Concept of term insurance

Term insurance is a contract where you pay a premium and hope that you do not have to make a claim.

For example, assume that for a group of working people, an average of 2 in 1,000 people will die each year due to accidents or illness. The participants can each contribute $200 into the pool to pay $100,000 to the family of the person who passes away.

Each person hopes that he will not be the person who makes a claim and that his contribution helps the family of the unfortunate person.

The life insurance company enters into the picture to provide a service to the 1,000 people. The company needs to have a loading of about 30% to cover the expenses and the cost of capital to support the pool (in case there is more than one claim in a certain year). Each participant pays a premium of $260. This is a fair loading to the true cost of insurance.

Many insurance companies offer other product that requires a high premium of $2,000 to $5,000 to cover $100,000, but provide some cash value (i.e. partial refund of the premium). However, most of these product are still too expensive, as a large part of the premium is used to pay commission and other expenses. The expense charges are likely to be more than the total premium payable under the term insurance.

It is better to pay a fair premium for the term insurance and hope that you do not make a claim.