How long do life insurance policies last for?
The average duration of a life insurance policy is surprisingly short. The average life of an insurance policy is between 7 and 8 years, which is consistent with an average lapse rate of between 10 and 14% depending on the type of policy and the way the premium is calculated.
The average life of an insurance policy is falling, and lapse rates are increasing.
Lapse rates are higher:
- after the first year claw back period ends
- where the policy is sold subject to an up-front commission agreement (the dominant agreement)
- where the premium is stepped and is not level over the life of the policy.
The combination of high up-front commissions and short policy lives means commissions are a large percentage of an insurer’s costs and therefore a large percentage of the premiums paid by clients.
Commissions are usually about 35% of premiums, calculated over the life of the policy.
This amount is greater where the policy lapses earlier than usual, and lower when the policy lapses later than usual. For example, if a level premium policy with up-front commissions lapsed in year three the average commissions would be 150% (i.e. 120% plus three lots of 10% divided by three years, or 50% a year).
It’s fair to say the high lapse rate coupled with high commissions is contributing to the low profitability of the life insurance sector. The high up-front costs, which include underwriting costs and other new business costs as well as the raw commissions, are only feasible if the policy lasts for a long period of time, at least ten years or more.
High lapse rates and short policy lives mean low or no profits for insurers.