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Applying for life insurance shouldn't be a black box

Have you ever wondered what goes into pricing life insurance? Many people overestimate the cost to obtain coverage.



Understanding how premiums are priced is one of the top complaints that applicants have when applying for life insurance. Insurance company pricing revolves around the risk of an applicant dying during the policy term, this is called a mortality factor. When insurance companies are pricing premiums, they consider all factors that could lead to filing a claim. For auto insurance, it may be how well you drive or how many car accidents occur in your zip code. For home insurance, it could be if you live in a floodplain or if you have a house that is more or less likely to be destroyed in a fire. For life insurance, the claim is often filed when the policyholder dies.


There are other ways that a claim can be filed for life insurance other than death but let us focus on this claim type for simplicity. We have written about how the type of policy (whole life or term life) can affect the premium price, so in this post we will focus purely on term life. The factors we discuss will apply to both whole and term with a few details being different.


What factors contribute to my premium pricing?


When insurance companies set prices, they create buckets to place an applicant into, so, that they can create a uniform pricing for all applicants that fall into a set criterion. This is a legal requirement to ensure that pricing is done fairly and no one person is treated unfairly. The names may differ from company to company but the buckets that insurance companies normally work with are preferred plus, preferred, standard, substandard and for smokers: preferred smoker, and standard smoker.


Most applicants will fall in preferred or standard rating classes. This is based on the population’s average health ratings. These health ratings use many factors but the biggest that affect the mortality of an applicant are: gender, age, height-to-weight ratio, and smoking status.


We will skip the term length and benefit amount as we assume that the higher benefit amount and the longer-term length will carry a higher cost due to their additional amount of coverage. The first factor to consider is gender. Women live longer than men, on average. So, women are less likely to die during their term policy, so their premiums are lower than a man of the same health and age.

Health status plays another huge role in pricing a premium. BMI (body mass index) or height-to-weight ratio helps companies assess the risk of your general health when you apply. Traditionally, high BMIs would lead to more expensive premiums, as the insurance company assess this applicant to be at a higher risk of death during the policy term.


Smoking is also taken into consideration because of its link to the higher likelihood of death. Many times, this is just for cigarette smoking and excludes the use of an occasional cigar and chewing tobacco. Every company is different so inquire to better understand how smoking status is determined for the policy for which you are applying.


Age is another big factor. Younger applicants are generally seen as less likely to die during their policy term. The further your age is from the average age of death the cheaper your premiums. Companies will also ask what is called Knockout questions. These are questions that automatically disqualify you from their policy. This could be certain health conditions or low/high BMIs.


Often most carriers will not insure substandard applicants. This could be due to the applicant falling outside of the company’s risk profile. These applicants then must seek life insurance in specialty markets. For many years diabetes would automatically move an applicant into substandard but today there are many specialty carriers. Due to improved care for diabetic patients, insurers are finding applicants with diabetes are less risky than before.


If this is how pricing premiums work, why do quotes vary from company to company for the same person?


All of this comes back to the company’s risk profile. Each company will have certain risk profiles of policyholders within their portfolio, and they will price this risk differently. They also have profit margins that they are looking to achieve. How well they operate and how likely they will have to pay out claims will affect this margin. This is not a major contributing factor, but it could vary the policy quotes by a few dollars.


There are products on the market that allow for no-physical applications. Depending on the company, and how they handle their underwriting process the applicant could pay more for this option due to the higher perceived risk of that applicant.


Always read into the details and get your questions answered when seeking quotes. Some products are better than others and some are better fits for applicants’ individual circumstances.


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