Insurance Companies - Financial Institutions Management - Lecture Slides, Slides of Financial Management

Download Insurance Companies - Financial Institutions Management - Lecture Slides and more Slides Financial Management in PDF only on Docsity! Insurance, Life and Health Insurance Companies Docsity.com Agenda 1. Size, Structure and Composition 2. Balance Sheet and Recent Trends 3. Regulatory System 4. Property and Casualty Firms Docsity.com Indemnify • To put the beneficiary back to the same financial condition as prior to the occurrence of the loss. NOTE: because of this, insurance is a lousy investment. The best you can hope for is to be put back to your original condition…but since you pay a premium, you have reduced your assets in order to buy this coverage. In addition, there is usually a deductible involved…this helps to avoid the moral hazard problem in insurance … (the incentive to purposefully suffer the loss in order to capitalize on the presence of insurance.) Docsity.com What do Insurance Companies Do? • Insurance companies address the problems of risk faced by customers by providing: – Risk off-laying – Risk absorption – Risk transformation Services. Docsity.com Pure Risk • In insurance parlance, “pure risk” involves only the chance of loss, and not of gain. • Examples of pure risk are: – Death – Disability – Accidental dismemberment – Damage due to hail Docsity.com Insured Risks • The major risks that insurance companies have traditionally insured involve: – Personal injury, illness and death – Loss and destruction of property, and – Legal liability Docsity.com Size, Structure and Composition of the Industry 4039 Docsity.com The Life Insurance Industry • The life insurance industry in Canada is about one-quarter the size of the banking industry when measured in terms of assets or income, and slightly under half the size in terms of equity and employees. Docsity.com Life Insurance Products • Traditionally, life companies have provided two main services: – Protection – Wealth management • Life insurance allows individuals to protect themselves and their beneficiaries against losses in income through premature death. • Life annuities protect individuals against insufficient income due to unexpectedly extended life. • By pooling risks, life insurance companies not only transfer income-related uncertainties from the insured individual to the group, but also reduce these risks. • Other important products include: – Disability insurance – Critical illness insurance Docsity.com Wealth Management Products • Life insurance companies manage pension plans and sell life annuity contracts, registered retirement income funds (RRIFs) and registered retirement savings plans (RRSPs) • Life insurance companies sell a type of pooled investment known as segregated funds. Docsity.com RRIF • A registered retirement income fund is a retirement tax shelter, allowed by the government, from which the retiree must withdraw specific amounts each year. Docsity.com Types of Life Insurance • Two basic classes or lines of life insurance distinguished by the manner in which they are sold to purchasers: 1. Individual life insurance 2. Group life insurance Docsity.com Individual Life Insurance • Is sold one policy at a time, person to person, through company and independent agents. • Traditionally, personal sales have been expensive but result in tailor-made financial services for each individual buyer; • To reduce the cost of individual life insurance delivery, insurance companies have implemented “affinity insurance” sold through organizations such as alumni associations, professional associations or unions where members share common characteristics. Docsity.com Group Life Insurance • Covers many people under a single policy. • These policies are usually issued to corporate or government employers. • Their premiums may be fully paid by the employer or shared by the employer and employee. • The plans are subject to mass sales and administration. • Average commissions and screening costs per