Term Life Insurance
Term life insurance, also known as pure life insurance,
is life insurance that guarantees payment of a death benefit
during a specified term. Once the term expires, the policyholder
can either renew for another term, convert to permanent coverage,
or allow the policy to terminate. Term life insurance policies
provide a stated benefit upon the death of the insured, provided that the death occurs within a specific period.
BREAKING DOWN 'Term Life Insurance'
Term life policies have no value other than the guaranteed death benefit. There is
no savings component as is found in a whole life insurance product. The policy's
purpose is to give insurance to individuals against the loss of life. All premiums
cover the cost of underwriting the insurance. As a result, term life premiums are
typically lower than permanent life insurance premiums.
Characteristics of Term Life Insurance
The basis for term life premiums is on a person’s age,
health, and life expectancy, which is set by the insurer.
If the person should die within the specified policy term,
the insurer will pay the face value of the policy. Should the
policy expire before the policyholder's death, there is no payout.
Policyholders may be able to renew a term policy at its expiration, but their premiums will be recalculated for their attained age.
Because it offers a benefit for a restricted time and provides only a death benefit, term life
is usually the least costly life insurance available. A healthy 35-year-old non-smoker can
typically obtain a 20-year level-premium policy with a $250,000 face value for between $20-$30
per month. Purchasing a whole life equivalent will have significantly higher premiums, possibly
between $200-$300 per month. Because most term life insurance policies expire before paying a
death benefit, the overall risk to the insurer is lower than that of a permanent life policy.
The reduced risk allows insurers to pass cost savings to the customers in the form of lowering premiums.
For example, 30-year-old George wants to protect his family in the unlikely event of his early death.
He buys a $500,000 10-year term life insurance policy with a premium of $50 per month. Should George
die within the 10-year term, the policy will pay George’s beneficiary $500,000. Alternatively,
George does not pass and is now 40 years old. His term policy has expired. If he chooses not to
renew and subsequently dies, his beneficiary receives no benefit. If he decides to renew the
policy, the new policy will base the premium on his current 40 years of age.
Term Life Premiums
An insured's age, sex, and health are the primary
determinants for calculating the policy premium. Depending on
the policy's face amount, a medical exam may be required. Other
common factors are the insured's driving record, current medications,
smoking status, occupation, hobbies, and family history.
Premiums are flat, or level, for the duration of the contracted term.
However, the cost of insurance increases as the life expectancy of an
insured decrease. Upon renewal, the policyholder will likely realize a
significant increase in premiums. Based on actuarial data, the average
life expectancy in the U.S. is 78.86 years. Therefore, a 20-year-old
person has a remaining life expectancy of 58.86 as compared to a 50-year-old
with a remaining life expectancy of 28.86 years. The risk to underwrite insurance
for the 20-year-old is less than the risk to cover a 50-year-old person.
Interest rates, the financials of the insurance company, and state regulations
can also affect premiums. In general, companies often offer better rates at "breakpoint" coverage
levels of $100,000, $250,000, $500,000, and $1,000,000.
Three Types of Term Life Insurance
Level term, or level-premium, policies provide coverage for a specified period
ranging from 10-30 years. Both death benefit and premium are fixed. Because
actuaries must account for the increasing costs of insurance over the life
of the policy's effectiveness, the premium is comparatively higher than yearly renewable term life insurance.
Yearly renewable term (YRT) policies have no specified term but are renewable every year
without requiring evidence of insurability each year. Early, premiums are low, but as the
insured ages, premiums increase. Although there is no specified term, premiums can become
prohibitively expensive as individuals age, making the policy an unattractive choice for many.
Decreasing term policies have a death benefit that declines each year according to
a predetermined schedule. The policyholder pays a fixed, level premium for the duration
of the policy. Decreasing term policies are often used in concert with a mortgage to
match the coverage with the declining principal of the home loan.
Who Will Benefit From Term Life Insurance?
Term life insurance is attractive for young couples with children.
Parents may obtain large amounts of coverage for reasonably low costs.
Upon the death of a parent, the significant benefit can replace lost income.
They are also well-suited for people who temporarily need specific amounts
of life insurance. In these cases, the policyholder believes their survivors
will no longer need extra financial protection, or they will have accumulated enough liquid assets to self-insure.
Term Life Insurance vs. Permanent Insurance
The choice between a permanent policy with cash-value
insurance product such as whole life or universal life
and a term life coverage depends on the circumstances
and needs of the policyholder. Term life policies are
ideal for people who want substantial coverage at low costs.
Whole life customers pay more in premiums for less coverage
but have the security of knowing they are protected for life.
While many buyers favor the affordability of term life, paying
premiums for an extended period, and having no benefit after
the term's expiration, is an unattractive feature. Upon renewal,
term life insurance premiums increase with age, which may make new
premiums cost prohibitive. In fact, renewal term life premiums may
be more expensive than what permanent life insurance premiums would
have been at the issue of the original term life policy.
Some customers prefer permanent life insurance because the policies
can have an investment or savings vehicle. A portion of each premium payment
is allocated to the cash value, which may have a growth guarantee. Some plans
pay dividends, which can be paid out or kept on deposit within the policy. Over
time, the cash value growth may be sufficient to pay the premiums on the policy.
There are also several unique tax benefits, such as tax-deferred cash value growth and tax-free access to the cash portion.
Financial advisers warn that the growth rate of a policy with cash value is often
paltry compared to other financial instruments, such as mutual funds and exchange-traded funds
(ETFs). Also, substantial administrative fees often hinder the rate of return. Hence, the common
phrase "Buy term and invest the difference." However, the performance is steady and tax-advantaged.
Apparently, there is no one-size-fits-all answer to the term vs. perm insurance debate. Other factors to consider include:
Is the rate of return earned on investments feasible for the client?
Will these investments be in a traditional or Roth IRA or other qualified
plan, and will there will be any matching contributions to employer-sponsored plans?
Is there the existence of a loan provision and other features in the permanent policy?
Does the policyholder have or intend to have a business that requires insurance coverage?
Will life insurance play a role in tax-sheltering a sizable estate?
Convertible Term Life Insurance
Convertible term life insurance is a term life policy that includes a
conversion rider. The rider guarantees the right to convert an in-force term policy,
or one about to expire, to a permanent plan without going through underwriting or proving
insurability. The conversion rider should allow you to convert to any permanent policy the insurance company offers with no restrictions.
The primary features of the rider are maintaining the original health rating of the term policy upon
conversion, even if you later have health issues or become uninsurable, and deciding when and how
much of the coverage to convert. The basis for the premium of the new permanent policy is on your age at conversion.
Of course, overall premiums will increase significantly, since whole life insurance is more expensive than
term life insurance. The advantage is the guaranteed approval without a medical exam. Medical conditions
that develop during the term life period cannot adjust premiums upward. However, if you want to add additional
riders to the new policy, such as a long-term care rider, the company may require limited or full underwriting.