Financial Products -

Insurance

Lecture 1
Insurance Products

 Many financial products provide benefits to

individuals on specified future events

 Benefits are usually either a regular income or

a single cash sum

 Possible future events include:

– retirement, ill health, death,
– unemployment
– damage to property
– legal liability
Main benefit providers

 The State operates a social security scheme in many

countries, providing benefits on retirement, death, ill
health, unemployment

 Employers operate benefit schemes for their employees,

providing benefits on retirement, death and ill health

 Insurance companies sell policies to employers and

individuals, providing benefits on a wide range of
contingencies
Insurance

 Life insurance companies sell (usually) long-term

policies providing benefits on death, survival or
sickness

 General insurance (or “non-life”) companies sell

(usually) short-term policies which compensate for
financial losses arising on specified events
Risk aversion and pooling

 Insurance is possible because individuals are risk

averse

 To avoid exposure to a random loss they will pay

more than the expected value of the loss
Risk aversion and pooling

 Insurance companies can make a profit by selling

policies covering a large number of independent
risks

 However they need sufficient data to estimate the

loss distribution of these risks
Policies sold by life companies

 The objectives of such policies include:

– protection, i.e. benefits on death or sickness
– saving, i.e. benefits paid on survival to the end of
the policy term
– income, i.e. a regular income in exchange for a
single premium
Policies sold by non-life companies

 The objective of most non-life policies is to

indemnify the policyholder against financial
risks

 For example:
– legal liability to 3rd parties
– damage or loss of property
– financial loss from fraud or insolvency
Insurance Companies

•Proprietary

•Mutual
Proprietary

 Shareholders provide capital

 Profits belong to shareholders

 Shareholders receive dividends in return for use of

their capital

 The company build its capital base by retaining

profits
Mutual
 All policyholders own the company and therefore
provide the capital

 Profits belong to policyholders

 Policyholders receive dividends in the form of

bonuses

 The company build its capital base by retaining

profits
Life Insurance Products

•Term
•Endowment
•Whole Life
•Annuities
Term Assurance

 Benefit payable on death within the term of

contract chosen at outset

 Provides protection against financial loss for

dependants at a lower cost.

 Commonly sold as MRTA in Malaysia. Why

people buy MRTA?
Term Assurance (cont’)

 Keyman / Key-person Insurance

 Group form can be used by employer to

provide benefits to employees

 Usually no benefit available on surrender.

Why?
Convertible Term Assurance

 Same as normal term assurance, but with the

advantage of being able to

– Convert to a permanent form of contract ie

Endowment or Whole Life
– Renew the original contract for a further period of
years without health evidence being provided
(unless benefit level is increased).
Whole Life Assurance

 A contract that pays benefit on the death of

life insured whenever that might occur.
 Uses
– To pay funeral expenses
– To transfer wealth
– Protection and saving
 Typically surrender value is available
Endowment Assurance

 Pays benefit on survival to a specified date or

on earlier death
 Combination of Term Insurance and Pure
Endowment
 Operates as savings vehicle as well as
protection
 Group endowment enable employer to
provide retirement benefit to employee
Endowment Assurance (cont’)

 Uses
– Tax efficient savings vehicle. Why?
– Retirement
– Capital repayment eg Mortgage
– Education plan
Annuities

 Usually a retirement product

 Pays out regular amounts of benefits as long
as life insured survives
 Purchased in advance by a single premium
 Main purpose is to convert capital into
lifetime income
 Benefit payments may be level or variable.
How?
Annuities (cont’)

 Examples of options available:

– Payments to be made for an initial number of
years irrespective of survival status
– Guarantee that any shortfall between the initial
premium paid and the amounts received will be
payable
 Better rates (cheaper) for impaired life
annuities. Why?
 Surrender values usually not available. Why?
Deferred annuities

 Income starts many years after the policy is

taken out
 Conversion terms may be guaranteed at
outset (less likely now)
 Can be funded by regular premiums
Basis of the products

•With Profits (Participating)

•Without Profits (Non-Participating)
•Unit Linked
Without-profits policies
 Provide fixed monetary benefits on death or survival

 Most term assurances and immediate annuities sold

are without-profits

 But most endowment and whole-life policies are not

without-profits

 Insurer has to invest reserves backing such policies

in fixed-income securities
With-profits policies

 Start off with a low monetary benefit

 This benefit is increased over the term of the

policy by bonuses

 Bonuses are not guaranteed in advance, but

cannot be removed once granted
With-profits policies (cont’)

 A terminal bonus may be paid at the end

 The level of bonuses reflect investment

experience but permit smoothing
Unit-linked policies

 These are saving policies, typically pensions

or endowments

 Premiums are invested in units of a managed

fund chosen by the policyholder

 The price of the units is based on the market

value of the assets of the fund
Unit-linked policies (cont’)

 The policyholder’s units are sold at market

price to provide benefits

 Transparent charges are deducted from the

fund and premiums. How?
Index-linked

 Offers a benefit that is designed to move in

line with the performance of an investment or
economic index.
Quick Questions

 If without-profit contracts are less risky for

policyholders, why might an individual take
out a with-profit or unit-linked contract?

