Thursday, June 14, 2012

Turn Back the Clock: Backdating Life Insurance for Lower Premiums

Believe it or not, you may be able to save a decent handful of cash by paying for coverage that's already expired. The concept is called "backdating," and what it means is that you get to set the start of your policy as some point in the past. (No, you can't use this to collect a benefit on someone who's already dead.)

The reason for backdating is that younger people pay lower insurance rates, and backdating enables an applicant to declare that the proposed insured is younger than he/she actually is. No, you won't be deceiving anyone; you'll still enter the true birthdate of the proposed insured on your application. Backdating is only performed at the consent of the insurance company and the government. Here's the nitty-gritty on how it works:

An insurance policy's effective date is the time when coverage starts. The effective date is also the time when the policy's "original age" is determined. The original age refers to the age of the insured at the time the policy went in force and is one of the factors used to calculate cost of insurance. With term life insurance and traditional whole life insurance, this rate is locked in for the duration of coverage. With universal life insurance, the rate will increment every year, but the rate is still based upon the original age of the insured. By setting the effective date for a time when the insured was of a different age, you change the policy's original age and, therefore, the cost of insurance.

In just a few minutes, you can compare quotes online to see that, although lowering a policy's original age a number of years will lead to cheaper premiums, it won't decrease your cost of coverage overall (as a general rule) because for every year that you backdate your policy, you'll need to purchase another year of coverage: if I backdate my 10-year term life insurance policy 5 years, then I only get 5 years of coverage starting now. So why backdate at all? Backdating is intended for use over just a few months, not years. That is, if I had a birthday just a month or two ago, I can backdate my policy two months so that I get the rate that I would have had if my coverage had started before my birthday. Most state governments impose a six-month ceiling on backdating.

Here's an illustration of backdating, using actual quotes I collected this morning. At age 50, I can get a term life insurance policy for ten years at a monthly premium of .89. If my birthday was six months ago, I can backdate my policy to get the rates I would have had at 49 years of age: .64. That's a difference of .25 per month, which translates to 0 over the 10-year lifetime of the policy. Since I'm backdating, though, my policy is going to end six months sooner than it would have done, so I've effectively blown six months' premiums (5.84). That makes my net savings 4.16 for backdating six months. If my birthday were recent enough that I could backdate only one month, my net savings would be 7.36.

Backdating won't always save you money. The cost of the extra months of coverage may outweigh any savings you'd get by using a younger age. What's more, applying for an age one year younger may not even get you a lower quote!

Another reason why backdating may not behave quite as you expect is that not all insurance companies use the same age basis for determining a policy's original age. Some insurers consider the most recent birthday of the proposed insured (which is how we normally measure age), but some insurers consider the nearest birthday. That means that a person's "age" could increase six months before his or her birthday. For some people, this will make backdating completely irrelevant, for others, this will make backdating useful.

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