Life Insurance Basics (Notes by Prof.

Sudip Bhattacharya)
1.1 Basic Concepts
Insurable interest : An insurable interest is necessary for the contract to be valid. It means a life or limb,
property, potential liability, or financial interest should be involved. The insured should suffer loss due to the
occurrence of the insured event. The loss should be pecuniary. Loss should be recognised by law e.g. Father has
no insurable interest in the event of death of the son, unless the he can prove a financial dependency on the son.
Indemnity : It is the concept of Exact financial compensation when a loss occurs. Implies that the insured is
placed in the same financial position before and after the event. However, loss due to death of a person is linked
to an extent to the income status and potential of the person. Because such a loss cannot be exactly
compensated, it is not an indemnity but only a guarantee of a benefit. Hence we use the term assurance for
life, whereas we use insurance for motor and other non-life risks.
Subrogation: On payment of claim, the insurer is entitled for any rights on the object of insurance that the
insured had before the claim.
Average (Underinsurance) Clause : If a property is insured for a value lesser than the current value, the claim
will also be settled at a proportionately reduced value. This average clause is not applicable to life insurance.
1.2 Difference between insurance and assurance.
Insurance
Subject of insurance is property / liability
Loss may / may not happen
Usually short term, renewable (higher premium /
refused further cover) e.g. Motor, Home Insurance
Indemnity
Risk cover only
No returns from policy

Assurance
Subject of assurance is life
Loss is bound to happen but time is uncertain
Usually long term annual premium fixed in advance
and normally not raised /lowered. e.g. Life Assurance
Guarantee
Risk cover which can be combined with savings
Maturity benefit (for most types)

2 Key business areas for life insurance companies

The 3 major areas of business for Life Assurance companies are Life Assurance, Pensions and Annuities.
LIFE ASSURANCE BUSINESS

LIFE ASSURANCE AND

MORTGAGE POLICIES

PENSION SCHEMES

TERM ASSURANCE

ANNUITIES

WHOLE LIFE ASSURANCE

PENSIONS

PERSONAL INVESTMENT
PRODUCTS

ENDOWMENT

Figure 1: Life Assurance business areas

Each of these types of assurance has different variants of products, which are listed below.

2.1 Traditional Life Assurance at a glance

Life Assurance Policies
Term Assurance

Level Term Assurance

Renewable Term Assurance
Convertible Term Assurance
Decreasing Term Assurance
Index linked Term Assurance

Whole Life Policies

Endowment Policies

Non Profit
Low Cost
With Profit
Single Premium UL
Regular Premium UL

Figure 2: Types of Life Assurance policies

2.2 Term Assurance
The features are
Life is assured for a fixed term (Sum Assured or SA is paid if death occurs within the term)
No benefit on survival
Premiums low compared to other types
In some contracts, however, premiums may be paid back with little or no interest, on survival.
Different variants of term assurance policies are available in the market.
a) Level: Life is assured for a fixed term, premium & SA remain the same throughout
b) Renewable: same as (a) but gives option to policyholder to renew for another term without any further
medical evidence. The rates for the renewed policy will be high, as it will be based on the age at renewal
c) Convertible: same as (a) but gives option to policyholder to convert into an endowment or whole life
policy without further evidence of health
d) Decreasing: SA decreases every year by a preset amount, decreasing to nil at the end of term. Suitable
to cover a reducing debt, e.g. capital outstanding / mortgage protection /house purchase loan
e) Expanding: SA is increased at a preset rate every year to avoid reduced real cover due to inflation
f) Index Linked: SA and premium are escalated in proportion to the rate of inflation by linking them to
the Retail Price Index (RPI), with a maximum limit on the increase (say 10%)
g) Family income policies: same as (a) but instead of a lump sum payment at death, an income is paid to
the beneficiary. The intention is to replace the income which the assured would have provided if he were
alive. These policies could also be of type expanding or index-linked
2.3 Whole Life assurance:
This type of policy is valid for life once taken out and not limited to any term and benefit is paid on death of the
life assured. Premiums tend to be higher as a payoff is a sure event and the cover extends over a long term till
death. Suitable as security for a loan, either from the life office or other lenders. Variants are
a) Non-profit: has a level premium payable throughout life and SA is fixed. No bonus is paid
b) With-profit: Here in addition to SA, all profits declared as bonuses (reversionary bonus) so far will be
paid on maturity or death. While reversionary bonus is added on a cautious assessment approach, the
insurer can also provide a terminal bonus as a reflection of fair return at the last opportunity
c) Low-cost: This is a with-profit policy with a guaranteed life cover. They are structured with SA in 2
parts, one basic and has bonus applied every year, and the other remains constant throughout the term,
this combines the with-profit and non-profit concepts

