Does Term Insurance Pay Out?

Why do most term insurance policies never pay out?

It is well known that the majority of term insurance policies never pay a death benefit. There are a few reasons for this: policies lapse, convert to permanent policies, or the insured outlives the term of the policy. Although many people view the low frequency of payouts as a negative, we view it as a good thing. Why do you think term insurance is so affordable? If a lot more people were dying, it would make the premiums much less affordable.

The fact that term insurance claims have a low and predictable frequency (with a large enough quantity of policies issued) and a known severity (the death benefit) makes it suitable for insurance. Events that have high or less predictable frequencies and unknown severities tend to be more costly to insure, and perhaps even uninsurable.

We won’t focus on policies that don’t pay out due to lapse or conversion in this article. We’ll focus on mortality and take a look at the chances of surviving to the end of a policy’s term for various ages, health ratings, and term lengths.

We’ll look at ages 30, 45, and 60; terms of 10, 20, and 30 years; health ratings of very healthy (preferred, or P) and average health (standard, or S); and we will do this for both men (M) and women (F).

Term 30/M/P 45/M/P 60/M/P 30/M/S 45/M/S 60/M/S 30/F/P 45/F/P 60/F/P 30/F/S 45/F/S 60/F/S
10 99.5% 98.6% 95.3% 99.0% 97.3% 90.7% 99.6% 98.8% 96.5% 99.3% 97.8% 93.3%
20 98.2% 94.2% 78.1% 96.6% 88.7% 59.4% 98.6% 94.9% 82.6% 97.5% 90.5% 70.5%
30 95.0% 81.2% 30.7% 91.0% 68.0% 16.7% 95.7% 84.6% 53.4% 92.6% 75.1% 32.3%

Preferred and standard mean different things to different companies, so these percentages are just ballpark figures. But, you can clearly see why something like a 10-year term insurance policy does not pay a lot of claims. Especially for relatively young ages like 30 and 45, the vast majority of people will survive the term. But this is good news, because it means lower life insurance premiums.

Life insurance contracts are aleatory in nature, so it does mean that it’s possible to pay premiums and never see a tangible return. But, you were covered the entire time, so you can view it as compensating the insurance company for taking the risk of insuring your life. And if you survive the term, who can complain about that?

If you’re interested, these articles on life expectancy and life insurance premiums are good reads.

It’s probably a little difficult to see patterns or trends from a table of numbers, so let’s take a look at some charts instead.

All of the charts are just different presentations of the data from the above table (with all of the years filled in).

This graph compares men who are very healthy for different ages:

This graph compares men who are in standard health for various ages:

This graph combines the previous two, so it compares the differences in health ratings for various ages. Compare the solid line with the dotted line of the same color.

This graph compares women who are very healthy for different ages:

This graph compares women who are in standard health for various ages:

This graph combines the previous two, so it compares the differences in health ratings for various ages. Compare the solid line with the dotted line of the same color.

This graph combines the very healthy men and women into one, comparing the differences in gender for various ages. Compare the solid line with the dotted line of the same color.

This graph combines the standard health men and women into one, comparing the differences in gender for various ages. Compare the solid line with the dotted line of the same color.

We mentioned that the low frequency of deaths for many term insurance policies contributes to the low premiums. But it is not only the number of deaths that occur during the term that is important, but when within the term they occur. If they tend to occur later in the term, this means that the present value of the death benefits will be lower and that more premiums will have been received and invested. This will also contribute to a lower premium.

To get a sense of when the deaths occur within a term, you can use the graphs. If you limit your time period to a specified term, when the graph is flat it means that relatively few people are dying. When it steepens, it means that more people are dying. If it’s always flat, it probably means the premiums are going to be low for that term. And if it’s always steep, it probably means the premiums are going to be high, and if it’s very steep, prohibitive (companies wouldn’t be likely to issue those policies anyway).

Conclusion

Various factors such as lapses, conversions, and deaths affect the frequency of term insurance payouts. In this article, we saw that it’s not surprising that few term policies pay benefits, because for many issue ages and terms, not a lot of people are expected to die. This of course leads to lower premiums, so it should not be viewed as a bad thing.

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