Although there may be a myriad of fees, expenses, interest assumptions, and other factors used to develop a given life insurance company’s premiums for a policy, the rates for life insurance are ultimately based upon one factor the statistical chances of the insured dying in a given year. Such statistics, based upon insurance company experience and government records, are used to calculate an annual death cost for each $1,000 of life insurance benefit.
Since statistically few people will die at younger ages, the death cost for those years will be extremely low. As people age, the statistical chance of death increases slowly at first, then more rapidly after the insured passes middle age and therefore so does the annual death cost.
Since term insurance only provides a benefit if the insured dies during the policy term, its premiums will be the closest to pure death cost. This is why term is the least expensive coverage to buy at younger ages. At older ages, however, the cost of a term policy rises rapidly along with the increasing death cost, and may soon become prohibitive for many senior citizens. A term insurance policy’s premium will remain the same during the term, and then increase at each renewal. For example, an annual renewable term policy is written for one year at a time, so the premium will generally increase each year. A five-year renewable term policy’s premium will remain level for the five-year term, and then increase at the renewal. Once renewed, the policy premium remains level until the next renewal, and so on until the renewal provision expires (typically at age 65), or when the insured either decides the premium has risen too high or the insurance is no longer wanted.
Permanent insurance rates are also fixed for the policy term. However, since the policy is permanent, this fixed premium must represent an average death cost over the entire expected life of the insured. The result is that permanent policy rates will be often be significantly higher than term rates at the younger ages, but then significantly lower at older ages.
There are many reasons. As food for thought, here are three of the key considerations: Permanent insurance will always be there. Some final expense needs are permanent, and only permanent insurance is guaranteed, assuming you pay the premiums, to be there when needed. Term insurance, by its nature, is temporary, and at some point will become nonrenewable. In fact, a good life insurance rule of thumb is to buy permanent insurance for permanent needs (funeral, burial, estate liquidity), and term insurance for temporary needs (mortgages, college costs).
Permanent insurance premiums are fixed for life. While the premium may be higher at younger ages than term, it will never go up. And that can be a great comfort upon reaching older age and not having to face the possibility of your term insurance premium increasing beyond your ability to pay, possibly at the very time you need your insurance the most.
Permanent insurance builds cash values. During those early years of your policy, when your lifetime average premiums are higher than the death cost, that extra money is set aside to help cover the higher death costs in later years. But in the meantime it is put to good use. In effect, it becomes a form of savings account inside your life policy. This cash value, as it grows, can be used as the basis for a loan from the insurance company, used to pay premiums if necessary, or taken as a cash settlement in the event you cancel the policy.
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