Risk Management and Insurance

CHAPTER FIVE:

5. LIFE AND HEALTH INSURANCE

Life Insurance

A human life has economic value to all whom depend on the earning capacity of that life, particularly to
two control economic groups- the family and the employer. To the family, the economic value of a
human life a probably most easily measured by the value of the earning capacity of each of its members.
To the employer, the economic value of human life is measured by the contribution of an employee to the
success of the business firm. If one argues that in a free competitive society a worker is paid according to
the worth and is not exploited, the worker’s contribution again is best measure by earning capacity. It
develops the earning capacity probably the only feasible method of giving measurable economic value to
human life.

There are four main perils that can destroy wholly or partially, the economic value of a human life. These
include “premature death, loss of health, old age and unemployment”.

For many people, the risk management tool that is most appropriate for dealing with the exposure of
premature death is “Life Insurance”. Every persons faces two basic contingencies concerning life; he
may die too soon, or he may live too long, to suit himself, it means that he may outlive his financial
usefulness or his ability to provide for his needs. The first category is physical death. The second is
economic death. A man, who is forced to retire at 60 from his job, unless he has substitute income, is
financially dead. Economic death may also occur at early ages if the person becomes too disabled or ill to
work. Life insurance is designed to provide protection against these two distinct risks premature death
and superannuation. Thus, life insurance may be defined as a special and economic devise by which a
group of people may co-operate to ameliorate (make better) the loss resulting form the premature death
or living too long the members of the group.

Characteristics of Life Insurance:

A. The event insured against is an eventual certainty. No one lives forever or maintains his
economic value. Yet we do not violate the requirements of an insurable risk in the case of life
insurance for it’s is not the possibility of death itself that we insurance against, but rather untimely
death. The uncertainty surrounding the risk in life insurance is not whether the individual is going
to die, but when.

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B. Life insurance is not a contract of indemnity. In most lines of insurance, an attempt is made to
put of individual back in exactly the same financial position after a loss as before the loss. For
obvious reasons, this is not possible in life insurance the simple fact of the matter is that we cannot
place exact value on a human life.

C. Insurance as a legal principle, every contract of insurance must be supported by an insurable

interest, but in life insurance the requirement of insurable interest is applied somewhat differently
than in property and liability insurance. When the individual taking out the policy is also the
insured, there is not legal problem concerning insurable interest. The important question of
insurable interest arises when the person taking out the insurance is someone other than the person
whose life is concerned. In such cases, the law required than an insurable interest exists at the
time the contract is taken out. There are many relationships, as stated earlier, than provide the
basis for an insurable interest.

D. Life contract are long-term contracts. Nearly all life policies are intended to continue until the
insured’s death or at least for several years. Other forms of insurance policies may be renewed
many times, but are usually twelve-month contracts, which may be terminated by either party.

E. Finally, the question of over insurance is immaterial in life insurance contracts.

Types of Life Insurance Contracts

From a generic viewpoint, life insurance policies can be classified as either Term insurance or cash-
value life insurance. Term insurance provides temporary protection, while cash-value life insurance has
a savings component and builds cash values. Numerous variation and combinations, of these two types of
life insurance are available today.

TERM INSURANCE:

It provided protection only for a definite period (term) of time. A term insurance policy is contract
between the insured and the insurer where by the insurer promises to pay face amount of the policy to a
third party (the beneficiary) should the insured die within a given period of time. If the insured does not
die during the period for which the policy was taken, the insurance company is not required to pay
anything. Protection ends when the term of years expires. In other words, term life insurance look like
automobile insurance, fire insurance, and the like, which are always term insurance. Term insurance is

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sometimes called temporary insurance. Common types of term life insurance are 1 year term, 5 year term,
10 years term, 20 years term, and term to age 60 to 65.

Types of Term Insurance:

A wide variety of term insurance products are sold today. They include the following:

Yearly renewable term

5-,10-,15- or 20 year term
Term to Age 65
Decreasing term
Reentry term

Yearly renewable term: Yearly renewable term insurance is issued for a one-year period, and the
policy owner can renew for successive one year periods to some stated age without evidence of
insurability. Premiums increase with age at each renewal date. Most yearly renewable term policies also
allow the policy owner to convert to a cash-value policy.

5-, 10-, 15- or 20 year term: Term insurance can also be issued to 5, 10, 15, or 20 years, or for longer
periods. The premiums paid during the term period are level, but they increase when the policy is
renewed.

