How Life Insurance Premiums Work: Definition + Costs

Updated

Life insurance has its own language: “face amount,” “death benefit,” and “suicide clause” are just a few terms that can cause buyers to feel a bit intimidated. Another term that comes up in every discussion you’ll have with a life insurance agent when you’re selecting a policy is “premium.” 

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This article will help you understand your life insurance premium, which will aid you in affording your policy and keeping it in force. Let’s start by defining the word “premium” as it relates to life insurance.

What Is a Life Insurance Premium?

A life insurance premium is a payment you make to the life insurance company to keep your policy in force. 

As long as you keep paying your premiums, your insurance will remain in force and the company will pay a death benefit to your beneficiaries when you die. If you stop paying premiums, your life insurance policy will lapse, and your beneficiaries won’t receive a payout.  


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Term life premiums vs. permanent life premiums

With permanent life insurance, like whole life insurance, as long as you pay your premiums, your life insurance policy won’t lapse, and coverage will stay in force your whole life (hence the name). 

With term life insurance, you pay premiums for a set period of time, usually 10 to 30 years, and the coverage then ends with no further premium payments necessary on your part.

Premium payments

Most people prefer to pay their life insurance premiums monthly, but some life insurers will discount your premium by 2% to 5% if you pay annually. It’s a nice discount, but many people prefer to pay monthly for budgeting purposes.

You can pay your premiums in a couple of different ways. The most common method is a monthly bank draft, also known as electronic funds transfer (EFT). With EFT, you sign a form giving the life insurance company permission to request and receive money from your bank account on a monthly basis. 

The other way some people pay their premiums is by sending a check to the insurance company. Some life insurance companies accept money orders for premium payments, but almost all life insurance companies won’t let you pay by credit card unless it’s the initial premium payment. None accept cash anymore.

Are There Different Types of Life Insurance Premiums?

There are two different types of life insurance premiums: fixed and annually renewable.

Fixed premiums

Whole life insurance has a fixed premium, meaning it won’t increase for as long as you have the policy. Level term life, decreasing term life, and convertible term life insurance are types of term life insurance that all have fixed premiums that are no longer paid when term life insurance policies end.

Annually renewable premiums 

One type of term life insurance has premiums that renew each year at a higher rate; that type of term life policy is annual renewable term (ART) life insurance. 

Premiums increase each year the policy renews because you’re a year older, making you a higher risk that the life insurance company will pay out a death claim to your beneficiaries in the future. How long it takes to get a life insurance payout will vary by insurer.


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What Are the Components of a Life Insurance Premium?

Proper pricing of premiums is critical to the financial success of a life insurance company, which is why they employ teams of people called “actuaries” to calculate what premiums need to be. 

Let’s look at the six primary factors that determine the premium for a life insurance policy:

1. Type of policy

Whole life insurance policies can be five to ten times more expensive than term life policies. That’s because whole life policies not only have the life insurance component but also have a tax-deferred savings mechanism built into them called “cash value.” 

This cash value accumulates over time and functions much like a savings account because interest is credited to the account, and money can also be withdrawn from it. 

Term life premiums are lower than whole life insurance because the only component in a term life policy is the life insurance protection; there is no cash value accumulating within the policy.

2. Coverage amount

The greater the amount that the insurance company is risking paying out, the higher the premium. For example, a 35-year-old female in good health can pay a premium of about $24 per month for a $500,000, 20-year level term policy. But she’ll pay about $42 per month for the same type of policy with a face amount of $1 million. 

3. Term length

For term insurance, the longer the term, the higher the premium. For example, a 35-year-old male in good health will pay a premium of about $30 per month for a 20-year, $500,000 policy, compared to a premium of $45 per month for that same face amount with a 30-year term.

