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Reading the premium line: policy fees, modal factors and annual cost
A worksheet for turning a monthly quote into an annual cost, spotting policy fees and payment-mode loading, and comparing quotes on true cost per year.
A life insurance quote usually shows one number in large type, "$38 a month" or "$480 a year". That number is a line in a longer calculation, and the lines that do not appear in large type can change which quote is actually cheaper. A policy fee that is billed separately, a payment-mode surcharge and the date of the first payment can each move the cost of a policy by tens or hundreds of dollars a year.
This post is a worksheet. It shows the arithmetic for turning any quote into a comparable annual cost, works one example from start to finish, and leaves blanks for your own numbers. The figures are invented round numbers, not prices.
The vocabulary on the premium line
Four terms appear on most quotes and illustrations.
- Annual premium. The price for one year of coverage if you pay once. It is the reference price from which the other payment options are derived.
- Policy fee. A flat dollar charge per year, sometimes per policy, that covers the insurer's administrative cost. Some insurers build it into the rate; some show it as a separate line. It does not shrink as you buy less coverage.
- Modal factor. A multiplier that converts the annual premium into the payment for a shorter period. Paying monthly, quarterly or semiannually costs more in total than paying annually, because the insurer collects the money later and bears the cost of collecting it. The resulting payment is the modal premium.
- Mode. The payment schedule: annual, semiannual, quarterly or monthly.
The modal factor is set by each insurer, so there is no standard percentage; our guide to paying life insurance monthly vs annually explains the reasoning. The point of the worksheet is to calculate it for the quote in front of you rather than trust a general rule.
The three formulas
You need only three calculations.
Formula 1: yearly cost at a given mode. Payment x number of payments per year + any fee charged separately = true yearly cost.
Formula 2: the implied loading. (Yearly cost at that mode / annual premium) - 1 = loading, expressed as a percentage.
Formula 3: total cost over the level period. True yearly cost x number of years, for a level premium policy whose price does not change during the term.
If a quote gives you only a monthly figure, you can still calculate Formula 1 and Formula 3. If it also gives the annual figure, you can calculate Formula 2 and see exactly what paying monthly costs.
Worked example: three quotes for the same policy
Say a shopper asks three companies for a $500,000 20-year term policy for the same person. Every figure below is invented.
| Quote A | Quote B | Quote C | |
|---|---|---|---|
| Annual premium | $480 (includes a $60 policy fee) | $450 (fee built in) | not shown |
| Monthly payment | $42 | $41 | $38 |
| Separate policy fee | none on top | none on top | $75 a year, billed with the first payment |
| Mode shown in large type | monthly | monthly | monthly |
Quote C is the one that looks cheapest at $38 a month. Now apply the formulas.
Quote A
Monthly payment $42 x 12 = $504 a year. No separate fee. True yearly cost: $504.
Loading: $504 / $480 = 1.05, so paying monthly costs 5 percent more than paying annually. Check the factor behind it: if the insurer's monthly factor is 0.0875 of the annual premium, then $480 x 0.0875 = $42 exactly. So a monthly factor of 0.0875 gives a monthly payment of $42, and twelve payments of that size equals 1.05 of the annual premium.
Over 20 years: $504 x 20 = $10,080.
Quote B
Monthly payment $41 x 12 = $492 a year. No separate fee. True yearly cost: $492.
Loading: $492 / $450 = 1.0933, so paying monthly costs about 9.3 percent more than paying annually. Over 20 years: $492 x 20 = $9,840.
Quote B has the lower annual premium ($450 against $480) and the lower monthly cost ($492 against $504), but it also has the higher loading, 9.3 percent against 5 percent. If the shopper paid annually, B would be cheaper by $30 a year. Paying monthly, B is cheaper by $12 a year ($504 - $492). The gap narrowed because B charges more for the convenience of monthly payment.
Quote C
Monthly payment $38 x 12 = $456. Add the separate fee: $456 + $75 = $531 a year.
Over 20 years: $531 x 20 = $10,620. Compared with Quote B's $492 a year, Quote C costs $39 more each year ($531 - $492), or $780 over the term ($39 x 20). The quote that looked cheapest is the most expensive of the three.
