INTRODUCTION TO LIFE INSURANCE

In any activity of life there is a possibility that a desired event may fail to occur and that
pecuniary (financial) loss may arise. In adventures by sea the ship may fail to make the port;
or the cargo may be damaged or lost. In the adventure of life itself, the life may fail and
death may occur, causing suffering to dependants. Death comes to all sooner or later, and it
is the only truth in this world. So if death is the only truth, then why do we ignore the
implications of the event? Because of the nature of its permanence, and all pervasive; death
requires understanding the financial implications on the dependents. Life insurance is
therefore the most important of all forms of insurance. Its significance pales the other forms
of not just insurance but also all investment instruments. The theory of insurance, in general
terms, may be expressed to mean that the good fortune of the many compensates for the
misfortune of the few. The consequences of such misfortunes cannot be in many instances
borne by the individual, and so the insurance company is prepared to shoulder the burden of
these consequences in exchange for an assessed payment for the risk undertaken. Those who
avail themselves of this service know that such misfortunes will occur but do not know to
whom, and when, and they are willing to make such contributions to a common fund to buy
the right to be compensated of misfortunes if they should befall them.
The insurance company is concerned with any factor that may affect normal longevity, and
once the contract is entered into, and premiums are regularly paid by the policyholder, the
company is at a risk on a permanent contract which it cannot break. From the collation of a
vast amount of data, an assessment can be made of the rate of mortality or the likelihood of
death occurring at each age. Numbers can be quoted, but which individuals will die at each
age cannot be stated. Consequently, all who pay life insurance premiums to the common
fund do so with the same willingness that the fund shall be used to compensate the estates of
those contributors at whatever age in life they may die, within their respective contract
period. This is the basic theory of life insurance. However increasing emphasis on
investment aspects has tended to overshadow the primary purpose of protection against
premature death.
Life Insurance-The Contract:
Definition of the Life Insurance Contract:
There are various definitions of the Life Insurance Contract, as there can be wordings
intrinsic to the contract. Some of these are following:
As defined by Bunyon (UK), in Law of Life Assurance: A Contract of Life Insurance is
one in which one party agrees to pay a given sum upon the happening of a particular
event contingent upon the duration of human life, in consideration of the immediate
payment of a smaller sum or certain equivalent periodical payments by another.
According to the Indian Contract Act 1872, A contract is an agreement between two or
more parties to do or to abstain from doing an act. It is intended to create a legally binding
relationship. A contract is an agreement but an agreement cannot be called a contract. It is
the legal binding intention that raises an agreement to the level of a contract.
Essentials of a valid contract are as follows:
1. Offer and acceptance
2. Consideration
3. Capacity to contract
4. Consensus ad idem (genuine meeting of the minds)

5. Legality of purpose
6. Possibility of performance
7. Intention to create legally binding relationship
In a contract to life insurance there are two parties, viz., the Insurer and the Insured. The
insured is generally called the life assured. In a life insurance contract the life assured
undertakes to pay an agreed sum as premium to the insurer at stipulated intervals called the
Mode during the selected term. According to the nature of the contract and the type of life
insurance cover purchased by the assured, the insurer is required to pay the contracted sum
to the legal heirs or to the nominee of the assured if death occurs during the currency of the
contract or to the assured on the expiry of the selected term if the contract so provides.
Normally, the premium remains uniform, but according to the nature of the plan, there could
be variations.
The method of paying the premium is called the Mode of Premium Payment. The assured
is required to pay the premium on the date of the policy anniversary covering the ensuing
one year. In practice, to facilitate policyholders in the payment of premium, and also to
ensure the retention of the business in their books, companies offer half yearly, quarterly
and monthly payment modes or frequencies.
In India, a contract of life insurance draws its legal authority from the Indian Contract Act
1872. It should be noted that each policy is a separate contract and is treated accordingly.
Though the contract of life insurance is governed by the Indian contract Act, it has certain
peculiarities that set it apart from the other legally enforceable contracts. Some of the
distinguishing features are: Life insurance is a contract of utmost good faith or Uberrima fides. This means that
both parties to the contract have to disclose all information for the fruition of the
contract.
The proponent has to complete a questionnaire designed by the insurer called the
Proposal form to enable the insurer to evaluate the risk and decide whether to
accept the risk or decline it or accept the same subject to certain conditions.
The proposer for the life insurance has to disclose all the material information, which
has relevance to his/her health and longevity, and also about his/her habits, however
insignificant the proposer may consider them to be.
In the event of any suppression of the information material to the contract, the insurer
will be within his rights to declare the contract null and void, and forfeit all the
premiums paid or decline to settle the claim in the event of death.
Similarly the insurer is also required to disclose: All the product features of the plan presented to the proponent for consideration
without distorting the product attributes.
If a plan for insurance is sold by any misrepresentation or if a different package is
offered to the proponent without his/her consent in lieu of the one asked for by the
proponent, the proponent will be well within his rights to terminate the contract and
demand for the repayment of the premium paid by him.
Life insurance protection comes in many forms, and not all policies are created equal, as
you will soon discover. While the death benefit amounts may be the same, the costs,
structure, durations, etc. vary tremendously across the types of policies. The basic types of
life insurance policies are as under:
1. Whole Life Insurance: A term insurance plan with an unspecified period is called a
whole life plan. Some plans also have a savings element to them. The insurance