d) Single Premium Unit Linked: When the policy is effected, the premium is used to purchase units in the
chosen fund and thereafter the policy value is dependent on unit price
e) Regular premium Unit Linked: offer a variable mix between life cover and investment. The initial
cover is set for every few years based on the growth rate of the fund to which premiums are linked. They
are periodically reviewed when the SA is compared with value of units purchased and increased
2.4 Endowment assurance:
Most popular type of assurance in U.K, here the life is assured for a fixed term, but benefit is payable either on
earlier death or at the end of the term. This type is usually taken for long terms such as 20 or 30 years, often
keeping the maturity date closer to retirement date. This policy can be used as security in getting loans because
a return is assured. All variants of Whole life policies are also available for Endowment assurance policies.
2.5 Benefits from Life assurance policies
Whereas a Term policy only insures the risk of death within a fixed term, Whole Life policies and Endowment
policies can also serve as investment vehicles as they can be either non-profit wherein they pay back only a
guaranteed sum assured or they may be linked to the insurers performance and earn benefits. 2 ways to link a
policy to the investment performance are With-Profit policies and Unit-Linked policies, which are collec
tively known as Investment Linked policies
2.6 With profits policy:
Every year insurer evaluates the assets & liabilities of its life fund, to determine the surplus funds, of which a
part is allocated to with-profits policyholders as bonus, as an addition to the SA. The insurer cannot
subsequently reverse the bonus so declared. Premiums for With-profits policies are always higher than those for
corresponding non-profit contracts, as higher benefits are paid out. There are 3 types of bonuses :
a) Reversionary Bonus: declared annually and added to the SA under the policy. This bonus amount
accrues to the policy value and is normally payable only on maturity or claims against the policy
b) Terminal bonus: A lump-sum bonus added when policy matures or death claim is made. It is not
mandatory and the policy must have been in force for a certain number of years for eligibility.
c) Interim bonus: Bonus calculated for policies claimed / matured between 2 reversionary bonus
declarations. E.g. Bonus rates for a company is declared on 31 st December. Now if a policy is matured
on October the bonus for that policy for the period from 1 st January of the maturity year till the date of
maturity (in October) is calculated depending on the previous years data. This is called interim bonus. A
WP policy can still have a Guaranteed Minimum Sum, which is a minimum amount the insurer will
have to pay-out on event of a claim or maturity of the policy.
2.7 Unit Linked (UL) Policy:
Whereas in case of WP policies the insurer handles the investment, Unit Linked policies allow the policyholder
greater involvement in the investment since the value is directly linked to units in one or more unitized funds
run by the insurer. Policyholder chooses which funds he wants to purchase units in. Part of the premium is used
to purchase life & disability cover and remaining premium is used to buy units in the fund. Usually the insurer
operates a variety of funds and the policyholder has options to invest in any of them and also switch
periodically, i.e. to shift his investment from one fund to another. On claim or maturity, the value of the policy is
calculated based on the unit value on that date. The insurer usually levies charges for fund mgt. and fund
switching. The price at which insurer offers the units of a fund to a policyholder is the offer price, while the
price at which the insurer buys back the units is the bid price (which is always lower than the offer price).
Unlike the With profits policy where the bonus is attached irrevocably, here the profits will vary depending on
the Unit value on the date of claim or maturity.
The major differences between With Profit policies and Unit Linked policies are

With Profit Policies

No investment choice for the policyholder
Since investment done by the insurer
Regular slower growth of invested value
Since the growth in value is due to the accumulation of
bonus, cash value is low in early years
Not easy to get the value of the policy
Investment risk with the life assurance company

Unit Linked Policies

Investment choice open to policy holder
Growth irregular
Since value is linked to the value of the unitized
funds, cash value not dependant on age of the policy
Easy to value
Investment risk with the investor (policyholder).

