The cost of life insurance has been tangentially touched upon in previous issues, but it will be given a more in-depth look today. And while the true cost of life insurance, or any item, really, is not necessarily its price, for our purposes today, cost will be synonymous with the premium.
Of all the factors that affect a life insurance premium (age, gender, face amount, health issues, smoking status etc.), none affect it more than the probability that the policy will mature in a death claim. Since research reveals that less than 2% of all death claims paid are paid on term policies, it stands to reason that term insurance will be priced considerably less than permanent insurance.
The majority of term insurance today is level premium term, primarily for 10 or 20 years, although 5, 15, 25, and 30 year durations are also available. All other things being equal, since the longer the term, the higher the probability of resulting in a death claim, it follows that those policies will carry a higher the premium.
A few examples will illustrate the effect each component has on the premium. A 25 year old nonsmoking male (female) in excellent health can expect to pay $240 ($215) annually for a $500,000 10 year level term policy. Change it to a 20 year level term policy and the premium becomes $315 ($275). Make him (her) 45 instead of 25 and it goes to $430 ($390) for the 10 year and $745 ($595) for the 20 year.
Now let’s make him (her) a smoker. The 10 and 20 year rates for the 25 year old become $715 ($595) and $935 ($725), respectively, and for the 45 year old, $1,675 ($1,415) and $2,895 ($2,145). Clearly, the life insurance companies believe that smoking adversely affects life span.
The previous examples illustrated the very best underwriting class, which usually less than 15% of applicants qualify for. The following premiums reflect the standard underwriting class, and most companies also have one or two classes in between. For the 25 year old nonsmoking male (female), the annual premiums for the 10 and 20 year plans are $430 ($365) and $570 ($455), while for the 45 year old they become $895 ($735) and $1,355 ($1,075).
Whole life premiums will be significantly higher than term premiums, because as discussed, the probability that a whole life policy will mature in a death claim is significantly higher than that of a term policy.
Using the same parameters as above, the annual whole life premium for the 25 year old nonsmoking male (female) in excellent health for $500,000 is $3,640 ($3,185) while the 45 year old’s premium is $9,060 ($7,155). The smoker rates are $4,305 ($3,440) for the 25 year old and $11,360 ($8,780) for the 45 year old.
This is meant to show representative premiums for a variety of scenarios. Most companies have 3 or 4 nonsmoking categories, another 2 or 3 for smokers, and 10 or more substandard rating classifications, so clearly there are many permutations. While premiums can be estimated, the only sure-fire way to determine a premium for a specific scenario is to go through the underwriting process.
For simplicity’s sake, I equated cost with premium, but in reality, they are not the same. In the best class whole life example above, the cash value would equal the sum of the premiums paid after 10 years. So if the policy were surrendered at that time, what was the cost?