How are Life Insurance Premiums Calculated?

Life insurance is also known in some jurisdictions as life assurance, a collection of insurance policies where an insurer agrees to make a financial payment to a designated beneficiary at the time of death of the insured person. However, while this basic precept is simple enough to understand, a number of complexities arise when you consider the fact that many life insurance policies are also used for investment purposes. The amount of life insurance premiums and the way that they are calculated depends on a number of factors, including the final benefit amount, the type of life insurance policy in question, and the risk factors that are associated with the insured person. Some of the individual factors that influence premium rates include age, sex, and a number of lifestyle factors such as smoking.

Calculation Considerations

The type of life insurance policy purchased has a large effect on the way that premiums are calculated, because different kinds of life insurance products work in very different ways. The two basic categories of life insurance on the market are protection based policies and investment related policies. While protection based contracts simply provide a financial benefit at the time of death of the insured person, investment contracts can also be used to facilitate the growth of capital over time. In all of these policies however, the basic tenants of insurability, underwriting, and risk are much the same. The insurer, who is normally an insurance company, calculates individual policy prices based on mortality tables calculated by actuaries, in relation to potential fund claims and administration costs. The three main variables in statistic based mortality tables are age, gender, and the use of tobacco products, although there are also a number of secondary indicators also used to set pricing.

Insurance companies receive money from the insurance owner in the form of premiums, and invest this money to create a pool of funds that is used for claims upon the occurrence of death. The difference between protection and investment policies is that purely protective contracts can only be accessed at the time of death, while the funds from investment contracts can also be withdrawn and borrowed from during the period that the insurance contract is in operation. Individual premium prices are based on the insurance type, the amount of the final benefit amount, and the risk factors associated with individual people and their relationship to specific mortality tables.