company declares bonuses for these plans based on the returns earned on
investments. As the name of the plan specifies, this plan covers the individual
throughout their entire life. On the death of the life insured, the nominee/beneficiary
is paid the sum insured along with the bonuses accumulated up until that point in
time. During the individuals lifetime they can make partial withdrawals to meet
emergency requirements. An individual can also take out loans against the policy.
Although, in case of Whole Life Plans, sum assured is payable only on death, some
insurers pay the sum assured when life insured completes a certain age. For example,
80 years, 90 years, 100 years, etc.
2. Endowment Life Insurance: An endowment insurance offers death cover if the life
insured dies during the term of the policy and also offers a Survival benefit if the life
insured survives until the maturity of the policy.
Some of the key features of an Endowment insurance plan are If the life insured survives the entire term of the plan, then a specified amount is
paid to him/her on maturity of the plan
If the life insured dies before the maturity of the plan, then the death cover benefit
is paid to the nominee/beneficiary
Savings element: After deducting the death cover charges & administration
charges from the premium, the remaining amount is invested by the insurance
company. The returns earned are later paid back to the life insured in the form of
bonuses.
Goal-based investment: Helps in accumulating money for specific plans like a
childs higher education or marriage, etc.
Some insurance companies also allow partial withdrawal or loans against these
policies
There are different variants under this plan
Higher death cover than the maturity benefit
Maturity benefit is double the death cover, known as a double endowment
insurance plan
3. Annuity Life Insurance: Pure savings and Pension plans address the risk of living
too long. In the age of medical advancement where the mortality rates have declined
and life span has increased significantly, it is important that the individual saves
enough to meet his financial needs during the age when his earning capacity
diminishes. In the Indian context, with the growth of the Indian economy, the nuclear
family system is fast spreading and therefore old aged parents are left to fend for
themselves. In order to mitigate the risk of not being able to meet financial needs
during such old age, the savings and pension plans are effective tools.
These plans should be looked at two parts:
Savings or accumulation stage- Deferred Annuity Plans. Under the deferred annuity
plan, the policyholder contributes a small amount on a monthly/quarterly/ annual
basis and on maturity; the sum assured is used to buy a pension plan (immediate
annuities) that will provide a monthly income throughout retirement. These plans are
best when bought at a young age as the corpus depends upon the period of
accumulation.
The term of the policy is called deferment period. During this period, the insurance
company will invest the lump sum amount on behalf of the policyholder and earn

