Premium Payment Modes
Let's meet Sally, who plans to purchase life insurance. Sally's agent indicated that she has flexibility when it comes to how often she pays her policy premium. Premium payment represents the cost of the insurance policy and Sally wants some advice on which policy to select, how often to pay her premium, and policy provisions. Let's see if we can help her.
Mode refers to the frequency with which a policyowner makes premium payments. If Sally decides to purchase insurance, she could pay her premiums:
An annual payment would require Sally to pay her premium once a year. This would be the most affordable option for her, since the insurance company wouldn't spend as much time and money processing payments. While this option would be best from a cost perspective, Sally would have to determine if she can afford to pay this premium all at once.
If Sally chose a semi-annual payment, then she would pay her premium every six months (twice a year). Her premium payments would be a bit higher than if she chose an annual payment frequency, but it might be easier for her to budget for two smaller payments instead of one larger one.
A quarterly payment would require Sally to make a payment every three months (four payments a year). Sally would find it easier to budget for four smaller payments, but her policy premium would be higher.
A monthly payment would require Sally to pay a premium every month (twelve times a year). This option would be the best for Sally's budget as she would pay a smaller amount every month. However, it would likely have the highest policy premium, since the insurance company would need to process these twelve payments per year.
Sally also has to decide whether she wants flexibility over the premium amount she pays. For example, she could select a level-premium policy or a flexible premium policy. Let's take a look at each of these policy types.
If Sally wants to keep her premium the same throughout the life of the contract, she would select a level-premium insurance policy. For example, if Sally purchased a 10-year level-premium policy, she would pay the same premium amount for all ten years. At the end of the term, she would have to decide whether she wants to renew her coverage. Her premium would likely rise at the time of renewal, as she would be older.
Since it is a type of term insurance, a level-premium insurance policy would only pay a death benefit when Sally dies and would not give her any opportunities to save money within the policy.
Flexible Premium Insurance
If Sally wants flexibility over her premium amount and frequency of payments, she could select a flexible premium policy. This type of policy provides a death benefit, but it would also allow Sally to save money within the policy. In addition, Sally would have an opportunity to change the face amount of the policy, or the amount of death benefit the insurance company would pay, as well as the amount of her premium and the payment period.
One advantage of this type of policy is that it would allow Sally to alter the policy as her life circumstances change. For example, if Sally were to have children, she could increase the face amount of the policy without having to apply for and be approved for an additional insurance policy.
Some policy provisions are mandatory and others are not. Let's examine two common policy provisions.
Grace Period Policy Provision
A grace period provision is mandatory and gives a policyowner some leeway in case he/she pays the premium after the due date. If a payment is made after the due date but during the grace period, the insurance company cannot cancel the policy. Grace periods usually range from one to 30 days and an insurance company would include the number of days in the policy contract.
Let's assume that Sally's policy premium is due on January 1st and the grace period provision in her life insurance contract is 15 days. If Sally pays her outstanding premium by January 15th, her insurance company would have to continue her insurance coverage.
Automatic Loan Provision
If a policy contains an optional automatic loan provision, then an insurance company can deduct the amount of outstanding premium from the policy's cash value if the policyowner has not paid the premium at the end of the grace period. This provision helps ensure that the policy will not lapse or be canceled due to non-payment of premiums. If an insurance company has used the automatic loan provision to process a premium payment, it must let the policyowner know.
Let's assume that Sally purchases a policy with a 30-day grace period and an automatic loan provision. Her insurance premium is due on March 1st. If Sally forgets to pay her premium, then her insurance company could deduct the amount of the outstanding premium from her policy's cash value after April 1st.
There are a number of modes or frequencies with which a policyowner can make a premium payment (the cost associated with an insurance policy).
Annual payments are made once a year, semi-annual payments are made twice a year, quarterly payments are made once every four months, or monthly payments are made once a month. An annual premium would be the least expensive, but a policyowner would find it easier to budget for a monthly premium.
In a level-premium insurance policy, the premium remains the same for the life of the contract and provides a death benefit. A flexible premium policy provides a death benefit as well as a savings component, and lets a policyowner change the face amount (or the amount of death benefit the insurance company would pay) as well as the premium amount and payment period.
The mandatory grace period provision prevents an insurance company from canceling a policy if a premium payment is late. With an optional automatic loan provision, an insurance company can deduct the amount of outstanding premium from the policy's cash value if the policyowner has not paid the premium after the grace period.