Chapter 10

Calculation of Premium

Slide prepared
prepared by:
by:Abdullah
AbdullahAl
AlYousuf
Yousuf Khan
Khan
Slide
Assistant Professor
Professor IUBAT
IUBAT
Assistant

McGraw-Hill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All

rights reserved.

Calculation of Premium
Premiums are two types;
1. Net Premium, and
2. Gross premium
Both types are further sub-divided into
two parts;
i. Single Premium, and
ii. Level Premium

Basic Characteristics of
Premiums
Net Premium

Gross Premium

Based on;

Based on;

The mortality
and
Interest

The mortality
rate
Assumed interest
rate
Expenses, and
Bonus

Basic Characteristics of
Premiums
Single Premium

Level Premium

Is paid in
lump sum

Is paid
periodically in
installments
May be yearly,
half-yearly,
quarterly, or
monthly

Firstly, net single premium is calculated and

other premiums are calculated based on this
4
calculation.

Net Single Premium

Received by the insurer in a lump sum.
Adequate
Generates returns
To be able to pay the claim (of agreed
amount)
At death, at maturity, or at surrender
Does not provide for management
expenses and contingency

Net Single Premium;

Steps for Calculation

Determine;
1.
What constitutes a claim; (a) death, (b) survival, or (c)
both
2. When claims are paid; (a) at the beginning, (b) at the end,
(c) during the year.
3. The number of insured.
4. The duration of the policy.
5. The probable number of claims per year.
6. The value of claims per year
7. The number of years of interest involved and find the
present value.
8. The PV of the claims for each year.
9. The PV of all future claims.
10. The net single premium (i.e. the PV of future claims)
divided by assumed number of policy buyer.
6

Assumptions underlying
Rate Computations
As many policies of given type are being
issued as are the number of persons.
Premiums are collected in advance or in
the beginning of the period.
All collections are immediately invested
and will remain invested until money is
needed for the payment of claims.
The insurer will receive an assumed rate of
interest.
Continues in next
7

Assumptions underlying
Rate Computations
The interest or dividend or any return of
the invested funds is immediately
reinvested.
Mortality rate will be the same as given in
the mortality table and will be uniformly
distributed throughout the year.
All policies are of the same amount, say
e.g. tk. 1,000.
Claims will be paid at the end of the
period.
8

Calculation of Net-Single
Premium
Term Insurance;
Simplest type of contract.
Payment is made only when the life assured dies within the term
specified.
Nothing will be paid if death does not occur during the designated
term.
Also called temporary insurance.

Premium is received in advance and will not be returned if life

assured survived.
Premium is paid only once in a single sum at the inception of the
policy.
Claims will be paid at the end of the year, not at the end of the term.
The probability of death in each year with the PV of the claim will be
calculated
Because death may occur at any time and the insurer may be
required to pay.

Term Insurance; Example of

Net-Single Premium
Calculation
Assume that the period of term insurance is 5 years. Rate of
return on investment is 3 percent. The person is proposing
at the age of 40 for a period of 5 years. The mortality
experience will be like shown in the Oriental 1953-54
Experience Life Table;
Table 10.1: Oriental 1953-54 Experience Life Table,
Ultimate Table
Age
Number of
Number of Deaths Mortality Rate per
Persons Living
1,000
40

96,463

273

2.83

41

96,190

302

3.14

42

95,888

336

3.50

43

95,552

375

3.92

44

95,177

418

4.39

45

94,759

476

4.03
10

Assumptions for Calculation

Each dead person will be paid tk.
1,000.
Because the insurer will earn a fixed
return on the investment, only PV of
the claim should be taken as
premium.
Thus the net-single premium for each
year will be calculated;
Number of Deaths Amount of Claims PV of tk.1 = PV
of ClaimsContinues in next
11

Table 10.2: Net Single Premium for 5-Year

Term Policy
Years of
Insurance

Age

Number
of
Persons
Living

Number Amount of PV of tk.

of Deaths
Claims
1
per
Deaths

PV of
Claim
4x5x6

40

96,463

273

1,000

0.971

265,08
3

41

96,190

302

1,000

0.943

284,78
6

42

95,888

336

1,000

0.915

307,44
0

43

95,552

375

1,000

0.888

333,00
0

PV of all claims tk. 1,551,043

Total5premium
be charged
96,463
policies
=
44 to95,177
418 on all
1,000
0.863
360,73
tk. 1,551,043
4
Therefore, premium per policy = tk. 1,551,043/ 96,463
Continues in next
= tk. 16.18
12

Calculation of Net Single

Premium
The PV of the 1st year will be calculated for one year
in the 1st year of insurance because death of death
occurs during the 1st year, the insurer can earn
interest at least for one.
Similarly, in the 2nd year of insurance, the PV of tk. 1
is calculated for two years at 3 percent per annum.
The equation for calculatingS PV is = (who does not
P
know this?)
(1 i ) n
Where,
P stands for Present Value
S stands for the amount of which PV is to be calculated
i stands for the rate of interest, and
n for number of years for which PV is to be calculated.
13