Various flavors of whole life & endowment assurance policies are structured based on their investment linkage.
2.8 Pensions
A pension is an annuity contract where the money becomes payable on policyholders retirement. Almost half
the employees in employment are members of pension schemes, which are schemes to build up funds during the
working life, to provide benefits on retirement, death or disability. 2 broad categories of pensions are
Occupational (superannuation) Pensions and Personal Pensions.
2.9 Superannuation
A superannuation fund (SF) is money set aside by an employee during his working years to be taken out as
income after retirement from active work. In many cases the employer is also required to contribute towards an
employees fund. Under the Superannuation Guarantee (SG) law an employer is required to pay a minimum
level of the employees earnings to the SF. Employed people usually have access to a SF operated by the
employer (Company Fund). Then the employee becomes a member of the SF on start of employment and both
the employee and employer contribute towards the fund. On retirement the employee is paid a regular income
(pension) out of the SF accumulated. If the employee changes jobs, usually the employer will transfer the fund
to the new fund of the employee. This is called a rollover. It is necessary because this money should be
accessible only after retirement. And if the employee, in his new job, does not have access to a company fund,
this money will be held in an Approved Deposit Fund (ADF) or by the Govt of India Pension Dept.
Self-employed do not have access to company funds and they need to set up their own superannuation funds.
Such funds are known as personal SFs and are operated by insurers (they also operate ADFs)
Superannuation Funds (SFs) : The money held in SFs is usually invested productively and earnings accrue.
The ADFs and comprehensive superannuation plans usually provide the employee with a choice of unit trust
funds in which the money can be invested. The insurer manages these funds which have a stated objective of
investment and also a time period for achieving it. When the benefits become payable, the units are cashed and
used to purchase an immediate annuity. At this point of retirement, the employee will have an option to take part
of the accrued benefits as a lump sum (Commutation), subject to a maximum limit.
Superannuation Benefits : Benefits from a SF can be classified based upon when they can be cashed. Any
amount that can be cashed at any time by the employee is classified as Unrestricted Non-preserved fund.
Usually this is the employees own additional contributions to a SF. In certain cases part of the benefits become
payable when an employee switches jobs. This is called restricted Non-preserved fund and is usually the
additional contributions that an employer makes towards the employees fund. In this case the money can be
moved to an ADF. The part of a SF that does not come under the above 2 categories is classified as Preserved
fund and it can be taken only on reaching the retirement age. In extreme circumstances money can be paid out
earlier in case of death or disablement.
Accounting and Reporting for SFs : SFs are required to prepare reports for a variety of purposes
o Reporting to members, unit-holders and sponsors

