Premium Computation In The Pricing Of Life Insurance

Computation of life insurance annual premiums is basically a three-stage process: calculation of the net single premium, calculation of the net level premium, and calculation of the loading for expenses to yield the gross premium. Since almost 80 percent of life insurance company income goes for benefits, it is important to understand how net premiums are calculated. Net single premium term insurance. The “net single premium” is the amount which the insurer needs in advance to pay all claims arising during the policy period. To illustrate, let us compute the net single premium for a $1,000 one-year term policy for a 20-year-old male. The mortality rate for this age is .00179, or
179 per 100,000. It is assumed that premiums will be collected at the beginning of the year and death claims paid at the end. It is further assumed that during the year the insurer earns 3 percent interest on the collected premiums. In order for the insurer to have $1.00 on hand at the end of the year, it must collect only $0.9709. This results from the fact that in one year $0.9709 will, at 3 percent interest, equal $1.00. Thus, to pay 179 claimants (i.e., the number dying at the end of the year) $1,000 each would require .9709 x $179,000 or $173,791. Each of the 100,000 insureds would then be charged $173,791/100,000, or $1.74. If each insured pays $1.74, the insurer will have adequate funds to pay all death claims.6 This $1.74 is the “net single premium” for that one-year policy. 

The same calculation can be carried out for 3-, 5-, 10-, or
20-year-level term insurance except that more than one period is used. Table 1 illustrates the calculation for a 3-year term contract. If the table were continued to age 100, it would be possible to calculate the net single premium for a whole life or ordinary policy. 

The fact that many death claims actually will be paid during the year rather than at the end is adjusted for in the expense loading.