Calculation of Net Single

Premium
The PV of claim for 1st year will be 273 x 1,000 x
0.971 = 265,083
The total amount of claim is 273 x 1,000 =
273,000.
The formula to calculate the
Net Singlen Premium
2
Vd x V d x 1 ........V d x n
is;
NSP

lx

Where,
V represents the value of tk. 1
dx represents deaths
lx represents number of living in the beginning
14

Other method of calculation of Single Policy

Premium by taking into account of probability
of death
Years of
Insurance

Age

Probability of
deaths
expressed in
units

Amount of
Policy

PV of tk. 1

Net Single
Premium
3x4x5

40

0.00283

1,000

0.971

2.74793

41

0.00314

1,000

0.943

2.96102

42

0.00350

1,000

0.915

3.20250

43

0.00393

1,000

0.888

3.48096

44

0.00439

1,000

0.863

3.78857

Total =

tk.
16.8098
(because
of
rounding
error)

15

Net Single Premium in

Whole Life Policy
A whole life policy continues for the whole life
and promises to pay the sum assured upon
the death of the insured to his beneficiary.
It has been assumed in most of the mortality
table that the life will continue up to 100
years.
Therefore, the calculation of premium will
start from the date of commencement of risk
to 100 years.
E.g., if a person takes a policy at age 45, the
calculation will continue till 100 th year.
16

Example
The chances of death in each separate year will
be multiplied by the face value of the policy and
this amount is discounted by the present value of
the 10.4
period.
Table
Calculation of Net Single Premium on the basis of CSO Mortality Table
Age

Probability of
Death

45

7,340/852,554

46

7,801/852,554

125/852,554

Policy amount

PV of tk. 1
@2.5%

PV of the
Claim

1,000

0.975610

8.399441

1,000

0.951814

9.039243

1,000

0.257151

10.037703

.
.
99

Net Single Premium (NSP)

17

tk. 551.372587

Net Single Premium in

Pure Endowment Policy
In this policy, insurer promises to pay the
insured value in case the holder survives a
certain fixed period.
Thus, the holder of 5 year pure endowment
will be paid only when he/she survives at
the end 5 year.
The insured cannot get possession of the
money invested before the expiration of he
endowment period.
If the insured dies during this period, all the
premium paid will be forfeited.
18

Example
Table 10.5 Calculation of Net Single Premium on the basis of Pure Endowment
Actual form of
Calculation

Probability
of Survival

Policy
amount

PV of tk. 1 for
the

Endowment
Period

Net Single
Premium

V nl x 1
NSP
lx

=94,689/93,463

=0.981

1,000

0.863

Thus the NSP of tk. 1,000 for 5 years will be

846.603
tk. 846.603

Vdx V 2 dx 2 V 3 dx 3 ..... for the end of the mortality table

NSP
lx
19

Net Single Premium in

Ordinary Endowment
Policy

Under this policy, the payment of

claim is made at the survival of the
term or at the death of the life
assured whichever is earlier.
Payment in this case is certain.
Since payment is based on the both
death and survival, the net single
premium is calculated on death and
survival rate.
20

Example
Since the net single premium for 5-year term
insurance and 5-year pure endowment insurance
is already calculated, we can easily calculate the
NSP for ordinary endowment policy as;
1. NSP on the basis of death for 5 years
= tk. 16.18
2. NSP on the basis of survival at the end of 5 year = tk.
846.60
tk. 862.78
The equation used to calculate
NSP
2
n for ordinarynendowment
Vd x V d x 1....V d x n 1 V l x n
is;

NSP

lx

lx

21

Net Single Premium in

Double Endowment
Under this policy, double of the amount is paid
if the life assured survives at the end of the
term of policy and only single amount is paid if
the death occurs within the term,
Thus, it is first like ordinary endowment policy
with only difference that double of the policy
amount is paid if the life assured survives up to
the term.
Since the double of the policy amount is paid at
the survival, one more premium on the basis of
pure endowment is added to the premium of
ordinary endowment policy.
22

Example
Double endowment policy is to be calculated of tk.
1,000 for 5 years.
The net single premium of ordinary endowment +
net single premium of pure endowment policy for
5 years at same age;
=tk. 862.78+846.60=1,709.38
The equation used to calculate double endowment
policy premium is;

(Vd x V 2 d x 1 V 2 d x 2 ..... V n d x n 1 ) 2V 2l x n
NSP
lx
23

Net Single Premium for a

Joint Life Policy
Under this policy, payment of claim will be
made at the first death of the assured lives
who may be two or more.
Here, the process of calculation will be the
same as has been shown in term insurance
with only difference that the probability of
death is compound one.
The compound probability of death is
calculated by addition of the probability of
deaths of one other and all of the every
aged.
24

