According to recent studies, the average American household earned $69,629 in 2015. $55,978 of this went to average expenditures, leaving only $13,651 as the free cash flow. 58% of their average expenditures went to housing costs (mortgage payments/rent), 21% to utility bills, 10% to furnishings, 11% to other essential housing expenses (maintenance, repairs). These don’t even include other costs, such as transportation, education, healthcare, personal finances, and arguably the greatest burden of all debts – credit card balances.
This brings up the importance of not just of money management, but the financial planning for the worst-case scenario: having a primary income earner suddenly develop a long-term critical illness or even pass away.
Life insurance: Providing a solid barrier against devastating financial losses
Although not mandated by law, life insurance is one of the best types of investments one can have for financial protection. It provides individuals, particularly the primary income earner of a household, a way to secure the future of their loved ones in the event of their passing.
With life insurance, policy holders can keep providing for their loved ones, saving them from the devastating consequences of financial losses that losing income brings.
It’s important to note though that, like all other types of insurance, life coverage comes with a considerable cost. This doesn’t mean though that consumers should just purchase the first policy they encounter even if they already know they’ll have a hard time paying for it. The key is to determine a household’s specific needs, purchase adequate coverage, and if financially-wise, obtain a policy that comes with a savings component.
A quick look at the state of life insurance in the United States
Studies found that in 2015, 60% of all residents of the United States carried some sort of life insurance. The researchers also found:
- 34% of those interviewed said they likely would invest in life insurance the following year.
- 66% also said that they somewhat would recommend others to purchase life insurance. This percentage represents an 11% percentage point increase from the last year’s findings.
- Almost 9 in 10 consumers believe that almost everyone needs this insurance product.
Factors that determine life insurance premiums
Insurers base the life insurance premiums of their policyholders on two primaries, but underlying factors: life expectancy and interest. The third one is an expense, which insurance companies add to the policy’s cost, and covers the operating costs of offering this product, investing the premiums, and making payouts for claims.
- Mortality – The basis of life insurance is the risk of death that a huge group of individuals shares. To predict how much each group member has to pay, insurers have to have an accurate idea of the amount at risk. Companies use mortality tables so they can estimate the cost of death payouts every year. Through this data, insurance providers can determine the average life expectancy for the different age groups.
- Interest – Interest earnings are the second-factor insurers use to calculate life insurance premiums. They invest the money policyholders pay in various investment assets, including real estate, mortgages, bonds, and stocks among others. They then come up with an assumption that will generate a certain interest rate on what they invested.
- Expense – Insurance companies also consider their own operating expenses. These include salaries, legal fees, compensation of agents, etc. Basically, all policyholders have their own share for covering these operating expenses, known as “expense loading.”
What influences the overall cost of life insurance
Life insurance helps solidify and strengthen a household’s finances, but for most, it’s also one of their costliest investments. And because most policies run for many years, even the slightest difference in premium can already lead to huge savings. One way consumers can continue to afford this insurance while ensuring they remain adequately covered is to learn about the various factors that influence how much they will spend on this product.
Understanding life insurance cost influencers is important because policyholders have control over some of the criteria. They can save a lot of money by making simple lifestyle choices or changes.
- Age – Unsurprisingly, this is the main factor that drives life insurance premiums. Someone who has a lot longer to live typically pays less than someone who is years ahead. This revolves around the idea that a young person will pay the insurance company for many years before the insurer would have to make a payout. This is why experts recommend purchasing life insurance at a younger age. On average, women have a life expectancy of 81.2 years. Men, on the other hand, have an average life expectancy of 76.4 years.
- Gender – As mentioned above, women live longer than men, so they usually pay less. Also, studies and statistics continue to show that females take fewer risks than men, which further makes them favorable to the eyes of insurance companies.
- Nicotine-using habits – Smokers can expect to have higher life insurance interest rates since this habit exposes them to numerous health risks. It has such a drastic impact on health than those with smoking habits can pay twice as much as their non-smoking peers of the same age.
- Historical and current health status – In many cases, life insurance buyers first have to undergo a medical examination. During this process, the insurer takes note of their height, weight, cholesterol levels, blood pressure, and other critical metrics. Some may also require an electrocardiogram (ECG or EKG), used to check the health of the heart. If the exams reveal a policyholder to have good health, he/she can expect competitive rates. Those with serious or chronic conditions, on the other hand, would have to pay higher premiums.
- Way of living – How one lives can already say a lot about his/her health. Risky behaviors and hobbies, such as car racing, mountain climbing, or deep-sea diving greatly increase a person’s risk of getting into an accident, or worse, suddenly passing away. So people who partake in these activities, even if they are otherwise in good health, may have to pay higher premiums than their same-aged peers who don’t.
