Have you ever seen a presentation discussing the differences between term and whole life insurance and thought, "Whole Life sounds like the way to go!" only to discover the monthly premium is much higher than the equivalent term policy? What about Long Term Care Insurance? Why does that cost so much? Why is the child life insurance offered through your employer only pennies each paycheck?
Today, I want to highlight a major consideration for insurance premiums that you may not have thought about. There are certainly many additional factors that I won't address here, such as but not limited to: agent commission, marketing costs, how large or small the company is, how many claims were paid last year, etc. These are all factors and can't be ignored. But let's take a look at another one: how likely the policyholder is to file a claim.
Have you considered that? Let me give you a couple of examples. First, term vs. whole life. Life insurance companies know there is about a 98% chance that your term policy isn't going to have a claim. How do they know that? From years and years of data to support it. This includes all types of term policies, not just 20 year term. These policies are 98% likely to either be replaced or dropped at maturity. Therefore, the insurance company can price accordingly. These policies also don't have any of the living benefits that whole life has. Term policies are not designed to be with you until you die. They are meant to last a set period of time and then be done. Since insurance companies control who they issue these policies to, they can limit approvals to the people who are statistically the most likely do outlive them.
Now, consider a whole life policy. What are the odds these policies will have a claim? Well, since the premium never goes up(many even drop in price after age 65 due to the disability rider coming off), there's a guaranteed claim as long as premiums are paid. Are there people that simply stop paying them and cash them in? Absolutely! However, these are more likely to have a claim. They also have living benefits. These include cash value, long term care(in rare cases), and many others depending on the policy. In addition, I've seen some of these policies become self-paying after 10 or so years, meaning you can keep it going without having to pay anymore premiums. All of these things(plus many more) have a cost for the insurance company, so they are factored into the premiums. But, the main factor is that these are guaranteed to require a claim one day(assuming they aren't dropped) because we are all guaranteed to die. The insurance company sets itself on the hook to pay you a huge death benefit compared to the small monthly premium. Pretty simple, right?
What about long term care? Statistics tell us that there is a very high likelihood of needing some type of long term care assistance as we age. Why? Because we're living longer. No matter how much we try to live forever and stay young, our bodies age and deteriorate. I've seen statistics that say there is a greater than 50% chance all of us under 60 years old today will need assistance later in life. Those are really high odds!
So, if we're likely going to need care, how much does it cost? I hesitate to post a number here because it is such a wide range depending on how much care you need, the type of care you need, where you live, etc. I've had numerous people tell me it costs greater than $65,000/year to live in a nursing home. Most people don't start out there, but even if costs start low, you'll likely need care for a long time and need more as time goes on. The odds are not in your favor.
With this brief summary of long term care in mind, how should insurance companies price them? There's a high likelihood of need, and the costs for care are already high and rising exponentially, so...that's right...high premiums! It comes down to the odds that you'll need it. If there was a 5% chance everyone over the age of 65 would need some living assistance, then those industry premiums would tank. But 50% odds? Well, you gotta pay for it.
What about my last example mentioned above: child life insurance? Thankfully, not many children die(statistically speaking according to actuaries). So, those premiums are next to nothing when they are added as a policy rider or work plan. Personally, I'm extremely grateful these policies have a miniscule chance of needing a claim.
Now, there are many types of insurance policies--way more than what I've mentioned here. But, no matter how you slice it, you need to consider what the odds are of needing it. That's why car insurance for a 16 year old is much higher than it is for a 40 year old. Insurance companies are there to prevent us from having catastrophic financial loss, but they sure will try their hardest to never have to pay a claim. If you've ever filed a claim, you know what I mean.
By the way, I am in no way discouraging people from purchasing insurance. All policies fill a need in some form or another, which is why there are thousands of companies to help you with that. Many companies offer the same type of policies, but with different bells and whistles, which is another reason for a different premium. Don't despair--do your homework and make your decision.
