Contents

• How Do Life Insurance Premiums Work?
• Determining Life Insurance Premiums – Make a Comparison
• Comparing Stepped or Level Premiums: What is the Best Option for You?
• Case Studies
• Keep Your Insurances Affordable

How Do Life Insurance Premiums Work?

Have you ever wondered, “how do life insurance premiums work?” You have probably heard about a person who got life insurance for half the price you had to pay or you may have seen that add on television that said, ‘For 25 cents a day we will insure your life for $15,000,’ when selling funeral cover, so you give them a ring only to get the answer that it will cost you the best part of $2 a day. To obtain cost effective cover on your life insurance, compare cover and quotes.

An insurance company is a lot like a bookmaker at the races. You want to lay a bet with them that you are not going to die within the period that you want your life to be insured. The insurance company then looks at the risk involved before it takes the bet on. If it feels you are a good risk, if you are young and healthy, it will accept your bet at a very low premium. If on the other hand it feels that you may not be such a good bet (you may be older and not as healthy as you would like to be) it will take the bet on but you will have to carry some of the risk yourself with the payment of a higher premium. If you are in your 80s and have had two previous heart attacks you would be lucky if they would take you on at any price. This is why, as stated earlier, it is important with all life insurance to compare cover and quotes.

Determining Life Insurance Premiums – Make a Comparison

There are two main considerations an insurance company must take into account when determining the premium it is going to charge a specific individual these are:

1. The amount of cover you want and the type of insurance you are looking for.
2. The risk the company has to carry of you personally dying during the period of cover.

“How do they know if I am a risk?” would be a fair question at this stage. This is a question that has been professionally perfected over the years by people known as insurance actuaries. It is their job to determine the risk the company is carrying in insuring their wide variety of customers, by knowing what that risk is and how much the customer should have to pay for the company to carry that risk. This is why it is important that with your life insurance, compare one company against another for what they offer.

To be able to do this properly they need the following information:

• Do you smoke, have you ever smoked, when did you stop smoking if you have previously been a smoker?
• Do you drink alcohol, if so how much, how often?
• How old are you? Your age is an important risk factor as the older you are the more risk there is of you dying whilst being covered and the less time to pay the premiums.
• Have you now or have you in the past suffered from any health problems.?

All this information is calculated against national averages from which it can be ascertained pretty closely to how long you are expected to live. From there it will be scientifically determined what the cost of that risk is. For instance if so many people of a certain risk factor were to die during the period they were covered for insurance what is the amount the company would have to pay out. This cost is then factored in to the amount of people wanting cover and a premium is arrived at.

Comparing Stepped or Level Premiums: What is the Best Option for You?

If you are looking at taking out life insurance, income protection or trauma insurance policies, you can have your premium payments structured in two ways; stepped or level. Although you may believe that this is a simple decision to make, and you simply take the cheapest, it is not necessarily so. Stepped premiums mean that your future premium payments will be recalculated as you get older. While you are young your premiums will be rather cheap but as you age they will get dearer. Level premium payment means the total payments you will be expected to pay over the term of the insurance cover have been averaged out. You might find yourself paying more at the beginning of a level premium policy compared to a stepped policy, but you’ll be paying less at the end than you would be doing with a stepped arrangement.

The reason to not jump in too soon and take up what, at first appearance, seems to be the better deal of a stepped arrangement, because of the initial lower cost, is because if you look into it more thoroughly you will find that it is the level arrangement that will give you savings over the longer term. In fact figures show you are able to save about 50 percent over your lifetime with a level premium insurance policy.

The reason to work this issue through before making a decision is based on the assumption that you will be needing your largest life insurance cover when you are aged between 40 and 55. These are the years when you will be most likely to have a relatively large mortgage and your children will be at their most expensive and dependent. Many people in this position find the cost of having adequate insurance cover at this most vulnerable stage of their lives is simply too expensive to afford, so they cut back on their cover when, in fact they should be increasing it. If you had have taken out your life insurance with level premium repayments the payments will have remained the same so you can budget easily and not worry about having enough insurance coverage.

An example of how stepped premiums increase with age:

Source: Money Magazine

Case Studies

As an example it is interesting to look at what would take place if a man aged 38 years, on a salary of $80,000 took out an income protection insurance policy for a term of 27 years with a $5,000 a month benefit. With his age next birthday being 39 he would be expected to pay a stepped premium of $1,193.07 but on a level premium his cost would be $1,805.55 for the first year. Quite a big difference and very easy to accept the stepped premium on this basis alone. But if we move on to the final year, 27 years later, when he is aged 65, we find his stepped premium payment is now $3,477.57 but if he had taken out the same policy and agreed to pay a level premium he would still only be paying $1, 805.55. Over the whole term of 27 years the total stepped payment will have amounted to $93,894.47 and the level premium just $48,749.85.

If the same man, at the same age, agreed to add critical illness to his life insurance policy cover, an amount of $500,000, with allowances for inflation, the following would occur. His first annual
premium payment with his age next birthday being 39 with a stepped premium would be $942.49 and a level premium would be $2,482.49. Fast forward him 27 years later to his last year before retirement, at age 65, and we find him paying $8,431.66 for his final stepped premium but still only $2,482.49 for his level premium. Over the years if he had chosen to pay via a stepped payment he would have paid a total of $227,654.96 but if he had chosen a level premium payment system his total cost would only have been $67,027.23.

Keep Your Insurances Affordable

By taking the level option the premium payment stayed the same throughout the entire term of the cover despite it being costlier initially, but in later years the situation changed and the level premium payment was better able to deliver the amount of cover the man needed, whereas the stepped payment would have made retaining the required amount of cover hard to keep up with and many people in this situation would simply cancel their cover, losing their protection when it was needed most.

The above examples show how important it is to do your figures thoroughly before committing yourself to a certain action. This also assumes you went through the entire 27 years without having to claim on the cover you had provided for yourself. Don’t forget that when you are taking out life insurance, trauma insurance, income protection insurance, in fact any insurances at all, including fire and general insurance on your home and contents, as well as accident insurance on your car, you are paying for financial protection as a form of risk management in case something untoward should unfortunately happen.

If you found yourself in the position where you had to make a claim, the premium cost on any type of insurance would shrink into insignificance. For instance in the last example where the total cost of the man’s critical illness cover of $500,000 was only $67,027.23, paid for in level premium payments of $2,482.49 annually over 27 years, if during any one of those 27 years disaster had have struck, the cost of the cover would have been minuscule compared to the financial hardship that would have otherwise occurred.

A major component of the premium to be charged will of course depend on the amount of cover you are seeking. It will cost more for a $1 million cover than it does for $1,000 but the end result will be the risk the company carries on them having to pay out. The less the risk the less the premium no matter what the amount of cover it is that you are requesting.