§ 5. Term policies and straight life. A person purchas ing life insurance, taking out a policy, finds himself facing a choice among a confusing variety of policy forms. Apart, however, from some comparatively minor features such as those mist described, as to distribution of dividends, the various forms of policies result from combining in various ways three features. The first of these is the term within which the level premium is calculated. This may be one year, or any number of years, most frequently five or some multiple. Whatever be the term, the rate of premium is calculated with respect to the expected mortality at the ages included, and at the renewal of the insurance for a new term the premium rate "steps up" to that required to meet the expected losses at the higher ages. Evidently, the shorter the term for which a policy is written, the lower the rate of premium, for the early years, because the smaller the reserve needed to keep down payments in the later years of the term. For example, on a twenty-year term policy taken at age 35 the natural premium would be $10.80 a year. Break this term up into two terms of ten years each, and the annual premium for the first ten year would be $9.36 ; but when the policy is renewed for the second term of ten years (at age 45) the rate would be nearly $15.00. The policy known as "straight life" or "level life" is simply term in surance for the term limit (or highest age) of the mortality table (in the American Experience table that is 96). The net premium for straight life at age 35 is $19.91, and this permits (at the rate of earnings assumed) the accumulation of a reserve of $310.75 at the end of twenty years, whereas the reserve on the twenty-year term ending then is zero. The income of this reserve, added to the annual premium, is enough to meet the expected losses in the later years as they gradually rise. (These amounts are on the assumption of the American mortality and 3% per cent interest.) § 6. Limited premium payments. A second feature in which policies differ is in regard to the number of premium payments to be made according to the calculation. If the number of payments is any less than the number of years of the term the policy is one of "limited payment." The most limited payment is the single premium already described, which may be used in connection with any term from one year to life. The single premium is simply the reserve required to meet the cost of the insurance, without further payments, to the end of the term. The net single premium, or reserve, for a straight life policy, at age 96 is $1000, the face of the policy. The most common limited payment policy is the twenty-payment life. The annual premium for this at age 35 is $27.40, which is more than twice as much each year as the premium on a twenty-year term ($10.80) although it provides no more indemnity. But whereas the reserve on the term policy at age 55 is zero, the reserve on the twenty-payment life is $566.15, this being just the amount of a single-pay ment life policy if taken at age 55.
By just as much as the experience of any company (or separate group of insured) is more favorable than the figures assumed as to rate of yield on investment, mortality, or ex penses, there will be excess premiums to refund ("divi dends"), which may be used by the insured to reduce his annual premiums or to purchase additional insurance or to add to the reserve. In the more successful companies an ordinary life policy eventually accumulates a reserve suffi cient to carry the policy to the limit of age without further payments, and thus becomes in fact a limited payment policy.
§ 7. The endowment feature. A third feature in respect to which life insurance policies differ is as to the extent to which they include the feature of saving with that of in surance. We have seen that, just to the extent that any reserve whatever is accumulated to keep the premium level, to prevent its "stepping up" as the mortality rate advances with age, there is an act of saving distinct from the payment of a premium for insurance in that year. This is brought out clearly in the case of many insurance policies which pro vide for a "surrender value" annually equal to the accumu lated reserve. So, in our example, the reserve of the straight life policy was $310.75, and that of the twenty-payment life was $566.15. If the insured survives he may, according to the terms of many policies draw for his own benefit these amounts, the "surrender value." This privilege in many cases unfortunately defeats the purpose of insurance for the families, and tempts men to use the proceeds of their policies for enjoyment or for investment in business.
A further step is taken in the savings process in endow ment policies. In these the level premium for a definite term is made high enough to accumulate a reserve more than sufficient for a single-payment life policy beginning at the end of the limited payment period. The premium on endow ment policies is so calculated that the reserve equals the face of the policy at the end of the payment period. For example, on a twenty-year endowment the net annual pre mium is $38.35, the terminal reserve is $1000, which is the surrender value. Many persons are attracted to endowment insurance by the oft expressed thought that "You don't have to die to beat it." But this is a mistake. The endowment policy is merely a convenient but somewhat costly plan of saving, hitched on to an insurance policy, with which "actu arially" it has no essential connection. In "scientific" in surance the insured pays its full actuarial cost for each feature of the policy that he buys: so much for the insurance, so much additional for the accumulation of the endowment. The premium for endowment insurance is much higher than that for term life insurance alone during the same period. If insurance is the thing one needs, one is purchasing only a fraction as much for the same annual outlay.
It will be observed that only the survivors to the end of the term get the endowment, and those dying earlier receive no more than if they carried the cheapest term insurance. This gives to the endowment policy a strong "tontine" or lottery character, the survivors profiting at the cost of those who die within the term. This often deceives the uninformed applicant for insurance into the belief that, despite the costs of management, an endowment policy yields a much higher return than other conservative investments at compound in terest. The excess of the net endowment premium over the net term premium in our example is annually $26.65, which, compounded at 4 per cent, would be about $825 at the end of the period; but this is sufficient to give the survivors $1000 each, or approximately 6 per cent compound interest. The survivors are lucky not only in living but in getting a monetary prize (paid for by those who have died) for their success. All those who have died, however, would have been better off if they had taken out some cheaper form of policy (term, or straight life, or limited premium) and had deposited in the savings bank each year the difference in the premiums.