Risk Analysis

Modified Products Money Back Policies These are endowment type plans and are also called Anticipated Endowment Policies. Under such products a certain percentage of the sum assured is paid to the proposer at regular interval, generally after every 4 or 5 years. The balance of the sum assured is payable on the date of maturity along with the bonus. However, the risk remains covered for the full sum assured throughout the policy term subject to the policy being in force. Illustration: for a policy with a term of 12 years, l/5th of the sum assured becomes payable on the life assured surviving 4 years, a further 1 /5th of the sum assured becomes payable on his surviving 8 years and the balance 3/5th of the sum assured on his surviving to the end of the term of 12 years Generally such policies are with profit policies and, therefore, the bonus amount will also be paid along with the balance sum assured. Hence under a policy of rupees 1 Lac sum assured, rupees 20,000/- will be paid on insured surviving for 4 tears, another 20,000/ - will be paid on his surviving 8 years and balance 60,000/- along with bonus will be paid on surviving the term of 12 years i.e. on the date of maturity. In case of earlier death at any time during the term, rupees 1 Lac along with bonus is payable. The bonus will always be calculated on basic sum assured. The death risk also remains constant for rupees 1 Lac subject to policy being in force at the time of death. If the insurer so desires he can frame a money back policy where 25% is payable after every four years and balance 50% may be paid on maturity. The money back policies on the above pattern are available for 15/ 20/ 25 years term where survival benefits ranging from 15% to 25% are paid after every 5 years interval as per terms of the policy. However, in a 20 years policy the first survival benefit may be paid after 10 years and in a 25 years policy after 15 years. Above products although costly yet are very popular in the market. In temptation to buy such policies one should not forget to cover death risk adequately. Joint Life Endowment Insurance Plan Normally husband and wife are covered under a single policy in such a plan. Death risk is covered for both the partners. On maturity sum assured is paid along with bonus. In case of death of any partner during the term of the policy, the basic sum assured is paid to the surviving partner and further premiums are waived and the policy remain in force. On maturity basic sum assured is paid with bonus to the surviving partner. Such policies can be issued for business partners as well with some modification. CFP Level 3: Module 1 – Risk Analysis – India Page 245

Marriage Endowment Policies These are endowment type of policies where the sum assured is payable only on the expiry of the policy term. Such policies are bought to save money for the marriage of the children. In case the proroser dies during the term of the policy, the premium payment ceases (if policy is with premium waiver benefit) and policy continues and the sum assured is paid on the expiry of the policy term along with the bonus, if the policy is with profit, to serve the specific purpose for which it was purchased. Some insurer pay basic sum assured on death during the term and another sum assured along with bonus on maturity. Children Deferred Plans/Children Anticipated Plans These are also endowment type plans taken on the lives of minors. A parent signs the contract on behalf of the child. The risk of child is not covered immediately and is deferred for sometime as per age of the child and policy provisions. On attaining majority, the child becomes the owner of the policy. The benefit of taking such a plan is that a father/ mother can buy this policy at a lower premium because of young age of the insured and it also inculcates a habit of saving in children. The amount received on maturity can help the child to establish himself / herself in life. Such plans are also issued in the form of money back policy where periodical payments are received before the final payment on maturity. The policies are called Children Anticipated Plans. Children Education Plan/Annuities These policies are also on the pattern of marriage endowment policies except the payment of the sum assured is spread over in 4 to 5 yearly instalments. The parents generally take such policies for the term when the child attains age 21 or so for meeting his/her higher educational expenses. Most of the educational plans are with profits. It will be observed that though above two plans are for the benefit of the children but coverage of risk is on the life of the parent, the proposer. Some insurers call these plans as children protection plans. CFP Level 3: Module 1 – Risk Analysis – India Page 246

Investment Linked Insurance A New Generation of Permanent Products During the decades of the 1970s and 1980s, the North American economy changed to such a degree that insurers, like many other financial institutions, were forced to take a long look at the products they offered. Inflation hit record highs; interest rates on savings accounts and consumer loans soared. Consumers realized that the cash values of their whole life policies were earning investment returns at rates that were much lower than the rates that savings accounts and other investment vehicles could earn. Insurers realized that much of their invested assets were earning a lower return than could be obtained through newer investments. To address the need for insurance products that were more responsive to the changing economy, insurers began marketing a new generation of insurance products. These plans are characterized by their ability to reflect current conditions in the financial marketplace. These new generation products include universal life, adjustable life, variable life, variable universal life, interest-sensitive whole life, and indeterminate premium products. Unit linked Insurance Plans These are market-linked insurance products also called Unit-Linked Insurance Plans (ULIP). Unit-Linked plans are fundamentally different from the conventional life insurance policies. Unit Linked Insurance offers the benefits of: a. Risk Cover (which can be a life cover or life cover with accident benefit or life cover and critical illness cover and accident benefit) b. Investment of savings in the capital market to ensure market linked returns to the insured c. Tax Benefits: income tax relief is available like in any other life insurance policy. CFP Level 3: Module 1 – Risk Analysis – India Page 247

It is a flexible saving Plan with transparency as to what portion of the premium is being invested in the market and how much of the premium is being earmarked for various expenses and charges. The investment of savings portion is made in the manner desired by the insured. Such Plans are normally for a fixed term but some insurers are offering such plans for whole life. Sometime there is an option to extend the term as per policy provision. The Plans carry a sum assured to cover the risk of death. Insurer collects contribution (Premium)) from the policyholders. A small portion of the premium is used to provide life cover, called mortality charges. After deducting the administrative and fund management charges, which are made known to the insured, the balance amount is used to purchase units in the investment Fund chosen by the insured. The units will be purchased on behalf of the insured as per the prevalent market price called offer price. Some Examples of the Funds are: Equity Fund Major portion of savings is invested in Stock Market. Some of these funds are Diversified Fund, Mid Cap Fund, Low Cap Fund, and Sector Fund. Debt Fund Major portion of savings is invested in Debt Market like investment in Government Securities, AAA/AA Rated PSU Bond/ Corporate Bonds/ or mix of them. Balanced Fund Savings are partly invested in Stock Market and partly in Debt Market. The proportion of equity and debt may be in the range of 40 to 60 or vice versa. The insurance company may offer more types of funds to satisfy some specific investment need of the insured. The policyholder should select the funds for investment after careful consideration and looking to his profile and financial position. For instance, selecting equity fund may also bring the risk of fluctuation in the market that can deplete his capital. Hence, the policyholder should park the fund after consulting an investment consultant. CFP Level 3: Module 1 – Risk Analysis – India Page 248

Other Salient Features of Unit Linked Insurance are: In conventional type of policies, sum assured is a guaranteed amount payable on death and/ or maturity but in ULIPs the situation is quite different as discussed below: Death Benefit The value of the plan (the amount paid on death or maturity) is directly linked to the value of the fund. Upon death prior to expiry of the term the amount paid out is the sum insured or the value of the units whichever is greater. In other words, if the insured dies during the term of the policy, sum assured or the value of the units whichever is higher is payable to the nominee/ legal heirs. Maturity Benefit On the date of maturity only the market value of the units is payable. Hence there is no guaranteed amount payable on maturity. The value of the units depends upon the net value of the investment in the fund. The Net Asset Value (NAV) of a Unit is declared periodically. There is liquidity in such plans as the insured can withdraw / partially withdraw by selling units to the insurance company at prevalent NAV subject to the policy provisions. IRDA has taken some restrictive steps to reduce the liquidity so that the plans are not used only as an investment tool. Flexibility in Payment of Premium A unit-linked policy can be structured with flexibility in the payment of premiums. If the insured does not pay some premium, the risk of death remains covered by deducting the mortality charges by canceling the appropriate number of units from his account. This depletes the number of units in ones account. There is also an option to make lump sum payment in addition to the regular premium to enhance the saving content as per the policy conditions. This additional remittance is called Top-Up. There are also options to switch from one fund to another fund. This way one can park his money in the fund of his choice looking to the prevalent market conditions at any time during the currency of the policy. A separate unit amount maintained for each insured person. Periodical statement is sent to the policyholder informing him the number of units accumulated in his account, NAV of the units and total CFP Level 3: Module 1 – Risk Analysis – India Page 249

value of his investment. He is also informed about the various charges and expenses deducted from his account. Some of the Important guidelines Issued by IRDA on Unit Linked Insurance Products: Cir. No. IRDA/ACT/CIR/ULIP/102/06/2010 June 28, 2010 Sub: Unit Linked Insurance Products (ULIPs) In order to meet the emerging needs of prospective insurance policyholders, this circular specifies certain elements which shall be incorporated in all ULIPs which may be offered for sale to the public commencing from September 1, 2010. 1. The three year lock-in period for all Unit Linked Products will be increased to a period of five years, including top-up premiums. During this period, no residuary payments on policies which are lapsed/surrendered/ discontinued will be made. The residuary payments for policies arising out of policies which stand lapsed/ surrendered/discontinued during the lock-in period shall be payable on the expiry of the lock in period and in accordance with the relevant Regulations of IRDA. 2. All regular premium/limited premium ULIPs shall have uniform/level paying premiums. Any additional payments shall be treated as single premium for the purpose of insurance cover. 3. All limited premium unit linked insurance products, other than single premium products, shall have premium paying term of at least 5 years. 4. The insurers shall distribute the overall charges, in ULIPs in an even fashion during the lock-in period. 5. All unit linked products, other than pension and annuity products shall provide a minimum mortality cover or a health cover, as indicated below: (i) Minimum mortality cover should be as follows: Minimum Sum assured for age at entry of Minimum Sum assured for age at entry of 45 below 45 years years and above Single Premium (SP) contracts: Single Premium (SP) contracts: 125 percent of single premium. 110 percent of single premium Regular Premium (RP) including limited Regular Premium (RP) including limited CFP Level 3: Module 1 – Risk Analysis – India Page 250

