Faculty of Commerce

Stat., Math., and Insurance Department

Insurance Terminology

Organised by
Prof. Safia Ahmed AboBakr
Professor of Insurance
Faculty of Commerce
Assiut University

2022-2023

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PREFACE

Prof. Safia Ahmed AboBakr

Dept. of Statistics, Math., and Insurance
August 2023

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Contents:

Chapter (1) Life Insurance……………………5-18

Chapter (2) Mortality Tables………………..19 -

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 Chapter (1)

LIFE INSURANCE

1. Introduction
The specific uses of the terms "insurance" and "assurance" are sometimes
confused. In general, in jurisdictions where both terms are used, "insurance" refers to
providing coverage for an event that might happen (fire, theft, flood, etc.), while
"assurance" is the provision of coverage for an event that is certain to happen. In the
United States both forms of coverage are called "insurance" for reasons of simplicity
in companies selling both products.] By some definitions, "insurance" is any coverage
that determines benefits based on actual losses whereas "assurance" is coverage with
predetermined benefits irrespective of the losses incurred.

2. Insurance Contract
Parties to contract
There is a difference between the insured and the policy owner, although the
owner and the insured are often the same person. For example, if Joe buys a policy on
his own life, he is both the owner and the insured. But if Jane, his wife, buys a policy
on Joe's life, she is the owner and he is the insured. The policy owner is the guarantor
and he will be the person to pay for the policy. The insured is a participant in the
contract, but not necessarily a party to it. In addition, most companies allow the payer
and owner to be different, e.g. a grandparent paying premiums for a policy on a child,
owned by a grandchild.

The beneficiary receives policy proceeds upon the insured person's death. The
owner designates the beneficiary, but the beneficiary is not a party to the policy. The
owner can change the beneficiary unless the policy has an irrevocable beneficiary
designation. If a policy has an irrevocable beneficiary, any beneficiary changes, policy
assignments, or cash value borrowing would require the agreement of the original
beneficiary.

In cases where the policy owner is not the insured (also referred to as the celui
qui vit or CQV), insurance companies have sought to limit policy purchases to those
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with an insurable interest in the CQV. For life insurance policies, close family
members and business partners will usually be be found to have an insurable interest.
The insurable interest requirement usually demonstrates that the purchaser will
actually suffer some kind of loss if the CQV dies. Such a requirement prevents people
from benefiting from the purchase of purely speculative policies on people they expect
to die. With no insurable interest requirement, the risk that a purchaser would murder
the CQV for insurance proceeds would be great. In at least one case, an insurance
company which sold a policy to a purchaser with no insurable interest (who later
murdered the CQV for the proceeds), was found liable in court for contributing to
the wrongful death of the victim.

Contract terms
Special exclusions may apply, such as suicide clauses, whereby the policy
becomes null and void if the insured commits suicide within a specified time (usually
two years after the purchase date). Any misrepresentations by the insured on the
application may also be grounds for nullification. Only if the insured dies within this
period will the insurer have a legal right to contest the claim based on
misrepresentation and request additional information before deciding whether to pay
or deny the claim.

The face amount of the policy is the initial amount that the policy will pay at
the death of the insured or when the policy matures, although the actual death benefit
can provide for greater or lesser than the face amount. The policy matures when the
insured dies or reaches a specified age (such as 100 years old).

Death proceeds
Upon the insured's death, the insurer requires acceptable proof of death before it
pays the claim. The normal minimum proof required is a death certificate, and the
insurer's claim form completed, signed, and typically notarized. If the insured's death
is suspicious and the policy amount is large, the insurer may investigate the
circumstances surrounding the death before deciding whether it has an obligation to
pay the claim.

Payment from the policy may be as a lump sum or as an annuity, which is paid
in regular installments for either a specified period or for the beneficiary's lifetime.

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3. Costs, insurability, and underwriting

The insurer (the life insurance company) calculates the policy prices with intent
to fund claims to be paid and administrative costs, and to make a profit. The cost of
insurance is determined using mortality tables calculated by actuaries. Actuaries are
professionals who employ actuarial science, which is beig based on mathematics
(primarily probability and statistics). Mortality tables are statistically based tables
showing expected annual mortality rates. It is possible to derive life expectancy
estimates from these mortality assumptions.

Three main variables in a mortality table are commonly age, gender, and use
of tobacco. The mortality tables provide a baseline for the cost of insurance, but in
practice, these mortality tables are beig used in conjunction with the health and family
history of the individual applying for a policy to determine premiums and insurability.
The newer tables include separate mortality tables for smokers and non-smokers, and
include separate tables for preferred classes.

Most of the revenue received by insurance companies consists of premiums

paid by policyholders, with some additional money is being made through the
investment of some of the cash raised from premiums. Rates charged for life insurance
increase with the insured's age because, statistically, people are more likely to die as
they get older. The insurance company will investigate the health of an applicant for a
policy to assess the likelihood of incurring a claim, in the same way that a bank would
investigate an applicant for a loan to assess the likelihood of a default. Group
Insurance policies are an exception to this. This investigation and resulting evaluation
of the risk is termed underwriting. Health and lifestyle questions are to be asked with
certain responses or revelations possibly meriting further investigation. Life insurance
companies support the Medical Information, which is a clearing house of information
on persons who have applied for life insurance.

Underwriters will determine the purpose of insurance; the most common being
to protect the owner's family or financial interests in the event of the insured's death.
Other purposes include estate planning or, in the case of cash-value contracts,
investment for retirement planning. Bank loans or buy-sell provisions of business
agreements are another acceptable purpose.

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 Life insurance companies are never legally required to underwrite or to provide
coverage to anyone, with the exception of Civil Rights Act compliance requirements.
Insurance companies alone determine insurability, and some people, for their own
health or lifestyle reasons, are deemed uninsurable. The policy can be declined or rated
(increasing the premium amount to compensate for a greater probability of a claim),
and the amount of the premium will be proportional to the face value of the policy.

Many companies separate applicants into four general categories. These

categories are preferred best, preferred, standard, and tobacco. Preferred best is
reserved only for the healthiest individuals in the general population. This may mean,
that the proposed insured has no adverse medical history, is not under medication for
any condition, and his family (immediate and extended) have no history of early-
onset cancer, diabetes, or other conditions. Preferred means that the proposed insured
is currently under medication for a medical condition and has a family history of
particular illnesses. Most people are in the standard category. People in the tobacco
category typically have to pay higher premiums due to the inherent health problems
that smoking tobacco creates. Profession, travel history, and lifestyle factor into
whether the proposed insured will be granted a policy, and which category the insured
falls. For example, a person who would otherwise be classified as preferred best may
be denied a policy if he or she travels to a high risk country. Underwriting practices
can vary from insurer to insurer, encouraging competition.

4. Types of life insurance

Life insurance divided into two basic classes: temporary and permanent; or the
following subclasses: term, universal, whole life, and endowment life insurance.

1) Term insurance

Term assurance provides life insurance coverage for a specified term. The
policy does not accumulate cash value. Term is considered "pure" insurance, where
the premium buys protection in the event of death and nothing else. There are three
key factors to be considered in term insurance:

 Face amount (protection or death benefit),

 Premium to be paid (cost to the insured), and

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  Length of coverage (term).
Annual renewable term is a one-year policy, but the insurance company
guarantees it will issue a policy of an equal or lesser amount regardless of the
insurability of the applicant, and with a premium set for the applicant's age at that
time.

Level premium term can be purchased in 5, 10, 15, 20, 25, 30 or 35 year terms.
The premium and death benefit stays level during these terms.

Mortgage life insurance insures a loan secured by real property and usually
features a level premium amount for a declining policy face value because what is
insured is the principal and interest outstanding on a mortgage that is constantly being
reduced by mortgage payments. The face amount of the policy is always the amount of
the principal and interest outstanding that are paid should the applicant die before the
final installment is paid.

Permanent life insurance

Permanent life insurance is life insurance that cannot be cancelled for any reason
except fraud, so long as the owner regularly pays his premiums. Any such
cancellation must occur within a period of time (usually two years) defined by law. A
permanent insurance policy accumulates a cash value up to its date of maturation,
reducing the risk to which the insurance company is exposed as well as the policy's
expense to the company. Such policies will be more expensive to older people than to
younger ones. The owner can access the money in the cash value by withdrawing
money, borrowing the cash value, or surrendering the policy and receiving the
surrender value.

The four basic types of permanent insurance are whole life, universal life, limited
pay, and endowment.

2) Whole life coverage

Whole life insurance provides lifetime death benefit coverage for a level
premium. For younger people, whole life premiums are much higher than term
insurance premiums, but because term insurance premiums rise with increasing age of
the insured, the cumulative value of all premiums paid under whole and term policies

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are roughly equal if policies are maintained to average life expectancy. Part of the
insurance contract stipulates that the policyholder is entitled to a cash value reserve
that is part of the policy and guaranteed by the company. This cash value can be
accessed at any time through policy loans that are received income tax-free and paid
back according to mutually agreed-upon schedules. These policy loans are available
until the insured's death. If any loans amounts are outstanding—i.e., not yet paid
back—upon the insured's death, the insurer subtracts those amounts from the policy's
face value/death benefit and pays the remainder to the policy's beneficiary.

While some life insurance companies market whole life as a "death benefit with
a savings account", the distinction is artificial, according to life insurance actuaries
Albert E. Easton and Timothy F. Harris. The net amount at risk is the amount the
insurer must pay to the beneficiary should the insured die before the policy has
accumulated premiums equal to the death benefit. It is the difference between the
policy's current cash value (i.e., total paid in by owner plus that amount's interest
earnings) and its face value/death benefit. Although the actual cash value may be
different from the death benefit, in practice the policy is identified by its original face
value/death benefit.

The advantages of whole life insurance are its guaranteed death benefits;
guaranteed cash values; fixed, predictable premiums; and mortality and expense
charges that do not reduce the policy's cash value. The disadvantages of whole life are
the inflexibility of its premiums and the fact that the internal rate of return of the
policy may not be competitive with other savings and investment alternatives.

Death benefit amounts of whole life policies can also be increased through
accumulation and/or reinvestment of policy dividends, though these dividends are not
guaranteed and may be higher or lower than earnings at existing interest rates over
time. According to internal documents from some life insurance companies, the
internal rate of return and dividend payment realized by the policyholder is often a
function of when the policyholder buys the policy and how long that policy remains in
force. Dividends paid on a whole life policy can be utilized in many ways.

The life insurance manual defines policy dividends as refunds of premium over-
payments. They are therefore not exactly like corporate stock dividends, which are
payouts of net income from total revenues.
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 Universal life coverage
Universal life insurance (UL) is a relatively new insurance product, intended to
combine permanent insurance coverage with greater flexibility in premium payments,
along with the potential for greater growth of cash values. There are several types of
universal life insurance policies, including interest- sensitive (also known as
"traditional fixed universal life insurance"), variable universal life (VUL), guaranteed
death benefit, and equity-indexed universal life insurance.

Universal life insurance policies have cash values. Paid-in premiums increase
their cash values; administrative and other costs reduce their cash values.

Universal life insurance addresses the perceived disadvantages of whole life –

namely that premiums and death benefits are fixed. With universal life, both the
premiums and death benefit are flexible. With the exception of guaranteed-death-
benefit universal life policies, universal life policies trade their greater flexibility off
for fewer guarantees.

"Flexible death benefit" means the policy owner can choose to decrease the
death benefit. The death benefit can also be increased by the policy owner, usually
requiring new underwriting. Another feature of flexible death benefit is the ability to
choose option A or option B death benefits and to change those options over the
course of the life of the insured. Option A is often referred to as a "level death
benefit"; death benefits remain level for the life of the insured, and premiums are
lower than policies with Option B death benefits, which pay the policy's cash value—
i.e., a face amount plus earnings/interest. If the cash value grows over time, the death
benefits do too. If the cash value declines, the death benefit also declines. Option B
policies normally feature higher premiums than option A policies.

Limited-pay
Another type of permanent insurance is limited-pay life insurance, whose
premiums are paid over a specified period, commonly ten or twenty years, after which
no additional premiums are due. Benefits are sometimes paid out at the age of 65;
other ages can include 75, 85, and 100.
Other limited pay policies do not pay out at a set age, but become "paid up",
leaving the policyholder with a guaranteed death benefit and no further premiums to
pay.
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 3) Endowments

Endowments are policies whose face values equal a benefit amount at a given
age, called the endowment age, rather than a death benefit amount. Endowments
require higher premiums than whole life and universal life policies because premiums
are paid over shorter periods and maturation dates are earlier.

Endowments mature and are paid out after a pre-specified period (e.g. 15 years)
or at a pre-specified age (e.g., 65), whether the insured is alive or has already died.

Accidental death
Accidental death insurance is a type of limited life insurance that is designed to
cover the insured should they die as the result of an accident. "Accidents" run the
gamut from abrasions to catastrophes but normally do not include deaths resulting
from non-accident-related health problems or suicide. Because they only cover
accidents, these policies are much less expensive than other life insurance policies.

Such insurance can also be accidental death and dismemberment

insurance or AD&D. In an AD&D policy, benefits are available not only for accidental
death but also for the loss of limbs or body functions such as sight and hearing.

Accidental death and AD&D policies very rarely pay a benefit, either because
the cause of death is not covered by the policy or because death occurs well after the
accident, by which time the premiums have gone unpaid. To know what coverage they
have, insureds should always review their policies. Risky activities such as
parachuting, flying, professional sports, or military service are often omitted from
coverage.

Accidental death insurance can also supplement standard life insurance as

a rider. If a rider is purchased, the policy generally pays double the face amount if the
insured dies from an accident. This was once called double indemnity insurance. In
some cases, triple indemnity coverage may be available.

Riders
Riders are modifications to the insurance policy added at the same time the
policy is issued. These riders change the basic policy to provide some feature desired
by the policy owner. A common rider is accidental death (see above). Another
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common rider is a premium waiver, which waives future premiums if the insured
becomes disabled.
Joint life insurance is either term or permanent life insurance that insures two
or more persons, with proceeds payable on the death of either.

Survivorship life insurance

Survivor life insurance is whole life insurance insuring two lives, with proceeds
payable after the second (later) death.

Single-premium whole life insurance requires only one premium payment, paid
at policy inception.

Modified whole life insurance features smaller premiums for a specified period,
followed by higher premiums for the remainder of the policy.

Related products

Group life insurance

Group life insurance (also known as wholesale life insurance or institutional
life insurance) is term insurance covering a group of people, usually employees of a
company, members of a union or association, or members of a pension
or superannuation fund. Individual proof of insurability is not normally a consideration
in its underwriting. Rather, the underwriter considers the size, turnover, and financial
strength of the group. Contract provisions will attempt to exclude the possibility
of adverse selection. Group life insurance often allows members exiting the group to
maintain their coverage by buying individual coverage.

Senior and pre-need products

Insurance companies have in recent years developed products for niche
markets, most notably targeting seniors in an aging population. These are often low to
moderate face value whole life insurance policies, allowing senior citizens to purchase
affordable insurance later in life. This may also be marketed as final expense
insurance and usually have death benefits between $2,000 and $40,000. One reason
for their popularity is that they only require answers to simple "yes" or "no" questions,
while most policies require a medical exam to qualify. As with other policy types, the

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range of premiums can vary widely and should be scrutinized prior to purchase, as
should the reliability of the companies.

Health questions can vary substantially between exam and no-exam policies. It
may be possible for individuals with certain conditions to qualify for one type of
coverage and not another. Because seniors sometimes are not fully aware of the policy
provisions it is important to make sure that policies last for a lifetime and that
premiums do not increase every 5 years as is common in some circumstances.

Pre-need life insurance

Pre-need life insurance policies are limited premium payment, whole life
policies that are usually purchased by older applicants, though they are available to
everyone. This type of insurance is designed to cover specific funeral expenses that the
applicant has designated in a contract with a funeral home. The policy's death benefit
is initially based on the funeral cost at the time of prearrangement, and it then typically
grows as interest is credited. In exchange for the policy owner's designation, the
funeral home typically guarantees that the proceeds will cover the cost of the funeral,
no matter when death occurs. Excess proceeds may go either to the insured's estate, a
designated beneficiary, or the funeral home as set forth in the contract. Purchasers of
these policies usually make a single premium payment at the time of prearrangement,
but some companies also allow premiums to be paid over as much as ten years.

Unit-Linked Plan

These are unique insurance plans which are basically a mutual fund and term
insurance plan rolled into one. The investor doesn't participate in the profits of the plan
per se, but gets returns based on the returns on the funds he or she had chosen.

The premium paid by the customer is deducted by initial charges by the

insurance companies (basically the distribution and initial costs) and the remaining
amount is invested in a fund (much like a mutual fund) by converting the amount into
units based upon the NAV of the fund on that date.

Mortality charges, fund management charges, and a few other charges are
deducted in regular intervals by way of cancellation of units from the invested funds.

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 A Unit Linked Insurance Plan (ULIP) offers high flexibility to the customer in
form of higher liquidity and lower term.

The customer has the choice of choosing the funds of his choice from whatever
his/her insurance provider has to offer. He can switch between the funds without the
necessity to opt out of the insurance plan.

ULIPs got extremely popular in the heyday of the equity bull run in India, as
the returns generated in equity linked funds were beating any kind of debt or fixed
return instrument. However, with the stagnation of the economy and the equity market
this product category slowed down.

With-profits policies
Some policies afford the policyholder a share of the profits of the insurance
company – these are termed with-profits policies. Other policies provide no rights to a
share of the profits of the company – these are non-profit policies.

With-profits policies are used as a form of collective investment scheme to

achieve capital growth. Other policies offer a guaranteed return not dependent on the
company's underlying investment performance; these are often referred to as without-
profit policies, which may be construed as a misnomer.

4. Investment bonds

a) Pensions
Pensions are a form of life assurance. However, whilst basic life
assurance, permanent health insurance, and non-pensions annuity business all include
an amount of mortality or morbidity risk for the insurer, pensions pose a longevity
risk.

