Why Do Life Insurance Premiums Vary So Much?

You would think that life insurance is basically the same no matter what company you buy it from. Unless you have a medical condition, or buy a special rider of some kind, any financially solid company can provide the same coverage amount and the same circumstances under which the policy pays out. It would be logical for the premiums to be almost the same as well. Same product, same price, right?

It's not that simple. Our research into term life insurance premiums found a wide range for basically the same life insurance policies. The premiums of the highest-priced policies were as much as 2.5 times the premiums of the lowest-priced policies. Why the big range?

Why Life Insurance Rates Vary from Person to Person

All insurance companies are trying to calculate potential risk, and weigh that risk against potential reward. Clients are not individuals--they're actuarial tick-marks. If the company writes policies on a hundred people with the same age, physical characteristics, and family medical history, how many of those people will live for ten more years? Twenty years? Fifty years? How will those numbers change if the insured people are five years older? How will they change if they have a family history of cancer? Premiums are based, for the most part, on those predictions.

To make things more difficult, companies are trying to make those predictions with old data. Steve Weisbart, senior vice president and chief economist for the Insurance Information Institute, said the mortality data used today by life insurance companies are based on actual deaths that occurred in the early 1990s. That's how long it takes for data to be collected, analyzed, approved by regulators, and put back in the hands of the people who set the premiums. However, Weisbart said the mortality tables are adjusted to take into account a likely improvement in mortality rates.

Why Rates Vary from Company to Company

But none of this explains why the same person, with the same characteristics, often receives such a big range of premiums for very similar life insurance policies. Some of it may have to do with the ratings assigned by Moody's and A.M. Best, two of the companies who rate insurers based on their relative financial health. All of the companies we looked at were rated A+ or higher according to A.M. Best, but two out of three of the companies with the highest premiums were assigned an even higher rating or A++. Moody's only provided ratings for 8 out of 10 of the companies we obtained quotes from, but all except one of the companies rated came in at Aa3 or higher, which means the Moody's considers them high quality companies. But the companies given Moody's highest rating of all, Aaa, all had premiums higher than the median.

According to Weisbart, the difference in premiums may have to do with the health rating companies assign to potential insureds (the term people in the industry use to describe insurance applicants). Companies may assign different degrees of importance to physical traits, such as height-weight ratios, cholesterol levels, and how many years have passed since the applicant last used tobacco.

In some cases, companies disregard certain traits altogether. For example, Rich Fiene, who consults about the life insurance industry, said at one time he knew of an insurance company that would give non-smoker rates to people who chewed tobacco as long as they didn't smoke. Most companies saw all tobacco use as being equal, and charged high premiums for smokers and chewers alike. Good insurance agents know which companies are most likely to overlook any potential problems in your demographic profile.

Some companies simply price their products more competitively, said Weisbart, especially within a specific niche market. A company who is targeting younger people may offer lower insurance rates than their competitors for people age 25-35, while another company may have more competitive prices for people in the 35-50 age range. Bill Evans, who sells insurance in California, said the company he works for has lowered its premiums on policies over a certain face value with 20 or 30 year terms in order to be more competitive in that market. He said the company hopes that selling longer-term policies will improve customer retention for all their insurance products, because people are less likely to switch insurance companies if they have more than one type of insurance packaged together.

Fiene said some companies also offer niche products, such as policies above or below a certain coverage amount. "Every insurance company will have a banding rate," he said. "That means a policy for $249,000 would be cheaper if you wrote it at $250,000." A good insurance agent will understand each company's banding as well as their product or client niche.

The cost of re-insurance can also trickle down to influence the premiums customers are asked to pay, said Weisbart. Re-insurance is the industry term for the policies insurance companies buy to protect themselves against higher than expected losses. Fiene said it is getting harder for insurance companies to find re-insurance. "If they can't pass off some of the risk," he said, "you're going to see a jump in the premiums."

The experts we spoke with disagreed about what kind of insurance agents provide the best service for people who want to buy life insurance. Evans is a captive agent, which means he in under contract to sell insurance from one specific company. Evans says he can offer his clients much lower premiums than independent brokers can because of the discounts that come from buying multiple policies from the same company (usually car insurance, homeowners insurance, and life insurance). Sometimes, he said, the discounts are so significant, the life insurance policies are "net free," which means the discounts on other policies add up to more than the premiums on the life insurance policy, so clients get life insurance without any additional out-of-pocket costs. Evans thinks this ability to help clients leverage premium discounts across policies is one of the reasons captive agents often give clients lower-cost policies and all-around better service.

Fiene disagrees that captive agents are better than independent ones. He recommends that people steer away from what he calls a one-stop shop, a company that provides many different kinds of financial products. He said most people are better off going with a company that specializes in the type of product they are looking to buy, i.e., buy life insurance from a life insurance company, not your car insurance company or the company that manages your 401k.

Fiene also prefers larger companies over smaller ones. "I don't know if a smaller company will be there four or five years from now," he said. For some people, though, he thinks smaller companies are the only option. Small companies are more likely to have good rates for consumers who need a niche market, such as people over a certain age or those with imperfect medical histories. "If you need a niche company, you'll pay more," said Fiene. Our research didn't show a correlation between the size of the companies and their premiums, but the larger companies were more likely to receive higher ratings for financial stability from Moody's and A.M. Best.

Evans has another reason to be suspicious of independent brokers who give multiple insurance quotes at once. He thinks many of these independent agents mislead their clients in the initial stages of the process. He says some use "bait and switch" tricks--giving deceptively low quotes before clients undergo required medical exams. "There are agents who will lead people down the road and make them believe that [a low rate] is available to them, when they know perfectly well they're not going to get that rate," he said. He said such brokers are assuming that once people go through a medical exam, they won't change to another insurer even if the final premium comes in higher than what they were originally led to expect. In addition, independent brokers may get bigger commissions if the premiums are higher, Evans said.

Jason Tennyson, an insurance broker for Accuquote, said he is able to accurately predict the final premiums of his clients eighty percent of the time, even before they undergo the medical exam. If he's not sure whether they'll qualify for the lowest premiums, he quotes the higher rate. He agreed with Evans that some agents are not so scrupulous. Some agents take only the bare minimum of client information, such as name, birth date, and smoking status, and give clients an overly optimistic premium quote. "If you get an agent who's not asking any questions, it's alarming," said Tennyson. Tennyson sells policies for a half-dozen life insurance companies, but Accuquote pays him based on the total number of policies he sells. He doesn't earn more for steering clients toward specific policies, and he doesn't get a bigger commission if his clients end up with higher premiums.

Sometimes, premiums differ because the policies you're comparing aren't as similar as you think, says Weisbart. He said some companies offer special features, such as a payout or suspended premiums if the insured becomes disabled. The level of coverage for each policy may be the same, but one company is including an extra cost because of the special features of their product.

So how can consumers find the best deals on life insurance, when so many factors influence the premiums? Some of the agents we spoke to think it's better to go with an independent broker, but some recommended using an agent from a single company that can supply many different types of insurance. All the agents agreed that you should vet candidates carefully. Most experts recommend interviewing more than one agent before choosing who you're going to work with. If you go with an independent agent, you want one who is familiar with each company's strong suit, so they can find a company whose niche you fit into. No matter what kind of agent you choose, you should ask how they get paid--whether their commissions are larger for specific companies and whether their commission is based on the size of the policy you buy. This will help you screen for possible bias in the agent's recommendations. It's also important to ask what kind of ongoing service an agent will provide. A good agent will check in with you annually to see if your needs have changed.

"When you buy life insurance, you're buying a relationship," Fiene said.