Life Assurance Chapter Five

CHAPTER FIVE
LIFE ASSURANCE
5.1 INTRODUCTION
As it is discussed in the previous units, there are large numbers of risks that surround
our day-to-day life or our business operation. Among these only few have got insurance
coverage. The diversified nature of the insurable risks also demands different provisions
and conditions, resulting in large number of insurance contracts or policies. In this unit,
we will discuss the different type of insurance contracts (property and life). However,
more time will be devoted in the discussing life insurance contract, its features and
provisions and condition that apply to it.

5.2 classification of insurance

Insurance can be classified as follows:
1. Life Insurance Vs Non-life Insurance
Life Insurance
Life/personal insurance sells on the individual persons. Human lives are insured under
this insurance. It also includes supplementary policies that sells to protect households
against a loss of earning from disability (disability insurance); injury or incurring a
disease (health insurance and living a certain period (endowments, annuities, and
pensions).
Non-Life Insurance
Non-life/property/general insurance sells insurance to protect property. Non-life
insurance companies sell policies to protect households and firms from the risks of
theft, fire, accident, or natural disaster.
It includes insurance to cover
 property losses (i.e., damage to or destructions of homes, automobiles,
business, aircraft, etc)
 Liability losses (i.e., payments due to professional negligence, product
defects, negligent automobile operation etc)
 Workers' compensation and health insurance payments.

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2. Social vs. Private Insurance

Social Insurance
The social insurance is meant to protect and uplift the weaker sections of the society and
may be in different forms like pension plans, disability benefits, unemployment benefits,
sickness insurance, industrial insurance etc. Premium under such insurance schemes is
paid by the government or the employers or by both. In some cases the employees or
beneficiaries also contribute their share of the premium.

Private Insurance
Private insurance emphasizes individual actuarial equity, i.e., premiums reflect the
expected value of losses. Most private insurances are voluntary although the purchase of
some insurance is required by law. A major part of social (governmental insurance) is
involuntary, i.e., it is required by law to be purchased by certain groups under certain
conditions.

The difference between life insurance and general insurance (non-life insurance)
The following are some of the factors that differentiate life insurance from property
(general insurance):
a) Risk
The occurrence of risk (death) in life insurance is certain. But in other insurance the
occurrence of the risk insured is uncertain.
b) Procedure
Life insurance requires medical certificate whereas survey is made before a property is
insured.
c) Premium and Amount
Since it is difficult to express life in monetary terms the amount insured depends on the
personal requirements of the insured. The insure also charges the insured a premium
determined according to the age and health condition of the insured. But in other forms
of insurance the premium is determined according to the risks involved. The amount of
the policy in the property insurance can be taken up to the value of the property.
d) Insurable Interest and Transfer of the Policy

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Insurable interest principle is applicable to both life and non-life insurance. However,
the time of its requirement may vary. In other words, insurable interest must exist at the
time of purchase of a life policy. In marine policy such interest must exist at the time of
loss and in fire insurance both at the time of taking the policy and at the time of loss.

A life insurance policy can be transferred either by assignment or by nomination. But in

other insurances, the financial right can be transferred only by assignment with prior
permission of the insurer.
e) Contract
General insurance contracts are contracts of indemnity, whose purpose is to recover the
loss. But life insurance is not a contact of indemnity and subrogation. The amount of
compensation is the insured sum in life insurance and life insurance is never a
protection against partial loss as compared to the other forms of insurance.
f) Elements and Purposes of Insurance
Life insurance contains both elements of protection and savings (investment). However,
in other insurances the investment part is totally absent. Its purpose is simply the
protection of the property.

5.3 Life assurance

Life assurance is one of the most common forms of insurance. It has gained greater
acceptance all over the world. Following the liberalization of the economy of the country
in 1993, private insurance companies has emerged in Ethiopia. This has encouraged and
motivated the society to use life insurance policies.
The main purpose of life insurance is financial protection of the dependents of the
insured and savings for an old age, to cover personal loan and tuition fees for education
expense.
5.3.1 Definition
Commercial Code of Ethiopia defines life insurance as "a contract by which the insurer,
for a certain sum of money or premium proportioned to the age, health, profession, and
other circumstances of the person whose life is insured engages that, if such person shall
die within the period limited in the policy, the insurer will pay according to the terms
specified thereof, to the person in whose favor such policies are granted."

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From this definition we can consider the following important features of life insurance.
1. Life insurance, like other insurances, is a contract between the insurer the
insured whose life is insured or someone who has an insurable interest.
2. Its purpose is financial protection of the dependents of the insured with financial
compensation amounting the sum assured if the insured die while the policy is in
force.