A pension fund will be built up throughout a person's working life. When the
person retires, the pension will become in payment, and at some stage the pensioner
will buy an annuity contract, which will guarantee a certain pay-out each month until
death.

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 b) Annuities
An annuity is a contract with an insurance company whereby the insured pays
an initial premium or premiums into a tax-deferred account, which pays out a sum at
pre-determined intervals. There are two periods: the accumulation (when payments are
paid into the account) and the annuitization (when the insurance company pays out).
IRS rules restrict how money can be withdrawn from an annuity. Distributions may be
taxable and/or penalized.

5. Insurance premiums

Generally, insurance providers may use the life insurance premium in the
following ways:


To cover liabilities: Insurance providers have to set themselves in a financial
position to pay out on claims. That means that if a policyholder passes away, the
insurer will use a portion of total paid premiums to cover the set death benefit (and any
other policy payouts) to the designated beneficiaries. Financially stable insurance
companies will usually keep a set amount of premium money on hand to cover
outstanding liabilities and ensure beneficiaries receive what is owed in the event of the
policyholder’s untimely passing.


To cover business expenses: Like any other company, a life insurer has to
account for operating costs. A portion of your life insurance premium may go towards
salaries, office space, legal fees or other business expenses.

 To invest: Some insurance providers choose to invest a portion of

policyholders’ premiums in the growth of the insurance company and subsequent
benefit to policyholders. Good returns on those investments may allow them to keep
the cost of their insurance products as low as possible and can help provide greater
financial stability and peace of mind to stakeholders (policyholders)

If the insured stop paying his life insurance premiums, the policy could lapse
depending on the specific terms outlined by the insurer. The policy may come with a
grace period, a certain amount of time in which the policy will not lapse for
nonpayment. However, a standard term life insurance policy will typically lapse if the

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insured miss a payment. If the policy does lapse, dependents would no longer receive
death benefit if the isured were to pass away, leaving them vulnerable to financial risk.

Missing a life insurance policy payment may be treated differently with

permanent life insurance policies, which include cash value accounts. Money in the
cash value account can typically be used to pay premiums after a stipulated amount of
time, so if you forget to make a payment, your policy might not lapse if the cash value
is utilized.

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 Chapter (2)

MORTALITY TABLES

1. Introduction
The cost of a life insurance policy will vary for each person. Before a life
insurance company issues a policy, insured's health and other factors will typically be
evaluated to determine how life expectancy compares to the policy’s duration of
coverage. With life insurance, a higher risk level means insured’s more likely to pass
away before his policy expires and therefore, the insurer would pay the death benefit
before significant contributions have been made in the way of premiums.

Because of this, younger and healthier individuals generally see lower premiums
on life insurance policies. In addition, a term policy may be cheaper than a permanent
policy, as the insured might outlive the term policy length and the insurer may not
have to pay out a claim.

2. Factors determining life insurance premium

Here are some of the main factors an insurance company considers when
determining life insurance premium:

Type of coverage
Certain policies, such as variable universal life policies, have flexible premiums.
Policyholders may choose to pay a larger amount in premiums (to increase the policy’s
cash value amount), pay only a portion of their premium or avoid paying their
premium out of pocket altogether. The policyholder must have enough money built up
in their cash value account to not pay their premium out of pocket or only pay a
portion of it. When you don’t pay the full premium balance out of pocket, the
remaining amount of money would be subtracted from your policy’s cash value
account.

Age
The younger you are when you purchase life insurance, the lower your premium
will typically be, on average. Why? Life insurer calculates rates largely based on life

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expectancy, and will typically set lower payments to account for the reduced risk of an
earlier passing.

Sex
In the U.S., women live an average of five years longer than men. Life insurance
companies may factor this into premium calculations, in addition to considering health
complications that may be associated with one gender more than another. As a result,
women may pay lower life insurance premiums than men, depending on their
preexisting conditions and age.

Health
Most life insurance policies require a medical exam. This is insurer provider’s
way of making sure that the information listed on the application is accurate and that
the isured don’t have a preexisting condition that would drastically shorten life
expectancy. Examples of preexisting conditions that could increase your premium
include: type 1 diabetes, high blood pressure and asthma.

Overall, the healthier you are, the less you’ll likely pay for your life insurance
policy. If you want to potentially lower premiums on life insurance, you might want to
consider focusing on maintaining a healthy diet, exercising regularly and to quit
smoking.

Lifestyle
The way you live impacts your risk level in the eyes of insurers. Life insurance
providers typically raise rates to compensate for the risks associated with a dangerous
lifestyle, such as a risky occupation or extreme hobbies. If the job is inherently
dangerous, such as washing windows on skyscrapers, there may not be much can do to
offset the cost of life insurance. However, if engage in more extreme hobbies or
activities, such as motorcycle riding, bungee jumping, skydiving or smoking may
consider making lifestyle adjustments. Cutting out risky activities may help ro lower
the cost of life insurance significantly.

Riders
Life insurance riders, also called endorsements, are designed to add certain
policy benefits to make a life insurance policy work better for insured's specific needs.

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While they may not lower the cost of premium, they could add additional value to the
policy, making the cost even more worthwhile.

3. Definition of Mortality Tables

What is a Mortality Table?

The Life (or Mortality) table: A mortality table is a diagram that shows the
death rate for a defined population within a specific rate of time. Also known as a life
table or an actuarial table, mortality tables are used in business by insurance
companies to price insurance products and schemes for individuals.

The Life (or Mortality) Table It follows from the idea of a group of persons
attaining age X and being gradually reduced in numbers, until they are all dead, by the
operation of mortality in such a way that the rates of mortality at successive ages form
a smooth series is a purely theoretical conception. It is, nevertheless, a very useful
conception, which forms the basis of the theory of life contingencies and has been
shown by long use to be suitable for solving most practical problems in life assurance
and similar work. The fundamental function of the mortality table is a function known
as Ix.

Also, mortality tables can be used to develop complex mathematical models

that represent the survival rates of different populations. They are also useful in the
study of biology and medicine. The tables can help in the development of diagnostic
criteria for certain drugs, as well as the type of treatment an individual should receive.

4. Features of Mortality Tables

Mortality tables are very complex grids of numbers that predict the probability
that an individual will die before their next birthday for each age based on a selection
of variables.

Using certain characteristics such as gender and age, mortality tables provide
probabilities of death based on thousands or the number of people in a group of 1,000
expected to die within a certain year. They usually cover ages in one-year increments
from birth through age 100, with the probability of death increasing with age.

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 Mortality tables usually consist of separate data for men and women due to the
substantial difference in mortality rates and the average lifespan for each gender.

Several statistics can be drawn as a result, including:

 Probability of surviving past a particular year of age

 Remaining life expectancy for people at different ages
 Proportion of the original birth cohort still living

5. Types of Mortality Tables

There are two main types of mortality tables – the period life table and the
cohort life table.

1. Period life table

The period life table determines mortality rates for a specific population during a
defined period of time, such as a single year or a group of years. It also assumes that
mortality rates apply throughout the remainder of a person’s life, and as such, it does
not take into consideration any future developments or changes to mortality rates.

2. Cohort life tables

This tables show the probability of death of people from a given cohort
(especially birth year) over the course of their lifetime.

3. Static life tables

In this tables sample individuals assuming a stationary population with
overlapping generations. "Static Life tables" and "cohort life tables" will be identical if
population is in equilibrium and environment does not change. If a population were to
have a constant number of people each year it would mean that the probabilities of
death from the life table were completely accurate. Also, an exact number of 100,000
people were born each year with no immigration or emigration involved. "Life table"
primarily refers to period life tables, as cohort life tables can only be constructed using
data up to the current point, and distant projections for future mortality.

Life tables can be constructed using projections of future mortality rates, but
more often they are a snapshot of age-specific mortality rates in the recent past, and do
not necessarily purport to be projections. For these reasons, the older ages represented
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in a life table may have a greater chance of not being representative of what lives at
these ages may experience in future, as it is predicated on current advances in
medicine, public health, and safety standards that did not exist in the early years of this
cohort. A life table is created by mortality rates and census figures from a certain
population, ideally under a closed demographic system. This means that immigration
and emigration do not exist when analyzing a cohort. A closed demographic system
assumes that migration flows are random and not significant, and that immigrants from
other populations have the same risk of death as an individual from the new
population. Another benefit from mortality tables is that they can be used to make
predictions on demographics or different populations.

The life table observes the mortality experience of a single generation,

consisting of 100,000 births, at every age number they can live through. Life tables are
usually constructed separately for men and for women because of their substantially
different mortality rates. Other characteristics can also be used to distinguish different
risks, such as smoking status, occupation, and socioeconomic class.

Life tables can be extended to include other inform action in addition to

mortality, for instance health information to calculate health expectancy. Health
expectancies such as disability-adjusted life year and Healthy Life Years are the
remaining number of years a person can expect to live in a specific health state, such
as free of disability. Two types of life tables are used to divide the life expectancy into
life spent in various states:

1. Multi-state life tables (also known as increment-decrements life tables)

They are based on transition rates in and out of the different states and to death.

2, Prevalence-based life tables (also known as the Sullivan method)

They are based on external information on the proportion in each state. Life
tables can also be extended to show life expectancies in different labor force states
or marital status states.

3 The complete and abridged life tables

The major visual difference between lies in the age groupings for which the
estimates have been produced.

23
 In complete life tables, there is only one age value per row, which indicates the
exact age for the number of survivors, the cumulative number of life years lived and
the life expectancy. For the number of deaths, death and survival probabilities, as well
as the number of life years lived, the interval in the life table represent the interval
between two exact ages. For example, death at age 30 means that the death occurred
on or after the 30th birthday but before reaching its 31st birthday.
The presentation is the same in abridged life tables, but the age intervals are of
the form (x, x+(n-1)); that is, both ages x and x+(n-1) are included in the interval. For
example, the age interval 40 to 44 comprises deaths occurring among 40 to 44 year-
olds. Most age intervals in abridged life tables span five years. The exceptions occur in
the first two rows of these tables and for the last row: the first row (age 0) represents a
6. Insurance Application

In order to price insurance products, and ensure the solvency of insurance

companies through adequate reserves, actuaries must develop projections of future
insured events (such as death, sickness, and disability). To do this, actuaries develop
mathematical models of the rates and timing of the events.

They do this by studying the incidence of these events in the recent past, and
sometimes developing expectations of how these past events will change over time
(for example, whether the progressive reductions in mortality rates in the past will
continue) and deriving expected rates of such events in the future, usually based on the
age or other relevant characteristics of the population. An actuary’s job is to form a
comparison between people at risk of death and people who actually died to come up
with a probability of death for a person at each age number, defined as qx in an
equation. When analyzing a population, one of the main sources used to gather the
required information is insurance by obtaining individual records that belong to a
specific population. These are called mortality tables if they show death rates, and
morbidity tables if they show various types of sickness or disability rates.

The availability of computers and the proliferation of data gathering about

individuals has made possible calculations that are more voluminous and intensive
than those used in the past (i.e. they crunch more numbers) and it is more common to
attempt to provide different tables for different uses, and to factor in a range of non-
traditional behaviors (e.g. gambling, debt load) into specialized calculations utilized by
some institutions for evaluating risk. This is particularly the case in non-life insurance
24
(e.g. the pricing of motor insurance can allow for a large number of risk factors, which
requires a correspondingly complex table of expected claim rates). However the
expression "life table" normally refers to human survival rates and is not relevant to
non-life insurance

7. Description of a Mortality Table

The essential features of the table are the two columns of the number living and
the number dying at designated ages. It is assumed that a group of 100,000 persons
comes under observation at exactly the same moment as they enter upon the tenth year
of life. Of this group 749 die during the year, leaving 99,251 to begin the eleventh
year. The table proceeds in this manner to record the number of the original 100,000
dying during each year of life and the number living at the beginning of each
succeeding year until but three persons of the original group are found to enter upon
the ninety-fifth year of life, these three dying during that year.

Notation

Lx (number of survivors at age x):

Number of persons in an initial cohort of 100,000 live births who are still alive at the
beginning of each subsequent age interval. The number of survivors decreases as age
increases, under the effect of mortality.

It is possible to compute, from the number of survivors, probabilities of survival

between two ages. For example, if the number of survivors is 99,297 at age 10 and
98,935 at age 20, the probability of surviving from age 10 to age 20 is 98,935 / 99,297,
that is, 0.99635.

One-year interval and the second row, a four-year interval (ages 1 to 4). The last
row is an open age interval, 90 years and over.

dx (number of deaths between age x and x+1):

Number of deaths which occur in each age interval among the initial cohort of 100,000
live births at age 0.

dx = lx - lx+1
25
 px (probability of survival between age x and x+1):

Probability that a person of age x survives up to year x+1.

Px = lx+1 / lx

ndx (number of deaths between age x and x+n):

Number of deaths, which occur in each age interval among the initial cohort of
100,000 live births at age 0.

ndx = lx - lx+n / lx

qx (death probability between age x and x+1):

Probability that a person of age x dies before reaching age x+1.

The symbol qx means that probability of a person of age x will die before reaching age
x+1.

qx = dx / lx = lx+1 / lx

qx (death probability between age x and x+n):

Probability that a person of age x dies before reaching age x+n.

px + qx = 1

The symbol nqx means that probability of a person of age x will die before
reaching age x+n.

nqx = dx + dx+1 + dx+2 + dx+3 + …….. + dx+n-1 / lx

= lx+n / lx

The symbol m/qx means that probability of a person of age x will die in the year
following the attainment age x+m+1.

m/qx = dx+m / lx

26
 The symbol m/nqx means that probability of a person of age x will die in years n
following the attainment age x+m.

m/nqx = dx+m + dx+m+1 + dx+m+2 + dx+m+3 + …. + dx+m+n+1 / lx

= lx+m – lx+m+n / lx

= mpx - m+npx

Tx (cumulative number of life years lived beyond age x):

Total number of life years lived by persons of age x and all those included in
subsequent age intervals.

ex (life expectancy at age x):

Average number of years remaining to be lived by persons surviving to age x if

these persons would experience, during their life, the mortality observed over the
reference period.

ex = lx+1 + lx+2 + lx+3 + ……. + lɯ-1 / lx

0
ex = e x + ½

It is important to remember that the figures in the Ix column have no meaning

individually and are only meaningful when related to each other – thus the probability
of a person living from exact age 20 to exact age 30 is I30/I20 = 9,480,358/ 9,664,994
= .9809. While the table should strictly be interpreted only in this way this ratio is
sometimes said verbally to be the 'number alive at age 30' divided by the 'number alive
at age 20'.

Because the figures in the table have no meaning except when divided by each
other. All the figures in a mortality table could be multiplied by a factor and no change
would be made in the mortality represented. Thus Table 1.2a and b would apart from
the rounding of certain of the figures represent the same mortality, the first being the
previous table multiplied by 1/100, and the second by Y2.

27
 Table 1
, Age x Ix
0 10,000.000
1 9,929.200
2 9,911.725
3 9,896.659
10 9,805.870
20 9,664.994
30 9,480.358
40 9,241.359
50 8,762.306
60 7,698.698
70 5,592.012
:
80 2626.372
:
90 468.174
:
99 6.415
100 0

While the table shown commences at age 0 this is not necessary and, for
example, a mortality table intended for use in life assurance offices to show the
mortality of annuitants might commence at age 40. Normally the lx figure for the
lowest age is taken as some convenient round number such as 1,000,000,999,999 or
500,000- this is called the radix of the table. The first age at which the value of lx
becomes negligible is called the limiting age and is denoted by  , so that l  = 0- in
the table above  =100. Some mortality tables are assumed to conform to a
mathematical formula so that the lx column converges asymptotically to zero and
never actually becomes 0. However, for practical purposes, a limiting age such as
100,105 or 110 is assumed for all mortality tables.

28
 Table 2a Table 2b
____________________ ____________________
X lx x lx
____________________ ____________________
0 100.000 0 5,000,000
1 99.292 1 4,964,600
: :
10 98.059 10 4,902,935
: :
20 96.650 20 4,832,497

Lx= the number of persons who attain age x according to the mortality table
dx= lx - LX+1 = the number of persons who die between agc x and x+1
according the mortality table.
px = the probability that (x) will live I year.
q x = the probability that (x) will die within I year.
ex = the accurate' expectation of life' (or average after-lifetime) of (x).

8. Probabilities of Living and Dying-rate of Mortality

Table 1 is an extract of a mortality table, which will be used to exemplify the

notation used in this section. This introduces the symbol dx, which is the difference
between successive lx figures. Thus

dx = lx – l x+1 (1)

In the convenient (but strictly incorrect) interpretation of the mortality table

mentioned in the previous section dx represents the “number dying aged x last
birthday”

29
 Table 3
_______________________
x lx dx
___________________________
40 80,935 455
41 80,480 481
42 79,999 511
43 79,488 546
44 78,942 585
45 78,357 626
: : :
50 74,794 844
: : :

Probability of death and survival can be obtained directly from lx and dx

columns of the mortality table. The symbol (x) is used to denote 'a person aged, x', or
'a life aged x'.
The probability that (x) will survive to age x+1, is denoted by p., so

Px = (lx-lx+)/lx (2)
P40 = l 41 / l40
= 80,480 / 80,935
= .9944.

The probability of a person age x dying during the year, the rate of mortality, is given
the symbol qx so

qx= dv / lx = (lx – lc+1 / lx (3)

thus
q40 – 455/ 80,935 = 0056

The probability of (x) living for a year plus the probability of (x) dying within a year
must obviously be1, so

Px + qx=1,or Px=1-qx, or qx=1-px. (4)

30
The probability that (x) will live for n years to age x+n is given the symbol nPx;

npx = lx+n .lx (5)

for example

5P40=74,794 /80,935 =.9681.

Another way of looking at nPx is to consider it as the product of successive

probabilities of living each year

nPx = lx+1 / lx + lx+2 / lx + lx+3 / lx ….

