Appraisal of Family Income Benefits Life Insurance - Coursework Example

University> Appraisal of Family Income Benefits Life Insurance by 111Equation Chapter 1 Section 1Abstract Family Income Benefit (F.I.B) insurance is a policy applicable in its term, and it entitles the family of the insured to a regular tax-free income that only last as long as the term. Mostly, the plan includes a level-term lump sum payment in the event of the death of the policyholder. However, the firm must take precautions not to end-up with losses or negative reserves in the long-term. As such, reservation, pricing (premiums), and profit aspects should reconcile with the needs of the policy holders while at the same time bearing business perspective of the firm. Appraisal of Family Income Benefits Life Insurance Introduction Family income benefit (F.I.B) is one of the many types of covers available in the market. Its policies apply to the “term” of its agreement, and entitle a family to a regular tax-free income that only last as long as the duration of the “term”. It also includes a level-term lump sum payment in the event of the death of the policyholder. In general, F.I.B, in the marketplace, guarantees monthly income payment and may or may not include a cover for critical maladies. Mathematical computations of F.I.B premiums, profits, and reserves, as well as an explanation of these aspects, constitute the core of this expedition. Product Description Harris, Easton, and Abkemeier (2014) defines Family Income Benefit Life Insurance as a protection against the loss of income to families following the untimely demise of the policy holder. Karve (2009) theorizes that the premiums of F.I.B cover are based on the amount of cover and the duration that the insured wants it for, age as well personal lifestyle. That is, an F.I.B of term n years “refers to a series of instalments payable to the family from the date of death of the assured life, if he dies within n years, for the balance of the term” (85). The assigned beneficiaries receive the benefits and are protected from the financial effects due to the passing of the insured. As such, the main goal of this product, F.I.B coverage, is to provide a financial security measure for young families after the insured’s death or when the insured is diagnosed with an illness that meets the firm’s definitions of critical or terminal illness. The terms of the coverage should allow for expenses, but particularly renewal kinds. Initial expenses should be shared between the firm and the policy seeker (Cohen and Rathbone, 1929). In the case of need to enforce this, then the expense should be the inform of commissions to avoid inflating the premiums. Furthermore, benefits can be payable continuously or per annum, with reserving bases of ELT15 male/female mortality rates, interest of 6%, and negligible expenses payables during renewals. Either increasing or reducing the expense amount can affect either amounts payable as premiums or results in business losses on the side of the firm respectively. The product herein proposed should abide by a given set of conditions and considers several factors. Firstly, it would be prudent to consider the standard of living and financial situation of potential policy holders before they seal the coverage contract. It would also suffice to re-evaluate the the terms of the policy on an annual or when the insured experiences a major life event such as marriage, birth or adoption of a child, divorce or purchase of major items such as land or house (Harris, Easton and Abkemeier, 2014; Purvis, 2010). Nonetheless, these conditions do not dictate the terms of the contract and can only weigh in if the condition is deemed special. Secondly, the policy that this product offers run for a set period, but pays a regular tax-free income upon the death of the policy holder, and until the term expires. The cover should be valid as long as the insurance policy runs, but it ceases on expiry of the term. In particular, the amount of the lump sum paid out to the beneficiaries in the event of the death of the insured remains the same irrespective of whether the death occurs in the first or last year of the insurance policy (Scott, 1999; Karve, 2009). There is, however, an inevitable danger that, should premiums be payable for the n-year term, the policy may have a negative implication on the reserve at later periods. Hence, the policyholder, particular the family of the deceased, may lapse the contract leaving the company with massive losses, and also with a possibility of obtaining the same benefits at cheaper costs by affecting the new policy (Scott, 1999). Harris, Easton, and Abkemeier (2014) emphasizes that F.I.B is a cheaper and easier way to cover financial benefits for the family, and youngest families will opt for it because it is sustainable until children are grown up. The income paid-out could be utilized to meet daily or on-going expenses such as school fees and rent. For the company to successfully launch its product, it must sensitize these families on the importance of having a sound expenditure. They should also consider inflation as a factor that can gravely affect the amount of income they will expect in future. Perhaps more importantly, this type of insurance policy should not cover mortgages and other loans. That is, the policies must restrict the monthly payment to pre-identified particulars. In the process of introducing this product, it may become a necessity to solicit the services of a financial advisor, who will guarantee the safety of the policy before purchase (Harris, Easton and Abkemeier, 2014; Karve, 2009). The advisor can also mentor the policy holder on how best to manage expenses so as to cover payments excluded by the F.I.B cover. Nonetheless, the firm may fail to pay the benefit due to the entitled family because of several reasons. Firstly, when the beneficiaries, the insured or their legal representatives, fail to provide the medical or other evidence necessary for processing of the amount payable. Secondly, when the diagnosis fails to meet the definition of the