How to plan your life insurance ?
The actual operation of a modern life insurance company is extremely complex, involving all the aids of modern technology and especially, of course, the computer. But the essential principle is simple. Let us assume that we were planning a scheme whereby 1,000 men all aged 45 would agree to pay into a common fund each year of their lives enough to pay out £1,000 to the dependants of any of them who died during any year. It is possible to determine fairly precisely just how many of the 1,000 will die in any year. To provide the £4,000 necessary to meet the claims of the dependants that are each of the original 1,000 would have to pay £4.
But if we continue in this way, deriving the premium from the year’s actual mortality each of them will have to pay in over £21 to meet the outgoings, since their income would quite probably be falling just as the contributions rose, such a scheme would be extremely unattractive.
What the founders of life insurance discovered, however, was that with a lot of mathematical calculation and a little guesswork, they could work out a premium rate which each of the 1,000 would agree to pay throughout their lives in return for the guarantee that all claims would be met when they fall due. The annual premium is far higher than the payments required in the early years of the “pay-as-you-go” scheme, because a reserve is being accumulated in the early years which will cover the excess of claims over premiums in the later ones. The fund is investing the surplus of the early years at interest to build up reserves which will meet future claims.
To devise such a system requires two principle calculations:
•1. The mortality rate
The mortality rate determines how much it is likely to be required each year to meet claims.
•2. The interest rate
The interest rate is needed to work out how much the premium can be reduced to allow for the effect of accumulation or reserves ands interest.
Tags: life insurance, life insurance cover, life insurance quote