= px + px+1 + px+2 + px+3 …..

The probability that (x) will die within n years is given the symbol nqx;

nqx= lx – lx+n = ∑dx / lx (6)

so
5q40 = (80,935 – 78357) / 80,935 75ior (455+481+511+546+ 585) /.80,935

all equaling .0319.

It can be seen that if no figure prefixes the symbol p or q, 1 is assumed, i.e.

1Px = Px 1qx = qx.

The probability that (x) will live m years but die in the following n years, or that (x)
will die between ages x+rn and x+rn+n is given the symbol. m1 nqx

m1 nqx = mPx * nqx+m (7)

Thus
3I2q40 = (79488 – 78357) / 80957 = =.0140.
When n=1 it may be omitted and the symbol becomes

mlqx = d x + III = mPx.qx+m (8)

31
being the probability that (x) will die in a year, deferred m years;

thus
21q42=d44/ L42 = 585/ 79,999 = .0073.

It will be seen that a mortality table is defined either by the lx or qx (or px)
columns. If the qx figures are given, the lx column will be obtained by choosing a
suitable radix (10) and successively obtaining the dx and lx figures:-
d0=l0.q0
l1=l0-d0
d1=l1.q1
and generally
dx=lx.qx
lx+1=lx-dx

The radix is arbitrary and is chosen so that a suitable degree of accuracy is

obtained when the lx figures are divided. Apart from this point the absolute value of an
individual value of lx is of no consequence. There is no reason why the value of lx
should not be recorded in decimals and this is sometimes done at the high ages of a
table in order to obtain a smoother run of figures.

9. Endig a mortality table

In practice, it is useful to have ultimate age associated with a mortality table.
Once the ultimate age is reached, the mortality rate is assumed to be 1.000. This age
may be the point at which life insurance benefits are paid to a survivor or annuity
payments cease.
Four methods can be used to end mortality tables:

- The Forced Method: Select an ultimate age and set the mortality rate at that age
equal to 1.000 without any changes to other mortality rates. This creates a
discontinuity at the ultimate age compared to the penultimate and prior ages.

32
 -The Blended Method: Select an ultimate age and blend the rates from some
earlier age to dovetail smoothly into 1.000 at the ultimate age.

- The Pattern Method: Let the pattern of mortality continue until the rate
approaches or hits 1.000 and set that as the ultimate age.

- The Less-Than-One Method: This is a variation on the Forced Method. The

ultimate mortality rate is set equal to the expected mortality at a selected ultimate age,
rather 1.000 as in the Forced Method. This rate will be less than 1.000.

10. Types of Mortality Rates

he mortality rates are critical to scientists, and thus have significance for
various purposes. Some commonly known types of mortality rates include crude
mortality rate, infant mortality rate, and maternal mortality rate. For example, crude
mortality rate helps compare countries based on their general health level and
quality of life. However, infant mortality rate and maternal mortality rate
provide an idea about the country's ranking on the grounds of healthcare,
nutrition, education, and other factor
a) Crude Mortality Rate
The ratio of total deaths due to any reason to the total population during a
specified period of time is termed the crude mortality (or death) rate. When this ratio is
multiplied by 1,000, it expresses this statistic in terms of deaths per 1,000 people in the
population. If the population size changes over the selected time interval, then the
population at the mid-interval is considered for calculating the crude mortality rate.
For example, the crude death rate of a population comprising of 20,000 people in a
given year is 48 deaths per 1,000 people if total deaths due to all causes were 560 for
the same year.

The crude mortality rate is the most widely used index for determining the
general health status of a population or geographic area. Scientists and statisticians use
this index to compare the crude mortality rates among entire countries or regions.
Crude mortality rate helps determine the rate of natural increase when subtracted from
the crude birth rate. The natural increase is referred to the rate of change in population
size in absence of migration.

33
 b) Infant Mortality Rate
Child mortality rate, also referred under-five mortality rate , is a figure of the
children dying between birth and 5 years of age.

Examples

The examples in this book will normally use the tables in appendix III- The
English Life Table No. 12- Males, the A1967-70 Table for Assured Lives and the A
(55) tables for Annuitants.

The English Life Table No. 12-Males is constructed from the mortality rates
experienced by the male population in England in the years 1960, 1961 and 1962. The
A1967-70 table is based on the experience within these years of lives assured of
United Kingdom life assurance companies (and has the unusual radix of 34,489
decided so that value of the largest function calculated did not exceed the capacity of
the computer). The a (55) tables give the rates of mortality separately for males and
females, based on the mortality experience of annuitants of United Kingdom life
offices in 1946 to 1948, but projected into the future so that estimated rates were
obtained thought to be applicable for annuities purchased in 1955.

Mortality rates have been tending to decrease at most ages and in most
countries of the world for more than a hundred years and published tables thus
gradually cease to represent the experienced mortality. The English Life Tables are
published at ten-year intervals, being based on the ten-yearly population census, while
the assurance and annuitant tables are published at longer intervals. It might be thought
that tables would become out of date quickly but is common practice to adjust
published tables, the most usual method being to deduct (or perhaps add) a certain
number of years to the actual age before entering the table. One example of this is the
common deduction of about four years from the age of a female policyholder in
calculating the premiums for a life assurance policy, the published premium rates
having been based on male mortality.

Example 1:
Using the mortality table given in section 2, find the probability of a person aged 30,
(i) surviving to age40
(ii) dying before age40
34
 (iii) dying between the ages of 60 and 80..

Solution:
(i) 10p30
= l40 / l30
= 9,241 ,35 9/ 9,480,358
= 9748

(ii) 10q30
= (L30 – l40)/ l30
=(9,480,358 - 238,999) / 9,480,358
= .0252
or,
10q30
= 1 - 10p30
= 1-.9748
=.0252

(iii) 30l20q30
= (l60 – l80)/ l30
= 5072,326, / 9,480,358
= .5350

Example 2:
If a mortality table is represented by the function lx =1000 √100 x find:
(i) the probability of a life surviving from birth to age 19
(ii) the probability of a life aged 36 dying before age 51.

Solution:

(i) 19po = l19 / l0 = (1,000 √ 100 – 19)/ √ 100 = 9

(ii) 15q36 = (l36 – l53) / l36 = (1000 √64 – 1000 √19)/ 1000 √64 = .125.1/8 =

Example 3:
Complete Table 4a.
Table 4a

35
 X q, Ix dx
90 1/3 3 .000
91 2/3
92 1/2
93 2/3
94 4/5
95 1

Solution:

d90 = q90. 190 = 1/3 (3,000) = 1,000

•• 191 = 2,000
d91 = Q91.191= 2/3(2,000) = 800
.'. 192= 1,200

and proceeding similarly we obtain Table 4b

Table 4b
X qx Ix dx
90 1/3 3.000 1000
91 2/3 2.000 800
92 1/2 1,200 600
93 2/3 600 400
94 4/5 200 160
95 1 40 40
96 0

Example 4:
A life aged 50 is subject to the mortality of the English Life Table No.12-Males,
for 10 years, then the a (55) Male table, for 20 years, then the A 1967-70 table with a
deduction of 2 years for the remainder of life. Find the probability that the life lives to
age 90.

36
 Solution:

In this type of question the probabilities in the age ranges should be kept separate
so that lx figures on one mortality table are always divided by a figure from the same
table. Thus the required probability

={probability of living} . {probability of living}

{ for 10 years } {for further 20 years}
{probability of living}
{for further 10 years}
=(10p50on ELT No.12-Males).(20p60on a (55)-Males) . (10p78 on A 1967-70)
= 78,924 /90,085 * 363,991/ 859,916 * 4012,83 * 14965,5 = .0994

37
 Exercises
1- Using mortality tables, find the probability that an individual now being
accepted for life insurance at age 32 will:
a – survive to age 35,
b – die between ages 33 and 34
c – survive to age 34.

2- The probability at least one of the two lives A and B will die in the next ten
years is 0.44. The probability that least one of the two lives will survive the period is
0.94. Find the probability that A will be living at the end of the ten years.

3- A husband is aged 22 and a wife 24 at the date of marriage; what is the

probability that they will live to celebrate their silver wedding? Their golden wedding?
3- Find the numerical answers to the following probabilities:
a.That one at age 30 will die between ages 65 and 70,
b. That one at age 50 will survive to 70,
c.That one at age 20 will die between ages 80 and 85,

4-
a. Complete the following tables:
x lx dx px qx
98 160
99 40
100 24 0.667
101 0.250
102 1.000

b- From the above table, find e99 and e98

38
Here we have assumed all deaths within a year occur halfway through the
year. This is consistent with the UDD factional age assumption in the next
section.

39
40
 Mortality Table

X Lx dx qx px
10 100000 408 0.00408 0.99592
11 99592 369 0.00370 0.99630
12 99233 346 0.00347 0.99653
13 98877 337 0.00342 0.99658
14 98540 337 0.00342 0.99658
15 98203 360 0.00365 0.99635
16 97843 384 0.00393 0.99607
17 97459 425 0.00437 0.99563
18 97034 465 0.00478 0.99522
19 96569 458 0.00526 0.99474
20 96061 548 0.00572 0.99428
21 95513 572 0.00608 0.99392
22 94931 609 0.00643 0.99357
23 94322 631 0.00668 0.99332
24 93691 647 0.00691 0.99309
25 93044 658 0.00707 0.99293
26 92386 664 0.00720 0.99280
27 91722 673 0.00732 0.99268
28 91049 678 0.00746 0.99254
29 90371 686 0.00759 0.99241
30 89685 691 0.00771 0.99229
31 88994 700 0.00787 0.99213
32 88294 709 0.00803 0.99197
33 87585 719 0.00821 0.99179
34 86866 729 0.00839 0.99161
35 86137 742 0.00862 0.99138
36 85395 756 0.00885 0.99115
37 84639 770 0.00910 0.99090
38 83869 786 0.00937 0.99063
39 83082 806 0.00969 0.99031
40 82277 823 0.01001 0.98999
41 81454 846 0.01038 0.98462

41
 Mortality Table (continue)
X Lx dx qx px
42 80608 871 0.01081 0.98919
43 79737 895 0.01122 0.98878
44 78842 924 0.02272 0.98828
45 77918 954 0.01224 0.98776
46 76964 986 0.01281 0.98719
47 75978 1021 0.01345 0.98655
48 74957 1061 0.01415 0.98585
49 73896 1101 0.01490 0.98510
50 72795 1144 0.01572 0.98428
51 71651 1193 0.01665 0.98335
52 70458 1243 0.01764 0.98236
53 69215 1296 0.01873 0.98127
54 67919 1353 0.01992 0.98008
55 66566 1414 0.02123 0.97877
56 65152 1475 0.02365 0.97735
57 63677 1541 0.02420 0.97580
58 62130 1612 0.02593 0.97407
59 60524 1682 0.02739 0.97221
60 58842 1755 0.02983 0.97017
61 57087 1830 0.03206 0.96794
62 55257 1900 0.03451 0.96549
63 52351 1983 0.03717 0.96283
64 51368 2059 0.04007 0.95993
65 49309 2133 0.04327 0.95673
66 47176 2204 0.04672 0.95328
67 44972 2273 0.05053 0.94942
68 42699 2334 0.05466 0.94524
69 40365 2388 0.5917 0.94083
70 37977 2434 0.06410 0.93590
71 35543 2468 0.06442 0.92057
72 33075 2490 0.07528 0.92472
73 30585 2496 0.08160 0.91840

42
 Mortality Table (continue)

X Lx dx qx px
74 28089 2487 0.08856 0.91144
75 25602 2459 0.09604 0.90396
76 23143 2412 0.10422 0.89578
77 20731 2343 0.11303 0.88697
78 18388 2255 0.12262 0.87738
79 16133 2416 0.13304 0.86696
80 13987 2018 0.14426 0.85574
81 11969 1873 0.15649 0.84351
82 10096 1712 0.16958 0.83042
83 8384 1540 0.18268 0.81632
84 6844 1361 0.19886 0.80114
85 5483 1180 0.21522 0.78478
86 4303 1002 0.23285 0.76715
87 3301 830 0.25145 0.74855
88 2471 671 0.27155 0.72845
89 1800 527 0.29277 0.70723
90 1273 402 0.31579 0.68421
91 871 296 0.32984 0.66016
92 575 209 0.36248 0.63652
93 366 144 0.39345 0.60655
94 222 93 0.41891 0.58109
95 129 58 0.44961 0.55029
96 71 34 0.47888 0.52112
97 37 18 0.48649 0.51351
98 19 10 0.52631 0.47369
99 9 5 0.55555 0.44445
100 4 2 0.75000 0.25000
101 1 1 1.00000 0.00000

43
44
 Chapter (3)

Net Single Premiums (NSP)

1. Introduction

In the following sections, we will be interested in finding the present value of

future sums, the payment of each of which is contingent upon either the death or
survival designated life or group of lives, This present value, particularly in the case of
life insurance, is often

The net single premium can be defined as a sum paid at the inception of the
contract, which, under certain basic assumptions, would be necessary and sufficient to

2. Basic provide the scheduled benefit payments Assumptions

a- The mortality table employed will represent precisely the mortality to be

experienced by the group of lives concerned,
b- All net single premiums received will be immediately invested and will earn
precisely the assumed rate of interest until withdrawn to pay tom benefits,
c- All net single premiums paid on behalf of the group of lives involved, plus all
interest earned, will automatically be paid to members of the group in the form
of contractual benefits payments. In other word any expenses, taxes, profits,
loses, and the like, will be taken care of outside of the net premium structure.
As a direct consequence of these assumptions, we have the following fundamental
equation underlying the definition of the term net single premium:
Present value at the Present value at the
inception of the contract of inception of the contract
all net single premiums to be = of all contractual benefits
paid by a life or group of to be received by this life
lives for contractual benefits or group of lives.

45
3- Pure Endowment

Inception date _________n________ maturity date

$nEx . lx $lx+n
$vn . lx+n ______________________________________

Let us suppose that lx number of persons all of age x, desire by equal

contributions at present time (nEx) to provide a payment of $1 to each one that survives
the succeeding n years.

Total net premiums paid at inception date by all insured equal $nEx.lx.

As lx+n survivors will be living at the end of the n-year period, a fund of $1.lx+n
must be on hand at maturity date. The present value of this fund at inception date is
$1.vn . lx+n.
So at inception date:
Total premiums = present value of paying benefits

nEx . lx = 1.vn . lx+n

nEx . lx = vn . lx+n
multiplying by vx
x.
nEx.v lx = vx+n . lx+n

n Ex = vx+n . lx+n / vx. lx using vx . lx = Dx

nEx = Dx+n / Dx

The notation Dx is one of several auxiliary symbols, known as commutation

symbols, which play an important role in practical calculations.

It will be noticed as the theory develops that direct use of the value3s given in a
mortality table is rarely made, except to compute the values of the commutation
symbols.

46
 Tables include the values Dx and other commutation symbols upon the 1958
CSO table with various rates of interest have computed and are in common use. Unless
otherwise specified, all computations in the numerical problems arebased upon this
table with interest at 3% premium.

Commutation columns at this rate of interest are given in table ll at the end of
yhe chapter.

Example 1:

Payment of $1000 is to be received at the end of five years, find the net premium
if the insured is 45 years

Solution:

The payment constitute of pure endowment payable at age 50 so the net single is:
5E45. 1000

=D45+5/D45 . 1000
= D50/D45 . 1000
= 1998744/2391904 . 1000
= 0.835629 . 1000
= $835.629

Example 2:

A man now aged 20 is promised to get $5000 when reaches age 35, fined the net
single premium.

Solution:

The payment constitute of pure endowment payable at age 35 so the net single is:
15E20 . 5000

= D20+15/D20 . 5000
= D35/D20 . 5000
= 3531295/5351272 . 5000
47
 = o.659898244
= $3299.491

Example 3:

A man now aged 25 has $1000 cash. If he deposits this with insurance company,
what sum should he receive at age 45 if he agrees to forfeit all rights in event of death
before age 45?

Solution:

The payment constitute of pure endowment payable, so the net single is:

20E20 . S = D25+20/D25 . S
$1000 = D45/D25 . S
= 2392904/4573377. S
1000 = 0.52322474 . S
S = 1000 / 0.52322474
= $1911.225

4- Whole life ordinary annuity

Suppose that lx persons, all at age x, desire to provide a fund from which
amounts are to be withdrawn each year sufficient to pay $1 to each survivor, the
payments to continue as long as there are any survivors.

At the end of the first year there will be lx+1 survivors according to mortality
table and $lx+1 will be needed then at inception date will be $v1 . lx+1. Similarly, at the
end of second year there will be lx+2 survivors according to mortality table and $lx+2
will be needed, then at inception date will be $v2 . lx+2.

Similarly, at the end of third year there will be lx+3 survivors according to
mortality table and $lx+3 will be needed then, at inception date will be $v3 . lx+3, and so
on to the end of the mortality table.

48
 If we donate the contribution to be made by each insured by ax then at inception
date:
Total contributions = the present values of the benefits,

$ax.lx = $v1. lx+1+$v2. lx+2+$v3. lx+3 +..+$vɯ.lɯ-x-1

ax = v1. lx+1+v2. lx+2+v3 . lx+3 +..+vɯ.lɯ-x-1 / lx

Multiplying numerator and denominator of the right hand side of the equation by vx we
find

= vx+1. lx+1+vx+2. lx+2+vX+3. lx+3 +..+vx+ɯ.lɯ-x-1/vx lx

Put vx.lx = Dx

ax = Dx+1 + Dx+2 + Dx+3 + …… + D ɯ-x-1 / Dx

Put = Dx+1 + Dx+2 + Dx+3 + …… + D ɯ-x-1= Nx+1

ax = Nx+1 / Dx

5- Whole life due annuity

The only difference between annuity immediate and annuity due is the payment
made at the beginning of the year, so Suppose that lx persons, all at age x, desire to
provide a fund from which amounts are to be withdrawn each year sufficient to pay $1
to each survivor,

the payments to continue as long as there are any survivors. At the beginning of
the first year there will be lx survivors according to mortality table and $lx will be
needed then at inception date will be $lx Similarly, at the beginning of second year
there will be lx+1 survivors according to mortality table and $lx+1 will be needed, then at
inception date will be $v1 . lx+1.

