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Life insurance premium: what it is and how it works

When you get a life cover quote you will obviously pay a great deal attention to the amount of money that you will have to pay for the cover. This is known as the life insurance premium, but what is it all about and how is it worked out?

What Is the Life Insurance Premium and How Is It Calculated?

Simply put, the premium is the cost of your insurance policy. People have paid insurers to protect against unexpected problems for centuries. During this time, the process of calculating an exact premium has turned into a major industry. From the insurer’s perspective, premium rates need to be at a level to cope with the number of insurance payouts that they are statistically likely to make.

Life insurance premiums are set by actuaries, professionals who assess risks to calculate appropriate rates, using mortality tables to help with their calculations. They use factors such as your age and gender to work out how much at risk you are of dying, and therefore what premiums you need to pay.

This is also why they ask for extra information such as your occupation, whether you smoke and about any previous health issues. All of these details are used to work out how much you need to pay, according to your mathematically calculated risk of dying during the term of the policy. This sounds quite cold, but it would be impossible to provide reliable life cover without this information.

What Does Your Life Policy Premium Cover?

A common misconception is that your life insurance premium builds up some sort of fund over the years that you pay it. This isn’t the case. Life cover isn’t a savings account that keeps your money separate from everyone else’s and then pays out that amount upon your death. Instead it is a guarantee that a large sum will be paid to your relatives if you die, and the amount you pay in premiums reflects the risk of that happening.

Your life cover premium is added to a common pool of funds made up of all the premiums paid by everyone who is insured by the company. These funds are then used for the following reasons:

  • To pay out any claims that are made. This is probably the most obvious use of an insurance company’s funds. Money collected through premium payments will be used to pay out for any policies where there is a successful claim.
  • To cover the insurer’s expenses. These companies typically have multiple offices and lots of staff. For instance, in the US there are over 2.5 million insurance workers. Their salaries are among the costs that need to be met by the premiums collected.
  • To provide a profit for the insurer. Insurance is a business, and insurance companies are typically owned by shareholders who want to see enough money brought in to see a profit made and dividends paid out.

Your premium payments, therefore, serve to keep the agreement between you and the insurer valid rather than contributing directly to what will be paid out by the policy. As long as you have paid your life insurance premiums to satisfy the terms of the policy, you’ll be eligible for a full payout amount even if you pass away very soon after taking it out and haven’t paid much in.

How much should my life insurance premium be?

Annoyingly this is one of those questions that can only really be answered by saying, ‘it depends on your circumstances and the level of cover you want.’ Life insurance companies will often advertise premium rates starting as low as £5 a month, but this rate will usually be for a specific policy and age group, and you are very likely to pay more than this amount.

Generally speaking the younger you are the lower you can expect your premium rates to be. 25 year-olds can generally expect premiums in the region of £10 per month, whereas at 50 that number rises to around £25. But these are ballpark figures and estimating premiums on no information is an inexact science.

As explained above, however, your premium is determined by a variety of factors as well as your age, such as your gender, health, and if you smoke. You will also find that premium rates will jump significantly if you want to add extras such as critical illness cover, or want to take out a policy with a very large cash benefit. The best strategy is to figure out exactly what you need from a policy and then compare the different company’s who offer that level of cover.

How do you pay your life insurance premium?

Usually you will have the option to pay your life insurance premium either on an annual or a monthly basis. Both of these have their advantages and drawbacks, and which one is best for you will depend on your individual circumstances. Here’s a quick summary:

Paying annually

  • Pay all the premium costs in one payment each year.
  • Usually slightly cheaper than paying monthly.
  • A good option if you can afford to pay the full amount at once.

Paying monthly

  • Pay a smaller amount each month.
  • Cost over a year works out as slightly more than if paying annually.
  • Comes in the form of a regular payment you can manage along with your other household bills.

Occasionally you will find policies that offer other payment options such as paying every 6 months, but typically these are the two options you will have to choose between.

Guaranteed vs reviewable premiums

One final consideration to take into account regarding your life insurance premium payments is whether you want them to be fixed or flexible. With guaranteed premiums, the amount you pay will be fixed throughout the term of the policy. If you opt for reviewable premiums, the cost will usually be fixed for the first five years, but then the insurer will review your policy at regular intervals and can increase the premium over time.

Reviewable premiums often start out cheaper than guaranteed ones, but they have the potential to increase in the future and could therefore end up being more expensive. It’s important to consider this, as the only way to get around any increases in your premiums would be to change policy, and this could end up costing you a lot more.

Where can I find the lowest premiums?

The best thing to do in order to find a cheap life cover policy is to research the options. Our reviews help cut through all the confusion to show you how much each policy costs, and what it actually covers. Either fill out our form to get a quote now, or have a look at our in-depth reviews and information to help you make the right choice and get a great deal on your premiums.