premium paying (LPP) contracts: premium paying (LPP) contracts: 10 times the annualized premiums or (0.5 x 7 times the annualized premiums or (0.25 X T T x annualized premium) whichever is X annualized premium) whichever is higher. At higher. At no time the death benefit shall no time the death benefit shall be less than be less than 105 per cent of the total 105 percent of the total premiums (including premiums (including top-ups) paid. top-ups) paid. (In case of whole life contracts, term (T) shall be taken as 70 minus age at entry) (ii) The minimum health cover per annum should be as follows: Minimum annual health cover for age at Minimum annual health cover for age entry of below 45 years at entry of 45 years and above Regular Premium (RP) contracts:5 times the Regular Premium (RP) contracts: 5 time annualized premiums or ₹100,000 per the annualized premiums or ₹75,000 annum whichever is higher. per annum whichever is higher. At no time the annual health cover shall be At no time the annual health cover shall less than 105 percent of the total premiums be less than 105 percent of the total paid. premiums paid. 1. All top-up premiums made during the currency of the contract, except for pension/annuity products, must have insurance cover treating them as single premium, as per above table. 2. The accumulated fund value of unit linked pension/annuity products is the fund value as on the maturity date. All ULIP pension/annuity products shall offer a minimum guaranteed return of 4.5 per cent per annum or as specified by IRDA from time to time, on the maturity date. This guaranteed return is applicable on the maturity date, for policies where all due premiums are paid. Mortality and/or health cover could be offered along with the pension/annuity products as riders, giving enough flexibility for the policyholders to select covers of their choice. 3. In the case of unit linked pension/annuity products, no partial withdrawal shall be allowed during the accumulation phase and the insurer shall convert the accumulated fund value into an annuity at the vesting date. However, the insured will have an option to commute up to a maximum of one-third of the accumulated value as lump sum at the time of vesting. In the case of surrender, only a maximum of one-third of the surrender value can be commuted after the lock-in period. The remaining amount must be used to purchase an annuity, subject to the provisions of Section 4 of Insurance Act, 1938. CFP Level 3: Module 1 – Risk Analysis – India Page 251

4. Caps on charges were fixed on Unit Linked contracts with a tenor of 10 years or less and for those with tenor above 10 years. However, taking into account the discontinuance/ lapsation/ surrender behavior and with a view to smoothen the cap on charges, the following limits are prescribed starting from the 5th policy anniversary: Annualized Premiums Paid (Difference between Maximum reduction Gross and Net Yield (% pa)) in yield 5 4.00% 6 3.75% 7 3.50% 8 3.30% 9 3.15% 10 3.00% 11 and 12 2.75 % 13 and 14 2.50 % 15 nd thereafter 2.25 % 1. The net reduction in yield for policies with term less than or equal to 10 years shall not be more than 3.00% at maturity. For policies with term above 10 years, the net reduction in yield at maturity shall not be more than 2.25%. 2. The maximum loan amount that can be sanctioned under any ULIP policy shall not exceed 40% of the net asset value in those products where equity accounts for more than 60% of the total share and shall not exceed 50% of the net asset value of those products where debt instruments accounts for more than 60% of the total share. Insurance Linked Annuities Difference between Annuity and Life Insurance Annuity Life Insurance 1. It is not Insurance. So no Risk cover. 1. Covers the risk of life - death and disability. 2. Receive the interest on the fixed 2. Accumulated bonus on the sum insured can be CFP Level 3: Module 1 – Risk Analysis – India Page 252

investment as promised. withdrawn during the policy period or at maturity. 3. Interest and last receipts are taxable. 3. No receipts are taxable. An annuity is a contract/ which provides a series of periodic payments. An annuity contracts is an insurance policy, under which the annuity provider (insurer) agrees to pay the purchaser of annuity (annuitant) a series of regular periodical payments for a fixed period or over someone's lifetime. Types of Annuities Annuities can be classified on the basis of  The number of lives covered  Single  Joint  The beginning of the payment of annuity  Immediate annuity  Deferred annuity  Method of premium payment  Single premium  Regular installment  Period of payment of annuity  Annuity Certain  Life Annuity  Life Annuity with guarantee  Quantum of annuity installments  Fixed CFP Level 3: Module 1 – Risk Analysis – India Page 253

 Variable  Index linked Single life annuities provide for payment of the periodical installments during the lifetime of the single annuities under the contract. Joint life annuities provide for payments during the lifetime of 2 annuitants. Here again it can beJoint life last survivor annuity' where annuity is payable as long as either one of them is alive. A joint life annuity provides for payments, which stop on the first death among the covered lives. Immediate annuity: Annuity payments begin immediately on purchase, with the purchase price being paid in a single installment of premium. The first installment of annuity will become due at the end of one payment interval (month, quarter, half year or year). Under deferred annuity the annuity installments begin at the end of a selected term of years (or on the annuitant's reaching a chosen age). Here the purchase premium can be paid in a single installments or the annuitant can choose to pay the premiums in regular installments spread through the deferment period. Annuities which are payable as long as the annuitant is alive is alife annuity' and the one which is payable for a definite number of years irrespective of whether the annuitant is alive or not is called anannuity certain'. A combination of these two is also prevalent, where the annuity payments are guaranteed for a definite period of years and thereafter for the life of the annuitant. Similarly, the annuity installments can be guaranteed to be paid during the lifetime of the annuitant and upon his death, a lump sum installment bearing a certain relationship to the face value (or purchase price) of the policy shall become due for payment. On the basis of the quantum of annuity installment payable, they can be classified as fixed annuity or variable annuity. A fixed annuity, as the name suggests, provides for a fixed sum of money to be paid periodically. Whereas a variable annuity is an annuity contract whose cash values and benefit payments vary directly with the experience of the assets allocated to the contracts. Every contract will have a separate account, to which the premium paid by the annuitant will be credited. The amount in the account will be utilized to purchase financial assets and the annuity that the contract will fetch will directly depend upon the value of the assets in the account backing the contract. Taxation of Individual Annuities Unlike what we have seen in the case of life insurance policies, the money received by the annuitant as per the annuity contract are treated as income and taxed at his hands. The premium paid by the annuitant for the annuity contract or the annuity policy is eligible for deduction under section 80C CFP Level 3: Module 1 – Risk Analysis – India Page 254

within the overall limit prescribed, provided such a policy does not provide an option to avail of a cash option in lump sum in lieu of the annuity payments. Classification of Annuities We can classify every annuity according to various criteria. In order to understand how a given annuity operates, we have to know:  How the annuity was purchased?  How often periodic annuity benefits are to be paid?  When annuity benefit payments are scheduled to begin?  The number of annuitants covered by the annuity policy? and  Whether annuity values are guaranteed or variable? Let's look at each of these criteria to get a better idea of the various ways that annuity policies may be structured. How Annuities are Purchased Most annuities today are purchased as single-premium annuities. A single-premium annuity is an annuity that is purchased by the payment of a single, lump-sum premium. Benefit payments under a single-premium annuity may begin shortly after the premium is paid or may begin many years after the premium is paid. An annuity also can be purchased by paying periodic premiums over a period of years. Periodic premiums can be paid by two methods: (1) on a level-premium basis or (2) on a flexible-premium basis. Under a periodic level- premium annuity, the contract holder pays equal premiums for the annuity at regularly scheduled intervals, such as monthly or annually, until some predetermined future date. Premiums might, for example, be payable annually for a stated number of years. Under a flexible-premium annuity, the contract holder pays premiums on a periodic basis over a stated period of time; the amount of each premium payment, however, can vary between a set minimum amount and a set maximum amount. For example, the policy might allow the contract holder to pay any premium amount between ₹250 and ₹10,000 each year. The contract holder can also choose not to pay any premium in a given year; the only requirement is that any premium amount paid each year must fall within the stated minimum and maximum. Hexible-premium annuities are sold far more often CFP Level 3: Module 1 – Risk Analysis – India Page 255

today than are periodic level-premium annuities. (See Appendix C for a sample flexible-premium annuity policy.) The operation of an annuity is basically the same regardless of whether the premium is paid in one sum or in a series of payments. The premium payment method, however, affects the length of time that the insurer holds the principal at interest. And the longer the insurer holds a given premium, the larger will be the investment earnings generated by that principal. How Often Benefits are Paid The frequency of periodic annuity benefit payments depends on the length of the annuity period. An annuity period is the time span between each of the payments in the series of periodic annuity benefit payments. The annuity period is typically either one month or one year, but other options, such as quarterly or semiannual, are also available. For example, an annuity policy that provides for a series of annual benefit payments has an annuity periodof one year and is referred to as an annual annuity. An annuity policy that provides for an annuity period of one month is referred to as a monthly annuity. When Benefit Payments Begin The date on which the insurer begins to make the annuity benefit payments is known as the annuity's maturity date or the annuity date. An annuity can be classified as either an immediate annuity or a deferred annuity, depending on when the insurer is to begin making periodic annuity benefit payments. Immediate Annuities An immediate annuity is an annuity under which benefit payments are scheduled to begin one annuity period after the annuity is purchased. Remember, an annuity period is typically one month or one year. Thus, if an immediate annuity contains an annuity period of one year, then the maturity date on which periodic annuity benefit payments will begin is one year after the annuity was purchased. Because benefit payments begin soon after an immediate annuity is purchased, an immediate annuity is generally purchased with a single premium; such a policy is known as a single-premium immediate annuity(SPIA). CFP Level 3: Module 1 – Risk Analysis – India Page 256