- Family medical history – This is one of the factors that individuals don’t have control over, but is seriously taken into consideration by insurance companies. Having a family history of severe medical conditions, such as cancer or stroke, leads to higher life insurance rates. There are other factors that determine a person’s life insurance premiums, but the ones discussed above are often the priority of insurance providers.
Term life insurance and what you can expect from it
Arguably the most popular type of life insurance, term insurance provides coverage for an agreed-upon length of time. This period can last anywhere from one to 20 years, or even more. Insurers sell these policies with different premium guarantees. As such, the longer the guarantee, the more the policyholder will pay initially.
In the event the insured passes away during the term, the insurance provider will pay the specified policy face amount to the beneficiary. If the policyholder lives beyond this period, the company will not make any payouts. And unlike permanent insurance, term policies only come with a death benefit and not a cash value or savings component.
The following are the common types of term life insurance policies:
- Renewable term: As the name already suggests, these policies give the owners a right to request a renewable of their term for another period as soon as the current one expires. The insurance company has to renew it, regardless of the policy holder’s current health status. However, each new term brings higher premiums.
- Convertible term: These policies allow owners to exchange their current insurance for a permanent plan. However, the insured has to do it during a specified conversion period, the length of which depends on the particular type of term policy initially bought. The insurance rate after the conversion depends on the person’s “current attained age,” which is basically his/her age upon conversion. One of its biggest benefits is the maximum protection it provides for the smallest cash outlay amount.
- Decreasing or Level term: Under a decreasing term policy, the policy’s face amount goes down over the length of the term. With a level term, it stays the same for the entire life of the insurance. However, the premiums don’t change for both. In many cases, consumers purchase this as a form of mortgage protection.
- Adjustable premium: Traditionally, once insurance companies sell a policy, they don’t have the right to alter the premiums. Nowadays though, they can, with an adjustable premium policy. This allows providers to offer such products at lower “current” rates, the basis of which are less conservative assumptions. Depending on a number of factors, they can change these premiums. However, the increase can never exceed the guaranteed premiums indicated in the policy.
When whole life insurance makes for a better choice
Permanent insurance, at its core, provides lifetime coverage. To maintain the rate level of the premium, it goes beyond the actual cost of protection while the insured is still of a young age. The extra then accumulates cash value or reserve, which then aids in paying for the coverage in the future, as the cost of protecting the policyholder goes above the premium. Basically, these policies stretch insurance costs over a longer period, so that insurers can level out the increasing expenses associated with the aging of the insured.
Aside from the death benefit, permanent or whole life policies also come with a cash value or savings component. This is actually one of the main reasons consumers are drawn to it. Over time, the cash value size grows bigger and bigger, accumulating serious amounts of funds that policyholders can borrow against. In other words, this is the type of life insurance that policy owners can actually enjoy and use themselves.
First-time life insurance buying tips
Shopping around for life insurance can overwhelm anyone. Fortunately, there are ways to make it less complicated and complex. Equipping one’s self with the knowledge of buying strategies will not just make the process easier and smoother; it will also help consumers save a lot of money.
Compare similar products.
When obtaining life insurance quotes, it’s important to compare only similar plans, as there are so many different terms and policy types available. For instance, it won’t make sense to compare term life with whole life. Consumers should explore all their options and base their decision on their many different needs, and not just the monthly cost of the coverage.
It’s critical to understand that this type of insurance product is for protection against potentially major financial losses. Yes, the savings component of whole life insurance sounds really attractive, but shoppers should also carefully assess whether they can afford the higher premiums or not.
Remember: unpaid premiums will only lead to invalidity of the policy, so it’s better to stick to something easy to afford than have a difficult time meeting the monthly payments.
Don’t buy too much or too small of a coverage.
This is one of the most important, yet difficult questions to answer when buying life insurance. Aside from the specific type of policy, buyers should also determine how much of coverage they really need. Of course, the more beneficiaries, the larger the payout needed. Aside from ongoing expenses, there are also college or education expenses to factor in.
The bottom line
Delaying the purchase of life insurance will only result in it becoming more expensive every year. For instance, a 30-year-old who puts off the purchase for 10 years can expect much higher premiums, more so if the consumer is a male. Insurance costs can quickly double, even triple the longer one waits to buy.
All in all, because insurance providers base the rates they charge primarily on life expectancy, it pays to make preparations as early as possible to take advantage of more affordable premiums.