At the end of every reporting period


At the members request

When members leave a fund

At transfer of lost members

o Reporting to relevant superannuation regulatory board for that country.
o Reporting to relevant tax authorities.
Reporting to ISC is in the form of an annual return, which is accompanied by a certificate from the auditor who
has carried out the statutory financial audit for the year. Any new regulated fund must provide certain basic fund
details within a week from fund establishment.
Superannuation Surcharge : When the employee pays premiums and these are tax deductible or paid by the
employer for a Superannuation policy the surcharge applies. E.g. in Australia, the surcharge can be up to 15%
and it applies when the sum of the taxable income and surchargeable contributions exceed $ 73, 220. This
policyholder pays the surcharge to the fund, which in turn pays it to the ATO.
2.10 Gratuity
Group gratuity scheme
Payment to employees upon cessation of service
Minimum period of service should be rendered to make payment
Enhanced death benefit
Evidence of age and certificate of insurability required
Nature of liability
Amount of gratuity depends on terminal salary and no of years of service completed by the employee
Appropriate funds called gratuity funds are set apart by forming trust in advance to take care of the liability
Gratuity funds reduces tax liability
Gratuity funds once set cannot be taken back by employer or his creditors
Cash accumulation system of funding
A minimum membership and initial fund is prescribed
No individual calculation of costs and benefits
Gratuity liability is fully met
Pace of accumulation is faster due to higher yield of the fund
Annual cost is determined after actuarial calculation, so liability is known in advance
Contribution
Initial contribution to secure gratuity for past service can be paid as one lump sum or in installments
For future service annual contributions should be paid
A tax deduction is given to employer for his contribution
Simple
Send employee's salary and service data once in a year
Particulars of new entrants should be intimated once in a month
2.11 Annuity
What is an annuity?
An annuity is a contract to pay a given amount every month/quarter or such frequency chosen by the annuitant,
while taking the policy. In this sense it is not a life assurance policy. The annuitant buys the annuity from the

insurer by paying a lump sum or regular premiums. Usually the annuity payments cease on the death of
annuitant. Annuities are usually expressed in terms of the annual amount payable. An annuity can be payable in
arrears or in advance. E.g., where are annuity is effected on 1 January 1999, if the first payment is made on the
same date it is called in advance, if it is paid on 1 January 2000 and if the frequency chosen is yearly, it is
called in arrears (which can be further classified as with proportion or without proportion depending on
whether a proportionate amount is paid on death for the period from last installment paid to date of death).
Annuity types : The different annuity contract types are as follows :
a) Immediate Annuity : provides, in return for a single premium, an annual payment starting immediately
and continuing for the rest of the annuitants life. An annuity payable for life is also called a life
annuity. People usually purchase these at the time of their retirement.
b) Deferred Annuity: provides annuity at some future date. For the period between the contract date and
deferred date, called the deferred period, regular premiums are usually payable. If the annuitant dies
during the deferred period the insurer will usually return the premiums paid, with or without interest.
Often a cash option will be available on the vesting date, in lieu of the annuity
c) Temporary annuity : Here the annuity is payable for a fixed period or for the annuitants lifetime,
whichever is shorter
d) Joint life or survivor annuities : Where the annuity is used as income after retirement by a married
couple, it would be helpful if the annuity is paid until either of them live. The joint life or survivor
annuities are used for such cases and annuities will be paid through the lifetime of both or till the death
of the last survivor
e) Annuity certain : In this type, the annuity is payable over a certain period agreed in advance. It does
not depend on survival or annuitant
f) Guaranteed annuity : The annuity is guaranteed to be payable over a fixed period of time say 5 or 10
years and continued thereafter throughout the life of the annuitant
g) Escalating annuity : In this type of annuity, the annuity installments payable are increased periodically
by an amount agreed at the outset. It is a simple form of protection against inflation
Difference between annuity and pension
Annuity
Annuity is a contract to pay a given amount every month
or quarter or such other frequency chosen by annuitant.
Annuity may start immediately or deferred.

Pension
Pension is an annuity contract where the money
becomes payable on policyholders retirement
Usually opted for post retirement income

3.0 Policy Life Cycle

A policy is a document, which is sent to the customer for formal agreement to the terms and conditions of that
product and to make sure that a person is legally bound by all the terms of the contract and enters into an
agreement to buy the product of the insurance provider.
3.1 Policy contents
a) Agreement : Gives the outline of coverage offered (Fire - states the perils insured Liability - states legal
actions for which the insured will be defended)
b) Exclusions : Exclusions are designed to protect the insurer against unprovable losses and against
catastrophic losses (flooding, war, invasion etc.)
c) Schedule / Declarations : What is covered, Who is insured, Period of policy, Policy limits, premium amount.
Declaration states all facts about the parties and the contract.
d) Conditions : Sets out the rights duties and responsibilities of both parties.
3.2 Policy life cycle
The Stages in the policy Life Cycle are :
1 New Business

