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Chapter 28
Reserves, nonforfeiture Values and
Gross Premiums
Policy Reserve
 Under the level-premium method for paying
premiums, premiums paid during early years are higher
than necessary to pay death claims.
The excess premiums are reflected in the policy reserve.
What is policy Reserve Definition
• Policy reserves should not be viewed as a fund.
• They are a liability item on the insurer’s balance
sheet that must be offset by assets equal to that
amount.
• Definition: The policy reserve is the difference between
the PV of future benefits and the PV of future net
premiums(Figure I).
FIGURE I.
Two purposes of policy reserves
• 1-It is a formal recognition of the insurer’s
obligation to pay future claims.
 The policy reserve plus future premiums
and interest earnings must be sufficient to
pay all future policy benefits.
• 2-It is a legal test of the insurer’s solvency.
 The insurer must hold assets at least equal to
its legal reserves and other liabilities .
Classification of Policy Reserves
Reserves can be classified based on the time of valuation.
 A terminal reserve is the reserve at the end of any
given policy year.
 The initial reserve is the reserve at the beginning of
any policy year.
 The mean reserve is the average of the terminal and
initial reserves. It is used to indicate the insurer’s reserve
liabilities on its annual statement.
Gross Premium
 Gross premium is the actual premium paid for
the life insurance contracts.
 The gross premium is derives after an analysis
of the competition and of the life insurance
company’s cash needs.
Life Insurance Expenses Categories
• First Group: Expenses that occur when the
policy is issued included in
1. Medical inspection costs
2. Commission expense
3. Premium tax
4. Underwriting
• Second Group:
Expenses arises out of the maintenance of
the contract and included in
1- Collection of premium
2- Record-keeping
3- Contract changes
4- Policy loan activity
• Third Group
Expenses occur at maturity of the contract
included in
1-The cost of setting the policy at the insured ‘s
death.
2- the cost of terminating the policy upon cash
withdrawal.
 Some expenses in this category vary according to
size, type, length, or number of contracts written.
 Fixed expenses also exist regardless of the size,
type . Length , or number of contracts written.
Calculation of Gross Premium
 The process of calculating the gross premiums is
similar to calculating the net single premium.
 The net single premium is equal to the present
value of future benefits under the contracts.
• If the life insurance company estimates the timing
and amount of the expenses, the present value of
the future expenses need only be added to the net
single premium to derive the gross single premium.
• Gross premium=
PV of future benefits + PV of future expenses
NSP
 The result is levelled by the use of the levelling
procedure.
 If the new gross premium is inadequate to meet
the cash needs of the firm, a redesign of the
contract may be warranted.
The bottom Line
 Regardless of the method used to determine the actual
gross premium, the life insurance company must be
assured that the premium paid by all insureds will
generate sufficient funds to meet all the financial needs of
the company, with excesses available to contribute to the
surplus position.