Of course, life insurance may also be engaged in encouraging savings to

accumulate an educational fund that could be used to pay tuition fees for children
when they join higher education, and to settle an outstanding balance of a debt.
3. The insurer charges premium based on age, sex, health condition, occupation and
other criteria.
4. Life insurance policy gives protection against special types of risks i.e., death
whose occurrence is certain. The uncertainty is related to the causes and time of
death.
5. The benefit, financial compensation upon death is determined in advance based
on the decision made by the insured and reasonableness of the premium.
6. The insured and policy owner may be different. For example, an individual may
insure the life of another person, if he/she has a financial interest.
7. Life insurance is not strictly a contract of indemnity. Because life is priceless. For
this reason, if the insured buys more than one policy all of the insurance
companies will indemnify fully.
8. The probability of claim for compensation increases with the passage of time due
to insured's deteriorating health conditions as they grow old.

5.4 Types of Life Insurance contracts (policies)

1. Term Insurance
The term-insurance is issued to provide death benefit to the beneficiary if the insured
dies within the specified time period stated in the policy. This policy matures for
payment only on the death of the insured within the term period, but if he/she survivals
the policy will expire and nothing is payable to the insured. The policy provides only
temporary protection and has no saving element. Another important feature of this
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policy is that since it is taken for a specified period to deal with premature death, the
cost/premium payment is relatively low.

Term policy is issued for short term ranging from few months to a specified number of
years such as 10 years, 15 years, 20 years etc.
Types of term life assurance
The following are the different types of term insurance policies.
i) Level Term Policy This policy provides a constant sum assured (amount of money
payable in the event of death) throughout the term of the policy. This means policy
benefits that remain the same over the term of the policy. It is the cheapest form of life
insurance since the cover is only temporary and there is normally no surrender value
available on early termination. If a premium is unpaid, the policy will lapse at the expiry
of the ‘days of grace’. For example, under a 20 year term policy of Br. 50, 000, the
amount of payment/compensation to the insured's beneficiaries will be Birr 50,000 if
the insured dies at any time during the term of the policy.
ii) Decreasing (or Diminishing) Term Policy
Sum assured reduces each year (or possibly each month, quarter or half
year) by a stated amount, decreasing to nil at the end of the term. This
means in this policy, the amount of claims to be paid to the insured decreases
periodically. The initial sum assured decreases periodically. These policies are usually
issued to borrowers of money and the amount of the policy payable at the end of each
year is automatically reduced and is equal to the outstanding loan which will be paid if
the insured dies before the end of the term. This is also known as "Mortgage –
Redemption Policy."

This type of policies provides financial protection to the policy holder (creditors) and the
dependents of the debtor who are supposed to cover the debt otherwise. Premiums for
such type of policies are paid at the beginning of the policy.
Consider the following example: assume that the benefit during the first year of
coverage of a five-year decreasing term policy is ETB 500,000.00 and then decreases by
ETB 100,000.00 on each policy anniversary. The amount of death benefit payable
would be as follows:

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 ETB 500,000.00 for the first policy year;

 ETB 400,000.00 for the second year;
 ETB 300,000.00 for the third year;
 ETB 200,000.00 for the fourth year;
 ETB 100,000.00 for the last year.
At the end of the fifth policy year, the coverage expires and the amount becomes nil.
The following are types of decreasing term policies.
A. Mortgage Protection Insurance (MPI)
Mortgage protection insurance is issued in connection with real estate loans made by
banks. It gives financial protection to the creditor and the dependents of the debtor of
the outstanding mortgage loans in the event of accidental death of the debtor. Since a
mortgage loan is paid on an installment basis, the outstanding loan decreases over time.
As a result the sum assured decreases and finally becomes zero. This is why it is called
decreasing term insurance.
B. Credit Life Insurance
Credit life insurance is issued to give protection to a lender/borrower's dependent of the
unpaid balance of a credit transaction if the borrower dies before setting the unpaid
balance of his debt.
designed to pay the balance due on a loan if the borrower dies before the loan is repaid;
like mortgage protection insurance, it is usually a type of decreasing term life insurance;
unlike mortgage insurance, it always provide that the policy benefit is payable directly to
the lender, or the creditor if the insured borrower dies during the term of the policy;
C. Family income coverage
A form of decreasing term life insurance that provides a stated monthly income benefit
amount to the insured’s surviving spouse if the insured dies during the term of the
coverage; Monthly income benefits continue until the end of the term specified when the
coverage was purchased;
It is also most commonly purchased as a rider to a cash value life insurance policy;
D. Credit Cooperative Insurance
This policy is issued to protect savings and credit associations from facing a financial
losses on the lo

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III) Increasing Term Contract

