by What is life insurance? And is life insurance worth it? What’s the difference between term life insurance and permanent life insurance? This post will cover all of that and more in detail to help you ultimately decide if life insurance is worth it for you.
Contents
What is life insurance?
Life insurance provides a guaranteed payout in the unfortunate circumstance that you die. You will need to pay a monthly premium to enroll in life insurance.
There are two types of life insurance: Term life insurance and permanent life insurance.
The difference between the two are as follows:
Term life insurance provides a guaranteed payout during a fixed term. For example, if you purchase 20-year term life insurance at the age of 25, you will only be covered for until the age of 44, right before you turn 45. You could purchase another term life insurance policy at the expiration of the initial term, however the monthly premiums will likely be higher.
Permanent life insurance provides a guaranteed payout throughout your entire life, as long as you’re still enrolled and paying your premiums.
Why do people buy life insurance?
The main attraction to purchasing life insurance is that your family will have financial support in the unfortunate circumstance of your death.
If you die, you will likely not be receiving regular paychecks. Who will be providing for your children? Who will pay for your funeral costs? Who will be paying your mortgage for your family to continue living in the house? Who will pay for your children’s education?
When you die, it’s obvious that YOU don’t need the money. What are YOU going to do with $200,000 when you die? YOU can’t spend it!
But… your family can spend it. And that’s really what life insurance is about. It is to provide for your family.
Life Insurance is a Business
Initially life insurance seems too good to be true. If I pay $20 a month, and I die, I would receive $250,000?? It seems like a no brainer.
Life Insurance, first and foremost, is a business. The business needs to pay for employees, office buildings, and various other operating expenses.
If they were paying out $250,000 to everybody, especially everybody who was just paying $20 a month, they would be out of business so fast.
The fact is that for every person they paid $250,000 to, there were 98 or 99 people they did not have to pay. They just continued to collect premiums from these people, who fortunately for the Life Insurance company, did not die during the life of their policy.
We’ll dive a little deeper into the financials of how life insurance companies make money in the next section.
How life insurance companies make money
Let’s examine the math behind life insurance.
Here are quotes I found of the average monthly premiums for a 20-year term life insurance policy for both males and females:
Life insurance companies know and understand very well the probability of your death according to your current age.
I will arbitrarily examine the $250,000 coverage policy in greater detail. The probability of death I used came from social security actuary tables.
| Age | Gender | Monthly Premium for $250,000 Policy | Premiums paid over 20 years | If you invested your premiums at 6% instead | Probability of dying within 20 years (range) | Average payout to all policy holders at upper end of death probability range |
| 25 | Male | 17.08 | 4099.2 | 9718.5 | 0.00161 – 0.003064 | 766 |
| 25 | Female | 14.22 | 3412.8 | 8091.17 | 0.000612 – 0.001881 | 470.25 |
| 35 | Male | 18.66 | 4478.4 | 10617.52 | 0.002138 – 0.007125 | 1781.25 |
| 35 | Female | 16.46 | 3950.4 | 9365.72 | 0.001085 – 0.004415 | 1103.75 |
| 45 | Male | 35.25 | 8460 | 20057.22 | 0.003285 – 0.015032 | 3758 |
| 45 | Female | 28.31 | 6794.4 | 16108.36 | 0.002029 – 0.009142 | 2285.5 |
| 55 | Male | 83.54 | 20049.6 | 47534.18 | 0.007766 – 0.032394 | 8098.5 |
| 55 | Female | 60.15 | 14436 | 34225.29 | 0.004813 – 0.022522 | 5630.5 |
Let’s walkthrough the first line for a 25 year old male.
He would pay $17.08 a month in premiums for a 20 year term life insurance policy with coverage of $250,000.
Over 20 years, he would have paid $4099.20 in premiums.
If he instead invested those premiums in the stock market at a conservative 6% growth rate, he would have $9718.50.
The likelihood of him dying within the 20 year term is extremely small. So small, that the probability of him dying at age 25 is 0.161% and at age 44 is 0.3064%. In fact, at age 25 he is expected to live another 52.22 years!
The average expected payout to all 25-year old male policyholders with a $250,000 at the upper probability range would be (0.003064 x $250,000) = $766.
That means that ON AVERAGE, the average policyholder of this policy would pay $4099 in premiums, while only receiving a payout of up to $766.
To add insult injury, if you had just invested in a moderate stock portfolio with 6% growth rate, you would instead have a payout of $9718.50.
Pros and Cons of Life insurance
Pros of life insurance
If life insurance isn’t worth it financially (at least when considering the whole population), then what is it good for?
Piece of mind / Security
Auto insurance provides security if you damage your vehicle, damage someone else’s vehicle, or injure somebody. 99% of the time when you drive, the insurance does nothing for you. But you’re glad its there for that 1% you do need it.
Home insurance provides security if your house suffers damage from a fire, theft, or accidents. Most of the time you’ll never use it. But it provides you the security and piece of mind, knowing that you’re covered JUST IN CASE.
Life insurance is no different for other insurances… it spreads risk amongst all of the policy holders. Rather than assuming all of the risk of death, you share it with all policy holders.
Insurance provides security. Security that your family will be provided for when you’re gone. You won’t need it until you NEED it.
Cons of life insurance
- Can be expensive
- Negative Expected Return
- Not much utility if you have no spouse or dependents who depend on your income
Medical Exam
I’m pretty cynical when I think of people. So of course I think about how insurance companies avoid getting scammed. For example, what if someone had a terminal illness with 2 months to live. Couldn’t they just purchase life insurance to provide a huge windfall to their family?
The answer is, probably not.
Many life insurance companies require enrollees to take a medical exam which consists of both a verbal questionnaire and a physical exam. Several things may be documented such as your blood pressure, cholesterol, nicotine usage, alcohol usage, cancers, and other diseases. They may also take a blood and/or urine same. Your monthly premium will consider many of these factors. In general practice, the healthier and younger you are, the lower your premium.
Some insurance companies might provide you with life insurance without a medical exam. However, they may review your medical records in great detail. The price of the premiums would reflect the risk that the company is willing to take on your health.
Source: Policy Genius
To get back to the original question. Can you purchase life insurance with a terminal disease? The answer is most likely no. It just wouldn’t make sense for them to fork out millions of dollars, knowing that you have two months to live.
What if you lie about it?
If your terminal illness was not disclosed during your verbal or physical exam, and the insurance company could prove that you knew about the disease, I think the insurance company would have good reason and legal authority to decline your claims.
Is life insurance worth it?
Life insurance is kind of like playing the lottery. There is a very small probability that you will receive a very large payout.
Going back to the Social Security Actuary table for a 35 year old male. Would you pay for something (20-year term life insurance) knowing that there is a 99.3% chance you’ll never need it?
The perception of life insurance is different from that of car insurance or home insurance.
Car insurance, in most cases, is required by law. Same for home insurance if you own a mortgage. These insurances cover you for many accidents or disasters that may be out of your control.
Life insurance, on the other hand, is not required by law. Furthermore, people believe that WE are in control of our own destinies, especially our own lives. If we’re healthy and we generally don’t engage in risky behavior, the probability of us living into old age is quite high. If we’re not healthy and we engage in risky behavior, the premium payments for life insurance will likely be quite high.
Are you willing to make a poor investment (in terms of expected return) in exchange for security and piece of mind that your family will be provided for when you’re gone? That’s what you need to answer before deciding if life insurance is worth it for you.
Let me know your thoughts below!
Are you considering life insurance? Do you think it’s worth it?
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