What is a life insurance premium and how does it work?
Many people believe that life insurance is expensive, but premiums can be surprisingly low depending on factors such as your age, the type of policy you choose, and the amount of coverage you require. Life insurance rates differ from person to person, and the cost can vary significantly. Understanding life insurance premiums, including how they work and how they are calculated, can be beneficial if you are in the market for life insurance.
What is a life insurance premium?
A life insurance premium is the amount of money paid to your life insurance company in exchange for coverage. Your coverage will remain in effect for the duration of your policy as long as your premiums are paid on time (or until your passing). If you have term insurance, the length of your coverage will vary, but if you have permanent life insurance, it will last until your death as long as you pay the premiums. Depending on how you set up the policy with your insurer, life insurance premiums are typically paid monthly, quarterly, semi-annually, or annually.
What if you stop paying life insurance premiums?
If you fail to pay your life insurance premiums, your policy may lapse, depending on the terms of your policy and the type of life insurance you have. Your policy may include a grace period — a period of time during which your policy will not lapse for nonpayment — though the actual grace period will vary depending on the policy type and company. A standard term life insurance policy, on the other hand, will typically lapse if you miss a payment and haven't paid within the grade period. If your policy lapses, your dependents will no longer receive a death benefit if you die, exposing them to financial risk. However, most policies have a reinstatement period during which you can make up any missed payments and reactivate your coverage.
With permanent life insurance policies that include cash value accounts, missing a life insurance policy payment may be treated differently. Money in the cash value account can typically be used to pay premiums after a certain period of time and if sufficient cash value has accrued, so if you forget to make a payment, your policy may not lapse if the cash value is used. However, make sure to discuss this feature with your insurer; a company may not automatically use your cash value to pay the premium, so you may need to authorize this safeguard.
How are life insurance premiums used by insurers?
Now that you understand what a life insurance premium is, you may be wondering what happens to the money after you give it to your insurer. Insurance companies may use your life insurance premium in the following ways:
- To cover liabilities: Insurance providers have to set themselves in a financial position to pay out on claims. That is, if a policyholder dies, the insurer will use a portion of the total premiums paid to cover the set death benefit (as well as any other policy payouts) to the designated beneficiaries. In the event of the policyholder's untimely death, financially stable insurance companies will typically keep a set amount of money on hand to cover outstanding liabilities and help ensure beneficiaries receive what is owed.
- To cover business expenses: A life insurer, like any other business, must account for operating expenses. Salary, office space, legal fees, and other business expenses may be covered by a portion of your life insurance premium.
- To invest: Some insurance companies choose to invest a portion of their funds in the growth of the company and the subsequent benefit to policyholders. Good returns on those investments may allow them to keep the cost of their insurance products as low as possible, thereby providing stakeholders with greater financial stability and peace of mind (policyholders).
How are life insurance premiums determined?
The cost of a life insurance policy will vary for each person. Before a life insurance company issues you a policy, your health and other factors are usually assessed to determine how your life expectancy compares to the duration of your policy's coverage. A higher risk level with life insurance means you're more likely to die before your policy expires, and thus your insurer would pay the death benefit before significant contributions in the form of premiums have been made. As a result, younger and healthier people typically pay lower premiums for life insurance policies. Furthermore, depending on your age, a term policy may be less expensive than a permanent policy because you may outlive the term policy length and the insurer may not have to pay out a claim.
Certain policies, such as universal life insurance, have adjustable premiums. Policyholders can choose to pay a higher premium (in order to increase the policy's cash value), pay only a portion of their premium, or avoid paying their premium at all. The policyholder must have enough money in their cash value account to either not pay or pay only a portion of their premium out of pocket. If you do not pay the entire premium balance out of pocket, the remaining amount will be deducted from your policy's cash value account.
Here are some of the main factors that an insurance company takes into account when calculating your life insurance premium.
Type of coverage
There are two types of life insurance policies available: term and permanent. Term policies are typically less expensive, but they only provide coverage for a limited time (the term). These policies may be most beneficial for those who only want coverage for a set number of years, such as when their children are young and dependent needs are at their greatest.
Permanent policies are typically associated with a cash value account and remain in force for the duration of your lifetime as long as premiums are paid. Because an eventual payout is more likely, permanent policies are typically much more expensive than term policies.
Permanent policies are available from a variety of life insurance companies.
- Whole life
- Universal life
- Indexed universal life
- Variable universal life
- Guaranteed issue life insurance
Age
When you buy life insurance, the younger you are, the lower your premium will usually be. Why? Your life insurance company calculates your rates largely based on life expectancy, and lower payments are typically set to account for the lower risk of an earlier death.
Sex
Women outlive men by five years on average in the United States. Life insurance companies may consider this in premium calculations, in addition to health complications that may be more prevalent in one sex than another. As a result, depending on their preexisting conditions and age, women may pay lower life insurance premiums than men.
Health
A medical exam is required for the majority of life insurance policies. This is your insurance company's way of ensuring that the information on your application is correct and that you don't have a preexisting condition that would significantly reduce your life expectancy. Type 1 diabetes, high blood pressure, and asthma are examples of preexisting conditions that could raise your premium.
In general, the healthier you are, the less you will most likely have to pay for your life insurance policy. If you want to potentially lower your life insurance premiums, you should focus on eating a healthy diet, exercising regularly, and quitting smoking.
Lifestyle
Insurers consider your risk level to be influenced by how you live. Life insurance companies typically raise your premiums to compensate for the risks associated with a dangerous lifestyle, such as a dangerous occupation or extreme hobbies. If your job is inherently dangerous, such as washing skyscraper windows, you may not be able to offset the cost of life insurance. If you enjoy more extreme hobbies or activities, such as motorcycle riding, bungee jumping, skydiving, or smoking, you should think about making lifestyle changes. Eliminating risky activities may help you significantly reduce the cost of life insurance.
Riders
Life insurance riders, also known as endorsements, are designed to add specific policy benefits to a life insurance policy in order to make it work better for your specific needs. While they may not lower your premium (in most cases, they will add premium to your policy), they may add additional value to the policy, making your cost more worthwhile. The following are examples of common life insurance riders:
- Long-term care rider
- Term conversion rider
- Waiver of premium rider
- Terminal illness rider
- Disability income rider
- Child benefit rider