Life Insurance and Annuities - PowerPoint PPT Presentation

Loading...

PPT – Life Insurance and Annuities PowerPoint presentation | free to view - id: 2d8f9-NDVmM



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Life Insurance and Annuities

Description:

Cash value policies. Pure life insurance Savings ... Cash value = amount of savings accumulation. Death protection = amount of pure death protection ... – PowerPoint PPT presentation

Number of Views:993
Avg rating:3.0/5.0
Slides: 46
Provided by: grego240
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Life Insurance and Annuities


1
Chapter 15
  • Life Insurance and Annuities

2
Product Overview
  • Term
  • Pure life insurance
  • Cash value policies
  • Pure life insurance Savings accumulation
  • Examples
  • whole life
  • universal life
  • variable life

3
Product Overview
  • Can obtain savings accumulation by surrendering
    the policy
  • Why bundle death protection savings
    accumulation?
  • Tax advantaged method of saving

4
Terminology
  • Death benefit amount beneficiaries receive
  • Cash value amount of savings accumulation
  • Death protection amount of pure death
    protection
  • death benefit - cash value
  • Face amount stated amount of coverage
  • death benefit (for term, whole life, some
    universal life)
  • death benefit - cash value (for some universal
    life)

5
Term Insurance
  • Data
  • 1/4 of policies
  • almost half of death protection purchased
  • Guaranteed renewable
  • Premium increases over time

6
Endowment Insurance
  • Pays face amount
  • if the insured dies
  • or
  • if the insured survives the policy period

7
Whole Life Insurance
  • Policy period ends when insured reaches 100
  • Equivalent to endowment policy to 100
  • Premiums
  • single premium
  • limited pay
  • continuous premium

8
Whole Life Insurance
  • Premiums generally do not increase over time
  • But probability of dying increases over time
  • higher upfront premiums than with term
  • Policyholder prepays part of the cost of future
    death protection
  • entitled to prepayments if policy is surrendered
  • this is the cash value (savings accumulation)

9
Whole Life Insurance
  • If insured dies,
  • beneficiaries receive face amount
  • death protection cash value
  • Structured so
  • cash value ? over time
  • death protection ? over time

10
Whole Life Insurance
11
Participating Policies
  • Can (and usually does) pay annual dividends
  • always with mutual companies
  • often with stock companies
  • Why? - premiums based on conservative assumptions
  • Key assumptions interest rate levels and
    mortality rates
  • These variables are correlated across
    policyholders
  • Insurers methods of dealing with correlated
    risk
  • Bear the correlated risk and hold a lot of
    capital
  • Share correlated risk with policyholders
  • Illustrated versus actual dividends

12
Other Whole Life Policy Provisions
  • Surrender Options
  • Take cash value
  • Use cash value as a single premium for
  • paid up whole life
  • term policy
  • Policy loans
  • borrow against cash value
  • interest now varies with market rates
  • in 1970s 80s, fixed rate disintermediation

13
Expense Loadings
  • Front-end expense charges
  • Cash value grows slowly at first
  • Implicit return on savings accumulation
  • initially low

14
Universal Life
  • Similar to whole life
  • Main differences
  • Greater flexibility in premium payments
  • Cash value does not follow a fixed schedule it
    varies with
  • policyholders premium payments
  • insurers expense and mortality charges
  • rate insurer uses to credit interest to cash
    value
  • minimum rate usually guaranteed
  • rate often linked to short term interest rates

15
Factors Affecting UL Cash Value
16
Death Benefit Options with UL
  • Level death benefit (as with WL)
  • Death benefit varies with cash value

Death benefit
Death benefit
Cash value
Cash value
age
age
17
Variable Life
  • Similar to whole life
  • Main differences
  • Cash value does not follow a fixed schedule it
    varies with
  • return earned on portfolio of mutual funds chosen
    by policyholder
  • Death benefit
  • minimum is guaranteed,
  • varies with cash value

18
(No Transcript)
19
Tax Treatment of Life Insurance
  • Death benefits are not taxed
  • Income tax is not paid on increases in cash value
    while the policy is in force
  • Upon surrender, income tax is paid on
  • Cash surrender value - sum of all premiums
  • sum of all policyholder dividends

20
Implications of Tax Treatment
  • Implicit returns on savings accumulation
  • Escape taxation if insured dies
  • Tax deferred if the policy is surrendered
  • Partially taxed if policy is surrendered
  • Amount which is taxed is less than implicit
    return b/c part of premiums is cost of death
    protection

21
Annuity Contracts
  • Large and growing part of life insurance business
  • Divide contract period in two
  • Accumulation period
  • Policyholder pays premiums
  • Payout period
  • Insurer makes payments

22
Use of Annuities
  • Risk management perspective
  • Protection against outliving resources
  • Savings perspective
  • Tax advantaged method of saving
  • Implicit returns are tax deferred

23
Savings Features
  • Fixed annuities
  • Return credited varies with interest rates
  • Variable annuities
  • Return credited varies with return on mutual
    funds chosen by contract holder

24
Overview of Annuity Contracts
25
Life Insurance Pricing
  • Ignore expenses and risk load
  • focus on net premiums
  • Use mortality table
  • Probability of dying at age x conditional on
    living through age x-1
  • Example Probability of male dying at age 40
    0.00302
  • Assume
  • Premiums paid at beginning of year
  • Claims paid at end of year

