It is really quite simple.
Safety In Numbers
The insurance company is not taking risk, the are managing risk. For the insurance company, it is a numbers game. They pretty much know how many people in each age group will not live to see the new year. About the only thing they don't know is who won't be at the next New Years Party.
Of course, we all understand there is a chance we will be one of the unfortunate ones that won't be at the next New Year's party. Insuring your life doesn't do you much good. The insurance money can only benefit your spouse and children or someone you would have supported had you lived. Entering into a life insurance contract is one of the most unselfish acts you can do in life.
All Life Insurance is Term Insurance
I know you have been conditioned to look at permanent insurance as being totally different than term insurance. It really isn't.
There are a number of different policy types available. Don't let yourself be confused by all of these terms because life insurance is not nearly as complicated as you may think. The different policies will become much clearer to you in minute.
1 Year Term
5 Year Term
10 Year Term
20 Year Term
25 Year Term
30 Year Term
Term to 65
Term to 100
Whole Life
Universal Life
The difference in the cost of life insurance, for you, varies due to the length of time you want to be insured. The numbers below are for example only. Please secure a quote at
Life Insurance Quotes if you want to know exactly how much life insurance will cost you.
Look at it this way. Let's insure one hundred 40 year old people for $100,000 each. Let's say there would be about 3 claims in the next 10 years. So $300,000 would have to be collected from these 100 people over the next 10 years so each claim could be paid. That equates to each person contributing a total of $3000 ($300,000 divided by 100 people) or $300 per year. This is 10 year term insurance in simple terms.
If we were to insure these same 100 people for the next 20 years instead of 10 years and let's also say that there will be about 10 claims during this 20 year period. So, in order to pay these ten $100,000 claims we need to collect $1,000,000. That means that each person would have to contribute $10,000 over 20 years. That means each person would contribute $500 per year. ($10,000 divided by 20 years) This is a twenty year term policy in simple terms.
If we insured the same 100 people until Age 100. We can predict that there is likely to be 100 claims. That means each person would have to contribute $100,000 and receive $100,000. Since it spans a 60 year period it equates to $1666 per year. This is Term to 100 in simple terms. It could also be called whole life.
The three additional factors that affect the amount of premium.
1. Reserves and the interest they earn. What is a reserve? First look at the Term to 100 premium of $1666. The 10 year term premium is $300. The difference is $1333. So if 100 people are contributing $1333 extra each year for the first ten years - an additional $1,333,000 is collected. This money is set in reserve and will be invested. This money will be used to pay future claims the group are sure to experience. At some point in time the claims will exceed the money that is being collected each year and this excess premium and the interest it earns will be used to help pay claims in the future.
2. Claims, or dropouts. Every time a claim is made there is one less person paying the premium next year. At the end of 10 years you have 97 people paying premiums. At the end of 20 years 90 people are paying premiums. At the end of thirty years maybe only 70 people are paying premiums. So, some people may only pay one premium. The lucky ones have to pay the premium for 60 years.
3. Costs. Administration, investment management, sales commissions, medical exams, claims estimators, and other personnel are required to make life insurance possible. These expenses must be paid by the group being insured. Costs are going to affect the 10 year term far more than the Term to 100 premium because costs are averaged over a longer time period in longer term policies.
So, life insurance is not all that complicated after all. This is how life insurance really works. It is not a difficult concept to understand. But let's expand our knowledge a bit more.
Grouping People.
The premium varies from person to person because they will be grouped with others of the same 'status' as them. First by age, then ................ Females, as a rule, live longer than males. Non-smokers live longer than smokers. People who's families are prone to certain conditions live shorter lives than those without hereditary exposures. The number of claims over any period of time are reasonably predictable regardless of the health conditions present in the group.
We would also group people together who have certain health conditions now. Diabetes, MS, High Blood Pressure, and the list goes on. Each condition changes the groups life expectancy. One can quickly see that some groups are going to have claims sooner than another group.
Most people can get life insurance. They may not like the premium, but they can still buy insurance.
We have the tendency to look at those examples of an uncle who smoked like a chimney for sixty years and lived to be 95. Although there are exceptions, there are just as many examples of uncles who died from heart attack or stroke at 60 after smoking for years. The group averages will vary but the end result is that there will be more claims earlier. And, that means less time to get the money to pay the claims and the less interest earned over time.
