Life Insurance Contract Design and Pricing
This domain tests how product promises become premiums, reserves and profit, including assumption-setting, profit testing and regulatory charge limits.
Pricing mechanics
A pricing model projects premiums, claims, surrenders, expenses, commissions, reinsurance and investment return, then deducts reserves to obtain profit. Assumptions cover mortality/morbidity, interest, expense inflation, lapse and tax. Premiums must be adequate, equitable and not excessive. Best-estimate assumptions are supplemented by margins, and sensitivity testing shows how profit responds to adverse experience. Participating products add asset-share and bonus-smoothing logic; ULIPs use explicit charges, with the fund management charge capped at 1.35% p.a. (1.00% for group). Benefit illustrations follow prescribed rates.
Worked example
A 20-year endowment has a premium of ₹50,000, expenses of 10% in year one and 3% thereafter, expected claims and a 6% investment return. After accumulating premiums and deducting expenses, claims and reserves, the asset share is ₹1,20,000 against a guaranteed sum assured of ₹1,00,000. The ₹20,000 surplus supports bonuses, with at least 90% passing to policyholders. If lapse experience worsens, the asset share falls and the bonus scale may be unsustainable.
Traps
Using the same lapse assumption for par and ULIP products; ignoring reserves when measuring profit; double-counting margins; treating the risk discount rate as an investment return; forgetting that ULIP charges are explicit and capped.