Learn more about Life Insurance than your Insurance Agent knows Part 3

This is Part 3 in the series, and it is strongly recommended that you read through Part 1 and Part 2 before reading this post. :)

So in the last article in the series, we saw how insurance premiums increase exponentially as a function of age.  From this we can extrapolate that if someone were to apply for an insurance policy every year, the cost for each successive year would increase, until it becomes unaffordable at some point.

For someone very young, the premiums are relatively inexpensive.  I remember a young client around 26 or so requesting a $250,000 life insurance policy and the premiums were around $130/year. For someone very old, the annual premium will actually approach $250,000 per year.  Of course at this point it becomes pointless to purchase the insurance as it would be silly to pay $250,000 for the year if you only collect $250,000 if you die.

Let’s break it down a little further.  For a 25 year old, we know the premiums are fairly cheap – if this person could spread out the cost of the insurance over a set time period (say 10 years) then they pay a set yearly or monthly amount for the entire 10 years.  Why would they do this?  Well, the set payment for the next 10 years will be higher than the payment when they are 25 and lower than when they are 35 – so they are averaging it out.  The idea is that they are willing to pay a little bit more than they should early on, so that they can pay less than they need to later in the term – thereby keeping the cost of insurance affordable as they get older.

Look at the following graph – we have inserted vertical lines at 10 year intervals.  In the beginning the growth rate in annual premiums is relatively small, but as the person gets older and the premiums increase exponentially you can see why choosing a longer "term" can become desirable. Insurance coverage becomes more desirable as you get older as people realize that they have a greater chance of dying – unfortunately this is exactly when the costs are greater.

Now we understand the basis of TERM LIFE. There are different lengths of term availabe – the most popular being 5 year Term, 10 year Term and 20 year Term. (There is also Term to 100 – which is a bit of anomaly, so we will cover that in a future post). TERM LIFE is known as temporary insurance in that there comes a point where it is unaffordable (when you are really old) – but when you are younger it is quite cheap and affordable. It stays in effect so long as you pay your premiums – if you miss a month your policy gets cancelled (you get no money back).  Term life is most often needed for temporary insurance needs. Examples of temporary insurance needs are: the mortgage – if you want the mortgage paid off if you die you would get insurance to cover the balance – but it goes down over time and hopefully one day you are mortgage free – therefore the insurance need is only temporary.

Okay, so the take home message of this post is that TERM LIFE is "temporary" insurance, and for the better part of your life will be the cheapest form of insurance coverage you can get.  As you get older however, it will eventually become unaffordable.

In the next part in the series on Insurance – we will take a look at PERMANENT INSURANCE. (Whole Life and Universal Life Insurance fall into this category). Click here to go to Part 4.

Related posts:

1. Learn more about Life Insurance than your Insurance Agent knows Part 4
2. Learn more about Life Insurance than your Insurance Agent knows Part 8
3. Learn more about Life Insurance than your Insurance Agent knows Part 5