Playing with the premiums. Compound interest has a dramatic affect on premiums.
Some people want to pay premium only until they are 65 but want to have insurance protection until the day they die. All the insurance company does is collect more premium (set more money in reserve) earlier. More reserves and more interest earned means you can stop contributing when you turn 65. Maybe you only want to pay for 10 years and stop. These calculations are pretty simple to make since you are just putting money in the bank so your premiums are there in advance. Don't confuse yourself - the costs of the insurance will remain constant. People don't live longer because they pay a higher premium.
These additional premiums, which are designed to shorten the number of years you pay premium, can be segregated and attributed only to you. If there is any money in this account it would be returned to your beneficiary along with the agreed death benefit. Perhaps you change your mind - drop the insurance - you can take the extra money you set aside in cash.
Playing with investment returns.
The longer the term you are insured for, the more interest rates (investment returns) will impact your premium. Remember that investment return does not affect a 10 year term policy very much because there is little in the way of reserves. Investment return will affect a Term to 100 quite a bit. In the past insurance companies have achieved greater than 3% returns on average. Recently that has not been the case. Most insurance companies use a 3% average rate of return when they calculate a guaranteed premium policy. That has been proven to be a safe bet, till now. Recently many companies have announced and increase in whole life premiums because of the low rates.
Maybe you think the returns are going to be higher in the future. If you want, the insurance company will make your premium variable based on the actual rate of return. If you get a higher return your premiums will be lower. IF you get less return your premium will be higher. They will even allow you to make the investment choices including equity mutual funds and the like. However, you give up the guarantee of a fixed premium. If you make bad investment choices it will mean paying more than you thought.
Again, there is no secret to how life insurance works. The insurance company is helping you manage the risk for the time period you choose.
What is renewable term Insurance?
The first example we used showed how a ten year term policy works. It assumes that you would no longer need insurance after ten years. Suppose you wanted to continue being insured when the 10 year period ends. How would you go about arranging that?
Option One. If you are still healthy or reasonably healthy you could apply for a new policy and your premium would be determined based on your age and health at that time.
Option Two. Policies that have a renewal feature will allow you to renew them for another term. The premiums are listed in the policy and are guaranteed. So even if you do not qualify for a new policy you will be able to renew your present policy. If you had a ten year term policy the renewal policy would likely be for another ten year term. Please note the renewal premium is always higher than what it would cost if you were still in good health and applied for a new policy. In fact, it will be much higher. The reason, of course - anyone who would not qualify for a new policy would want to renew - while those that could apply for a new policy would simply drop out. The insurance company is left insuring only those individuals who are a much higher risk hence the much higher premium.
Renewable policies can usually be renewed up to age 75, 80, or 85. Anyone with a term to 100 does not need a renewal feature since they would never have to renew.
It is for this reason you want to match the length of the "term" of your policy with the length of time you will need the coverage. If you need coverage for 20 years get a twenty year term policy. This is the only way you can be sure of paying the least amount of premium over the time you need the insurance.
Remember that you may mix the term coverage. Under one policy you can have some of the coverage for a ten year term, some for twenty, some for thirty, and so on. You can even purchase whole life and attach term coverage to it. Perhaps your children are only 10 years away from being independent and your need for coverage would decrease. Having some coverage for 20 years, 30 year or longer is simple to do.
What is Convertable Term Insurance
This simply allows you to switch from your term insurance policy to a permanent ("term to 100") policy at any time during the option period. There is no need to provide medical evidence in order to make this change. All you have to do is request the change.
Remember, you are converting your term insurance policy (with a low premium) to a policy that has the highest premium so you really don't have to prove if you are healthy.
One thing to remember about convertible insurance is that you must convert by a certain age. Usually by age 65 or 70.
Most Term Insurance Policies end at age 70 to 85.
Just remember that when buying term insurance the policy does run out. You will not be able to renew your policy after age 85. You may out live the policy if you don't convert to a permanent policy before age 65 or 70.
That is why most term policies allow you to convert to permanent insurance if you want to do so.
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