RISK5001 Chap.4 Life Insurance and Longevity Risk
Life Insurance and Longevity Risk
This chapter estimates the financial gap created by premature death, compares human-life-value and needs approaches, distinguishes term from permanent insurance, reads mortality information and prices a simple one-period benefit. Coverage is a cash-flow decision rather than a multiple chosen in isolation.
The analyst must identify whose income or service is lost, when obligations arise, which resources remain and how discounting changes present values. Mortality assumptions help price death benefits, while longevity analysis reverses the concern and asks whether resources can support unexpectedly long survival.
What this chapter covers
- 01
Human-life-value approach
- 02
Needs analysis
- 03
Term and permanent insurance
- 04
Mortality and survival
- 05
Longevity risk
- 06
Net and gross premiums
Worked example · free
A one-period net premium
- 1Expected claim is $750,000 x 0.0016 = $1,200.
- 1Discount the year-end amount: $1,200 / 1.05.
- 1Present value is $1,142.86 before loadings.
Key terms
- Human-life value
- The present value of future income contribution lost to dependants after premature death.
- Needs analysis
- A coverage method that subtracts available resources from the present value of identified financial needs.
- Mortality rate
- The probability that a person in a defined population and age interval dies during the specified measurement period.
- Survival probability
- The probability of remaining alive to a specified future time under the population and assumptions used in the mortality model.
- Term insurance
- Life cover for a defined period that pays the contractual benefit if death occurs while the policy remains in force.
- Longevity risk
- The possibility that survival lasts longer than financial resources, pricing assumptions or institutional funding were designed to support.
Life Insurance and Longevity Risk FAQ
How do the coverage approaches differ?
Human-life value begins with the income contribution that disappears, while needs analysis begins with obligations and available resources. Both depend on explicit timing and discount assumptions.
Why is longevity risk different from death risk?
Premature-death risk concerns life ending before expected support is delivered. Longevity risk concerns survival beyond the period that accumulated assets can finance, so the direction of uncertainty reverses.
What should be included in a needs analysis?
List immediate costs, debt repayment, education or care commitments, income replacement and any final reserve required by the household. Convert future amounts to a consistent valuation date, then subtract liquid assets and existing cover that are genuinely available. Avoid double counting an asset or treating illiquid property as immediate cash without explanation.
Why do discount and growth assumptions matter?
A higher discount rate lowers the present value of future support, while expected growth in income or expenses can raise projected cash flows before discounting. Small rate changes compound across long horizons. State whether amounts are nominal or real and use internally consistent rates so a coverage estimate does not hide contradictory inflation assumptions.
How is a simple net premium interpreted?
For a one-period death benefit, multiply the benefit by the probability that the covered death occurs within the period and discount if payment is delayed. This produces expected claim cost under the assumptions, not the final charged premium. Expenses, capital, uncertainty, options, selection effects and profit can all require additional loading.
When might permanent cover fit better than term cover?
Permanent cover may fit an enduring need such as estate liquidity or support for a lifelong dependant, provided the policy remains affordable and its guarantees are understood. Term cover often matches temporary income replacement or debt horizons more directly. The recommendation should follow the timing of the need rather than a generic product preference.
How should cover be reviewed after circumstances change?
Rebuild the cash-flow need rather than applying the old coverage multiple to a new salary. Update dependants, debts, education or care commitments, available assets, existing policies and the period over which support is required. Check whether ownership, beneficiaries and affordability still fit the objective.
Interest, inflation and income-growth assumptions may also have changed, so preserve a consistent nominal or real basis. A new need can increase cover, while repaid debt or accumulated liquid wealth can reduce it. Product replacement requires extra care because new underwriting, exclusions, waiting periods, fees or lost guarantees can make a superficially cheaper policy worse for the household.
Exam move
Sketch cash-flow timing before using a present-value formula. Keep benefit need, mortality probability, expected claim and gross premium as separate calculations with separate interpretations. Build a small table with year, required support, available resource, survival or mortality assumption and discount factor. Check that every future amount is valued at the same date and that no resource is counted twice.
Then explain what the numerical result means for the household, insurer or pension provider. Practise reversing the scenario: turn premature-death protection into a longevity problem and identify which cash flows and risk-management tools change.
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