Term to Age 65: A term to age 65 policy provides protection to age 65, at which time the policy
expires. The policy can be converted to a permanent plan of insurance, but the decision to convert must
be exercised before age 65. For example, the insurer may require conversion to a permanent policy
before age 60. Because premiums are level, the policy develops a small reserve that is used up by the end
of the period.

Decreasing term insurance: Decreasing term insurance is form of term insurance where the face amount
gradually declines each year. Although the face amount declines over time, the premium is level (same)
throughout the period. In some policies, the premiums are structure so that the policy is fully paid for a
few years before the coverage expires. For example, a 20 year decreasing term policy may require
premium payments for 17 years. This method avoids paying a relatively large premium for only a small
amount of insurance near the end of the term period. Finally, decreasing term insurance can be written as
a separate policy, or it can be added as a rider to an existing contract.

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Reentry term insurance: Reentry term also called revertible term is another important term insurance
product. Under a reentry term policy, renewal premiums are based on select mortality (death) rates if the
insured can periodically demonstrate acceptable evidence of insurability.

Uses of Term Insurance:

 If the amount of income that can be spent on life insurance is limited, term insurance can be
effectively used.
 Term insurance is appropriate if the need for protection is temporary.
 Term insurance can be used to guarantee future insurability.

Limitation of Term Insurance:

 Term insurance premiums increase with age and eventually reach prohibitive levels.

 Term insurance is inappropriate if you wish to save money for a specific need.

WHOLE LIFE INSURANCE: In contrast to term insurance, which provides short term protection,
whole life insurance is a cash-value policy that provides lifetime protection. Form a historical or
traditional perspective; the following two types of whole life insurance:

 Ordinary Life Insurance

 Limited – Payment Life Insurance

Ordinary Life Insurance: Ordinary life insurance also called straight life and continuous premium whole
life provides lifetime protection to age 100, and the death claim is a certainty. If the insured is still alive
age 100, the face amount of insurance is paid to the policy owner at that time. In addition, premiums do
not increase from year to year but remain level thought the premium paying period. Under an ordinary
life policy, the policy owner is overcharged for the insurance protection during the early years and
undercharged during the later years when premiums are inadequate to pay death claims. Ordinary life
insurance also has an investment or saving element called a cash surrender value. The cash values are due
to the overpayment of insurance premiums during the early years.

Limited Payment Life Insurance: A limited payment policy is another type of traditional whole life
insurance. The insurance is permanent, and the insured has lifetime protection. The premiums are level,
but they are paid only for a certain period. For example Girma, age 35 may purchase a 20 year limited
payment policy in the amount of 25,000 Birr. After 20 years, the policy is completely paid, up, and no
additional premiums are required even though the coverage remains in force. A paid up policy should not

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be confused with one that matures. A policy matures when the face amount is paid as a death claim or as
an endowment. A policy is paid up when no additional premium payments are required. The most
common limited-payment policies are for 10, 20, 25 or 30 years. A policy can paid up at age 65 or 70 is
another form of limited payment insurance. An extreme form of limited payment life insurance is single
premium whole life insurance, which provides lifetime protection with a single premium. Because the
premiums under a limited payment policy are higher than those paid under an ordinary life policy, the
cash values re also higher.

ENDOWMENT INSURNCE:

Endowment insurance is another traditional form of life insurance. An endowment policy pays the face
amount of insurance if the insured dies within a specified period; if the insured survives to the end of the
endowment period, the face amount is paid to the policy owner at that time. For example, if Stephanie,
age 35, purchased a 20-year endowment policy and dies any time within the 20-year period, the face
amount would be paid to her beneficiary. If she survives to the end of the period, the face amount paid to
her.

VARIATIONS OF WHOLE LIFE INSURANCE

Some important variations of whole life insurance include the following:

Variable Life Insurance: Variable life insurance is fixed premium policy in which the death benefit
and cash surrender value vary according to the investment experience of a separate account maintained by
the insurer. The entire reserve is held in a separate account and is invested in equities or other
investments. The cash surrender values are not guaranteed.

Universal Life Insurance: Universal life insurance is another variation of whole life insurance.
Theoretically, universal life can be viewed as a flexible premium policy that provides life time protection
under a contract that separates the protection and saving components. Universal life insurance has
following features:

 Unbundling of protection, savings, and expense components

 Two forms of universal life insurance
 Pays a level death benefit during the early policy years.
 Provides for an increasing death benefit.
 Considerable flexibility.