returns on it. The maturity of the policy is called vesting where the accumulated
corpus will be used to pay a regular annuity to the policyholder.
At the time of vesting the policyholder can decide whether to buy the immediate
annuity plan from the same insurance company or some other life insurer of his
choice. This option to choose the pension provider is known as the open market
option.
At the time of vesting the policyholder will also have the choice of selecting the type
of annuity plan that he would like from the annuity options available to him. The
annuity payout will depend on the type of annuity chosen and the rates prevailing at
the time of vesting.
The deferred annuity plans are available both in traditional and ULIP forms. In India
the deferred annuity plans are largely driven by tax benefits.
Payout or annuity stage Immediate Annuity Plans- An annuity is a series of
regular payments from an annuity provider (insurance company) to an individual
(called the annuitant) in return for a lump sum (purchase price) or instalment
premiums for a specified number of years. Annuities are usually sold by life
insurance companies. They may be purchased by a single lump sum payment or
under a deferred annuity plan. The premium (purchase price) may be made by the
person who is to be the annuitant or another annuity purchaser such as the annuitants
employer, other personal benefactor or a pension scheme.
4. Term Life Insurance: One of the most commonly used policies is term life
insurance. Term insurance can help protect your beneficiaries against financial loss
resulting from your death; it pays the face amount of the policy, but only provides
protection for a definite, but limited, amount of time. Term policies do not build cash
values and the maximum term period is usually 30 years.
Premiums for term coverage are usually initially lower than other types of life
insurance because the policy only provides a death benefit for a defined period.
Later, some term insurance policies can be extended or converted into another type
of coverage.
Convertible term assurance policy: This policy meets the needs of those who are
initially unable to pay the larger premium required for a whole life or endowment
assurance policy but hope to be able to do so within a few years. It would also enable
such persons to take final decision at a later date about the plan suitable for their
future needs.
However, if you renew or convert your coverage, your new premium will probably
be higher than your previous coverage, and can continue to increase as you grow
older.
5. Joint life insurance: Joint life insurance policies are designed to cover couples or
partnerships in the event of either partners death. Life insurance is designed to
ensure that your dependents do not suffer financially in the event of your death, and
traditionally many policies were set up to cover the main breadwinner of the family.
As this person makes the most significant financial contribution to the running of the
household, this approach might appear to make sense. But the consequences of the
other partners death even if they dont earn as much, or have no income because
they look after the children full-time can also be serious from a financial point of

view. This is why its worth considering taking out life insurance that covers either
partners potential death.
Advantages of joint life insurance:
The advantages of joint life cover are that it pays out regardless of which
partner dies, and is cheaper than taking out two individual life insurance
policies. It may be good for young couples who are trying to save money on
premiums, or for business partners.
Joint cover offers extra protection over taking out just one individual policy
for the main breadwinner. Even where one person may stay at home to look
after the kids, its usually worth having some cover for them as if they were to
die, childcare costs could be a significant burden.
Where the salaries of each partner in the home are vastly different, it may be
worth taking out two individual policies - one each. These can be tailored to
provide adequate cover for each person.
Taking out two individual policies of the same amount will cost more than the
equivalent joint policy, but provides double the cover.
6. Unit Linked Insurance Plan: A Unit Linked Insurance Plan or ULIP as it is
popularly known is basically a combination of insurance as well as investments,
similar to a protection cum savings plan. While a part of the premium paid is utilized
to provide insurance cover to the policy holder the remaining portion is invested in
various equity and debt schemes. A fund is created from a pool of premiums
collected from policyholders and the fund is used to invest in various market
instruments (debt and equity) in varying proportions similar to mutual funds. The
significant difference between a protection cum savings plan and a ULIP is that the
investment risk in a ULIP is borne by the policyholder (similar to a Mutual Fund),
whereas the risk is borne by the Insurance company in the other case. The Policy
holders can select the type of funds (debt or equity) or a mix of both based on their
investment need and risk appetite. ULIP policy holders are allotted units and each
unit has a net asset value (NAV) that is declared on a daily basis. The NAV is the
value based on which the net rate of returns on ULIPs are determined. The NAV
varies from one ULIP to another based on market conditions and the funds
performance.
7. Group Life Insurance: 'Group insurance' is an insurance that covers a group of
people, usually who are the members of societies, employees of a common employer,
or professionals in a common group. Group coverage can help reduce the problem
of adverse selection by creating a pool of people eligible to purchase insurance who
belong to the group for reasons other than for the purposes of obtaining insurance. In
other words, people belong to the group not because they possess some high-risk
factor which makes them more apt to purchase insurance (thus increasing adverse
selection); instead they are in the group for reasons unrelated to insurance, such as all
working for a particular employer. This is when a group of people have been named
under a single life insurance policy. It is popular for an employer or a company to
add employees under the same policy. Each member of the group has a certificate as
legal evidence of insurance.

