A life insurance premium is a payment made to the life insurance company, to pay for a life insurance policy. One way to look at the premium payment is as the cost of the life insurance, but the cost of insurance and the premium due are not always the same amount due to things like dividends.
Premium payments are required to be made to the insurance company for a life insurance policy, otherwise, the policy will lapse. Sometimes the premium payment is more than the minimum required to keep the life insurance. Different types of policies have very different costs, and permanent life insurance has higher premium payments than term life insurance. Payments for a policy can also vary in structure. For instance, some policies only have one payment, some are structured to have payments last for a few years, universal type policies have flexible timing and dollar amount of premiums, or some policies have a level premium for the entire policy duration.
If you are unsure of the premium due for your policy, contact your life insurance company or agent.
How Much Does Life Insurance Cost?
Life insurance costs vary widely depending upon the type of policy and age of the insured person. Here is an example of premiums:
|Face Amount||Policy Type||Age||Premium|
For more information about prices you can view our post on term life insurance prices, or get a quote.
How do Life Insurance Companies Calculate your Premium?
Premiums are calculated differently depending upon the policy type and the features and goals of the policy, but at a basic level premiums are calculated on a few factors. These factors include the age of the insured person, the health rating of the insured person, the length of the policy and type of life insurance, and the face amount of the policy (amount of insurance).
The older the age of the insured person, the more expensive the insurance will be. Life insurance companies consider your half birthday when calculating your age because they round to the nearest age. So if you are 32 and 6 months old, you will be considered 33 for the purposes of the policy age. As people get past the age of 50, life insurance premiums will typically go up in an accelerating way for each additional year of age.
Life insurance companies assign a health rating to each individual so that they can group them in a way that creates a pool of people with roughly the same risk of dying. The health rating determines the cost of insurance because a worse health rating represents a greater mortality risk, and therefore a greater risk that the life insurance company will need to pay a claim.
Length of Coverage or Type of Policy
The length of the policy matters when the policy is term life insurance. This is because the longer the life insurance company is guaranteeing coverage, the higher the risk to them that they will need to pay out a claim. This is especially true for policies that expire when the insured person is older than 70. The type of life insurance matters because permanent forms of life insurance such as whole life insurance will always pay out a claim (as long as the owner makes the premium payments). So permanent life insurance is quite a bit more expensive than term life insurance, in terms of the annual premium due. Over time, permanent life insurance can actually be less expensive than term because dividends and cash value can grow in the policy and be used to pay the premiums.
The face amount matters because the more coverage the life insurance policy provides the higher the risk to the life insurance company. Premiums go up proportionally with each additional dollar of coverage assuming the other factors are the same.
Ultimately, the life insurance company is calculating the risk that any policy is going to ultimately payout, and how much they owe if the insured person dies. The higher the risk to the company, the higher the premiums will be.
Other Factors Affecting Premium
There are some additional factors that can affect the amount of premium due. These include additional features of the policy known as riders and how the policy was designed if its permanent insurance.
For any type of life insurance, additional benefits known as riders can cost more money. Different riders may add a waiver of premiums due during a disability, income during a disability, an accelerated death benefit during a terminal illness, or even long-term care insurance. Variable and universal policies may have premiums guaranteeing minimum cash values if certain conditions are met. Each of these benefits may provide additional protection to the insured person, and additional risk to the life insurance company. For this, they charge more.
Structure of Policy
Permanent life insurance policies can be structured differently, and tailor-made to the owner’s preferences. For instance, by design, a whole life policy may only require 1 lump-sum premium payment. Universal and variable universal life insurance allow for flexible premium payments to be made depending upon the owner’s preference and the performance of the cash value account. Whole life insurance pays a dividend, and this dividend payment can be used to offset premiums if desired. Sometimes policies are designed to have higher premiums in the early years so that that the cash value grows more quickly over time.
Premiums For Each Type of Life Insurance
Term Life Insurance Premiums
Term life insurance does not build cash value. Therefore, the premium payment made to the insurance company only covers the cost of insurance for the life insurance policy. The premiums for term life insurance are the lowest amongst all types of insurance policies for this reason. If a larger than required payment is made for a term life insurance policy the excess will normally be held in an account similar to an escrow account, and future premiums due will be drawn from this account.