2
3

Policy Management, Premium Accounting and reporting

Exits processing

3.2 New Business

As the name suggests, this is the initial stage of the policy life cycle where the relationship with the customer is
sought to be established. The life office attempts to sell the customer a policy and once the customer accepts, it
sets out the policy details. The following phases are a part of New Business stage of policy lifecycle
1 Quotation
2 Proposal Capture and validation.
3 Risk Assessment
4 Reinsurance Validation (if required)
5 Policy acceptance and data setup
6 NTU/Cancellation
Quotation
A quotation is a proposal sent out to the customer or the provider (an IFA) detailing the salient features of the
product and the benefits /charges in lieu of that. Once the provider or the customer thinks that a particular
product may satisfy a customers needs, then the
Life Company may send out further documents with details of an assumed investment and premium structure,
listing charges and expected benefits. This is the Key Features document.
Proposal Capture
Once the customer is ready to take up a particular product, the relevant details to set up his policy are to be
collected from him. This may include his personal and medical history and his income status. This may be in the
form of questionnaires to be answered by the customer, the IFA and the medical authorities and relevant
documentation to be provided or even via a telephonic interview. Here the principle of utmost good faith
applies, i.e. the facts given should be true to the best of the customers knowledge and that the insured should
inform the insurer of all changes.
Risk characteristics
Not all risks are insurable. To deserve insurance, a risk should have the following characteristics:
It must involve a loss that can be measured in monetary terms. Eg. Obsolescence is not insurable
There must exist a large number of similar risks. However, one-off risks may also be insured, but the
premium will be very high and prohibitive. Eg. Space vehicles
Insurance should not aim at profit making. It should be for security. Eg. A shop cannot insure to have
guaranteed profits
A loss must be entirely fortuitous or accidental. Eg. Loss should not be pre-mediated
Insurance must not be against public good. Eg. Penalties for traffic rules violation
The person insuring should be the person who will suffer if loss occurs.
Underwriting
This is a process performed by the insurer, on receipt of a proposal, to decide whether or not to accept the risk
and if so, on what terms. An underwriter is the person authorised to accept, reject or fix terms for accepting a
risk. The underwriter looks for factors adversely affecting the longevity of the life assured, such as health,
occupation, industry and life style.
The underwriter scrutinizes the facts given in the medical part of the proposal. He can also check in the
alphabetical name index maintained by the life office to find out whether the proposer has been offered an
under-average rate for an earlier policy or has been declined a policy previously. He will compare the sum
assured and age with the non-medical limit set by the life office, and also will examine whether the insurance
cover including earlier insurance is at a reasonable level and not too high.