Designed to combat the effects of inflation; the initial amount of insurance increases
every year at a rate determined in advance (often 10%) Whenever the sum assured is
increased, the premium is correspondingly raised. In addition, because the insurer is
giving the right to increase the cover substantially without any medical evidence, the
initial premiums for these increasable contracts are higher than those for ordinary level
term insurance with comparable sums assured; under this policy the sum assured can be
arranged each year to correspond to a need of the insured that increases periodically.
And they provide to their members, due to death before setting his/her debt.
Consider the following example again.
 Plan of insurance: 10-Year increasing term policy;
 Sum assured: ETB 300,000.00;
 Increasing by: ETB 10,000.00 at the end of each year.
The policy will provide for the following death benefits.
ETB 300,000.00 for the first policy year;
ETB 310,000.00 for the second year;
ETB 320,000.00 for the third year;
ETB 330,000.00 for the fourth year;
ETB 140,000.00 for the last year.
Therefore, the amount of death benefit depends on when the insured dies; the later this
occurs, the higher the death benefit.
Features of term life insurance
Temporary protection only: at the end of the policy term, the policy expires;
Convertibility: the policy gives the policy owner the right to convert the term policy to a
cash value policy; the policy is referred to as a convertible term insurance policy;
Note that renewable/convertible term policies contain both Renewability and
Convertibility features.

Characteristics of term life assurance

 It just provides cover against death within a specified period;
 The cover is pure protection with no investment element;

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 A payout (payment of death benefit) is possible but not certain as the life assured
may not die during the term of the policy;
 If the life assured survives, no payment is made and the policy will simply
terminate (expire).
 Term life insurance is very similar to non-life insurance
 Cheapest form of life insurance in terms of premium.
 Renewability: - This is a term policy that can be renewed after the expiry of the
term without medical examination but at a different rate of premium applicable
to the age level reached at the time of renewal. For instance, a one year term
policies require renewal every year. Similarly, a 10 year term policy may be
renewed upon its maturity.

 Convertibility:-Under the convertible term policy an option is available to the

insured to convert it into whole life or endowment life policy without going in for
new medical examination. However, the premium may be adjusted either at the
attained age at the time of conversion of the term policy or using the initial term
policy issued.
To make the conversation process simple, the following requirements are to be met
upon conversation:
 There will not an increase or decrease in the sum assured.
 Conversion will have to be made within a specified period, usually before the
maturity date of the term policy.
On the basis of mode of premium payment, term insurance policies can also be
classified as:
 Level Premium Policy or Regular premium policy - The level-premium
policy requires the payment of premium regularly in equal installments at fixed
intervals throughout the policy period such as monthly, quarterly or yearly.
 Limited Premium Policy – The payment of premium is limited to a period of
attaining certain age of the assured, say retirement age.
 Single Premium Policy – Single premium policy requires the payment of the
entire premium only once in a lump sum at the time the policy is issued.
2. Whole-life policies/contracts
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This policy provides financial protection to the dependents of insured upon the event of
his death. The policy will mature for payment only on the death of the assured or as an
exception on the death of his attaining 100 years of age. In other words, the insured can
pay premium as long as he/she lives or payment of premium may be made for a
specified number of years such as up to retirement date. Whole life policy provides
permanent protection to the insured's dependents in the event of death and it also
allows for the accumulation of savings over the life of the insured.
Whole life insurance policies, depending on the manner of premium payment, can be
classified as under:
a) Ordinary whole life policy
Under ordinary whole life policy, also known as straight life insurance, the same
amount of premium is to be paid at a regular interval, usually annually until the death of
the assured or until the achievement of the specified age limit i.e., 100 years. This policy
provides life time or permanent protection at a lower cost/premium.
b) Limited-payment whole life insurance
Under the limited payment whole-life policy the premiums are paid for a limited or
selected period of time, which is determined in advance (say 10,15,30 years or up to the
retirement age of the insured). But the policy will mature for payment only on the death
of the assured. That means, after the expiration of the specified period, the policy is said
to be "paid up" and no more premium payment is required to keep the policy in force
until the death of the insured.

Limited payment life insurance is desirable when one intends to stop premium
payments after reaching a given age level, usually upon retirement, but wants to keep
the policy in force until his/her death. The insured pays a higher premium than he
would be required on ordinary life plan. Because premium is paid only for a limited
number of years in the limited pay insurance plan.
c) Single-payment whole life policy
In this policy premium is paid in a single installment at the purchase of the whole life
insurance. This mode of payment is not preferred by most buyers. Both the premium
payments have the same goal. They reach at the same destination. However, the straight
pay is better for the insured if the person dies early because she/he pay smaller amount

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as compared to the other two modes of payment. On the other hand, if the person
terminates the contract, the single pay provide a higher cash value.
 Provide lifetime coverage;
 Also provide a savings element;
 Have a level premium rate that does not increase as the insured ages;
 Death benefit payable upon the insured’s death, whenever that may be;
 Premium payment periods:
Continuous-premium policies; or
Limited-payment policies
3. Endowment Insurance Policy
Endowment policy is issued for a fixed period (endowment period) and premium is
payable during that period only. This policy provides protection of the beneficiary of the
insured if he/she dies within the endowment period. In addition, it provides for the
payment of the face value of the policy to the insured if he/she is living at the end of the
policy period.
This policy is known as a modified form of whole life insurance policy. The period of
this policy is shorter than that of whole life insurance and hence the premiums are
higher for the same age level. In general, the shorter the endowment period, the higher
the premium will be.

