How Life Insurance Works

  • Key Takeaways

    • The concept of pooling is critical to life insurance because the losses of the few can be paid for by relatively small contributions from the many.
    • Life insurance premiums are adjusted for investment income, marketing/administrative costs, taxes, and actuarial risks.
    • Yearly renewable term life insurance is cost-prohibitive in later years due to adverse selection and the increased probability of death.
    • In whole life policies, the level premium is higher than necessary to pay claims and other expenses during the early years of the contract, but less than the cost of protection equal to the total death benefit during the later years.
    • Level premium policies allow for cash value accumulation.
    • The difference between the reserve and the face amount of the life insurance policy is the net amount at risk for the insurer and the protection element for the insured.
    • Insureds may realize their cash value by surrendering the policy, taking out a loan, or letting the policy mature as part of the policy’s death benefit.
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