Deferred Annuities A deferred annuity is an annuity under which periodic benefits are scheduled to begin more than one annuity period after the date on which the annuity was purchased. Although a deferred annuity typically specifies the date on which benefit payments are scheduled to begin, the contract holder usually can change this date at any time before those benefit payments begin. People often purchase deferred annuities during their working years in anticipation of the need for retirement income later in their lives. The period during which annuity benefit payments are made is known as the payout period or the liquidation period. The period between the contract holder’s purchase of a deferred annuity and the onset of the payout period is known as the accumulate period. Because a deferred annuity has an accumulation period, the contract holder generally can choose to pay for the annuity either in a single premium or in a series of periodic premiums. Although most deferred annuities are purchased as single-premium deferred annuities (SPDAs), insurers also sell flexible- premium deferred annuities(FPDAs). Note that every annuity purchased with the payment of periodic premiums is by definition a deferred annuity. Example: When she was 48 years old, Jaya Ingle received a lump sum of ₹50,000. She used that amount to purchase a deferred annuity that will provide her with a benefit each month during her retirement years, beginning when she reaches age 65. Analysis: The information given in this example tells us that Jaya purchased a single-premium deferred annuity. The annuity has an accumulation period of 17 years - the time between Jaya's purchase of the annuity at age 48 and the time she begins receiving benefits at age 65. The annuity period is one month; therefore, the annuity is a monthly annuity. The insurer's obligations and the rights of the contract holder differ depending on whether a deferred annuity is in its accumulation period or its payout period. Let’s look at how a deferred annuity operates during these two periods. Accumulation period: During a deferred annuity's accumulation period, the insurer invests the premiums paid by the contract holder. Thus, during the accumulation period, the deferred annuity builds an accumulated value. An annuity's accumulated value is equal to the net amount paid for the annuity, plus interest earned, less the amount of any withdrawals. The manner in which the policy provides for investment earnings on the accumulated value depends on whether the deferred annuity is a fixed-benefit annuity or a variable annuity. We describe these distinctions later in the chapter. Accumulated Value of a Deferred Annuity = Net Amount Paid for Annuity + Interest – With drawls CFP Level 3: Module 1 – Risk Analysis – India Page 257

The contract holder typically can make withdrawals from a deferred annuity's accumulated value in accordance with the policy's withdrawal provision. The withdrawal provision grants the contract holder the right to withdraw all or a portion of the annuity's accumulated value during the accumulation period. Most annuity policies allow the contract holder to withdraw a stated percentage of the annuity's accumulated value each year without charge. If the contract holder withdraws more than that stated percentage in one year, then the insurer generally imposes a withdrawal charge. Withdrawals of less than a stated minimum amount are typically not permitted. Throughout the accumulation period, the contract holder also has the right to surrender the policy for its cash surrender value - the accumulated value less any surrender charges included in the policy. A surrender charge is typically imposed if the policy is surrendered within a stated number of years after it was purchased. The amount of any surrender charge that is imposed usually declines over time. An insurer usually imposes these surrender charges during the early years of an annuity policy in order to recoup the costs it incurred in issuing the policy. Cash Surrender Value of a Deferred Annuity = Accumulated Value – Surrender Charges Deferred annuity policies usually provide a survivor benefit; if the annuitant or contract holder dies before annuity benefit payments begin, the annuity's accumulated value is paid to a beneficiary designated by the contract holder. No surrender charges are incurred when the accumulated value is paid as a survivor benefit. Payout Period. When an annuity matures, the insurer uses the annuity's accumulated value to fund the periodic annuity benefit payments. Thereafter, all provisions relating to the policy's accumulated value - including the withdrawal provision and the survivor benefit provision - become inoperable, and the terms of the payout option provision govern the parties' rights and obligations under the policy. The payout option provision in an annuity policy lists and describes each of the payout options from which the contract holder may select. In the next section, we describe some of the payout options typically available under an annuity policy. When Benefit Payments End The length of the payout period depends on the payout option that the contract holder selects. Under the three general types of payout options available, the annuity benefits will be paid as either (1) a life annuity, (2) an annuity certain, or (3) a temporary life annuity. CFP Level 3: Module 1 – Risk Analysis – India Page 258

Life Annuity A life annuity is an annuity that provides periodic benefit payments for at least the lifetime of a named individual. Some life annuities also provide further payments guarantees. The various forms of life annuities and commonly available payment guarantees are described later in this chapter. The terminology used to describe the people connected with an annuity varies widely throughout the insurance industry. The named individual whose lifetime is used as the measuring life in a life annuity typically is called the annuitant. Note that the annuitant is not always the owner of the annuity, although in most situations the annuity contract holder and the annuitant are the same person. Just as we distinguish between the insured and the policy owner of a life insurance policy, we also need to distinguish between the annuitant and the contract holder. Additional confusion over annuity terminology results from the use of the term beneficiary in an annuity. An annuity beneficiary is the individual the contract holder names to receive any survivor benefits that the payable during the accumulation period of a deferred annuity. Once the payout period begins, the person who receives the annuity benefit payments is often known as the payee. Generally, the payee is also the contract holder. Example: Padma Chaturvedi is 53 years old and has just received an early retirement package from her employer. Part of that package was a ₹50,000 lump-sum payment. Padma has accepted a position with another employer and has used the ₹50,000 to purchase a deferred annuity that will make payments to her beginning when she retires at age 65. She named her daughter, Kavita, to receive the policy's survivor benefit. Analysis: Padma purchased the annuity, and, thus, she is the contract holder. Because annuity benefits will be paid to Padma throughout her lifetime, she is also the annuitant and the payee. Finally, because Kavita will receive any survivor benefits payable if her mother dies before the annuity benefit payments begin, Kavita is the annuity beneficiary. We will come back to the topic of life annuities later in the chapter. For now, let's return to our discussion of how annuities are classified. Annuity Certain An annuity can be purchased to provide periodic payments over a period of time that is unrelated to the lifetime of an annuitant. An annuity certain is an annuity that is payable for a stated period of time, regardless of whether an individual person lives or dies. The stated period over which the insurer will make benefit payments is called the period certain. At the end of the period certain, annuity payments cease. The annuity certain is useful when a person needs an income for a specified period of time. An CFP Level 3: Module 1 – Risk Analysis – India Page 259

annuity certain also might be purchased to provide income during a specified period until some other source of income, such as a pension, becomes payable. Example: Madhuri Hegde is a 50-year-old office manager who plans to retire at age 60. She will not begin receiving pension benefits from her employer-sponsered pension plan until she reaches age 65. Thus, she wants to purchase an annuity that will provide her with periodic benefit payments during the five-year period following her retirement before she begins receiving her pension benefits. Analysis: Madhuri wants to begin receiving annuity benefit payments in ten years, when she retires at age 60. Thus, she should purchase a ten-year deferred annuity. Madhuri wants to receive annuity benefit payments only until she will begin to receive her pension benefits. Thus, she should elect a payout option under which annuity benefits are paid as a five-year annuity certain. Temporary Life Annuity A temporary life annuity provides periodic benefit payments until the end of a specified number of years or until the death of the annuitant, whichever occurs first. Once the stated period expires or the annuitant dies, the annuity benefits cease. For example, under the terms of a five-year temporary life annuity, five years is the maximum length of time during which annuity benefits will be payable. If the annuitant dies before the end of that five-year period, no further annuity benefits will be payable. Although the temporary life annuity is not sold very often, it is sometimes purchased to fill a gap between the end of an earning period and the time some other anticipated income, such as a pension, begins. Number of Annuitants The examples we have looked at so far have all involved situations in which a life annuity was based on the life of one annuitant and benefits were paid to a named individual. It is possible, however, to purchase a life annuity that provides an income to more than one individual. When a couple purchases a life annuity, they usually want the annuity to provide benefit payments throughout both of their lives. A joint and survivor annuity, which is also known as a joint and last survivorship annuity, provides a series of payments to two or more individuals, and those payments continue until both or all of the individuals die. The terms of a joint and survivor annuity policy determine whether the amount of each periodic benefit payment remains the same after the death of one of the annuitants. For example, the annuity might provide that the amount of the periodic benefit payment will remain the same until the last annuitant dies, or the annuity might provide that the amount of the periodic benefit will be reduced by a stated amount, such as 50 percent, following the death of the first annuitant. Of course, the premium amount required to fund the annuity will vary, CFP Level 3: Module 1 – Risk Analysis – India Page 260