terminal or critical illness, or when a medical consultant does not diagnose the terminal or crictical illness, or when the terminal illness is not expected to result in death within a period of 12 months. Thirdly, if the basis of the claim is an event that is specifically excluded from the terms of the cover. Fourthly, in case the firm discovers that the information provided during application is inaccurate or incomplete, which would have affected the company’s decision to offer the cover or would have led it, all the same, to offer the cover with different conditions. Finally, if the cover is not active at the time of the claim. Pricing Analysis Scott (2009) postulates that family income benefits insurance is a decreasing term cover in which the benefit of death is an annuity-certain for the balance of the term. The assurance can be available in three different scenarios. First, a case in which all the benefits are payable in a continuous manner. In such a case, if coverage payments are at rate £β per year, and life assured is aged x at the issue date, then the present value of the benefits is, It follows that the M.P.V is defined as Where x is the age of the insured and a future lifetime random variable. The demise of x can occur at any age greater than x, and such can be modelled as. From which the survival probability is Given that an individual’s survival probability at birth is known, it is easy to use the two equations to establish survival probabilities of policy holders at future age (x). Although, the survival function for a density distribution must conform to the following set of conditions for the product to be valid. First, the probability that a life currently aged x survives zero years is 1, and secondly, all lives eventually die. Other additional mathematical assumptions include 1. is differentiable for all 2. 3. All these assumptions are necessary for modelling human life, especially for this product in which the policy holder is assumed to be young, and hence, the policy holder is 25 years (Scott, 1999). The second option for the F.I.B is a case where the benefits are in arrear, beginning at the end of the year of death. That is, the F.I.B is combined with an temporary annuity of term n years, payable in arrears. In this case, the total present value remains regardless of the time the policy older dies. In the third scenario, the payments begin immediately after death. Comparatively, a policy holder who is 25 years can take a level annual premium payable for a maximum of 35 years. Suppose that there are a 6% interest and 3% expense of all premiums, then the policy holder will only pay £96.93 premium per annual. Premiums are the most powerful element used in the marketing strategy of the insurance cover and affect the final sale of the product. As such, the premiums or prices must be attractive to the targeted families. Decisions regarding premium (pricing), commission rate, investment return, insured sum amount, pricing strategy, and price related contingencies are evaluated regularly by the insurer to avoid losses. It is done by testing whether the prices will work at extreme amounts and ages. Family Income Benefit Life Insurance is sold through the use of sales illustrations, which show the prices and the development of guaranteed and non-guaranteed annual values. Such illustrations must be certified, and the assumptions tested to derive whether they are appropriate. The sales illustrations normally indicate the expected premiums to be paid and the accumulating annual values and benefits under a given set of assumptions defined in the illustration. Usually, a sales illustration indicates more than one set of rules and hence more than one set of values and benefits. Making the necessary adjustments to the sales illustration systems for F.I.B assurance is an important method the insurer can use to improve the product pricing. The insurer can also facilitate the preparation of other sales measures such as rate cards, and sales brochures. Once the cover has been introduced and pricing has begun, it is important to invent programs aiming at monitoring the sales and profits. It will help establish whether the criteria for pricing adopted is favorable for both the insured and the insured. It will also assist the management and marketing department to understand whether there are deviations from the competitors’ pricing techniques. The information will not only assist in making necessary modifications to the product pricing but will also sharpen the focus of the insurer to strategize future product pricing. The most important sources of profit for firms offering F.I.B coverage include gains from interest, mortality and expense. Analyzing the three factors annually help company management understand what needs to be done to have the profit on track. For instance, in case, all the other sources of profit are significantly benefiting the firm, but gains from mortality are less than what was established in pricing, then the management is aware the policies are not tightly underwritten, and hence they adjust them appropriately. Profit Analysis The company should go for a profit F.I.B product that will maximize profit and compare it to their profit plans in different measures (Karve, 2009). Almost all the efforts of life insurers are focused on adjusting the firm’s operations to improve the profit. Many of these ways encompass taking a portion of the profit to a different financial item. The profit margin in this type of the policy is affected considerably by the choice of a set of assumptions for the present value. The present value, in regards to this form of life insurance, involves the assumptions relating to mortality and police persistency, and interest. The comparison of profit margins of two companies is sometimes misleading, and therefore life insurers seek to create some uniformity in the selection of assumptions. There is no consensus, however, on the appropriate assumptions despite many F.I.B based firms discounting using the current rates of benefits on the product. Profit margin is normally used by the