What Is Level-Premium Insurance?
Level-premium insurance is a type of permanent or term life insurance where the premium remains the same over the policy's life. With this type of coverage, premiums are thus guaranteed to remain the same throughout the contract. For a permanent insurance policy like whole life, the amount of coverage provided increases over time.
As a result, the coverage can be advantageous over a long period of time: a policyholder keeps paying the same amount but has access to increased death benefit coverage as the policy matures.
Term policies are also often level-premium, but the overage amount will remain the same and not grow. The most common terms are 10, 15, 20, and 30 years, based on the needs of the policyholder.
- Level-premium insurance is a type of life insurance in which premiums stay the same price throughout the term, while the amount of coverage offered increases.
- Level-premium policies may be permanent or term life.
- Permanent insurance like whole life with level-premiums will typically see the death benefit increase over time even as the premiums remain the same.
- This is because permanent life insurance accrues a cash value that adds to the death benefit amount.
- Term life policies will not see increasing coverage and are usually set at 10, 15, 20, and 30 years.
How Level-Premium Insurance Works
Level-premium insurance premiums are fixed for the life of the policy. For a term policy, this means for the length of the term (e.g. 20 or 30 years); and for a permanent policy, until the insured passes away.
Level-premium policies will typically cost more up-front than annually-renewing insurance policies that have terms of only one year at a time. But over the long run, level-premium payments are often more cost-effective. This is because the higher premiums have typically been offset by an increase in coverage during a time period when a policyholder typically has more medical issues.
The amount of level premium paid on a policy will depend on one's age and health: the younger and healthier one is, the lower the level premium will be. For term life policies, the length of the term will also matter: longer-dated policies will cost more per month than shorter policies. The length of a term policy will often be selected to best suit one's specific needs.
For example, if the primary purpose of the death benefit is to provide income to support very young children and fund college expenses, a 20-year level premium might be appropriate. However, if these children are already in their early teens, a 10-year level premium may be sufficient. If the insured is the same age, the 10-year term policy would cost less, all else equal, than the 20-year policy's premiums.
Some forms of life insurance are vulnerable to premium increases or are sensitive to interest rate changes, such as universal life or variable life policies. With level-premium insurance, premiums and the death benefit are guaranteed as long as the policy is in-force. or unless the policyholder requests a change.
Level-Premium Term Insurance vs. Decreasing Term Life Insurance
With level-premium term life insurance, the policy pays a benefit if the policyholder passes away during a fixed period (whatever the term of the insurance is). If death occurs outside of this term timeframe, there is no payout.
With decreasing term life insurance, the amount of coverage declines over time, similar to the way a repayment mortgage decreases over time. Decreasing term life insurance is usually purchased to pay off a specific debt, like a repayment mortgage. The policy ensures that, upon death, the repayment mortgage (or other specified debt) gets settled.
Other specialty types of life insurance include "over 50s life insurance," which is a specialized kind of insurance geared toward people between the ages of 50 and 80. There is also joint life insurance, in which two people in a relationship take out individual policies. The policy will cover both lives, usually on a first-death basis.
Example of Level-Premium Insurance
The age and timeframe of the policyholder are both crucial factors in determining if a guaranteed, level-premium policy is optimal (versus an annual renewable term (ART) policy, which increases as the policyholder ages).
For example, suppose two female friends, Jen and Beth, both 30 years old and in good health, opt to buy life insurance. They each seek 30-year term with $1 million in coverage.
- Jen buys a guaranteed level-premium policy at around $42 per month, with a 30-year horizon, for a total of $500 per year.
- But Beth figures she may only need a plan for three-to-five years or until full payment of her current debts. Instead, she opts for a yearly renewable term (YRT) policy that starts at $20 per month and increases by 20% a year each ear. So in year 1, she pays $240 per year, 1 and around $500 by year five.
In years two through five, Jen continues to pay $500 per month, and Beth has paid an average of just $357 per year for the same $1 million of coverage. If Beth no longer needs life insurance at year five, she will have saved a lot of money relative to what Jen paid. But if Beth still thinks she needs 25 more years of life insurance coverage, she will start to be at a relative disadvantage. Each year as Beth gets older, she faces ever-higher annual premiums. Meanwhile, Jen will continue to pay $500 per year.
How Do Level-Premium Insurance Policies Work?
Life insurers are able to provide level-premium policies by essentially "over-charging" for the earlier years of the policy, collecting more than what is needed actuarially to cover the risk of the insured dying during that early period. These extra premiums are then credited toward later years when the insured is a higher risk.
What Types of Policies Are Traditionally Level-Premium Contracts?
Level-premium insurance is usually associated with term life policies or with whole life policies, which guarantee the premium will not change. Other forms of insurance like variations of universal life (UL) or annual term may be subject to changing premiums over time as circumstances change.
Why Are Premiums Higher for Permanent as Opposed to Term Insurance?
Premiums are higher for permanent insurance like whole life policies than term life for two primary reasons. The first is that the policy covers the insured for their entire life, and not just during a specific period of time. Insurers know that most people, statistically, will pass away only after the term coverage has terminated. The second reason is that a portion of a permanent life premium is paid into the policy as cash, which accumulates over time and can be drawn upon while the policy owner is still alive.