depending on the amount of benefits that are to be paid out - the larger the expected amount of benefit payments, the larger the premium required to pay for the annuity. Whether Annuity Values are Guaranteed or Variable People who purchase annuities have different purposes in mind for the funds they place in an annuity. Annuity contract holders also have different capacities for assuming a financial risk when they place money in their annuities. Thus, many insurers offer two general options to annuity purchasers: (1) the insurer will guarantee to pay at least a stated interest rate on the annuity funds it holds or (2) the insurer will pay interest at a rate that is not guaranteed; instead, the interest rate will vary according to the earnings of certain investments held by the insurer. Fixed-Benefit Annuities A fixed-benefit annuity is an annuity under which the insurer guarantees that at least a defined amount of monthly annuity benefit will be provided for each dollar applied to purchasing the annuity. Most fixed-benefit annuities specify that once the insurer begins paying annuity benefits, the amount of each benefit payment will not change. A new fixed-benefit annuities, however, specify that benefit payments may increase if the insurer's investment earnings exceed those the insurer expected when it calculated the benefit amount. If the fixed-benefit annuity is an immediate annuity, then the amount of the annuity benefit payments is known when the insurer issues the annuity policy. The purchaser pays a single premium amount, and the insurer calculates the annuity benefit amount that will be provided by that premium amount. If the fixed-benefit annuity is a deferred annuity, then the annuity policy includes a chart of annuity values. This chart lists the amount of annuity benefit that is guaranteed for each ₹1,000 of accumulated value on the maturity date is ₹20,000 and the annuitant is ages 40, then the insurer will pay the annuitant ₹82.60 per month (20 x ₹4.13 = ₹82.60) for the remainder of the annuitant's life. Note, however, that the amounts listed in the policy are the minimum guaranteed benefit amounts. These are the benefits amounts that the insurer is comfortable guaranteeing when it issues a fixed-benefit annuity. If the insurer's investment experience is more favorable than expected, then the insurer will pay a larger benefit than the guaranteed amount. When an insurer provides interest rate guarantees in an annuity policy, the insurer agrees to assume the investment risk of the policy. The insurer places the funds in relatively secure investments, such as bonds and real estate, as part of its general investment account. If the general investment accounts performs well, the insurer can pay interest rates that the higher than the rates guaranteed in its policies while still achieving profits from the investment account. The insurer, however, takes the risk CFP Level 3: Module 1 – Risk Analysis – India Page 261

that if its investments perform poorly and its investment returns are less than the minimums guaranteed in its policies, then the insurer will lose money. Variable Annuities A variable annuity is an annuity under which the amount of the policy's accumulated value and the amount of the annuity benefit payment will fluctuate in accordance with the performance of a separate account. The individual who purchases a variable annuity assumes the investment risk of the policy. Because the insurer makes no guarantees regarding the investment earnings or the amount of a variable annuity's benefit payments, the insurer retains no risk under the policy. Instead, the purchaser realizes all gains from profitable investments and incurs all losses from unprofitable investments. Variable annuities are considered to be securities contracts because of this investment risk transfer and, thus, are subject to federal regulations in the United States. Guaranteed Annuity A guaranteed annuity is a life annuity which is guaranteed to be payable for a minimum period regardless of when the annuitant dies. Thus, an annuity guaranteed for ten years will be payable for life or ten years, whichever is longer. If the annuitant dies during the guaranteed period then the balance of the guaranteed instilments will be payable to the nominee of the legal heirs as the case be. This type of arrangement is also called Annuity certain for 5/10/15 years and thereafter for life'. Annuity with Return of Purchase Price Some annuitants want that the capital or the purchase price of the annuity should be returned to the legal heirs after his death. Hence, there are annuities which pay life annuity and return the purchase price or the capital to the legal heirs or nominee as the case be on the death of the annuitant. There are also guaranteed annuities as discussed above where the purchase price is also returned on the death of the annuitant. The financial planner is duty bound to advise his client as to what type of annuity will suit him the most. CFP Level 3: Module 1 – Risk Analysis – India Page 262

Life Insurance Policy Analysis: Practice Sums Q1. A money back policy for 12 years with a sum assured of ₹5,00,000 pays 20% of the sum assured at the end of every three years and the balance at maturity. The premium per year is ₹80 per thousand sum assured. Calculate the rate of return at maturity assuming an annual bonus rate of ₹50 per thousand sum assured. Ans. Annual premium = (80/1000) X 500000 = 40000 Money back received = 500000 X (20/100) = 100000 at the end of 3rd, 6th & 9th years Sum assured payable at maturity = 500000 - (100000 X 3) = 200000 Bonus at Maturity = (50/1000) X 500000 X 12 = 300000 Rate of return for the money back policy: We use cash function of calculator in this question. Cash flow entries CASH OUTFLOW CASH INFLOW NET CASH FLOW 1 -40000 0 -40000 2 -40000 0 -40000 3 -40000 0 -40000 4 -40000 60000 5 -40000 100000 -40000 6 -40000 0 -40000 7 -40000 0 60000 8 -40000 -40000 9 -40000 100000 -40000 10 -40000 0 60000 11 -40000 0 -40000 12 -40000 -40000 13 0 100000 500000 IRR 0 12.85% 0 500000 Q2. The annual premium for a 20 year pure term policy of ₹12,00,000 sum assured is ₹4,920. A similar participating endowment policy charges an additional premium of ₹30 per thousand sum assured compared to the pure term policy. You client has being paying premiums regularly for the last sixteen years towards the participating endowment policy. The annual bonuses CFP Level 3: Module 1 – Risk Analysis – India Page 263

declared under the participating endowment policy were ₹50 per thousand sum assured. What is the rate of return under this participating endowment policy assuming that the client dies today? Ans. Annual premium for the participating endowment policy: 4920 + ((30/1000) X 1200000) = 40920 Rate of return under the participating endowment policy: SET = Begin; N = 16; I = 13; PV = X; PMT = -40920; FV = 1200000+((50/1000)X1200000X16) Q3. Your client purchased a single premium annuity policy by paying ₹50 lakh as premium when he was 53 years old and his spouse was 48 years old. The policy vested when the client became 60 years old with a purchase price of ₹1.61 crore in the form of an immediate life annuity with return of purchase price under the assumption that at least one out of the client and his spouse will survive till 85 years. The annuity amounts to ₹10.15 lakh. What is the maximum return expected from the vesting date? Ans. Note: Annuity policy: An annuity policy issued by a life insurance company is a pension policy where initially the client has to pay the premiums either on a lump sum (single premium) or periodic (regular premium) basis. Once the premium payment term is complete, the insurer starts paying the pensions. The date on which premium payment stops and pension payment starts is known as vesting. The total amount of corpus comprising of net premiums paid along with interest earned thereon is known as the purchase price. Tenure of the annuity: 85 - 55 = 30 years Rate of return under the annuity policy from the date of vesting: SET = Begin; N = 30; I = 6.72; PV = -1.61; PMT = -0.1015; FV = 1.61 Tax benefits in life insurance policies: 1. 80C/80CCC: 1. Benefit is available to Individual assessee and Hindu Undivided Family assessee. a. In case of individual assessee - Himself/herself, spouse, children of such individual b. In case of HUF assessee - any member of HUF CFP Level 3: Module 1 – Risk Analysis – India Page 264

2. If the amount of premium paid in a financial year for a policy is in excess of 20% of the actual capital sum assured, then deduction will be allowed only for premiums upto 20% of the sum assured. 3. For insurance policies issued on or after April 01 2012, deduction is allowed for only so much of the premium payable as does not exceed 10% of the actual capital sum assured.(15% of actual capital sum assured in case of person with severe disability or specified ailment). 4. Above benefits shall be reversed if the policy is terminated/cease to be in force within 2 years for traditional products and 5 years for ULIP products after the date of commencement of policy. 5. Sec 80CCE - Maximum amount of deduction that an assessee can claim under Sections 80C, 80CCC will be limited to Rs. 150,000. Tax Treatment of money received: If the policy holder fulfills the criteria of payment of premiums, the maturity proceeds from the life insurance policies are tax free under section 10(10)D. Money received by the family member or the nominee on the death of the policy holder, including the bonus, in respect of the life insurance policy is exempt from income tax For events other than death, proceeds received from an insurance company in lieu of a life insurance policy, issued up to March 31, 2003, will be exempt from income tax. However, for policies issued between April 1, 2003 to March 31, 2012 money received from an insurance company, other than on death, shall be taxable if the premium exceeds 20% of the sum assured in any of the years. For policies issued after April 1, 2012 the same will become taxable if the premium exceeded 10% of the sum assured in any year. According to Section 194DA of the IT Act, TDS is to be deducted on maturity payouts if the policy is not exempt under section 10(10) D or if the maturity amount exceeds Rs. 1 lakh in a given financial year. The applicable rate of TDS is 5% for all cases where PAN number is available and 20% where PAN is not available. 3.4.1 Maturity of Policy Maturity claim is payable under endowment type of policies. There are also some Term Assurance plans where under premiums are refunded if the life assured survives the policy term. CFP Level 3: Module 1 – Risk Analysis – India Page 265

Intimation is sent normally by the insurer well in advance to ensure timely payment. Post-dated Cheque in payment of the claim amount are normally sent to the policy holder in advance. The Insurer has to satisfy beforehand that- a. the life assured or the assignee, as the case may be, is the holder of the policy; b. identity of the life assured or the assignee, as the case may be, is proved; c. age of the assured stands admitted; d. all the premiums due have been paid. e. the original policy together with completed discharge voucher is furnished f. The title to claim policy moneys is clear. In case of absolute assignment, claim is settled in favour of the assignee and hence intimation goes to the assignee. In case of conditional assignment, claim may be settled in favour of life assured and hence intimation goes to the life assured In case of MWPA policy, the proceeds are to be paid  To the trustee if there is no trustee, official trustee will step in  If the beneficiaries are major and competent to contract claim can be paid to them. Hence the discharge voucher is signed by the beneficiary/trustee and not by the assured. Intimation under ‘Survival Benefit’ Survival benefit becomes payable at the end of the specified periodical intervals during the policy term if the life assured is surviving. The intimation procedure is same as in the case of maturity claims. Maturity Claims Page 266 The insurer call for the following documents: CFP Level 3: Module 1 – Risk Analysis – India