Whole Life Insurance Premiums
Premium payments made for whole life insurance policies cover the cost of insurance just like with term insurance, but the premium payments are higher the same death benefit coverage. The reason the premium payments are higher is that whole life insurance is guaranteed to build cash value at a certain rate, as long as all premium payments are made in a timely manner. Premium payments above the amount detailed in the initial illustration can be made, but the excess is held in what amounts to an escrow account, which will pay a stated rate of interest. The excess payment does not go into the policy when the payment is made, but future premium payments will draw from the escrow account.
Universal and Variable Universal Life Insurance Premiums
Premium payments for universal life insurance and variable universal life insurance policies are flexible in nature, as long as the cost of insurance is covered by the premium payment or by the existing cash value within the policy. These policies tend to benefit clients the most when premium payments are made well in excess of the cost of insurance during the early years of the policy. This is because the excess premium payments create a large cash value reserve, which grows at either a guaranteed rate in the case of universal life insurance or at market returns in a variable universal life insurance policy.
Illustrated Premiums vs. Minimum Premium Due
With whole life insurance, universal life insurance, and variable universal life insurance policies, sometimes a larger than needed premium payment is illustrated by a life insurance agent in the original illustration. This is because the intent of the policy is to build cash value at a faster rate for a higher internal rate of return, or because premium payments are meant to stop after a certain point, and sufficient cash value must be built up to end payments.
While you may be paying more than the minimum amount due to cover the cost of life insurance, this does not mean that your premium payments are being wasted, or are going into the insurance company’s pockets for no reason. Larger than needed premium payments may help you stop paying your insurance premiums earlier than otherwise needed, or may create a higher internal rate of return, or higher gross return in the policy for your benefit.
Sometimes illustrated rates of return are assumed, and a policy could perform better or worse than the illustration. This means that sometimes clients must make premium payments for longer or shorter than expected, and the rate of return in the policy may differ from the illustrated amount. An ethical insurance agent always illustrates life insurance policies using conservative assumptions, so it is likely the policy performs better than the client’s expectations.
Failure To Pay Required Premium
A failure to pay a premium payment when due will cause a life insurance policy to go into the grace period. This is the period of time after a missed premium payment when a policy has not lapsed but will if no payment is made. If no premium payment is remitted to the insurance company during the grace period, a life insurance policy will lapse and must be reinstated to resume coverage, if allowed.
If sufficient cash value exists in the policy, often times a missed premium payment will just reduce the cash surrender value by the amount of premium due. This means that premiums may sometimes be missed in policies with cash value. Term life insurance premiums must always be made by the due date, or the policy will promptly go into grace period status.
Limits To Amount of Premium Payments That Can Be Made
All forms of permanent life insurance have rules regulating the amount of money that can be paid into a policy. There are two separate limitations that the premium payments must adhere to for the contract to still be considered life insurance.
The first is the TAMRA 7 pay limit, which limits the amount of money that can be added to a life insurance policy during the first 7 years of a life insurance policies’ life. If these limits are violated, the policy will become a modified endowment contract (MEC). Modified endowment contracts are subject to different taxation rules than life insurance.
The second limitation that all life insurance must adhere to is the guideline premium limit. The guideline premium limit is calculated at issue and is based on the age of the insured, health rating, cost of insurance, and face value of the policy. A life insurance company can not legally accept more premium than the specified guideline limit and must return any excess to the payer. The guideline limit increases each policy year by the same value, called the annual guideline premium limit accrual amount.
How to Reduce Your Premium Payments
There are ways to reduce your premium payments, depending upon the type of policy that you have and want. Here are some of the best ways to lower your payments:
- Switch from permanent life insurance to term insurance. Term life insurance is the lowest-priced form of life insurance.
- Reduce your face amount. Most life insurance companies have no problem doing this and premiums will be reduced roughly proportionally.
- Compare quotes on new policies to see if you can lower your costs. Life insurance prices generally drop over time, but once your policy is issued premium payments are often level.
- Change dividend options on a whole life policy. You can direct dividends to offset premium payments. Eventually, the dividend may pay the entire premium.
There are other ways to lower premium amounts in addition to these, but they depend on the exact type of policy that you own. Please check with your life insurance agent for the best ways, given your specific situation.
Understand Your Premium Payment
A life insurance premium is defined as the amount of money an individual pays for a life insurance policy. Simply put, “premium” means payment.
We always recommend that our clients fully understand their premium payments due, why they are the size that they are, and how this compares to the cost of insurance. A clear understanding must always be made as to how long premium payments need to be made, and the assumptions being made in this calculation.