Premium calculation - Concept of Insurance, Principles of Insurance Video Lecture | Principles of Insurance - B Com

hi and welcome back to the business
Career College video series in this
video we're going to look at the
calculation of premiums for a life
insurance policy this is quite
appropriate for students going through
the life license qualification program
also probably useful for a student going
through a financial planning course so
when we look at premiums for a life
insurance policy we're going to look at
three or arguably four factors we're
going to look at mortality and if we
were dealing with a disability policy we
would refer to this as morbidity so
mortality is the likelihood of dying at
a given age morbidity as likelihood
becoming disabled at a given age we also
will look at the insurers expenses and
we also have to consider the insurers or
the investment component of a policy and
there is a fourth factor it's not
something that's covered in any detail
in the life license qualification
program but lapse and I will talk about
it
at least for a few moments I near the
end of this presentation will look at
lapse very briefly mortality however is
by far the most important consideration
and mortality is going to be based on
somebody's age somebody sex and
somebody's smoking status and based on
this information
actuaries create tables referred to as
mortality tables or sometimes you'll see
them referred to by their correct name
which is the commissionaires tables and
these mortality tables they are
proprietary information in Canada the
Canadian Institute Institute of
Actuaries
prepares these mortality tables and
they're really offered to insurers
exclusively they're not public
information
so the mortality table describes for us
the likelihood of somebody dying at a
given age based on these factors and the
way this mortality table works it uses a
sample generally a sample of a million
people and it says at a given age so
let's start start with h0 at a given age
how many out of this million might die
so it's a typically and sort of sort of
a depressing topic here but typically
3,000 out of a million might die in that
first year giving us a mortality rate of
3 so we have a deaths per thousand then
we'd have 3 deaths per thousand now next
year our sample size would be less than
a million our sample size would have
come down and now our sample size would
be just 997 thousand of them and then we
say ok out of that 997 thousand how many
would die and the next year it would be
substantially less it might be a
thousand that would die and then we
could say that gives us a mortality rate
of that gives some mortality rate of one
point zero zero now let's fast forward a
little bit here and we'll look at
mortality let's say that we have a male
nonsmoker and we'll
going to see the mortality tables broken
down like this by sex so you'll have
different mortality tables for men than
for women and will see their smoking or
non-smoking status giving us two
separate sets of mortality tables so a
lot of times we say somebody's rated for
smoking but that's not true they're
actually on a separate mortality table
and let's say that our male nonsmoker
is age 44 and at age 44 a mortality
table might show that we're going to
have three deaths for every thousand
insurance or life insurance sorry or
lives insured and my male nonsmoker
wants to buy we'll just keep this nice
and easy one hundred thousand dollars of
life insurance and life insurance is
only sold in blocks of a thousand
dollars or in units of a thousand
dollars so we're not going to have
somebody buying one hundred thousand
four hundred and eight dollars of life
insurance a hundred thousand is a nice
round number so we want to know what
this is going to cost well what we have
here this would be a thousand units of
insurance sorry I apologize it's a
hundred units of insurance so now we
have to look at what each unit costs
well at a mortality rate have three for
every thousand the insurer knows then
that they have to collect three dollars
per unit so this is going to have an
annual premium of three hundred dollars
and that covers our mortality cost now
not every insured who not every life
insured who's acquiring insurance is
necessarily at the optimal level of
health so this is where the insurer
looks at this and says now we have to
apply a rating so if we have this person
with a $300 premium that's we would
refer to as their 100% rating that's the
insurer the insurers
cost when this person is acquiring
insurance add a healthy sort of normal
rate we can have I superior ratings
sometimes we have somebody who actually
represents a lower degree of risk and
they might get a discount off of this
but let's say that this person happens
to represent a little bit more risk
maybe they have some health problems in
their history or maybe they have some
dangerous hobbies or something like that
so that's where we might attach let's
say a one hundred and fifty percent
rating and that means now the insurer
figures this person is about 50 percent
riskier than their normal amount of risk
you'll see ratings usually up to about
four hundred percent is as high as
insurers will go I have heard of
instances of ratings going as high as
five hundred percent but usually four
hundred percent is the top end so this
person instead of paying a 350 or $300
premium is now paying a four hundred and
fifty dollar premium and that's just for
their mortality costs or this is what we
might refer to as the cost of insurance
that is what does it actually cost to
buy the insurance in this case now in
addition to that we'll typically have
some expenses associated with this
policy and that's assessed in the form
of a policy factor or a policy fee so
let's say for the sake of argument that
we have a sixty dollar policy fee or
policy factor that's how the insurer
recovers its expenses because if they
only charged that mortality cost at four
hundred and fifty dollars and the
expected number of people died the
insurer is going to be out all of that
money so now
we have a premium of 510 dollars and if
this were a permanent insurance policy
then we would also add something in here
for the investment component but we'll
just use term insurance here for the
time being but if this were permanent
insurance we would add some investment
component interior but let's just leave
this at five hundred and ten dollars now
the other thing that does happen is that
we can incorporate lapse into these
policies it's actually a good thing to
some extent for the insurer when a
policy lapses and insurers do count on
this insurers count on a number of
people lapsing their policies when we
get to maybe you're a two-year ten or
year 12 of the policy and if that
happens then really the insurer comes
out ahead because that's somebody who
paid a number of years of premiums and
now no death benefit has to be paid on
that person's behalf so we can
incorporate those lapse assumptions into
our calculations and normally lapse
assumptions are somewhere around one to
three percent that is we assume that
somewhere between one to three percent
of a given type of policy will lapse in
a given year and if that holds true
that's generally good for those who stay
in their insurance policies so now we
end up at a five hundred and ten dollar
premium now this is what your premium
would be if you paid annually but it's
actually pretty rare for somebody to pay
their insurance premiums annually as
with a lot of costs we might choose to
pay this premium monthly and what
happens then is it's assumed that you
paid this five hundred and ten dollars
in advance so we assume this is paid in
advance
beginning of the year so then the
insurer has that money available to pay
claims out throughout the year if you
don't want to pay it in advance it is if
you want to pay it monthly then we're
going to add a policy fee or a policy
factor and this policy or policy factor
policy for your policy factor might be
in the realm of let's say 8% so now we
have an 8% policy fee added on to this
insurance policy and if you're doing
this in your calculator you can do five
hundred and ten plus eight percent with
most calculators that will give you your
answer and you'll see that the the total
annual premium now will be five hundred
and fifty dollars and eighty cents and
now you're going to pay that monthly and
this amount this eight percent sorry
that's not policy fee I apologize that's
your sorry about that that's what we
call the modal factor we saw the policy
fee up above so this modal factor this
eight percent modal factor means you're
using a mode of premium payments other
than annually and now we take that five
hundred and fifty dollars and eighty
cents divided by twelve and your monthly
premium for this one hundred thousand
dollars of insurance for a forty
four-year-old male and this would assume
a one-year non-renewable term policy
will be 45 dollars and ninety cents per
month now when we get later into this
course we'll see that there are some
things we can do to create different
types of insurance or to average out
this cost over a number of years but for
now this one year non-renewable term
insurance policy would have an a monthly
premium of just shy of forty six dollars
that's what it would cost using these
calculations for a million dollars of
insurance
sorry $100,000 of insurance I hope that
helps to understand the calculation of
premiums a little bit of math in there
but it's mostly about the concepts and I
hope you enjoy your ongoing studies
thank you very kindly