Considering that people who take life insurance would inevitably die and so the companies have to pay out the premiums, why do insurance companies still offer these options?
[Used the economics flair as I didn’t know which one to use.]
In: Economics
Life insurance comes in different forms. Term life insurance lasts for a specified term (hence the name), and premiums are based on the age and general health of the insured and the length of the term. For example, a fit, healthy 25 year old non-smoker who takes out a 10 year term policy will pay far lower rates than a 45 year old obese, diabetic smoker who takes out a 20 year term policy. The premium reflects the risk of each of them dying during the policy term, and once the term ends, there is no more coverage.
Term life is the most basic form of life insurance. There are other forms (called whole life, universal life, and other names) that have a component similar to term life, but add one or more “investment” components where some of the money paid in goes to an investment account of some sort and the account builds in value over time (both because you pay in more and because the investments grow). These policies can last until death (or 99 years, at which point they pay out as if you died), and there are lots of variations with a broad range of premiums. But the premiums paid and the insurance company’s share of investment returns will (when averaged out over lots of policyholders) total more than the death benefit paid. The insurance can benefit heirs if a policyholder dies at a younger than expected age, and there’s some favorable tax treatment of premiums so there can be benefits to the policyholder as well, but those benefits are generally not as strong as they could possibly be with other forms of accounts and investments that don’t have a death risk component. There’s a bit of a trade off – financial protection against early death of a breadwinner (for example) in return for giving up a bit of the gains to the insurance company if the breadwinner doesn’t die young.
No matter what form of life insurance is utilized, the carriers know exactly how to price coverage so that when the risk of untimely death (and death benefit payouts) is spread among all its policyholders, the insurance company makes a tidy profit (and covers all its expenses).
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