Based on this the underwriter arrives at a decision on the risk. The various underwriting decisions are:
1 Accept normally (at ordinary rates proposed)
2 Charge an extra premium
3 Offer normal rates for a limited type (if the risk increases after a particular time then the underwriter
may propose a term assurance policy at normal rates until that time, instead of a whole life policy.)
4 Impose a numerical rating
5 Impose a debt (i.e. a decrease in benefits like the sum assured) if the customer refuses to pay the
extra premium.
6 Decline the risk.
To help in assessment of the risk, the underwriter may impose a numerical rating. Numerical rating involves the
classification of client information gathered on basis of debit/credit points to assess the extent of extra risk.
Unfavourable points are given a debit point while favorable points are given a credit point. The ideal situation is
zero points in which case it is a standard risk Numerical rating assesses all factors correctly and is easily
understandable and tabulated.
3.3 Policy acceptance and cancellation :
Once a policy is accepted, then all the relevant policy documents are sent to the customer, detailing his exact
investment, the premiums to be paid, the benefits and the charges, this time projected on the basis of the
customers actual investment. This is sometimes known as Post Sales Information document.
NTU / Cancellation : Not Taken Up. All policies that the life office offers to cover the risk and sends a policy ,
but not taken up by the policyholder are referred to as Not taken Up. These policies will lie dormant.
Cancellation : According to statutory laws the policyholder has a right to cancel a policy, on its issue, until a
period of time called the Cooling off period. A Cancellation Notice will usually be sent along with the policy
document. If the policyholder wishes, he may complete and return this form within cooling off period (is the
maximum period of time within which if the customer declines to take the policy, the life office will return his
investment at no charge. It is usually 14 days if the life office sends a cancellation notice. Otherwise it is two
years. After this the policy becomes legally binding contract). On receipt of a completed cancellation notice, the
policy status is set to Cancelled and premiums received will be refunded in full, except in case of unit linked
policies where the unit price on date of cancellation will be used to calculate the amount to be returned.
4 Payment of Commission
The traditional way in which a life office transacts business is through exclusive agents attached to the
company (who can be associated with a Non-Life insurer also). Another distribution channel is brokers who
dont represent the insurer or the prospective policyholder. Life Insurers in UK also use a channel called
Independent Financial Advisers (IFA) who represent policyholder interests. They analyze his insurance needs
and suggest a suitable one from those available in the market.
All agents are paid remuneration for business generated, which is called commission. The 2 major types of
commission are Initial commission - which is paid for getting the policy and Renewal commission - which is
paid for continuation of the policy during later years of the policy. Commission is paid based on preset rates for
various products. However preferential commission rates are negotiable by the agents. Cos usually have a limit
on the %-age of premium that can be paid as commission. When agents operate as a hierarchy the commission
is also split across them. Initial commission is specified as a %-age of the average commission recommended by
IRDA (In UK it is the Life Assurance and Unit Trust Regulatory Organization), which may range from 0% to
90%. When high rates of initial commission is paid, part of it is paid with the understanding that it will be taken
back if the policy lapses within the initial year. This part of the initial commission is clawback commission

3.5 Policy maintenance / Accounting/Reporting

Premium billing and accounting : Billing is the process where premium payment notices are generated and
sent to policyholders when premium is due. Usually it is done by a batch process which identifies premiums
payable, usually a month ahead of due date, sets up a premium record for policy and generates a renewal notice.
When premiums thus billed are received the Accounting process starts. Received payment is tallied with the bill
pending for the policy. On receipt of a premium payment a record is created with status Policy Suspense,
which is called a Suspense account record. Then the premium due for the policy is picked up and payments are
allocated and settled. If premiums are received as cheques and they bounce, the payment has to be Unsettled
where the old premium record is canceled and a new premium record is created.
Renewals : A little before the renewal of a policy is due, notice is sent to the policyholder. Any change of terms
agreed between the insured and the insurer are applied, the renewal premium is paid and accounted for and the
renewal commission due, if any, is sent to the agent/IFA.

Endorsement : During the period when a policy is in force a lot of details can be changed by the policyholder,
with the consent of the insurer and as per the provisions laid out in the policy contract. All changes to policy
terms like additional benefits, additional premiums, increased or decreased term, fund switches, indexation
changes, date of birth change is called policy endorsements. A lot of other details that do not affect the terms
of the policy but alter data held for the policy like bank account details, address details can also be altered when
a policy is in force. This is called general amendments.
3.6 Policy charges: The life insurers apply certain charges for the services rendered which are either adjusted
against the value of the policy or have to be paid along with the premium.
3.7 Policy Reporting : The Life Assurance co should be able to report back to the customer regarding the
financial position of the policy at fixed intervals. It should also be able to project the financial position in the
future based on assumed rate of returns. This not only gives the customer a good idea of the value of his
investment, it also gives the Life Office a chance to spot potential discrepancies in the future. Based on these
projections the co may make relevant suggestions to the customer from time to time.
3.8 Product Pricing : The process of determining the premiums that are commensurate with the risks covered
is called product pricing. Various factors considered in pricing are Mortality, Morbidity/ Disability, Expenses,
Investment Income and Contingency & profit loading, as follows
a) Mortality: mortality is the probability of a person surviving upto the given age. This statistics is
published every 10 years, specifying the number of persons per 1000, completing the age from 1 to 106
years or any other upper limit as practical and applicable. Insurers hold this statistics in mortality tables.
Mortality rates at different ages are effected by factors such as race, sex occupation, geographical area,
industry, life-style etc. Cos. often use more than one table for different groups of policyholders. Some of
these tables are favorable to the insurer while some others are favorable to the insured. Premiums may
thus be high or low based on which table is used
b) Morbidity: Like mortality, the morbidity rates describe the statistics of disability and they are used in
evaluating the premiums payable for disability cover
c) Expenses: Every insurer has marketing, service and dividend expenses which will all be footed by the
premiums paid by policyholders. Thus a lean co. may be able to offer lower priced policies
d) Investment Income Insurers invest the collected premiums in properties, stock market, bonds &
mortgages. A sound investment strategy will pay better returns, thereby giving more money that can be
used to settle payments. So premiums are indirectly linked to the investment performance of life office
e) Contingency and profit loading : Every life office holds a certain portion of the premium collected as
contingency margin. A high contingency percentage will lead to a higher premium because this money