individual are correspondingly lower for group life policies than for individual life policies. Some of these savings are passed on to customer through lower premiums. Docsity.com Terms and Definitions Legal for Life: A regulated quality standard that an investment asset must achieve before it can be booked by a life insurance company (ie. bonds must be BBB or above). Policy Loan A loan made by an insurance company to a policyholder using his or her policy as collateral. Docsity.com Canadian Life Insurance Industy Consolidated Balance Sheet (as of December 31, 1998) Amount (C $ Millions) Percent Amount (C $ Millions) Percent Cash and short-term investments 11,240 4.08% Net actuarial liabilities under insurance policies and annuity contracts 196,037 71.19% Accrued investment income 3,300 1.20% Other insurance policy and contract liabilities 15673 5.69% Bonds 145,026 52.67% Trust and banking deposits 4,645 1.69% Policy loans 13,253 4.81% Accounts payable 4,411 1.60% Mortgage loans 58,033 21.07% Net deferred gains (losses) on disposal of portfolio investments 12,043 4.37% Shares 14,277 5.18% Deferred income taxes 495 0.18% Real estate 9,767 3.55% Other liabilities 13,483 4.90% Other loans and investments 2,491 0.90% Total liabilities 246,787 89.62% Accounts receivable 4,459 1.62% Policyholders equity 19,764 7.18% Other assets 13,522 4.91% Shareholders equity Capital stock 3,594 1.31% Total assets excluding segregated funds 275368 100.00% Other 5,225 1.90% Segregated funds 153,161 55.62% Total Liabilities and equit 275,370 100.00% Assets Liabilities Docsity.com How to Price Life Insurance 4039 Docsity.com Figure 3: Classification of Pure Risk Increasing Probability of Loss In c re a sin g M a g n itu d e o f L o ss Docsity.com Figure 3: Classification of Pure Risk Increasing Probability of Loss In c re a sin g M a g n itu d e o f L o ss Losses to property (flood, fire, theft) – Losses to human capital – high magnitude but low probability. Probability and Magnitude of loss help to select an appropriate risk management strategy. Docsity.com Counterintuitive • An increasing probability of loss does not necessarily mean that you require insurance against the risk. • When the probability of loss is very high, buying insurance is of no value, since it would simply be a prepayment plan. • Can you give me examples of this? • Lava flow damage next to a volcano • Earthquake damage on structures built on the San Andres fault • Water damage on homes built outside Winnipeg’s flood way. Docsity.com Figure 3: Classification of Pure Risk Increasing Probability of Loss In c re a sin g M a g n itu d e o f L o ss Probability and Magnitude of loss help to select an appropriate risk management strategy. Insurance for dents in automobile paint for a person who drives long distances on a regular basis over heavily traveled gravel roads. Docsity.com Important Concepts 2 Insurance as an Hedge • Why is insurance a lousy investment? • Because the pure payoff is simply to indemnify you for a loss…the indemnification is simply equal to the loss. • The pure premium (price) the insurance company sets (in a perfectly efficient and competitive market place) is designed to exactly balance cash inflows and outflows. • Of course the insurance company must in addition to the pure premium, charge fees, commissions and keep a margin for profits/losses. From a consumers point of view you are always expected to make less from an insurance contract than what you pay in premiums. Docsity.com Life Insurance • Obviously, death is a pure risk. • For some individuals this may be a catastrophic risk that must be managed. • Why just some individuals? • Insurance is usually the best way to manage that risk. • What factors affect the magnitude of the risk? Docsity.com Do you need life insurance? • Basically if you have financial dependents, you need life insurance. • Regardless of whether or not you have financial dependents, learning how to determine the amount of life insurance coverage needed is a valuable tool. Docsity.com