Consider whole life insurance premiums. Have you ever given any thought
to it? Have you ever wondered why whole life premiums are so much higher
than term life premiums.
The reason is so simple, so logical, that you will be shocked when you learn how it all works.
All life insurance companies use the same mortality tables. The best way to explain how the actuaries arrive at a given whole life premium is to first look at term life insurance.
Let us begin with the yearly renewable term policy. This is life insurance in it's purest form.
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Let us say you start at age 30 and the insurance company shows you a given premium for $100,000 of life insurance. The death benefit remains level for as long as you own the policy. The premiums, however, increase every year.
The yearly renewable term policy is a one year term policy. The older you are the more life insurance costs. So next year you will pay a higher premium. The following year you will pay an even higher premium and so on.
Though logical, people don't like the idea of their premiums increasing every year. The life insurance companies put their actuaries to work and here is what they come up with.
Let us suppose you want your coverage for a 10 year period. They
total up the premiums that you would pay over the 10 year period if you
had bought a yearly renewable term policy.
They divide it by 10 and charge you a level premium over the 10 year period. In other words you pay the same premium every year.
They make certain adjustments as you are paying too much in the first year for your policy. You will pay less than you should be paying in the tenth year for your policy as well. Thus is born the 10 year level term policy.
You will find as a result that the level premiums are higher because of the longer duration. The life insurance company is at risk for a longer period of time. policy.
A whole life insurance policy can remain in force up until age
100. Some companies stop at age 90. Remember, the longer the period of
time that the life insurance company is at risk the higher the term
The same rule applies when calculating whole life insurance premiums with one twist.
Whole life continues until age 100 so the average premium must be higher. If you start at age 30 it takes 70 years to get to age 100. You pay your premiums diligently for 3 years, for example, and you don't die.
The life insurance company is very aware that you overpaid for
those 3 years. They calculate the difference between what you should be
paying for those 3 years and what you actually pay and return the excess
premiums to you.
This is called a cash value. They do this every year. You earn a guaranteed interest rate on these cash values. Over a long period of time this can amount to a considerable sum.
Whole life insurance is decreasing life insurance. As the cash value grows it replaces the death benefit. The basic whole life death benefit decreases but because of the increase in cash value the death benefit remains level.
I hope I have given you a better understanding of how life insurance companies arrive at whole life insurance premiums. Simple isn't it?
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I recently did some research on the development of the 30 year term insurance policy over the years. What I learned was quite interesting.
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