will not be invested in only short-term instruments where the returns are low. And in most countries,
legislation specifies that solvency exist for insurance companies to maintain specified solvency margins
3.9 Exit processing
This term is collectively used to denote all processing that is done to handle the following events
Cancellation / Lapse
Surrender
Paid - up
Death Claim
Maturity
In all the exits cases, computer records are updated to cease the process of premium billing for the policy and
also help in various MIS and actuarial functions.
Maturity : The life assured has been alive for the term of an endowment policy and the SA (along with the
bonus, if any) will be payable to him.
Lapse - The premiums have not been paid regularly and the insurance policy is not in force. When a policy
lapses the insurer is automatically relieved of his liabilities, in case of the covered event happening. When a
policy lapses no money is paid back to the insured.
Claims : The claimant or solicitors will initiate a claim, when the life assured dies. On receipt of a death claim,
the life office will calculate the amount payable. In case of with profit policies, this will include the bonuses
declared till date and also any terminal bonus. For Unit linked policies, it will be the higher of the Guaranteed
Minimum Death Benefit (GMDB) or the bid value of units held by the policyholder. A claim form, a letter
stating the claim amount and request for documents required to settle the claim will be sent. The main
requirements are Proof of Death, Proof of entitlement by the claimant, Proof of age etc. On receipt of the
completed claim form and the required documents the cheque for the claim amount is sent.
Surrender : Any time after the cooling off period, and after the policy acquires a surrender value(SV) , during
the term of a policy the policyholder may wish to cash in the policy. Usually during the first few years a policy
will not achieve a SV value as most of the premium paid goes towards policy set up expenses, commission and
charges. On receipt of a surrender request, the life office will calculate the SV of the policy. SV will be in
proportion to premiums paid. Since the life office incurs high expenses initially in setting up the policy records
and policy procurement, it is usual to recover part of this loss while paying out the surrender claim. The SV is
calculated based on plan, either by using a formula or by an explicit penalty as a %-age of premiums paid. The
earlier the surrender, higher the penalty and hence a lower SV. On calculation of SV, a letter will be sent to the
policyholder, listing the documents required and a Surrender Form. On receipt of the completed surrender form
and all required documents, the cheque for SV will be sent. Surrender can be of 2 types :
a) Partial surrender: In case of with-profits policies, the policyholder is sometimes given the option of
partial surrender, whereby he may encash only the bonus accrued. In this case the current value of the
bonus declared till date will be calculated as the Partial SV and paid out.
b) Full surrender: When the policyholder surrender the whole policy to en-cash it before maturity
Paid Up Policy: If a policyholder can no longer afford to pay the premiums he may choose to make the policy
paid-up. This means that no further premiums are payable and cover continues at an appropriately reduced
level. Only whole of life and endowment policies which have a surrender value can be made paid-up. A term
assurance policy just lapses. On receipt of a paid-up request the life office will calculate the reduced SA based
on the policys current value. A communication will be sent to the policyholder detailing the reduced SA and
proof required to make the policy paid-up. On receipt of proof, the policy status will be set to Paid-up and the
reduced SA will be in force. This will usually be handled as an endorsement to the policy

