If you’ve ever carried an insurance policy, you’ve paid an insurance premium, either out of your own pocket or through your employer. That recurring premium is the price you pay to keep your policy in effect.
In insurance sectors familiar to many Americans, it’s common practice for insurers to recalculate premiums each year. The out-of-pocket cost of your auto insurance policy, if you have one, almost certainly changes after your annual policy renewal date. The same may be true for your property insurance premium — homeowners insurance or renters insurance, depending on your ownership status.
But term life insurance through a company like Bestow works a little differently. In general, term life premiums remain fixed for time spans much longer than one year, and premiums for level-premium life policies — a common type of term life insurance — remain fixed for the entire initial term. Following the end of a term life policy’s initial term, the policyholder may have the option to continue the policy for a predetermined number of one-year terms. The issuer sets the annual premium for each one-year renewal term at the time of issue, ensuring pricing transparency for as long as the policyholder wishes to keep coverage.
Term life insurance premiums differ from other types of insurance premiums in other ways too. And there’s a lot you need to know to become and remain an informed policyholder.
How Insurers Determine Term Life Insurance Premiums
Life insurance is a competitive industry, so understandably, underwriters aren’t eager to pull back the curtain on their work.
At least not too far. Even if each company’s weighting (the importance assigned to each variable) is proprietary, the variables considered during the underwriting process are well known.
Every year lived is a year closer to death. Accordingly, older applicants are more likely to die during a policy’s term than younger applicants, all other things being equal.
Coverage Amount (Death Benefit)
Life insurance premiums increase in direct proportion to coverage. Doubling your coverage doesn’t necessarily double your premium, but you can expect to pay 50% more — at least — for a $1 million policy than for a $500,000 policy.
Because the probability of death increases with age, policies with longer terms are likelier to pay death benefits than policies with shorter terms. That’s true regardless of applicant age, though the premium on a 30-year policy beginning at age 25 is significantly lower than the premium on a 30-year policy beginning at age 40.
Tobacco use significantly increases the risk of serious health issues that may result in premature death, such as cardiovascular problems and cancer. Insurers typically ask applicants to voluntarily disclose any tobacco use within the past five years, and they routinely include nicotine screening in the post-application paramedical exam.
Personal health questions cover known medical conditions that may increase the risk of premature death, such as diabetes and depression, along with recent medical events (including surgeries) and medications taken by the applicant. Insurers may review applicants’ medical records to verify these answers, and discrepancies or omissions may result in denial of coverage.
In many cases, the applicant must submit to a paramedical exam taken by a licensed health care professional, either at the applicant’s home or a designated medical testing facility. These exams typically cover:
- Health history questions, some or all of which may be redundant if the application included a personal health questionnaire
- Lifestyle questions covering topics like alcohol and recreational drug use, applicant occupation, and hobbies (the latter two question help identify applicants with potentially dangerous jobs and hobbies)
- Checks of vital signs, such as heartbeat and blood pressure
- Collection of a blood or urine sample for screening at a diagnostic facility for indicators of risk factors like high cholesterol or abnormal kidney function
The paramedical exam is the underwriter’s best source of quantifiable information about the applicant’s risk profile. For applicants, that makes it a double-edged sword. A concerning result can compel an insurer to raise premiums or deny coverage entirely. But applicants whose exams show nothing out of the ordinary can expect to pay lower policy premiums than applicants permitted to forgo the paramedical exam. Virtually all term life insurers require paramedical exams from applicants applying for more than $1 million in coverage.
Family Health History
Family health history questions cover the applicant’s hereditary risk factors independently of present health, which may be excellent. Insurers typically ask applicants to disclose any immediate family members’ premature deaths (before age 65 or 70, depending on the insurer) due to potentially heritable conditions like cancer or cardiovascular disease.
Insurers use the applicant’s personal and family health history information to assign a risk classification, known as an “insurance risk class.” All other things being equal, lower-risk policyholders pay lower premiums than higher-risk policyholders, with premiums increasing sharply in the substandard classes:
- Preferred Plus. Also known as preferred elite or super preferred, this class is for policyholders with no known personal health issues, low-risk lifestyles, and no familial red flags.
- Preferred. This class is for policyholders with few personal health issues, low-risk lifestyles, and no serious familial red flags.
- Standard Plus. This class is for policyholders with some combination of personal health issues (such as high cholesterol or blood pressure), lifestyle or occupational risk factors (such as working as a lineman or rock climbing for fun), or family risk factors.
