Insurance loans comparision - financial intermediaries as they collect and invest large amounts of premiums

Insurance companies play a vital role as financial intermediaries, collecting substantial premiums from policyholders and strategically investing these large sums. Beyond offering essential protection and savings mechanisms, certain life insurance policies can also serve as valuable financial tools, potentially allowing policyholders to access funds through policy loans. This article explores the fundamental nature of insurance companies, delves into the structure of various life insurance plans, and examines how these policies are valued and utilized within the broader financial landscape.

Understanding Insurance Companies as Financial Intermediaries

Insurance companies function as contractual savings agencies, receiving a consistent inflow of funds through premiums and contributions to pension plans. Their ability to accurately predict future payouts and the long-term nature of many liabilities (some life policies extend for 30, 40, or even 50+ years) means that liquidity is generally not a significant concern. This allows them to focus primarily on long-term investments. Since they provide life coverage with a relatively low guaranteed rate of return, they don't necessarily need to chase exceptionally high returns on their investments.

Historically, insurance companies have invested heavily in government bonds, mortgages, state and local government claims, and corporate bonds. Their activities span various fields, including life, health, and general insurance, and they have expanded into operating pension schemes and mutual funds. The core of insurance involves spreading risks over time and distributing them among individuals and organizations.

Life insurance, a major segment of the industry, operates based on mortality statistics. A key distinction between life and general insurance is that life insurance claims are fixed and certain, whereas general insurance claims are uncertain, with the amount determined only after an event occurs. Pension business is considered a specialized form of life assurance.

The Life Insurance Corporation of India (LIC): A Case Study

History and Organization of LIC

Life insurance has been present in India since 1818. Before 1956, the industry was fragmented, with numerous companies of varying sizes and structures offering both life and general insurance, alongside several Provident Societies.

In 1956, the life insurance sector was nationalized, leading to the establishment of a single, unified entity: the Life Insurance Corporation of India (LIC). Today, LIC dominates the life insurance market in India, with only a negligible and declining amount of business handled by the Post and Telegraph Department for its employees.

What are LIC's Core Objectives?

The primary objectives of the LIC include:

• Spreading life insurance and offering protection to the general public at an affordable cost.
• Mobilizing public savings through insurance-linked savings schemes.
• Investing funds in a manner that benefits both policyholders and the nation.
• Operating efficiently and economically, always remembering that the funds belong to policyholders.
• Acting as trustees for policyholders, safeguarding their individual and collective interests.
• Innovating and adapting to meet the evolving life insurance needs of the community.
• Fostering a sense of pride and job satisfaction among all employees and agents through dedicated service to achieve corporate goals.

How Has LIC Diversified Its Services?

In recent years, LIC has significantly expanded its activities by establishing several subsidiaries:

1. LIC Housing Finance Limited (LICHFL)
2. LIC Mutual Fund (LICMF)
3. Jeevan Bima Sahayog Assets Management Company (JBS AMC) Limited
4. LIC (International) E. C.

Exploring Types and Structure of Life Insurance Plans

LIC has introduced and popularized a wide array of insurance policies, making life insurance a highly flexible financial instrument. While there are many variations, the basic types of policies include term insurance, whole life insurance, endowment policies, annuity contracts, individual insurance, group insurance, pension plans, children's plans, and equity-linked plans. These policies are often tailored to different income and age groups.

Whole life policies require premium payments throughout one's life, whereas endowment policies are taken for a fixed period. Endowment policies offer both life coverage and a suitable return, while whole life policies primarily provide long-term risk coverage rather than focusing on high returns. These basic types can be combined in numerous ways to create a diverse range of plans to serve various purposes.

With-Profits vs. Without-Profits Policies

Life policies can be structured as either "with profits" or "without profits."

• Without-Profits Policies: The sum paid upon maturity or death is precisely the sum insured when the policy was initially taken out.
• With-Profits Policies: Bonuses, derived from extra earnings on various investments, are periodically added to the assured sum during the policy's term or occasionally paid out in cash. Premiums for "with profits" policies are typically higher to account for these potential bonuses.

How Can You Access the Value of Your Life Policy?

As a financial instrument, a life policy represents a claim to a future payment, either as a lump sum or a stream of income. The value of a policy is the present value of these future benefits minus the value of future premiums. Policyholders can realize the present value of their policy and withdraw from future premium obligations through several methods:

• Surrendering the policy for cash.
• Assigning it in the open market.
• Raising a loan using the policy as security.
• Converting it into a free or paid-up policy.

Life insurance policies and pension funds are popular not only for their life cover and savings aspects but also for added benefits like profit sharing and various tax advantages. Life policies often serve as vehicles for linking actions such as home purchases, funding education, investing in unit trusts, and tax planning. In many cases, the provision of life cover becomes a secondary motive, with other financial objectives taking precedence when acquiring a life insurance policy.

How Are Life Policies Valued?

The funds generated from selling life insurance plans are invested in a variety of income-producing assets. The "life fund" grows from the excess of premiums and investment income over claims and expenses. This fund is periodically valued by discounting future income and expenditures back to the present.

The discount rate used typically matches the average interest rate expected from the fund's assets, potentially adjusting for anticipated increases in interest rates and future bonuses.

Understanding Surplus Distribution

A life fund is considered to be in surplus if its valuation exceeds the present value of its future liabilities. This surplus can then be partially distributed to policyholders and partly added to reserves. Only "with-profits" policies participate in this surplus distribution. There are three primary ways to distribute surplus to policyholders:

• As cash payments.
• As a reduction in future premiums.
• As an addition to the policy's value, known as a reversionary bonus.

A reversionary bonus can be declared as a simple bonus, calculated on the original sum assured, or as a compound bonus, calculated on the original sum assured plus any bonuses already declared. Surplus can be categorized as revenue surplus (excess of future income over outgoings) or capital surplus (when the fund's value aligns with the balance sheet value of its assets).