Actuarial computations and calculations as to how rates (premiums) are determined in detail are outside the scope of this discussion.
However, the basic concept of how annuity premiums are determined should be known by those who represent annuity insurers - even an auto salesman needs to have some understanding what happens within the block of steel in the front part of the car.
The mortality tables show the probability of a person living or dying at certain ages at certain periods of time.
To an actuary, this is just a start of premium calculation as the interest that the company will receive on premiums received over the period of the policy/annuity, and expenses that will occur in both issue and maintenance in addition to the survival probability must be calculated.
In addition, there must be some profit for the company calculated plus a margin for contingencies.
All of these are factored in with the age and sex of the annuitant.
Now you see why actuaries get the "big bucks.
" ANNUITY RESERVES One of the primary functions of actuaries is the calculation of "reserves.
" The best way to explain this complicated subject is to use the method used for Deferred Annuities.
DEFERRED ANNUITY RESERVES Deferred annuities are usually paid for by flexible, periodic premiums, or sometimes by fixed and periodic premiums.
Even though the premiums may be flexible, the contract holder may choose to pay a level amount into the annuity so as to build to a larger sum at annuitization and/or retirement.
Theoretically, premiums may continue through the entire period of deferment.
The level annual premium is paid only while the insured is still alive.
If, for example, the deferred annuity issued at age 40 starts the payment of $100 a month at age 70, and if the net single premium (the amount needed to deposit immediately to create the payment at age 70) for this is $239.
36, the annual premium on this policy may be paid until one year prior to the annuitization of the payment of the benefits (in this situation, the contract holder would be age 69).
Therefore, the series of annual payments is a temporary annuity due for a term of 30 years (age 40 to age 69 inclusive).
The amount of this net annual premium would be found by dividing the net single premium by the present value of an annuity due of "1" computed for the 30 year period.
The present value (as calculated by the actuaries from existing tables) of the 30 year annuity just happens to be 16.
141 (actually, it is 15.
141 plus 1 - if that helps) or to put it in another way, the present expected value or an annual level premium of "1" paid over the same term as the premiums on the deferred annuity.
This figure, divided into the net single premium for the annuity, gives a net annual level premium of$239.
36/16.
141 which equals $14.
83 Now that we know how a net annual premium is created, obviously there has to be funds held by the insurance company to pay for any such obligations.
Therefore, there are "reserves.
" RESERVING The reserves of an insurance company basically reflects its obligations to its customers.
Policy reserves are liabilities that represent in respect to business in-force, the amount that, with future premiums and interest earned, is expected to be needed to pay future benefits.
Another explanation is simply that reserves are the present value of future benefits.
Reserve calculations require the use of mortality tables and an interest rate.
If an insurer underestimates its policy reserves, or fails to maintain sufficient assets to back its reserves, it may find itself in the untenable situation of not being able to pay claims.
Incidentally, there are other reserves, such as Reserves for Substandard Policies; Reserves for Special Benefits, Reserves for Premiums Paid in Advance, Reserves for Claims Not Reported, etc.
, but the Policy Reserves are the most important - far and away!
However, the basic concept of how annuity premiums are determined should be known by those who represent annuity insurers - even an auto salesman needs to have some understanding what happens within the block of steel in the front part of the car.
The mortality tables show the probability of a person living or dying at certain ages at certain periods of time.
To an actuary, this is just a start of premium calculation as the interest that the company will receive on premiums received over the period of the policy/annuity, and expenses that will occur in both issue and maintenance in addition to the survival probability must be calculated.
In addition, there must be some profit for the company calculated plus a margin for contingencies.
All of these are factored in with the age and sex of the annuitant.
Now you see why actuaries get the "big bucks.
" ANNUITY RESERVES One of the primary functions of actuaries is the calculation of "reserves.
" The best way to explain this complicated subject is to use the method used for Deferred Annuities.
DEFERRED ANNUITY RESERVES Deferred annuities are usually paid for by flexible, periodic premiums, or sometimes by fixed and periodic premiums.
Even though the premiums may be flexible, the contract holder may choose to pay a level amount into the annuity so as to build to a larger sum at annuitization and/or retirement.
Theoretically, premiums may continue through the entire period of deferment.
The level annual premium is paid only while the insured is still alive.
If, for example, the deferred annuity issued at age 40 starts the payment of $100 a month at age 70, and if the net single premium (the amount needed to deposit immediately to create the payment at age 70) for this is $239.
36, the annual premium on this policy may be paid until one year prior to the annuitization of the payment of the benefits (in this situation, the contract holder would be age 69).
Therefore, the series of annual payments is a temporary annuity due for a term of 30 years (age 40 to age 69 inclusive).
The amount of this net annual premium would be found by dividing the net single premium by the present value of an annuity due of "1" computed for the 30 year period.
The present value (as calculated by the actuaries from existing tables) of the 30 year annuity just happens to be 16.
141 (actually, it is 15.
141 plus 1 - if that helps) or to put it in another way, the present expected value or an annual level premium of "1" paid over the same term as the premiums on the deferred annuity.
This figure, divided into the net single premium for the annuity, gives a net annual level premium of$239.
36/16.
141 which equals $14.
83 Now that we know how a net annual premium is created, obviously there has to be funds held by the insurance company to pay for any such obligations.
Therefore, there are "reserves.
" RESERVING The reserves of an insurance company basically reflects its obligations to its customers.
Policy reserves are liabilities that represent in respect to business in-force, the amount that, with future premiums and interest earned, is expected to be needed to pay future benefits.
Another explanation is simply that reserves are the present value of future benefits.
Reserve calculations require the use of mortality tables and an interest rate.
If an insurer underestimates its policy reserves, or fails to maintain sufficient assets to back its reserves, it may find itself in the untenable situation of not being able to pay claims.
Incidentally, there are other reserves, such as Reserves for Substandard Policies; Reserves for Special Benefits, Reserves for Premiums Paid in Advance, Reserves for Claims Not Reported, etc.
, but the Policy Reserves are the most important - far and away!