Contractual Financial Institutions

Life Insurance companies have been classified as "Contractual Financial Institutions "

Mutuality & Diversification

It is one of the most important ways to reduce risk in financial markets, the other being diversification

Diversification

• The  funds are spread out amount various assets (placing the eggs in different baskets)
• we have funds flowing from one source to many destinations

Mutuality 

• Under Mutuality or Pooling, the funds of various individuals are combined (Placing all eggs in one basket)
• we have funds flowing from many source to one

Level Premium

It is a premium fixed such that it does not increase with age but remains constant throughout the contract  period.

It has 2 components :

• Term or Protection Component

It consists of that portion of premium actually needed to pay the cost of the risk.

• Cash value Element

It is made up of accumulated excess payments of the policy holder. It constitutes the saving component.

Premiums collected in early years of the contract are held in trust by the insurance company for the benefit of its policy holders. The amount  so collected is called a "reserve". An insurance company keeps this reserve to meet the future obligations of the insurer. The excess amount also creates a fund known as the "Life Fund". Life Insurers invest this fund and earn an interest.

Difference between Life Insurance and General Insurance

General  ( Non Life ) Insurance                                                           Life Insurance

Indemnity : It Means the loss which has been                           Life Insurance policies are contracts 

occurred will be compensated to the extent of loss                    of assurance. The principle of 

It is applicable only for non life insurance except personal        Indemnity is not applicable for life 

 accident insurance                                                                        insurance

Uncertainty : In general  insurance contracts, the risk event     In the case of life insurance, there is 

protected against is uncertain                                                      no question whether the event death 

                                                                                                     would occur or not. Death is certain                                                                                                           once a person is born. What is                                                                                                                    uncertain is the time of Death

Increase in probability : The Probability of the                        The probability of death increases       happening of the event does not increase with time.                    with age

Short term : to be renewed every year / occasion                      Long Term : run for 10,20 or more                                                                                                              years

Life Insurance Involves

1. ASSET - a kind of property that yields value or a return
2. Human Life Value (HLV):

• Developed by prof.Hubener
• HLV concept considers human life as  a kind of property or asset that earns an income
• It measures the value of human life based on an individual's  expected Net future earnings. these earnings are capitalized, using an appropriate interest rate to discount them.
• Helps to determinr how much insurance one should have for full protection 
• the amount of insurance should be around 10 to 15 times of one's annual income

     3. Typical concerns faced by ordinary people

• Dying too early
• Living too long
• Living with disability