flexible premium method include universal life insurance and variable universal life insurance.