Term life insurance and death probability | Finance & Capital Markets | Khan Academy

Khan Academy
18 Apr 201104:22
EducationalLearning
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TLDRThe speaker is considering purchasing a $1 million term life insurance policy to secure his family's financial future, particularly for his mortgage and children's education. He explains his preference for a term policy over a whole life policy, highlighting the lower annual premium of $500 for 20 years. The speaker then calculates the insurance company's break-even point, suggesting that the probability of his death within 20 years must be less than or equal to 1 in 100 for the company to profit. This rough estimate reassures him about the risk, as it indicates a relatively low likelihood of dying within the policy period.

Takeaways
  • 🏡 The individual is considering life insurance due to having a mortgage and a young family.
  • 👶 The primary concern is to provide financial security for his son and upcoming baby in case of his untimely death.
  • 💰 The goal is to ensure that the mortgage can be paid off and there is money left for the children's future needs.
  • 📋 The person has inquired about a $1 million term life insurance policy, focusing on coverage for the next 20 years.
  • 🔢 The term life policy costs $500 per year for 20 years, with a payout of $1 million if the policyholder dies during this period.
  • 📉 After the 20-year term, the policy would need to be renewed, potentially at a higher cost due to the policyholder's age.
  • 🤔 The individual is curious about the insurance company's assessment of his risk of dying within the next 20 years.
  • 🧐 He uses a simple calculation to estimate the insurance company's break-even point, suggesting a 1 in 100 chance of death over 20 years.
  • 💡 The calculation is a rough estimate, implying that the actual probability of death used by the insurance company might be lower to ensure profit.
  • 📊 The insurance company's pricing suggests they believe the risk of death is significantly less than 1 in 100 to make a profit.
  • 😌 The thought process provides reassurance that the odds of dying within the next 20 years are not as high as one might initially fear.
Q & A

  • Why is the speaker considering getting life insurance?

    -The speaker is considering life insurance due to having a mortgage, a young son, and another baby on the way. They want to ensure that their family can pay off the mortgage and have some money left over for college and living expenses in case something happens to them.

  • What type of life insurance policy is the speaker interested in?

    -The speaker is interested in a term life policy, specifically for the next 20 years, as they believe this will cover the period they need financial protection for their family.

  • What is the main advantage of a term life policy according to the speaker?

    -The main advantage of a term life policy, as mentioned by the speaker, is the lower cost. They will only pay $500 per year for the next 20 years, and if they die during this period, their family receives $1 million.

  • What is the difference between term life and whole life insurance policies?

    -A term life policy provides coverage for a specific period, like 20 years, and is less expensive. A whole life policy, on the other hand, requires payments for the rest of the insured's life and guarantees a payout at any time of death.

  • How much does the speaker expect to pay annually for their term life policy?

    -The speaker expects to pay $500 per year for their term life policy.

  • What is the total amount the speaker will pay over the life of the term life policy?

    -Over the life of the 20-year term life policy, the speaker will pay a total of $10,000 in premiums.

  • How does the speaker calculate the insurance company's break-even point?

    -The speaker calculates the break-even point by comparing the total premiums paid ($10,000) to the insurance payout ($1 million). They conclude that the insurance company would break even if the probability of the speaker dying within 20 years is less than or equal to 1 in 100.

  • What is the speaker's assumption about the insurance company's profit motive?

    -The speaker assumes that the insurance company is likely to estimate the probability of their death to be lower than 1 in 100, such as 1 in 200 or 1 in 300, to ensure they can make a profit by insuring more people for every $100 in premium they collect.

  • How does the speaker feel about the probability of dying within the next 20 years?

    -The speaker feels a bit better after their analysis, as they consider a 1 in 100 chance of dying over the next 20 years to be not too bad.

  • What is the speaker's intention with the video?

    -The speaker's intention with the video is to think about and understand the odds of them dying within the next 20 years based on the numbers quoted by the insurance company.

  • What does the speaker mean by 'back-of-the-envelope way' of thinking?

    -The 'back-of-the-envelope way' refers to a rough estimation or a quick, informal calculation method used to get a ballpark figure or understand a concept, in this case, the probability of the speaker's death.

Outlines
00:00
🏡 Considering Life Insurance for Family's Financial Security

The speaker is contemplating purchasing life insurance to secure his family's financial future, especially with a mortgage and children to care for. He has a young son and another child on the way, and he wants to ensure that if something happens to him, his family would be able to pay off the mortgage and have funds for their future needs, such as college education. He visits an insurance company with the intention of obtaining a $1 million term life policy, which would cover him for the next 20 years. His reasoning is that within this period, he hopes to have paid off the mortgage and saved enough for his children's education. The term life policy would cost him $500 per year for 20 years, and if he dies during this period, his family would receive the $1 million payout. He acknowledges that after 20 years, he would need to get a new policy, which might be more expensive due to his age and higher mortality risk. However, his primary concern is the next two decades, and he is considering the insurance company's quote to determine the implied probability of his death within that timeframe.