Policy Bond (Policy Document)  In case policy document not available due to having been lost/destroyed, ‘indemnity bond' is required. The indemnity bond is executed by the life assured alongwith a surety of sound financial position.  In case of small claim amounts, a letter of a indemnity may suffice instead of an indemnity bond where original policy bond is lost.  For very small claim amounts, requirement of indemnity may be waived by an Insurer.  In case of a survival benefit payment, a duplicate policy is issued before settlement of the payment. For maturity claim, a duplicate policy need not be issued. Age proof, if age not already admitted. Deed of Assignment, if any. Discharge form duly signed by the life assured and witnessed. On receipt of the required documents by the insurer-  Documents are scrutinized.  If found in order claim amount is sanctioned by the competent authority of the Insurer Payment is made by an account payee cheque.  The claim money is usually paid to the life assured himself or the assignee in case of an absolute assignment. Hence settlement is simple.  If the claim determines the policy finally i.e. the contract comes to an end on claim payment, the policy document is cancelled. Survival Benefits Payment of survival benefit does not determine the policy finally i.e. the contract does not come to an end. Therefore, the policy document is not cancelled. Only a suitable endorsement is made on the policy document and the document is returned along with the cheque. However, now-a-days, some insurers do not call for policy document to make such endorsement if the survival benefit amount is less than certain amount (limit on such amount or procedures in this regard vary from insurer to insurer). CFP Level 3: Module 1 – Risk Analysis – India Page 267

If the life assured dies after survival benefit becoming due but before its settlement, the survival benefit is not paid to the nominee. It is payable to legal heirs of the life assured. Unusual Situations There may be certain unusual situations, such as-  The life assured (or the person to sign the discharge) is known to be mentally deranged. In that event: A certificate tinder Indian Lunacy Act, appointing a person to act as Guardian to manage the properties of the lunatic is called for. The assured has been adjudged insolvent before the policy matured and a notice to that effect was received. In that event:  The official assignee is intimated about the maturity.  Payment of policy money is made to the official assignee under advice to the assured.  In the policy has been sold in court action, the purchaser will be entitled for the payment on production of the certificate. Prohibitory Order from a court of law or a Notice from the Income Tax Authority u/s 226(3) subsists. In that event  The life assured has to get withdrawal of such Order/Notice.  Otherwise payment is processed according to the Order/Notice. Life assured missing - If the life assured is reported to have disappeared and is not heard of for the last 7 years  The disappeared person is presumed to be dead under the Indian Evidence Act. In such a case a court order is required and the payment is made according to the status of the policy. Miscellaneous Under a policy financed through HUF funds, the policy moneys go to the Karta of HUF. Payment to Non Resident Indian is governed by the Foreign Exchange Control Regulations. CFP Level 3: Module 1 – Risk Analysis – India Page 268

3.4.2 Death Claim Page 269 Death Claim Intimation Intimation about death of the life assured has to be given in writing Intimation may be given by either of these  Nominee  Assignee  A relative of the assured  A gent or development officer Intimation about death of the life assured has to be given in writing Intimation may be given by either of these CFP Level 3: Module 1 – Risk Analysis – India

 Nominee  Assignee  A relative of the assured  A gent or development officer Intimation should contain the following particulars  Policy number  Name of the life assured  Date of death  Cause of death  Informant's relation with the life assured Sometimes insurer can also initiate claim action without waiting till the claim intimation is received. This could be on the basis of obituary columns or newspaper reports about accident or air-crash. However, identity of the deceased as life assured is the most important aspect in any case. The ‘Death Claim Intimation' must satisfy two conditions:  It must be from a concerned person;  It must establish the identity of the deceased life assured beyond doubt. On receipt of the death intimation, the following documents are called for- 1. Policy document 2. Deed of assignment, if any 3. Proof of age, if age is not admitted earlier 4. Certificate of death issued by Municipality or Local Board 5. Legal evidence of title, if there is no nomination or assignment. 6. Claimant's statement giving details like life assured's name, policy number, date & cause of death CFP Level 3: Module 1 – Risk Analysis – India Page 270

7. Certificate of identity and cremation/burial by an independent person who attended the same 8. Form of discharge executed and properly witnessed In case of death within three years from the date of issue of the First Premium Receipt or the date of last revival, following additional requirements are called for:  Statement from the last medical attendant giving details of last illness and treatment;  Statement from the hospital if the deceased had been hospitlised  Statement from the person who had seen the dead body and attended the funeral rites  Statement form the employer showing details of leave, if the deceased was employed somewhere In case of unnatural death such as accident/suicide /murder or unknown cause, FIR,PIR, Chemical Analyst's report, Postmortem report Coroner's report etc will also be required. In case of proper nomination or assignment, no further proof of title of the claimant is needed. In case there being no nomination or assignment, legal evidence of title to the estate of the deceased from a competent court is required.  Evidence of title may be dispensed with, up to a certain limit if:  The claim amount involved is small;  There is no other estate left by the deceased; and  There is no dispute amongst the claimants of the policy money. On completion of the formalities as above, death claim is paid to the claimant. Time-barred death claim  If the intimation is received after 3 years from the date of death, the claim is time-barred. In that event;  If the claim is otherwise payable, ex- gratia payment can be considered. CFP Level 3: Module 1 – Risk Analysis – India Page 271

 If death had occurred within 3 years from the policy's commencement or the last revival, investigations are also conducted. Alternative proofs of death may be; In case of an air-crash, certificate from airlines certifying that the deceased was traveling as a fare-paying passenger on the plane In case of ship accident, a certified extract from the shop's log-book In case of defence personnel  Certificate from the commanding officer of the Unit.  If a court of inquiry is ordered, its findings are also required. Early Death Claim In case of death within 2 years from the issue of the first premium receipt or the last revival, investigation of the possibility of suppression of material information is necessary. In case of death within 3 years from the issue of the premium receipt the last revival, the insurer would verify the possibility of intentional misrepresentation or concealment of material information at the time of proposal or revival, for which investigation may be conducted. Non-Early Death Claim (Beyond three years) – Presumed to be Dead for missing persons, applicability of Indian Evidence Act, 1872 Proof of death is necessary for settling a claim. However, sometimes a person is reported missing without any information about his or her whereabouts. Sections 107 and 108 of the Indian Evidence Act, 1872 deals with presumption of death. Under this Act, if an individual has not been heard for seven years, he or she is presumed to be dead. If the nominee, or heirs, claim that the life insured has been missing and should be assumed to be dead, insurers require a decree from a competent court. However, the insurer may also act on its own, without a decree of the court, if reasonably strong circumstantial evidence exists to show that the life insured could not have survived a fatal accident or hazard. CFP Level 3: Module 1 – Risk Analysis – India Page 272

It is necessary that the premiums should be paid until the court decrees presumption of death; although insurers may, as a concession, waive the premiums during the seven years’ period. This is at the option of the individual insurer. Surrender Value Surrender involves voluntary termination of contract by the policyholder during the currency of the policy. The amount, which he gets by surrendering the policy, is called surrender value or cash value. Some insurers mention surrender value are given in the Prospectus or in the policy conditions. Rates of surrender value are given by various insurers which is a percentage of premiums paid or a percentage of paid up value, are mentioned either in the Prospectus or Policy conditions. Special surrender value is calculated generally higher than the Guaranteed Surrender value. Surrender value is calculated either as a percentage of premiums paid or as a percentage of paid up value. 1. This percentage increases as the duration of the policy increases. In a policy with a term of 25 years, the percentage of paid up value, which will be payable, as surrender value will be higher after 15 years as compared to the surrender value after 10 years. 2. If there are two policies under similar plans with policy term of 25 years and 30 years, and both remained in force for 15 years surrender value on the former will be higher than on the later. Return on Savings Component Life insurance is a contingent financial product. Contingency may be premature death or disability or the risk of living too long. It pays the benefits only when the contingency occurs. In case of term assurance plans, the benefit is payable if death occurs during the specified period and nothing is payable after the term of the policy i.e. the return on term assurance at maturity on the death of the life assured is very high. Now consider an endowment assurance plan. In endowment plans, the benefits are payable in the event of death as well as in the event of survival at maturity. Therefore premium of endowment plans consists of the following elements: Premium = risk premium + savings premium + expenses Risk premium is based on the higher death rate of sixties and savings premium is calculated such that guaranteed sum of money is accumulated at the end of the contract at the interest rate of 6% or actual rate of return on savings. CFP Level 3: Module 1 – Risk Analysis – India Page 273