26
Pricing 1-Year Term
  • Find fair premium for 100,000 1-year term for 40
    year-old
  • Interest rate 10
  • Insurers cash flows
  • Beg. of Year End of Year
  • -100,000 with
    prob 0.00302
  • Premium
  • 0
    with prob. 0.99698
  • Premium Present value of expected claim cost
  • 302 / 1.1 275

27
Pricing 1-Year Term
  • Find fair premium for 100,000 1-year term for 41
    year-old
  • Interest rate 10
  • Insurers cash flows
  • Beg. of Year End of Year
  • -100,000 with
    prob 0.00329
  • Premium
  • 0
    with prob. 0.99671
  • Premium Present value of expected claim cost
  • 329 / 1.1 299

28
Pricing 1-Year Term
  • Premium increases as probability of dying
    increases

29
Pricing 2-Year Term
  • Find fair premium for 100,000 2-year term for 40
    year-old
  • Insurers claim costs
  • Beg. of Year 1 End of Year 1 End of Year 2
  • -100,000 -100,000
  • with prob 0.00302 with prob x
  • 0 0
  • with prob. 0.99698 with prob 1-x

30
Pricing 2-Year Term
  • What is x? it is the probability of a 40
    year-old dying in his 42nd year?
  • Mortality table
  • Number Number
  • Age of People of Deaths
  • 40 937723 2832
  • 41 934891 3076
  • Probability of 40 year-old dying in 41st year
    0.00302
  • Probability of 40 year-old dying in 42nd year
    0.00328

31
Pricing 2-Year Term
  • Single premium
  • Insurers expected cash flows
  • Beg. of Year End of Year 1 End of Year 2
  • Premium -302 -328
  • Premium PV of expected claim costs
  • 302 / 1.1 328 / 1.12
  • 275 271 546

32
Pricing 2-Year Term
  • Level Premium
  • same premium paid at beginning of each year (if
    insured survives)
  • Insurers expected cash flows
  • Beg. of Year End of Year 1 End of Year 2
  • Premium Premium x 0.99698
  • -302 -328
  • Find Premium so that PV of expected premiums
    PV of expected claims

33
Pricing 2-Year Term
  • Premium (1 0.99698/1.1) 546
  • Premium 286.41
  • Note
  • 286.41 1/2 of single premium (546)
  • Why?
  • Chance second premium payment will not be made
  • Second premium is discounted b/c of time value of
    money

34
A Comparison
  • Expected costs of three alternative methods of
    obtaining coverage

35
Implications
  • Annual premiums for successive term policies
    reflect the annual cost of insuring
  • Annual cost 275 and 298
  • With 2-year policy,
  • premium in year 1 275
  • premium in year 2
  • With this example, size of difference is small
  • With whole life policies (UL, VL)
  • difference can be large
  • gives rise to cash value

Essentially, pre-funding costs
36
Pricing Immediate Annuities
  • Example Find single premium for a 5,000 life
    annuity for a 95-year-old
  • Assume person dies by age 100
  • Interest rate 10
  • Premium PV of expected payments to annuitant
    4,530
  • Probability Expected PV of
  • of 96-year- Payment Expected
  • Age old surviving 5,000 x prob Payment
  • 97 6050/9831 3077 3,077 / 1.1 2,797
  • 98 3145/9831 1,600 1,322 / 1.12 1,322
  • 99 1076/9831 547 547/ 1.13 411
  • 100 0 0 0

37
Pricing Single Premium Whole Life
  • Apply same principles used with term
  • Forecast expected cash flows to age 100
  • Find single premium
  • PV of expected cost
  • Assume
  • no expenses or profits
  • 5 interest rate
  • policy will not lapse

38
Pricing Single Premium Whole Life
Single Premium
39
Continuous Level Premium Whole Life
  • Continuous level premium
  • Same premium is paid until insured dies or
    reaches 100
  • Equivalent to a life annuity
  • Present value of a life annuity that pays P
    starting at age 40 16.30 x P
  • Find P so that PV of premium payments PV of
    costs
  • 16.30 x P 22,373 P 1,372.58

40
Limited Payment Whole Life
  • Limited payment level premium
  • Same premium is paid for fixed number of years
  • Example 20 years
  • Equivalent to a 20 year annuity
  • Present value of a 20-year annuity that pays P
    starting at age 40 12.58 x P
  • Find P so that PV of premium payments PV of
    costs
  • 12.58 x P 22,373 P 1,778.45

41
Comparison of Cash Values in Whole Life
42
How Much Life Insurance Should be Purchased?
  • Rules of thumb
  • Death benefit 8 times income
  • Forecast beneficiaries sources uses of funds
  • Uses
  • Living expenses
  • Education expenses
  • Sources
  • Social security
  • Earnings

43
Term Insurance Cost Comparisons
  • Adjusted cost index
  • Idea calculate accumulated future value of all
    costs
  • Procedure
  • accumulate premiums (P) per 1,000 of coverage
  • less policyholder dividends (D)
  • for 20 years
  • at a 5 interest rate

44
Whole Life Cost Comparisons
  • One approach use adjusted cost index again
  • but subtract cash value (CV) at end of 20 years
  • AC20 AC20 - CV20
  • In practice adjust cost indices are scaled to get
    interest adjusted cost (IAC)
  • Another approach calculate implicit rate of
    return

45
Universal Life Cost Comparisons
  • More complex
  • One approach
  • Use interest adjusted cost index subtracting an
    estimate of cash value
  • under common assumptions(across policies being
    compared) about premiums and interest rates
  • No consensus exists
About PowerShow.com