4.0 Commonly used Life insurance terms and Concepts

Actuary: A specialist statistician in the insurance business. He performs the financial calculations for
premiums, investment, dividend etc. Every insurance co will have its accounts inspected by an Actuary once a
year, at which time the companys financial worth will be calculated.
Assignment Process of assigning the rights in an insurance policy to parties not involved in the contract. In
life contracts the benefits can be assigned to spouse, children.
Extra Fund injection (EFI) - applicable to unit linked life assurance policies. By this method the insurer pays
back to the policyholder a portion of the money it took out of the premiums paid towards capital units.
Premium Waiver Benefit (PWB) - This is an option wherein, the policyholder can stop premium payments for
a short period when a critical illness occurs or he is out of work. Insurers usually account for it by raising the
premium slightly.
Life assured The Party whose loss of life is covered in the insurance policy.
Sum assured (SA) The money that is payable by the insurer to the insured on the event of the risk happening.
It is the limit of insurers liability in a policy.
Index linking The real value of money decreases over time as the retail price of various commodities rise. If
the premium is held constant, the value of a policy will decrease with inflation. To overcome this, the premium
is increased by a rate proportionate to the inflation. This is index linking. Usually the Retail Price Index (RPI)
is linked with the premium and a cap on the increase percentage is also fixed at the outset.
PVR - Pension Value Record
Direct debit (DD) - A payment method, where the Insurer collects the premium dues from the bank account of
the policyholder automatically, when a premium becomes due.
Market Value Adjuster (MVA) - A factor applied to the value of units, at the time of encashment, if the insurer
feels that the current bid price of units do not reflect the market movements.
Additional Voluntary Contribution (AVC): An AVC is where the employee contributes more than the
standard amount towards his pension. The reasons to opt for an AVC are 2 fold - When an employee wants to
increase his own retirement benefits, above the levels defined in the occupational pension scheme provided by
the employer. The other reason is the tax rebates available for an AVC. According to the law 15% of
pensionable annual income can be paid into a pension scheme. So, in cases where the employers scheme takes
out less than that, say 10%, the employee can choose to voluntarily contribute the remaining 5%, thereby
qualifying for tax benefits.
Free Standing AVC (FSAVC) : An AVC can be paid into the employers pension scheme itself or to a personal
pension plan. The latter is called FSAVC. These are attractive because certain types of perks, which are not
included as pensionable income under the Inland Revenue rules, are counted as pensionable for FSAVC.
Moreover an early retirement age can be specified for an FSAVC, so that the benefits become available
immediately on early retirement. In case of an employers pension scheme, the benefits will usually start only at
the specified retirement age, even if the employee takes an early retirement.

State Employment Related Pension Scheme (SERPS) : A pension scheme run by UK Govt. By Inland
Revenue law, all employed people should pay a basic amount from their salary to this scheme. The amount paid
as pension, after retirement, depends upon the duration of the working -life for which the employee has paid
premiums. This is a cumbersome scheme, mostly used by employees not having access to employers schemes.
Where an employer offers pension schemes, the employees can contract out of SERPS, and avail premium
rebates for doing so. In such cases the employers scheme has to maintain separate accounts for the SERPS
(called the Protected Rights) and non-SERPS parts of the premiums and benefits. Recent regulations have
allowed employees to choose even FSAVCs for contracting out. Such products are called Contracted Out
Money Purchase Schemes (COMPS).
Defined Contribution (also called Money Purchase) Scheme & Defined benefits
Pensions can be calculated in two ways:
a Define the benefits that are payable and pay sufficient contributions to provide those benefits,
b Define the level of contributions and then provide benefits, based on the accumulated amount available when
the benefit falls due.
Based on the methods of pension calculation pensions can be classified as Defined Benefit schemes as in (a)
above and Defined Contribution schemes as in (b) above. Hybrid schemes are also available, which offer a mix
of both.