Calculation of Net Liabilities and Calculation of Life Insurance Fund

Calculation of Net Liabilities and Calculation of Life Insurance Fund

The valuation involves calculation of net liabilities apart from this main process; the valuation also includes comparison of insurance funds with the net liabilities during a particular period. The comparison will reveal the surplus or deficiency which is treated accordingly.

If the fund is more than the net liabilities (reserves), it would be a case of surplus. Similarly, deficiency will occur where the insurance fund is less than the net liabilities.

I. Calculation of Net Liabilities :

The Net liabilities may be calculated with prospective method or retrospective method. Whatsoever method may be applied, the result will be the same provided the past assumptions are also applicable to future estimations.

In other words, if deaths occurred as anticipated, interest earned is also as expected and expenses are also incurred according to assumptions, there will be no difference between the value accumulated (retrospective reserve) and the present value required (prospective reserve) to meet the obligations.

This brings out the fact that policy value would be the same whether obtained retrospectively from past experience or prospectively on future anticipation. But in practice, the assumed rate of mortality has been observed more than the anticipated mortality.

Similarly, the assumed rate of interest has been lesser than the future rate of interest. Thus, the retrospective value has been more than the prospective values.

It has been made clear while explaining the relative merits of these methods that the valuation is made on the gross premium. In the chapter of reserve we have dealt with the calculation of reserve on the basis of net premium.

But, so far determination of solvency is concerned, reserve or value is calculated on gross premium where we take into account not only mortality and interest but expenses also.

(a) Prospective Value :

The excess of present value of future claims over the present value of the future premiums is called net liability. There will always be excess because the net liability is calculated after some time of the commencement of the policies.

The calculation has been explained in detail in the chapter of reserve. There is only difference of gross and net premium. Here the value is calculated on the basis of gross premium. The method reveals the net liabilities up to which the Insurer must have sufficient funds.

(b) Retrospective Method:

Under this method, the premium is accumulated every year with certain rate of interest after meeting the claims. The accumulated excess is called life values (reserves). The actual accumulated funds should always be more than the assumed reserves.

But if the insurer has experienced heavier mortality than what he expected, earned less interest, or incurred greater expenses, the excess of his income over outgo would be less than what it ought to be. If it were so, the insurer’s position is not solvent because if this state of affairs were left to continue, he would not be able to meet his future obligations.

Similarly, if his experience had been favorable, he would have accumulated more than what he ought to have accumulated and this difference is therefore the ‘Surplus’.

I. Bases of Valuation of Net Liabilities :

While calculating rates of premium, the insurer bases his calculation on mortality rates, interest, expenses and bonus loading on past experience. But, at the time of valuation of net liabilities, assumptions would have been changed completely and the estimation of ‘net liabilities’ would be erroneous.

Therefore, it is very essential to calculate the ‘net liabilities’ only on the future estimation which are expected to occur because the net liabilities do not represent past; it reveals the future responsibilities. These bases of calculation of net liabilities are discussed in the following sections.

(i) The Mortality Rate:

The morality rate is assumed that which is likely to be experienced in future during the policy. The past mortality which is revealed recently is modified in the light of present conditions and future prospects of the mortality rates.

(ii) Rate of Interest:

Like mortality rates we are not depending upon the past assumed rate; but we should base our valuation on such rates which may reasonably be anticipated. The expectation of future earnings is well regarded although some conservative rates are used for valuation.

(iii) Rate of Expenses:

The appropriate expenses should be assumed. Past expenditure ratios may not be the correct figure of valuation. The future expense may be unduly heavy, if businesses are expanding or vice versa is also true. All the classes of expenses are well anticipated for purpose of valuation.

(iv) Bonus Rate:

Premiums on the participating policies are loaded with bonus extras. In exchange of the bonus loading, the participating policyholders are getting bonus. At last, past years’ bonus should be distributed. So the bonus loading must assume at least previous loading.

2. Calculation of Life Insurance Fund :

The Life Fund is obtained from the revenue account of the insurer. The previous fund is shown in the credit side of the revenue account in respect of life insurance. During the period, all incomes including premiums, interest, rents, etc., are credited to the revenue account and all payments, like policy claims, annuities, management expenses etc., are debited to the account.

The difference of the two sides will disclose the Life Insurance Funds available to insurer at the end of the period. The excess of the incomes over the expenditures during the year will disclose the life insurance fund of the year.

Thus, the Life Insurance Fund at a particular date is the accumulation of previous excesses of actual total income to total expenditures in respect of life insurance business. Here, it should be noticed that the Life Insurance Fund is different from Life Insurance Reserve.

The Fund reveals the actual amount with the insurer whereas the Reserve discloses the net liabilities of the insurer. Reserve ensures what amount should be with the insurer to pay the claims and Fund replies what amount is with the insurer.

3. Comparison of Net Liabilities with Life Insurance Fund :

The valuation in India is done in every alternate year because the process of valuation of net liabilities’ is very different and it cannot be estimated every year. The insurance Act has provided that the valuation should be done once in a period of 3 years.

However, the Life Insurance Corporation of India has taken a liberal attitude and makes the valuation once within 2 years. The last valuation was done on 31st March, 1977 and the next valuation will be on 31st March, 1979:

The comparison of net liabilities with Life Insurance Fund will disclose surplus or deficiency, if the former is less than the latter one, surplus is create and when the former is more than the latter one, deficiency is arrived.

Treatment of Deficiency :

When deficiency arises, the insurer has to apply some drastic actions such as the expenses are curtailed, profitable investments are sought and bonus is not declared. The premium rates are increased. But increase in premium rates causes reduction in business.

Treatment of Surplus :

The surplus arrived on can be distributed among the policyholders and shareholders only after certain provisions. The provisions may be General Contingency Fund, Dividend Equalisation Fund, Bonus Equalisation Fund, and Taxation Fund.

As is clear from their names, these funds are provided for meeting certain objectives, e.g., constant rate of bonus to the policyholders or dividend to shareholders.