Utilisation of life insurance premiums
Insurance being the equitable transfer of the risk of a loss from one entity to another in exchange for payment primarily used to hedge against the risk of a contingent and uncertain loss thrives on what is called premium.
The transaction involves the insured assuming a guaranteed and known relatively small loss in the form of payment to the insurer in exchange for the insurer's promise to compensate the insured in case of a financial loss. The insured pays a premium and receives a contract, called the insurance policy which details the conditions and circumstances under which the insured will be financially compensated.
Indeed, the recent insistence on insurance policyholders to pay upfront has further deepened the ancient belief that insurance companies are enriched with ‘supposedly’ free monies. This ‘misplaced’ belief, therefore, has essentially prompted the need to put the subject in proper perspective.
What is an insurance premium?
The insurer is a risk-bearing company selling the insurance and the insured, risk transferor, is the person or entity purchasing the intangible product called insurance. The amount of money to be charged for a certain amount of insurance coverage is called the PREMIUM.
In other words, insurance premiums can also be described as the financial costs involved in taking up an insurance policy, usually paid as a one-off or in monthly, quarterly and sometimes daily installments, over the duration of the policy. The renewal of insurance policies is often activated by the continuous payment of premiums. In this case, an insurance policy is automatically cancelled / lapsed if no premiums are received until after outstanding premiums are paid within a defined period, thus reinstating the policy.
What informs life insurance premiums?
Insurance premiums are often informed by such factors as perceived or expected risks, expected sum assured. The premiums are determined by a number of underwriting factors including one’s age, gender, lifestyle, medical conditions among others.
Why life insurance premiums are not free monies
Life insurance premiums can be likened to bank deposits – the owner or his or her heirs would definitely come for them! Life insurance premiums are received in advance of assured risks or financial projections. For example, for an Endowment Policy, one can decide to take a policy for the next 10 years and expect a projected returns on investment plus total contributions of say GH¢10,000 less administrative charges which are often applied in the early months/years of the policy’s existence.
Once the policyholder maintains the policy over the agreed term (say 10 years), he or she is entitled to the policy’s fund value (i.e. total contribution Plus accrued interest). However, in the unfortunate event of death before the policy maturity, the nominated beneficiary of the policyholder is paid the maturity or expected fund value at the end of the policy, without prejudice to the time of the death of the policyholder.
What happens to risk premiums?
In the case of risk policies such as funeral policies, however, a defined waiting period (say six months) may be allowed before the payment of such claims. On the other hand, until death occurs, no claims are paid on pure risk policies. For instance, if one takes out a funeral policy and ‘refuses’ to die after several years, he / she is still expected to continue to pay the required premiums until the unfortunate inevitable event of death (i.e. premium will continue ‘Till Thy Kingdom Come’).
Insurance is akin to the traditional “Ndoboa’’ system in Ghana where there is a communal assistance in the unfortunate event of a calamity. It is a pool where individuals with similar risks are grouped into so that if any mishap befalls any member in that pool, he or she would be indemnified with a defined sum of the funds in the pool.
Individuals in a group
The thrust is that, if you take for instance, Group Life Comprehensive Policies, which involve employers taking out a form of scheme insurance for their staff and paying premiums annually, if in a particular year there is no claim resulting from the death of a member, the premiums already paid are retained by the insurer. This is, therefore, what is often misconstrued as free money to the company. The fact that nobody dies in Company A in a particular year does not mean there was no death in some other company, say Company Q, whose members are also in the pool. Thus, the pool, into which all employers have contributed, then becomes the guaranteed source of reserves to pay claims.
Besides, there may be no death this year, but there could be death the following year in that organisation and the claims paid could wipe out the previous years’ contributions, leaving the pool badly depleted, and the insurers, ultimately running a deficit.
Do life insurers really earn premiums?
The answer is an outright NO! The reason is that whether a person lives on to come for an early claim or dies for his or her nominated beneficiary to make the claim, the premiums so collected will invariably be paid out in claims. The life insurers are only likely to earn their income through returns on investment or when there is a pure risk that does not happen! In short, life insurers are only keeping the premiums for the insured that will definitely come for them in the future.
Inherent product profitability
Life insurers in particular earn Inherent Product Profitability from mainly risk products, which have higher margins than the savings products.
The components of life insurance finances are principally in the following key areas: Revenue, Expenditure, Asset, Liability and Shareholders’ Fund. When all these come to play, it is easy to realise that insurance companies rarely earn so much as perceived by a section of the public. Because insurance funds are against future uncertainties, managers of these funds pay particular attention to prudence by investing a large chunk of these funds in short and long-term financial instruments to generate enough returns to enable them pay claims.
Industry statistics
Life insurance dominates the market, accounting for 59.7 per cent of the market’s value. A strong, growing life insurance industry remains one of the key avenues for domestic financing for local infrastructure and economic development across the globe. In spite of the annual industry premium income growth averaged at about 52 per cent in Ghana in 2010, life both and general insurance penetration in Ghana is still less than one per cent of GDP, creating a significant opportunity for future growth and drawing interest from global life insurance firms seeking to tap into the industry’s unexploited opportunities.
The life insurance industry in 2013 made cumulative premium income of GH¢468 million with cumulative claim and administrative cost of GH¢327million, representing 69 per cent of industry premium income for 2013 leaving the industry with only a paltry 31 per cent of the premium income for investment against future claims.