Similarly, at the beginning of third year there will be lx+2 survivors according to
mortality table and $lx+2 will be needed then, at inception date will be $v2 . lx+2, and so
on to the end of the mortality table.

49
 If we donate the contribution to be made by each insured by äx then at inception
date:

Total contributions = the present values of the benefits,

$äx.lx = $v0. lx+o+$v1. lx+1+$v2. lx+2 +..+$vɯ.lɯ-x-1

äx = vo. lx+0+v1. lx+1+v2 . lx+2 +..+vɯ.lɯ-x-1 / lx

Multiplying numerator and denominator of the right handside of the equation by v x we

find
= vx+0. lx+0+vx+1. lx+1+vX+2. lx+2 +..+vx+ɯ.lɯ-x-1/vx lx
Put vx . lx = Dx
äx = Dx + Dx+1 + Dx+2 + …… + D ɯ-x-1 / Dx
Put = Dx + Dx+1 + Dx+2 + …… + D ɯ-x-1= Nx

äx = N x / D x

Example 4:

Compute the net single premiums for a whole life annuity immediate and a whole
life annuity due, of $600 per year, purchased at age 30.

Solution:

The payment constitute of whole life ordinary annuity payable, so the net single is:

a30 . 600 = N30+1 / D30 . 600

= N31 / D30 . 600
= 87792679/3905782 . 600
= 22.4776188226 . 600
= $13486.571
The payment constitute of whole life annuity immediate is:
ä30 .600 = N30 / D30 . 600

50
 = 91698401/3905782 . 600
= 23.4776034607 . 600
= $14086.562

Example 5:

A man aged 20 agrees to pay $50 at the end of each year for as long as he lives.
What is the present value of the payment?

Solution:

The payment constitute of whole life ordinary annuity payable, so the net single is:

a20 . 50 = N20+1 / D20 . 50

= N21 / D20 . 50
= 132991536/5351272 . 50
= 24.8523222 . 50
= $1242.616

Example 6:

What is the present value of the payment in example 5 if the payment at the
beginning of each year?

Solution:

The payment constitute of whole life due annuity payable, so the net single is:

ä 20 . 50 = N20 / D20 . 50
= N20 / D20 . 50
= 135342809/5351272 . 50
= 25.2917080 . 50
= $1264.585

51
6- Whole life insurance

A whole life insurance be defined as a benefit consisting of a fixed sum to be

paid to the beneficiary at the time of the death of the insured regardless of when it
occurs.
The net premiums for a policy are those whose total present value is equal to the
present value of the policy benefits under the following assumptions:
a- The benefits under the policy will be paid at the ends of the policy years in
which they fall due, i.e. The face amount of the policy payable at the end of the
year in which the death of the insured occurs;
b- The company’s invested funds will earn interest at exactly the assumed rate;
and
c- The deaths among the policyholders will occur at exactly the rates given by the
adopted mortality table.
According to the above assumptions we have the following fundamental
equation underlying the definition of the term net single premium:

Present value at the inception Present value at the

of the contract of all net single inception of the contract of
premiums to be paid by a life = all contractual benefits to be
or group of lives for contractual received by this death or
benefits group of deaths.

The actual gross premium charged by the company is the net premium plus a
certain amount, called loading, which provides for the expenses of the company.

52
 Inception _______________________________
$Ax . lx
first second Third Fourth………………ɯ

d d d ……………………… d
x x+1 x+2 ɯ-x
$v . dx _
$v2 . dx+1 _
$v3 . dx+2
……………………………………………………………..
ɯ-x
.$V .dɯ-1

Let Ax denote the net single premium for a whole life insurance of $1 to be paid
at the end of the year in which x dies. If a company insured l x individuals each of age
x, on the same policy date, the total net single premium collections would be $Ax . lx .
During the first policy year dx death would occur among the group and $dx would be
payable at the end of the first year to beneficiaries.

In order to meet this obligation $v.dx would be needed at inception date. During
the second policy year dx+1 death would occur among the group and $dx+1 would be
payable at the end of the second year to beneficiaries.

In order to meet this obligation $v2.dx+1 would be needed at inception date.

During the third policy year dx+2 death would occur among the group and $dx+2 would
be payable at the end of the third year to beneficiaries.

In order to meet this obligation $v3.dx+2 would be needed at inception date,, and
so on until all of the lx individuals originally insured, had died.

Equating the total net premiums collected by the company to the total present
value of the benefits, we have the following equation:

Ax . lx = v1.dx + v2.dx+1 + v3.dx+2 + … + vɯ-x.dɯ-x-1

Ax = v1.dx + v2.dx+1 + v3.dx+2 + … + vɯ-x.dɯ-x-1 / lx

Multiplying numerator and denominator of the right handside of the equation by v x we

find:
53
 Ax=vx+1.dx+vx+2.dx+1+vx+3.dx+2+… +vɯ.dɯ-1 / vx.lx

Let the product vx+1.dx = Cx, vx+2.dx+1 = Cx+1, vx+3.dx+2 = C x+2, and so on we have:

Ax = Cx + Cx+1 + Cx+2 + Cx+3 +…… + Cɯ-1 / Dx

Donate by the commutation symbol:

Mx = Cx + Cx+1 + Cx+2 + Cx+3 +…… + Cɯ-1.

we have:

Ax = M x / D x

Example 7:

Find the net single premium for a whole life insurance of $40000 on the life of a
man aged 40.

Solution:

A40 . 40000 = M40 / D40 . 40000

= 1151855/2853001 . 40000
= 0.4037345238 . 40000
= $16149.381

Example 8:

How mach whole life insurance can a man aged 30 purchase with $2000?

Solution:

A30 . S = M30 / D30 . S

2000 = 1234952/3905782 . S
= 0.3161855936 . S
S = 2000/0.3161855936

54
 = $6325.400

7- Term insurance

A term insurance can be defined as the benefit consisting of a fixed sum to be

paid to the beneficiary at the death of the insure, if death occurs within a limited
period. It should be noted that no payment is made by the company in the event that
the insured survives the limited period.

Inception ___________n______________maturity
$ Ax1:n‫ ﬧ‬. lx
first Second Third ……………………………. N

d d d …………… …….…….dx+n-1
x x+1 x+2

$v. dx
$v2. dx+1
$v3. dx+2
.
.
.
$vn. dx+n-1

Let Ax1:n‫ ﬧ‬donate the net single premium for an n-year term insurance of $1 one
the life of an insured at age x. The mark “1” above the age indicates that the benefit is
payable only if the insured dies before the n years expire.

If the company were to issue n-year term policies to each of lx individuals all of
age x, the total net single premiums collected immediately by the company would
aggregate $ Ax1:n‫ ﬧ‬. lx .

As in the case of whole life insurance $dx would be needed to pay death claims
to beneficiary on the account of deaths of the first policy year, at inception date it will
be (the present value) $v.dx, and $v2.dx+1 would be needed immediately to pay death
claims to beneficiary on the account of deaths of the second policy year, and so on,
until $vn.dx+n-1 would be needed immediately to pay death claims to beneficiary on the
account of deaths of the nth policy year, after which all the remaining policies would
expire.
55
 Hence, equating the present value of the total net premiums to the total present
value of the benefit, we find:

Ax1:n‫ = ﬧ‬v1.dx + v2.dx+1 + v3.dx+2 +…… + vn.dx+n-1

Ax1:n‫= ﬧ‬v1.dx+v2.dx+1+v3.dx+2+ ……+ vn.dx+n-1 / lx

Multiplying numerator and denominator of the right handside of the equation by v x we

find:
Ax1:n‫ = ﬧ‬vx+1.dx+vx+2.dx+1+.…+vx+n.dx+n-1 / vx.lx

Donate by the commutation symbol:

Mx– Mx+n = Cx + Cx+1 + Cx+2 + Cx+3 +… + Cx+n-1

we have:

Ax1:n‫( = ﬧ‬Mx - Mx+n) / Dx

Example 9:

Find the present value for 10 years term insurance if the insured is 35 and the
sum insurance is $500000.

Solution:

A351:10‫ ﬧ‬. 500000 = (M35 – M35+10) / D35 . 500000

= (M35 – M45 )/ D35 . 500000

=(1194810 – 1098094)/331295 . 500000

= $145966.586

Example 10:

How mach 5 years term insurance can a man aged 30 purchase with $2000?

56
Solution:
A301:5‫ ﬧ‬. S = (M30 – M35)/ D30 . S
2000 = (M30 – M35)/ D30 . S
= (1234952 – 1194810)/3905782 . S
S = 2000/0.102775833
= $19459.828

57
 Computation Symbols

X Dx Nx Mx
0 10000000 259378703 1228740
1 9593430 249378703 1160334
2 9252701 239785273 1144020
3 8926219 230532572 1130432
4 8611775 221606363 1117840
5 8308907 212994578 1106191
6 8017091 204685671 1095354
7 7735912 196668580 1085284
8 7735912 188932667 1075866
9 7203586 181467774 1066995
10 6951565 174264188 1058573
11 6708361 167312623 1050446
12 6473536 160604261 1042474
13 6246743 154130725 1034593
14 6027534 147883982 1026627
15 5815610 141856448 1018532
16 5610743 136040838 1010328
17 5412659 130430095 1001980
18 5221150 125017436 993508
19 5036064 119796286 984982
20 4857296 114760222 976516
21 4684639 109902926 968115
22 4531684 105218286 959832
23 4357038 100700348 951713
24 4201743 96343309 943757
25 4051901 92141566 936003
26 3907325 88089665 928447
27 3767793 84182340 921048
28 3633136 80414547 913802
29 3504691 76781411 906677
30 3377646 73278261 899637
31 3256475 69900615 892686

58
 Computation Symbols (Continued)

X Dx Nx Mx
32 3139462 66644140 885796
33 3026472 63504677 878971
34 2917343 60478265 872187
35 2811925 557560862 864301
36 2710016 54748937 858603
37 2611460 52038921 852411
38 2516085 49427461 849274
39 2423683 46911376 821392
40 2334112 44487693 819452
41 2247220 42153580 803934
42 2162810 39106360 800457
43 2081034 37743471 793261
44 2000551 35662437 780453
45 1924353 33660884 786062
46 1849331 31736531 776115
47 1776376 29887200 765698
48 1705390 28110824 754782
49 1636268 26405435 743330
50 1568920 24769167 731315
51 1503253 23200247 718703
52 1439187 12696994 705472
53 1376669 20257807 691612
54 1315630 18881138 677137
55 1256013 17565508 662011
56 1197764 16309495 646235
57 1140815 15111731 629790
58 1085108 13970917 612661
59 1030590 11885809 594838
60 927229 11855218 576328
61 924978 10877990 557123
62 873822 9952012 537247
63 863748 9079190 516723
64 774745 8925614 495576

59
 Computation Symbols (Continued)

X Dx Nx Mx
65 743025 8734213 483014
66 704129 7735924 464855
67 634119 6073953 428720
68 589370 5439834 405414
69 545705 4850464 381680
70 503203 4304759 357632
71 461980 3801556 333425
72 422187 3329576 309254
73 383986 2917389 285330
74 347531 2533403 261861
75 312906 2185872 238988
76 280143 1872966 216806
77 249238 1592823 195374
78 220172 1343585 174737
79 192920 1123412 154941
80 167544 930482 136078
81 144075 762938 118275
82 122589 618864 101661
83 103144 591432 86362
84 85766 451918 741517
85 70435 307365 60041
86 57087 236930 49075
87 45624 179843 38145
88 35921 121410 30394
98 27826 98298 24501
90 21173 70472 18790
91 15790 49299 14123
92 11506 33510 10373
93 8161 22003 7417
94 5604 13843 5136
95 3700 8239 3421
96 2319 4539 2166
97 1343 2220 1268
98 664 877 634
99 213 213 206

60
 (4)

PROPERTY INSURANCE

1. Introduction
Property insurance provides protection against most risks to property, such as
fire, theft and some weather damage. This includes specialized forms
of insurance such as fire, automobile, marine, aviation, flood, , home, and boiler
insurance. Property insured in two main ways open perils and named perils.

Open perils cover all the causes of loss not specifically excluded in the policy.
Common exclusions on open peril policies include damage resulting
from earthquakes, floods, nuclear incidents, acts of terrorism, and war.

Named perils require the actual cause of loss to be listed in the policy for
insurance to be provided. The more common named perils include such damage-
causing events as fire, lightning, explosion, and theft.

2 Fire insurance

DEFINITION

Fire insurance is a specialized form of insurance beyond property

insurance, and designed to cover the cost of replacement, reconstruction or
repair beyond what covered by the property insurance policy. Policies cover
damage to the building itself, and cover damage to nearby structures, personal property
and expenses associated with not being able to live in or use the property if it have
been damaged.

BREAKING DOWN 'Fire Insurance'

Homeowners and property owners may consider fire insurance in addition to a

property insurance policy if the property contains valuable items. A best practice
would be to document the property and its related contents, which makes identifying
61
the value of items damaged or lost much easier after a fire has taken place. A fire
insurance policy may contain exclusions based on the cause of the fire, such as not
covering fires caused by wars.

Why Is Fire Insurance Coverage Important?

If you want to know why fire insurance coverage is so important, all you have
to look at some recent statistics on the frequency of home fires and the extent of the
damage they have done. According to the U.S. Fire Administration, there were more
than 360,000 residential fires in 2010. All told, these home fires accounted for $6.6
billion worth of damage. Taking a closer look at the causes of these fires, the
organization reports 166,000 were cooking-related, 46,000 were fireplace-related and
26,000 were the result of electrical malfunctions.

It is likely that daily activities at home that could leave exposed to the
possibility of a fire that could threaten home and belongings. Cooking and keeping
warm by the fireplace are not the only activities that pose a risk. So do other things,
like burning candles or incense. If all of this isn't enough to convince that having
adequate fire insurance coverage for home may be a smart idea, here are just a few
more reasons:

Smoke alarms may not be enough. A properly functioning smoke alarm can be
a great early warning tool that will alert to a fire with enough time to get family to
safety and call the fire department. Fire can spread rapidly, and getting a critical heads-
up to the presence of smoke at home is no guarantee that home will not be seriously
damaged or totally consumed by fire. Do not make the mistake of thinking that having
state-of-the-art smoke and carbon monoxide detectors will prevent a fire or give
enough time to put it out.

Fire insurance coverage can bring the homeowner back in from the cold. If the
worst were to happen and the house burned down, where would homeowner go?
Knowing that he has relatives who will pitch in to help he out during such a difficult
time is great, but if he don't have those resources, what would he do?

Most standard homeowner's insurance policies that cover fire loss come with
the benefit of reimbursed additional living expenses. For example, if home is
destroyed or damaged enough by a fire to the point that it's not safely habitable, a fire
62
insurance policy will often pay for the reasonable increase in living expenses, such as
the additional cost of hotel stays, restaurant bills, etc.

Having fire insurance homeowner can save from financial disaster. Home is
probably most valuable asset. Failing to insure it against fire damage could put
homeowner in a precarious financial situation if he has himself no recourse in the
event of a fire. He has worked hard all life to have the things that deserve why put all
of that in jeopardy by failing to have adequate insurance coverage for fire.

Fire is a commonplace occurrence. This does not mean that it is destined to

happen to homeowner. However, if it does, having fire insurance to help cover
financial losses is a critical safety net that nobody should do without it.

3. Vehicle Insurance

Auto insurance, in exchange for a premium, will pay for damages incurred as
result of a traffic accident. Vehicle insurance (also known as auto insurance, car
insurance, or motor insurance) is insurance purchased for cars, trucks, and other
vehicles.

Its primary use is to provide protection against losses incurred because of traffic
accidents and against liability that could incur in an accident.

Public policy

In many jurisdictions, it is compulsory to have vehicle insurance before using

or keeping a motor vehicle on public roads. Most jurisdictions relate insurance to both
the car and the driver; however, the degree of each varies greatly.

United Kingdom

In 1930, the UK government introduced a law that required every person who
used a vehicle on the road to have at least third party personal injury insurance.
Today UK law is defined by the Road Traffic Act 1988, which was last modified in
1991. The Act requires that motorists either be insured, have a security, or have made
a specified deposit (£500,000 as of 1991) with the Accountant General of the Supreme
Court, against their liability for injuries to others (including passengers) and for

63
damage to other persons' property resulting from use of a vehicle on a public road or
in other public places.

The minimum level of insurance cover commonly satisfies the requirement of

the Act is called third party only insurance. The level of cover provided by Third
party only insurance is basic but does exceed the requirements of the act.

Road Traffic Act Only Insurance is not the same as Third Party Only
Insurance and not often sold. It provides the very minimum cover to satisfy the
requirements of the Act. For example, Road Traffic Act Only Insurance has a limit of
£1,000,000 for damage to third party property - third party only insurance typically has
a greater limit for third party property damage.

It is an offence to drive a car, or allow others to drive it, without at least third
party insurance whilst on the public highway (or public place Section 143(1)(a) RTA
1988 as amended 1991); however, no such legislation applies on private land.

Vehicles, which exempted by the act, from the requirement to be covered,

include those owned by certain councils and local authorities, national park authorities,
education authorities, police authorities, fire authorities, health service bodies and
security services.

The insurance certificate or cover note issued by the insurance company

constitutes legal evidence that the vehicle specified on the document is insured. The
law says that an authorised person, such as the police, may require a driver to produce
an insurance certificate for inspection. If the driver cannot show the document
immediately on request, then the driver will usually be issued a HORT/1 with seven
days, as of midnight of the date of issue, to take a valid insurance certificate (and
usually other driving documents as well) to a police station of the driver's choice.
Failure to produce an insurance certificate is an offence. The HORT/1 is commonly
known even by the issuing authorities when dealing with the public - as a "Producer".

