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How Level Term Life Insurance Is Priced
You need life insurance, but you don\’t want to overpay for it. Overpay – it\’s a specter of of the life insurance industry. You\’ve been told that you should shop around endlessly for the cheapest level term life insurance policy. After all, all policies are the same, right? Not so fast. Life insurance is a complex financial product. Just because you\’re paying a low premium doesn\’t mean you\’re getting an awesome deal. Life insurance pricing takes into account a multitude of factors – all of which are important to you.
Your health obviously drives the cost of insurance. An insurer can only take on risks that it knows how to insure. This means that the risk needs to be quantifiable and pure. A \”pure risk\” is a type of risk where there is no possibility of profit or gain. In life insurance, your death is obviously a loss all around – even if a sizable policy death benefit is paid out, it never replaces the value of your life. Your family is merely made whole from an economic standpoint.
The better your health, the lower your premium will be. Also, in general, women tend to have lower premiums than men due to their generally longer lifespans.
Your insurer has to pay salaries, keep the lights on, and someone has to keep track of your money until your family files a claim. With that said, only a small portion of your premium goes toward overhead. This is usually considered a fixed cost that doesn\’t change over the term of your policy. Insurers try to keep overhead low because it\’s one of the only controllable costs the company has. By keeping overhead low, it can remain competitive in the UK insurance market – which is important, since competition is pretty fierce.
Your lifestyle also plays a big role in the premium. If you smoke, have a bad driving record, don\’t exercise, and have an alcohol problem, your premium will be much higher than if you\’re in good physical shape and are a responsible driver.
Certain sports, like skydiving, rock climbing, and race car driving, can also negatively impact your premiums. Life insurance companies see these as inherently risky. You could be rated up and pay a significantly higher premium than someone who works at a desk all day long.
The Financial Strength of the Insurer
A lot of the premium also depends on the financial strength of the insurer. Some insurance companies have sufficient cash reserves to take on a lot of risk. Others do not. Even when an insurer has a sizable cash reserve, it may not be in a good financial position – requiring it to charge higher premiums to make up for investment losses or a poor underwriting experience.
You see, insurers that are more liberal in their underwriting may have to charge higher premiums because they experience more death claims than more conservative insurers. Sometimes, the higher premium is masked by introductory rates on term policies or clever pricing schemes. For example, a company may design its term policies to be very inexpensive for people aged 30 to 45. However, once you move out of this age-range, the policy becomes more expensive. Why?
Because the younger and older policyholders are subsidizing this lower rate given to 30 – 45 year-old people. The premium looks attractive, but an insurer engaging in this type of pricing scheme might be trying to cover up poor financial strength or an inability to manage risk well compared to its peers.
Premium Funding Schemes
You have a multitude of ways to pay for your policy\’s premium. Annual renewable term allows you to pay for just the pure cost of insurance. Each year, the premium increases to reflect the higher costs inherent in life insurance (you\’re getting older, so premiums increase each year).
A level premium funding scheme allows you to pay a flat premium for a set period of time. This is where most people benefit from insurance, since level funding allows you to leverage the insurer\’s investments to lower your out-of-pocket costs.
The premium is initially higher than the annual renewable policy premium. This is because the insurer collects an amount of money far in excess of the pure cost of insurance. It invests that excess premium to hold down the future, rising, cost of insurance in the later years of the policy.
Each year, the cost of insurance actually increases. The only reason you never pay for those increased costs is because of the insurer\’s successful investment of those excess premiums.
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