One important advantage of this policy over that of term policy is that the insured can
terminate the contract at anytime and can collect the cash value in a lump sum which
normally becomes positive after two or more years. The policy, therefore, has dual
purpose: financial protection and accumulation of funds for possible contingencies in
the future. Unlike the term insurance whose purpose is only protecting the insured's
dependents upon the death of the insured, endowment policy helps insured to save
money for some other purposes. Another advantage of endowment policy is that it
provides the assured with loan facility after the policy acquires cash value.
The following are the different types of endowment policies.

 Ordinary Endowment Policy

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This policy will mature for payment on the survival of the assured on the date of
maturity or on the date of his death within the endowment period. This means payment
to the insured or his dependents is certain whether or not he dies before the policy
matures or survives the endowment period.
 Pure Endowment Policy
The pure endowment policy will mature only if the insured person survives the
endowment period. In other words, the sum assured is payable only if the insured
survive beyond the endowment period. In this case, payment to the insured is uncertain.
The objective of this policy is to benefit the insured himself rather than his dependents.
As a result, it is considered as more of an investment than protection.
Cash Surrender Value
Many types of life insurance coverage can be analyzed as consisting of two parts: term
insurance and an investment. Normally, this type of contract provides a benefit payable
under any set of circumstances, with a larger benefit payable if the insured dies. For
example, whole life and endowment life insurance policies provide a set of
circumstances, with a larger benefit payable if the insured dies. For example, whole life
and endowment life insurance policies provide a stated benefit when the insured person
dies, with a smaller benefit if the insured person is living when the benefit is paid.

This smaller benefit, called the cash surrender value. Cash surrender value is the
amount the holder of the policy can elect to receive by surrendering the contract to the
insurer while the insured person is alive.
Whole life and endowment policies acquire cash value after two or three years of
premium payment. The cash value can be used to keep the policy in force under the
automatic premium loan provision, if the insured discontinues premium payment. The
policyholder can also apply for loans when the policy acquires cash value.
Unlike a whole life policy, however, an endowment life insurance policy,
 Is issued for a specified term and specifies a maturity date; a maturity date is a
date on which the insurer will pay the policy’s face amount (called maturity
benefit) to the policy owner if the insured is still living;
 Pays the policy’s face amount to the policy owner if the insured is still living, or to
a designated beneficiary if the insured dies before the maturity date;

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 Reserve and cash value usually equal the policy’s face amount on the policy’s
maturity date;
 Premiums are generally more expensive because claim payments are generally
made earlier;
 The shorter the term, the higher will be the premium for a give sum assured
because it will be payable for a smaller period;
4. Supplementary Insurance Policies
Supplementary policies as their name suggests are issued only in conjunction with the
main life insurance policies i.e., term, whole life or endowment for additional premium
for each contract. Supplementary policies also known as RIDERS. The supplementary
contracts include:
 HEALTH INSURNCE
Health insurance may be defined broadly as the type of insurance that provides
indemnification for expenditure and loss of income resulting from loss health. Health
insurance is insurance against loss by sickness or bodily injury. The loss
may be the loss wages caused by sickness or accident, or it may be expenses for doctor
bills, hospital bills medicine etc.
 Disability Income Insurance and
 Medical Expense Insurance
Total or permanent Disability Income Insurance:
Disability income insurance is form of health insurance that provides periodic
payment 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 accidental bodily injury or it
may cover both contingencies in one contract. Benefit eligibility presumes a loss of
income, but in practice this is usually defined as the inability to pursue an occupation.
The fact that the insured’s employer may continue his or her wages does not reduce the
insurance benefit.
The disability must be one that prevents the insured from carrying on the usual
occupation. Most policies continue payment of the benefits for only a specified
maximum number of years, but lifetime benefits are available on some contracts.
However, under all loss of income policies, the benefits are terminated as soon as the

