Term Life Insurance
What is Term Life Insurance?
Term life insurance provides death protection for a stated time period, or term.
Term life insurance is perhaps the simplest form of life insurance. It was developed
to provide temporary life insurance protection on a limited budget. Since term
insurance can be purchased in large amounts for a relatively small initial premium, it
is well suited for short-range goals such as life insurance coverage to pay off a loan,
or providing extra life insurance protection during the child-raising years.
Features of Term Life Insurance
Initial affordability
Adjustable premiums: Term life insurance policies have adjustable
premiums. This means that the insurance company may raise or lower premiums at
some point specified in the policy based on projected changes of investment
earnings, mortality experience, persistency, and expenses. However, premiums may
never be raised above the maximum premiums stated in the policy.
Renewability: The Insurance Company’s level term policies allow the
policyholder to continue coverage past the original coverage period of the policy.
Each time the policy is renewed the premium increases to the amount for the then
attained age of the insured. This right is usually offered for a specific period, which
varies depending on the type of policy.
Conversion: The Insurance Company’s term policies are
convertible. Conversion allows the policyholder to exchange a term life insurance
policy for any permanent life Insurance policy offered by the Company at any time
while the policy is in force (subject to established policy minimums).
Usage
Because term life insurance is a pure death benefit, its primary use is to provide
coverage of financial responsibilities, for the insured. Such responsibilities may
include, but are not limited to, consumer debt, dependent care, college education for
dependents, funeral costs, and mortgages. Term life insurance is generally chosen
in favor of permanent life insurance because it is usually much less expensive
(depending on the length of the term) Many financial advisors or other experts
commonly recommend term life insurance as a means to cover potential expenses
until such time that there are sufficient funds available from savings to protect those
whom the insurance coverage was intended to protect. For example, an individual
might choose to obtain a policy whose term expires near his or her retirement age
based on the premise that, by the time the individual retires, he or she would have
amassed sufficient funds in retirement savings to provide financial security for their
dependents.
Annual Renewable Term
The simplest form of term life insurance is for a term of one year. The death benefit would be paid by
the insurance company if the insured died during the one year term, while no benefit is paid if the
insured dies one day after the last day of the one year term. The premium paid is then based on the
expected probability of the insured dying in that one year.
Because the likelihood of dying in the next year is low for anyone that the insurer would accept for the
coverage, purchase of only one year of coverage is rare.
One of the main challenges to renewal experienced with some of these policies is requiring proof
of insurability. For instance the insured could acquire a terminal illness within the term, but not actually
die until after the term expires. Because of the terminal illness, the purchaser would likely
be uninsurable after the expiration of the initial term, and would be unable to renew the policy or
purchase a new one.
Level Term Life Insurance
Much more common than annual renewable term insurance is guaranteed level premium term life
insurance, where the premium is guaranteed to be the same for a given period of years. The most
common terms are 10, 15, 20, and 30 years.
In this form, the premium paid each year remains the same for the duration of the contract. This cost
is based on the summed cost of each year's annual renewable term rates, with a time value of money
adjustment made by the insurer. Thus, the longer the term the premium is level for, the higher the
premium, because the older, more expensive to insure years are averaged into the premium.
Most level term programs include a renewal option and allow the insured to renew for a maximum
guaranteed rate if the insured period needs to be extended. It is important to note that the renewal
may or may not be guaranteed and the insured should review their contract to see if evidence of
insurability is required to renew the policy. Typically this clause is invoked only if the health of the
insured deteriorates significantly during the term, and poor health would prevent them from being able
to provide proof of insurability.
Payout likelihood and cost difference
Both term insurance and permanent insurance use exactly the same mortality tables for calculating
the cost of insurance, and a death benefit which is income tax free, as long as the policy is in force
and premiums are current; however, the premiums are substantially different.
The reason the costs are substantially different is that term programs may expire without paying out,
while permanent programs must always pay out eventually. To address this, permanent programs
have built in cash accumulation vehicles to force the insured to "self-insure", making the programs
many times more expensive.
Insurance industry studies have shown that the probability of filing a death benefit claim under a term
insurance policy is unlikely.[citation needed] One study placed the percentage as low as 1% of policies
paying a benefit. The low payout likelihood allows term insurance to be relatively inexpensive. The low
payout percentage is a combination of there being a low likelihood (in the aggregate) of a random,
healthy person dying within a short period of time. Because of the low likelihood of an insurer having
to pay a death benefit, term insurance seems better when considered in terms of coverage per
premium dollar basis - by a factor of up to 10.