What is the premium model?
When you buy life insurance, you agree to pay a certain amount or premium to the insurance provider on a regular basis. The frequency or duration of your payment depends on your premium model. Most insurance companies offer multiple premium models, the most common of which is once a year, half a year, quarterly or monthly.
The premium payment method is different from your payment method. Your premium payment method determines how often you pay. It also determines how you pay, such as cash, check, credit card, or other methods.
- Most life insurance companies offer multiple premium models, the most common being annual, semi-annual, quarterly or monthly.
- In addition to how often you pay for life insurance, the premium model also determines how you pay, such as by check or credit card.
- More frequent premium payment models generally cost less per payment.
- Compared with more frequent payment methods (such as monthly payments), the long-term costs of infrequent payment methods (such as annual payments) are usually much lower.
Understand the premium model
Policyholders choose their premium model when signing the policy. The usual practice is to pay your first premium to activate the coverage of your policy. Before you sign the policy, the insurance agent should emphasize the frequency of possible premium payments.
Many insurance companies allow policyholders to change the premium model to a higher or lower frequency during the validity period of the policy. The change date usually coincides with the pre-existing payment date, which means that if you want to change from the semi-annual premium to the monthly premium, then you may make the first monthly payment on the next scheduled semi-annual payment date. From then on, the payment schedule will switch to monthly payments.
The impact of premium models
As a general rule, more frequent premium payment methods tend to reduce the cost of each payment. However, more frequent payments also tend to result in higher total costs. For example, an insurance company may charge you a policy fee of US$150 per month, US$400 per quarter, US$700 every six months, or US$1,250 per year.
The upfront cost paid each year is much higher than other methods, but it is actually the cheapest model in the whole year coverage. The monthly, quarterly, and semi-annual models cost $1,800, $1,600, or $1,400 per year, respectively, while paying $1,250 per year.
More frequent payment methods tend to be more costly because insurance companies need to offset uncertainty and higher collection costs. Imagine that you are an insurance provider-you are likely to add value in receiving a full year’s advance payment, because it means you have to worry about reducing late payments or omissions in the future. Higher payments will immediately improve cash flow and make it easier for you to predict your future financial situation. You can also use additional funds to make larger and earlier investments.
Think about payment methods, such as loan payments. In the case of loans, borrowers who take a long time to repay the principal usually end up paying more interest. Similarly, the longer it takes for policyholders to pay the full cost of their annual life insurance, the higher the cost.
Life insurance is not debt, and policyholders are not borrowers, but the relationship between time and payment costs is comparable. Some insurance companies even provide annual percentage rate (APR) calculators on their websites to understand how premium payment models affect final costs.
Choose your premium model
In order to ensure the lowest total cost of your life insurance, please choose a less frequent premium payment method. Ignoring other considerations, the annual cost of infrequent payment methods is usually significantly discounted compared to more frequent payment methods.
Don’t forget to consider two factors: opportunity cost and liquidity. Your working capital is the amount of cash you are prepared to pay the premium. If your bank deposit is only US$50, it may not be wise to choose the premium payment option of US$1,250 per year.
Even if you have enough money to pay the annual fee, the opportunity cost of choosing an annual fee of US$1,250 instead of a monthly fee of US$150 is all you can do with US$1,100 in the short term. It is possible to invest this money and earn extra costs that exceed the monthly payment option.
Another consideration is that if you terminate the policy early, many insurance companies will not refund part of the premiums paid. Suppose you buy life insurance and pay the annual premium on January 10. Unfortunately, your insurable benefits changed in the middle of the year and you decided to terminate the contract on July 10. Even if you only use 50% of the annual insurance, your insurance company will do so without refunding your remaining 50%.
What are the common intervals for insurance payments?
The most common is to pay annually, semi-annually, quarterly or monthly. This is the premium model.
What should buyers consider before deciding on payment frequency?
The more you pay in a year, the lower the amount you pay each time. Nevertheless, due to fees, more frequent payments usually cost more in the long run. More frequent payment methods tend to be more costly because insurance companies need to offset uncertainty and higher collection costs. Although the upfront cost paid each year is higher than other models, it is actually the cheapest model in the annual coverage.