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disability ends. It is defined here as disability resulting from bodily injury or disease that
totally prevents the insured from performing any business or occupation
uninterruptedly for a period of at least six months. (Dismemberment included)
Certain types of accidents are excluded, for example, losses caused by war, intentionally
inflicted injuries, and injuries while in military service during wartime.
Medical Expense Insurance:
Medical expense insurance provides for the payment of the cost of medical care that
results from sickness and injury. Its benefits help meet the expenses of physicians,
hospital nursing the related services, as well as medications and supplies. Benefits may
be in the form of reimbursement of actual expenses, up to a limit, cash payments or the
direct provision of services. The medical expense may be paid directly to the provider of
the services or the insured.
Medical expense insurance is divided into four major classes:
1. Hospitalization Expense Contract
2. Surgical Expense Contract
3. Regular medical Expense Contract
4. Major medical Expense Contract
Hospitalization Expense Contract: The hospitalization contract is intended to
indemnify the insured for necessary hospitalization expense, including room and board
in the hospital, laboratory fees, nursing care, use of operating room, and certain
medicines and supplies.
Hospitalization expense is usually written for a flat daily amount for a specified number
of days such 30, 120, or 365. The contract provides that costs up to the maximum
benefit per day (say 50 birr, 60 birr, 70 birr etc.,) will be paid for the number of day
specified, while the insured or an eligible dependent is in the hospital.
The agreement may set birr allowance for the different items or may be on a service
basis. Typical contracts offered by insurance companies, for example may state that the
insured will be indemnified up to X birr per day for necessary hospitalization.
Exclusions under hospitalization contracts: Like all insurance policies, hospitalization
contracts offered by insures are subject to exclusions. The following exclusions are
typical of hospitalization contracts:

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 Expenses resulting from war or any act of war.

 Expenses resulting from self-inflicted injuries.
 Expenses payable under worker’s compensation or any occupational disease law.
 Expenses incurred while on active duty with the armed forces.
 Expenses incurred for purely cosmetic purposes.
 Expenses incurred by individuals on an outpatient basis.
 Services received in any government hospital not making a charge for such
services.
Surgical Contracts: 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. It reimburses the
policyholder according to a schedule that lists the amounts the policy will pay for a
variety of operations.
Regular Medical Contract: The regular medical expense insurance pays part or all of
physicians’ ordinary bills, such as his called at the patient’s home or at a hospital or a
patient’s visit to his office. It is 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.
Major Medical Contract: The major medical expense insurance provides protection
against the very large cost of 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.
The contract is issued subject to substantial deductible of different sorts and with a high
maximum limit. Since this kind of policy is designed to cover only serious illness or
accidents, a deduction is used to eliminate small claims. A major medical policy might
have 5,000 birr maximum limit for any one accident or illness, have a 200 birr
deductible for any one illness, and contain an agreement to indemnify the insured for a
specified percentage of bills, such as 80% over and above the amount of the birr
deductible. This means the insurance company pays 80% of the loss in excess of the
deductible, and the insured pays the 20%. In the absence of the coinsurance clause,

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there would be no incentive for the insured or the doctor to keep expenses within
reasonable limits.
 Supplementary Accident Insurance:
The amount of cover under this contract is equal to the sum assured under the related
main policy. Supplementary accident insurance gives cover against bodily injury
affected through external violent and accidental means of which there is evidence of
visible contusion or wound on the exterior of the insured's body. After the presentation
of proof of bodily injury as specified in the policy, the person will be indemnified in the
policy; the person will be indemnified according to different schedule of benefits.
 Comprehensive Accidental Indemnities (CAI):
This scheme, in addition to the covers stated under Accidental insurance and total or
permanent disability benefit above, provides protection against death and amputation of
fingers or toes that are covered by a Group Personal Accident Insurance policy.
 CAI plan is, therefore, a "two-in-one" cover. Why hold two separate
policies, i.e. Life and GPA when you can manage it by a single life with CAI
policy?
 Group Insurance: life insurance policies are issued on a group basis. Some of
these are:
1) Modified large group life insurance
This policy can be issued to cover natural or accidental death only and compensation is
made to the beneficiary only upon the occurrence of death of the member of the group.
This policy is a new type of group life policy and issued at least for 200 individuals.

2) Group ordinary life insurance

This is a policy where a number of individuals are insured under a single policy.
Basically, it is a whole life insurance issued on a group basis. The members of the group
are not required to present evidence of insurability unless the person is above 40 years.
The policy holder in this scheme is an employer, a union, a professional association and
the like.
The policy can be issued for all employees of the organization as a single group or for
different classes of members (management, factory workers etc). The employer decides
on behalf of the members of the group. It is also the employer who bears the Insurance

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premium (non-contributory). In some cases, contributions are made by employees

(contributory scheme).
3) Group regularly, yearly renewable term life insurance.
This policy which is issued on a group basis covers risk of death. The policy expires
unless it is renewed every year at the appropriate time. The premium is adjusted for the
attained age level when it is renewed every year.