4. Age

When a person is 25, their life expectancy is about 55 more years—plenty of time for the life insurance company to collect a large number of premiums before they pay out a death benefit. For a 60-year-old, the life expectancy is about 20 more years, meaning the life insurer has less time to collect premiums before they write a check to a beneficiary. Because of that, they’ll collect a higher premium as you get older.

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5. Health, hobbies, and other factors

A big determinant of your premium is your health history. For that reason, when you apply for most types of policies, you’ll have to answer a host of questions about your health history, your family’s health history. You may also be required to have a medical exam (paid for by the insurer). 

In addition, the underwriter working on your policy (the person who makes the ultimate decision if your application is approved or not) will examine your credit score, your driving history, and any risky hobbies you participate in to help assess the risk.

Once they have all of the information about you in hand, the underwriter will assign you a “health rating,” which will be used to calculate your premiums.

6. Riders 

Riders are additional benefits you can add to your life insurance policy. The life insurance company provides some riders at no cost; however, some riders will be added to your base premium, including:

  • Long-term care rider: Your policy's death benefit can be used to pay for assisted care if you ever need it. The amount the life insurance company pays out while you’re living will be deducted from the death benefit your beneficiaries will receive.
  • Return of premium rider: You’ll receive back the premiums you paid for the term life policy when it expires.
  • Waiver of premium rider: The insurance company will pay the premium for you if you become disabled and can’t work.

Why Can Life Insurance Premiums Be So High?

Life insurance premiums can get very pricey and be much higher than what an agent initially quoted you if the underwriter who evaluates your application and medical exam results, and decides that you represent a higher risk than their standard applicant for your age, gender, and face amount of insurance. 

Underwriters use something called a “table rating,” which is a tool that tells them what percentage to increase your premiums based on all of the information they have accumulated about you.

For example, a 45-year-old male with Type 2 diabetes may receive a 25% increase in their premium amount, whereas if they had Type 1 diabetes, they would have a 75% increase in premiums.

Can You Do Anything to Lower a Life Insurance Premium?

If you hear back from your agent after you’ve applied and had your exam, and the agent tells you that your premium is 50% higher than you were quoted after the underwriter reviewed your information, there are a few things you can do to lower your premium.

  • Lower your face amount: As we’ve seen in the examples above, premiums increase as the policy’s face amount increases. Therefore, reducing your face amount by 25% to 50% will substantially lower your monthly premium.
  • Decrease the term length: If you’re buying level term life insurance, you can decrease the length of the term. For example, a 20-year term policy will cost you much less than a 30-year level term policy because the insurance company is at risk financially for a shorter period of time.
  • Make lifestyle changes: Smokers pay higher rates for life insurance than non-smokers. If you were a smoker when you were issued the policy and paid a higher rate because of it, you may have quit smoking by now. If you’ve quit smoking and haven’t smoked for at least 12 months, many insurers will give you the lower non-smoker premium rate.

Similarly, if you were obese when you were issued your policy and subsequently lost enough weight to qualify for standard rates, as long as you’ve kept that weight off for one year, a fair number of life insurers will lower your premiums.

Do You Ever Get a Refund on Your Premium If You Didn’t Make a Claim?

There are a couple of instances where you can be refunded your premiums.

Some policies come with the “return of premium” provision. With these policies, after the term of the policy expires without a payout, the insurance company will return to you all of the premiums you paid. 

How can they make any money if they do this? Simple—they charge you higher than standard rates for the policy, and they have the use of your money for many years to invest it. 

Also, the “suicide clause” of a policy stipulates that if the insured commits suicide within the first two years after the date the policy was issued, no death benefit will be paid to the named beneficiaries, but they will receive back the premiums that were paid by the insured.

It’s Not Just the Premium That Matters

The premium is important, of course. But when you choose a life insurance policy, you want to check the financial status of the insurer carefully. There is a big difference between an A+ rated life insurance company and one that’s rated A-. 

Premiums are fairly consistent between insurers, so the insurer's stability can be a good way to choose between companies and get the policy you’ll feel most confident owning.

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