LIFE INSURANCE AND ANNUITY CONTRACTS

INTRODUCTION TO LIFE INSURANCE
The life insurance and annuity contracts examined by early actuaries closely resembled those formulated until the 1980s throughout all developed insurance markets. Recently, the design of life insurance products has undergone a drastic transformation, and the strategies required to administer these contemporary contracts have become increasingly complex.

The rationale for the modifications encompasses:
• Heightened interest among insurers in providing integrated savings and insurance solutions. The initial life insurance products offered a payment to compensate for the difficulties resulting from the policyholder’s death.
Numerous contemporary contracts integrate the concept of indemnity with an investment opportunity.
• Enhanced computational capabilities enable the modelling of more intricate products.
• Policyholders have evolved into more discerning investors, necessitating a broader array of alternatives in their contracts, such as the ability to adjust premiums or insured amounts.
•Increased competition has compelled insurers to develop progressively intricate products to capture additional business.
•Risk management approaches in financial goods have grown increasingly intricate, and insurers have provided certain advantages, notably financial guarantees, that necessitate advanced methodologies from financial engineering to assess and mitigate the risk.

TRADITIONAL INSURANCE AGREEMENTS
Term, whole life and endowment insurance are conventional products that offer cash rewards at death or maturity, typically with a fixed premium and benefit levels. We elaborate on each aspect in further depth here.

TERM INSURANCE: Term insurance disburses a lump sum payout upon the policyholder’s death, contingent on death before the conclusion of a designated period. Term insurance enables a policyholder to secure a predetermined amount for their dependents upon the policyholder’s demise.
Level-term insurance denotes a fixed sum insured and consistent, fixed premiums.
Decreasing term insurance signifies that the insured amount and, typically, the premiums diminish throughout the contract. It is prevalent in the UK and commonly utilized with home mortgages; upon the policyholder’s death, the outstanding mortgage balance is settled using the term insurance earnings.
Renewable term insurance allows the policyholder to renew the policy upon the conclusion of the initial term without additional proof of the policyholder’s health condition.
Yearly Renewable Term (YRT) insurance is prevalent in North America. It provides assured insurability for a specified duration, but the contract is executed annually.
Convertible term insurance allows the policyholder to transition to whole life or endowment insurance upon the expiration of the initial term.

Period, additional evidence regarding the policyholder’s health condition was absent.

WHOLE LIFE INSURANCE: Whole life insurance provides a lump sum reward upon the policyholder’s death, regardless of when it occurs. In regular premium contracts, the premium is often due only until a certain maximum age, commonly 80. This mitigates the issue of older individuals being unable to afford the premiums.

ENDOWMENT INSURANCE: Endowment insurance provides a lump sum payable upon the policyholder’s death or after a designated period, whichever event transpires first.
This constitutes a combination of a term insurance benefit and a savings component. Upon the policyholder’s death, the sum insured is disbursed similarly to term insurance; if the policyholder survives, the sum insured is regarded as a maturing investment. Endowment insurance is outdated in numerous jurisdictions. Traditional endowment insurance policies are not presently available in the UK; nonetheless, substantial portfolios of such policies remain with UK insurers, as these policies were frequently utilized to repay home mortgages until the late 1990s. The policyholder, a homeowner, paid interest on the mortgage loan. At the same time, the principal was settled using the income from the endowment insurance, either upon the policyholder’s death or at the mortgage’s ultimate repayment date.
Endowment insurance policies are gaining popularity in poor countries, especially in ‘micro-insurance’ where the sums involved are minimal. Small investors struggle to attain favourable rates of return on investments due to substantial expense charges. By consolidating the death and survivor benefits under the endowment contract, the policyholder benefits from enhanced investment returns due to economies of scale and the insurer’s financial acumen.

PARTICIPATING INSURANCE
The conventional insurance structure includes categorizing businesses into ‘participating’ or ‘par’ businesses, referred to as ‘with-profit,’ and ‘non-participating’ or ‘non-par’ businesses, known as ‘without profit.’ In participatory insurance, the earnings generated from invested premiums are distributed among the policyholders.
In North America, profit distribution manifests as cash dividends or lowered premiums. In the UK and Australia, the conventional method involves utilizing profits to augment the insured amount, with guaranteed bonuses provided. Terminal bonuses are granted at the maturation of the policy, either due to the insured’s death or when an endowment policy concludes its term.
Reversionary bonuses can be articulated as a percentage of the cumulative previous sum insured plus bonuses or as a percentage of the original sum insured plus an alternative proportion of the previously announced bonuses. The insurer establishes reversionary and terminal incentives according to the performance of the premiums invested.
Participating insurance provides clients with a savings component alongside their life insurance. The conventional participation contract was primarily structured for life insurance coverage, with the savings component being a secondary feature.

MODERN INSURANCE CONTRACTS
In recent years, insurers have offered more flexible products that integrate death benefit coverage with a substantial investment component to compete for policyholders’ savings against other institutions, such as banks or open-ended investment companies (e.g., mutual funds in North America or unit trusts in the UK). Increased flexibility enables policyholders to acquire less insurance coverage during financial constraints and augment their coverage when their economic situation improves.
This section presents examples of contemporary, adaptable insurance contracts.
• UNIVERSAL LIFE INSURANCE integrates financial components with life insurance coverage. The policyholder establishes a premium and a degree of life insurance coverage. Premiums are adaptable, provided that the total value of the premiums is adequate to cover the specified sum insured within the term insurance component of the contract. Universal Life is a prevalent insurance policy in North America.