Mindmap
Keywords
💡Life insurance
Life insurance is a contract between an individual and an insurance company, where the company agrees to pay a sum of money upon the death of the insured person. It serves as a financial safety net for the insured's beneficiaries. In the script, the speaker is considering life insurance to ensure that his family would be financially secure if he were to pass away, specifically mentioning the need to pay off the mortgage and provide for his son's future education.
💡Mortgage
A mortgage is a loan used to purchase real estate, where the property serves as collateral for the loan until it is paid off. The speaker in the video has a mortgage and is concerned about his family's ability to continue paying it in the event of his death, which is why he is considering life insurance.
💡Term life policy
A term life policy is a type of life insurance that provides coverage for a specified term, or period of time. If the insured dies within this term, the death benefit is paid to the beneficiaries. The speaker is considering a term life policy for the next 20 years, which aligns with his goal to cover the period of his mortgage and his children's early education years.
💡Whole life policy
A whole life policy is a type of permanent life insurance that provides coverage for the insured's entire lifetime, as long as premiums are paid. It also accumulates a cash value component over time. The speaker mentions whole life policy as an alternative to term life, but decides against it due to the higher cost and his specific financial goals.
💡Premiums
Premiums are the payments made by the policyholder to the insurance company to keep the life insurance policy in force. In the script, the speaker mentions that he would pay $500 per year for his term life policy, which is a key factor in his decision-making process.
💡Death benefit
The death benefit is the amount of money that is paid out by the insurance company to the beneficiaries upon the death of the insured. In this video, the speaker is seeking a $1 million death benefit to ensure his family's financial security.
💡Insurance company
An insurance company is an entity that provides insurance policies to individuals or entities. In the context of the video, the speaker is negotiating with an insurance company to obtain a term life policy that suits his needs.
💡Probability of death
The probability of death is a statistical measure used by insurance companies to assess the likelihood of an insured person dying within a given period. The speaker is trying to deduce the insurance company's assessment of his probability of death over the next 20 years based on the premiums they quoted.
💡Break-even point
The break-even point in the context of insurance is the point at which the total premiums collected equal the total claims paid out, meaning the insurance company neither makes a profit nor incurs a loss. The speaker calculates that for the insurance company to break even, the probability of his death within 20 years should be less than or equal to 1 in 100.
💡Risk assessment
Risk assessment is the process of evaluating the likelihood of an event occurring and the potential impact of that event. Insurance companies perform risk assessments to determine the premiums for policies. The speaker is essentially doing his own risk assessment to understand the insurance company's perspective and the value of the policy.
💡Financial security
Financial security refers to the state of being free from financial worries or fears. The speaker's primary motivation for considering life insurance is to provide financial security for his family, ensuring they can maintain their lifestyle and pay off debts in the event of his death.
Highlights

Individual is considering life insurance due to having a mortgage and a young son, with another child on the way.

The purpose of life insurance is to ensure the family can pay off the mortgage and have funds for college and living expenses.

The individual inquires about a $1 million term life policy, focusing on coverage for the next 20 years.

Term life policy is chosen over whole life policy due to its lower cost and specific time frame coverage.

The individual plans to pay $500 per year for a 20-year term life policy.

In the event of death within 20 years, the family would receive $1 million.

After 20 years, a new policy would be needed, likely at a higher cost due to age and health risks.

The individual is primarily concerned with financial security for the next 20 years.

The video aims to analyze the insurance company's quoted numbers to infer the odds of dying within 20 years.

The insurance company's profit margin is calculated by comparing total premiums to the insured amount.

A hypothetical scenario of 100 similar individuals is used to illustrate the insurance company's break-even point.

The insurance company would break even if at most 1 out of 100 similar individuals die within the policy period.

The individual speculates that the insurance company likely believes the probability of death is lower than 1 in 100.

The individual feels reassured by the analysis, as a 1 in 100 chance of death over 20 years seems acceptable.

The analysis provides a back-of-the-envelope calculation to understand the insurance company's perspective on risk.

The individual finds the morbid topic of death probabilities necessary for making an informed decision on life insurance.

Transcripts

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Life InsuranceMortgage ProtectionFamily PlanningFinancial SecurityTerm PolicyWhole LifeInsurance PremiumsRisk AssessmentDeath ProbabilityPersonal Finance