K. Hartviksen Life Insurance • Life insurance claim payments are generally free of income tax. (Although interest generated by investing such funds would be taxable.) • To determine the amount of life insurance required, reasonable estimates of a family’s immediate and long-term financial needs are required. • This TOTAL NEEDS PLANNNING focuses on three cash and income needs: – last expenses – mortgage, education and emergency fund – dependents income Docsity.com K. Hartviksen Last Expenses • Upon death, an income earner’s last expenses become the surviving family’s first expenses. They include: – final medical bills (doctor, hospital and nursing fees) – funeral and burial costs – current bills for household and personal expenses – bank or other outstanding loans – unpaid property taxes – probate costs, legal and executor fees – unpaid income tax including capital gains taxes generated by deemed dispositions. Docsity.com K. Hartviksen Capital Needs Analysis • Determining how much life insurance is necessary is a two step process: – first, an asset inventory is prepared – second, estate obligations at death are determined based on cash needs, and income needs (discounted by a conservative real return rate). – The shortfall between available assets and estate obligations represents the amount of insurance required. • Since the beneficiary of the life insurance proceeds will likely pay tax on the annual investment income, the appropriate discount rate should be the after-tax rate. Docsity.com Mortality Tables Construction and Interpretation Docsity.com Pricing of Life Insurance • The pricing of insurance products follows a common procedure based on amount of the likely claim and the probability of occurrence. Docsity.com Law of Large Numbers • The Law of Large Numbers is not the same thing as the Law of Averages. – Mathematics tells us that the probability of heads coming up on any individual coin toss is 50% - but the outcome of each toss is independent of all the other. (It is neither influenced by previous tosses nor does it influence future tosses). – Consequently, the Law of Large Numbers cannot promise that the probability of heads will rise above 50% on any single toss if the first hundred, or million, tosses happen to come up only 40% heads. – There is nothing in the Law of Large Numbers that promises to bail you out when you are caught in a losing streak. Docsity.com Mortality Tables – how to read Age Alive at Start of Year Deaths During Year Probability of Survival Probability of Death 0 100000 709 0.9929 0.0071 1 99291 51 0.9995 0.0005 2 99240 41 0.9996 0.0004 3 99199 34 0.9997 0.0003 4 99165 25 0.9997 0.0003 5 99140 19 0.9998 0.0002 6 99121 16 0.9998 0.0002 7 99105 15 0.9998 0.0002 8 99090 13 0.9999 0.0001 9 99077 13 0.9999 0.0001 10 99064 14 0.9999 0.0001 11 99050 16 0.9998 0.0002 Standard Mortality Table - Canadian Males 709291,99000,100year during Deaths =−= 9929. 100,000 99,291Survival ofy Probabilit == 0071.0 0.9929 - 1 Death ofy Probabilit = = This image cannot currently be displayed. The only data required to build a mortality table for a given group or cohort of individuals is the actual number of surviving individuals at the start of each year over the lives of a large group. The larger the group, the more likely the law of large numbers will apply. Docsity.com Mortality Tables – by gender Age Alive at Start of Year Deaths During Year Alive at Start of Year Deaths During Year Male Deaths less Female Deaths During Year 0 100000 709 100000 577 132 1 99291 51 99423 45 6 2 99240 41 99378 30 11 3 99199 34 99348 24 10 4 99165 25 99324 18 7 5 99140 19 99306 14 5 6 99121 16 99292 13 3 7 99105 15 99279 12 3 8 99090 13 99267 11 2 9 99077 13 99256 11 2 10 99064 14 99245 13 1 11 99050 16 99232 11 5 12 99034 23 99221 16 7 Canadian Females Standard Mortality Experience Canadian Males Male babies are not as robust as female Males die in greater numbers statistically in every year of life for the first 82 years of life. Docsity.com Calculating the Pure Premium Pricing Term Life