Example – 1: A participating policy of 20 years with sum assured of ₹5 lakhs at a premium of ₹31356 p.a. has revisionary bonus of 50/1000 of SA for the first 4 years, 55/1000 of SA in the next 10 years and 60/1000 of SA in the remaining years. The maturity bonus is also declared at 115/1000 of SA. Find the effective rate of return? a) 5.19% b) 11.19% c) 7.74% d) 4.73% Correct Answer: (A) 5.19% Sum Assured 5lakhs Term 20 years Premium 31356 p.a. Revisionary Bonus First 4 years = 50/1000 * 500000 * 4 = 100000 Next 10 years = 55/1000 * 500000 * 10 = 275000 Remaining 6 years = 60/1000 * 500000 * 6 = 180000 Total Revisionary Bonus = 555000 Maturity Bonus Maturity Bonus = 115/1000*500000 = 57500 Total Maturity Benefit = RB+MB+SA = 1112500 Calculate Rate (i%) Set Begin, N=20, PMT=31356, FV=1112500, P/Y=C/Y=1, Calculate I, i=5.19% Example – 2: A 40 year old male individual can get a 15-year with-profit life insurance policy of a company at an annual premium of ₹12,046 which gives a sum assured of ₹1.5 lakh. The company historically has declared reversionary bonuses and terminal bonus per thousand sum assured at ₹35 CFP Level 3: Module 1 – Risk Analysis – India Page 274

and ₹80, respectively. A term plan with same life and other parameters is generally available for an annual premium of ₹3,565. Find the return on investment component of the company’s policy on surviving the term. Ans: Premium of with-profit policy ₹12,046 Premium of term policy ₹3,565 The excess premium paid for the investment component = 12046 - 3565 = ₹8,481 Revisionary Bonus = 35/1000 * 150000 * 15= 78750 Terminal bonus = 80/1000 * 150000 = 12000 Maturity value from with-profit policy on surviving the term = 150000 + 78750 + 12000 = 240,750 Return from an investment component = (Set begin, N= 15, PMT=-8481, FV=240750; P/Y=C/Y=1, I (Solve) = 7.6264) Return on investment component 7.63% p.a Claims: Practice Sums Q1. Calculate the claim amount payable under each of the following cases: S. NO PARTICULARS CASE A CASE B CASEC CASE D 1 Date of Commencement 20-02-2011 12-01-2011 20-01-2011 07-02-2011 2 Annual Premium (₹) 10,000 10,000 10,000 10,000 07-02-2018 3 Last Premium Paid Date 20-02-2017 12-01-2018 20-01-2017 (paid on 20- 01-2018) 4 Sum Assured (₹) 3,00,000 3,00,000 3,00,000 3,00,000 5 Vested Bonus (₹) 1,20,000 1,20,000 1,20,000 1,20,000 6 Vested Bonus (Last 31-03-2017 31-03-2017 31-03-2017 31-03-2017 CFP Level 3: Module 1 – Risk Analysis – India Page 275

Declaration Date) 7 Interim Bonus (₹/000), if 40 40 40 40 applicable 8 Date of Death 24-01-2018 24-01-2018 24-01-2018 24-01-2018 Solution (Case A): Step - 1: Calculation of Final Policy Year Date of Death 24-01-2018 Policy Anniversary 20-02 Final Policy Year 20-02-2017 to 19-02-2018 Step - 2: Calculation of Policy Status as on Date of Death LPP: 20-02-2017 Add: Term: 1 FUP: 20-02-2018 Add: Grace Period: 01-01 Effective Date of Coverage: 21-03-2018 Date of death: 24-01-2018 Thus, policy was in force as on the date of death. Step - 3: Check for Premiums & Bonuses Final Policy Year 20-02-2017 to 19-02-2018 Premium Payable on 20-02-2017 (Paid) Bonus Receivable on 31-03-2017 (Received) CFP Level 3: Module 1 – Risk Analysis – India Page 276

Step - 4: Calculation of Claim Amount Sum Assured: 300000 Add: Vested Bonus: 120000 Claim Amount 420000 Solution (Case B): Step - 1: Calculation of Final Policy Year Date of Death 24-01-2018 Policy Anniversary 12-01 Final Policy Year 12-01-2018 to 11-01-2019 Step - 2: Calculation of Policy Status as on Date of Death LPP: 12-01-2018 Add: Term: 1 FUP: 12-01-2019 Add: Grace Period: 01 Effective Date of Coverage: 12-02-2019 Date of death: 24-01-2018 Thus, policy was in force as on the date of death. Step - 3: Check for Premiums & Bonuses Final Policy Year 12-01-2018 to 11-01-2019 Premium Payable on 12-01-2018 (Paid) Bonus Receivable on 31-03-2018 (Not Received) CFP Level 3: Module 1 – Risk Analysis – India Page 277

Step - 4: Calculation of Claim Amount Sum Assured: 300000 Add: Vested Bonus: 120000 Add: Interim Bonus:12000 {(40/1000)*300000} Claim Amount 432000 Solution (Case C): Step - 1: Calculation of Final Policy Year Date of Death 24-01-2018 Policy Anniversary 20-01 Final Policy Year 20-01-2018 to 19-01-2019 Step - 2: Calculation of Policy Status as on Date of Death LPP: 20-01-2017 Add: Term: 1 FUP: 20-01-2018 Add: Grace Period: 01 Effective Date of Coverage: 20-02-2018 Date of death: 24-01-2018 Thus, policy was in force as on the date of death. Step - 3: Check for Premiums & Bonuses Page 278 Final Policy Year 20-01-2018 to 19-01-2019 Premium Payable on 20-01-2018 (Unpaid) Bonus Receivable on 31-03-2018 (Not Received) CFP Level 3: Module 1 – Risk Analysis – India

Step - 4: Calculation of Claim Amount Sum Assured: 300000 Add: Vested Bonus: 120000 Less: Unpaid Premium: (10000) Add: Interim Bonus:12000 {(40/1000) *300000} Claim Amount 422000 Solution (Case D): Step - 1: Calculation of Final Policy Year Date of Death 24-01-2018 Policy Anniversary 07-02 Final Policy Year 07-02-2017 to 06-02-2018 Step - 2: Calculation of Policy Status as on Date of Death LPP: 07-02-2018 Add: Term: __ 1 FUP: 07-02-2019 Add: Grace Period: 02-01 Effective Date of Coverage: 09-03-2019 Date of death: 24-01-2018 Thus, policy was in force as on the date of death. Step - 3: Check for Premiums & Bonuses Final Policy Year 07-02-2017 to 06-02-2018 Premium Payable on 07-02-2017 (One extra premium Paid) CFP Level 3: Module 1 – Risk Analysis – India Page 279

Bonus Receivable on 31-03-2017 (Received) Step - 4: Calculation of Claim Amount Sum Assured: 300000 Add: Vested Bonus: 120000 Add: Advance Premium: 10000 Claim Amount 430000 Q3. Given the following data, calculate the amount of death claim payable: Plan & Term = Endowment 25 years Sum Assured = ₹40,000 D.O.C = 20-07-2005 D.O.D = 18-02-2018 Vested Bonus = ₹30,000 Quarterly premium of ₹320 due in Jan, 2018 has not being paid. Interim bonus declared after valuation on 31-03-2017 is ₹70 per thousand. Solution: Step - 1: Calculation of Final Policy Year Date of Death 18-02-2018 Policy Anniversary 20-07 Final Policy Year 20-07-2017 to 19-07-2018 Step - 2: Calculation of Policy Status as on Date of Death FUP: 20-01-2018 Add: Grace Period: 01 CFP Level 3: Module 1 – Risk Analysis – India Page 280

Effective Date of Coverage: 20-02-2018 Date of death: 18-02-2018 Thus, policy was in force as on the date of death. Step - 3: Check for Premiums & Bonuses Final Policy Year 20-07-2017 to 19-07-2018 Premium Payable on 20-07-17, 20-10-17, 20-01-18& 20-04-18 (Two premiums Unpaid) Bonus Receivable on 31-03-2018 (Not Received) Step - 4: Calculation of Claim Amount Sum Assured: 40000 Add: Vested Bonus: 30000 Add: Interim Bonus:2800 {(70/1000)*40000} Less: Unpaid Premium: (640) (320*2)* Claim Amount72160 Life Insurance Policy Riders Till now we have described the basic coverage provided by different types of individual life insurance CFP Level 3: Module 1 – Risk Analysis – India Page 281

products. Although their features vary, each type of life insurance policy we have described provides a benefit payable upon the death of the insured. We have also noted that term insurance can be provided by a policy or by adding a term insurance rider to another policy, such as a whole life policy. A number of other benefits can also be added to the various forms of life insurance policies. These additional benefits are usually provided by adding riders to the life insurance policy, although in some situations the benefits are provided through standard policy provisions. Policy riders benefit both the policy owner and the insurer because they give both parties flexibility. When an insurance company issues a policy, it can include riders in order to customize a basic plan of insurance for the policy owner. If the policy owner later wants to adapt the policy to better meet his needs, the insurer can drop or add riders. Thus, the insured and the insurer need not enter into a new contract when the insured desires customized or additional coverage. The insurance company usually charges an additional premium amount for each supplementary benefit that is added to a policy. This additional premium charge typically ceases when the supplementary benefit expires or is cancelled. These additional premiums, however, do not affect the cash value, if any, of the basic policy. Supplemental Disability Benefits Rider Disability benefits are generally classified as a type of health insurance coverage because such benefits are paid to cover financial losses that result from a sickness or injury rather than those that result from the insured's death. Some disability benefits, however, can be added to the coverage provided by a life insurance policy. In this section, we describe three types of disability benefits that may be provided by a life insurance policy. These benefits arethe waiver of premium for disability benefit, the waiver of premium for payer benefit, and the disability income benefit. Waiver of Premium for Disability Benefit Rider One of the most common supplementary benefits available in nearly all types of life insurance is the waiver of premium for disability (WP) benefit. Under a WP benefit rider, the insurer promises to give up - to waive - its right to collect renewal premiums that become due while the insured is totally disabled. Most WP riders define total disability as the insured's inability to perform the essential acts of her own occupation or any other occupation for which she is reasonably suited by education, training, or experience. Premiums that are waived under a WP benefit are actually paid by the insurance company. Therefore, if the policy is one that builds a cash value, the cash value will continue to increase just as if the premiums were paid by the policy owner. Likewise, if the policy is a participating policy, the insurance CFP Level 3: Module 1 – Risk Analysis – India Page 282