• UNITIZED WITH-PROFIT is a UK insurance contract representing an evolution of the traditional with-profit policy to enhance transparency compared to its predecessor. Premiums are utilized to acquire units (shares) of an investment fund known as the with-profit fund. As the fund generates investment returns, the shares appreciate (or additional shares are issued), augmenting the benefit entitlement as a reversionary bonus.
The shares will not diminish in value. Upon death or maturity, an additional terminal bonus may be disbursed contingent upon the performance of the with-profit fund. Following negative press regarding with-profit businesses and, by extension, unitized with-profit businesses, these product designs were retracted from the UK and Australian markets in the early 2000s.

EQUITY-LINKED INSURANCE provides benefits contingent upon an investment fund’s performance. Two distinct forms exist. The initial scenario involves the policyholder’s premiums being allocated to an open-ended investment company account; upon maturity, the benefit corresponds to the total accumulated value of the premiums.
A guaranteed minimum death benefit is payable if the policyholder dies before the contract’s maturity. In certain instances, a guaranteed minimum maturity benefit is also payable.
Equity-indexed annuities (EIAs) typically have shorter terms than unit-linked products, with seven-year policies being standard; in contrast, variable annuity contracts often extend for 20 years or longer. Equity-indexed annuities (EIAs) have significantly lower consumer popularity than variable annuities.

DISTRIBUTION METHODS
Many individuals perceive insurance as excessively complex. Brokers facilitating connections between individuals and suitable insurance products have historically played a significant role in the market. An adage among actuaries’ states that ‘insurance is sold, not bought,’ highlighting the essential role of intermediaries in convincing potential policyholders to purchase insurance policies, thereby ensuring a sufficient volume of new business.
Brokers and other financial advisors are typically compensated via a commission structure. The commission is defined as a percentage of the premium paid. A higher percentage is generally paid on the initial premium compared to subsequent premiums, known as a front-end load. Advisors may receive compensation through a fixed-fee structure or may be employed by one or more insurance companies on a salaried basis.

UNDERWRITING
In estimating life insurance liabilities, it is crucial to consider the outcomes upon the acquisition of a life insurance policy. Marketing life insurance policies is a competitive endeavour, and life insurance businesses, or life offices, constantly evaluate methods to modify their operations to enhance efficiency. They can enhance customer service and attain a competitive edge over rivals. The summary provided below regarding the sale of policies addresses several critical aspects but is inherently a simplified representation of the subject occurs.
For a specific policy type, such as 10-year term insurance, the life insurance company will include a schedule of premium rates. These charges will be contingent upon the dimensions of the policy and other additional elements referred to as grading criteria. The risk associated with an applicant the level is evaluated by requesting the completion of a proposal form that provides information on pertinent rating elements, typically encompassing age and gender.

Collecting and evaluating this information is referred to as underwriting. The primary objectives of underwriting are to categorize potential policyholders into broadly similar risk groups and to assess the appropriate additional premium for applicants whose risk factors suggest that standard premium rates are insufficient. Based on the application and accompanying medical information, prospective life insurance policyholders are typically classified into one of the following categories:
PREFERRED LIVES: exhibit a significantly reduced mortality risk according to standard data. The ideal candidate should possess no recent history of smoking, no indications of drug or alcohol misuse, no engagement in high-risk hobbies or professions, no familial predisposition to diseases with significant genetic links, and no negative medical markers such as elevated blood pressure, cholesterol levels, or body mass index. The preferred life category is prevalent in North America but has not yet gained traction in other regions. In other contexts, there is no distinction between preferred and everyday lives.

NORMAL LIVES may exhibit higher risk factors than preferred lives, where applicable; however, they remain insurable at standard rates. The majority of applicants belong to this category.

RATED LIVES exhibit one or more elevated risk factors, rendering them ineligible for standard premium rates. Nonetheless, they may be insured at an elevated premium. An example could be an individual with a familial predisposition to heart disease. Individual assessments may be conducted to determine the appropriate additional premium for these lives. This category also encompasses individuals engaged in hazardous occupations or hobbies that elevate their risk levels.

UNINSURABLE LIVES present a risk that precludes insurers from engaging in an insurance contract, regardless of the price offered.

PREMIUMS
A life insurance policy may consist of a single premium, payable at the contract’s inception, or a regular series of premiums contingent upon the policyholder’s survival, with a predetermined termination date. In conventional agreements, the standard premium typically remains constant throughout the contract’s duration; however, in contemporary contracts, the premium may be variable, determined by the policyholder for investment products like equity-linked insurance or by the insurer for specific types of term insurance. Regular premiums might be remitted annually, semi-annually, quarterly, monthly, or weekly. Monthly premiums are prevalent because they align the policyholders’ expenses with the regularity of their income.
A key characteristic of all premiums is that they are remitted at the commencement of each term. Assume a policyholder agrees to remit annual premiums for a decade-long insurance contract. Premiums shall be remitted at the commencement of the contract and subsequently at the beginning of each ensuing year, contingent upon the policyholder’s survival.