The comparison
| Quote A | Quote B | Quote C | |
|---|---|---|---|
| True yearly cost, paying monthly | $504 | $492 | $531 |
| Over 20 years | $10,080 | $9,840 | $10,620 |
| Rank (lowest first) | 2 | 1 | 3 |
Ranked by the large-type monthly figure, the order was C ($38), B ($41), A ($42). Ranked by true yearly cost, it is B, A, C. The quote that looked cheapest finished last, and the arithmetic needed was two multiplications and an addition.
How to find the fee when the quote does not show it
A policy fee can hide in several places:
- A separate line on the illustration. Look for "policy fee", "annual fee", "administrative fee" or similar.
- Inside the annual premium. The annual premium may already include the fee. If you know the rate per $1,000 of coverage, you can calculate the part that is rate and the part that is fee.
- In a footnote. Some quotes say "monthly price excludes the annual policy fee" in small type.
- In the first payment. Some insurers collect the fee with the first payment, so the first bank draft is larger than the rest.
If you cannot find it, ask in writing: "Is there a policy fee, and is it included in the quoted premium?" Keep the answer. Our guide to how to compare life insurance quotes fairly lists other questions worth asking.
A simple test of whether a fee is included is to vary the coverage. If the annual premium for $250,000 is exactly half the premium for $500,000, there is probably no flat fee. If it is more than half, part of the price is a flat charge. For example, suppose $500,000 costs $480 and $250,000 costs $270. If everything scaled with coverage, doubling $270 would give $480. It gives $540, which is $60 too much, and that $60 is the flat amount, because a flat fee is counted once in each premium and so is double-counted when you double the smaller one. Check: the rate part is ($480 - $60) / 500 = $0.84 per $1,000, so $250,000 costs 250 x $0.84 + $60 = $270. The test works only if both quotes come from the same company, class and age, and it assumes the insurer prices by one flat rate per $1,000, which is not always the case.
Other modes, and the same arithmetic
The monthly mode is the most common, but a quote may offer semiannual or quarterly payments too. With the same invented $480 annual premium, here is what each mode costs if the modal factors are 0.51, 0.26 and 0.0875.
| Mode | Payment | Payments a year | Yearly cost | Loading over annual |
|---|---|---|---|---|
| Annual | $480.00 | 1 | $480.00 | 0 percent |
| Semiannual | $244.80 | 2 | $489.60 | 2 percent |
| Quarterly | $124.80 | 4 | $499.20 | 4 percent |
| Monthly | $42.00 | 12 | $504.00 | 5 percent |
The factors are illustrations. Check the first row: $480 x 0.51 = $244.80, and two of them equal $489.60, which is 1.02 times $480. The loading rises as the payments get smaller because the insurer waits longer for the money and handles more transactions. If you can manage semiannual payments instead of monthly, in this example you save $504.00 - $489.60 = $14.40 a year. The payment method can matter too; a card payment or a paper check may carry a different rule than a bank draft, so read the billing terms.
Cost per $1,000: a way to compare different amounts
Sometimes the quotes you collect are not for the same face amount. One engine offers $500,000 and another only $450,000 or $525,000. To compare them, divide the true yearly cost by the number of thousands of coverage.
Using the example: Quote A's $480 annual premium divided by 500 is $0.96 per $1,000, and Quote B's $450 divided by 500 is $0.90. A third quote for $450,000 at $420 a year is $420 / 450 = $0.93 per $1,000, which is cheaper than A and more than B, though it buys less coverage. This is a rough yardstick. Because of the flat fee, a smaller policy has a higher cost per $1,000 than a larger one from the same company, and many insurers lower their rate at higher amounts. Use cost per $1,000 to narrow the field, then ask for exact quotes at the amount you need.
Should you pay annually instead? A budget check
Using Quote A at the invented numbers, paying monthly costs $504 and paying annually costs $480, a difference of $24 a year. There are three ways to capture the saving.
- Pay the annual premium up front. This requires $480 at once, which may be a strain in the first month.
- Pay monthly in year one, then switch. Many insurers let you change the mode at the policy anniversary. You pay the loading for a year, then move to annual payments once you have saved the lump sum.
