School of Economics

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• School of Economics
• Peking University
• Fall 2003

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• ???? life
• ???? health
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Overview of types of life insurance

• Three classes
• Term life insurance
• Endowment insurance
• Whole life insurance

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Term Insurance

• 1. Definition
• 2. Three features
• 3. Types

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1. Definition

• Term Insurance Polices that promise to pay
  benefits only if the insured dies during the
  policy term.
• Nothing is paid in case of survival.
• Term policies may be issued for as short a period
  as one year but customarily provide protection
  for at least a set number of years, such as 5, 10
  or 20, or to a stipulated age, such as 65 or 70.

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1. Definition (cont.)

• Two questions
• Q Whose premium rates are lower, term life or
  whole life?
• Q Which market is more price competitive, term
  market or market for cash-value policies?

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2. Three features

• Three features applicable to many term life
  policies deserve special attention before
  discussing specific term products.
• Renewability
• Convertibility
• Reentry

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2.1 Renewability

• Many term policies contain a renewal option.
• This renewal option allows the policyowner, at
  the expiration of each term period, to continue
  the policy without reference to the insureds
  insurability status at renewal time.
• Usually companies limit the age (65 or 70) to
  which such term policies may be renewed.

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2.1 Renewability (cont.1)

• The premium increases with each renewal.
• A scale of guaranteed future premium rates is
  contained in the contract.

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2.1 Renewability (cont.2)

• Renewable term policies can be viewed as
  increasing-premium, level-benefit term life
  insurance.
• The renewal option is in effect a call as
  understood in finance.

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2.2 Convertibility

• Most term insurance policies include a
  convertible feature.
• This feature permits the policyowner to exchange
  the term policy for a cash-value insurance
  contract, without evidence of insurability.
• Q Is it a call option?

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2.2 Convertibility (cont.1)

• The conversion privilege increases the
  flexibility of term life insurance.
• Could you give an example that shows a
  policyowner can benefit from this privilege?
• As with any call option, its value stems from the
  holders (policyowners) ability to exercise the
  option on conditions most favorable to him or
  her.
• Q Who will most likely exercise the option?

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2.2 Convertibility (cont.2)

• Conversion may be permitted on an attained age or
  original age basis.
• Attained-age conversion the insurer determines
  the premium by the insureds age at the time of
  conversion.
• Original-age conversion the insured is required
  to pay a conversion premium equal to the
  difference between the premiums paid on the term
  policy and what would have been paid if the
  permanent policy had been begun initially.

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2.3 Reentry

• Many insurers include a reentry feature in their
  term policies.
• It allows the possibility of paying a lower
  premium than otherwise if insureds can
  demonstrate that they meet certain continuing
  insurability criteria.
• To understand the mechanics of reentry term, we
  must first understand the three types of
  mortality tables used by insurers.

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2.3 Reentry (cont.1)

• Three types of mortality tables
• Select mortality table
• Ultimate mortality table
• Aggregate mortality table

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2.3 Reentry (cont.2)

• A select mortality table reflects the mortality
  experience of newly insured lives only.
• An ultimate mortality table reflects the
  mortality experience beyond the select years
  (i.e., of those who already have been insured for
  several years).
• An aggregate mortality table includes data from
  both select and ultimate experience.
• Q Which one exhibits higher mortality? Which one
  lower? Which one falls between?

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2.3 Reentry (cont.3)

• Traditional term premiums often are based on
  aggregate mortality experience.
• Reentry term premiums are based on a
  select/ultimate mortality split.
• This results in a scale of premium rates that
  varies not only by age but also by the duration
  since the insured last demonstrated insurability.

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2.3 Reentry (cont.4)

• See Figure 4-1.
• It illustrates how an insurer might price a term
  policy with a reentry feature.
• The insurer uses a five-year select period.

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2.3 Reentry (cont.5)

• Figure 4-1 a Ultimate Mortality Curve
• Figure 4-1 b Ultimate and Five-Year Select
  Mortality Curves
• Figure 4-1 c Ultimate and Five-Year Select (2)
  Mortality Curves
• Figure 4-1 d Ultimate and Five-Year Select (5)
  Mortality Curves

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2.3 Reentry (cont.6)

• The insurer could be charging six otherwise
  identically situated insureds a different premium
  for the same coverage under the same policy form.
• Such policies are referred to as reentry term
  because the insured may be able to reenter the
  select group periodically if the insured
  resubmits to the insurer evidence of satisfactory
  insurability at that time.
• For those who fail to qualify for reentry,
  ultimate rates are charged thereafter.

