Valuation of Life Insurer

Valuation is a process to value the net liabilities of a life insurer on a particular date.

It determines the total amount of reserve that an insurer must have to meet his obligation. It means that the valuation, firstly, determines the total net liabilities of the insurer and secondly, compares his liabilities with the available funds.

Ultimately, it can be revealed whether the insurer has sufficient funds to meet his obligations or not.

Purpose of Valuation

There are two main objectives of the valuation :

(i) to determine the solvency of the insurer
(ii) to determine the distributable surplus amongst the participating policyholders.

(i) To determine the Solvency

The life insurer must find out whether he has sufficient funds to meet the current obligations or not. In case of insolvency, he has to curtail his expenses and increase the income.

He has to raise the premium rates and has to stop bonus distribution. Extra-precaution has to be applied in restraining the outflow of funds.

(ii) To determine the divisible Surplus

The excess of receipts over expenditures of a period cannot be regarded as profit of the year because unless all the claims are paid out, insurer cannot know the actual amount of profit.

Since the insurer transacts a continuing business, he cannot know the exact amount of profit at a point.

The valuation comes to help the insurer at this stage. The net profit or net loss is estimated through the comparison of net liability at a particular point of time with the available funds at that time.

If the funds are more than the net liability, a part of the excess can be distributed as a bonus or as a dividend to shareholders. How much will be distributed depends upon the amount of surplus at that time.

Calculation of Valuation

The valuation involves calculation of net liabilities apart form this main process, the valuation also includes comparison of insurance funds with the net liabilities during a particular period.

The comparison will reveal the surplus or deficiency which is treated accordingly. If the fund is more than the net liabilities (reserves) , it would be a case of surplus. Similarly, deficiency will occur where the insurance fund is less than the net liabilities.

Calculation of Net Liabilities

The Net Liabilities may be calculated with prospective method or retrospective method. Whatsoever method may be applied, the result will be the same provided the past assumptions are also applicable to future estimations.

In other words, if deaths occurred as anticipated, interest earned is also as expected and expenses are also incurred according to assumptions, there will be no difference between the value accumulated (retrospective reserve) and the present value required (prospective reserve) to meet the obligations.

This brings out the fact that policy value would be the same whether obtained retrospectively from the past experience or prospectively on future anticipation.

But in practice, the assumed rate of mortality has been observed more than the anticipated mortality. Similarly, the assumed rate of interest has been lesser than the future rate of interest.

Thus, the retrospective value has been more than the prospective values.

It has been made clear while explaining the relative merits of these methods that the valuation is made on the gross premium. But so far, determination of solvency is concerned, reserve or value is calculated on gross premium where we take into account not only mortality and interest but expenses also.

(a) Prospective Value

The excess of present value of future claims over the present value of the future premiums is called net liability.

There will always be excess because the net liability is calculated after some time of the commencement of the policies.

There is only difference of gross and net premium. Here the value is calculated on the basis of gross premium. The method reveals the net liabilities up to which the Insurer must have sufficient funds.

(b) Retrospective Value

Under this method, the premium is accumulated every year with certain rate of interest after meeting the claims. The accumulated excess is called life values (reserves).

The actual accumulated funds should always be more than the assumed reserves. But if the insurer has experienced heavier mortality than what he expected, earned less interest, or incurred greater expenses, the excess of his income over outgo would be less than what it ought to be.

If it were so, the insurer’s position is not solvent because if this state of affairs were left to continue, he would not be able to meet his future obligations.

Similarly, if his experience had been favourable, he would have accumulated more than what he ought to have accumulated and this difference is there the ‘Surplus’.