More Detailed Information about Life Insurance
At first glance, it might seem insurance companies take an unwise financial risk when selling an insurance policy. There is a chance that any given client could die shortly after purchasing the policy, in which case the insurance company has to make a large payout to a beneficiary without having received much money from the policyholder. To minimize this risk and to maximize the probability that they will profit from the sale of the policy, insurance companies use a complex statistical system to establish premiums for each of their clients. The professionals who analyze mortality (death) rate statistics to determine the cost of a policy are called actuaries, whose practice is called actuarial science.
When establishing premiums actuaries consider a number of important variables, such as the age and gender of the client, the type of policy being purchased, and the number of dangerous lifestyle obligations, habits, or hobbies that the client maintains. Holding a life-threatening job, such as firefighting, or having a dangerous habit, such as smoking tobacco, or having a risky hobby, such as skydiving, increases the likelihood of an early death. Therefore clients who participate in such endeavors are required to pay higher premiums for their life insurance policies. Insurance companies also review the health history of a client’s family to determine the cost of the policy. If, for example, there is a history of cancer in his family, the client will be required to pay a higher premium. Evaluating risk and determining price through these exhaustive background checks, which include questioning both the client and his or her physician, is called “underwriting.” An insurance company pools the premiums it receives from individual clients and makes investments to cover losses incurred when a client dies.
Different types of life insurance are available; the most common are term insurance, whole life insurance, and universal life insurance. Term life insurance is the most basic and least expensive type of policy. It offers a predetermined payoff only in the event of the policyholder’s death. According to most term life insurance policies, the client begins by paying a small annual premium and gradually pays a higher rate as he or she gets older. Experts recommend term life insurance for young people in their early to mid-20s who do not receive some form of life insurance from their employers. Experts also recommend that these people obtain what is called a “guaranteed renewable policy,” since many life insurance companies retain the right to terminate the agreement if the condition of a policyholder’s life changes.
As with term life insurance, whole life insurance policies usually pay beneficiaries at the end of the insured’s life. However, with these policies the insured usually pays the same high premium throughout the policy. According to these policies, a specified portion of every premium is invested on the insured’s behalf in an interest-bearing account. The interest earned on the funds in this account increases the value of the payoff to the beneficiary upon the death of the client. There are many different types of whole life policies, each of which offer clients various options. According to some policies, clients can control the amount they invest and how the money is invested over the course of the policy. Clients can often borrow money against whole life policies. Despite these options, it has been shown that whole life insurance policies tend on average to yield relatively small returns. Universal life insurance policies were established in the 1980s to offer potentially higher returns than whole life policies. Such policies offer a wider range of investment choices and often guarantee fixed interest rates on investments for a year at a time.