life insurance companies to measure the profit for F.I.B insurance. However, simply understanding the sources of profits of losses is not enough although it provides some useful information. The proposed F.I.B product will not lead the firm to losses if only it has profit attributes attached to it. The profits will depend on the prospective and retrospective reserves value of the firm. The reserving bases, as explained in the next section, will form an integral part of this profit process. However, considering this product to be for profit can, under relaxed regulations, force the company to pay expenses that it excludes from the terms of the policy. In fact, operating a profit oriented product may obligate the company to cover return on investment. Reserve Analysis Lombardi and Tullis (2006) describe that reserve calculations and analysis are important to understanding the operations of F.I.B firm. From the perspective of finance and accounting, reserves are typically the largest liability on such firm’s balance sheet, and importantly affect the business’ statutory and taxable income. The makeup of the reserves is also crucial to determining whether or not F.I.B firm is taxed as a life insurance company or as a non-life insurance company. To be taxed as a life insurance company, the status of the firm’s life insurance reserves must constitute more than 50 percent of its total insurance reserves. Mathematically, reserves are the amount of money held by financial institutions involved in insurance processes. It covers the difference between the present value of the future liabilities, expenses included, and the present value of future premium (Scott). It would be imperative to consider prospective and net reserves for the F.I.B policy product. For a life that will have age x at time t of taking the policy should have a prospective reserve defined by a moment given as; A calculation of the reserve from the above random variable L is as shown below Expenses may be ignored or included depending the terms of agreement between the firm and the policy holder, and if that be the case then the reserve computation equation become, The computation of net premium reserves does not include allowances for the expense, hence operating on the assumption that premium and reserve bases are in agreement. Nonetheless, if the premium and the reserving bases agree, just like in the above case, the prospective and retrospective reserves will apply for the policy and will be equal. In general, the reserving basis includes a mortality table showing the force of mortality rate (ELT15), a 6% interest rate, and negotiable allowances for future expenses. It should be noted that either of the reserving approaches has its downside. In particular, including the expenses in the reserving process may inflate the premium while neglecting it may force the firm to incur expenses that may reflect on its financial statement as losses. Theoretically, family income benefits firms use contingency reserves as buffers to their accounts for the risk that they know will happen. For instance, a firm may have contingency reserve for lack of skilled workers in one of the departments. The company may also adopt management reserves for unidentified risks to protect their operations from critters. Despite the type of reserve that the life insurance firm adopts, the amount of buffer is equivalent to the cost of risk predicted. Besides, the norms within the firm may also determine the amount of buffering applicable. However, the rule of thumb requires that Family Income Benefit Life Insurance firm should buffer according to the level of risk predicted for individual activities. Recommendation From the background information provided, it would be prudent for the company to offer a package that will pay out an annual income to the family of the policy holder, should he pass on while the plan is active. Suppose that the policyholder is averagely 27 years at the time of taking the coverage, then the income payouts term should be 25 years. However, this computation is subject to the assumptions of the random variable x and can vary depending on the age, lifestyle, and income of the target population. Perhaps more importantly, the firm must impose conditions on lifestyle and critical illnesses considered by the plan. It would also be easier to minimize the commission to agents at the point of signing in the policy holder. Dickson, Hardy, and Waters (2009) assesses and concludes that “initial and renewal expenses are proportional to premiums, proportional to benefits or may be ‘per policy,' that is, it assumes fixed amount for all policies” (151). For this particular product, assuming per policy renewal would mean that the associated expense would have to increase at a compound rate over the term of coverage with an aim of approximating the effects of inflation. The effects of such compounded interest increment would reflect on the premiums and increase the amount payable. The extra cost can be avoided by ensuring that the commission rate as well as the renewal expense remains constant over the term of the policy. List of References Cohen, J. L. and Rathbone, E. F., 1929. Family Income Insurance: A Scheme of Family Endowment by The Method of Insurance. London, P.S. King. Dickson, D.C.M., Hardy, M.R., and Waters, H.R., 2009. Actuarial Mathematics for Life Contingent Risks. Cambridge: Cambridge University Press Gupta, P., 2007. Fundamentals of Insurance. Mumbai, IN: Himalaya Publishing House. Harris, T. F., Easton, A. E. and Abkemeier, N. J., 2014. Actuarial aspects of individual life insurance and annuity contracts. Winsted, Conn: ACTEX Publications. Karve, S. L., 2009. Principles of Life Insurance. Mumbai, IND: Himalaya Publishing House. Lombardi, L. J. and Tullis, M. A., 2006. Valuation of Life Insurance Liabilities: Establishing Reserves for Life Insurance Policies and Annuity Contracts. Winsted, Conn: ACTEX Publications. Purvis, K., 2000. English for The Insurance Industry. Karlsruhe, VVW. Scott, W. F., 1999. Life Assurance Mathematics. Edinburgh, Heriot-Watt University. Read More