12

The Reserve

Slide prepared by: Abdullah Al Yousuf KhanAssistant ProfessorIUBAT12

ChapterMcGraw-Hill/IrwinCopyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.12/21/2015Slide prepared by:AAYK1.NatureThe reserve in life insurance is different from the reserve in other business.It is not accumulation of profit.In life insurance, it is a liability which is to be met by insurer at and when it arises.It represents a liability which must be adequately met. 22.Definition The reserve is that fund, which together with future premiums and interest, will be sufficient to pay future claims.The reserve is considered as the accumulation at interest of the difference between the net premiums received and claims paid out.33.Origin of ReserveThe reserve originates in the excess of premiums receipts over payment of claims. The premium receipts are more than the payments in the beginning and less after a point. The excess receipts are accumulated at the assumed rate of interest and build up the reserve up to a point of time.The reserve grows, particularly, because of such receipts. 44.Sources of ReserveThe first and foremost source of reserve is premiums.Assessment Premium PlanNatural Premium PlanLevel Premium PlanThe second source of reserve is interest because the accumulated fund (premiums) is not remained idle. Nature of Policy55.Need for ReserveTo Meet the Amount of Claims;The insurer must have sufficient amount to meet the claims. Therefore, the reserve is essential to meet these claims.To Build up Funds;The reserve is also useful to build up funds that can be invested for a longer period to earn at least assumed return.Policyholders Benefit;The accumulated fund (the reserve) belongs to the policyholders and is safely and profitably invested by the insurer.66.Methods of Calculating Reserve76.1Retrospective MethodThe reserve is derived entirely by reference to past experience.The reserve represents the net premiums collected by the insurer for a particular class of policies plus interest (at an assume rate), less the death claims paid out.For each year how much would have been received on the basis of assumed interest rate and how much would have been paid by way of claims on the basis of assumed mortality figure. 86.1.1.Group ApproachThe begins with the first year when the total net premium has been received for the first time.We then determine the amount of interest that this total of net premiums receipts will earn one full year at the assumed rate of interest. For the total of these two claims paid for the first year are deducted to get the reserve. 9Example There are 10 policyholders insured for tk. 10,000 each for the period of 10 years. They are required to pay net premium of tk. 1,000 each. The rate of interest is 10 percent per year.First yearTk.Net premiums of 10 policyholders @tk. 1,000 each10,000Add: interest @ 10% 1,000Total amount11,000Less: claims paid out (no claims)0Terminal reservetk. 11,000Second yearNet premiums of 10 policyholders @ tk.1,000 each10,000Add terminal reserve of last year11,000Initial reserve 21,000Add: Interest @ 10%2,100Less: claims paid out (on death)10,000Terminal reservetk. 13,10010Individual ApproachA policyholder takes a policy of tk. 10,000 for 10 years and pays tk. 1,000 an annual premium, the rate of interest is 10 percent. The probability of death, in the first year, is 0.002 and, in the second year, 0.003. we have to calculate the reserve for two years. The equation used to calculate;Cost of insurance = amount of risk x probability of death = (policy amount initial reserve) x probability of death 11Example First yearTk.Net premiums 1,000Add: interest @ 10% 100Total amount1,000Less: cost of insurance0= Amount of risk x probability of death= Policy amount reserve x probability of death= 10,000 0 x 0.002201,080Second yearNet premium1,000Add: reserve of last year1,080Initial reserve tk2,080Add: Interest @ 10%208Total2,288Less: Cost of Insurance (10,000 1,080) x 0.003 =26Terminal reserve tk. 2,26212Prospective Method13End of Chapter

14