Life Insurance Premiums

Let’s look at the 30 year old guy who pays $25 per month for a policy with a $200,000 death benefit. How can the insurance company make any money if the guy dies in the first year? The correct answer is that they can’t make any money off that guy. But let’s put 20,000 of those guys together and bring in $500,000 each month or $6,000,000 for the year. The insurance company now has some money to invest and has the opportunity to make those dollars grow and earn interest.

For our purpose, let’s assume we invested very well and achieved a 10% return, or $600,000. We now have 20,000 policyowners so any expenses we have can be spread over 20,000 accounts. Let’s keep it simple and say we have building rental, staff costs and selling expenses, including commissions, totaling $2,000,000 this year. From our mortality tables we can also determine that five of those 20,000 30-year old guys will pass away this year and the death benefits to be paid-out are expected to be $1,000,000.

This is obviously an extremely simplified explanation but it does identify the three key components that go into making-up the insurance premium. These components are mortality, expense and interest. If you assume the insurance company has thousands, if not hundreds of thousands, of these and other types of policies from people of all ages, the numbers become mind boggling. You start putting term insurance policies with whole life insurance and variable products into the account and you have to wonder how they keep track of it all. Expenses and mortality costs all come out of the insurance company’s general account. In some policies, the interest earned is paid into the general account. We’ll talk more about general accounts and separate accounts later.

For purposes of insurance lingo:

• Gross premiums = mortality + expenses – interest
• Net premiums = mortality – interest

Keep in mind that monthly payments are more expensive than annual payments simply because the insurance company must deal with the paperwork each month and those added costs are passed on to the policyowner. Annual premium payments buy more insurance for the same dollars because of the paperwork cost reduction and the fact the insurance company can invest the money for the entire year rather than only one month.

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This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contract your insurance agent. Our articles are intended to assist in educating you about insurance generally and not to provide personal service. They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. If you need more information or would like personal advice you should consult an insurance professional. You may also visit your state’s insurance department for more information.