Mortality, Expenses, And Investment Earnings In The Pricing Of Life Insurance

Mortality 

The first and major cost ingredient of the life insurance product is the cost of death claims. The probable number of such claims in each year for any particular risk class is estimated from a mortality table. This table expresses its probabilities based on the actual experience of large groups of individuals. It shows the relationship between the number of persons living and the number dying at each age from 0 to 99. The table currently in use is the Commissioner’s 1958 Standard Ordinary Mortality Table. The death rate (e.g., the number of deaths in a given risk class per 100,000 persons living at the beginning of the year) shown in the mortality table is not the actual experience of the past but is modified by the addition of a safety factor to allow for unpredicted increases in the death rate and for temporarily adverse mortality fluctuations. Thus, while the death rate in the mortality table for a male age 25 is 193 per 100,000, the rate without safety margins is 93 per 100,000. Just to be safe, participating policies will often use a figure greater than 193 to calculate the initial premium. A decrease in mortality will result in lower insurance cost since fewer claims will result for any given age group. The death rate, however, has remained relatively constant in the United States over the last decade. 

Expenses 

The costs of operating an insurance business, such as insurance agent’s commissions, field office overhead expenses, taxes, and dividends to stockholders, must be provided for in the price of insurance. In addition, there is also a loading factor added to the premium to provide for contingencies such as unexpected decreases in earnings or future increases in expenses. A major problem in the determination of the expense loading is the attempt to achieve equity among policyholders in order that each pays his fair share of the expenses. The problem of expense allocation arises because some expenses vary with the size of premium (i.e., sales commissions) and some with the amount of insurance (i.e., medical costs), while others are relatively constant for large ranges in premium volume
(i.e., general overhead). Decreases in expenses will cause decreases in the premiums needed if other costs remain unchanged. In 1969, expenses (including taxes and stockholder dividends) accounted for 22.7 percent of the total income of life insurance companies. Investment Earnings 

Because insurance premiums are always payable in advance, while claims are often not due for many years, particularly death claims, a fund of money is accumulated which companies are able to invest. The return on such investments serves to lower the price needed to cover all costs. For example, if $105 is needed to pay a claim one year from now, only $100 in premiums would be required if 5 percent interest can be earned during the year. Present value tables are used to project the amount of funds needed at the beginning of a period to generate enough funds to pay claims arising during the period. This figure represents the present value of future claims. The average net rate of return for life insurers before federal incomes taxes has risen from 3.06 percent in 1949 to 5.12 percent in 1969 and is still rising.5 The greater the return on investments, other things equal, the lower the premium needed to cover claims.