- Save the monthly amount in a separate account. Set aside $40 a month in a savings account, which accumulates $480 by the next anniversary, and pay the annual premium then. The monthly set-aside is $2 less than the $42 bank draft, and you earn a little interest, though it means paying from your own discipline rather than an automatic draft.
The best choice depends on your cash flow and your habits. The research in the guide on paying life insurance monthly vs annually notes that policyholders who pay by automatic draft tend to lapse less often, which is a reason to value the convenience of a monthly draft. A lapsed policy costs far more than a $24 loading.
Converting the implied loading to a yearly interest rate
A loading can be read as the interest rate on a loan. If you pay monthly, the insurer in effect lets you pay $480 over the year in 12 payments of $42. The first payment is made at the start, so the shopper has borrowed $480 - $42 = $438 and repays it in 11 further payments of $42.
Solving for the rate that makes those match gives about 0.9 percent a month, or roughly 10.8 percent a year. That is a calculation, not a quoted rate, and it ignores other considerations. But it shows why a loading that looks small, 5 percent, is not small compared with the interest you would earn on cash held in a savings account while you accumulate the annual premium. If you can hold $480 for a year at a lower cost than that, paying annually is cheaper. If an annual payment would strain the budget, the loading is the price of staying insured. Either choice is reasonable; the worksheet just lets you see the price.
Other items on the premium line
Premium taxes. Insurers pay state premium taxes and other taxes that are priced into the premium; our guide to Premium taxes and the DAC tax: the taxes inside your premium explains it. You do not see a separate line.
Riders. A waiver of premium, an accelerated death benefit or a child term rider may add a charge. Some are included at no cost, and some add a fixed amount. Check whether the rider is in the large-type number.
Premium changes. For level term, the premium is guaranteed to stay the same during the level period. If a quote does not say so, confirm it. After the level period, the premium rises; see what to compare between term policies besides price.
Due dates and the grace period. The first premium is typically due when you apply or accept the offer, and later payments fall on the policy anniversary or its monthly equivalent. A grace period of about 30 days usually applies. If you pay monthly by bank draft, make sure the account has enough funds on the draft date.
Your worksheet
Make a copy for each quote.
Quote from: ______________ Date of quote: ______________
- Face amount: ______________ Term: ______ years Mode: ______________
- Annual premium (if shown): $______________
- Payment at this mode: $______________ x number of payments per year ______ = $______________ (A)
- Policy fee billed separately: $______________ per year (B)
- True yearly cost at this mode = A + B = $______________
- Loading = (line 5 / line 2) - 1 = ______ percent (if line 2 is shown)
- Years of level premium: ______ True total = line 5 x years = $______________
- Riders included in this price: ______________________________
- Is the premium guaranteed for the full term? Yes / No / Not stated
- Rate class assumed by the quote: ______________________________
When you have filled in three or four copies, line them up by line 5 and line 7. The life insurance quote comparison worksheet on this site does the same arithmetic if you prefer to type the numbers in.
Mistakes the worksheet catches
- Comparing different modes. One quote in annual figures and another in monthly figures will mislead unless converted.
- Missing the separate fee. The cheapest-looking monthly payment may carry the largest extra charge.
- Comparing different classes. The best price at a class you will not receive is not a price you will pay. Our post why two quotes for the same person and policy can differ so much explains why.
- Forgetting riders. A cheaper quote without a rider you wanted is not cheaper for you.
- Comparing only the first year. For level term the first year equals every year, but for a policy whose premium steps up, it does not.
Key takeaways
- The large-type number on a quote is not the cost of the policy. True yearly cost is payment x payments per year, plus any fee billed separately.
- Paying monthly typically costs more than paying annually, and the loading differs by insurer. A company with the lowest annual premium can have the highest loading.
- A separate policy fee can reverse the ranking of quotes. In the worked example the cheapest-looking quote was the most expensive once the fee was added.
- Compare quotes on a yearly or 20-year basis, with the same face amount, class and riders. A worksheet takes a few minutes and is worth doing before you apply.
- If you cannot see a fee, ask in writing and keep the answer.