DEFINITION of 'Validation Period'

Validation period is the amount of time necessary for the premium on an insurance policy to cover the commissions, the cost of investigation, medical exams, and other expenses associated with the issuance of the policy. To an insurance company, the length of a validation period is important because it indicates when an insurance product becomes profitable or starts contributing to surplus. Validation period is also known as the break-even period.

BREAKING DOWN 'Validation Period'

The validation period is the time period that an insurer needs to fully amortize the expenses associated with establishing a life insurance policy. The length of the validation period varies with the policy and the associated costs. An insurance company can shorten the duration of the validation period by decreasing the cost of a new policy issuance, charging a higher premium for the policy, or both. However, because life insurance is a very competitive industry, an insurer will have limited capacity to charge higher policy rates if it is offering essentially the same types of benefits as competitors. Therefore, an insurer will try to cut commissions and other costs to reduce the validation period.

Validation Period Illustration

Suppose a 45-year old non-smoking male applies for a new policy. The commission to the sales agent, medical exam, cost of investigation and a portion of overhead amount to $1,800. The insurance company prices the policy at $100 per month. In this simple illustration, the validation period is 18 months ($1,800 divided by $100 per month). After this break-even point is passed, the insurer will begin booking profits on the policy. If the insurer manages to cut the new policy expenses to $1,500 for the same policy, the validation period will decrease by three months.

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