Question

Which Limited Pay Whole life contract would have the highest annual premium?

A. 10 pay
B. 20 pay
C. 30 pay
D. 25 pay

Answer 1

The correct answer is A. 10 pay, as this Limited Pay Whole Life insurance policy would have the highest annual premium since the total cost is spread over the shortest period. Calculating premiums involves assessing the risk for policyholders, with higher risks leading to higher premiums.

Step-by-step explanation:

The question is asking which Limited Pay Whole Life insurance contract would have the highest annual premium, given options of 10 pay, 20 pay, 25 pay, and 30 pay. A Limited Pay Whole Life policy allows a policyholder to pay the entire cost of their life insurance in a set number of years. Premiums for these types of policies are calculated based on the payment period—the shorter the payment period, the higher the annual premium will be.

In this case, a 10 pay policy will have the highest annual premium because the total cost of the insurance is divided over the fewest number of payments.

To determine the actuarially fair premium for life insurance, an insurer must analyze the risk associated with each policyholder. For instance, in the example given, 50-year-old men with a family history of cancer have a higher risk of death within the next year than those without, which influences the premium calculations:

1. For the first group (with family history of cancer), the fair premium would be calculated as (1/50 chance of death) x (20% of the men) x ($100,000 death benefit), which is $40,000.
2. For the second group (without family history of cancer), it would be (1/200 chance of death) x (80% of the men) x ($100,000 death benefit), which is $40,000.
3. For the overall group, you'd need to blend these risks into a single premium since the risk information is not discrete.

If the insurance company tries to charge the actuarially fair premium to the group as a whole, there could be adverse selection, as healthier individuals might opt out due to higher premiums, leaving a less healthy (higher risk) group of insureds, and potentially leading to losses for the company.

The correct answer to the original question is: A. 10 pay.