5.5 Provisions of Life Assurance

The policy conditions and provisions in life insurance that must be agreed by all parties
of the contract include the following:
1. Contract documents: The life insurance contract requires documents such as the
proposal form, the policy term, the medical report and any other supplementary
contracts.
2. General information: The general information relates to the granting of
insurance which is based on the following factors for selection of lives:
- The build: it relates to the present condition of health and physical build, such as
height, weight and other measurements of the life to be insured.
- Physical condition: the medical examiner's report will reveal the physical
condition of the life to be insured.
- Personal history: relates to the records of illness suffered, accidents met with,
surgical operations undergone, etc by the life to be insured.
- Habits and temperaments
- Moral hazards
- Hobbies or avocations
- Family history
- Occupational hazard
- Age, sex
- Residence and the like
These are the factors used to assess the insurability of individual or group lives.
3. Payment of Premium: one of the responsibilities of an insured is to pay the
premium agreed at the time of the contract. Payment can be made in different
arrangement such as annually, semi-annually, quarterly or monthly. In an annual

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premium payment arrangement, the insured is expected to pay in advance. However,

the insured have the following privileges:

 Grace Period: the insured will usually receive a notice of reminder for the
payment of premium on the due date for the payment of yearly, semi-annually or
quarterly premium not for the monthly payment premium. Usually 30-day grace
period is given to the insured. If death occurs within the grace period, the total
sum assured less the outstanding premium will be payable to the beneficiary.
 Non-forfeiture Options: as explained earlier, the cash surrender value of a
life insurance contract (whole life and endowment) is the amount the policy
owner could receive if the policy is surrendered to the insured prior to the
insured's death. If the policy owners discontinue payment of premiums, he/she
can use the cash value to keep the policy in force under the automatic premium
loan provision. The insurer will allow the policy to continue automatically with
the payment of premium out of the net surrender value.
 Loan Provision: The policy owner is entitled to borrow money from the
insurer to the extent of the surrender value by assigning his policy as a

security for the loan so advanced. Such a loan is subject to interest charge. A
policy loan is actually an advance payment of part of the amount that the insurer
eventually must pay out under the policy.
A policy loan differs from a commercial loan in two ways: First, the policy owner
is not legal obligated to repay a policy loan; a commercial loan creates a debtor-
creditor relationship between the borrower and the lender. The borrower is
legally obligated to repay a commercial loan. Second, a policy loan also differs
from a commercial loan in that the insurance company does not perform a credit
check on a policy owner who requests a policy loan. The policy loan’s request is
evaluated only in terms of the amount of the net cash value available.
Although, as in the case of any loan, interest on policy loan may be paid at any
time, the policy owner is not required to pay the interest. Any interest charges
that are unpaid become part of the policy loan.

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If the amount of a policy loan plus unpaid interest increases to the point at which
the total indebtedness is greater than the amount of the policy’s cash value, then
the policy terminates without further value.
4. Policy Conversations: A policy change clause permits the insured to convert the
policy, without demonstrating evidence of insurability, to some other form requiring
a higher premium.

5. Restrictions(exclusion) clause: A life policy is subject to the following

restrictions:
 Occupation – all policies are free from all restrictions as to travel, residence
and occupation except where a proposer has at the time of proposal an intention
to take up a hazardous occupation or the propose is a student. In all such cases,
policies will be issued subject to a suitable endorsement and, if necessary, extra
premium will be charged to cover any additional risk, if any.
 Suicide – if the insured commits suicide within one year of taking insurance,
noting is payable to the beneficiary. In the absence of a suicide clause, adverse
selection could occur when a person contemplating suicide takes out a large
amount of coverage shortly before committing suicide. The suicide clause makes
this type of adverse selection unlikely.
 Proof of Age – as the premium is charged on the basis of age of the proposer,
proof of age by any one of the prescribed certificates should be submitted along
with the proposal invariably where the age of the life insurance at entry is found
to be lower than the age given in the proposal form, the premium shall be payable
at the correct age and the excess premium already collected will be refunded. On
the other hand, if it is higher than the age given in the proposal form, the
difference between the premium for the correct age and the original premium
already paid will be collected within a certain interest rate.
6. Reinstatement provision: - Describes the conditions the policy owner must
meet to reinstate his policy; to revive or reinstate his policy. Reinstatement is a
process by which a life insurance company puts back into force a life insurance
policy that either has been
-terminated because of non-payment of renewal premiums; or

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-continued in force under ETI (Extended Term Insurance) or reduced paid-up

options.