company will continue to pay policy dividends just as if the policy owner were continuing to pay premiums. In the case of the universal life insurance policy, the WP benefit typically specifies that the insurer will waive any mortality and expenses charges that become due while the insured is disabled. In contrast, the WP benefit provided by the some universal life insurance policies specifies that the insurer will waive the amount of the target premium while the insured is disabled. Waiver of Premium for Payer Benefit Rider A variation of the waiver of premium for disability benefit is the waiver of premium for payer benefit. Note that the WP benefit provides a waiver of premium if the insured becomes disabled. Most individual life insurance policies are issued to a policy owner who is also the policy's insured, and the WP benefit was designed for such policies. In contrast, the waiver of premium for payer benefit is often included in third-party policies, such as juvenile insurance policies. A juvenile insurance policy is a policy that is issued on the life of a child but is owned and paid for by an adult, usually the child's parent or legal guardian. The waiver of premium for payer benefit provides that the insurance company will waive its right to collect a policy's renewal premiums if the policy owner - the person responsible for paying premiums - dies or becomes disabled. Because the disability or death of the policy owner triggers this benefit, the policy owner generally must provide satisfactory evidence of his own insurability - in addition to providing evidence of the insurability of the insured - before the insurer will add this benefit to a life insurance policy. When the benefit is provided by a juvenile life insurance policy, the policy usually states that the insurance company will waive the premium payments only until the insured reaches a specified age, such as 18 or 21, when ownership and control of the policy typically passes to the insured. Waiver of Premium v/s Payor Benefit Rider S. NO. Conditions Waiver of Premium Rider Payor Benefit Rider 1 Life Assured & Payor Same Different 2 Conditions leading to Disability & Critical Illness Disability, Critical lllness grant of benefits & Death 3 Condition leading to Reinstatement of income Life Assured attaining withdrawal of benefits earning capacity of the payer age of majority CFP Level 3: Module 1 – Risk Analysis – India Page 283

Disability Income Benefit Rider Another benefit that may be added to a life insurance policy is the disability income benefit. A disability income benefit provides a monthly income benefit to the policy owner - insured if he becomes totally disabled. Disability income riders typically define total disability as the insured's inability to perform the essential acts of his own occupation or any occupation for which he is reasonably suited by education, training, or experience. Typically the amount of the monthly disability income benefit is a stated dollar amount - such as ₹10 - per ₹1,000 of life coverage. Life insurance coverage provided by the policy continues, and, if the insured dies before recovering from a disability, the insurer pays the policy's death benefit. The disability income rider also usually includes a three - to six - month waiting period before disability income benefits will begin. Example: Praveen Hegde was the policy owner - insured of a ₹150,000 life insurance policy that included a disability income benefit rider. The rider stated that, if the Praveen became disabled, then the insurance company would pay him a monthly benefit of ₹10 per ₹1,000 of life insurance coverage during the period of disability; the income benefit would begin three months after the onset of a disability. While the policy was in force, Praveen became disabled as defined in the disability income benefit rider. Two years later, he died as a result of his disability. Analysis: Three months after he became disabled, Praveen became eligible to receive a disability income benefit of ₹1,500 per month. ₹10 X 150 units = ₹1,500 per month This monthly disability income benefit was payable as long as Praveen remained disabled. Upon Praveen's death, the policy's death benefit became payable to the named beneficiary. Policies issued with a disability income benefit generally include a WP benefit as well. In such a case, both the renewal premiums charged for the life policy and the additional premiums charged for the disability income benefit are waived during the total disability of the insured. Accident Benefit Rider Accident benefits may be added to any type of life insurance policy. The two most commonly offered accident benefits are accidental death benefits and dismemberment benefits. CFP Level 3: Module 1 – Risk Analysis – India Page 284

Accidental Death Benefit Rider A policy rider that provides an accidental death benefit specifies that if the insured dies as a result of an accident, the insurer will pay the named beneficiary an amount of money in addition to the basic death benefit provided by the life insurance policy. This additional sum is often equal to the policy’s face amount. When the amount of the accidental death benefit is equal to the face amount of the life insurance policy, the benefit is often referred to as a double indemnity benefit because the total death benefit payable if the insured dies in an accident is double the policy's face amount. The additional sum payable if the insured dies accidentally may also be some other multiple of the policy’s face amount - such as three times the face amount - or it may be an amount that is unrelated to the policy’s face amount. Most accidental death benefit riders expire when the insured reaches age 65 or 70. Generally, in order for the accidental death benefit to be payable, the insured person's death must have been caused, directly and independently of all other causes, by an accidental bodily injury. Determining the precise cause of an insured's death, however, can sometimes be quite difficult. Example: An insured with a history of heart problems died in an automobile accident. Her policy provides a ₹50,000 death benefit and includes an accidental death benefit riders that provides an accidental death benefit of ₹50,000. Analysis: The insured's death may have been caused by the accident itself. In that case, the accidental death benefit is payable in addition to the policy's basic death benefit. On the other hand, she may have died from a heart attack while driving her automobile. If so, then the death did not result from an accident, and only the policy's basic death benefit is payable to the named beneficiary. Accidental death benefit provisions usually contain several exclusions and limitations. For example, the provision typically states that the insurance company will not be required to pay the accidental death benefit if the insured's death results from certain stated causes, including  Self-inflicted injuries (suicide),  War-related accidents,  Accidents resulting from aviation activities if, during the flight, the insured acted in any capacity other than as a passenger, and  Accidents resulting from illegal activities. Laws in some jurisdictions, however, prohibit insurers from excluding some of these accidents in their accidental death benefit provisions. CFP Level 3: Module 1 – Risk Analysis – India Page 285

Some accidental death benefit provisions contain a limitation that relates to the time span between the insured's death and the accident that caused the death. This time span is usually stated as 3 months or 90 days, though some insurance companies specify a longer period. The insured's death must occur within the stated time after the accident in order for the additional benefit to be payable. This limitation is included because of the difficulty that can arise in determining the cause of an insured's death. When the insured obviously died as the result of an accident, many insurance companies will disregard the stated time limit and pay the accidental death benefit. This is especially true now that medical science often can prolong life functions almost indefinitely, sometimes extending the life of an accident victim who in the past would have died shortly after the accident. Further, some jurisdictions prohibit insurers from including a limitation concerning time span in accidental death benefit riders. Keep in mind that these exclusions and limitations relate only to the accidental death benefit. With few exceptions, which will be described later in this text, the basic death benefit provided by the life insurance policy is payable regardless of the cause of the insured's death. Disablement Benefit Rider An accidental death benefit rider may also provide an additional benefit for dismemberment, in which case the rider is called an accidental death and disablement (AD & D) rider. These riders generally specify that a stated benefit amount will be paid if an accident causes the insured to lose any two limbs or sight in both eyes. The amount of the dismemberment benefit is usually equal to the amount of the accidental death benefit. In many cases, however, a smaller amount - such as one-half the amount of the accidental death benefit - will be payable if the insured loses one limb or sight in one eye. The loss of a limb may be defined either as the actual physical loss of the limb or as the loss of the use of the limb. Usually, AD & D riders state that the insurer will not pay both accidental death benefits and dismemberment benefits for injuries suffered in the same accident. Terminal Illness Benefit Rider The most common of the accelerated death benefits is the terminal illness benefit. The terminal illness (TI) benefit is a benefit under which the insurer pays a portion of the policy's death benefit to a policy owner-insured who suffers from a terminal illness and has a physician-certified life expectancy of 12 months or less. A statement by an attending physician establishes evidence of the terminal condition and certifies that the insured is likely to die within the time period specified in the rider. Unlike other supplementary benefits, the terminal illness benefit is typically paid for by an administrative charge that the insurer assesses when a policy owner-insured elects to exercise the TI CFP Level 3: Module 1 – Risk Analysis – India Page 286

benefits. By contrast, when they issue a policy that provides other supplementary benefits, insurers typically impose an additional premium charge for each supplementary benefit that the policy provides. The amount of the TI benefit that is payable varies from company to company. Some policies permit payment of the full face amount prior to the insured's death. Generally, however, the maximum benefit payable is a stated percentage - usually between 25 and 75 percent - of the policy's face amount. The benefit is usually paid in a lump sum to the policy owner. The remainder of the death benefit is paid to the beneficiary at the insured's death. Dread Disease Benefit Rider ( critical illness rider ) Perhaps the earliest form of accelerated death benefits coverage offered by insurers is the dread disease (DD) benefit under which the insurer agrees to pay a portion of the policy's face amount to a policy owner-insured who suffers from one of a number of specified disease. The remainder of the death benefit is paid to the beneficiary at the insured's death. Another form of dread disease coverage can be purchased as a stand-alone health insurance policy. An insured becomes eligible for DD benefits when he is afflicted by certain diseases or undergoes certain medical procedures specified in the rider. These specified diseases or medical procedures are known as the insurable events and usually include  Life-threatening cancer,  AIDS,  End-stage renal (kidney) failure,  Myocardial infarction (heart attack),  Stroke, and  Coronary bypass surgery. Some companies also include vital organ transplants and Alzheimer's disease as insurable events. Although the accelerated death benefit is usually paid in a lump sum, some companies pay the benefit in monthly installments over a period of 6 to 12 months. Most companies provide DD coverage only to insured’s who are under the age of 70 and only to insured’s who are standard risks. And some companies do not make payments for multiple or recurring events. The DD benefit may offer a premium waiver option under which the insurer agrees to waive all renewal premiums payable after the accelerated death benefit payment. Sometimes the premium CFP Level 3: Module 1 – Risk Analysis – India Page 287

waiver option applies only to premiums payable while the insured is disabled; if the insured recovers, then subsequent renewal premiums are no longer waived. Alternatively, premiums may be waived only if the policy includes a waiver of premium benefit. 3.5.3 Lapse, Non-forfeiture Provision, Surrender and Revival In term of the policy contract, the obligation of the insurer to pay claim is conditional to premiums being paid on due dates. Premium received within ’days of grace' is taken as received on due date. If premium is not paid within the ‘days of grace' it is a default on the part of policyholder and the policy ‘lapse' - no claim is entertained on a lapsed policy and all premiums are forfeited. In practice, insurers do not forfeit all the premiums paid under a lapsed policy. Insurance Act 1938 does not permit such forfeiture. The basis of this stipulation is that every policy acquires a reserve because - (i) premiums in the initial years are more than justified; and (ii) there is savings element in the premium. It would be unfair to forfeit this reserve. In the event of premium default, various safeguards have been provided to policy holders. These safeguards have various options and are called Non-Forfeiture Provision. One of the options is to return to the policyholder an amount, which represents the reserve - This amount is called the ‘Surrender Value' or ‘Cash Value'. CFP Level 3: Module 1 – Risk Analysis – India Page 288

