Investment of Funds in Life Insurance

While calculating premium, it has been assumed that the accumulated premiums are invested. The funds are invested to earn at least assumed rate of interest. The needs of investment of funds are given below.

Needs of Investment

1. Payment of Claims

The first and most important obligation of the insurer is to pay the amount of claims whenever they arise. For this, insurer is getting a substantial amount in form of premiums and has to preserve them for payment later on.

To keep such amounts idle will be a failure on the part of the insurer who is expected to invest them on behalf of the policy-holders.

2. To Avoid Financial Deficit

If funds are not invested, the total income of the insurer will fall short of its requirements for meeting its commitments because a particular rate of interest on its investments has been assumed while calculating the rate of premium.

Again, if funds are not invested and interest not earned, it would be an under-estimation of its future liability which may prove disastrous at the time of higher mortality.

3. National Interest

A huge fund of the society is taken by the insurers in the form of premiums. Therefore, it is essential for the insurers to invest the funds for the economic development of the nation.

Sources of Funds

The funds with the insurers are accumulated from the various sources, some of which are given below:

(i) Premiums

The main source of funds is the premiums collected by the insurer. The premiums may be single premium, level premiums or annuity considerations.

The excess of these premiums over the needed premiums for meeting claims and expenses is the source of funds.

(ii) Interest

The second source of funds is the excess interest earned over the assumed rate of interest.

The assumed rates are lesser than the actual rate in most of the cases. In reverse, the funds will decline.

(iii) Capital Gain

Funds obtained from the sale of share capital and debentures are included under capital gains.

(iv) Savings in Expenses

Savings in expense loadings, bonus loadings, or mortality savings are also contributing to the funds of the insurers.

(v) Non-payment of Claims

In pure endowment or term insurance, the claims may not arise, therefore, the premiums paid for such benefits are saved. Sometimes, in certain cases, the claimants do not come for payment at all. Thus, the saved money also form a part of the funds of insurers.

Problems of Investment

While investing the funds, the insurer will have to face various problems, some of which are given in the following sections.

1. The main problem of investment is to preserve the interest of the policy-holders. The insurer keeps the money of the policy-holder as a trust money.

To maintain the trusteeship it is essential that the fund must be invested in such securities which are safe and secured.

2. The payment of the claim amount is the second problem of the life insurer. The insurer must have sufficient funds to pay the claims. So, the interest earned from the investment must be adequate enough.

3. The assets of the insurer should be protected from any elements of fluctuations. Therefore, the insurer must earn sufficient amount to pay its expenses. Moreover, the earning should be constant and the market price of the securities must not fall considerably.

4. There should be complete good faith of the public in the insurer’s management of funds. In case of doubtful investment the purpose of public may be defeated.

The insurer, therefore, may be losing its business in future.

5. A great care has to to be taken while selecting suitable channels of investment. The principles of investment should be followed to a considerable extent.

Investment should be such that profit thereon should be maximum without hampering safety and marketability.

The Principles of Investment

The canons of investment are safety, profitability, liquidity, diversification and increasing of life business.

1. Safety

The securities in which the funds of insurer is to be invested should never at any time fall in their face values, otherwise the liability will be more than its corresponding assets.

The primary purpose of investment is not to earn maximum profit but to maintain a complete security. Therefore, speculative investments involving possibilities of large profits or large losses are not suitable for life insurance funds.

On account of trusteeship status, the insurer should invest the funds only in sound channels.

Security of principal amount is more important consideration. Therefore, in India, the investment regulations are made whereby the life insurer is required to invest at least 50 per cent of its controlled funds in Government Securities.

Safety includes safety of principal amount and interest, thereon. It means that the principal and interest must not fall, below the expected level at any time.

This principle is the keystone of investment.

2. Profitability

The insurer must earn at least the assumed rate of interest otherwise he will suffer loss.

The investment, so, should be made in such securities which yield the highest return consistent with the principle of safety. The insurer can reduce his future premiums by earning higher interest and thus will be able to increase his business.

It has been realized that the safety and the profitability principles are opposite to each other.

The most safe securities earn little profit and vice-versa is also true.

Therefore, the investment department has to establish a proper balance between safety and profitability. However, there are certain securities where the safety and the profitability principles are fully observed. Gilt-Edge Securities, National Defence Securities are some of the examples of such securities.

A very large portion of funds may be invested in safe-securities which might yield at least assumed rate of interest while the other small portion may be invested in profitable securities guaranteeing at least safety of principal amounts.

In addition, an investment fluctuation funds may also be created to meet any possible losses on account of fluctuations in return.

In profitability reasonable rate of return with regularity and stability of income is essential. The second factor to be considered is no fluctuation in capital and lesser expenses of investments.

The third factor i.e., taxation is also important because unfavourable taxation may reduce the net income of the insurer.

3. Liquidity

It represents convertibility of investments into cash without undue loss of capital. The principle is essential because of immediate requirement of money for payment of claims.

However, there is no higher chance of maximum outflow at any time because the maturity, unlike the bank withdrawal, may not fall within a short period.

The claims  are, generally , following a set-trend on the maturity and death experience.

A rough estimation can be made of the payments of claims, surrender values, policy loans and regular expenses ‘Funds’ should be invested according to the requirements of the insurers, i.e. investments are so made that the maturities will occur at intervals to meet the needs of maturity obligations.

For meeting the daily outflow of funds, it is not essential to keep maximum amount in cash or in ready convertible securities because a vast inflow of cash is observed in form of premium return on investment and sale of securities.

For the established and financially stronger insurers, the liquidity is not much essential. Moreover, the insurer can insert a clause of delay in payment for a specific period.

The principle of liquidity is against the principle of profitability because the idle cash will earn nothing and invested cash will have no liquidity.

4. Diversification

Diversification of investment may mean spreading investment over different channels. The spreading may take place in the following manners.

(a) Diversification on the basis of geographical distribution.

(b) Distribution of the portfolio over the different economic enterprises of the country, political changes and time.

(c) Diversification may be according to number of investment in a security, maturity of security and duration of security.

(d) The distribution of funds according to industries, firms and sectors.

The diversification provides maximum security with high yield and better liquidity provided the diversification was done taking into account of all these factors.

Do not invest all the funds at one place in an industry, in a security and for a period of maturity.

Investments should spread over the widest possible range to minimise unfavourable consideration and to gain favourable advantages.

Under diversification, the law of average reduces the losses to minimum.

5. Increasing of Life Business

Investments should also be made in those sectors which are going to benefit the business in the return.

Naturally, the social objective principle helps in increasing the business. For example, the life funds, if utilized to finance the schemes of housing, sanitation, medical and education, it will go a greater way to lower the mortality and to increase the standard of people.

Decreased mortality and increased income cause more business to insurer because the lower mortality tends to reduce the rate of premium which increases the business.

Higher income induces person to get more policies.