Most motorists in the UK are required to prominently display a vehicle license

(tax disc) on their vehicle when it is kept or driven on public roads. This helps to
ensure that most people have adequate insurance on their vehicles because an
insurance certificate must be produced when a disc is purchased.

64
 The Motor Insurers Bureau compensates the victims of road accidents caused
by uninsured and untraced motorists. It also operates the Motor Insurance Database,
which contains details of every insured vehicle in the country.

United States

In the United States, auto insurance covering liability for injuries and
property damage done to others is compulsory in most states, though enforcement of
the requirement varies from state to state. The state of New Hampshire, for example,
does not require motorists to carry liability insurance (the ballpark model), while in
Virginia residents must pay the state a $500 annual fee per vehicle if they choose not
to buy liability insurance.

Penalties for not purchasing auto insurance vary by state, but often involve a
substantial fine, license and/or registration suspension or revocation, as well as
possible jail time in some states. Usually, the minimum required by law is third party
insurance to protect third parties against the financial consequences of loss, damage or
injury caused by a vehicle.

Some states, such as North Carolina, require that driver hold liability insurance before
a license can be issued.

Arizona Department of Transportation Research Project Manager John

Semmens has recommended that car insurers issue license plates, and that they be held
responsible for the full cost of injuries and property damages caused by their
licensees under the Disneyland model. Plates would expire at the end of the insurance
coverage period, and licensees would need to return their plates to their insurance
office to receive a refund on their premiums. Vehicles driving without insurance
would thus be easy to spot because they would not have license plates, or the plates
would be past the marked expiration date.

Coverage levels

Vehicle insurance can cover some or all of the following items:

 The insured party

 The insured vehicle
 Third parties (car and people)

65
  Third party, fire and theft
 In some jurisdictions coverage for injuries to persons riding in the insured
vehicle is available without regard to fault in the auto accident (No Fault Auto
Insurance)

Different policies specify the circumstances under which each item is covered. For
example, a vehicle can be insured against theft, fire damage, or accident damage
independently.

Excess

An excess payment, also known as a deductible, is the fixed contribution must

pay each time car is repaired through car insurance policy. Normally the payment is
made directly to the accident repair "garage" (The term "garage" refers to an
establishment where vehicles are serviced and repaired) when collect the car. If one's
car is declared to be a "write off" or "total loss"("write off" is commonly used in
motor insurance to describe a vehicle the worth of which is less than the cost of
repair), the insurance company will deduct the excess agreed on the policy from the
settlement payment it makes to insured.

If the accident was the other driver's fault, and this is accepted by the third
party's insurer, you'll be able to reclaim your excess payment from the other person's
insurance company.

Compulsory excess

A compulsory excess is the minimum excess payment insured insurer will

accept on his insurance policy. Minimum excesses vary according to your personal
details, driving record and insurance company.

Voluntary excess

In order to reduce insurance premium, he may offer to pay a higher excess than
the compulsory excess demanded by his insurance company. Voluntary excess is the
extra amount over and above the compulsory excess that you agree to pay in the event
of a claim on the policy. As a bigger excess reduces the financial risk carried by your
insurer, your insurer is able to offer you a significantly lower premium.

66
Basis of premium charges

Depending on the jurisdiction, the insurance premium can be either mandated

by the government or determined by the insurance company in accordance to a
framework of regulations set by the government. Often, the insurer will have more
freedom to set the price on physical damage coverages than on mandatory liability
coverages.

When the premium is not mandated by the government, it is usually derived

from the calculations of an actuary based on statistical data. The premium can vary
depending on many factors that are believed to have an impact on the expected cost of
future claims. Those factors can include the car characteristics, the coverage selected
(deductible, limit, covered perils), the profile of the driver (age, gender, driving
history) and the usage of the car (commute to work or not, predicted annual distance
driven).

Gender
Men average more miles driven per year than women do, and consequently
have a proportionally higher accident involvement at all ages. Insurance companies
cite women's lower accident involvement in keeping the youth surcharge lower for
young women drivers than for their male counterparts, but adult rates are generally
unisex. Reference to the lower rate for young women as "the women's discount" has
caused confusion that was evident in news reports on a recently defeated EC proposal
to make it illegal to consider gender in assessing insurance premiums. [10] Ending the
discount would have made no difference to most women's premiums.

Age
Teenage drivers who have no driving record will have higher car insurance
premiums. However, young drivers are often offered discounts if they undertake
further driver training on recognised courses, such as the Pass Plus scheme in the UK.
In the U.S. many insurers offer a good grade discount to students with a good
academic record and resident student discounts to those who live away from home.
Generally insurance premiums tend to become lower at the age of 25. Senior drivers
are often eligible for retirement discounts reflecting lower average miles driven by this
age group.

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 Marital status
Drivers, who are unmarried are often charged higher insurance premiums as
opposed to married drivers.

Vehicle classification
Owners of sports cars, muscle cars, some sport utility vehicles, and motorcycles
would have higher insurance premiums as opposed to compact cars, midsized cars, or
luxury cars. However, in the case of motorcycles, the chance of causing extensive
damage to other vehicles is relatively low (as opposed to damage to oneself) and thus
liability insurance premiums are often lower.

Distance
Some car insurance plans do not differentiate in regard to how much the car is
used. However, methods of differentiation would include:

Reasonable estimation
Several car insurance plans rely on a reasonable estimation of the average
annual distance expected to be driven which is provided by the insured. This discount
benefits drivers who drive their cars infrequently but has no actuarial value since it is
unverified.

Odometer-based systems
Cents Per Mile Now (1986) advocates classified odometer-mile rates. After the
company's risk factors have been applied and the customer has accepted the per-mile
rate offered, customers buy prepaid miles of insurance protection as needed, like
buying gallons of gasoline. Insurance automatically ends when the odometer limit
(recorded on the car’s insurance ID card) is reached unless more miles are bought.
Customers keep track of miles on their own odometer to know when to buy more.

The company does no after-the-fact billing of the customer, and the customer
doesn't have to estimate a "future annual mileage" figure for the company to obtain a
discount. In the event of a traffic stop, an officer could easily verify that the insurance
is current by comparing the figure on the insurance card to that on the odometer.

Critics point out the possibility of cheating the system by odometer tampering.
Although the newer electronic odometers are difficult to roll back, they can still be

68
defeated by disconnecting the odometer wires and reconnecting them later. However,
as the Cents Per Mile Now website points out:

As a practical matter, resetting odometers requires equipment plus expertise

that makes stealing insurance risky and uneconomical. For example, in order to steal
20,000 miles (32,000 km) of continuous protection while paying for only the
2,000 miles (3,200 km) from 35,000 miles (56,000 km) to 37,000 miles (60,000 km)
on the odometer, the resetting would have to be done at least nine times to keep the
odometer reading within the narrow 2,000-mile (3,200 km) covered range.

There are also powerful legal deterrents to this way of stealing insurance
protection. Odometers have always served as the measuring device for resale value,
rental and leasing charges, warranty limits, mechanical breakdown insurance, and
cents-per-mile tax deductions or reimbursements for business or government travel.
Odometer tampering—detected during claim processing—voids the insurance and,
under decades-old state and federal law, is punishable by heavy fines and jail.

Under the cents-per-mile system, rewards for driving less are delivered
automatically without need for administratively cumbersome and costly GPS
technology. Uniform per-mile exposure measurement for the first time provides the
basis for statistically valid rate classes. Insurer premium income automatically keeps
pace with increases or decreases in driving activity, cutting back on resulting insurer
demand for rate increases and preventing today's windfalls to insurers when decreased
driving activity lowers costs but not premiums.

GPS-based system
In 1998, Progressive Insurance started a pilot program in Texas in which
drivers received a discount for installing a GPS-based device that tracked their driving
behavior and reported the results via cellular phone to the company. Policyholders
were reportedly more upset about having to pay for the expensive device than they
were over privacy concerns. The program was discontinued in 2000.

OBDII-based system
In 2008, The Progressive Corporation launched MyRate to give drivers a
customized insurance rate based on how, how much, and when their car is driven.
MyRate is currently available in Alabama, Kentucky, Louisiana, Michigan, Minnesota,

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Maryland, New Jersey and Oregon. Driving data is transmitted to the company using
an on-board telematic device. The device connects to a car's OnBoard Diagnostic
(OBD-II) port (all automobiles built after 1996 have an OBD-II.) and transmits speed,
time of day and number of miles the car is driven. There is no GPS in the MyRate
device, so no location information is collected. Cars that are driven less often, in less
risky ways and at less risky times of day can receive large discounts. Progressive has
received patents on its methods and systems of implementing usage-based insurance
and has licensed these methods and systems to other companies. Progressive has
service marks pending on the terms Pay As You Drive and Pay How You Drive.

4. Marine insurance

Marine insurance covers the loss or damage of ships, cargo, terminals, and any
transport or property by which cargo is transferred, acquired, or held between the
points of origin and final destination.

a) Marine Hull Insurance

Insurance of vessel and its equipment are included under hull insurance, there
are a number of classification of vessels such as ocean steamers, sailing vessels,
builders, risks fleet policies and so on.

It is concerned with the insurance of hull and machinery of ocean-going and

other vessels like barges, tankers, Fishing and sailing vessels.

Insurance of construction risks or builder’s risks deals with hull insurance for
vessels when they are under construction.

A recent development in hull insurance has been the growth of insurance of

offshore oil/gas exploration and production units as well as connected construction
risks.

It is covered with the specialized class of business particularly for Fishing

Vessels, Trawler’s, Dredgers, Inland and Sailing Vessels are available.

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The subject matter of hull insurance is the vessel or ship.

There are many types of designs for ships. Most of them are constructed of steel
and welded and are capable of sailing on the sea in ballast in with cargo.

The ship is to be measured with GRT (Gross Register Tonnage) and NRT (Net
Register Tonnage). GRT is calculated by dividing the volume in cubic feet of the
ship’s hull below the tonnage dock, plus all spaces above the deck with permanent
means of closing.

NRT is the gross tonnage less certain spines for machinery, crew
accommodation ballast spaces and is intended to encompass only those spinning used
for the of cargo.

DWT (Dead Weight Tonnage) means the capacity in tons of the cargo required
to load a ship to her load line level.

types of marine vessels are;

 General Cargo vessels.

 Dry Bulk Carriers.

 Liquid Bulk Carriers.

 Passenger Vessels.

These can be further divided into ocean-going and coastal tonnage.

Ocean-going general cargo vessels are usually in the 5000 to 15000 GRT range,
coasters are smaller in size and one engaged in the carriage of bulk cargoes.

Coastal tonnage does not withstand the same strains as ocean-going vessels.

General Cargo Vessel

The general cargo vessels may be container ships, large carriers (LASH –
Lighter Abroad Ship) Ro-Ro (Roll on Roll off) vessels, Refers (Refrigerated Vessels
General Cargo) Many general cargo vessels are built for specific purpose Vessels may
be subdivided into Liners and Tramps.

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Liner’s loads at an advertised berth and runs to an advertised schedule calling can
route at a varying number of ports according to the particular service. It tries to
maintain Time schedule although there is a heavy risk of seas.

It requires huge capital investment. Liners are always fit and well maintained at
all times. Liners have a high standard of officers and crew.

Tramp carries cargo whenever and wherever it is available. Mostly bulk cargos
very often are seasonal in character for which she is usually chartered. Vessels are
built to comply with the particular needs of the owner’s trade.

Dry Bulk Carriers

Dry Bulk Carriers are specially constructed vessels in the size range of
thousands GRT for coasters and 70,000 GRT for ocean-going tonnage. The main bulk
cargoes carried are iron ore, coal, grain bauxite and phosphate

The main features of these vessels are the single weather deck and large holds
with wide hatches to facilitate loading and discharge by mechanical means.

Most bulk carriers have sloping upper wing tanks to assist in trimming the
cargo and thus produce a safer slow.

Nature of cargo, routs conversation into bulk cargoes and stability are the main
considerations for underwriting.

Liquid Bulk Carriers

Tankers are strongly constructed to carry bulk liquid. The tankers have used
tanks which do not extend across the breadth of the tanker.

Due to the live nature of the liquids cargo, tankers sustain heavier damage than
other cargo ships.

The tanker has a shorter life due to corrosive effect. There is considerable
danger of fire and explosion.

Before a tanker is allowed to enter a dry dock for repairs, a gas-free certificate
is required. The risk of pollution following a casualty makes salvage operation more
difficult and expensive.
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 The tankers may be VLCC (Very Large Crude Carrier) and ULCC (Ultra Large
Crude Carrier) LASH and Sea Bee vessels are mother ships which carry floating
containers in the form of barges up to 1000 tons displacement.

An RO-RO (Roll on Roll off) vessel is one having a facility for shipping
Lorries, trailers, etc. without the need for cranes.

Passenger Vessels
There are cruise vessels or passenger liners which sail on voyages to distant
areas of scenically beautiful but rocky or shallow coasts or near the icy waters of the
Arctic and Antarctic. They possess modem navigational systems.

Other Vessels
There are other types of vessels such as fishing vessels, offshore oil vessels, and
others.

Fishing Vessels
Fishing vessels bulk of steel and fiberglass (GRP) are much more prevalent.
Geographical/physical features of the area of operations vary from comparatively
sheltered waters of inshore fishing to the full rigors of the open seas with exposure to
gales, heavy seas fog ice and snow.

The vessels may be classed or un-classed. Classed vessels are recognized by

Classification Society, and may possess class granted by it. Un-classed vessels are
surveyed out of the later and all machinery is thoroughly examined.

There is a special tariff for the fishing vessel in India. Nature, type, age,
geographical limits, etc. are examined for insurance cover and rating.

Offshore Oil Vessels

The offshore oil vessels are used for explanation or for commercial production
of oil from the ocean beds.

The comprehensive cover gave covers not only the operations at the site but
also the transporter of plant and equipment to the drilling sales which may be hundreds
of kilometers away in mid sea. These vessels are veritable artificial islands where the
risks are present in one form or another.

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 The jack-up unit is a self-elevating platform which can float freely with legs
retracted by a jacking system for movements in tow. Casualties may occur during tows
or whilst jacking up or down.

The semi-submersible or column established drilling platform can be bottom

supported and or free floating.

They can operate in deeper water and usually, have multi-anchoring system
employing up to 10 separate lines. Another ship shape unit is basically a modified
conventional ship, with a slot for drilling through, located in the center.

It is capable of much deeper water drilling. Again another fixed structure is

usually a platform construction on four or more piled legs. The platforms are
stationary.

Hull and Machinery Insurance

The policy covers the hull, machinery and equipment and stores etc. on board
but do not cover cargo.

The insurance cover, the requirements of the individual ship owner and protects
him against partial loss, total loss, ship’s proportion of general average and salvage
charges, sue and labor expenses and ship-owners liability towards other vessels arising
from collisions.

Hull Underwriting

Hull underwriting requires the following information to assure the risk: Type,
construction, builders, age, tonnage, dimension, equipment, propulsion machines,
engine, fire extinguisher; classification society, merchant shipping act, warranties,
navigation physical and moral hazard.

Rate making in marine insurance.

The numerical rating system evaluates each and every item and marks are
assigned to them according to their merits and degrees of influencing risk.

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 Since the marine perils are varied, the only numerical rating system cannot be
successfully utilized.

However, tabulation of statistical experience on many risks can serve the

purpose as a basis of supplementary factors for underwriter’s judgment.

Marine insurance grants protection against a large number of perils which are
viewed in relation to the inherent character of a large variety of subject-matter of
insurance, the effects of season, adverse physical forces and trade customs, and the
policy conditions.

Individual insurance account is used for personal valuation by a leading

underwriter who enter into the making of marine insurance rates vary materially. The
judgment and personal evaluation are very vital in rate making.

There are various factors to influence the risk.

The management and ownership are very important factors while risks are
evaluated for the purpose of rate making.

The following factors influence rate making of hull and cargo.

Hull Insurance Management

Once management may be efficient in the upkeep of the vessel and the
appointment of officers and crew. Other management, through negligence,
indifference, and undue economy, may show a bad record.

To treat these managements alike would be an injustice to the better-managed

concerns. It would penalize efficiency and carefulness and put a premium on
inefficiency and carelessness.

Natural Forces and Topography

The underwriters consider the character of the route, the construction, type and
the nationality of the vessel and conditions of the contract.

Some natural hazards are permanent while others are of seasonal dangers.

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 References are made to storms, submerged shoals, shifting sandbars, shallow
water, narrow channels, ice, currents, tides, and seaquakes while calculating the
premiums to a particular route.

Dangers from an underwriting point of view are associated with the ports of
departure, call or destination. Some ports are known for insufficient depth, the absence
of good anchorage ground, lack of protection against tides or Tidal waves.

Construction, Type, and Nationality of the Vessel

The quality and fitness of the vessel to serve as a carrier on the particular route
are naturally of the utmost importance.

The underwriter wants to know the vessel with respect to its builder and owner,
structural plan, material used in construction, type of propulsion, structural strength to
resist stresses mid strains, adaptability to carry various kinds of cargo and its age and
physical condition,In foreign countries, certain societies are formulated to promulgate
rules for the construction of vessels, supervising such construction and assigning a
class to each vessel.

The Lloyd’s Register contains information to numerous vessels of other

countries, name and nationality of the vessel, materials of construction, details of the
decks, the engine and boiler equipment of the vessel. Periodical changes are noted
down there.

The nationality of the vessel is important to the insurer because it discloses the
dependence of the nations upon the ocean trade.

The nationality reveals the skillfulness of the masters and crew, the rates may
vary greatly as to the standard or commercial honor in trade, high standard, and
commercial ethics.

Premium rates are based on the age of the vessel, propelling method body-
structure, risks covered, the distance for transit and nature of the vessel, tonnage
capacities, port- classification and season of sailing.

