Whilst 1.1 above outlines the developing appreciation of the many uses of life insurance, the modern scene tends to look upon available life insurance products from the perspective of meeting various needs. These we may think of as:
In the Core Subject for this Insurance Intermediaries Quality Assurance Scheme, "Principles and Practice of Insurance", the principles of insurance were studied in detail. By way of reminder, but not detailed comment at this stage, these principles are:
(d) Indemnity: providing an exact financial compensation;
(e) Contribution: insurers sharing an indemnity payment;
(f) Subrogation: the insurer taking over rights against third parties.
1.2.1 Insurable Interest
In simple terms, insurable interest is that relationship with the subject matter of insurance (a person’s life, in the case of life insurance) which is recognised at law as giving rise to a legal right to insure that person’s life. This is a legal concept that has applied for more than two centuries and is obviously based on common sense. If you have no relationship with a given person, why should you have the right to insure his life and thus profit from his death?
Some particular points to be noted with this principle are:
(a) Statutory requirement: in life insurance, the legal requirement for insurable interest is derived from section 64B of the Insurance Companies Ordinance (ICO).
(b) Effect of lack of insurable interest: Section 64B renders a contract of life insurance void where the person for whose use or benefit or on whose account it is made has no interest.
(c) Insurable interest in oneself and in spouse: we all have an insurable interest in our own lives for an unlimited amount. In addition, a person is presumed to have an insurable interest for an unlimited amount in the life of his spouse, so that no proof of such an interest is required.
(d) Insurable interest in others: to have an insurable interest in other people (i.e. people other than oneself and one’s spouse), the law requires some financial involvement which could be at risk by the other persons dying. Some examples which may be reasonably common are:
(i) debtors: if a person owes you money, you may insure his life for the amount of the loan, plus accrued interest;
(ii) business partners: especially where personal services are involved, such as performers and musicians;
(iii) contractual relationships: if another person's services have been engaged under contract (booking a singer for a concert, a professional sportsperson, etc.), that person's death may cause the other contracting party to suffer financially. That potential loss is insurable.
Note: This heading would include a type of life insurance known as Key Person Life Insurance (or Key Employee Life Insurance), where an employer insures the life of an important employee, in case of loss to the business from the employee's death.
(e) Blood relationships and family members: in some countries (e.g. in most jurisdictions of the U.S.), a family relationship (brother, sister, parent, child, grandparent, grandchild, etc) is sufficient to constitute insurable interest. This is not true in Hong Kong, where blood relationship in itself is not regarded in law as constituting an insurable interest.
(f) Statutory extension of insurable interest: by virtue of Section 64A of the ICO, a parent or guardian of a minor (i.e. a person aged under 18) is given an insurable interest in that young person. This is an important exception to the general rule in (e) above. It also means that, apart from one’s spouse, only the relationships mentioned (parent/guardian of a minor) constitute insurable interest arising from blood or family connection. An insurance effected on the basis of any other blood or family relationship is technically void (see (b) above).
(g) Sections 64C and 64D of the ICO: these Sections have two other important provisions:
(i) the person interested in the life insured, or for whose use or benefit or on whose account the contract is entered into, must be named in the contract;
(In practice, this provision has not been construed so widely as to include all those who the policyowner intends to benefit by receiving the policy proceeds. Therefore, where a life insurance policy is payable to the executors of the policyowner, no one cares whether the names of the executors and of the persons who are intended to benefit under the will appear in the policy.)
(ii) no more than the amount of the interest the insured (i.e. policyowner) has in the life insured is recoverable under the contract [this provision is significant only where the life insurance concerned is effected on an indemnity basis, credit life insurancebeing an example (see 2.1.1a(b)(i))].
(h) When is the interest needed?: this is a key question, and very important consequences flow from its answer. The answer is that insurable interest is only needed when the contract begins, and becomes irrelevant thereafter. What could be the (quite legal) consequences of this? Some examples are:
(i) Divorce: a spouse, who insures his/her spouse and then becomes divorced, can keep the policy in force and be perfectly entitled to collect the benefit in due time.
(ii) Debts: it is legally possible to insure your debtor, have the debt repaid, keep the policy in force, and be "paid again" in due time by the insurer.
(iii) Assignment: a policyowner is capable of assigning a properly arranged life insurance contract to a third party even though the latter has no insurable interest in the life insured, provided that this is not a premeditated act of getting round the requirement for insurable interest. The latter act will be ineffective on the grounds that it is done for the purpose of defeating the object of a statute, and the contract is indeed void as from inception because the de facto insured (i.e. the intended assignee) has not the required insurable interest. Therefore, what matters is the intention of the policyowner when he is effecting a life policy. Taking out a life policy with the general intention of assigning it is legitimate, but doing so with the intention of assigning it to a specified person who has no insurable interest in the life insured is another matter.
1.2.2 Duty of Disclosure
This concerns another important insurance principle, that of utmost good faith. Put simply, utmost good faith requires the disclosure of all material facts, whether the insurer requests them or not. A material fact is legally defined as ‘every circumstance which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will accept the risk’.
Some points to note:
(a) What to disclose: clearly, the insurer wishes to know all important facts, but you cannot be expected to disclose what you reasonably cannot be expected to know. Some conditions, for example, may be easily recognisable to qualified doctors, but the average layman cannot be expected to self-diagnose and reveal such things.
(b) Non-medical application: if the insurance is arranged without a physical examination of the applicant, the insurer will normally have 1/8 great difficulty in alleging non-disclosure of a material fact not covered by questions on the application or the personal physician's form.
(c) Medical application: if the insurance is arranged with a physical examination of the applicant, the insurer cannot hold against theapplicant negligent omissions or mis-diagnosing by the medically qualified person concerned.
