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Why life insurance companies don't go broke...

Insightful question received from a reader...

Q

I would love to buy life insurance but I have one concern. If insurers cover you until you are 100 years old, there’s a 100% chance the insurance company will have to pay you the amount you are covered for.

I have put together a spreadsheet with a $30/month payment and interest at 8% pa. I could not save even $250,000 in 50 years, whereas if I die, the insurance company would have to pay out $420,000 - the amount I covered myself for.

What am I missing here? How come the insurance companies don’t go broke?

Thanks, Roxanne.

A

Thanks for this Roxanne.

There are a few things that you haven’t factored into your spreadsheet.

Firstly, a life insurance policy that covers you until you are 100 years old would have a monthly premium that increases each year. This annual price increase takes into account the fact that your risk of dying increases each year, as you age. In the first year you may be paying $30/month but after say 20 years you would be paying something like $200/month. So you’ll need to factor this annual increase into your spreadsheet numbers.

Secondly, a large proportion of people taking out life insurance cancel their policy long before they die. Life insurance is like car insurance in some ways… you only need car insurance while you have a car. Once you sell your car, you can stop paying the insurance and cancel your policy.

Most people don’t continue with their policy past age 75. Besides the fact that it gets very expensive, the purpose of life insurance is to financially protect those people that are dependent on you. By the time you are 60 or 70, most people don’t have financial dependants – their children generally have their own income. So they no longer need the insurance and they stop paying.

That’s insurance for you… collecting premiums from the many, only to end up paying the few.

Great business:-)

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