The Mathematics of Life Insurance - Do You Need More Life Insurance?

Life Insurance has evolved into a practical necessity in the modern world. Marketing life insurance to lesser developed countries is not cost effective to retail insurance companies. The mathematics of life insurance revolve around actuarial tables devised by hyper-intelligent mathematicians. Given a large enough sample set, these tables predict reasonably well the anticipated life span of an individual policy holder.

Term Life is conceptually simple. For a specified period of time, the insurance company agrees to pay you a pre-determined amount of money if you pass away. As the policy holder, you agree to make a periodic payment to the insurance company. The amount of your payments are derived from your age, gender, marital status, some of your health risk factors, and some of your lifestyle risk factors.

For example, a smoker pays significantly more than a non-smoker for the equivalent life insurance policy. Research consistently indicates that smokers simply do not live as long. Keep in mind that a plain vanilla term life insurance policy does not pay out one dime until death occurs; the smoker or non-smoker may contract a debilitating disease or experience an injury but still have no claim against the policy.

Some lifestyle choices that affect the cost of a Term Life insurance policy are recreational activities that by their nature include a high risk of death. A sky diver or rock climber may expect to pay more than an earth-bound marathon runner. Activities that affect the cost of a policy are directly driven by the same type of actuarial table calculations that form the costs basis for all policies.

Purchasing life insurance can be frustrating. On an individual level, you may feel great. You may have a resting heart rate of 59 BPM, a 32 inch waist line, and a BMI (Body Mass Index) that is spot-on for your age/height/gender. Unfortunately, you may also be 95 years old. Actuarial tables lack the capacity to 'care' about your personal situation. Statistically, you have a relatively short time left on Earth if you've already celebrated your 95th birthday. Your family expects you to be around forever, your life insurance agent does not. An obese 25 year-old will pay less than a marathon-running basketball-playing Nobel-prize-winning octogenarian.

Life insurance companies advertise incessantly; they sell their product based on agent-customer relationships, personalities, the human touch, and other touchy-feely aspects that cannot be quantified. Market research tells big business that consumers do not trust them. Advertising blitzes are constructed according to that nugget of truth

For most consumers, however, the bottom line is price.

For the purposes of comparison only consider these examples. A 10 year policy for a healthy 26 year-old male who does not engage in risky activities and who does not smoke will cost about $225 per year. A 20 year policy for the same demographic will cost about $350 per year. The difference is an additional $125 per year over 20 years, for a total increase of $2500.

Is the 20 year policy a better purchase? A consumer planning to completely drop life insurance coverage after 10 years should certainly purchase the 10 year policy and pocket the difference. Consumers who plan to continue purchasing coverage have the option of paying the lower 10 year rate, then opening a new policy at the expiration of that policy at a new and unknown rate, or paying a little extra at the outset to be guaranteed a level rate for 20 years. The worst case scenario is a life-threatening illness at the tail-end of the 10 year policy, which would negatively impact the cost of a new policy for the next 10 years. In other words, finding life insurance after contracting a critical illness can be problematic. Purchasing a Term Policy for a longer term will cost more in the short term but may cost less in the long term.

One very good reason to build a relationship with a local life insurance agent is to get valid feedback regarding the amount of life insurance that might be 'enough'. Some customers are content to invest in a policy that will retire their outstanding debts; others prefer to know that their policy will provide ongoing financial support for their family. Insurance companies often recommend a policy that pays out 5 times the salary of the policy holder.

For example, a customer earning $50,000 per year would need a policy for $250,000 in order to meet the "5 times" rule. Is this enough to replace the wage earner and support a family? Assuming that the survivors prefer to draw income from interest earned from the policy rather than reducing the principal, an investment vehicle that returns an annual rate of 20 per cent would be necessary.

Many insurance companies provide online calculators for computing insurance rates and coverage necessities.