A life insurance policy can help to protect your loved ones when you die by providing a death benefit that could help make it easier to cover expenses and maintain their current lifestyle. But, with all of its unique terminology, understanding life insurance can sometimes get tricky.
One of the terms you'll come across when taking out a policy is "premium." A life insurance premium is the payment you make to an insurer, usually on a monthly or annual basis, in exchange for the company agreeing to pay a death benefit to your chosen beneficiary when you die. With some policies, a portion of the payment you make might also fund your cash value balance.
Several factors can affect the amount of your life insurance premium, including the amount of coverage you obtain, your projected risk to the insurer and the type of policy you choose. Here's what to consider.
What Benefits Are Provided for Premium Payments?
The premiums you pay into a life insurance policy primarily pay for the death benefit coverage provided. They also may go toward covering cost of insurance fees or other applicable charges based on the type of policy and/or riders you have. Also, depending on the type of coverage, the premium payment may also provide a cash value. Here are the most common types of life insurance, with more information about the benefits provided for the premium payment.
Term Life Insurance
Term life insurance provides pure insurance coverage (no cash value) for a certain period of time (the term). Premiums may be level for the term or may increase with the insured person's age, depending on the product. People take out a term life insurance policy with the sole objective of providing a death benefit for their beneficiary. Paying the premium helps enable your loved ones to receive the death benefit if you die during the time period, or term, that your policy is active.
Whole Life Insurance
Whole life insurance policies work a bit differently. The premium you pay helps ensure the policy stays in force and that a death benefit is available to your beneficiary. Over time, the cash value has potential to grow. When your cash value reaches a certain amount, you may be able to borrow from it. Keep in mind that loans will accrue interest. Loans and withdrawals may generate an income tax liability, reduce the cash value and the death benefit, and may cause the policy to lapse.
Universal Life Insurance
Another type of insurance is known as universal life insurance. It has cash value like whole life insurance, but unlike whole life, there is premium flexibility and often the ability to adjust the death benefit based on your needs. Just keep in mind that there must be enough cash value in the policy to cover monthly charges if a lower premium is paid than the amount selected at issue or if a premium payment is skipped. Additional premium payments may need to be made to keep the policy in force.
How Does Underwriting Affect Premiums?
When you apply for a life insurance policy, the insurance company will typically perform a process known as underwriting. Based on your age, gender, health and lifestyle information, the insurer estimates the mortality risk it would assume by extending coverage to you. Underwriting is a key factor in determining whether you qualify for a policy and how much your premium will be.
Among the factors involved in this process are:
- Age: Younger customers typically have a lower mortality rate and generally pay lower premiums.
- Gender: On average, females live longer and, therefore, may pay less for the same coverage.
- Health: Most companies look at medical information from health records and a questionnaire; some also require a medical exam.
- Lifestyle: The insurer will likely assess the risk posed by your profession or hobbies. Frequent involvement in dangerous activities will typically result in a higher premium.
How Do the Terms of Your Policy Affect Your Premium?
In addition to your policy type and underwriting, the amount and length of the coverage you're obtaining has a large effect on the premium. Some customers might opt to take out relatively small policies to merely help cover the cost of a funeral when they die. Others may seek a death benefit that provides full income replacement, potentially for many years. These larger policies will require a higher premium to account for the larger risk being placed on the insurance provider.
The length of the contract is another key variable. Term polices, which provide a death benefit for a set number of years, tend to be less expensive than whole life and other permanent policies that have no such limitations. For any given individual, a shorter term policy will usually cost less than a longer one. Riders, which are extra benefits that you can add to a policy, also typically increase the premium you pay.
What Happens If You Stop Paying Your Premium?
Knowing the amount of your premium and how it's calculated is an important part of understanding life insurance. Making payments on time will help to keep your policy in force and help ensure that your beneficiary receives the death benefit. Should someone with term coverage miss a premium payment, their policy will typically enter a grace period. If they fail to make full payment within that grace period, their policy will lapse.
Whole life policies sometimes work the same way. The premium is fixed and failure to make payment can result in the loss of coverage. With universal life, there may be flexibility as to the timing and amount of payments, but as explained above, sufficient premium must be paid to avoid the loss of coverage.
For more information on how life insurance premiums work, consider speaking with a financial representative.