Insurance Docsity.com What is the Pure Premium? • The Pure Premium is the price an insurer would charge a term policyholder if the present value of the revenues received by the insurance company is exactly equal to the expected present value of the benefits paid to the beneficiaries. • The insurer is assumed not to earn a profit under the pure premium approach. Docsity.com Likelihood of the Insured Dying • The Pure Premium depends on the likelihood of the insured dying during the insurance coverage period. • Historical death rates for defined groups of people have been observed and reported in mortality tables. • Standard Canadian mortality tables follow a hypothetical group or cohort of 100,000 persons from birth to death and report the actual number of deaths each year for that year. Docsity.com Calculating the Pure Premium … Premiums are paid at the beginning of the year, but benefits are paid throughout the year. The insurance payout must therefore be discounted for this period. Assuming a 5% discount rate, the pure premium that must be charged is equal to $300 ÷ 1.05 = $285.71 If servicing costs are $35, then the final premium is equal to ($285.71 + $35.00) or $320.71 Docsity.com Calculating the Pure Premium … summary • The premium on a term insurance policy will increase with the insured’s age because the probability of death increases with age. • Larger insurance companies enjoy economies of scale advantage that allows their sample of clients to more closely match the experience of the mortality tables because of the Law of Large Numbers. Docsity.com Life Expectancy and Median Age Mortality Experience and Gender Differences Docsity.com Use of Conditional Probabilities Pricing Term Life Insurance Policies Docsity.com Using Conditional Probabilities to Solve a More Common Problem in Insurance • At some age, a person will decide to buy insurance, therefore you must measure the conditional probability of a person dying during the term of a Term Insurance policy given the fact they have already reached that given age. Example: What is the probability of a 35 year old woman surviving to age 45? Docsity.com Conditional Probability • We rarely buy life insurance for a child at birth, however, and the more useful information is the conditional probability that a person will live to a certain age, given that she is already ‘y’ years old. Age Alive at Start of Deaths During Year Probability of Survival Probability of Death 34 98405 61 0.9994 0.0006 35 98344 67 0.9993 0.0007 36 98277 73 0.9993 0.0007 37 98204 79 0.9992 0.0008 38 98125 85 0.9991 0.0009 39 98040 91 0.9991 0.0009 40 97949 98 0.9990 0.0010 41 97851 105 0.9989 0.0011 42 97746 116 0.9988 0.0012 43 97630 129 0.9987 0.0013 44 97501 145 0.9985 0.0015 45 97356 161 0.9983 0.0017 46 97195 180 0.9981 0.0019 Standard Mortality Table - Canadian Females %99.98 344,98 356,97 Surviving SurvivingyProbabilit lConditiona t 10t == = + What is the probability of a 35-year old woman surviving to age 45? • At age 35 there are 98,344 women surviving out of the original 100,000. At age 45 there are 97,356. The probability of survival, given that the woman has already reached 35, is 97,356/98,344 = 98.99%. Docsity.com Conditional Probability Example (NSP) policy insurance theof term the ratediscount the yearnext theduring die will)( aged individualan y that probabilit the years more survive will aged individualan y than probabilit the benefit)(death policy insurance theof valueface the M Where )07.1()07.1()07.1()07.1()07.1( 00,200$ )1( (NSP) Premium SingleNet x 5 35035 4 35035 3 35035 2 35035 1 35035 1 0 1 = = += = =       × + × + × + × + × ×= + × = + +++++ − = + +∑ T k ix Q i xP QPQPQPQPQP k QPM ix i iiiii T i i ixix $200,000 Term policy for a 35 year old woman expiring at age 40 (no costs, no saving component). Docsity.com Conditional Probability Example (NSP)…       × + × + × + × + × ×=             × + × + × + × + × ×= 54321 54321 )07.1( 0009.9969.0 )07.1( 0009.9978.0 )07.1( 0008.9986.0 )07.1( 0007.9993.0 )07.1( 0007.1000,200$ )07.1( 0009. 