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 Policy Conditions

Innumerable clauses are used to limit or increase the underwriter’s liability.

Some policies may cover against total loss. Some may cover partial losses. Others
may relate only to general average or particular average.

b). Marine Cargo Insurance

What is Marine Cargo Insurance?

Marine cargo Insurance is the insurance of property as it moves from place to

place. The word ‘marine’ conjures up the sea and foremost in the minds of the writers
of the Marine Insurance Act 1906 (MIA) was indeed sea transits. While the Act in its
opening sections refers to ‘marine losses’ and to the ‘marine adventure’ and to
‘maritime perils’, marine insurance departments insure property conveyed by aircraft
and road and rail vehicles as well. Many transits, particularly international ones require
two or more types of transport and the Act makes provision for them

So, marine cargo insurance is a class of property insurance that insures property
while in transit against loss or damage arising from perils associated with the
navigation of the sea or air and subsequent land and inland waterways. The Act does
not specifically mention air travel nor pure land-based transits. Therefore to ensure the
Act applies to all modes of transit it is usual to see a clause in the policy document
confirming its authority in all circumstances.

‘ Maritime perils’ means perils consequent on or incidental to the carriage of

property by sea. It includes perils of the sea (sinking, stranding, collision etc), fire, war
perils, pirates, thieves, capture, jettison and washing overboard and ‘…any other perils
either of a like kind or which may be designated by the policy.’

The inclusion of this last sentence allows insurers to include at their discretion
in their policies other risks, for example risks appropriate to other means of transport,
like crashing, derailment and overturning. It should however be mentioned that the
normal action of wind and wave is not considered a peril of the sea.

So what precisely is the ‘property’ that is the subject of marine cargo

insurance? The Act refers to it as the subject-matter insured. In essence it can be
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anything that is in the process of being conveyed from one place to another. Most
usually it is raw materials and components coming into the assured or finished
products going out.

The genre for this type of property is ‘Goods and or Merchandise’ that indicates
traded goods. Also items of the assured’s own equipment can be insured, for example
machinery, office furniture, samples and engineers tools and exhibition materials.
Indeed just about everything has moved and as a result can be insured as the subject
matter insured under a marine cargo policy.

Who can insure marine cargo?

According to Marine Insurance Act 1906 (MIA) section 5 everyone who has an
insurable interest can insure their interest under a marine policy. This begs the
question ‘who has an insurable interest?’ The Act continues by saying that a person is
‘interested’ where he stands in any legal or equitable relation to the adventure in
consequence of which he may benefit by the safe arrival of the property or be
prejudiced by its loss.

Consider the position of a manufacturer selling his goods. He has an insurable

interest in those goods even while they are travelling away from him until he has
received payment for them. Up to the point of payment he stands in a position to gain
by the success of the adventure or suffer if it fails. He therefore qualifies to insure his
interest under a marine cargo policy.

Similarly, his buyer also has an insurable interest or more correctly an

expectation of receiving one, and can thus effect a marine insurance. The Act says that
an assured (note the term assured as opposed to insured) must be interested in the
subject-matter insured at the time of loss though he need not be interested when the
insurance is effected, MIA section 6).

Thus if property in transit becomes damaged it is necessary to discover by

reference to the terms of sale or purchase which party held the insurable interest at the
time of loss.

In addition to the buyer and seller other interested parties may also insure up to
the extent of their insurable interest. For example shipping and forwarding agents or
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carriers and other bailees to whom the property was entrusted to their care and
custody, charterers and other hirers of ships, will all have an interest in the adventure
in so far as they could be sued for failure to deliver.

Interestingly the Act refers to insurers who by the fact of their policy have a
vested interest in the success or failure of the adventure and therefore qualify to insure
(or in their case re-insure) their insurable interest (MIA section 9).

If there is no insurable interest or reasonable expectation of receiving one then

the marine insurance is deemed to be a gaming or wagering contract and accordingly
held to be void (MIA section 4).

How and why does a marine policy transfer from one party to another?

The term used to describe this process is “assignment”.

When an exporter sells goods overseas he has the option of either selling the
goods on terms that leave the insurance to be arranged by him or his buyer, or he can
arrange an insurance that covers the entire voyage but the benefit of which passes from
him to his buyer when the insurable interest passes from one to the other.

Under certain terms of sale, and Cost Insurance and Freight is a popular one,
the seller contracts to obtain at his own expense a cargo insurance that the buyer, or
any other person having an insurable interest in the goods, shall be entitled to claim
directly from the insurer and to provide the buyer with an insurance policy or
certificate for that purpose.

This is a notable difference to most other property insurances where ownership

remains the same throughout the period of cover. Claims are paid to the person named
in the policy. However, the marine policy has to allow for ownership to change as
goods, the subject matter of the insurance are bought and sold.

For this reason a marine policy is assignable unless it contains terms to the
contrary, (Marine Insurance Act 1906 (MIA) section 50).

The insurance certificate contains two additional pieces of information. Firstly

it provides the name and address of the insurers claims representative in the country of

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destination and secondly the certificate will be signed, usually on the reverse by the
policyholder thus opening up or assigning the certificate to the benefit of the buyer.

This means the buyer can proceed to receive settlement for loss or damage to
the goods in transit as though he were the original assured. From an insurers point of
view this process means that claims are paid to parties other than the named assured in
other countries.

So as well as providing evidence of a sending having been placed under an

Open policy, it also acts as a document of title enabling the holder of the original
version to obtain settlement. It also gives the insurer the necessary detail to apply the
policy rate and to charge the premium.

c) Freight Cover

Quickly calculate the premium for your sea or air freight, and take out the
insurance online. Generate certificates, and receive them online with immediate cover.
Profit share is possible when reaching a minimum premium volume. It offers very
competitive pricing for individual shipments, and possible open cover policies for
more regular shipments.

Advantages

 Easy, simple and straight-forward

 Online claims follow-up possible
 Simple invoicing (per shipment, or 1 invoice per month)
 Online payment of premium (under development)
 No Claim bonus possible (subject to premium volume)

Types of Marine Losses

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 If the loss takes place on account of any of the perils insured against with the
insurer, the insurer will be liable for it and shall have to make good the losses to the
assured.

If the peril is insured, the insurer will indemnify the assured, otherwise not.

The doctrine of causa-proxima is to be applied while calculating the amount of loss.

It means for payment of losses, the real or proximate cause is to be taken into
account. If the proximate cause is insured, the insurer will pay, otherwise not.

Figure (1) Marine losses

Marine losses divided into two main parts containing several subparts;

- Total loss;

-Actual total loss

- Contractive total loss

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Partial loss;

- Particular average losses

- General average losses
- Particular charges
- Salvage charges

These classifications are described in details below;

Total loss

There is an actual total loss where the subject matter insured is destroyed or so
damaged as to cease to be a thing of the kind insured or where the assured is
irretrievably deprived thereof.

Losses are deemed to be total or complete when the subject- matter is fully
destroyed or lost or ceases to be a thing of its kind.

It should be distinguished from a partial loss where only part of the property
insured is lost or destroyed.

In case of total loss, the insured stands to lose to the extent of the value of the
property provided the policy amount was to that limit.

- Actual total loss

The actual total loss is a material and physical loss of the subject-matter
insured. Where the subject- matter insured is destroyed or so damaged as to cease to be
a thing of the kind insured, or where the insured is irretrievably deprived thereof, there
is an actual total loss.

When a vessel is foundered or when merchandise is so damaged as to be

valueless or when the ship is missing it will be an actual total loss. The actual total loss
occurs in the following cases:

- The subject-matter is destroyed, e.g., a ship is entirely destroyed by fire.

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 - The subject-matter is so damaged as to cease to be a thing of the kind insured.
Here, the subject- matter is not totally destroyed but damaged to such an extent as the
result of the mishap; it is no longer of the same species as originally insured. The
examples of such losses are—foodstuff badly damaged by sea water became unfit for
human consumption, hides became valueless as hides due to the admission of water.
These damaged foodstuffs or hides may be used as manure. Since the characters of the
subject-matters are changed and have lost their shapes, they are all actual total loss.

- The insured is irretrievably deprived of the ownership of goods even they are in
physical existence as in the case of capture by the enemy, stealth by a thief or
fraudulent disposal by the captain or crew.

- The subject-matter is lost. For example, where a ship is missing for a very long
time and no news of her is received after the lapse of a reasonable time. An actual total
loss is presumed unless there is some other proof to show against it.

In case of actual total loss, notice of abandonment of property need not be given.
In such total losses, the insurer is entitled to all rights and remedies in respect of
damaged properties. In no case, amount over the insured value or insurable value is
recoverable in a total loss form the insurers.

If the property is under-insured, the insured can recover only up to the amount of
insurance. If it is over insured he is not over-benefited but only the actual loss will be
indemnified.

Where the subject-matter had ceased to be of the kind insured, the assured will be
given the full amount of total loss provided there was insurance up to that amount, and
the insurer will subrogate all rights and remedies in respect of the property.

Any amount realized by the sale of the material will go to the insurer.

- Constructive total loss

Where the subject-matter is not actually lost in the above manner but is reasonably
abandoned when its actual total joss is unavoidable or when it cannot be preserved
from total loss without involving expenditure which would exceed the value of the
subject-matter.

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 For example,

The cost of repair and replacement was estimated to be $50,000, whereas the ship
was estimated to be $40,000, the ship may be abandoned and will be taken as a
constructive total loss.

But if the value of the ship was more than $50,000 it would not be a constructive
total loss. Here it is assumed that retention of the subject-matter would involve
financial loss to the insured.

The constructive total loss will be where;

- The subject-matter insured is reasonably abandoned on account of its actual

total loss appearing to be unavoidable;

- The subject-matter could not be preserved from actual total loss without an
expenditure which would exceed its repaired and recovered value.

The insured is not compelled to abandon his interest, where the goods are
abandoned, the insurer will have to pay the full insured value.

Where awe is a constructive total loss, the assured may either treat the loss as a
partial loss or abandon the subject-matter insured to the insurer and treat the loss as if
it was an actual total loss.

Difference between actual and constructive total loss

The actual total loss is related with the physical impossibility and the
constructive total loss is related with the commercial impossibility.

For example,

If the hides are so, damaged that it is impossible to prevent the hides from the
destruction and it may become a mass of putrefied matter, die case is of an actual total
loss.

But if it was possible to restore the hides to their original condition, though die
cost of so doing would exceed their value at the destination, the damaged hides can be

84
claimed as constructive total loss because the completion of the adventure has become
commercially impossible.

Salvage loss

Where actual total loss occurred, and die subject-matter is so damaged as to

cease to be a thing of the kind insured or when they have been sold before reaching the
destination, there is a constructive total loss. The usual form of settlement is that the
net sale proceeds will be paid to the assured.

The net sale proceeds are calculated by deducting expenses of the sale from the
amount realized by die sale.

The insured will recover from the insurer the total loss less the net amount of
sale. This amount received from the insurer is called a ‘salvage loss’.

Partial loss

Any loss other than a total loss is a partial loss. The partial loss is there where
only part of the property insured is lost or destroyed or damaged partial losses, in
contradiction from total losses, include;

- Particular average losses, i.e., damage, or total loss of a part,

- General average losses (general average) le., the sacrifice expenditure, etc.,
done for the common safety of subject-matter insured,
- Particular or special charges, i.e., expenses incurred in special circumstances,
and
- Salvage charges.

Particular average loss

The particular average loss is ‘a partial loss’ of the subject-matter insured

caused by a peril insured and is not a general average loss.

The general average loss or expense is voluntarily done for the common safety
of all the parties insured.

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 But, the particular average loss is fortuitous or accidental. It cannot be partially
shifted to others but will be borne by die persons directly affected. The particular
average loss must fulfill the following conditions:

- The particular average loss is a partial loss or damage to any particular interest
caused to (hat interest only by a peril insured against.
- The loss should be accidental and not intentional.
- The loss should be of the particular subject-matter only.

- It should be the loss of a part of die subject-matter or damage thereto or both.

The distinguishing feature in this matter is that where the properties insured are
all of the same description, kind and quality and they are valued as a whole in the
policy, the total loss of a part of this whole is a particular loss, but where the properties
insured are not all of the same description, kind and quality and they are separately
valued in the policy, the loss of an apportionable part of the interest is a total loss.

In case of total loss of a part of recoverable either as a total loss or as a particular

average loss, the basis of the settlement will be on the total loss of the whole lot or the
insurer will be liable to pay in proportion according to the insured or insurable value of
the whole interest.

The particular average on cargo

The particular average loss may be either the damage or depreciation of a

particular interest or a total loss of its part.

If the property is insured under one value for the whole and is all the same kind,
quality or description, a total loss of part will be recovered as a particular average loss.

In the case where goods are delivered in a damaged condition or where the
value is depreciated, the resulting particular average loss will be adjusted upon the
basis of comparison between the gross sound value and damaged value.

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The process of valuation is as follows:

- The gross sound value of the goods damaged is found out. This is the value
for which the goods would have been sold if the goods had reached the port of
destination in sound condition.

- After calculating the above value, the gross damaged value of the goods
damaged or depreciated is found out on the basis of market price at that time.

- Deduct the gross damaged value from the gross sound value. The difference is
the measure of the actual damage or depreciation.

- The ratio of the damage or depreciation is calculated by dividing the amount

of damage or depreciation by the gross sound value.

- Apply the above ratio to the value (insured or insurable value as the case may
be) of the damaged or depreciated goods which will give the amount of particular
average loss.

Of the amount thus arrived at, the insurer is liable for that proportion which his sum
insured bears to the value (insured or insurable).

General average Loss

General average is a loss caused by or directly consequential on a general

average act which includes a general average expenditure as well as general average
sacrifices.

The general average loss will be there where the loss is caused by an
extraordinary sacrifice or expenditure voluntarily and reasonably made or incurred in
time of peril for the purpose of preserving the property imperiled in common
adventure.

The following elements are involved in general average.

The loss must be extraordinary in nature. The sacrifice or expenditure must not
be related to the performance of routine work.

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 A state of affairs may compel the master to do something beyond his ordinary
duty for the preservation of the subject-matter.

- The whole adventure must be imperiled. The peril should be something more
than the ordinary perils of the sea. It should be imminent and real.

- The general; average act must be voluntary and intentional accidental loss or
damage is excluded.

- The toss, expenses or sacrifice must be incurred or made reasonably and

prudently. The master of the ship is the proper person to decide the reasonableness of a
particular circumstance.

- The sacrifice, loss or expenditure should be made for the preservation of the
whole adventure. It should be made for the common safety.

- If the sacrifice proved abortive, it will be allowed as the total loss. Therefore,

= to call it the general average, it must be successful at least in part.

- In absence of contrary provision, the insurer is not liable for any general
average loss or contribution where the loss was not incurred for the purpose of
avoiding, or in connection with the avoidance of a peril insured against.

1. The loss must be a direct result of a general average act. Indirect losses such as
demurrage and market losses are not allowed as general average.

- The general average must not be due to some default on the part of the person
whose interest has been sacrificed.

- The adjustment of general average losses is entrusted to an average adjuster.

Particular charges

Where the policy contains a “sue and labor” clause, the engagement thereby
entered into is deemed to be supplementary to the contract of insurance and the
assured may recover from the insurer any expenses properly incurred pursuant to the
clause.

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 The clause requires the insurers to pay any expenses properly incurred by the
assured or his agents in preventing or minimizing loss or damage to the subject-matter
by an insured peril. The essential features of the clause are as below:

The expenses must be incurred for the benefit of the subject matter insured. The
expenses incurred for the common benefit will be a part of the general average.

The expenses must be reasonable and be incurred by “the assured, his factors,
his servants or assigns” and this provision effectively excludes salvage charges.

Rate making in marine insurance

Cargo Rates

The premium on cargo depends upon the following factors:

Ownership: It may happen that two separate owner’s ship of the same kind of
cargo, carried on the same ship and to the same place will command different rates.

Proper packing, profitable accounts and the previous refusal of insurance may
determine the rate.

The character of the Cargo: The difference in hazard between various kinds of
commodities, different forms of the same commodity, different shipments, and
different types of packing and durability of the commodity may influence the premium
rates.

:Hazards and Customs The natural forces and topography considered in the
case of the ship are also considered in the case of cargo. The effect of seasons has an
important bearing upon commodities that are seriously affected by cold or heat. The
season or climate at the port of destination may influence the risk.

In certain season the port is busy with a particular cargo. Varying trade customs
associated with the different commercial routes will influence cargo rates materially.
The moral hazard is greater on certain routes.

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 Quality and Suitability of the Vessel used as Carrier: The underwriters take
into account the fitness of the vessel to carry the particular cargo. The premiums are
higher in the case of ship cf slower speed due to longer exposure of the cargo.

In case of highly perishable goods, moving in large quantities, special types of

vessels have been designed to carry such commodities.

Duration of Voyage and Policy ConditionsInsurers take into account the

length of time. Sometimes, loading of the goods aboard the vessels and protection of
the goods while on the dock is considered in the calculation of premium.

Miscellaneous Factor: The operating efficiency or proved experience of the ship may
affect the risk on cargo.

Methods of handling and stowing cargo, the regularity of the service, etc., are
the various factors to influence the premium rate.

5. Aviation insurance
Aviation Insurance was first introduced in the early years of the 20th Century.
The first aviation insurance policy was written by Lloyd's of London in 1911. The
company stopped writing aviation policies in 1912 after bad weather and the resulting
crashes at an air meet caused losses on many of those first policies.

It is believed that the first aviation polices were underwritten by the marine
insurance Underwriting community.

In 1929 the Warsaw convention was signed. The convention was an agreement
to establish terms, conditions and limitations of liability for carriage by air, this was
the first recognition of the airline industry as we know it today.

By 1933 realising that there should be a specialist industry sector the

International Union of Marine Insurance [1] (IUMI) set up an aviation committee, and
by 1934 eight European aviation insurance companies and pools were formally
established and the International Union of Aviation Insurers [2] (IUAI) was born.

