Just as the taxes we pay keep our roads paved, life insurance premiums keep us insured and our families protected. No one particularly likes paying them, but they are necessary for our overall well-being.
But who determines their price? What do the insurance companies do with the premium? What if I can’t pay my premium because I become disabled or lose my job? All of these questions about life insurance premiums, and more, will be answered in this post.
What is a Life Insurance Premium?
Insurance premiums have been around as long as life insurance has been, dating back to the 1800s. Back then, there was no automatic bank draft capability, so the selling agent of the policy would go by each week to collect the monthly payment, called a premium, from the policy owner. Some companies still have their agents collect premiums from insureds, and they’re referred to as “industrial agents.”
Your insurance company calculates insurance premiums using employees called “actuaries.” The actuaries sit behind the scenes and use complex formulas to arrive at the cost of the insurance. They take into account your age and sex if you’re a smoker or non-smoker, your life expectancy, your health condition, the insurance companies cost to issue and maintain your coverage, and various other factors.
Ideally, when you apply for a life insurance policy, you will be issued the policy at standard rates. However, sometimes health conditions will dictate that the insurance company charges an extra premium because their risk of paying out a claim sooner than expected is a possibility. This additional charge is called a “rated premium,” and can be two times higher than the standard premium, or more, depending upon the health condition and other considerations.
How Premium is Calculated
As it is with any type of business, insurance companies have costs associated with issuing and keeping coverage in force. The agent that sells the policy must be paid for his or her efforts, home office insurance company employee’s salaries need to be covered, expenses needed to issue the policy and keep it in force each month are taken into account, and money must be kept in reserve to pay beneficiaries when an insured passes away. All of these factors are taken into consideration when the cost of insurance is calculated.
How Premium is Used
Insurance companies also take a portion of the premium collected and invest it. This is important to the policy owner because the return on investment is what funds the cash value that accumulates over the years as part of the policy.
These investments can be conservative in nature to be sure dividends are paid, as is the case with whole life insurance policies. They can also be invested more aggressively to obtain higher interest rate returns, as is the case with universal life insurance policies.
The investment performance is also important to the insurance company to offset some of the costs they incur in the administration of the policy, as well as claims they pay when an insured dies. The claims a large insurer pays each year is considerable, considering that they have billions of dollars of insurance in force.
A policy’s cash value grows as each premium payment is made, and can grow to be a considerable amount of money over the life of the policy. The policy owner can borrow funds from the cash value at low-interest rates as well. This money can be used to pay for college for kids, provide additional income during retirement, or used for a wide variety of other purposes.
How Premium Payments are Scheduled
Because of budgeting considerations, most people prefer to pay their premiums monthly. For most families, it is far more reasonable to pay $250 per month for their life insurance coverage than it is to write a check for $3,000 when they apply for the coverage and pay the annual premium. Businesses often prefer to pay annually for life insurance because of convenience.
Insurance companies would prefer that all insureds paid their policies annually. It is less expensive for an insurance company to bill and collect money once per year than it is for them to administer the monthly billing, collection, and processing of premium payments.
The length of time that insurance policies are paid by the policy owner can vary from policy to policy. This happens because different types of policies are designed for different lengths of premium payment.
For example, whole life insurance typically requires that premium payments be made for the entire time that the life insurance policy is in force. If premium payments are not made on time, the insurance coverage will lapse, meaning it will no longer be in force.
There are exceptions to this rule for whole life insurance. When the policy is issued, it may be written that premium payments need to be made for only 10 years, 20 years, or until age 65. After these periods, the insurance would be “paid-up,” or paid by the dividends, and the coverage would remain in force with no further premium payments necessary.
Premium payments for Universal Life
Premium payment is a bit different with guaranteed universal life (GUL). Just as it is with whole life insurance, premium payments can be made monthly, quarterly, semi-annually, or annually. But unlike whole life, UL policies have flexible premium payments and can use the cash value to make premium payments if the insured chooses to do so.
While this can be very helpful to the policy owner when it’s necessary to do so, it can also be disadvantageous in the respect that the cash value is depleted when this is done. The money used to pay premiums is no longer compounding, which can severely impact the cash value totals in later years.
Just as there are minimum payment amounts that must be made to keep life insurance policies in force, there are also maximum amounts that cannot be exceeded to keep insurance policies from becoming “modified endowment contracts.” If a policy becomes a modified endowment contract, there are different taxation rules which will apply.
Premiums for Survivorship Policies
With some policies, one premium payment insures two lives. These types of policies are called Second-to-Die policies, or Survivorship Life, and are often used in business life insurance scenarios, or for estate planning purposes.
Due to an unforeseen accident or illness, sometimes an insured can become disabled and is no longer to work. This can place a considerable financial strain on them and make it difficult to pay the premium each month. Fortunately, most insurance companies offer a disability waiver of premium feature. In this case, the premium is paid by the insurance company when the insured is unable to work. Once they can get back to work, they resume payment of the premium.
There’s always a grace Period
Occasionally premium payments aren’t able to be made on their due date. Instead of the insurance company automatically canceling coverage when the premium isn’t made on time, they extend a “grace period” during which the policy owner can submit payment and the policy coverage will continue. Because of this, there is no lapse in coverage, and the next policy premium payment is due on its regularly scheduled date. This grace period is generally for 30 days.
The premium due date is often the date when the policy is issued, making it easy for the insurance company to track the premium due date. However, occasionally an applicant for a life insurance policy will request that the due date be a specific day of the month due to budgeting purposes or for the ease of their record keeping. Most insurance companies are flexible with these premium due date requests.
The Bottom Line
Which company has the lowest life insurance premium rate is not always the best way of deciding which policy to buy. The reputation of the insurer and the quality of the life insurance products are every bit as important as the premium amount. Overhead may be a bit higher for an insurance company dedicated to providing the highest levels of policy owner support. “You get what you pay for” rings true for premium payments as it does for many other things in life.
Frequently Asked Questions
How is my life insurance premium determined?
Your insurance company calculates insurance premiums using employees called “actuaries.” The actuaries sit behind the scenes and use complex formulas to arrive at the cost of the insurance. They take into account your age and sex if you’re a smoker or non-smoker, your life expectancy, your health condition, the insurance companies cost to issue and maintain your coverage, and various other factors.
What happens if I forget to pay my life insurance premium?
Occasionally premium payments aren’t able to be made on their due date. Instead of the insurance company automatically canceling coverage when the premium isn’t made on time, they extend a “grace period” during which the policy owner can submit payment and the policy coverage will continue. Because of this, there is no lapse in coverage, and the next policy premium payment is due on its regularly scheduled date. This grace period is generally for 30 days.
How often do I have to pay my life insurance premium?
Because of budgeting considerations, most people prefer to pay their life insurance premiums monthly. There are also options for quarterly, semi-annually, and annually. Insurance companies would prefer that all insureds paid their policies annually. It is less expensive for an insurance company to bill and collect money once per year than it is for them to administer the monthly billing, collection, and processing of premium payments.