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2.3 Reentry (cont.7)

• These ultimate premiums are considerably higher
  than the select premiums, and higher than
  traditional aggregate term rates as well.
• Q Which do you prefer, traditional term or
  reentry term?
• Q Why there emerges reentry term life insurance?

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3. Types

• Types of Term Life Insurance
• 3.1 Level Face Amount
• 3.1.1 Increasing Premium
• 3.1.2 Level Premium
• 3.2 Non-Level Face Amount

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3.1.1 Increasing Premium Policies

• Types
• YRT (yearly renewable term) or ART (annual
  renewable term)
• Five-year renewable term
• Renewable term policies of other durations, such
  as 3, 6 and 10 years.

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3.1.1 Increasing Premium Policies (cont.1)

• Intense price competition
• The trend in YRT design
• Lower premium
• A greater number of rate bands (e.g., different
  rates at 100,000, 250,000, 500,000, and 1
  million amount bands)
• Differentiated pricing categories

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3.1.1 Increasing Premium Policies (cont.2)

• Differential pricing can be accomplished
• Use separate smoker/nonsmoker rates (Table 4-1)
• utilize a reentry feature to differentiate
  pricing (Table 4-2)

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3.1.1 Increasing Premium Policies (cont.3)

• Common minimum issue age for YRT range from 15 to
  20 years old, with common maximum issue ages of
  from 60 to 70.
• Some YRT contracts are now renewable to age 95 or
  100 and convertible to age 65 or 70.

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3.1.2 Level Premium Policies

• Written for a set number of years
• 10-year (level-premium, nonrewable) term
• 20-year (level-premium, nonrewable) term
• To cover the typical working lifetime
• Life-expectancy term
• Term-to-age 65 (or 70)
• Q Whats the pattern of cash value for level
  premium policies?

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3.2 Non-Level Face Amount

• 3.2.1 Decreasing term
• 3.2.2 Increasing term

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3.2.1 Decreasing term

• Mortgage protection term
• Payor benefit
• Family income policy

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Mortgage protection term

• Provide for face amount decreases that match the
  projected decreases in the principal amount owed
  under a mortgage loan.
• Q Could you illustrate for the face amount of a
  30-year mortgage protection policy (1,000
  initially)?

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Payor benefit

• Usually a rider to a policy insuring the life of
  a juvenile
• Provides a death (and typically a waiver of
  premium) benefit on the life of the premium payor
  (usually a parent)
• The death benefit is exactly sufficient to pay
  all premiums that would be due from the payors
  death until the insureds age 21.
• Q Why is the death benefit decreasing?

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Family income policy

• Is designed to appeal to young men and women
  whose family responsibilities call for monthly
  income to be paid to the surviving spouse until a
  certain age or for a set period of usually 10,15,
  or 20 years from the date of policy issuance.
• Is often sold to protect the family during the
  child-rearing years.
• Q Why is the death benefit decreasing?

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3.2.2 Increasing term

• Cost-of-living-adjustment
• Return-of-premium

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Cost-of-living-adjustment (COLA)

• Often as a rider to many policies.
• Provide for automatic increases in the policy
  death benefit in accordance with increases in
  inflation, as measured by a national
  cost-of-living index.
• Q Could you give an example of such index?

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Return-of-premium

• It is a feature or a rider.
• If the insured dies within a set number of years
  (e.g., 20 years) from the policy issue date, the
  death benefit will be augmented by an amount
  equal to the sum of all premiums paid to that
  point.
• Q Why is the death benefit increasing?

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Endowment Insurance (?Term Insurance ??)

• Nature
• Mathematical Concept
• Economic Concept

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Mathematical Concept

• The insurer makes two mutually exclusive promises
  under endowment insurance
• (1) to pay the face amount if the insured dies
  during the endowment period, or
• (2) to pay the face (or some other) amount if the
  insured survives to the end of the endowment
  period.
• Endowment Insurance Level Term Pure Endowment

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Economic Concept

• Endowment Insurance Decreasing Term
  Increasing Savings
• Decreasing term, when added to the savings
  accumulation, equals the policys face amount.
• The savings part is available to the policyowner
  through surrender of the policy.
• Q Whats the pattern of cash value for endowment
  policies?

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