8. Credit life insurance (Advance life insurance): Credit life insurance is a type of
term insurance plan designed to pay the balance due on a loan, if the borrower dies
before the loan is repaid. Like mortgage redemption it is usually decreasing term
assurance. It is more popularly sold to lending institutions as group insurance to
cover the lives of the borrowers of these institutions. It may be also available for
automobile and other personal loans. The benefit under these policies is often paid
directly to the lender or creditor if the insured borrower dies during the policy term.
9. Bank-linked Life Insurance: Some banks offer personal accident and health
insurance cover at a discount to account holders. What one needs to check is the
product and how much is the payable premium if one buys the same product in the
market. The insurance product is not bundled with the account, as these are cobranded products, launched in association with general insurance companies offering
medical insurance. Some banks are offering personal accident or medical insurance
cover at a discount to their account holders. For instance, State Bank of India (SBI)
two years back introduced personal accident insurance to all its savings account
holders worth Rs 4 lakh for Rs 100 annual premium in tie-up with SBI General
Insurance.
Circumstances affecting Risk in life Insurance:
Since life insurance is a financial contract, and a long-term contract and that a contract
which may come to be executed when one of the parties to the contract may not exist and
may be called up to a court of law in case of dispute in future, it is essential that all the
terms and conditions of the contract must be clearly understood and put in writing legibly.
Looking at the importance of the contract combined with the raised expectation of a benefit
which is still in the womb of a promise, unstinted trust should be created in the mind of the
insured so that he remains confident of its benefit and continues to perform his part of the
duty during the continuance of the contract. In life insurance, the factors which may affect
the risk are usually those factors which are affecting the mortality; they are also called
factors affecting longevity of a person. The mortality is not the only risk but the capacity
and willingness of a person also influence the insurance decision. These factors are
discussed hereunder:
1. Age: The age of the life to be assured is the most important factor to affect mortality.
Except for a few years of the childhood, the premium is determined at every year of the
completion of age. The corporation asks for the age nearer to birthdays.
The person below six months and the person above six months older of the age will be
treated of the same age. For instance, a person of 22 years 7 months and another person
of 23 years 5 months will be treated the age of 23 years.
The age proof is very essential for calculating premium rate. So, unless age is proved
payment of claim is not made if the age was not admitted at the time of proposal. Now it
has been the common practice that the age should be admitted at the time of proposal to
avoid dispute. On the basis of age, in future, if a misstatement is discovered after the
policy has become a claim; the amount of the claim is adjusted in accordance with the
rectification of age. Age proof is essential at the proposal if the policy is term insurance,
non-medical policies and immediate annuity or the insurance is taken at advance age or
for a child because they are maximum and minimum limits of age.
Minimum and Maximum limit of age: The maximum age limit is fixed to avoid adverse
selection. At advance age, the need for insurance is a doubtful proposition, i.e., the
chances of moral hazard are higher. The third reason for fixing maximum limit is the

