What is a Life Insurance Premium and How Does it Work?

Published: October 31, 2018

Whether you’re buying life insurance for the first time or want to review your policy, learning how life insurance premium payments work is essential to finding the right coverage and making it an important part of your budgeting plans.

A life insurance premium is the amount of money you pay, in advance, to the life insurance company so they will take on the risk of providing you with protection should something happen to you, for example, death, disability or illness, depending on the policy type you purchase.

Use this article as a guide to how premiums are calculated, the different types of premiums available in Australia and how your premiums play a role in your coverage.

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How are premiums calculated?

The cost of life insurance is paid through a regular premium. A life insurance premium calculation is generally based on the information you provide on your insurance application and depends on various factors, including your age and gender, overall health and the type of cover you choose. Ultimately, it’s about how big of a financial risk it will be to provide you with coverage.

With term life insurance premiums, your cover will remain active for a certain amount of time – the term of that policy. After your term is up, your policy usually expires, and you'll no longer have to pay premiums. Different insurers have different term lengths, with some only expiring at your age 99.

What factors determine your insurance premium?

  • Age: Generally, the older you are, the higher your premiums will be because you're more likely to pass away or become ill. The younger you are, the lower your risk to life-threatening illnesses or death usually are.

  • Gender: According to the Australian Institute of Health and Welfare, women tend to live longer than men in Australia, all other things being equal. Thus, men might pay more for life insurance premiums.

  • Health: This includes your current health and health history. Usually, the less healthy you are, the higher the risk that you'll lodge a claim in future, which typically results in more expensive premiums.

  • Family medical history: If your family has a high prevalence of hereditary illnesses, like specific cancer and heart attacks, insurers are likely to increase your premium to cover the risk of you possibly contracting such a disease.

  • Smoking-status: People that smoke will generally pay a higher premium compared to non-smokers because of the increased possibility of developing a critical illness. This usually includes smoking e-cigarettes.

  • BMI: Body mass index is a standard tool used by insurers to help them determine your general health. A BMI between 18.5 and 24.9 is generally considered to be a healthy weight range.

  • Occupation: If you're applying for income protection or TPD the insurer might inquire about the level of risk your profession entails. An electrician might pay more for coverage than an accountant that sits at their desk for most of the day.

  • Sports and past-times: If you participate in dangerous activities, like skydiving or mixed martial arts, your premiums could be higher due to the increased risk of you dying or getting injured.

  • Type of cover: The kind of life insurance you choose will also affect the premium you pay, for example, accidental death only cover is usually cheaper than a full life insurance policy because it does not include cover for natural causes.

  • Sum insured: The higher the amount of cover you purchase, the more you’ll usually pay in premiums.

  • Premium type: The cost of your premium will also depend on whether you choose a stepped or level premium structure. Stepped life cover generally starts cheaper but increase every year as you get older. Level premiums are typically more expensive at the beginning, but usually, do not increase as you age.

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How often do you pay an insurance premium?

Premiums can usually be paid monthly, quarterly, half-yearly or annually, depending on your personal preference and the options available from the insurer. However, it must be paid on the terms set out in your insurance contract. If you decide to pay your premiums annually every year, you can get a 5% to 8% discount because paying annually usually results in lower administrative costs compared to paying monthly.

You can generally pay your premiums via direct debit from your bank account or credit card, or if insurance was purchased through superannuation, you pay your premiums via your super fund.

Once you've purchased a policy, the insurer will provide you with the product disclosure statement (PDS) and your policy schedule which outlines the date of your first premium, the type of premium you've chosen and any extra amounts charged due to the information provided during your application.

Can life insurance premiums increase?

Yes, the cost of premiums generally increases throughout the duration of your policy via the process of indexation. Your premium will typically be indexed under the Consumer Price Index (CPI), or a formula based on the CPI, both for stepped and level premiums. However, if you do not want your cover to increase in line with the cost of living, you can choose to remove the inflation protection by contacting your insurer.

Other reasons your premium might increase include:

  • The base rate of a life insurance policy can increase due to economic changes in the insurers' total pool of policyholders, thus safeguarding the insurer against unexpected claims.
  • If you’ve opted for a stepped premium policy, your premiums will increase every year as you age.
  • A higher than expected claims rate might increase the price of your premium, to help the insurer cover their cost.
  • Old policies generally purchased between the 1980s and 1990s are called legacy products and such products are becoming very expensive because of the need to keep up with the maintenance costs.

Tips for managing your life insurance premium rates

There are many things you can do to keep your premiums more affordable, including:

  • Shop around and compare prices side-by-side online. Start by filling in the quote form above.
  • Review what type of coverage you have, or have a broker take a look and make sure you’re not over-insured.
  • Pay you premiums annually and you could receive a 5% to 8% discount.
  • Combine personal insurance products, like life and TPD, into one policy.
  • Remove the nice-to-have benefits you do not require, for example, accommodation benefit.
  • Assess your current stage of life and determine whether the cover you have now is still suitable.
  • Reduce your cover amount if you no longer need as much cover, for example, your children are grown and financially independent.
  • Remove CPI increases if you don’t need your sum insured to keep up with inflation.

Frequently asked questions and answers

Will your life insurance quote match your premium?

Generally, a life insurance quote is an estimate of how much you’re likely to pay for your policy, based on the initial information you’ve provided.

Quotes are usually given before you’ve gone through the whole underwriting process, so they may not match your final rates because the underwriting process might reveal significant information not previously taken into account.

Does GST affect life insurance premiums?

No, life insurers are not generally liable for Goods and Services Tax (GST) on premiums. However, general insurance, for example, your car insurance, does attract GST and will thus generally be added to your premium amount.

What does the company do with your premiums?

Generally, a life insurance company may invest the premiums they receive and use the interest they accumulate to pay for their day-to-day operations, as well as cover the cost of claims received.

What happens if you stop your life insurance premium payment?

If you do not pay your life insurance premium on the date and frequency as is listed in your policy schedule, your life insurance might be cancelled, and no premiums refunded. If you do not keep up to date with your premiums, you will generally not be covered, and you cannot claim.

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