344,98 040,98 )07.1( 0009. 344,98 125,98 )07.1( 0008. 344,98 204,98 )07.1( 0007. 344,98 277,98 )07.1( 0007. 344,98 344,98 000,200$ Age Alive at Start of Deaths During Year Probability of Survival Probability of Death 34 98405 61 0.9994 0.0006 35 98344 67 0.9993 0.0007 36 98277 73 0.9993 0.0007 37 98204 79 0.9992 0.0008 38 98125 85 0.9991 0.0009 39 98040 91 0.9991 0.0009 40 97949 98 0.9990 0.0010 41 97851 105 0.9989 0.0011 Standard Mortality Table - Canadian Females             × + × + × + × + × ×= + × = ∑ − = + + 54321 1 0 1 )07.1( 0009. 344,98 040,98 )07.1( 0009. 344,98 125,98 )07.1( 0008. 344,98 204,98 )07.1( 0007. 344,98 277,98 )07.1( 0007. 344,98 344,98 000,200$ )1( (NSP) Premium SingleNet T i i ixix k QPM $200,000 Term policy for a 35 year old woman expiring at age 40 (no costs, no saving component). Docsity.com Conditional Probability Example (NSP) …       × + × + × + × + × ×=       × + × + × + × + × ×=             × + × + × + × + × ×= 54321 54321 54321 )07.1( 0009.9969.0 )07.1( 0009.9978.0 )07.1( 0008.9986.0 )07.1( 0007.9993.0 )07.1( 0007.1000,200$ )07.1( 0009.9969.0 )07.1( 0009.9978.0 )07.1( 0008.9986.0 )07.1( 0007.9993.0 )07.1( 0007.1000,200$ )07.1( 0009. 344,98 040,98 )07.1( 0009. 344,98 125,98 )07.1( 0008. 344,98 204,98 )07.1( 0007. 344,98 277,98 )07.1( 0007. 344,98 344,98 000,200$ Age Alive at Start of Deaths During Year Probability of Survival Probability of Death 34 98405 61 0.9994 0.0006 35 98344 67 0.9993 0.0007 36 98277 73 0.9993 0.0007 37 98204 79 0.9992 0.0008 38 98125 85 0.9991 0.0009 39 98040 91 0.9991 0.0009 40 97949 98 0.9990 0.0010 41 97851 105 0.9989 0.0011 Standard Mortality Table - Canadian Females ∑ − = + + + × = 1 0 1)1( (NSP) T i i ixix k QPM $200,000 Term policy for a 35 year old woman expiring at age 40 (no costs, no saving component). Docsity.com Conditional Probability Example (NAP) … 91.147$ 38116.4 648$ 76054.81448.8722.93393.1 648$ )07.1( 344,98 040,98 )07.1( 344,98 125,98 )07.1( 344,98 204,98 )07.1( 344,98 277,98 )07.1( 344,98 344,98 648$ 43210 = = ++++ =             +++ × + = Age Alive at Start of Deaths During Year Probability of Survival Probability of Death 34 98405 61 0.9994 0.0006 35 98344 67 0.9993 0.0007 36 98277 73 0.9993 0.0007 37 98204 79 0.9992 0.0008 38 98125 85 0.9991 0.0009 39 98040 91 0.9991 0.0009 40 97949 98 0.9990 0.0010 41 97851 105 0.9989 0.0011 Standard Mortality Table - Canadian Females ∑ − = + = 1 0 )1( (NAP) Premium AnnualNet T i i ix k P NSP $200,000 Term policy for a 35 year old woman expiring at age 40 (no costs, no saving component). Again, it is necessary to adjust the Net Annual Premium for the fact that there will be fewer paying insured over the term of the policy because of attrition. The solution assumes an annuity due. Docsity.com Pricing Pure Premium Term Insurance Interest rate = 0.08 Net Single Premium Calculation: Age of Woman Year Prob. Of Death Alive at Start of the year Prob. Individual at age x will survive i more years. Prob. Individual age (x+i) will die during the next year Joint Probability Discount Factor Present Value of Joint Probability' Present Value of prob. Individual aged (x+i) will die during next year 35 98344 36 1 0.0007 98277 1.0000 0.0007 0.0007 0.9259 0.0006 0.9259 37 2 0.0007 98204 0.9993 0.0007 0.0007 0.8573 0.0006 0.8568 38 3 0.0008 98125 0.9993 0.0008 0.0008 0.7938 0.0006 0.7932 39 4 0.0009 98040 0.9992 0.0009 0.0009 0.7350 0.0007 0.7344 40 5 0.0009 97949 0.9991 0.0009 0.0009 0.6806 0.0006 0.6800 41 6 0.001 97851 0.9991 0.0010 0.0010 0.6302 0.0006 0.6296 42 7 0.0011 97746 0.9990 0.0011 0.0011 0.5835 0.0006 0.5829 43 8 0.0012 97630 0.9989 0.0012 0.0012 0.5403 0.0006 0.5397 44 9 0.0013 97501 0.9988 0.0013 0.0013 0.5002 0.0006 0.4997 45 10 0.0015 97356 0.9987 0.0015 0.0015 0.4632 0.0007 0.4626 46 11 0.0017 97195 0.9985 0.0017 0.0017 0.4289 0.0007 0.4282 47 12 0.0019 97015 0.9983 0.0019 0.0019 0.3971 0.0008 0.3965 48 13 0.0021 96815 0.9981 0.0021 0.0021 0.3677 0.0008 0.3670 49 14 0.0023 96596 0.9979 0.0023 0.0023 0.3405 0.0008 0.3398 50 15 0.0025 96356 0.9977 0.0025 0.0025 