good to go back to the basics. What is
insurance and how does it work? By really
understanding these two questions, we can make
better decisions when
choosing term life insurance
or any insurance for that matter. So let's go
back to the basics and understand how insurance
works and more importantly, how it can work for you.
been around centuries in one form or another and has
really exploded into so many variations and types
that it can be overwhelming. From Property and
Casualty to Health to the one most relevant to our
decision, life insurance...insurance can be bought
on most things and situations these days.
Before we become overwhelmed with the options, let's
go to the heart of how insurance functions.
based on the premise that a given situation, whether
it's the death of a financial provider (life), a
catastrophic illness/injury (medical), or a tragic
house fire (property and casualty), would so
adversely affect a person or group of people
financially, they would be unable to recover.
It is a catastrophic loss that any given individual
cannot financially survive. How do we do deal
Life insurance typically involves a
great deal of money as we may need to replace the
potential income from an earner over decades.
Health insurance bills can run hundreds of
thousands....even millions of dollars. The
total destruction of a person's house can also be
hundred's of thousand or millions of dollars.
These are big numbers and society needs a tool to
somehow offset these situations which although rare,
do occur to individuals within a group. The
answer is insurance.
term life or some
other type has a simple premise and promise.
If we can group many individuals together (the more
the better), then we can spread an individual's risk
of a catastrophic situation occurring among the
whole group. We never know for certain which
individual it might happen to which is why we need
insurance in the first place. There is
however, a probability or percentage chance for any
one individual based on historical data. If
for a given population, 1 person out of 1000 dies
from age 40-45 each year, we now can calculate how
much to charge each individual in that group of 1000
people for a certain level of benefit. Let's
say for $100,000 of benefit to paid out in the even
that a person dies, we know we can divide the $100K
by 1000 (number of people) and then charge each
individual $100/per year. 999 of the
people will pay $100 and not receive a benefit but
the one person who passes away will be able to pass
$100,000 down to their beneficiaries. This in
a nutshell, is the core functioning of life
insurance and indeed, insurance itself.
people we have in the pool, the better. Let's
say there is a really bad year where five people in
that "risk pool" die. The premium would become
$500 or five times the original amount. That's
too much volatility. Or let's say 1 person in
a risk pool of 10 individuals dies. The
premium then becomes $10,000. That doesn't
work either. The way to address either
situation is to have 100,000's or millions of people
in the risk pool. This way, the odd years or
spikes in probability are smoothed out for a more
life insurance carriers
in this situation try to best estimate risk,
probability, and premium so that they attract as
many people as possible into the pool. If they
can successfully do this, they are able to add a
small percentage to the premium to both operate
their business and have a profit (if they are a
Stock Company model). The carriers have also
taken this core design and tweaked it over the years
with add-ons such as
Riders or certain
Exclusions that either augment or protect the
original risk assessment.
Why is it
important to go back to the basics? Well for
one, you now will have a better understand of why
term life insurance might be a better or more pure
form of insurance than whole life or annuities.
Insurance is about risk...not investment.
There are better ways to invest than through life
insurance as we discuss in detail at our
Term versus Whole life
We hope this
helps give you a core understanding of insurance.
You can now compare and choose the right for you
term life quoting engine
as a final test!