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When you buy Life Insurance, How does the Life Insurer make money?

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My major at university was actuarial (I still remember the 2 most important things I learn there were in the case of 50/50 chance, the side with the more capital wins and they used to deduct marks for multiple choices to encourage taking known risks) and I spent a number of years as an actuarial analyst as well as a stock analyst for life insurance companies.

Even then, I have to admit I actually understand very little about insurance. Firstly, there are so many specialisations, life, non-life, reinsurance, pension, investments. The life insurance products look the same except in details, which are in fine prints.

In fact, I actually lost money in one of my life policies because the surrender value I got was more than what I would receive if I just allow the fees to keep eating into my capital.

In this post, I will still try to explain as layman as possible what I understand in the hope that I could help people make better decisions when it comes to buying life insurance.

The margins or profits for life insurance is basically split into 3 categories, namely, mortality/morbidity, expense and investment.

Now, remember with life insurance, everything works in actual vs expected.

Mortality effectively means when you actually die compared to when the actuaries expect you to die based on their life tables and certain knowledge about your habits such as whether you are a smoker, drink alcohol, conduct high risk activities, have certain health conditions (known through body checking). It is effectively betting on your life and the insurer knows you better than you do because they have a database and know the historical trends of people like you.

Expense is basically cost of doing business and acquisition cost. Investment is the investment returns from the premiums the customers paid to the life insurer for the coverage.

The below is a chart from the presentation of a life insurance company.

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As can be seen, Standalone A&H (Accident and Health) has the highest margin. This is because it is usually relatively small sums so people pay less attention to the pricing, which is expensive relative to the actual rate that people have accidents and health issues. Personally, I believe this is a phenomenon because people read news about accidents and health issues all the time and there is a perception that these things happen more often than they actually do.

The lowest is Investment-Linked, which is similar to mutual funds but life insurers can still make 15% margin on what is effectively platform fees, ie, excluding fund management fees.

The margin for traditional individual life insurance is about 30% and remember this is only profits for the insurer and excludes the commissions paid to the agent that sold the policy, which is usually around 30-40% of first year premium.

The agent is the person that starts by asking if dying is inevitable. Then say, for an aging man with a million in the bank account, he could use 10% of that million to buy a life insurance that will pay a million when he dies and spend the rest of the 90% throughout his life time. When he dies, his children could still inherit that million. Even better, if he used 20% to buy life insurance, his children would get 2 million instead. Who in their right minds would not want this deal?

Disclaimer: This article is not meant to be investment advice.

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