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When it comes to buying life insurance, here’s one big thing we often wonder about: how the heck is this type of insurance priced? And how much should we really pay for it?
An actuary should be able to help. An actuary is an individual who uses statistical analysis to calculate the cost of future risks, such as the risk of dying. And the actuary plays an essential role in determining how life insurance is priced, which is what we care about when we’re writing that check.
To figure out your risk and how much you should pay for life insurance, the actuary and management of the insurance company consider:
Your costs are directly related to the chance of dying in the given time frame that the life insurance covers. Unlike many other risks, our mortality is certain; but when our death will occur is uncertain.
We do know some things though: it’s likely I will die before my son, and the likelihood of both of us dying increases every day. There is a higher likelihood that a 40-year-old will die in 30 years than the same 40-year-old dying in 10 years. So part of the cost of life insurance depends on your age.
Insurers use rate classes, or risk-related categories, to determine your premiums. For example, some factors considered in traditional rate classes are:
Standard: Good health, average cholesterol, relatively low-risk lifestyle
Preferred: Very good health and family medical history, low cholesterol, low-risk lifestyle
Super-Preferred: Excellent health and family medical history, very low cholesterol, low-risk lifestyle
Your rate class is determined by a number of factors, including overall health and family medical history and your lifestyle. Tobacco use, for example, would increase risk and therefore cause your premium to be higher than that of someone who doesn’t use tobacco. So part of the cost of your life insurance depends on your health.
Length and type of life insurance policy
The longer a life insurance policy is in place, the older the insured person is, the more likely the insured person will die. Then one should consider the type of policy, permanent life insurance or term life insurance. Permanent life insurance premiums, for example, are more expensive than term premiums because some of the money is put into a savings program, and the upfront commissions on permanent insurance are larger than term insurance.
Size of the death benefit you want
The higher the benefit your policy pays upon your death, the larger the premium payments you will make while you are living.
Interest the life insurance company expects to earn on investing your premiums
The length of our lives and life insurance are all about time. The insurance company estimates the investment return it expects to earn on your premium dollars. When the investment return is expected to be lower, your premium will be higher.
Operating costs of the insurance company (including commissions) and the insurance company’s profit
The insurance company considers in its life insurance premium pricing its operating costs and target profit. If the insurance company has lower operating costs and lower targeted profit, your premium will likely be less.
Each of these factors has an impact on the premiums you pay on your insurance. Understanding these factors can help you make sure you pay the right price for your policy. Next time you have a conversation with a life insurance salesman, your accountant or your financial planner, you’ll know what you’re talking about!
Are you considering purchasing life insurance? How are you evaluating the proposed insurance premiums?