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 Cash withdrawals permitted.

 Favorable income tax treatment.

Variable Universal Life Insurance: This is similar to universal life insurance with two major exceptions.
First, the cash values can be invested in a wide variety of investments. Second, there is no minimum
guaranteed interest rate, and the investment risk falls entirely on the policy owners.

Current Assumption Whole Life Insurance: Current assumption whole life insurance is a
nonparticipating whole life policy in which the cash value is based on the insurer’s current mortality,
investment, and expense experience. An accumulation account is credited with a current interest rate that
changes over time.

An Indeterminate Premium Whole Life Policy: This is a policy that permits the insurer to adjust
premiums based on anticipated future experience. The initial premiums are guaranteed for a certain time
period and can then be increased up to some maximum limit.

Modified Life Policy: Modified life policies are whole life policy in which premiums are lower for
the first three to five years and are higher thereafter.

ANNUNITIES:

An annuity maybe defined as a periodic payment to commence at a stated data and to continue for a fixed
period or for the duration of a life. The person whose life governs the duration of payments is called the
annuitant. Annuity is insurance against living too long-against outliving one ability to provide an income
for oneself.

Annuities can be classified according to several characteristics. First, annuities can be classified as
immediate or deferred, depending upon whether the benefits are payable immediately after the purchase
of the contact. The rent of annuity can be gin as soon as the annuity is purchased, in which case the
transaction is called an immediate annuity. Alternately, the rent can be beginning at some future time in
which case the annuity is called a deferred annuity. Often the rent begins at retirement.

Second, annuities may be paid for by a single premium or by annual premiums. An annuity ca be wholly
paid up on a lump sum payment or it can be wholly paid up in lump sum payment or it can be purchased
in installments over a period of years. If the annuity is paid up at once, it is called a single-premium
annuity. If it is paid for in installments, it is known as an annual premium annuity.

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Third, annuities may cover one life or joint lives. If two or more lives are covered, the payments may
stop at the death of the first annuitant or at the death of the last annuitant. An annuity may be issued one
more than one life. For example, the agreement might be to pay a given rent during the lifetime
individuals, as long as either shall live.

This is a very common arrangement, is known as a joint and last survivorship annuity, because the rent is
payable until the last survivor dies. The rent may be constant during the entire period or may be arranged
to be reduced by, say one third upon the death of the first annuitant. Thus, a husband and wife both ages
65 may elect to receive the proceeds of the pension of a pension plan on a joint and last survivor basis,
with an income guaranteed as long as either shall live.

LIFE INSURANCE PREMIUMS:

There are three primary elements in life insurance rate making:

 Mortality Charge.
 Interest Charge.
 Loading Charge.

Mortality: The morality table is simply a convenient method of expressing the probabilities of living
or dying at any given age. It is a tabular expression of the chance of losing the economic value of human
life. Since the insurance company assumes the risk of the individual, and since this risk is based on life
contingencies, it is important that the company know within reasonable limits how many people will dies
at each age. One the basis of past experience actuaries are able to predict the number of deaths among a
given number of people at some given age.

Interest: Since the insurance company collects the premium in advance and does not pay claims
until the future date, it has the use of the insured’s money for some time, and it must be prepare to pay
interest on it. The life insurance companies collect vast sums of money, and since their obligations will
not mature until some time in the future, they invest this money and earn interest on it.

Loading Charge: When a life insurance policy is sold, the insurer incurs relatively high first-year
acquisition expenses because of commissions, sales, and administrative expenses. Thus, the premium
charges must include a loading for expenses.

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Net Single Premium: The net single premium is the amount that the insurer must collect in advance to
meet all the claims arising during the policy period.

Net Level Premium: It would be impractical at attempt to collect a net single premium from each member
of an insured group. Few people would have the necessary funds for an advance payment of all future
obligations. Therefore, actuaries must calculate an annual premium.

Gross Premium: Gross premium is the pure premium plus loading for he necessary expenses of the
insurer. The net level premium for life insurance represents the pure premium that is unadjusted for the
expenses of ding business. The pure premi8m is actually the contribution that each insured makes to the
aggregate insurance fund each year for the payment of both death and living benefits.