5.6. Life insurance premium determination

The determination of a price for insurance is a complex activity and involves the
incorporation of a mathematical analysis into competitive business decision processes.
This price is known as premium, which may be paid annually, semi-annually, quarterly
or monthly. These premium rates, and therefore the resultant premiums, should
generally be
Adequate;
Equitable; and
Reasonable
There are three primary elements (major determinants) in life insurance rate making:
 Mortality Charge.
 Interest Charge.
 Loading Charge.
Mortality: The morality 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 dies at each age.
One the basis of past experience
Actuaries are able to predict the number of deaths among a given number of people at
some given age. Boss

Mortality as a factor affecting Life Insurance Premium Rates

Let’s see the following 1958 mortality table
5-year level term insurance for ETB 1,000 issued at age 30

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Age (X) Number Living at Number Dying Mortality

Beginning of year During year Rate

30 100,000 213 0.002130

31 99,787 219 0.002200
32 99,568 224 0.002250
33 99,344 230 0.002320
34 99,114 238 0.002400
35 98,876 248 0.002510
. . . .
. . . .
. . . .
98 1,933 1,202 0.621830
99 641 641 1.000000
100 - -

Mortality Rate Calculation

Mortality Rate = Column (3)/ Column (2)
=213 /100,000
=0.00213
=2.13‰
There are two methods of premium determination
1) The Natural Premium System (Assume sum assure is 1,000)
The share of each person at year 1 is given by
Share of each =Sum Assured x Mortality Rate
=1,000.00 x 0.002130
=2.13
The share of each person at year 2, the probability of death is slightly higher; so each of
the survivors must pay a slightly higher premium:
Second year premium= 1000*0.0022
=2.20

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The same process must be followed for each of the remaining three years, the net annual
premiums for which will be:
Third year premium=2.25;
Fourth year premium=2.32; and
Fifth year premium=2.40
2) The level premium system
The annual premium remains constant throughout the period of insurance
despite the increasing mortality rate during this period; the policy owner
pays the same amount of premium every year.
Going back to the previous example of a 5-year level term insurance for
ETB 1,000 issued at age 30, the net annual premium would be derived as
follows:
Age No. No. Dying Death Premium
Living Claim
30 100,000 213 213,000 2.13 (+0.13)
31 99,787 219 210,000 2.20 (+0.06)
32 99,568 224 225,000 2.25 (+0.01)
33 99,344 230 232,000 2.32 (-0.06)
34 99,114 238 240,000 2.40 (-0.14)
Total 497,813 1124 1,124,000 2.26 (average)
If the total claim is ETB 1,124 and the number of annual premiums is
497,813 then each premium is equal to
Each premium = 1,124,000÷497,813
= 2.2578759
= 2.26
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 prepare to pay interest on it. The life insurance companies collect vast sums
of money, and since their obligations will not mature until sometime in the future, they
invest this money and earn interest on it.
Interest as a factor affecting Life Insurance Premium Rates
Assumes a specified compound interest rate

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The higher the interest rate assumed, the lower would be the premium rates.
The lower the interest rate, the higher would be the premium rates.
Loading Charge: When a life insurance policy is sold, the insurer incurs relatively
high first-year acquisition expenses because of commissions, sales, and administrative
expenses. Thus, the premium charges must include a loading for expenses.
Expense as a factor affecting Life Insurance Premium Rates
Gross Annual Premium (GAP) = Net Annual Premium (NAP) + Loading
The loading is intended to cover mainly expenses of acquisition and administration.
It also contains provision for possible unfavorable fluctuations in mortality and a
margin for profit.
Other factors required to determine premium rate include: age and sex of the insured,
period of the insurance policy, and sum assured.
Net Single Premium: The net single premium is the amount insurer must collect in
advance to meet all the claims arising during the policy period.
Net Level Premium:It would be impractical at attempt to collect a net single premium
from each member of an insured group. Few people would have the necessary funds for
an advance payment of all future obligations. Therefore, actuaries must calculate an
annual premium.
Gross Premium: Gross premium is the pure premium plus loading for the necessary
expenses of the insurer. The net level premium for life insurance represents the pure
premium that is unadjusted for the expenses of doing business. The pure premium is
actually the contribution that each insured makes to the aggregate insurance fund each
year for the payment of both death and living benefits.

Basic Assumptions for premium determinations (NSP

assumptions)
 Premium will be collected at the beginning of the policy period.
 Death benefit will be paid at the end of the policy period
 The premium fund will be deposited in a bank and it will earn interest.
 Every insured will contribute to the premium fund that is meant for the
payment of future death claims.
Premium determination for term insurance policy

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Example 1:
Consider term insurance policy buyers at age 30 male population of (policy
holder)958,000.,The expected number of death is 1657,the policy amount(death
benefit) is birr 5000 , the going interest rate is 10%.Assuming a one year term insurance
policy purchased by the insured group, compute the NSP?
Method-I
Step one: Compute the expected future death claim (EFDC)
(EFDC) = policy amount x number of people dying
= 5000x1657=8,285, 000

Step two: Find the present value of the expected future death claim.
PV (EFDC) = EFDC = 8,282,000 = 7, 531, 818.18
(1+i) n
(1+0.1) 1

Step three: Find the NSP per insured person.