- Standard. This class covers policyholders whose overall personal, family, and lifestyle risks are higher than any of the lower-risk categories. In actuarial terms, policyholders in this class have average life expectancies relative to other policyholders.
- Substandard. This multiclass category covers policyholders with below-average life expectancies due to significant personal, lifestyle, or familial risk factors.
- Tobacco. This multiclass category covers policyholders who use (or recently have used) tobacco or nicotine products. Premiums paid by tobacco users are invariably higher than premiums paid by tobacco nonusers with otherwise comparable risk profiles.
Higher insurance premiums are one of the many negative consequences of a bad credit score. Every underwriter is different, and the relationship between an applicant’s credit score and term life insurance premium isn’t always clear. But applicants with impaired credit can expect to pay higher premiums than comparable applicants with excellent credit. That’s because people with poor credit are more likely to file insurance claims, according to research by the Federal Trade Commission, though the reasons for that aren’t clear.
Driving & Criminal Records
Because driving is the most dangerous part of most policyholders’ daily routines, an applicant’s driving habits tell underwriters a great deal about their risk of premature death. Applicants with multiple moving violations or accidents in their recent past — usually looking back five years — can expect to pay higher life insurance premiums than applicants with squeaky-clean driving records. Applicants with more serious driving-related infractions, such as reckless driving or driving under the influence, face higher premiums still.
Term life underwriters may also consider applicants’ criminal histories. Nonviolent or victimless misdemeanors are more likely to be overlooked (though illegal substance use is a red flag). But convictions for felonies and violent crimes (such as assault or armed robbery) increase premiums and may result in an outright denial of coverage.
A policy rider is an optional add-on that may provide additional financial or practical benefits during or after the policy’s term. A policy with one or more riders usually has a higher premium than an otherwise identical policy with no riders, though the difference is often negligible.
Common policy riders include:
- Waiver of Premium. This rider kicks in if the policyholder becomes disabled during the policy term (or in some cases, before a specified age). Generally, the disability must result in income loss, rendering continued payment of premiums financially untenable. If the policyholder recovers to the point that they’re able to work again, their obligation to pay premiums may restart.
- Accelerated Death Benefit. This rider applies when the policyholder receives a terminal diagnosis expected to result in death within a specific time frame (often six months to one year). The policyholder may receive up to 40% of the death benefit before their death, depending on the rider’s terms, with the beneficiaries’ payout reduced by a corresponding amount.
- Guaranteed Insurability Rider. This rider allows the policyholder to apply for coverage in excess of the original death benefit during the policy’s term without additional medical underwriting. It may also permit the policyholder to renew the policy at the end of its original term without additional medical underwriting. Though most insurers impose an age restriction on this allowance.
Common Questions About Term Life Insurance Premiums
Carrying life insurance is a long-term commitment, making plenty of time for questions like these to come up.
Are Life Insurance Policy Quotes Guaranteed?
No. A policy quote is the insurer’s best guess at your actual premium based on your age, requested coverage amount and term length, tobacco use, and any other self-reported details. The insurer doesn’t set the actual policy premium until the underwriting process is complete — meaning after you’ve completed your application, submitted to credit and background checks, and received the results of your paramedical exam.
Are Life Insurance Premiums Tax-Deductible?
Not usually. You can’t deduct life insurance premiums on your personal state or federal income tax return.
But the rules are different if you engage in business activity and earn business or self-employment income, even if you’re merely an employee-less solopreneur, with or without a formal business structure protecting your assets. You may be permitted to deduct life insurance premiums as a business expense. Important exclusions apply — for instance, premiums aren’t tax-deductible if the business is a direct or indirect beneficiary of the policy. Consult a qualified tax professional for advice pertinent to your specific situation.
Do Term Life Premiums Build Cash Value?
No. A policy that’s canceled or allowed to lapse for any reason before its term ends becomes worthless, and the insurer keeps all premiums paid to that point.
That’s why it’s vital you keep your policy in good standing unless and until you’re confident you no longer need the coverage. For example, it may be safe to cancel in the unlikely event you receive an inheritance equal to or greater than the value of the death benefit and update your will to reflect that your policy’s beneficiary will receive the entirety of that windfall at your death.
Other types of life insurance, collectively known as permanent life insurance, do build cash value. Common permanent life insurance variants include whole, universal, and variable. Because permanent life insurance policies aren’t restricted to a finite term and therefore pay death benefits in the vast majority of circumstances, their premiums are significantly higher than comparable term policies.
