LIFE PRICING

FUNDAMENTALS
Richard MacMinn

Understand the law of large numbers as it relates

to insurance.
Describe insurers pricing objectives and explain
why they are of relevance to the life insurer and
consumer.
Outline elements of life insurance rate making
including the assumptions made in the absence of
perfect information.
Draw distinctions between participating and
guaranteed cost, nonparticipating life insurance.
Explain how asset share analysis is used to test
the adequacy of life insurance rates.

August 10, 2016

OBJECTIVES

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August 10, 2016

LAW OF LARGE NUMBERS

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The Weak Law of Large Numbers: For each n = 1,

2, . . ., suppose that R1, R2, . . . , Rn are
independent random variables on a given
probability space, each having finite mean and
variance. Assume that the variances are
uniformly bounded; that is, assume that there is
2i M for
some finite positive
number
M
such
that
n
all i. Let Sn R i Then,
i 1

Sn E Sn
0 asn
n

August 10, 2016

PRICING OBJECTIVES
Adequacy

payments generated by a block of policies plus

any investment return on same must be sufficient to
cover the current and future benefits and costs

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The

Equity
This

equity refers to setting premiums commensurate

with the expected losses and expenses; it also
suggests no cross subsidization. The equity notion
sets a floor.

Not excessive
The

excessive notion sets a ceiling

Regulation
Competition

Probability of insured event

and morbidity tables

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Mortality

August 10, 2016

ELEMENTS OF RATE MAKING

Time value of money

Premiums

paid now
Interest on accumulated funds

Promised benefit
period

of coverage
level of coverage
type of coverage

Loading or expenses, taxes, contingencies and

profit

LIFE INSURANCE RATE

COMPUTATION

Yearly renewable term life

insurance

The YRT covers the life for one

year at a set premium and is
renewable
The YRT premium for a 30 year
old male would be $1.73 per
$1,000 of coverage while it would
be $1.38 for a female the same
age. If investment income is
included then the company would
set the premium at $1.65 and
$1.31 for males and females
respectively

Single premium plan

Level premium plan

August 10, 2016

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SINGLE PREMIUM PLAN

This plan provides multiyear coverage for a single

premium now

This eliminates the rising

premiums associated with
the YRT.
This gives the insurer the
ability to generate
compound interest and
reduce the rate for
coverage

Table 2-2
Modified Version of 1980 CSO Mortality Table
1

Age

Number Living
(Beginning of
Year)

Probability
of Death
(During the
Year)

Number
Dying
(During
the year)

95

100,000

0.330

33000

96

67,000

0.385

25795

97

41,205

0.480

19778

98

21,427

0.658

14099

99

7,328

1.000

7328

100

August 10, 2016

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August 10, 2016

MODIFIED VERSION OF 1980 CSO

MORTALITY TABLE

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August 10, 2016

PRESENT VALUE OF CLAIMS FOR 95YEAR-OLD MALES

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August 10, 2016

POLICY RESERVES FOR NET

SINGLE-PREMIUM WHOLE LIFE
INSURANCE

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LEVEL PREMIUM PLAN

11

If some of the 100,000

policyholders prefer to pay
premiums on an annual basis
then how much must be charged
per year to make the insurer
indifferent between the single
premium and the annual level
premium?
Let pt be the proportion of the
insured population alive at the
beginning of policy year t. Let at
be the annuity factor for the
premium payment stream.
Let x be the level premium.
Then x must satisfy the last
equation on the RHS.
August 10, 2016

pt
t1
t 1 (1 r)

aT

p1 p2
p4

1
1
p3
2
1 r
1 r

1
1

p
L
5
3
4
1 r
1 r

aT x pvT(L)
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August 10, 2016

NET LEVEL PREMIUM

CALCULATION

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12

Guaranteed-cost, non-participating insurance

(without profits policies)

Participating insurance (with profits policies)

Policy elements fixed at inception

They offer no way of passing changes in mortality
(morbidity), interest or loading to policyholders

Policy gives its owner the right to share in surplus

accumulated due to experience
Surplus is distributed as dividends

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August 10, 2016

EXPERIENCE PARTICIPATION IN
INSURANCE

Current assumption insurance

Policy allows values to deviate from those at policy

inception on the upside and downside
Unlike participating policies that adjust ex post the current
assumption policy adjusts ex ante; for example, if the
insurer expects a 7% return on investments backing policy
reserves then the policyholders may get a promised 6.5%
credited to their cash values.

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The asset share calculation is a simulation of the

anticipated operating experience of a block of
policies
An example

August 10, 2016

ASSET SHARE CALCULATION

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