Guy Baker: Life Insurance [Financial Stewardship]

(upbeat music) – One of the questions that we get a lot is how does life insurance work? And, let’s talk about that for a minute, ’cause I think you’ll find that you know, insurance is, you know, one of those things that’s important. I mean, why do people buy life insurance? Is it an investment? Or is it protection
against pre-mature death? Or both? – [Voiceover] Both. – Yeah, I think it can be both. And there are basically
two types of policies, okay, there’s what’s
called term insurance, and then permanent insurance. And let’s assume for a minute that we had a 40-year-old and we had 10 million of ’em. Okay? And that, in actuarial terms, that’s called a radix, all right? And we know in that first year that, of that 10 million 40-year-olds, if they were all, start
in a homogeneous grouping, so they were all healthy,
they didn’t smoke. You know, they could pass
a physical and so on, we know that maybe one out
of a thousand will die. All right? And then five years later, maybe it’s you know, one out of 750, all right, and 10 years later, maybe
it’s two out of a thousand. And those numbers keep
increasing, accelerating until we can account for
the entire 10 million. So what this means is that, you know, if one out of a thousand died, at the end of that year
you would have what, 10,000 fewer people in
that population, right? And then the next year, you know, you’d have 15,000 more people that would be out of that population. So, this is called an actuarial science. The probabilities of death
are very, very defined. We don’t know who, but we know how many. And of course then there’s
that old joke about the Sicilian actuaries,
who know who, why, when and all the rest of it, so anyway, that may be a joke that
no one gets. (laughs) You got it, all right, so, if we’ve got one person
out of a thousand dying, and they want a million
dollars worth of insurance, how much do they have to put into the pot in order to have a
million dollars at the end of the year to pay that
one person who died? Because the other 999 are
going to pay premiums, but they’re going to be alive, right? That’s the way insurance works. So, let’s say they have
to put in $900, all right, and here, maybe they have to put in $1200. And here, maybe they have to put in $1500. And so on. So if we graph this, it’s gonna look like this. Anybody recognize that? What is that? It’s a compound interest curve. Right? It’s the same principle, only it’s compound interest applied to the predictable probabilities of death as opposed to money, as we talked about before. Okay, so you know, here
the first year it was $900, and then it was 1200, and
1500, and so on, up there. So, how much did my million dollar life insurance policy cost me? So, if I’m one of those 40-year-olds, and I buy a million dollar policy, and I start at $900, how much did my policy cost me? Well, if you don’t know the answer, I would not be surprised. Because you can’t calculate it, right? Tell me when you’re gonna die, and I’ll tell you what it costs, ’cause if you died the first year, what did it cost? – [Voiceover] 900
$900. – [Guy] But if you died in the 20th year, how much did it cost? You know, it cost the sum of all these premiums that you paid, right? So, the only place on this entire curve that we can know the cost for sure, you know, mathematically,
is at this place right here. And that point right there on that curve, we’ll call it Life Expectancy. Now, there’s a lot of confusion about what life expectancy means. Okay? Most people think life expectancy means how long I’m expected to live. Right? So you, if you’re born, they say your life expectancy
is 73 if you’re a male, and 75 if you’re a female. But, what’s your life
expectancy if you’re 73? – [Voiceover] Two. – Huh? – [Voiceover] Two.
Two more years? – [Guy] (laughs) Yeah,
that’s a good guess, ’cause I see your logic. So, you know, for a 73 year old, their life expectancy
is probably 12 years. So out to age 85. Okay, and if you’re 85,
what’s your life expectancy? You know, it could be another
seven or eight years, see. So, life expectancy is based on how old you are at the point in time when you’re asking that
question, all right? So, when they say your life expectancy is 73 years old or 72 years old, that’s for a newborn baby. You know, if you’re 10 years old, your life expectancy is probably 78. If you’re 21, your life
expectancy might be 80. If you’re 65, your life expectancy could be 88, 87, something like that. And of course, we know that
people are living longer. I mean, I think it’s
predicted that like, 15, 12 to 15% of the population will live past age 100 in the next 50 years. So, anyway, so you mea, here’s how you measure
life expectancy, all right? It’s a bell-shaped curve
that looks like that, all right, where 50% of this group is dead and 50% of the group is alive. so you have a 50/50 chance of getting to the other side of that line. Okay, starting here. So that’s the definition
of life expectancy. So if we take, and we add up the premium every year
that’s gonna be paid, the sum of that premium equals 74% of the face amount. So if I buy a million dollar policy, How much will I pay in premium? In aggregate sum, between now starting the policy and
age life expectancy. How much would that be? (class murmurs) $740,000, right? Okay. So, the answer to the question of how much did my life insurance cost me, it cost me $740,000 to buy
a million dollar policy, starting today, you know,
based on life expectancy. But if I am unfortunate and live past life expectancy, and I get out to the place where 2/3 of the group is dead, okay, that premium now goes up to 119%. So that means it’s $1,190,000 to own a million dollar policy out to, to the 2/3 point. So, if life, let’s say life expectancy, let’s say we’re talking
about a 21-year-old, life expectancy would
be, let’s say, 79, okay? So this would be, like 85, let’s say. So if they lived out to 85, they’d pay $1,190,000. But that’s only 2/3 of the group. 1/3’s still alive. If we go out to the
second standard deviation which is 95% of the group is dead, you know, now we’re out to age, like 92, that premium goes up to 240%. So now you’re gonna pay $2,400,000 in premium to keep a
million dollar policy. Now, I know you guys
aren’t MBAs in finance, but does that seem like a good deal? To pay $2.4 million in premium for a million dollar policy? Does that seem like a good deal? Matt, is that something
you’d be willing to do? Would you like to sign up for that today? Okay, but that’s the
mathematics of life insurance. Every life insurance company
in America works on this math. Okay, doesn’t matter what company it is, New York Life, Mass Mutual, Prudential, John Hancock, Pacific Life,
they all work on this math. All right, now what’s, this curve is term insurance. Okay, that’s how term insurance works. And so, when somebody buys term insurance, and you know, you sit down
with an insurance agent, and they say, “Let me sell
you a million dollar policy,” and at your age, today, you know, a million dollar life
insurance policy, Lucas, for your age, would probably
be $300 a year for 10 years. So, $3600 to have that amount. But then at the end of 10 years, that premium is going to go up to maybe $450, and then at
the end of 10 more years, it’s going to go up to $900, and then at 10 more years, so it’s going to stair-step up exactly the way this is stair-stepping up. So, the point is that, and it goes back to what I said before. Tell me when you’re going to die, and I’ll tell you what to do. Okay? ‘Cause if you’re going to die down here, term insurance is a great buy. All right, but if you want insurance for your whole life, okay? Then, this becomes pretty expensive to be able to keep it. (upbeat music) – [Voiceover] We hope
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