0.3152 0.0008 0.3145 51 16 0.0027 96093 0.9975 0.0027 0.0027 0.2919 0.0008 0.2912 52 17 0.003 95807 0.9973 0.0030 0.0030 0.2703 0.0008 0.2695 53 18 0.0033 95492 0.9970 0.0033 0.0033 0.2502 0.0008 0.2495 54 19 0.0036 95148 0.9967 0.0036 0.0036 0.2317 0.0008 0.2310 55 20 0.0039 94773 0.9964 0.0039 0.0039 0.2145 0.0008 0.2138 56 21 0.0043 94363 0.9961 0.0043 0.0043 0.1987 0.0009 0.1979 57 22 0.0047 93916 0.9957 0.0047 0.0047 0.1839 0.0009 0.1831 58 23 0.0052 93428 0.9953 0.0052 0.0052 0.1703 0.0009 0.1695 59 24 0.0057 92896 0.9948 0.0057 0.0057 0.1577 0.0009 0.1569 60 25 0.0062 92318 0.9943 0.0062 0.0062 0.1460 0.0009 0.1452 61 26 0.0068 91691 0.9938 0.0068 0.0068 0.1352 0.0009 0.1344 62 27 0.0074 91010 0.9932 0.0074 0.0073 0.1252 0.0009 0.1243 63 28 0.0081 90270 0.9926 0.0081 0.0080 0.1159 0.0009 0.1151 64 29 0.0089 89466 0.9919 0.0089 0.0088 0.1073 0.0009 0.1065 65 30 0.0097 88596 0.9911 0.0097 0.0096 0.0994 0.0010 0.0985 Sum of the Present Value of single probability = 11.2370 Sum of the Present Values of Joint Probabilities = 0.023376271 Assumed size of life insurance policy = $500,000.00 Net Single Premium (NSP) = $11,688.14 Net Annual Premium (NAP) = $1,040.15 Data from Standard Mortality Tables: Calculate the pure level premium for a 35 year old woman buying a policy at age 35 that will mature at age 65. Interest rate is 8%. Example of a Spreadsheet Solution Docsity.com K. Hartviksen Other Life Insurance Topics Docsity.com Types of Life Insurance Term Permanent Docsity.com K. Hartviksen Term Insurance • Is like a wager. The insured pays the insurance company a premium. If the insured dies before the policy expires, the insurance company pays the beneficiary. If the insured is still alive when the policy ends, coverage ceases and the insurance company pays nothing. • Term insurance policies are generally issued for one, five, ten, 15 or 20 years. Often they terminate at age 65. • The biggest single advantage of term insurance is it’s price. Docsity.com K. Hartviksen Term Insurance... • Most term insurance policies include the right to convert to permanent insurance or to renew without having to prove insurability. Although the premium after conversion is always higher, it may be well justified if the life insured has suffered a medical impairment or taken up hazardous work. Insurance companies normally refuse to offer coverage when these conditions exist. • To avoid automatic expiry of term insurance, renewable term insurance provides an option to extend coverage for a similar period. The premium for the second term will be higher because of the age of the insured. • Yearly renewable term insurance can be renewed annually for a specified number of year, usually to a maximum age of 60 or 65. Docsity.com K. Hartviksen Term vs. Permanent • The main benefits of permanent insurance over temporary insurance are: – coverage is available until death whereas most term policies expire at age 65 – premium payments don’t change whereas term policy premiums increase with each renewal – in time the premium payments build up a creditor-protected cash surrender value and make a variety of ancillary benefit possible such as: – automatic premium loan - if the insured forgets or cannot pay the premium within the specified days grace period, APL charges unpaid premiums as a loan against the CSV so coverage can continue. Docsity.com K. Hartviksen Term vs. Permanent ... – in time the premium payments build up a creditor-protected cash surrender value and make a variety of ancillary benefit possible such as: – Extended term insurance - when a whole life policy holder dies, only the insured amount is paid, not the policy reserve. However, ETI allows the insured to increase coverage by using the reserve to purchase additional term insurance. The amount and policy term purchased is directly proportional to the policy reserve size. – Paid-up Insurance: if a policy owner is unwilling or unable to pay premiums, rather than cancelling the policy, coverage can be reduced to an amount equal to whatever