How does a life insurance company determine your life insurance premium
Let us examine some life insurance policies and see how they calculate the rates.
There are 3 things which determine your rates.
They are your age, your health and your occupation.
We will assume that everyone is in good health and is employed in the type of occupation that is not hazardous in anyway.
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We will, for the sake of this discussion, focus on why premiums are higher as you get older and why longer term policies are more costly than short term policies.
Probably the purest type of life insurance policy is the yearly renewable life insurance policy. You buy this policy at a given age, let us say age 25. As you get older the premium increases. You will pay more at age 26 and even more at age 27.
The reason you pay more for a policy you already qualified for is that the risk increases as you get older. The older you are the more likely you are to die. The death benefit of the policy remains the same but the premium increases.
Now let us look at a 5 year level term policy. The face amount of the policy is level just like that of the yearly renewable term policy. The premium, however is level, unlike that of the yearly renewable term policy. The premium is also more than the initial yearly renewable term premium. Why is this so?
What the life insurance companies do is to charge you an average of the premium costs for the 5 year period. You will therefore pay more than you need to in the first year and less than the mortality tables suggest you should in the fifth year. They of course, adjust the costs a bit as you are initially overpaying.
They do the same thing with all life insurance policies. This makes the premium they charge more acceptable to the buying public. Here is where they run into a problem though.
Whole life insurance covers you to age 100. If you consider how much the premium costs are in the latter years you can appreciate why whole life insurance is so costly. The life insurance companies are aware of this also and that is why whole life policies have guaranteed cash values.
With whole life like any other level premium you overpay in the initial years. The life insurance companies build into your policy cash values which really helps to offset the excessive initial premiums. They guarantee it and the guarantee the interest rate on these cash values.
The cash values of a whole life policy can grow to a considerable sum over the years. When you add the dividends, if you earn dividends on your policy, to whole life insurance the cash value can eventually be more than the premium you put out.
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