how does life insurance make sense, like how does $40/month for 10 years get you 500,000 life insurance?

Question

I’m probably just stupid 😭

In: 4901

Answer 1

There are two major forms of life insurance: term life, and whole life.

Term life only applies for a specific *term*, usually while you keep making those payments, and the rates will usually change every year. Many people have this through your job – and if you leave your job, the term ends. So this is really cheap (mine’s a few bucks a month), because of the large number of people who don’t die while still working – they die after retiring, hopefully. Or, if you’re young, you’ll at least switch jobs before croaking, which means they don’t have to pay out. I worked at my last job for almost 10 years before moving to another company – all of the money I gave to their life insurance company was basically free for them, since I stayed alive through the term.

Whole life though, that’s a different story – this lasts forever until you die, meaning (unless some exclusion applies, or unless it’s cancelled for some reason like missing payments), every whole life policy will *eventually* pay out their benefit. And here’s the thing about whole life: insurance companies actually do *lose* money, if you just look at the premium they take in (your payments) compared to the benefits they pay out after death. They’re the only type of insurance where that happens.

But what makes up that difference is investments – for most of their policyholders, a life insurance company knows that they have years, often decades, before they’ll have to pay anything out. This means that the money they take in can be invested for a super long term, so long as they keep enough cash on hand to cover the people who *do* die in that period. Because of that, they can make huge returns on their investments, and it still ends up profitable. And of course, keep in mind that a cheap price is only going to happen if you’re young and healthy. If you’re a 60-year old with a smoking habit, whole life insurance is either going to cost *much* more, or they just won’t offer you a policy at all.

**TL;DR:** Even if you’re only paying a small amount per month, they’re investing your money until you croak. These investments make up your death benefit and more in most cases; this is enough to cover people who die earlier (and therefore haven’t paid in as much), plus room for profit.