Читать книгу Risk Management and Financial Institutions - Hull John C. - Страница 32

In life insurance contracts, the payments to the policyholder depend – at least to some extent – on when the policyholder dies. Outside the United States, the term life assurance is often used to describe a contract where the event being insured against is certain to happen at some future time (e.g., a contract that will pay $100,000 on the policyholder's death). Life insurance is used to describe a contract where the event being insured against may never happen (for example, a contract that provides a payoff in the event of the accidental death of the policyholder.)4 In the United States, all types of life policies are referred to as life insurance and this is the terminology that will be adopted here.

There are many different types of life insurance products. The products available vary from country to country. We will now describe some of the more common ones.

Term Life Insurance

Term life insurance (sometimes referred to as temporary life insurance) lasts a predetermined number of years. If the policyholder dies during the life of the policy, the insurance company makes a payment to the specified beneficiaries equal to the face amount of the policy. If the policyholder does not die during the term of the policy, no payments are made by the insurance company. The policyholder is required to make regular monthly or annual premium payments to the insurance company for the life of the policy or until the policyholder's death (whichever is earlier). The face amount of the policy typically stays the same or declines with the passage of time. One type of policy is an annual renewable term policy. In this, the insurance company guarantees to renew the policy from one year to the next at a rate reflecting the policyholder's age without regard to the policyholder's health.

A common reason for term life insurance is a mortgage. For example, a person aged 35 with a 25-year mortgage might choose to buy 25-year term insurance (with a declining face amount) to provide dependents with the funds to pay off the mortgage in the event of his or her death.

Whole Life Insurance

Whole life insurance (sometimes referred to as permanent life insurance) provides protection for the life of the policyholder. The policyholder is required to make regular monthly or annual payments until his or her death. The face value of the policy is then paid to the designated beneficiary. In the case of term life insurance, there is no certainty that there will be a payout, but in the case of whole life insurance, a payout is certain to happen providing the policyholder continues to make the agreed premium payments. The only uncertainty is when the payout will occur. Not surprisingly, whole life insurance requires considerably higher premiums than term life insurance policies. Usually, the payments and the face value of the policy both remain constant through time.

Policyholders can often redeem (surrender) whole life policies early or use the policies as collateral for loans. When a policyholder wants to redeem a whole life policy early, it is sometimes the case that an investor will buy the policy from the policyholder for more than the surrender value offered by the insurance company. The investor will then make the premium payments and collect the face value from the insurance company when the policyholder dies.

The annual premium for a year can be compared with the cost of providing term life insurance for that year. Consider a man who buys a $1 million whole life policy at the age of 40. Suppose that the premium is $20,000 per year. As we will see later, the probability of a male aged 40 dying within one year is about 0.0022, suggesting that a fair premium for one-year insurance is about $2,200. This means that there is a surplus premium of $17,800 available for investment from the first year's premium. The probability of a man aged 41 dying in one year is about 0.0024, suggesting that a fair premium for insurance during the second year is $2,400. This means that there is a $17,600 surplus premium available for investment from the second year's premium. The cost of a one-year policy continues to rise as the individual gets older so that at some stage it is greater than the annual premium. In our example, this would have happened by the 30th year because the probability of a man aged 70 dying in one year is 0.0245. (A fair premium for the 30th year is $24,500, which is more than the $20,000 received.) The situation is illustrated in Figure 3.1. The surplus during the early years is used to fund the deficit during later years. There is a savings element to whole life insurance. In the early years, the part of the premium not needed to cover the risk of a payout is invested on behalf of the policyholder by the insurance company.

FIGURE 3.1 Cost of Life Insurance per Year Compared with the Annual Premium in a Whole Life Contract

There are tax advantages associated with life insurance policies in many countries. If the policyholder invested the surplus premiums, tax would normally be payable on the income as it was earned. But, when the surplus premiums are invested within the insurance policy, the tax treatment is often better. Tax is deferred, and sometimes the payout to the beneficiaries of life insurance policies is free of income tax altogether.

Variable Life Insurance

Given that a whole life insurance policy involves funds being invested for the policyholder, a natural development is to allow the policyholder to specify how the funds are invested. Variable life (VL) insurance is a form of whole life insurance where the surplus premiums discussed earlier are invested in a fund chosen by the policyholder. This could be an equity fund, a bond fund, or a money market fund. A minimum guaranteed payout on death is usually specified, but the payout can be more if the fund does well. Income earned from the investments can sometimes be applied toward the premiums. The policyholder can usually switch from one fund to another at any time.

Universal Life

Universal life (UL) insurance is also a form of whole life insurance. The policyholder can reduce the premium down to a specified minimum without the policy lapsing. The surplus premiums are invested by the insurance company in fixed income products such as bonds, mortgages, and money market instruments. The insurance company guarantees a certain minimum return, say 4 %, on these funds. The policyholder can choose between two options. Under the first option, a fixed benefit is paid on death; under the second option, the policyholder's beneficiaries receive more than the fixed benefit if the investment return is greater than the guaranteed minimum. Needless to say, premiums are lower for the first option.

Variable-Universal Life Insurance

Variable-universal life (VUL) insurance blends the features found in variable life insurance and universal life insurance. The policyholder can choose between a number of alternatives for the investment of surplus premiums. The insurance company guarantees a certain minimum death benefit and interest on the investments can sometimes be applied toward premiums. Premiums can be reduced down to a specified minimum without the policy lapsing.

Endowment Life Insurance

Endowment life insurance lasts for a specified period and pays a lump sum either when the policyholder dies or at the end of the period, whichever is first. There are many different types of endowment life insurance contracts. The amount that is paid out can be specified in advance as the same regardless of whether the policyholder dies or survives to the end of the policy. Sometimes the payout is also made if the policyholder has a critical illness. In a with-profits endowment life insurance policy, the insurance company declares periodic bonuses that depend on the performance of the insurance company's investments. These bonuses accumulate to increase the amount paid out to the policyholder, assuming the policyholder lives beyond the end of the life of the policy. In a unit-linked endowment, the amount paid out at maturity depends on the performance of the fund chosen by the policyholder. A pure endowment policy has the property that a payout occurs only if the policyholder survives to the end of the life of the policy.

Group Life Insurance

Group life insurance covers many people under a single policy. It is often purchased by a company for its employees. The policy may be contributory, where the premium payments are shared by the employer and employee, or noncontributory, where the employer pays the whole of the cost. There are economies of scale in group life insurance. The selling and administration costs are lower. An individual is usually required to undergo medical tests when purchasing life insurance in the usual way, but this may not be necessary for group life insurance. The insurance company knows that it will be taking on some better-than-average risks and some worse-than-average risks.