Level premium

The risk of dying goes up every year you live. So why does a term policy usually cost the same every year?

Because of how the premium is structured. The workbook lists the choice plainly: the premium can remain the same every year — a level premium — or it can increase as the insured gets older.

A level premium is not a discount. It is an averaging. The insured pays more than the year's true risk cost in the early years and less than it in the later years.

What the insured gets in exchange is certainty. A number he can plan around for twenty or thirty years, whatever happens to his age or his health.

Term insurance is where this matters most, because term insurance is the purest form of the product. The workbook calls it a pure risk cover: the premium buys protection on death and nothing else.

The three things to settle in any term policy are the sum assured, the premium and the length of coverage. Level or increasing is a feature of the second.

Where the workbook says it. Section 2.3, under Term Insurance, gives the three key factors and then the premium choice. Insurance companies sell term insurance with many different combinations of sum assured, premium and term, and the term can be for one or more years.

The figures the chapter attaches to it. Two real quotations appear in the workbook, both for level annual premiums.

From section 1.7.1(b), for a person aged 30:

Extending the term by ten years adds Rs 2,400 a year, about 17%, and the workbook frames that as the price of an option to keep renewing past the earning years.

From section 2.3, a real-life comparison from one insurer for a sum assured of Rs 1,00,00,000 over a 30-year tenure:

The difference of Rs 8,057 a year is the part the insurer invests to fund the return of premium at maturity — Rs 5,24,190, which is 30 times the annual premium of Rs 17,473. The workbook works out the implied return on that difference using the RATE function in Excel.

What a level premium does not fix. Two things.

First, tenure changes the level. The workbook notes that some companies now provide coverage up to 85 or 100 years, and that the premium for such extended-term policies is much higher than for policies covering only the earning years. A level premium is level within a policy, not across policies.

Second, payout structure varies. Term payouts can be a lump sum, a fixed regular monthly amount for a specified period such as 10 years, or both. The premium structure and the payout structure are separate choices.

Why the term premium is low in the first place. The workbook's reason: term insurance covers only the risk of death and has no investment component. It calls it the most affordable form of life insurance and an ideal way to cover the life insurance need, because the entire protection need can be covered at affordable premiums.

The workbook's own real-life comparison, worked through. Mr Agarwal, buying Rs 1,00,00,000 of cover for 30 years:

The difference in premium is Rs 8,057 a year. That is the amount the insurer effectively invests on his behalf to be able to hand back Rs 5,24,190 in year 30.

What return is that? On the workbook's method, put nper = 30, PMT = Rs 8,057 and FV = Rs 5,24,190 into the RATE function. Paying Rs 8,057 a year for 30 years to receive Rs 5,24,190 is a return well below what the same Rs 8,057 invested elsewhere would need to earn — which is exactly the point the chapter is making about investment-cum-insurance structures.

Now the tenure decision, using the other quotation. At age 30, cover to 60 costs Rs 13,800 a year and cover to 70 costs Rs 16,200.

The longer policy costs Rs 2,34,000 more in total. Both are level premiums; the level is simply set higher because the insurer is covering ten more, and riskier, years.

And the alternative he rejected. An increasing premium policy would have started below Rs 9,416 and climbed each year. For a 30-year commitment that makes the later years — when his income may have stopped — the most expensive ones. The level structure front-loads the cost into the years he is earning.

Chapter 2 (Features of Life Insurance Products), section 2.3, under Term Insurance, gives the level-versus-increasing premium choice alongside the three key factors of a term policy, the extended-tenure note and the return-of-premium comparison with the Rs 9,416 and Rs 17,473 figures. Chapter 1, section 1.7.1(b), supplies the Rs 13,800 and Rs 16,200 quotation for a 30-year-old.

Expect a definition question distinguishing a level premium from an increasing one, and a computation question on the return-of-premium variant using the RATE function. The three key factors — sum assured, premium and length of coverage — are reliable list recall.

• Level means level within the policy, not across policies. A longer term has a higher level premium. The workbook's own figures show Rs 13,800 for 30 years and Rs 16,200 for 40.
• A level premium is an averaging, not a discount. The early years overpay relative to the true risk cost so that the later years can underpay.
• Level premium is not the same as a guaranteed premium on renewal. The workbook talks about the structure within a term, not about what a fresh policy will cost later.
• Term with return of premium carries a much higher level premium. Rs 17,473 against Rs 9,416 on the same Rs 1 crore of cover, and the difference is the invested portion.
• Do not read the returned amount as a gain. Rs 5,24,190 is 30 times the annual premium of Rs 17,473 — it is the premiums coming back, and the implied return has to be computed to judge it.
• Extended cover to 85 or 100 years costs much more, and the workbook is clear that the premium for such policies is much higher than for cover limited to the earning years.
• Premium structure and payout structure are separate. A level premium says nothing about whether the death benefit arrives as a lump sum or as a monthly income for a specified period.