Almost 85% of [US life insurance] term policies fail to end with a death claim; nearly 88% of universal life policies ultimately do not terminate with a death benet claim. In fact, 74% of term policies and 76% of universal life policies sold to seniors at age 65 never pay a claim.
A death benet is not paid on most policies. For term policies that oer coverage over a xed number of years, most are lapsed prior to the end of the term; a majority of permanent (e.g., whole life) policies are surrendered (i.e., lapsed and a cash value is paid) before death.
Insurers make substantial amounts of money on clients that lapse their policies and lose money on those that do not. Insurers, however, do not earn extra-ordinary prots. Rather, lapsing policyholders cross subsidize households who keep their coverage.
Real premiums decrease over time (i.e., policies are front loaded) rather than increasing with age in a manner more consistent with either actuarially fair pricing or optimal insurance in the presence of reclassication risk where new information about mortality risk is revealed.
While consumers correctly account for mortality risk when buying life insurance, they fail to suciently weight the importance of background risks. Since consumers do not anticipate the need to lapse, this front-loaded policy appears to be cheaper than a policy that is actuarially fair each period. The introduction of a secondary market undermines this cross-subsidy by oering lapsing households better terms relative to surrendering. (more)