INSURANCE

Perpetual insurance is a type of homeowners insurance policy written to have no term, or date, when the policy expires. From the effective start date, the coverage exists for perpetuity. The insured deposits money, called a deposit premium, with the insurer for insurance for the life of the risk. The deposit is usually ten times larger than the cost of a non-refundable, annual premium for an equivalent policy with a one-year term. The insurer must earn enough income from investing the deposits to cover losses and operating expenses for the model to be economically viable. Upon cancellation, the insured is entitled to a full refund of the initial deposit premium, usually without interest. Perpetual insurance, first issued in the U.S. in Philadelphia in 1752, is still used for fire and home­owner's insurance.

In the United States, there are also tax advantages to perpetual insurance. The deposit premium does not yield any income to the insured. However, the expense of the annual premium for term homeowners insurance is eliminated. Therefore, the tax-adjusted, equivalent rate of return to the insured homeowner on the deposit premium can be calculated by taking the gross amount of money he or she needs to earn to net the amount of an annual premium for a term policy, divided by the amount of the deposit premium. For example, a house which costs $150,000 may typically be charged an annual premium of $1,000 for a term policy. That same house would likely require a $10,000 single deposit premium for a perpetual insurance policy of equivalent coverage. A person in the 28% Tax bracket would need to earn $1,389 in gross income to pay the annual premium. Since that amount no longer needs to be paid annually, the tax-adjusted, equivalent rate of return to the insured homeowner on the single deposit premium would be $1,389, less the after-tax returns that would have been earned on investing the deposit premium (or $600, assuming a 6% after-tax rate of return) divided by $10000, in other words, 7.89%.

Return of premium life insurance is a type of term life insurance policy. The concept is that the policy returns the premiums you have paid for coverage over that fixed term period if coverage is never used. For instance, a $1 million policy bought for $50000 over a 30 year period would result in the $50000 being refunded to the policyholder.

Critics point to the rate of return being less than in a typical investment, as well as the extra cost of the policy compared to basic term life insurance policies. Also, if the policy is cancelled at any time, no money is refunded. While this was the original concept, many current policies do allow prorated refunds at some point during the life of the policy.

It sounds too good to be true or it sounds like some kind of gimmick right? Well, it is true and it's known as return of premium term life insurance. This type of life insurance combines the value of term life (affordable and guaranteed level-premiums for 10, 20, or 30 years), as well as a return of premium feature.

RETURN OF PREMIUM FEATURE

So how does it work?

Let's say you buy a $250,000 20 year term policy, and let's say your premiums are an even $100 per month. At the end of 20 years, you are still alive and well so the insurance company will send you a check for all the premiums that you paid into your policy. That's $100 per month for 20 years, or $24,000. You can then use that money to buy a single premium life insurance policy if you still need life insurance coverage, or you can use it for whatever else you choose. If you did not have the return of premium feature then your policy will end and you will get back nothing.

IS IT WORTH THE EXTRA MONEY?

Answer to that is yes!

Statistics show that only about 1% of term life policies are ever paid out. That means that 99% of people pay their premiums, but never actually "need" the policy. In other words, there is no death benefit claim. So you pay a little bit extra each month for the return of premium feature, and there is a 99% chance that you will get back all of your money at the end of the term. The odds are definitely in your favor that you'll receive your premiums back.

SO HOW DOES THE INSURANCE COMPANY MAKE MONEY

The 99% chance that the insurance company will have to pay you all of your premiums back so you are probably wondering how the insurance company can make money with a feature like this. Since the return of premium feature costs more than a "regular" term life policy, they invest the extra premiums for capital growth so that they can return your premiums at the end of the term and still make a profit.

If you can afford to pay a little more for the return of premium feature, then it's definitely a wise choice. You can get peace of mind knowing that your family is financially protected if anything happens to you, and you can look forward to a chunk of money if you outlive your term. It really is a win-win situation.

An insurable risk is a risk that meets the ideal criteria for efficient insurance. The concept of insurable risk underlies nearly all insurance decisions.

For a risk to be insurable, several things need to be true:

• The insurer must be able to charge a premium high enough to cover not only claims expenses, but also to cover the insurer's expenses. In other words, the risk cannot be catastrophic, or so large that no insurer could hope to pay for the loss.
• The nature of the loss must be definite and financially measurable. That is, there should not be room for argument as to whether or not payment is due, nor as to what amount the payment should be.
• The loss should be random in nature, else the insured may engage in adverse selection (antiselection).

Insurance is not effective for risks that are not insurable risks. For example, risks that are too large cannot be insured, or the premiums would be so high as to make purchasing the insurance infeasible. Also, risks that are not measurable, if insured, will be difficult if not impossible for the insurer to quantify, and thus they cannot charge the correct premium. They will need to charge a conservatively high premium in order to mitigate the risk of paying too large a claim. The premium will thus be higher than ideal, and inefficient.