What it means
The chance of dying rises with age, so the true cost of insuring someone gets higher every year. A policy that charged exactly that cost would start cheap and become very expensive, which is how annual renewable term cover works.
A level premium policy smooths the cost by charging the same amount every year. To make this work, the insurer charges more than the risk is worth in the early years and less than it is worth in the later years.
The extra paid at the start is held and invested by the insurer to fund the shortfall later. In a whole life policy, part of this surplus also builds up as cash value that the policyholder may be able to borrow against.
Level premiums are common in term policies sold for fixed periods such as 10, 20 or 30 years, and in whole life policies where the premium is set for life. The key advantage is certainty: you can plan for the cost, and it does not jump if your health worsens, since the premium is fixed when the contract is issued.
There are trade-offs. If you cancel the policy early, you may lose the benefit of the extra early payments, because in term policies there is usually no refund.
And the level premium may look high compared with the first year of an increasing-premium policy, even though it is cheaper in total over a long period. Businesses use level premium cover to fund key person protection and buy-sell agreements, because the cost can be built into budgets for the whole period.
As always, the premium depends on age, health, the amount of cover and the insurer, and terms differ between countries.
In practice
Real-world examples.
Example
A 30-year-old buys a 30-year term policy with a level premium of $45 a month. Her cost stays at $45 a month until the term ends, even though the insurer's risk goes up every year she gets older.
Example
A construction company owner takes out level premium cover on his chief engineer. The finance team records the same annual premium in each year's budget, which makes cost forecasting simple.
Example
A 45-year-old man buys a whole life policy with a level premium. After some years, the policy has built up a cash value, and he borrows against it to help fund a deposit on a business property.
Formula
Calculation
Cumulative cost = Sum of premiums paid up to the chosen year
Worked example: a level premium policy costs $1,200 a year for 20 years. An annual renewable policy starts at $600 and rises by $100 each year.
Level policy total after 20 years = $1,200 x 20 = $24,000.
Renewable policy premiums are $600, $700, $800 and so on, up to $2,500 in year 20. The total = 20 x $600 + $100 x (0 + 1 + 2 + ... + 19) = $12,000 + $100 x 190 = $12,000 + $19,000 = $31,000.
The renewable policy is cheaper in the early years, but the cumulative cost catches up with the level policy in year 13, when both total $15,600. By year 20, the renewable policy has cost $31,000 - $24,000 = $7,000 more.Case study
Seen in the real world.
Larkspur Design is a fictional studio with two founders. They needed $800,000 of cover on each other to fund a buy-out if one of them died.
The adviser quoted a level premium of $1,900 a year for a 20-year term, or an annual renewable policy starting at $900 and rising about $150 a year. The finance director built a table showing that the cumulative cost of the renewable policy overtook the level premium in year 15.
The founders chose the level premium policy because they planned to run the studio for more than 20 years and wanted stable costs. This is an illustrative story, but it shows how a simple cumulative cost table can settle the choice.
Watch out
Common mistakes.
- Assuming the cheapest first-year premium is the cheapest policy. Rising premiums can cost much more over a long period.
- Thinking level premium means the insurer takes no extra risk. The premium is fixed, but the insurer sets it based on assumptions that cover the full term.
- Expecting a refund if you cancel. Most term policies have no cash value, so stopping payments simply ends the cover.
Questions
People also ask.
Is a level premium the same as a level death benefit?
No. The premium is what you pay, and the death benefit is what the insurer pays out. A policy can have both level or only one of them.
What happens at the end of the term?
In a term policy, cover ends, and renewal usually costs much more at the older age. In a whole life policy, cover continues for life as long as premiums are paid.
Can the premium change after I buy?
For a true level premium policy, no. Some policies have non-guaranteed elements, so read the contract carefully.
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