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16
Chapter Outline
The calculation of a net single premium involves an equation, one side of which represents the present value of the benefits promised under the contract and the other the sum of money that must be on hand to provide the benefits. At the inception of the contract, the two sides of the equation are in balance. Moreover, the net single premium can be converted into a series of net level premiums without impairing the balance of the equation. However, once the contract has run for one or more premium-paying periods, the situation changes. The present value of future benefits and the present value of future net premiums are no longer equal. As the years go by, the present value of future benefits increases since the date of death draws steadily nearer, while the present value of future premiums declines since there are fewer to be received. The benefit side of the equation increases each year until it eventually equals the face amount of the policy, whereas the side representing premium payments (yet to be collected) declines until it ultimately reaches zero.
If the equation is to remain in balance, a third element must be introduced: the reserve. Thus the reserve may be defined as the difference between the present value of future benefits and the present value of future net premiums. It is the balancing factor in the basic insurance equation.
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