Health Insurance

Health insurance may be defined broadly as the type of insurance that provides indemnification for
expenditure and loss of income resulting from loss health. Health insurance is insurance against loss by
sickness or bodily injury. The loss may be the loss wages caused by sickness or accident, or it may be
expenses for doctor bills, hospital bills medicine etc.,

Types of Health Insurance:

There are two types of insurance in the generic term health insurance:

1. Disability Income Insurance and

2. Medical Expense Insurance

Disability Income Insurance:

Disability income insurance is form of health insurance that provides periodic payment when the insured
is unable to work as a result of illness or injury. It may pay benefits only in the event of sickness or only
in the event of accidental bodily injury or it may cover both contingencies in one contract. Benefit
eligibility presumes a loss of income, but in practice this is usually defined as the inability to pursue an
occupation. The fact that the insured’s employer may continue his or her wages does not reduce the
insurance benefit.

The disability must be one that prevents the insured from carrying on the usual occupation. Most policies
continue payment of the benefits for only a specified maximum number of years, but lifetime benefits are

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available on some contracts. However, under all loss of income policies, the benefits are terminated as
soon as the disability ends.

Certain types of accidents are excluded, for example, losses caused by war, suicide and intentionally
inflicted injuries, and injuries while in military service during wartime.

Medical Expense Insurance:

Medical expense insurance provides for the payment of the cost of medical care that results from sickness
and injury. Its benefits help meet the expenses of physicians, hospital nursing the related services, as well
as medications and supplies. Benefits may be in the form of reimbursement of actual expenses, up to a
limit, cash payments or the direct provision of services. The medical expense may be paid directly to the
provider of the services or the insured.

Medical expense insurance is divided into four major classes:

1) Hospitalization Expense Contract

2) Surgical Expense Contract

3) Regular medical Expense Contract

4) Major medical Expense Contract

Hospitalization Expense Contract: The hospitalization contract is intended to indemnify the insured for
necessary hospitalization expense, including room and board in the hospital, laboratory fees, nursing care,
use of operating room, and certain medicines and supplies.

Hospitalization expense is usually written for a flat daily amount for a specified number of days such 30,
120, or 365. The contract provides that costs up to the maximum benefit per day (say 50 birr, 60 birr, 70
birr etc.,) will be paid for the number of day specified, while the insured or an eligible dependent is in the
hospital.

The agreement may set birr allowance for the different items or may be on a service basis. Typical
contracts offered by insurance companies, for example may state that he insured will be indemnified up to
X birr per day for necessary hospitalization.

Exclusions under hospitalization contracts:

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Like all insurance policies, hospitalization contracts offered by insures are subject to exclusions. The
following exclusions are typical of hospitalization contracts:

 Expenses resulting from war or any act of war.

 Expenses resulting from self-inflicted injuries.
 Expenses payable under worker’s compensation or any occupational disease law.
 Expenses incurred while on active duty with the armed forces.
 Expenses incurred form purely cosmetic purposes.
 Expenses incurred by individuals on an outpatient basis.
 Services received in any government hospital not making a charge for such services.

Surgical Contracts:

The surgical contract provides allowances for different surgical procedures performed by duly licensed
physicians. In general, a schedule of operations is set forth together with the maximum allowance for
each operation. It reimburses the policyholder according to a schedule that lists the amounts the policy
will pay for a variety of operations.

Regular Medical Contract: The regular medical expense insurance pays part or all of physicians’
ordinary bills, such as his called at the patient’s home or at a hospital or a patient’s visit to his office. It is
contract of health insurance that covers physicians’ services other than surgical procedures. Normally,
regular medical insurance is written in conjunction with other types of health insurance and is not written
as a separate contract.

Major Medical Contract: The major medical expense insurance provides protection against the very
large const of serious or long illness or injury. The major medical policy is mot appropriate for the large
medical expenses that would be financially unaffordable for the individual.

The contract is issued subject to substantial deductible of different sorts and with a high maximum limit.
Since this kind of policy is designed to cover only serious illness or accidents, a deduction is used to
eliminate small claims. A major medical policy might have 5,000 birr maximum limit for any one
accident or illness, have a 200 birr deductible for any one illness, and contain an agreement to indemnify
the insured for a specified percentage of bills, such as 80% over and above the amount of the birr
deductible. This means the insurance company pays 80% of the loss in excess of the deductible, and the
insured pays the 20%. In the absence of the coinsurance clause, there would be no incentive for the
insured or the doctor to keep expenses within reasonable limits.

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