Life insurance as a concept

StevieD54

I’ve never quite understood this. Any insurance, whether it be car, house, travel etc, is surely a hedge against the possibility of an event happening. But with Life Insurance, there’s no grey area as you are definitely going to die at some point. So the LI company will have to pay out. Can someone explain the rationale behind it?

DullGreyGuy

StevieD54 said:

I’ve never quite understood this. Any insurance, whether it be car, house, travel etc, is surely a hedge against the possibility of an event happening. But with Life Insurance, there’s no grey area as you are definitely going to die at some point. So the LI company will have to pay out. Can someone explain the rationale behind it?

First of all you need to differentiate between two products:

Life Insurance (aka Term Insurance) - only pays out if you die before a particular date, if you live beyond that date then its the same as any other insurance in terms of the premiums

Life Assurance (aka whole of life) - pays out whenever you die. Naturally this could be in 5 years time or 50 years time. Similarly some will pay into the policy for 20 years then decide they dont need it any more so lapse the policy. So the insurer needs to balance mortality risk against investment returns.


Many life insurers are also in the annuity game which has the opposite risk, that people live longer than were predicted. Clearly longevity and mortality risks offset each other and so if you take an event like Covid, this was bad for the life book with lots of premature deaths but good for the Annuity book with lots of premature deaths. 

lisyloo

StevieD54 said:

I’ve never quite understood this. Any insurance, whether it be car, house, travel etc, is surely a hedge against the possibility of an event happening. But with Life Insurance, there’s no grey area as you are definitely going to die at some point. So the LI company will have to pay out. Can someone explain the rationale behind it?

Many people take out term insurance e.g. mortgage term and you may not die within the term (in fact most people won't).

For whole of life insurance - yes you will die eventually but some people will stop premiums (no pay out) and others will live a long time and overpay. Our parents both lived a long time and both paid far more in than they got out. However it would have covered funeral costs if they'd died in the first few weeks or years, so it's still a hedge regarding when you get paid out.
The rationale for the buyer is covering the risk at the front end.
it may also be a convenient way of paying for funeral costs. it's not the only way of paying for a funeral but it's the only one where you might "win" by dying early which is highly ironic.