How is the Premium of a Life Insurance Policy Calculated?

The amount of money that the customer pays to purchase an Insurance Policy is called Premium. The actual calculation is a complex technical process, involving actuarial and statistical principles. Only trained professionals called Actuaries do it.

The premium paid by the customer for a life insurance policy has various components. Let us first understand the various components of Premium. Diagrammatically, the components on premium are given below:

The premium that is paid has 3 distinct components in any life insurance product. It is commonly called EMI, i.e. Expenses, Mortality and Investment.

1. The Expenses are the charges incurred in opening and maintaining the policy.
2. The Mortality Charge is the charge for the Life Cover that is provided. It is the amount charged for the guaranteed Sum Assured which is paid on premature death of the policyholder. It is basically the cost to meet the risk of death for one year at a particular age. Based on the expectation of death and by gathering past data, Mortality Tables have been created by actuaries, which is utilized to calculate the Mortality Charges for each individual. The Mortality Charge provides for the Death Benefit that needs to be given to the policy holder’s family on death of the policyholder.
3. The rest of the premium is utilized for Investment. This is to provide Maturity Benefit to the policyholder if he survives till the end of the term.

All life insurance products may or may not have the 3 components. It is the combination of 2 or 3 components that make each product unique. In any Life insurance Product, first the expenses are deducted, then mortality charges and finally the remaining amount is Invested. If the investment is done according to the customer’s choice, i.e. the risk of investment is borne by the customer, then it is ULIP and if the risk of investment is borne by the company, then it is Traditional Policy.