NSP= PV (EFDC) =7,531,818-18
Total number of Policy Buyers 958,000
= birr 7.86
Method II

NSP= P.AMT X.D RATE

(1+I) n

=5000x1657/958.000 = birr 7.86

(1+0.1) 1
Example 2:
Considering the question in example one above and if the policy is a 3 year term
insurance compute the NSP?
Step one: Compute expected future Death Claim (EFDC)

Yr Age Number Number Dying policy amt EFDC

Living Step
1 30 958,000 1657 5000 8,285,000 two:
2 31 956,343 1702 5000 8,510,000
3 32 954,640 1747 5000 8,735,000
compute the present value of EFDC
Year EFDC PVIF (10%) PV( EFDC)
1 8,285,000 0.90911 7,531,976.35
2 8,510,000 0.8264 7,032,664
3 8,735,000 0,7513 6,562,605.5
T.PV (EFDC) = 21,127,246
Step three: Calculate NSP

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NSP= Total PV (EFDC) = 21,127,246 =22.053

Original Pop. Size 958,000
NSP= 22.053 birr

Method II
Apply the following formula

NSP= ∑n x
Policy amount x death rate
(1+i) n

NSP= 5000x1657/985,000+ 5000x1702/985,000 +

5000x1747/985,000
(1+0.1)1 (1+0.1)2 (1+0.1)3

NSP= 22.053 birr

Example 3
Considering the question under example 2, convert the net single premium in to a net
level premium (NLP) i.e. level off the premium payment over the policy period.
Method I
Step one: Assuming that each of the surviving policy buyers will pay a 1 birr
premium during the beginning of each year, compute the present value of a
1 birr premium payment.

Year Insured PVIF at 10% (2) PV of 1 birr

Paying Premium(1) premium =1x2
1 958,000 1 958,000
2 956,343 0.9091 869411.4213
3 954,640 0.8264 788914.496
Total PV of 1 birr premium=2616325.917

Step two: Compute PV of 1 birr premium per insured

PV of 1 birr premium per insured= Total PV of 1 birr premium

original population size

PV of 1 birr per insured = 2616325.917 = 2.731

958.000
Step Three: Compute the NLP

NLP= NSP = 22.053 = 8.075 for year

PV of 1 birr premium 2.731

Method II

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In order to compute the present value of a 1 birr premium payment per insured, you may use the
following formula:

PV of 1 birr premium per insured =∑Survival rate x PVIF x1

PV of 1 birr premium/ insured = (958,000 x 1 x1) + (956,343 x 0.9091x1) + (954, 640 x o.8264x1)
(958,000) (958,000) (958,000)
=2.731

Exercise 1

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According to the 1995 Ethiopian Central Statistical office of mortality table, out of an
initial population size of 1,500,000 male people of Bahir Dar city, 100,000 live at the
age of 40.The number of people expected to die at age 40 is 500. This means that the
probability of death at age 40 will be 500/100,000 = 0.005 or 0.5%. Assume that
Ethiopian Insurance Corporation issued a one-year term insurance to all these male
individuals aged 40 for death benefit of Birr 10,000 each. Death claims is to be paid at
the end of the term and premium is collected at the beginning of the policy.
Interest rate is 3%.Each insured is assumed to bring the same level of risk to the group.
Required: Based on the information given, how much premium the insurer should
charge each insured? (Net single premium)
Exercise 2
Based on the above information and the following mortality table, answer the questions
that follow:
Year Age No. of living Number of dying
1 40 100,000 500
2 41 99,500 750
3 42 98,750 1,250
4 43 97,500 1,500
5 44 96,000 ---
Assume that the 100,000 population has purchase a 4 year term insurance at the age of
40 for a sum assured equal to Br. 10,000.
Required: Determine
A) The net single premium (NSP) of Term Insurance
B) The net level premium (NLP) of Term Insurance

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Exercise 3
The following table shows mortality rate and group size of MASSO Life Insurance
Company.
Year Age Number of Number of Insures
Insured’s paying expected to die
premium
1 20 150,000 500
2 21 ? 700
3 22 ? 300
4 23 ? 400
Additional Information
Masso Insurance Company used to collect premium at the beginning of the year and pay
death claim or benefits at the end of the year. Face value of the policy to this group is Br.
5,000. The prevailing interest rate is 10%.
Required: Determine
1) The probability of dying at the end of each year and number of insured’s expected to
pay premium
2) NSP of term insurance
3) NLP of term insurance

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