Most people are of the opinion that an insurance company will issue as much life insurance as you are willing and able to pay for, but that’s not true. Why not, you ask. Since an insurance make money by selling insurance, isn’t it better to sell more? Generally, yes, but it must make sense, from both a medical and a financial perspective.
Insurance companies want to avoid being in a position where an insured is worth more dead than alive. While that will occasionally happen due to financial reversals, they try to protect against it by employing financial underwriting.
The good news is the amount of insurance companies will consider has increased over the years. Most companies will issue 30 times earnings for a 25 year old today, whereas that number was typically 15-20 times earnings 40 years ago. So while the limits aren’t onerous, they aren’t unlimited either.
I have heard of companies going to 40 times earnings on a case by case basis. In the low interest rate environment of today, it doesn’t appear unreasonable that that amount could be required in certain situations.
The mutiples decrease with age. Five to ten times earnings is pretty representative of what companies will issue for a person in his 60s, the theory being that there is less income to insure.
For larger face amounts, the companies won’t just take your word for your income. Many have incorporated IRS Form 4506-T into their application packages and those that haven’t will still require it at certain thresholds.
In addition to earned income, companies will also underwrite based on net worth. That is because life insurance is commonly used by the well-to-do to pay estate taxes.
Most companies are somewhat lenient in this area in that they will allow for the growth of the estate at a reasonable rate of return to life expectancy. For example, a person worth $5 million today wouldn’t have an estate tax problem as the exemption is $5.43 million for people dying in 2015.
The rule of 72 tell us that money doubles every 10 years at 7.2%, so that estate could be worth $10 million in 10 years and $20 million in 20 years. Every case is different, but it is conceivable that an insurance company would consider issuing a $5-10 million policy in this situation.
So yes, life insurance companies do make money by writing policies, but not just any policies. The policy must be justifiable, both medically and financially. If it isn’t, the likelihood of it being profitable is greatly reduced.