Zee Insurance Company

In its simplest form, life insurance consists of a contractual agreement that works in the following
way: The insured person pays the insurance company a certain amount of money every year. This
amount is called the premium. If the insured dies during the year, the company pays his or her
beneficiaries (usually family members) an amount that has been agreed upon in advance. The
higher the amount pledged to the beneficiaries in the event of the death of the insured, the higher
the premium. If the insured survives, the insurance company keeps the premium and has no
further obligations toward the insured. Clearly, then, the insurance premium is related to the
probability of the insured's survival. The greater the chance of survival, the lower the premium
charged by the insurance company. All comparative analyses in this regard are based on the
premium per $1,000 insurance benefits. For example, if the insured buys a $50,000 life insurance
policy (that is, $50,000 will be paid to the beneficiaries at the death of the insured) and the
premium is $250 per year, the premium per $1,000 is $5 [($250/$50000)x$1000]. From now on,
unless we say otherwise, we shall be considering the premium per $1,000 insurance coverage.
Suppose an US based insurance company is contemplating a plan to expand its operations and
offer life insurance to people in Madagascar. As an exploratory step, the company wants to know
if it can offer the insurance in this country at the same premiums it charges in the US, or whether
it should charge higher or lower premiums. The data for the analysis are given in Table. It shows
the frequency of male deaths by age in the US and Madagascar. Male deaths per 100,000 are
given for each country, which means that the data show how many males in each group (of
100,000) die on the average in the first year of life (class 0-1), between their first and fifth years
(class 1-5), and so on.
Table: Death Frequency of Males in U.S. and Madagascar, by Age Group per 100,000 males
United States
Madagascar
Age group
Frequency of deaths
Frequency of deaths
0-1
2060
17584
1-5
352
5575
5-10
229
1585
10-15
246
858
15-20
772
1371
20-25
1061
1954
25-30
955
1934
30-35
1054
2093
35-40
1411
2487
40-45
2111
3059
45-50
3306
3830
50-55
4789
4884
55-60
7085
6186
60-65
9617
7682
65-70
11828
9262
70-75
13836
10169
75-80
14216
9377
80+
25072
10110
Source: Samuel H. P., Nathan K., and Robert S., Causes of Death: Life Tables for National Populations, New York: Seminar Press, 1972.

1 In which country, the incumbent risk of the insurance company is more.

2. What is your suggestion?

Solution

Consider, for example, the 40-year-olds.

For every 100000 males there are 35441 deaths of males 40 years old or younger in Madagascar,
compared to 8140 in the United States.
This relationship (higher cumulative frequency in Madagascar as compared to the United States)
holds not only for the age of 40 but for each and every age we choose to examine. (Of course, the
cumulative frequency in the age interval 80+ is 100000 in both countries.)
Since the probability of dying at a younger age is greater in Madagascar for any age we choose,
the incumbent risk the insurance company takes in Madagascar is greater, and it is obvious that
higher premiums must be charged there than in the United States.