How is My Life Insurance Premium Calculated

A couple of common questions we get asked are how are life insurance premiums determined and why do they vary by individual? This post provides some insight into how your premium is calculated, and outlines some of the factors that might affect it.

What is a premium?

First, the basics…what’s a premium? A premium is the amount you pay to an insurance company periodically (typically monthly) in exchange for your insurance coverage. The premiums make up your side of the contract with the insurance carrier (the other side being the payout your beneficiaries receive in the event of your death).

How is a Premium Calculated?

Your premium is determined by an actuary. An actuary is a person who uses statistical analysis to calculate the probability of a given risk and the premiums required to manage those risks. In the case of life insurance, a life insurance actuary would analyze data related to deaths to determine the probability that a person will die within a specified period of time and convert that probability to a monthly premium.

What Makes Up My Premium?

Your premium is made up of a few components. First, there is an amount required to cover the expected insurance payouts across all of the insurer’s customers (this is called the underwriting expense in industry jargon). Second, there is an amount to cover administrative and marketing expenses. Finally, there’s a small amount of profit margin for the insurance company.

Let’s explore each of these in greater depth.

Underwriting Expenses

The component of a premium associated with probability of death will vary by individual based on factors that impact mortality. The higher the chance of the death, the higher the premium. Some of the more important factors include:

age (older people have higher mortality rates than younger people)
sex (males tend to have higher mortality rates than females)
tobacco usage (smokers tend to have higher mortality rates than non-smokers)
lifestyle (people who engage in risky activities – skydivers, for example – have higher mortality rates)
health and medical history, both your own and your family’s

A major consideration for insurance companies is the risk of adverse-selection. This is the tendency for people who know they are ill and have a higher likelihood of dying to seek out life insurance. Life insurance is intended to cover unexpected risks, which requires equal information between the insurer and the insured. If an insurer’s customers have higher mortality rates than the general population, the insurance company would experience more claims than expected. This is where things like medical exams and underwriting questionnaires come into play – they are tools to help identify individuals who are riskier to insure and whose premiums therefore need to be adjusted.

Administrative and Marketing Expenses

Like other businesses, insurance companies have to employ staff, pay rent, keep the lights on and the toilets flushing, etc. Additionally, traditional insurance companies tend to have large marketing expenses driven by large scale branding efforts as well as hefty commissions paid to agents or brokers who sell their products.

A plug here for Mosaic Life…this component of the premium is where Mosaic Life outperforms other insurers. Mosaic Life sells directly to consumers and doesn’t pay commissions to brokers. Additionally, because Mosaic Life was built technology-first, we don’t have expensive legacy systems or processes. This results in cost savings which we pass on to our customers.

Profit

At the end of the day, insurance companies need to make a profit in order to continue to do business. The profit to the insurance company is the difference between the premium collected and the underwriting and administrative/marketing expenses.

Am I Being Quoted the Best Premium?

Your premium is intended to reflect your specific likelihood of death. Generally speaking, if you’re healthy and not engaged in a risky lifestyle, you’ll likely get an insurer’s best rates for your age and sex. It’s worth noting here that with term life insurance, once your premium is set, it does not change for the duration of the policy, even if you become ill later.

A couple tips to ensure you get the lowest premiums possible…first, look for an insurance company that doesn’t have major administrative and marketing expenses. Typically, these are insurers that offer policies online and without a broker, like Mosaic Life. Second, get life insurance early in order to avoid the additional charges that will come with surprising life events and the process of getting older. It’s never too soon to protect yourself.