Why do short-term life insurance policies cost less than long-term ones?
[social_share]Short-term life insurance policies tend to cost less than long-term ones, when the monthly premiums are compared. This can seem strange to people who are familiar with other financial products, where the longer the term, usually the lower the monthly costs.
With loans, for example, an increase in the term generally reduces the monthly repayment amount dramatically. In part, this is because the principal of the loan is the same, and so increasing the number of months payments will be made spreads that principal over a wider area. As well, the interest charged will be lower, not only because it’s calculated over a shorter length of time but also because the related administration costs will be less.
However, with life insurance the opposite is true. With life insurance, the longer the term for which a person is insured, the higher the monthly cost. There’s a good reason for this.
As people get older, their chance of dying in the next year increases. While the risk may still be low, both for a person in their twenties and another in their fifties, the comparative risk nevertheless rises as the person ages.
Long-term life insurance usually carries the same premium at the beginning of the term as at the end, despite the risks rising throughout the policy’s term. In effect the person is paying an average premium, so that in a ten-year life insurance policy they are paying one-tenth the total cost in the first year, the second year, and the tenth year, as well as the years in between. The life insurance premium is averaged between the years of lower risk and the years of higher risk.
The premium is not in fact higher if the whole term is taken into account, and a person who would otherwise rely on annual life insurance policies, rather than one long-term one, is likely to pay out more money in total as their premiums rise with their age.