the CSV can purchase as a single premium based on the insured age. Paid-up insurance also contains cash values which accumulate and are payable if the policy is surrendered before death. Docsity.com K. Hartviksen Term vs. Permanent ... – in time the premium payments build up a creditor-protected cash surrender value and make a variety of ancillary benefit possible such as: – Loan Values - Banks or the insurance company itself are willing generally to lend the policy owner up to 90% of the CSV. Docsity.com K. Hartviksen Permanent Insurance Riders • For additional premiums, policy riders can be added such as: – Accidental Death Benefits: sometimes called double indemnity, pays two times policy face value if death is caused by accident. – Total Disability Waiver of Premium: premium payments are waived if the insured becomes totally disabled by sickness or accident prior to a predetermined age (usually 60) and remains so disabled for three to six consecutive months. – Total Disability Monthly Income (TDMI): in addition to waiving premiums, some policies also pay disabled policy owners a monthly income, generally equal to $10 per month for each $1,000 insured. Docsity.com K. Hartviksen New Money Policies • Also known as interest-rate sensitive policies – premium rates are based on assumptions (estimates) of future claims, operating expenses and investment earnings. – Since premiums and benefits for traditional whole life policies are guaranteed throughout the contract term, investment earnings estimates are conservative. – In the late 1970s and early 1980s, interest rates rose to unprecedented levels. For competitive reasons, insurers began offering policies based on their new (higher return) investments…hence, the origin of the term new money. – New money or adjustable policies usually guarantee premiums and death benefits for a specified time (eg. Five years) and re-adjust premiums and/or death benefits at the end of the period. Premiums may be increased or decreased depending on the insurance company’s investment income. Docsity.com K. Hartviksen New Money Policies ... • In contrast with whole life policies that have level premiums, new money policies have premiums that vary inversely with interest rates: • when interest rates are high, premiums decline – when interest rates fall, premiums increase. • The only feature not guaranteed is policy dividends in a participating policy. Docsity.com K. Hartviksen Variable Life • Variable life policies are the insurance industry’s equivalent of mutual funds, but with one exception: at death or maturity they guarantee at least a 75% return of the amount paid in. This proviso exempts then from being subject to provincial securities acts. • Variable contracts come with or without life insurance. They can be purchased with regular, single or intermittent premiums and generally have the same contract provisions as regular life insurance policies. • As with many mutual funds, sales charges can be front-end or back-end loaded and a fee is charged for managing the fund. An insurer’s investment fund supporting variable contracts is segregated from all other funds. Docsity.com K. Hartviksen Variable Life ... • Every variable contract contains two main elements: – an insurance element as either life insurance or an annuity, and – a reserve which varies in value depending on segregated fund performance (the equity element). • As with mutual funds, any interest, dividends or capital gains realized by the segregated fund are taxed in the policyowner’s hands as the insurance company issues T-5 receipts. Docsity.com Endowment Life Policy • This form of insurance pays the face amount to the beneficiaries if the insured dies, however, unlike other insurance policies, it will also pay the face amount to the insured – the amount paid is called the endowment – if the insured lives to a certain age. • The premium of an endowment policy is set in such a way that the savings component will be invested to reach the endowment value at a specified date. Docsity.com