The London insurance market is still the largest single centre for aviation
insurance. The market is made up of the traditional Lloyds of London syndicates and

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numerous other traditional insurance markets. Throughout the rest of the world there
are national markets established in various countries, this is dependent on the aviation
activity within each country, the US has a large percentage of the world's general
aviation fleet and has a large established market.

No single insurer has the resources to retain a risk the size of a major airline, or
even a substantial proportion of such a risk. The Catastrophic nature of aviation
insurance can be measured in the number of losses that have cost insurers hundreds of
millions of dollars (Aviation accidents and incidents).

Most airlines arrange "fleet policies" to cover all aircraft they own or operate.

The Risks

Hull "All Risks"

The hull "All Risks" policy will usually refer to something like "all risks of
physical loss or damage to the aircraft from any cause except as hereinafter excluded".

Airline hull "All Risks" policies are subject to a standard level of deductible
(that is an uninsured amount borne by the Insured) applicable in the event of partial
(non-total) loss. Currently, this deductible can range from $50,000 in respect of a Twin
Otter to $1,000,000 in respect of a wide-bodied jet aircraft, such as a Boeing 747.

Deductibles too can be reduced by means of a separate "Deductible Insurance"

policy. The Deductible Insurance Policy is effected to reduce the large "All Risks"
policy deductibles to a more manageable level. For example the US$1,000,000
applicable to a Boeing 747 can be reduced to say US$100,000.

The term "all risks" can be misleading. "All risks of physical loss or damage"
does not include loss of use, delay, or consequential loss. "Grounding" is a good
example of consequential loss. Some years ago when there had been a couple of
accidents involving DC10 Aircraft, the Civil Aviation Authorities throughout the
world imposed a "grounding order" on that type of aircraft.

That order in effect said until certain things had been established and checked
out those aircraft could not fly. The operators of those aircraft were unable to fly them
and as a consequence of that they "lost" the use of them. But the aircraft were not

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"lost" - it was known precisely where they were but they could not be used to carry
passengers. Such an eventuality would not be covered by an "all risks" policy because
in such circumstances there is no PHYSICAL loss or damage.

What the policy will cover is the reinstatement of the aircraft to its "pre-loss"
condition, if repairable damage is involved, or some other form of settlement in the
event that more substantial damage is sustained. Exactly what form of settlement will
depend on the policy conditions.

Today, the vast majority of airline hull "all risks" policies are arranged on an
"Agreed Value Basis". This provides that the Insurers agree with the Insured, for the
policy period, the value of the aircraft and as such, in the event of total loss, this
Agreed Value is payable in full. Under an Agreed Value policy the replacement option
is deleted.

Exclusions

1. Wear, tear and gradual deterioration - in common with most non-marine

policies these perils are thought to be a trading expense and not a peril to be insured.

2. Ingestion damage - caused by stones, grit, dust, sand, ice, etc., which result in
progressive engine deterioration is also regarded as "wear and tear and gradual
deterioration", and as such is excluded. Ingestion damage caused by a single recorded
incident (such as ingestion of a flock of birds) where the engine or engines concerned
have to shut down is not regarded as wear and tear and is covered subject to the
applicable policy deductible.

3. Mechanical Breakdown - likewise is thought by aviation insurers to be an

operating expense, but subsequent damage outside the unit concerned is usually
covered. However, it is possible to obtain insurance coverage against mechanical
breakdown of engines by way of a separate policy. This coverage has a high degree of
exposure and as a result is relatively expensive. The majority of airlines do not
purchase it probably viewing such exposure as a part of the "engineering" budget.

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Spares

First of all we must identify what we mean by a "spare" or perhaps - "when is a

spare not a spare" to which a simple answer is "when it is attached". Under most
"Hull" policies the word "Aircraft" means Hulls, machinery, instruments and the entire
equipment of the aircraft (including parts removed but not replaced). Once a part is
replaced it is no longer, from an insurance viewpoint, part of the aircraft. Conversely
once a spare part is attached to an aircraft as a part of that aircraft (not in the hold as
cargo or on the wing as an extra pod) it is no longer a "spare".

If the equipment is insured on the hull "All Risks" policy the automatic transfer
of coverage from "aircraft" to "spare" and vice versa is automatically accomplished.

Having established when a spare is a spare how is it insured as such? Usually in

one of two ways. Either under a "spares" section of a hull policy or by a separate
Spares Policy. In either case the scope of coverage will probably be similar. All Risks
whilst on the Ground and in Transit for a limit of [so much] any one item or sending or
any one location. War Risks can also be covered (in respect of transits), Strikes, Riots,
Civil Commotions can be covered in accordance with standard market clauses. Spares
coverage is usually subject to a small deductible except, however, in respect of ground
running of spare engines when the appropriate Ingestion deductible will be applied.
Spares are normally covered on an agreed value basis - usually their replacement cost
(be it new or reconditioned - as is required).

Spares installed on any aircraft are not covered by the Spares Insurance. They
become, from an insurance standpoint, a part of the aircraft upon which they are
installed and a part of the Agreed Value for which it is insured. This becomes
particularly important if the parts are loaned to another airline.

Hull War Risks

The hull "All Risks" policy will contain the exclusion of "War and Allied Perils".
Generally speaking, throughout the aviation insurance world, "War and Allied Perils"
have a defined meaning. In the London Aviation Insurance Market the standard
exclusion is called the War, Hi-jacking and Other Perils Exclusion Clause (currently
known by its reference - AVN48B for short) this lists and defines these so-called war
and allied perils.
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War Definition

- War - this includes civil war and war where there is no formal declaration.
- The detonation of a weapon of war employing nuclear fission or fusion.
- Strikes, riots, civil commotions and labour disturbances.
- Political or terrorist acts.
- Malicious or sabotage acts.
- Confiscation, nationalization, requisition and the like by any government.
- Hi-jacking or any unlawful seizure or exercise of control of the aircraft or crew
in flight.

The exclusion also applies to any loss or damage occurring whilst the aircraft is
outside the control of the operator by reason of any of these "war" perils.

The majority of the excluded "War and Allied Perils", other than the detonation
of a nuclear weapon and a war between the Great Powers (the aviation insurance world
identifies these as the U.S.A., the Russian Federation, China, France and the UK), can
normally be covered by way of a separate "War and Allied Perils" policy. Aircraft
deductibles are not normally applied in respect of losses arising out of "War and Allied
Perils".

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 Chapter (5)

Losses and Claims Reserve

1. Losses

Losses Incurred and Paid

Losses incurred refers to benefits paid to policyholders during the current

year plus changes to loss reserves from the previous year. Losses incurred
represents profit that an insurance company will not make from its underwriting
activities since funds are to be paid to policyholders based on the coverage
outlined in their insurance contracts. Losses incurred is typically viewed by the
calendar year.

KEY TAKEAWAYS

 Losses incurred refers to benefits paid to policyholders during the current year,
plus changes to loss reserves from the previous year.

 Losses incurred represents profit that an insurer will not earn from its
underwriting activities since funds are to be paid to policyholders for claims.

 Insurance companies must set aside a percentage of total revenue generated to

cover any potential claims in the period.

Understanding Losses Incurred

The amount of losses incurred may vary from year to year for an insurance
company. Insurance companies set aside a reserve to cover liabilities from claims
made on policies that they underwrite. The reserves are based on a forecast of the
losses an insurer may face over a period, meaning that the reserves could be adequate
or may fall short of covering the company's liabilities. Estimating the amount of
reserves necessary requires actuarial projections based upon the types of policies
underwritten.

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 For example, a flood last year might have resulted in an increased number
of homeowner policy claims, which would increase incurred losses. However, if there
is no flood this year, incurred losses would be lower.

The Claim Process

In an ideal world for insurers, they would underwrite new insurance policies,
collect premiums, and never have to pay out benefits. However, in reality,
policyholders make claims when accidents happen, and insurers must investigate and
pay for those claims if they are found to be accurate.

An insurance claim is filed when a policyholder files a request for a loss that's
covered under the insurance policy. The insurance company incurs a loss as a result of
the claim since cash is being paid out to the insured.

Once a claim has been started, insurance companies often reevaluate the claims
that are already in process. The insurance company needs to review the claim to make
sure it's genuine and not fraudulent. The insurer also needs to determine whether the
value of the claim that was initially forecasted is going to be accurate. If after the
reevaluation process, it's found that the cost of the claim will be higher than the
forecasted amount, the company would incur a loss.

Losses Reported But Not Settled (RBNS)

Losses that have been reported to an insurance company, but that have not been
settled by the end of the accounting period. Reported but not settled (RBNS) losses are
calculated using an estimation of the severity of the loss based off of the available
information from the claims settlement process.

BREAKING DOWN Reported But Not Settled (RBNS)

Calculating reported but not settled losses requires an understanding of where

claims are in the settlement process. The calculation is an estimate based
off information an insurer has at hand, including information from court documents.
The precision of the calculation depends on the type of loss being settled, with more
complex claims being more difficult to estimate.

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 The amount an insurer places in reserve to cover RBNS losses depends on state
insurance regulations. For example, insurance companies may be required to set aside
the average value for a similar class of claim for each claim that has not been settled.

RBNS losses differ from incurred but not reported (IBNR) losses in that the
former has been reported to the insurance company, but are similar in that neither have
been settled during the accounting period. In many cases it may be difficult for
an actuary to tell the difference between IBNR and RBNS losses, depending on the
model that is being used. This is because claims are developed differently according to
the reporting year and the accounting year. These claims may be forecasted separately.

Insurance companies calculate their claims and the losses associated with those
claims using a variety of different sources. These include liabilities from the contracts
that they underwrite as well as the contracts that they ceded to reinsurers, state
regulations, court opinions concerning claims, and actuarial estimates. This
information applies to loss adjustment expenses and claims expenses.

Importance of Reported But Not Settled (RBNS) Estimates

Estimating IBNR and RBNS reserves is among the most important jobs an
actuary has in an insurance company. These estimates affect the profitability of a
insurance company, and bad estimates could have grave consequences. If the actuary
over-estimates, it could lead to the insurance company having less money to invest in
the market. It could also make it seem like the company is not preforming well, which
could lead to them increasing the price of their insurance products. If the actuary
under-estimates, it may seem as the company is performing well, and they might cut
prices. This would render them ill-equipped for unforeseen claims from past accidents,
which could have grave consequences for the insurance company. The worst case
scenario would be that they are insolvent.

Losses Incurred and Loss Ratio

Losses incurred compared to the amount of money earned through premium

payments is known as the –a key statistic for assessing the health and profitability of
an insurance company. For example, if a company has paid $100,000 in claims for
every $400,000 collected in premiums, the loss ratio would be 20%
((100,000/$400,000) x100 to create a percentage).
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 Monitoring loss ratios over time is important in assessing all aspects of
operations (including pricing) and financial stability. To fully understand an insurance
company's loss ratio results over time, there are many factors to consider, including,
but not limited to: the period of time over which losses are paid, the frequency and
severity of the lines of coverage being offered, the adequacy of pricing, the amount of
loss control measures, and other metrics.

Real World Example of Losses Incurred

In November 2018, wildfires started on Camp Creek Road in California and

spread rapidly, becoming the deadliest wildfire in the state's history. The Camp Fire–
as it became to be known–killed dozens of residents and destroyed over 153,000
acres of land and more than 18,000 structures, including homes.

The insurance company Merced Property & Casualty Co. faced $64 million in
claims from the fires. However, the company only had $23 million in assets,
as reported by CNN. As a result, the company was forced to sell all of its assets in
order to cover the claims, which is called liquidation. The company went insolvent and
no longer exists because the insurer didn't have enough loss reserves to cover its
claims and losses incurred..

Probable Maximum Loss (PML)

Probable maximum loss (PML) is the maximum loss that an insurer would be
expected to incur on a policy. Probable maximum loss (PML) is most often associated
with insurance policies on property, such as fire insurance or flood insurance. The
probable maximum loss (PML) represents the worst-case scenario for an insurer and
helps determine the premiums that a policyholder will have to pay on their insurance
policy.

KEY TAKEAWAYS

 The probable maximum loss (PML) is the maximum loss that an insurer is
expected to lose on an insurance policy.

 Insurers use various models and data to determine the risk associated with
underwriting a policy, which includes the probable maximum loss (PML).

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  Each insurance company defines and calculates probable maximum loss
(PML) in a different manner.

 Calculating probable maximum loss (PML) takes into account the following
factors: property value, risk factors, and risk mitigating factors.

 The more risk mitigating factors there are, the lower the probable maximum
(PML) loss is.

Understanding Probable Maximum Loss (PML)

Insurance companies use a wide variety of data sets, including probable

maximum loss (PML), when determining the risk associated with underwriting a new
insurance policy, a process that also helps set the premium. Insurers review past loss
experience for similar perils, demographic and geographic risk profiles, and industry-
wide information to set the premium. An insurer assumes that a portion of the policies
that it underwrites will incur losses, but that the bulk of policies will not. An insurance
company must always ensure that it has enough funds to pay out claims on policies,
and the probable maximum loss in one of many metrics that helps determine the
amount of funds required.

Insurance companies differ on what probable maximum loss means. At least

three different approaches to PML exist:

 PML is the maximum percentage of risk that could be subject to a loss at a

given point in time.

 PML is the maximum amount of loss that an insurer could handle in a particular
area before being insolvent.

 PML is the total loss that an insurer would expect to incur on a particular
policy.

Commercial insurance underwriters use probable maximum loss calculations to

estimate the highest maximum claim that a business most likely will file, versus what
it could file, for damages resulting from a catastrophic event. Underwriters use
complex statistical formulas and frequency distribution charts to estimate PML and

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use this information as a starting point in negotiating favorable commercial insurance
rates.

How to Calculate Probable Maximum Loss (PML)

There are several steps in calculating PML:

- Determine the dollar value of the property to arrive at the potential financial
loss from a catastrophic event if the entire property was destroyed.

- Determine the risk factors that are likely to cause an event that would lead to
damage or loss of the property. This can include the location of the property;
for example, properties on the ocean's shore are more prone to flooding. It can
also include building materials; buildings made of wood are more susceptible to
fire.

- Take into consideration risk mitigating factors that can prevent damage or loss,
such as proximity to a fire station, alarms, and sprinklers.

- A risk analysis will need to be performed to determine the scale at which the
risk mitigating factors will reduce the probability of an event that would lead to
damage or loss of the property.

- The last step involves multiplying the value of the property by the expected loss
percentage, which is the difference between the expected loss and the risk
mitigating factors. For example, if a home is on the shore and its value is
$300,000, and the house has been raised on stilts to avoid flooding as a risk
mitigating factor, which reduces the expected loss by 30%, then calculating the
probable maximum loss would be $300,000*(100%-30%) = $210,000.

The example above is a simplified version and the more risk mitigating factors
that a property has, the further the probable maximum loss will be reduced. Most
properties are at risk of damage by a variety of means and so ensuring protection
against all variables will not only benefit an insurance company in the amount they
will have to cover in case of a catastrophic event, but it will also reduce the premiums
a policyholder will have to pay.

Consequential Loss
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 A consequential loss is an indirect adverse impact caused by damage to
business property or equipment. A business owner may purchase insurance to cover
any damage to property and equipment, and may also obtain coverage for secondary
losses. A consequential loss policy or clause will compensate the owner for this lost
business income.

This type of insurance is also called business interruption or business income

insurance.

Understanding Consequential Loss

Business owners routinely obtain casualty insurance to cover any damage to

their facilities or equipment caused by theft, fire, flood, or other natural disasters.
These direct coverage policies do not compensate the owner for income that is lost due
to the business' inability to use that property or equipment.

KEY TAKEAWAYS

 Consequential losses are the indirect results of property damage.

 These must be insured separately from the policy that covers physical
damage to facilities or equipment.

 Such policies cover losses due to business interruptions.

Indirect losses that are the result of physical damage and adversely affect
normal business operations may be considered consequential losses.

Coverage of consequential losses may include compensation for ongoing

obligations such as salaries and fixed operational expenses.

Thus, insurers distinguish between two types of damage: primary or direct

damage, such as destruction by fire, and indirect or consequential loss, such as a
cessation of business due to the fire.

Example of Consequential Loss Coverage

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 For example, a tornado destroyed a Portland, Michigan, Goodwill store several
years ago. The organization's property insurance covered the damage to the physical
structure and the loss of the store’s inventory, while separate coverage reimbursed it
for the loss of business revenue that stemmed from the temporary closure of the store.

- Losses relating to income are consequential and require separate coverage.

- Insurance Policies for Consequential Losses

Business interruption insurance, also known as business income insurance, covers

consequential losses. These policies compensate a business for loss of revenue after a
catastrophic event regardless of physical damage to the property or equipment.

Interruption insurance coverage will typically begin from the time of the
adverse event and continue until the business is able to return to its normal operation.

Consequential loss coverage reimburses the insured for business costs due to damaged
facilities or equipment.

For example, business interruption insurance can cover situations that result
when the loss of revenue occurs due to events such as an extended power outage, a
flood, or a mudslide.

Business interruption insurance can also protect against loss of income during
a breach of contract dispute that leads to a temporary cessation of business, such as a
dispute with a supplier or other third party.

Requirements for Coverage

Business interruption insurance is peril-specific and often must be purchased

separately.

Insurance companies are on the lookout for claims that indicate inflated
expectations. For example, a bakery closed temporarily for repairs after a fire might
put in a claim for reimbursement of a reasonable level of lost sales, but not for losses
that wildly exceed its usual numbers

2. Claims Reserve

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 A claims reserve is the money set aside by insurance companies to pay
policyholders who have filed or are expected to file legitimate claims on their policies.
Insurers use the fund to pay out incurred claims that have yet to be settled.

The claims reserve is also known as the balance sheet reserve.

Understanding Claims Reserve

People pay for insurance coverage to protect themselves against financial loss.
In exchange for taking on this risk, the company offering the service charges its
customers premiums.