Accruing cash value over time certainly sounds enticing, but permanent life insurance isn’t always a good investment. For many individuals and families, it’s more cost-effective to carry a term life policy adequate to cover significant ongoing and future obligations, such as the mortgage on your primary residence and the expected cost of higher education for your kids. Then you can invest surplus funds in a diversified age- and risk-appropriate securities portfolio.
What Do Life Insurers Do With Policy Premiums?
In part, your term life insurer turns a profit by keeping the total value of death benefits paid lower than the total value of premiums received. It’s Business 101.
But it’s not the whole story. Policy premiums also serve as profit engines for life insurance companies. All life insurers externally invest premium revenue not earmarked for overhead expenses, death benefits, and internal investments, such as expansion into new geographic markets. Big life insurance companies typically have billions in excess premiums to invest each year, and collectively, the industry is a significant source of capital for relatively low-risk market sectors like bonds and commercial mortgages.
Once a Policy Is Underwritten, Can Its Premiums Be Reduced?
No. On a level premium policy, premiums are fixed for the entirety of the policy term. If you choose to renew your policy at the end of its term, the renewed policy will be more expensive because you’ve aged. Should your level premium become a financial burden at any point, you can reduce your monthly payment by canceling your policy (or allowing it to lapse). Then you can apply for a new policy with a lower death benefit — though factors like your health status and age could mitigate your savings.
What Happens When You Miss Your Premium Due Date?
If your premium due date passes without payment, your policy’s grace period kicks in. During the grace period, your policy is in limbo: Though it’s technically still in effect, it lapses if the balance owed isn’t satisfied by the grace period’s end. The grace period typically lasts 30 days but may be shorter or longer.
With case-by-case exceptions, insurers don’t reinstate a lapsed policy on its original terms. You must reapply for coverage and repeat the entire application process. And because you’ll be older, you’ll pay more for a comparable policy.
Avoid a lapsed policy and higher premiums for subsequent coverage by:
- Enrolling in auto-pay, which virtually all life insurers offer
- Keeping your auto-pay method up to date, setting a calendar reminder the month before your credit or debit card’s expiration date
- If not enrolled in auto-pay, setting a calendar reminder at least 10 days before your monthly premium due date
- Promptly opening and responding to official communications from your insurer
- Whitelisting your insurer’s email address to prevent your email suite from flagging the company’s emails as spam
Can You Recover Paid Premiums During or After Your Policy’s Term?
Not without a return-of-premium rider, which increases your premium while the policy remains in effect. A return-of-premium rider is a hedge against outliving your policy’s term (and thereby denying your beneficiaries its death benefit).
Before adding a return-of-premium waiver to your policy, speak with a financial advisor about the potential tradeoffs. The insurer guarantees the return of paid premiums after the term ends, providing some measure of financial stability. But the amount you receive may be less than you’d earn by investing your marginal premiums in the stock market over the same time frame.
Can Your Insurer Deny a Beneficiary’s Death Benefit Claim if the Policy Hasn’t Lapsed Due to Nonpayment?
Yes, albeit not without good reason. If you die during your policy’s term after making every scheduled premium payment on time and in full, your insurer may be within its rights to deny your beneficiary’s death benefit application in cases of:
- Suicide. You die by suicide within the first two years of the policy term. After two years, death by suicide is not grounds for denying a death benefit application.
- Murder. You’re the victim of a murder for which a policy beneficiary is responsible.
- Criminal Activity. You’re killed while engaging in criminal activity, such as an illegal drug deal that ends in violence or a high-speed car chase with police.
- Lying on Your Application. The insurer determines that you lied or materially misrepresented information on your policy application. The most common misrepresentations concern medical history or tobacco use, but even trivial misstatements (such as omitting a speeding ticket) can jeopardize the policy’s death benefit. This restriction may only apply during the early part of the policy term at the insurer’s discretion.
Your term life insurance policy’s premium is a snapshot of your risk of death during the policy’s term, as understood by the policy underwriter at the time of your application.
In evaluating your application and determining how much you must pay for coverage, that underwriter considers multiple risk and other factors: your age, requested coverage amount, tobacco use, family health history, paramedical exam results, driving record, and credit score.
The process can feel impersonal, even dehumanizing. Its results may feel capricious, especially if you’re assigned a higher risk class (and thus asked to pay more for coverage) or they deny your application outright.
Nevertheless, securing adequate term life coverage is one of the most important steps you can take to avoid burdening your loved ones after your death. Your policy’s death benefit won’t dull the pain of your loss or bring you back from the grave, of course. But that’s not to say it won’t be a welcome light amid unimaginable grief.
Do you have a life insurance policy?
Originally posted at https://www.moneycrashers.com/term-life-insurance-premiums-determined/