 How does the consumer accept a greater

element of the risk under unit-linked
contracts than they do under with-profit
contracts?
Health Insurance

•Medical Expenses Insurance

•Critical Illness
•Income Protection
•Disability Insurance
Medical Expenses Insurance

 Reimburses insured in whole or in part for

the expense of medical treatment
 Benefits may be limited to fixed amounts for
certain types of treatment
 Comprehensive cover vs. Competitive rates
Medical Expenses Insurance (cont’)

 In Malaysia usually hospital cash allowance

is offered
 Overall annual limit and overall lifetime limit
applies
 Exclusions applies (Exclusions.pdf)
 Example Schedule of Benefits.jpg
Critical Illness (CI)

 Lump sum paid if the insured suffers from one

of a number of specified conditions
 Product designed not to indemnify the
policyholder. Why?
 3 characteristics for an illness to be
considered to be included into a CI product:
– Condition perceived as serious
– Condition can be defined clearly
– Sufficient data is available to price
Critical Illness (CI) (cont’)

 Often sold as ‘rider’ product, providing

acceleration of death benefit in a term
assurance contract
 Standalone cover exist as well
 Terminal Illness is often added to complete
the overall cover. Why?
 Terminal Illness usually not offered in
Standalone CI. Why?
Income Protection Insurance
 Provides an income during disability

 Income may be for a period or for life

 Income commences after a period of disability

(waiting period). Why?

 Used to protect policyholder and dependants from

loss of income due to Incapacity before retirement

 Protects lender if used as a mortgage add-on

Total and Permanent Disability (TPD)

 Usually included together with CI coverage.

Why?
 Cost of TPD will depend on the definition of
disability used
– Occupational-based
– Related to Activities of Daily Living (ADLs)
Total and Permanent Disability (TPD)

 Occupational-based
– Own occupation
– All occupation to which suited by education,
training or experience
– Any occupation
 Related to Activities of Daily Living (ADLs)
– Washing - Toileting
– Feeding - Dressing
– Mobility - Transfer
Total and Permanent Disability (TPD)

 Occupational-based vs. ADLs which one to

use?
General Insurance

•Liability insurance
•Property damage
•Financial Loss
•Fixed Benefit
Liability

 Liability - Liability cover is used to provide

indemnity where the policyholder is legally
liable to pay compensation to a third party
usually due to some form of negligence.
– Employers’ liability
– Product Liability
– Public Liability
– Professional Indemnity
– Attached to Marine and Aviation
Liability (cont’)

 Employer’s liability:
– Accidents caused by negligence of the employer
or by other employees.
– Exposure to harmful substances
– Exposure to harmful working conditions.
 Public Liability:
– Usually attached to other policies so will depend
on the main policy e.g. motor, household
Liability (cont’)

 Product Liability:
– Side-affects of drugs
– Misleading instructions

 Professional Indemnity
– Typically obtained by business professionals who
provide advice to their customers
Liability (cont’)

 Professional Indemnity
– Common industries to purchase PI include:
 Accounting and Financial Services
 Architecture
 Consulting
 Information Technology
 Legal (involuntary)
 Medical (involuntary)
Property Damage

 The purpose of this insurance is to indemnify

the policyholder against any loss or damage
to property that is covered by the policy
– Residential Buildings
– Commercial Buildings
– Land Vehicles
– Marine Craft & Aircraft
Financial Loss

 Pecuniary Loss. This covers the

nonperformance or insolvency of debtors and
gives protection against losses due to a
contractor going insolvent.
 Fidelity Guarantee Insurance. Also known
as suretyship this protects the insured from
losses due to fraudulent practices or poor
services of another party.
Financial Loss (cont’)

 Business Interruption Cover. Also known

as consequential loss insurance. This
protects the earnings of the insured when an
incident stops the company from being able
to carry out its business.
 Travel Insurance
 Extended Warranties
Fixed Benefits

 These claims are usually part of a personal

accident (PA) policy (eg UTAR PA)
 Under the policy a loss of limb may entitle the
insured to make a monetary claim of
£100,000