Plans of Premium in Life Insurance | Explanation, Merits, Demerits
Basically there are three plans of premiums. They are Assessment plan, Natural premium plan and Level premium plan or Instalment premium plan. They are briefly explained as follows.
1. Assessment plan in Life Insurance
This is an old but simple method of calculating premiums. Under this plan, the rates of premiums are not fixed in the policy but are collected from the surviving members or a group in order to pay for the sum assured to the beneficiary. Members of the group had to contribute to a fund which was utilized to render assistance at the time of death to the surviving dependents of the deceased member, of the group. Contributions were voluntary initially and the death benefits varied with the requirements for payments to individuals.
Subsequently, the benefit to be paid was definitely fixed and the contributions varied with the needs of the organization.
Demerits of Assessment Plan
1. The premium amount is not fixed, as it relates to the number of claims in a year.
2. Collection of premium at every claim is very difficult.
3. Equal contributions are collected from all members irrespective of their age.
This plan proved inequitable and unscientific and was therefore discontinued.
2. Natural premium plan in Life Insurance
The above mentioned defects of assessment plan are removed by this plan. Here the premium to be paid during the year is fixed in advance and is charged at the commencement of the year. Secondly the premium is graded according to the age at entry, so that different persons of different ages have to pay different premiums.
A 25 year old Adult may pay less premium when compared to a 50 year old man because of his chances of death which is comparatively remote. This calculation of premiums in advance and linking it to the age is made possible by the help of mortality tables. As premium is determined on the basis of mortality table, every year the amount of premium changes and hence it is named as “yearly renewable term plan“.
Merits of Natural Premium Plan
1. A very simple method of calculating premium with the help of mortality table.
2. A lower premium at lower age, and
3. Premiums are collected in advance.
Demerits of Natural Premium Plan
1. Higher premiums at old age, hence unattractive for old age persons.
2. Premium rates are not stationary. They increase with the increase in age.
3. As the premium increases year after year, the possibility of insurance being discontinued at later stage also increases.
3. Level premium or Installment Premium plan in Life Insurance
The above defect of higher premiums at old age is removed by the level premium plan. Here the premiums to be paid are leveled up so that usually the same premium is paid every year. The policyholders are well aware of the rate of premium which is uniform throughout the insurance period. This plan is considered to be the most scientific method based on mortality, under which a uniform rate of premium is determined on the basis of attained age and is payable throughout the term of the policy.
Merits of Level Premium Plan
1. The premiums are constant and stationary.
2. The method is simple and easy to understand.
3. Premiums are received in advance, so that fund is created to earn interest.
4. The method has both the element of saving as well as safety.
Difference Between Natural premium plan and Level premium plan
In natural premium plan, premium is charged as per mortality tables and age, therefore, there is increase in premium every year, whereas in level premium plan, the same premium is charged throughout the term.
Under natural premium plan, premium is not constant and increases with the increase in age, but in level premium plan, premium remains constant.
In natural premium plan, the premium amount increases every year as one advances in age, whereas in level premium plan, increase in the age does not affect the premium.
4. Life fund
There is no need to create life fund under natural premium plan, whereas in level premium plan, life fund has to be created as premium rates are higher at lower age.
5. Element of safety and investment
Only element of safety is present in normal premium plan, but in level premium plan, element of safety as well as investment is present.
6. Surrender value
No surrender value is available in natural premium plan, whereas in level premium plan, the surrender value is paid whenever a policy is discontinued.
The normal premium plan is old and not practicable. The level premium plan is more scientific and practicable.