Maybe I just don’t understand what they’re doing. BUt it seems to me if I take out a 10 year policy that costs $100 per month, I’m betting that I’m going to die within that period of time and the company is betting that I won’t or that they won’t have to pay out. If I get to the end of that 10 year term, then I’m just out $12,000. What am I missing?
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I’ll try to break this down in math terms.
You are 30 years old, with a kid. You want to make sure your kid’s life is not completely thrown off course by you dying. In order for you to do this, you need to have money available to them to help with housing, college, food, etc.
You can do this by investing the money. Let’s say you invest $1000 a month. If you got a modest 5% interest rate, after 5 years you will have saved $53,000, after ten years you’ll have saved $95,000. That’s a good chunk of change that if you were to die exactly 10 years after you started to save, would be given to your kid (hopefully not spent on yolo outs with WSB friends, this has really happened, sadly).
So let’s set that 95k as the minimum goal to be giving your kid at the end of ten years. What if you die within that timeframe? They would get whatever you have accumulated until that point. Could be 92k, could be 8k, nobody knows when you will die. This is where insurance comes in.
The tables I have aren’t totally accurate, but if you are 30, you have a .004% chance of dying within the next 10 years. When you do the math (too complicated for ELI5), the insurance company figures out that 95,000 paid out at the time of death if it happens within the next ten years is is worth .00295 * 95000 = 280.25
If you paid a yearly premium, it would be calculated to be about $35 dollars a year. So, instead of invest $1000 a month to get $95k at the end of ten years, you can pay a $35 yearly premium and give your kid $95k if you die within the next ten years.
So for roughly $3 a month, you can guarantee the money to your kid in 10 years, which is a good deal if you ask me. That’s how term life insurance policies work. You can scale the up to be whatever benefit amount that you want, the math stays the same. It’s essentially an investment product just in case your unfortunately die at a time you haven’t established yourself you pass on what you would pass on. Whole life insurance is similar, but the chance of you dying at some point in your life is 100%, so the premium is much higher because you don’t have that .004% chance of dying within the term to bring the premium down.
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