Example

Compound probability of any one of the two lives assured will be;
(a) Probability of death of the younger person
+
(b) Probability of death of the older person
+
(c) Probability of death of both the persons
It is calculated by multiplying the probability of death of each
person.
The following method is used to calculate the compound
probability;
1 Probability of survival of young life Probability of survival of older life

25

Net Single Premium in

Annuities
An annuity is defined as a contract whereby, for a cash
consideration (called premium), one party (the insurer)
agrees to pay the other party (the annuitant) a
stipulated sum (the annuity), throughout life, or during
the life within a fixed term, either annually semiannually,
quarterly, or monthly.
The purpose of annuity is to protect a hazard the
outliving of ones income.
It is just opposite of insurance contract.
The annuity protects against the absence of income in
old age.
A periodical amount is given by the insurance company
to the insured up to his life or up to a fixed period of life
thereafter.
26

Net Single Premium in

Annuities
Under the annuity, the payment of annuity starts
from the date of first annuity period.
E.g., if annuity is to be paid six monthly, and the
contract of annuity, i.e. payment of purchase
price is made on 1st January, 2014, the first
annuity will be paid on 1st June, 2014.
Therefore, up to this period, the insurer can enjoy
the premium paid six months ago.
If the annuitant survives to next installment
period, the insurer have to pay the second
installment of the annuity.
Annuity can be (1) Life Annuity, (2) Term Annuity.
27

Example
Suppose net single premium for an immediate annuity of tk.
1,000 to be paid annually issued at the age of 105 is to be
calculated.
Assuming the rate of interest is 3 percent and the 1937
Standard Annuity Mortality Table is used.
The calculation will be as follows;
Table 10.6 Calculation of Net Single Premium
Age

Probability of
Survival

Amount of
Annuity

PV of tk. 1 @ 3%

106

97/249

1,000

0.971

94,187/249

107

30/249

1,000

0.943

28,290/249

108

6/249

1,000

0.915

5,490/249

109

1/249

1,000

0.888

888/249

110

0/249

1,000

0.863

0/249

Net Single Premium (NSP)

28

PV of Annuity

tk. 128,855/249 =
tk. 517

Net Single Premium for

Temporary Annuity
An annuity of tk. 1,000 to be paid
annually is taken at the age of 70 and
continues up to 5 years.
The rate of interest is 2.5% per
annum.
So the net single premium will b;

29

Example
Table 10.7 Calculation of Net Single Premium
Age

Probability of
Survival

Amount of
Annuity

PV of tk. 1 @
2.5%

PV of Annuity

71

553,332/577,445

1,000

0.975610

934.87

72

538,443/577,445

1,000

0.951814

871.04

73

502,843/577,445

1,000

0.928599

808.63

74

476,611/577,445

1,000

0.905951

747.75

75

449,841/577,445

1,000

0.883854

688.54
tk. 4,050.79

30

Equations
Equation for Life Annuity
Vl x 1 V 2l x 2 V 2l x 3 .... life
NSP
lx
For Temporary Annuity
Vl x 1 V 2l x 2 V 2l x 3 .... (if for 3 years)
NSP
lx

31

Calculation of Level
Premiums
Table 10.7 Calculation of Net Single Premium
Years of
Insurance

Age

Number of
Persons
Living

No. of
Premium
Received

Amount of
Premium
Received

PV of tk. 1

PV of
Premium
Received

40

96,463

96,463

96,463

1.000

96,463

41

96,190

96,190

96,190

0.971

96,190

42

95,880

95,880

95,880

0.943

95,880

43

95,552

95,552

95,552

0.915

95,552

44

95,177

95,177

95,177

0.888

95,177

Total present value=

tk. 452,225

The present value (PV) per policy of all the net level premiums = net
single premium of all the policy
The ratio between level premium and net single premium is 1:452,225/96,463
32

Calculation of Level
Premiums
On this ratio the net single premium (NSP)of tk.
16.18 = 15,551,043/96,463 can be converted into
several premium policy.

452 ,225
Since, for NSP of tk.
, the NLP is tk.1
96,463
1x96 ,463
For NSP of tk. 1 the NLP
452,225
1,551,043
96 ,463 1,551,043
For NSP of tk.
, the NLP

96 ,463
452 ,225 96 ,463
tk. 3.43 per annum.
33

Exercise # 7
From the following mortality table, calculate the
NSP of
Term insurance of 5 years,
Endowment insurance for 5 years,
Pure endowment for 5 years, and
Double endowment for 5 years.
The rate of interest is 5 percent
The insurance amount is tk. 1,000.

25

26

27

28

29

30

lx

100,000

99,500

98,900

98,200

97,400

96,500

dx

500

600

700

800

900

1,000

34