medical examination will disapprove most of the proposal at that stage. Mortality is
certainly increased at that age. The minimum age limit is meant to avoid risk of infant
mortality.
2. Physical Condition: The physical condition of the age life proposed has a direct bearing
on the mortality of the life. Insurers are, therefore, very particular about the conditions of
an applicants' sight, hearing, heart, arteries, lungs, tonsils, teeth, kidneys, nervous
system, etc. The experts in the field can assess the longevity or mortality of a person due
to impairment of certain organs.
The questions are also designed to elicit information on the physical status of the
applicant in the proposal form. The information is confirmed and supplemented by a
medical examination. The primary purpose of the medical examination is to detect any
malfunctioning of the vital organs of the body.
3. Personal History: The personal history of the life proposed would reveal the possibility
of death to him. The history may be connected with the (i) health record, (ii) past habit,
(iii) previous occupation, (iv) insurance history.
(i) Health Record:
The past health record is the most important factor under personal history because it
affects the longevity or mortality of a person to a greater extent. It includes any
operations of the life proposed. The medical examination may reveal these facts.
This information is also given by the applicant. Particular emphasis is placed on the
recent injuries and illness. It is customary to consult attending physicians.
It has been the practice not to accept the proposal form of the applicants who are
suffering from illness. If the applicant has suffered from certain serious disease or
operation during the past 5 years, he may be under the possibility of getting it again.
(ii) Past Habits:
The insurers want to know the past habit the life proposed, for drugs or alcohol because
the cure may be only temporary. The past history is usually expected to be repeated.
Therefore, past history is very cautiously examined.
(iii) History of Occupation:
If the proponent was employed in hazardous or unhealthy occupation, there is a
possibility that he may still retain ill-effects there from or may revert to such occupation.
An intimate association within a person suffering from a contagious disease may
influence the health of the life proposed. The past hazardous occupations generally
affects, health slowly occupational diseases are contacted. Inorganic dust may create
silicosis.
(iv) Insurance History:
The previous amount of insurance may disclose the degree of risk of the applicant. If he
was refused insurance, it might be a suspicious factor of his insurability. If it was found
that the applicant was already insured for adequate amount this request for more
insurance is regarded with suspicions.
4. Family History: Like the personal history, family history also requires information of
habit, health, occupation and insurance of other family members, particularly of the
parents, brother and sisters. The children's history of health is also required.
The certain diseases, like tuberculosis and insanity, etc., and longevity of the parents will
be relevant factors for determining the degree of risk of the proponents. The favourable
family history, however, is not considered for offsetting the adverse effect of the
personal history. The family history is considered significant to know the transmission
of certain, characteristics by heredity. Hearts, lungs, build, etc., follow family.

5. Occupation: Occupation is an important factor to affect the risk. It affects the

occupation in various ways. Firstly, the nature of work may be hazardous because he
may suffer an accident at any time while at work.
Secondly, the morale of the workers may go down. They may be tempted to indulge in
intoxicating or liquor or other forms of immoral living.
Thirdly, the chemical effect may be poisonous. For instance, the workers may contact
poison while engaged in match or chemical factories.
Fourthly, the dusty or unventilated house, unhealthy or insanitary environments may
deteriorate the health of the workers.
Fifthly, in certain occupation, the occupational diseases are common.
Sixthly, excessive mental and nervous strain may cause financial worries, and lastly, the
lesser income may affect the health of the worker.
6. Residence: The residence also affects the risk. The risk will be lesser in a good climate
area and more in a bad climate although the difference is narrowed down because of
better medical and sanitary facilities! Information about the previous residence is equally
important. The geographical location, atmosphere, political stability, climate,
construction of house, travel, etc., are important factor which may affect the risk.
7. Present Habits: The general mode of living of the proposer affects the risk. Drunkards
and non-temperate persons cause increase in mortality. Similarly, temperate habits tend
to increase longevity of a person. Excessive and careless smoking tends to shorten the
life due to development of nicotine poisoning. The past habits are also considered
important. The intoxication affects the health of a person and consequently his mortality.
The general mode of living is also considered in habits.
8. Morals: It has been observed that the departure from the commonly accepted standards
of ethical and moral conduct involve extra mortality. Infidelity and departure from the
code of sex behaviour are seriously regarded because these may affect the health.
Unethical conduct is considered to be another form of moral hazard. Insurance is not
generally given to bankrupt and reputed dishonest persons.
Consideration, of morals is essential to determine the moral hazard. There are two types
of hazards Moral and Physical hazards we have discussed factors affecting physical
hazards in the other sections. Moral hazard will be discussed only under this heading.
The moral hazard occurs due to intention of the insured whereas the physical hazard is
beyond his approach. The former is present where the policy is taken not with a view to
protect one-self against losses but to obtain gain through crooked means.
The moral hazard is judged by the reputation and fairness in dealings. The moral hazard
is expected to present where insurance is taken at advanced age, where person is
suffering from serious disease, proposal is on other's life and the proponent is engaged in
hazardous occupation.
9. Economic Status: It is essential to examine that the family and business circumstances
of the proponents are such as to justify the amount of insurance applied for. This
investigation also reveals whether the income of the applicants bears a reasonable
relationship to the amount of insurance which he proposes to carry. The higher economic
status generally provides a better field for insurance due to various reasons. Educational,
financial and professional consciousness makes the proponent insurance minded. The
chance of death is also lower in higher strata of the society.

It is suggested to go through class notes also.