(d) Medical tests: the insurer is entitled to supplement information supplied verbally with reasonable medical examinations or tests, but great caremust be taken not to breach the Personal Data (Privacy) Ordinance, which requires insurers to explain the need for gathering information before any testing takes place. The subject of the tests also has the right under that Ordinance to be told their results.
(e) Breach of the duty on the part of the policyowner: at law, a breach of utmost good faith renders the contract voidable by the insurer. But with most life policies in Hong Kong, regard has to be taken of the Incontestability Provision (see 4.2), which means that the policy cannot be contested after it has been in force for a specified period (contestable period), unless there is proof of fraud.
1.2.3 Other Insurance Principles
(a) Proximate cause: this principle is concerned with the identification of the dominant, effective cause that produced the loss being claimed for under the insurance. The principle does apply to every class of business, but it is very likely to have rather less significance with life insurance partly because of the minimal use of exclusions. The application of proximate cause is very much concerned with different kinds of perils(i.e. causes of loss):
Note: 1 Suicide is an exception to the general statement that life policies seldom have exclusions, so proximate cause will be important indetermining whether death arose from suicide or not. However, even here the principle does not have full impact, because suicide is only excluded for a limited time period (suicide exclusion period) (see 4.12).
2 We may conclude that the principles of insurance, especially those concerned with claims, have less application in life insurance than in non-life insurance.
(b) Indemnity: this means an exact financial compensation for the loss sustained and is very important in most General Insurance policies. As far as life insurance is concerned, however, (i) it is immediately obvious that the policy proceeds (or ‘insurance proceeds’) in no way pretend to (or can) represent an exact financial compensation. That is why life policies are called benefit policies, not indemnities;
(ii) it is impossible to over indemnify. The insurable interest (closely linked with indemnity) in many cases is unlimited (see 1.2.1(c)).
(c) Indemnity corollaries: a corollary is a sub-principle and indemnity has two corollaries, Contribution and Subrogation.
(i) Contribution: in most General Insurance classes, if by some chance a person has more than one policy covering the loss, he does not get paid twice. Each policy contributes to (shares) the loss rateably. On the other hand, if he has more than one policy not by chance, a vigilant claims handler might well take that as an indication of fraud!
Life insurance policies are normally not subject to the principle of indemnity, so it is quite normal for a person to have more than one life policy and each must pay in full upon the insured event happening.
(ii) Subrogation: this relates to the legal right of the insurer who has provided an indemnity to take over any remedies the “policyholder” (the UK equivalent of the American term “policyowner”) possesses against third parties, to seek to recover his payment to the policyholder. This does not apply to life insurance.
If, for example, a third party negligently damages a person's car (which has comprehensive cover), the person's motor insurer must pay but can attempt to recover its payment from the third party.In that same accident if an innocent victim in the car is killed, his life insurer must pay, but the life insurer has no right of recoveryfrom the third party.
1.3 CALCULATION OF LIFE INSURANCE PREMIUM
The individual premium to insure a given life may have to take into account individual features which make the risk better or worse than the average for a person of that age and sex. That, however, is essentially a matter of underwriting, which we shall consider in more detail in 5.3. Life insurance (premium) rates, which may be thought of as the normal or standard premiums applicable according to age and sex, are subject to certain common features considered below.
The classic criteria usually applied to life insurance premiums are that they should be:
(a) adequate: so that the insurer will have money to pay the benefit and meet other obligations under the contract; and
(b) equitable (fair): so that each policyowner is paying an amount in linewith the risk and contracted benefit involved.
To achieve these criteria, a number of factors must be taken into account
in the course of rating.
1.3.1a Mortality, Interest and Expenses
(a) Mortality: perhaps more accurately phrased as the Rate of Mortality, this indicates the rate at which insured lives are expected to die. Whilst this sounds very morbid, it will be immediately obvious that this is absolutely at the heart of life insurance premium calculation. To know, on average, when the life to be insured may be expected to die is a crucial factor in determining the correct premium to charge.
Of course, individual lives may live much longer or shorter than the average, but following the "law of averages" (which is sometimes called the "law of large numbers") reasonable predictions and calculations can be made. These are greatly facilitated by the use of mortality tables, which are published tables showing the expected rate of mortality at any given age.
As mentioned above, individual risks may call for special terms and consideration, but that is an underwriting matter. Premium rating using mortality tables merely deals with normal risks and normal expectations.
(b) Interest: in very simple terms, life insurance involves collecting money now and at specified intervals, to provide for a benefit at some time or upon some event in the future. This, by definition, means we have some time, and as the old saying goes "time is money"!
How much time we have, on average, largely concerns (a) above. The fact that we have some time means that we have an opportunity for investment. The interest earned on invested premiums and previous interest earnings is another crucial factor in determining premium rates. If the anticipated returns of investment are good, an insurer can charge lower premium rates than its competitors, and/or make more profit for its shareholders.
Note: The above two factors combined will produce what is called the net premium (sometimes called the pure premium), i.e. the money required to be collected from the policyowners just to meet death claims arising in the future under normal statistical expectations. But there is more to consider.
(c) Expenses: the net premium has to be subject to a loading (surcharge or additional sum) to take care of all expected and possible expenses. These will include all internal operating costs, commissions, tax and overheads to which any business is subject. With life insurance, there is also the possibility (however remote) of unusual mortality rates from some new disease or other disaster - and existing premiums cannot be increased later to deal with changed circumstances. Loading the net premium will include an amount to cover that kind of contingency.
Note: The loading added to the net premium produces the gross premium, which takes into account all three basic factors mentioned above.