Computation of Paid up Value Paid Up Value = No. of Premiums Paid x S.A. + Bonus (If any) No. of Premiums Payable Paid up Value Full sum assured is payable under in force policy on the happening of the event insured stops paying premium after a minimum required premium paying period, this stun is proportionately reduced. The reduced Sum Assured, which is also called Paid up Value bears the same ratio to the full sum assured as the number of premium paid bear to the total number of premium payable. Paid up Value = [Number of premiums Paid x Sum Assured)/Number of Premiums Payable] + Bonus (if any) Examples for Calculating Paid-up Value Q1. Calculate the Paid-Up Value under a Policy with the following Particulars. S.A – ₹50,000/- Plan & Term – Endowment 20 Years D.O.C. – 01-06-2002 Mode – Half – Yearly Last Premium Paid Due – 01-12-2017 Ans. First Unpaid Premium (F.U.P.) = Last Premium Paid + Made = 01-12-2017 + 6 Months = 01-06-2018 No. of Premiums Paid = 01-06-2018 01-06-2002 = 16 Years = 16 x 2 (Since hlf yearly mode) = 32 No. of Premium Payable = 20 x 2 = 40 Paid-up Value = CFP Level 3: Module 1 – Risk Analysis – India Page 289

= = 40,000/- + attached bonus (if any)  Only the sum assured is reduced proportionately. Bonus already vested before the policy became paid up, will remain unaffected. A paid up policy will not participate in future bonuses from the date it becomes paid up policy will also not be entitled to any interim bonus.  Premiums need not be paid after a policy becomes paid up. If there are some other benefits, which are related to sum assured, these benefits also will be proportionately reduced. Rider Benefit will get exhausted if he Policy becomes paid up for Reduced Sum Assured. Insurance Companies provide that policy must acquire some minimum value (say, ₹250) to become paid up. If paid up value works out to be a lower figure, this non-forfeiture benefit will not be available. In that case, the policyholder is entitled to surrender value as guarantee under the provision of law. Guaranteed Surrender Value Section 113 of Insurance Act 1938 states that every policy where under premiums for at least three years have been paid, shall acquire \"guaranteed surrender value\". It is the minimum amount, which has to be paid to the policyholder, in case the policy holder wants to cancel the contract. However, the insurer may pay higher surrender value, which is more than the guarantee minimum. The stipulation that a policy must have remained in force for at least three years is because in the first year most of the premium goes out in expenses and not much is left for accumulation. Other Non-Forfeiture Provisions are —  Converting the policy into a paid-up one  Keeping the policy in force by advancing premiums out of the acquired surrender value (APA)  Providing term assurance cover out of acquired surrender value. CFP Level 3: Module 1 – Risk Analysis – India Page 290

Computation of Surrender Value Surrender Value = Paid Up Value x Surrender Value Factor KEEPING POLICY INFORCE (Automatic Premium Advance Clause) Under this option, if the premium are in default, the policy is kept in force by notionally advancing premium out of the Acquired Surrender Value. The policy is finally determined when the surrender value is not sufficient to advance a full premium installment. In that case the balance of surrender value will be paid to the policyholder and the policy contract shall stand terminated. It may be noted that with every premium advanced and treated as paid, surrender value will also increase. Advantages The original insurance cover granted continues and is not reduced. Policyholder can resume payment of premium whenever he is in a position to do so. If it is a₹ with profit' policy, it will be entitled to bonus additions, which will increase the Policy Value. CFP Level 3: Module 1 – Risk Analysis – India Page 291

Disadvantage If arrears of premium are not paid and surrender value is exhausted, sense of loss is much more as the cash available will be very little. Benefit of cover remains notional and not real. From policyholder's point of view disadvantage outweigh the advantages. Insurers, therefore, prefer the paid up option and the automatic premium advance clause is offered on specific request from the policyholder. Revival If a policy lapses, the insured, the insurer and the agent - all are adversely affected.  Insured loses the risk cover. Lapsation tantamount to a reversal of his earlier decision to provide security to his family and the family is again exposed to possible adverse circumstances.  Insurer charges level premium on the assumption that barring death claim, the policy will run for the full term. Initial expenses are high and can be recovered only if the policy remains in force. People with good health would tend to keep their policies in force, while people with good health may not value the continuance of policies so much. Thus will lead to ‘selection against the insurer', which means that insurer's liability will be greater than what was assumed while determining the premiums.  Agent not only loses his future commission but the lapsation also reflects that he had not fully convinced the policyholder about the usefulness of the plan. Lapsation may not be intentional and it may occur due to the neglect of the life assured in payment of premiums or due to temporary financial difficulties. As it affects both the Life Assured and the Insurer adversely, insurers facilitate revival of lapsed policies. When a policy lapses, neither the insurer nor the insured is benefitted. Life assured loses the full benefits. The insurer loses further expected revenues. The agent loses his future earnings Normally, people enjoying bad health value insurance and continue the policies, while other with normal health may discontinue. In that case, when the policy lapses, there is adverse selection or ‘selection against the insurer'. Lapsation may happen due to sheer neglect to pay or because of temporary financial difficulties. The lapsed policies are brought back into full force. This is called ‘revival'. A revival requires that the arrears of premiums be paid with interest. Insurers generally do not allow CFP Level 3: Module 1 – Risk Analysis – India Page 292

revival after five years of lapse as a fresh policy may be more beneficial to the policyholder. On revival the risk cover under the policy is being increased. Therefore, revival is treated on the same line as underwriting a new propsal. Accordingly policyholder will have to produce proof of continued insurability. The policy may also be revived without proof of continued insurability. Schemes of Revival LIC of India, generally categorize the revival into following schemes.  Ordinary revival scheme (without evidence of good health)  Ordinary revival scheme (with evidence of good health)  Special revival scheme  Revival by installment Loan-Cum-Revival Scheme Ordinary revival scheme (without evidence of good health): it allows revival a. If arrears are paid within 6 months of the date on which the first unpaid premium was due b. If arrears are paid within last 12 months of the date of maturity c. If arrears are paid within 12 months of the date on which the first unpaid premium was due provided the policy had been in force for the last 5 years Ordinary revival scheme (with evidence of good health) Under this scheme, the insurer asks for a satisfactory declaration of good health from the life insured (called DGH) a. If a new proposal on the same life for a similar type of policy can be considered without any medical examination b. If arrears received within 12 to 24 months prior to date of maturity c. If policy is in force for at last 10 years and the arrears are paid within 12 to 18 months from the date of lapse Different insurance companies may modify the rules of revival looking into the type of plan, the period the policy has remained in force, sum assured involved, the age of the life assured etc. CFP Level 3: Module 1 – Risk Analysis – India Page 293

Special Revival Scheme This scheme is designed to meet the needs of those policyholders who are not in a position to pay the arrears. The revival under this scheme may be allowed if following conditions are satisfied: a. The policy must not have acquired the surrender value b. Lapsation period should not be less than 6 months or more than 3 years c. Revival under this scheme allowed once during the life of the policy A new date of commencement will be fixed by dating back by the period for which premiums were received under the policy. Plan and term will remain same but the date of maturity shall not exceed the maximum allowable. New premium will be charged as per age on the new date of commencement. The assured will have to pay the accumulated difference between the old and revised premium. Revival by Installment This is similar to ordinary revival. The scheme can be availed of: If the assured is not entitled to revive under special revival scheme The arrears of premiums are more than one year A sum equal to six months premium should be paid immediately The balance should be paid in current policy year and next two policy years Loans Against Life Insurance Policies  Loan facility is provided in most of the policies.  Loans can be given up to 80% or 90% of surrender value.  Policy loan is interest bearing  Loan may be repaid in full or in part during the currency of the policy or else it will remain as a debt on policy recoverable with interest from claim amount.  Payment of interest is not compulsory. If premiums are paid regularly, with the payment of every subsequent premium, surrender value will increase and would always be more than the outstanding loan with interest any point of time. Loan facility is not available on all policies: Rules regarding availability of loan under policies vary from insurer to insurer. However, a few examples of non-availability of loan are - CFP Level 3: Module 1 – Risk Analysis – India Page 294