a fresh look - life insurance

Our fresh look at life insurance advice

Buying life insurance can seem hard (and not just because it involves thinking about the day when you’ll kick the bucket.) Life insurance products come in many shapes and sizes, and they differ in how much they cost and pay out. This makes choosing the right one about as easy as buying a gift for your mother-in-law.  Even worst, life insurance advice is hard to come by!

But although life insurance products have different features, they’re all priced based on the same principle: actuarial equivalence.

What is actuarial equivalence?

Two options are actuarially equivalent if their expected outcomes have the same value. This may sound like nothing more than a bunch of insurance mumbo jumbo, the kind that’s only meant to confuse you. But actuarial equivalence is an easy concept to understand once someone breaks it down for you. That’s what we’re about to do with this simple example.

Actuarial equivalence Example 1: The coin flip

Let’s say that I give you two options to choose from, both involving a coin flip but with different payoffs.

In Option 1, if the coin lands on heads, I give you 1 dollar. If it lands on tails, I give you nothing. (That’s right. If you’re unlucky enough to land on tails, you get a big fat zero.)

In this case, there are two possible outcomes. And because flipping a coin is a 50/50 game, you’d expect to get 50 cents on average with this option. That is, 50% of the time you’d get 1 dollar, and 50% of the time you’d get nothing.

In Option 2, we flip a coin and you get 50 cents regardless of the outcome. In other words, you get 50 cents if it lands on heads and 50 cents if it lands on tails. With this option, you’d expect to receive 50 cents. In fact, the 50 cents is guaranteed.

Insurance companies would say that Option 1 and Option 2 are actuarially equivalent. Why? Because they both have the same expected value: 50 cents. The average amount you would expect to get from each option is the same. With both options having the same value, insurance companies wouldn’t care about which one you choose. They would pay you the same amount in each case. For this reason, they would charge the same price for these options.

But here’s the important thing: just because two options have the same value to an insurance company doesn’t mean they have the same value to you, the customer. This may be hard to appreciate when we’re talking about arbitrary coin flips that aren’t any more meaningful to you than the current weather on Mars. So let’s take this example a step further and add some concrete value to our options.

Actuarial equivalence Example 2: Stuck in the desert

Using the same coin flip example, let’s consider two customers. We’ll name them Dave and Alice.

Suppose Dave is in the middle of the desert and needs 50 cents to buy a glass of water. (If only you could purchase water this cheap anywhere else.)

Remember that Dave can choose between Option 1 (getting either 1 dollar or nothing at all) and Option 2 (getting 50 cents no matter what). Dave needs just 50 cents for his life-saving glass of water. So to him, the guaranteed payout of 50 cents is significantly more attractive than the chance of earning 1 dollar but potentially walking away with nothing. As a result, this decision is a no-brainer for Dave. He’s obviously going to go with Option 2.

Now let’s suppose that Alice wants to buy a chocolate bar that costs 95 cents. (It must be one heck of a chocolate bar if it’s going to save her life in the desert more than a glass of water would.)

For Alice, Option 2 isn’t very attractive. She needs more than 50 cents to buy the chocolate bar she’s craving. For this reason, Alice would choose Option 1. The chance of getting 1 dollar is her best bet (even if it means she might get nothing at all).

Choosing between actuarially equivalent options

What’s the key takeaway from our examples? When you’re choosing between two actuarially equivalent choices, you need to consider the features of each option and your needs as a customer.

Of course, the features of life insurance products are a lot more complex than the sides of a coin or the sustenance available in the middle of a desert. That’s why it’s critical for insurance advisors to understand the deep intricacies of product mechanics and pricing to truly provide “best interest” life insurance advice to customers. As you can imagine, doing so is no easy feat. It takes years of experience, specialized mathematical training, and a strong analytical mind built for problem solving. In other words, it takes an actuary.

We use actuarial expertise to provide you with the best customized life insurance advice

PolicyMe was founded under actuarial leadership with a mission to provide transparent and unbiased life insurance advice guided by actuarial principles. And that’s exactly what our proprietary algorithms do.

We start by understanding your family’s situation so we can assess your needs. We then project your needs over time and use our expert understanding of the available products and features to identify the most affordable policy that’s right for you. After all, policies aren’t one-size-fits-all scarves, and your needs differ from those of the person standing behind you at the grocery store.

We’re very passionate about insurance, and it’s important to us that you get the personalized life insurance advice you deserve in a convenient and stress-free environment. We were trained as mathematicians, not salespeople, and we’re committed to simplifying life insurance and giving affordable recommendations to those who need it most.

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