Where are my life insurance premiums going?

Let’s talk about your life insurance premiums.

The thought of dying at the peak of your income-generating years isn’t exactly comforting. After all, you work hard day in and day out to provide for your family and give your dependents the lifestyle they deserve. The last thing you want is for all of it to vanish in an instant like the door crasher for a Black Friday sale. And that’s where life insurance comes in.

The core purpose of life insurance is to protect your family against the risk that you’ll kick the bucket prematurely. It’s designed to give your dependents the money they need by making up for the future income you would no longer be earning. But this protection comes at a price. If you want coverage, you have to pay your insurance company monthly life insurance premiums.

How exactly are these life insurance premiums calculated?

If you pay life insurance premiums, there are some key questions that may run through your mind: “Am I getting a fair deal? Does the price I’m being charged make sense given the payout my family would receive?”

Well, we hate to break it to you, but the short answer is “no.” When you break down the likelihood of when you’ll die, life insurance isn’t a great deal and you’re probably overpaying for coverage.

Here’s why:

Life insurance may not seem like it has much in common with casino games or sports betting. But there’s a key similarity between the industry and its more entertaining counterparts. Just like how a casino sets payouts for its games or a bookie sets odds for sports bets, insurance companies calculate the probability of the event they’re covering (in this case, a person’s death) and price the coverage accordingly. But here’s the kicker: an insurance company has to add a significant margin to this price to cover the “cost of doing business.”

Let’s use the example of a sports bookie to see how this works.

Imagine that there’s a sporting event with a 50/50 outcome. That is, both teams are fairly matched and have an equal probability of winning the game. In an ideal world, making a $10 bet on one of the teams should pay you back $10 if that team wins.

But there’s a “cost of doing business” associated with being a bookie. It takes time and effort to set odds, accept bets, pay out wins, and collect losses. All of this adds up, which is why bookies can’t accept bets at the calculated odds. Instead, they add a 10% margin to the bet (known on the street as the “juice”), and pay you only $9 if the team you bet on wins.

As a bettor, you know you’re technically getting an unfair deal (because the probabilities of the different outcomes suggest you should be paid $10). But you’re willing to forfeit that $1 as a “fee” to the bookie to cover their costs and profits.

How does this play out in the insurance world?

Bookies and insurance companies both generate money by “betting” on probabilities. But this is where the similarities end. Being a bookie is a relatively low-cost business model. That’s why bookies can charge just an extra 10% fee to cover their costs and make a profit. Being an insurance company, on the other hand, is a very high-cost business model. (It involves betting on life and death, after all.) As a result, the amount that insurance companies charge to cover the “cost of doing business” is significantly higher than 10% and can often be 50% or more.

Why is the cost of doing business in insurance so high?

Insurance companies have lots of expenses. They need to invest in marketing, pay commissions to their distribution force, build advanced and sophisticated pricing models, administer policies, investigate claims, and hold a large amount of money in reserves to protect their policyholders (and that’s only a fraction of the list). As you can imagine, all of this becomes very expensive. So an insurance company can’t just charge you the money it eventually expects to pay out to you. It has to add on a very large fee to cover its “cost of doing business.”

So what does this all mean for me?

We told you earlier that buying life insurance isn’t a great deal. If you look purely at your probability of dying each year that your policy is active, you’ll realize that you’re paying significantly more in life insurance premiums than the odds suggest you should. But for most families, life insurance is an extremely important necessity, one that’s worth overpaying for to ensure your family is protected. It’s absolutely worth paying the “cost of doing business” fee (as sky high as it may be) if you’re one of the many who need the protection.

The key is being efficient with your life insurance strategy

Life insurance may not be cheap. But there are ways to make sure you aren’t shelling out more money to your insurance company than you need to be. Here are 2 key rules you should always keep in mind:

Rule #1: If your family doesn’t need financial protection against the potential loss of your future income (for example, if you have a large amount of savings or don’t have friends or family in your life who depend on your income to live) – do not buy life insurance.

Rule #2: If your family does need the financial protection (and most families do) – make sure you’re buying only the protection needed and not a single dollar more.

Sound complicated? At PolicyMe, our customized and automated recommendation engine does the work for you.

Based on a few questions you answer online, our algorithms determine if you need protection, and if you do, the minimum amount of protection you need. We then give you an overall recommendation on the most cost-effective policy that will give you this protection. And we’ll make sure you don’t buy more insurance than you need.

We’re not in the business of selling expensive policies to maximize our profits. Our goal is to give you objective life insurance advice that matches your needs, all with a convenient and optimized customer experience.

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