MilesToPass

Modes of premium payment

What "mode" means

The mode of premium payment is simply how often the policyowner pays. Life, health, and disability premiums are almost always quoted as an annual premium, but the insurer lets the policyowner split that amount into installments. The four traditional modes are:

  • Annual — one payment per policy year
  • Semiannual — two payments per year
  • Quarterly — four payments per year
  • Monthly — twelve payments per year

The dollar amount actually due at each installment is called the modal premium. It is calculated by multiplying the annual premium by a modal factor published in the insurer's rate book.

Why paying more often costs more

Add up twelve monthly premiums and the total is greater than the single annual premium for the same coverage. Three reasons drive this:

  1. Lost investment income. Money the insurer does not receive up front cannot be invested, so a portion of the expected interest earnings must be recovered in the premium.
  2. Higher administrative expense. Twelve billings, twelve collections, and twelve accounting entries cost more than one.
  3. Greater lapse and collection risk. More due dates mean more chances for a payment to be missed.

Rule of thumb for the exam: the more frequent the mode, the lower each payment but the higher the total annual outlay. Annual mode is always the least expensive way to pay for a year of coverage.

A chart titled Modes of Premium Payment showing four rows, each representing the same year of coverage split into different numbers of installments. The top row, annual, is a single wide block labeled one payment. The second row, semiannual, is two medium blocks labeled two payments. The third row, quarterly, is four smaller blocks labeled four payments. The bottom row, monthly, is twelve narrow blocks labeled twelve payments. An arrow running down the left side of the chart says frequency up, each payment smaller. A red arrow running down the right side says total annual cost increases, so annual sits at the low-cost end and monthly at the high-cost end. A box across the bottom lists collection methods: direct billing, automatic bank draft or electronic funds transfer, payroll deduction, and list billing, and notes that annual mode has the lowest total cost while a single premium is paid in one lump sum.
More installments mean smaller payments but a higher total premium for the year.

How the money actually gets collected

Mode answers how often; the collection method answers how. Common arrangements include:

  • Direct billing — the insurer mails or emails a notice to the policyowner for each modal premium.
  • Automatic premium withdrawal (pre-authorized bank draft or electronic funds transfer) — the insurer debits the account each month. Because it is cheap and reliable, this is often the only way a true monthly mode is offered, and it usually carries the lowest cost of the frequent modes.
  • Payroll deduction / salary allotment — the employer withholds the premium from pay; typical in group and worksite plans.
  • List billing (group billing) — the insurer sends one statement covering many individual policies to an employer or association, which remits a single check.
  • Single premium and limited-pay plans — the entire cost is paid in one lump sum, or premiums are paid only for a stated number of years, after which the policy is paid up.

Remember that the initial premium must generally be paid before coverage takes effect, and that later modal premiums are protected by the policy's grace period, during which the contract stays in force even though the payment is late.

Marketing the modes honestly

How a producer describes premium modes is a market-conduct issue. Misrepresenting the terms of a policy, the amount of premium, or the true cost of paying in installments — for example, telling a client that monthly mode is "free" when the twelve payments exceed the annual premium — is an unfair or deceptive act. Comparing costs must be done accurately, and cost figures on illustrations must match the contract. A producer also may not use the existence of the state guaranty association as an inducement to buy insurance, so solvency reassurance is never a substitute for an honest premium comparison.

Sample questions

In life and health insurance, the term "mode of premium payment" refers to which of the following?

  • The method the insurer uses to invest collected premiums
  • How often during the policy year the policyowner pays premiums
  • The formula used to determine the policy's cash value
  • Whether the premium is paid by the insured or by a third party
Preview

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