A Guide To Life Insurance - Insurance And Investment - More ....


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What the founders of life insurance discovered, however, was that with a lot of mathematical calculation and a little guesswork, they could work out a premium rate which each of the 1,000 would agree to pay throughout their lives in return for the guarantee that all claims would be met when they fell due. (see http://www.forbes.com/fdc/welcome_mjx.shtml)

Here we show how it works. The annual premium is far higher than the payments required in the early years of the "pay-as-you-go" scheme, because a reserve is being accumulated in the early years which will cover the excess of claims over premiums in the later ones.

The fund is investing the surplus of the early years at interest to build up reserves which will meet future claim.

To devise such a system there are two principal calculations: the mortality rate and the interest rate.

The first determines how much is likely to be required each year to meet claims. The second is needed to work out how much the premium can be reduced to allow for the effect of accumulation of reserves at interest. In the early years of life insurance, neither calculation could be made as precisely as they can be today.

In fact, some early companies made substantial errors - the funds accumulated significant surpluses after meeting all the relevant claims, and various means had to be devised for returning this surplus to the policyholders.

It might appear difficult to work out what proportion of the surplus was attributable to any class of policyholder if the company was continually taking on new policyholders of different ages, but in fact the actuaries rapidly developed ways of relating the value of the company's assets to its "liabilities", the latter being the amounts due on death at dates which could be predicted from mortality tables.

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As much of the business taken on by companies was very long-term, they did not need to keep all the reserves in the bank. Investments in Government securities, property and shares were made, and these helped to increase the surplus achieved.
As the presence and predictability of the surplus was recognised, companies split their policies into two classes, those participating and those not participating in profits, with different rates of premium.
What the companies were saying, in effect,........ see: click here for Premium Rates Increasing?


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