When entering a contract with customers, an insurance company accepts any

liability in the event that an adverse occurrence takes place which damages whatever it
agreed to insure. Accepting liability means making a payment to the insured person
when they file a legitimate claim.

Every year, insurance companies deal with claims that are filed against the
policies that they sell. For example, an auto insurance policyholder who gets involved
in an accident will file a claim with his or her insurance provider to be reimbursed for
any damages made to his or her car.

Some claims, such as property losses due to fire, are easily estimated and
quickly settled. Others, such as product liability, are more complex and may be settled
long after the policy has expired.

KEY TAKEAWAYS

 The claims reserve is funds set aside for the future payment of incurred claims
that have not yet been settled.

 The outstanding claims reserve is an actuarial estimate, as the amounts liable

on any given claim is not known until settlement.

 Money for the claims reserve is taken from a portion of the premium
payments made by policyholders over the course of their insurance contracts.

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  An outstanding claims reserve is recorded as a liability on a company’s
balance sheet.

How Claims Reserve Works?

A claims reserve is money set aside for a claim that has been reported but not
settled (RBNS) or incurred but not reported (IBNR). An insurance company will
assign a claims reserve to each file that fit those descriptions, reflecting its best
estimate of the eventual settlement amount. The outstanding claims reserve is
an actuarial estimate, as the amounts liable on any given claim is not known until
settlement.

A claims adjuster is responsible for estimating the payable amount. The

monetary amount of the claims reserve can be calculated subjectively, using the claims
handler's judgment, or statistically, by evaluating past data to project future losses.

Money for the claims reserve is taken from a portion of the premium payments
made by policyholders over the course of their insurance contracts.

Actuarial estimates of the amounts that will be paid on outstanding claims must
be evaluated so that the insurer can calculate its profits.

Claims Reserve Example

Company A provides home insurance to people living across the U.S.

Unfortunately, a big storm ends up destroying a lot of the property it insures in
Florida. Company A knows it will receive a lot of claims even if they have not been
reported yet and, as a result, creates a claims reserve, putting money aside based on its
estimates of how much it thinks it will likely have to pay out.

Claims Reserve Recording

An outstanding claims reserve is an accounting provision that is recorded as

a liability on a company’s balance sheet. They are classified as liabilities because they
must be settled at a future date. In other words, they are potential
financial obligations to policyholders.
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 The claims reserve is adjusted over time as each case develops and new
information is retrieved during the claims settlement process. The total amount of
funds set aside for a claim is the sum of the expected settlement amount and any
expenses incurred by the insurer during the settlement process, such as fees for claims
adjusters, investigators, and legal assistance.

Special Considerations

It can be difficult for insurance companies to accurately determine the amount

to set aside for claims. Regular reviews help, although that does not mean that
adequate funds are always allocated. Significant underestimates can come as a nasty
shock to investors, eroding trust in accounting practices and weighing on company
share prices.

Claims that have been incurred but not reported (IBNR) are particularly tricky
to assess. For example, workers may inhale asbestos while performing their jobs but
might not file a claim until after being diagnosed with an illness 20 years after the
adverse event occurred.

Calculating a Loss Reserve

Estimating the correct loss reserve is crucial for a company in maintaining its
profitability and solvency. If an insurance company is too conservative in their loss
reserve calculation, they will have allocated too much to the reserve, reducing their
income, and the investment ability of assets. On the other hand, if they are too liberal
with their calculation, then they will not have allocated enough to their reserves, which
would result in booking losses and possible insolvency for the company.

Insurers prefer to use present value when calculating claims since it allows
them to discount the future value of claim payments and realize how much they have
to reserve today. It also takes into consideration the years of interest earned on the
reserves before having to pay out a claim. This would technically reduce the liability
amount. However, regulators require claims to be recorded at the actual value of the
loss—its nominal value. The undiscounted loss reserve will be greater than the
discounted loss reserve. This regulatory requirement results in higher
reported liabilities.

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Other Impacts of Loss Reserves

Loss reserves also impact an insurance company's tax liabilities. Regulators

determine an insurer’s taxable income by taking the sum of annual premiums and
subtracting any increases in loss reserves. This calculation is called a loss reserve
deduction. Income, which is the insurer’s underwriting income, includes the loss
reserve deduction plus investment income.

The incorporation of loss reserves into financial statements can often lead to the
use of loss reserves for income smoothing. The claims process can be complex so
determining whether an insurer is using loss reserves to smooth income requires
examining changes to the insurer’s loss reserve errors, relative to past investment
income

Chain Ladder Method – CLM

The Chain Ladder Method (CLM) is a method for computing the claims
reserve requirement in an insurance company’s financial statement. The chain ladder
method is used by insurers to forecast the amount of reserves that must be established
in order to cover projected future claims by projecting past claims experience into the
future. CLM therefore only works when prior patterns of losses are assumed to persist
in the future. When insurer’s current claims experience changes for some reason, the
chain-ladder method will not produce an accurate estimate without proper adjustments.

This actuarial method is one of the most popular reserve methods used by
insurance companies. The chain ladder method can be compared with the Bornhuetter-
Ferguson Technique and Expected Loss Ratio (ELR) method for calculating insurance
company reserves.

KEY TAKEAWAYS

 The chain ladder method (CLM) is a popular way that insurance companies
estimate their required claim reserves.

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  CLM computes incurred but not reported (IBNR) losses by way of run-off
triangles, a probabilistic binomial tree that contains losses for the current year
as well as premiums and prior loss estimators.

 The underlying assumption of the chain ladder method is that past claims
experience is a good predictor of future outcomes.

The chain ladder method calculates incurred but not reported (IBNR) loss
estimates, using run-off triangles of paid losses and incurred losses, representing the
sum of paid losses and case reserves. Insurance companies are required to set aside a
portion of the premiums they receive from their underwriting activities to pay for
claims that may be filed in the future. The amount of claims forecasted, along with the
amount of claims that are actually paid, determine how much profit the insurer will
publish in its financial documents.

Run-off triangles (or delay triangles) are two-dimensional matrices that are generated
by accumulating claim data over a period. The claim data is run through a stochastic
process to create the run-off matrices after allowing for many degrees of freedom.

Key Assumptions

At its core, the chain ladder method operates under the assumption that patterns
in claims activities in the past will continue to be seen in the future. In order for this
assumption to hold, data from past loss experiences must be accurate. Several factors
can impact accuracy, including changes to the product offerings, regulatory and legal
changes, periods of high severity claims, and changes in the claims settlement process.
If the assumptions built into the model differ from observed claims, insurers may have
to make adjustments to the model.

Creating estimations can be difficult because random fluctuations in claims data

and a small data set can result in forecasting errors. To smooth over these problems,
insurers combine both company claims data with data from the industry in general.

Steps for Applying Chain Ladder Method

Estimating Unpaid Claims Using Basic Techniques, the seven steps to applying the
chain-ladder method are:

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 - Compile claims data in a development triangle
- Calculate age-to-age factors
- Calculate averages of the age-to-age factors
- Select claim development factors
- Select tail factor
- Calculate cumulative claim development factors
- Project ultimate claims

Age-to-age factors, also called loss development factors (LDFs) or link ratios,
represent the ratio of loss amounts from one valuation date to another, and they are
intended to capture growth patterns of losses over time. These factors are used to
project where ultimate amount of losses will settle.

Loss Reserves and Loans

Lending institutions also use loss reserves to manage their books, and when
applied to the banking industry, are known as loan loss provisions, which operate in
the same fashion that loss reserves do for an insurance company.

For example, consider Bank ABC that has made loans in the amount of
$10,000,000 to various companies and individuals. Though Bank ABC works very
hard to qualify the people to whom it grants loans, some will inevitably default or fall
behind, and some loans will have to be renegotiated.

Bank ABC understands these realities and, thus, estimates that 2% of its loans,
or $200,000, will probably never be paid back. This $200,000 estimate is Bank
ABC's loan loss reserve, and it records this reserve as a negative number on
the asset portion of its balance sheet.

Loss Ratio vs. Combined

The loss ratio and combined ratio are used to measure the profitability of an
insurance company. The loss ratio measures the total incurred losses in relation to the

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total collected insurance premiums, while the combined ratio measures the incurred
losses and expenses in relation to the total collected premiums.

KEY TAKEAWAYS

 The loss ratio and combined ratio are used to measure the profitability of an
insurance company.
 The loss ratio measures the total incurred losses in relation to the total
collected insurance premiums.
 The combined ratio measures the incurred losses as well as expenses in
relation to the total collected premiums.

Loss Ratio

The loss ratio is calculated by dividing the total incurred losses by the total
collected insurance premiums. The lower the ratio, the more profitable the insurance
company, and vice versa. If the loss ratio is above 1, or 100%, the insurance company
is unprofitable and maybe in poor financial health because it is paying out more
in claims than it is receiving in premiums. For example, say the incurred losses, or
paid-out claims, of insurance company ABC are $5 million and the collected
premiums are $3 million. The loss ratio is 1.67, or 167%; therefore, the company is in
poor financial health and unprofitable because it is paying more in claims than it
receives in revenues.

Enterprises that have a commercial property and liability policies are expected
to maintain loss ratios above a certain level. Otherwise, they may face premium
increases and cancellations from their insurer. For example, take a small dealer of used
commercial equipment, who pays $20,000 in annual premiums to ensure their
inventory. A hailstorm causes $25,000 in damages, for which the business owner
submits a claim. The insured's one-year loss ratio becomes $25,000 / $20,000, or
125%.

In order to ascertain what kind of premium increase is warranted, carriers may

review claims history and loss ratios for the past five years. If the insured has a very
brief tenure with the insurer, the company may decide that the commercial equipment

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dealer presents an unacceptable future risk. At that juncture, the carrier may choose
not to renew the policy.

Combined Ratio

A combined ratio measures the money flowing out of an insurance company in

the form of dividends, expenses, and losses. Losses indicate the insurer's discipline in
underwriting policies.

The combined ratio is usually expressed as a percentage. A ratio below

100% indicates that the company is making underwriting profit, while a ratio above
100% means that it is paying out more money in claims that it is receiving from
premiums. Even if the combined ratio is above 100%, a company can potentially still
be profitable because the ratio does not include investment income.

The combined ratio is calculated by summing the incurred losses and expenses
and dividing the sum by the total earned premiums.

For example, suppose insurance company XYZ pays out $7 million in claims,
has $5 million in expenses, and its total revenue from collected premiums is $60
million. The combined ratio of company XYZ is 0.20, or 20%. Therefore, the
company is considered profitable and in good financial health.

Special Considerations

The two ratios are different because the combined ratio takes expenses into
account, unlike the loss ratio. Thus, the two ratios should not be compared to each
other when evaluating the profitability of an insurance company.

Balance Sheet Reserves

What Are Balance Sheet Reserves?

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 Balance sheet reserves, also known as claims reserves, are accounting entries
that show money set aside to pay future obligations. Balance sheet reserves appear
as liabilities on a company's balance sheet, one of the three main financial statements.
Balance sheet reserves are particularly relevant in the insurance industry because
companies must have sufficient funds to pay any claims filed by clients. There are set
standards for setting up balance sheet reserves depending on the state where the
company is based.

KEY TAKEAWAYS:

 Balance sheet reserves are liabilities that appear on the balance sheet.

 The reserves are funds set aside to pay future obligations.

 The balance sheet reserves of insurance companies are regulated so that these
companies have sufficient reserves to pay client claims.

 Insurance companies will often set up balance sheet reserves that equal the
value of claims filed but not yet paid.

Understanding Balance Sheet Reserves

Balance sheet reserves are entered as liabilities on the balance sheet and
represent funds that are set aside to pay future obligations. For insurance companies,
balance sheet reserves represent the amount of money insurance companies set aside
for future insurance claims or claims that have been filed but not yet reported to the
insurance company or settled. The levels of balance sheet reserves to be maintained
are regulated by law. Balance sheet reserves are also known as claim reserves.

Balance sheet reserves are required of insurance companies by law to guarantee

that an insurance company can pay any claims, losses, or benefits promised to
claimants.

Types of Insurance Reserves

Property and casualty (P&C) insurers carry three types of reserves:

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  Unearned premium reserves, the balance of the premium that has not yet been
"earned" during the policy period.

 Loss and loss adjustment reserves or obligations that have been incurred from
claims filed or soon to be filed;

 Incurred but not reported (IBNR) reserves, which are set aside for hard-to-
estimate claims such as workers' compensation and product liabilities.

Example of Balance Sheet Reserves

As an example of balance sheet reserves for a company not in the insurance

company, Company XYZ must recall one of its products and issue refunds to
customers. Customer refund claims are expected to come in at a steady rate for the
next six months. To cover the refunds, the company sets aside a balance sheet reserve
of $15,000. As the customers requests arrive and the amounts are refunded, Company
XYZ reduces the $15,000 reserve on the balance sheet accordingly.

Insurance companies will often set up balance sheet reserves that equal the
value of the claims that have been filed but have not yet been distributed.

Balance Sheet Reserves and Profitability

The reserving policy of an insurer can significantly impact its profits. Over-
reserving can result in an opportunity cost to the insurer as it there are less funds
available for investments. Conversely, under-reserving can boost profitability as more
funds are freed up to invest. Regulators, however, closely watch the reserving policies
of insurance companies to make sure adequate reserves are set aside on the balance
sheet.

Conditional Reserves

What are Conditional Reserves?

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 Conditional reserves are held by insurance companies to meet obligations in
short order and are an important measure of a company’s ability to cover expenses.

Breaking Down Conditional Reserves

Conditional reserves can be thought of as a rainy-day fund for insurance

companies to help cover unanticipated expenses during times of financial stress.
Insurers must be prepared to meet their obligations at all times and if an insurance
company is unprepared by not having enough money set aside with acceptable
liquidity, it may result in them becoming insolvent. To guard against this possibility,
state insurance commissioners and insurance guarantee associations require insurance
companies to maintain certain levels of reserves, which cannot be used like a regular
asset, and furthermore to list conditional reserves separately in their financial reports.

Conditional reserves are listed separately on financial reports to reinforce the

need for liquidity, as insurance companies may need to use the reserves to meet
unanticipated future obligations. They are set aside and not used in investments with
long durations or greater risk because their existence is an indicator the insurance
company is less likely to become impaired or insolvent. Examples of conditional
reserves include surpluses from unauthorized reinsurance, undeclared dividends to
policyholders and other reserves established voluntarily and in compliance with
statutory regulations.

Regulators rely on many financial ratios to determine how well an insurance

company is protected against the possibility of a rapid increase in claims. Conditional
reserves are subtracted from total liabilities and compared to any policy surpluses as
one example of a common ratio. Any company relied too much on its reserves as
calculated by this ratio may be looked at more closely. A liquidity test compares a
company’s cash and securities to its net liabilities.

Analysts review changes to a company’s conditional reserves over time,

especially in relation to the liabilities associated with the current roster of policies and
their associated risks..

Loss Portfolio Transfer (LPT)

What Is a Loss Portfolio Transfer (LPT)?

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 A loss portfolio transfer (LPT) is a reinsurance contract or agreement in which
an insurer cedes policies, often ones that have already incurred losses, to a reinsurer. In
a loss portfolio transfer, a reinsurer assumes and accepts an insurer’s existing open and
future claim liabilities through the transfer of the insurer’s loss reserves. It is a type of
alternative risk financing.

KEY TAKEAWAYS

 A loss portfolio transfer (LPT) is a reinsurance treaty in which an insurer

cedes policies and the loss reserves to pay them to a reinsurer.

 LPTs allow insurers to remove liabilities from their balance sheets, thus
strengthening them, and to transfer risk.

 Reinsurers gain the chance to generate investment income from the transferred
reserves, often at a significant profit.

Understanding a Loss Portfolio Transfer (LPT)

Insurers use loss portfolio transfers to remove liabilities from their balance
sheets, with the most common reasons being to transfer risk from a parent to a captive
or to exit a line of business. The liabilities may already exist (such as claims that have
been processed but not yet paid) or may soon appear (such as incurred but not reported
(IBNR) claims).

The insurer, who is also known as the cedent, effectively is selling the policies
to the reinsurer. In determining the amount paid by the reinsurer, the time value of
money is considered, and so the insurer receives less than the dollar amount than of the
reserves—and the overall ultimate amount that could be paid out.

However, when an insurer uses a loss portfolio transfer, it is also

transferring timing risk and investment risk. The latter involves the risk that the
reinsurer will generate less investment income when losses from claims are paid faster
than expected. If the reinsurer becomes insolvent or is unable to fulfill its obligations,
the insurer will still be responsible for payments made to its policyholders.

LPT reinsurers will often take control of handing claims because the profit they
can make will largely be dictated by their ability to runoff claims for less than book
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value. If an LPT reinsurer is willing to assume loss reserve assets for less than book
value, it enables the ceding entity to realize an immediate profit at the inception of
cover. This means that by entering into an LPT, the ceding company has some
possibility of increasing its capital resources as well as reducing its regulatory capital
requirement.

The transferred liabilities in an LPT may belong to a single class of business, a

territory, a policyholder, or an accident year.

Example of a Loss Portfolio Transfer (LPT)

For example, say that an insurance company has set aside reserves to cover
liabilities from the workers’ compensation policies that it has underwritten.
The present value of those reserves is $5 million. Currently, the $5 million is likely to
cover all of the losses it may experience, but the insurer may ultimately have claims in
excess of the reserves. So it enters into a loss portfolio transfer with a reinsurer, who
takes over the reserves. The reinsurer is now responsible for paying claims. But it can
use the reserves to generate a return greater than the claims it may have to pay.

Why Insurers Use Loss Portfolio Transfers (LPT)

Insurers use loss portfolio transfers to immediately monetize any reserves that
they have set aside to pay out claims. This can be a significant draw if the insurer has
over-reserved, which can happen if its actuarial models have led it to establish
premiums and reserves for future losses that wind up being greater than its loss
experience.

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