Term Life Insurance

This type of insurance provides coverage at a fixed rate of payments for a limited period of time, the relevant term.  When the relevant period expires, coverage at the previous premium rate is no longer guaranteed.  The client must either forfeit coverage or apply for further coverage with different premiums and/or conditions.  If the life insured dies during the term, the death benefit will be paid to the beneficiary.

Term insurance is the least expensive way to purchase a substantial death benefit on a coverage amount per premium dollar basis over a specified period of time.  Term insurance is not generally used for estate planning but is used for pure income replacement needs for an individual.  Some policies offer a feature called guaranteed insurability that allows the insured to renew the policy without proof of insurability.

Usage

The primary use of term life insurance is to provide coverage of financial responsibilities for the insured or his or her beneficiaries.  These may include consumer debt, dependent care, university education, funeral costs and mortgages.

a)  Annual Renewable Term :

The simplest form is 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 based on the expected probability of the insured dying in that one year.  A challenge 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.  As a result of the terminal illness, the insured would likely be uninsurable after the expiration of the initial term, therefore unable to renew the policy or purchase a new one.

Some policies offer a feature called guaranteed reinsurability that allows the insured to renew without proof of insurability.

The period for this type of insurance varies from 10 to 30 years.  As the insured ages, the premiums increase with each renewal period, eventually becoming financially inviable as the rates would eventually exceed the cost of a permanent policy.

b)  Level Term Life Insurance:

In this instance the premium is guaranteed to be the same for a given period of years, commonly 10, 15, 20 and 30 years.  The premium paid each year remains the same for the duration of the contract, however, the longer the term, the higher the premium, because the older, more expensive to insure years are averaged into the premium by the insurer.  Renewal options may or may not be included and the insured should review the contract to see if evidence of insurability is required in order to renew a policy.

c)  Options:

Most term policies include an option to convert to a Universal Life or Whole Life Policy.  A person who acquired the term life policy with a preferred rating class and later is diagnosed with a condition that would make it difficult to qualify for a new term policy would be able to use this option.

d)  Return Premium Term Life Insurance:

This provides a return of some of the premiums paid during the policy term if the insured person outlives the duration of the term life.  The repayment would be less the fees and expenses which the insurance company retains.  The premiums for a return premium term life plan are usually much higher than for a regular level term life insurance policy.

Cost Difference

Both term and permanent insurance use the same mortality tables for calculating the cost of insurance.  The premium costs for term insurance are substantially lower than those for permanent insurance.  The reason for lower costs is that term programs may expire without paying out, whereas permanent programs must always pay out eventually.  To address this, some permanent programs have built-in cash accumulation vehicles to force the insured to “self-insure” making the programs many times more expensive.

Conclusion

Insurance industry studies indicate the the probability of filing a death benefit claim under term insurance is as low as 1% of policies paying the benefit.  Term insurance may offer more coverage per premium dollar – by a factor of up to 10.

“Although there are many kinds of insurance (such as whole or universal life) the only type you need is Term Insurance, because it is simple and affordable. Use the “rule of 20” to determine the death benefit.  You want the beneficiary to be able to invest the payout and live off the income, so he or she does not have to worry about tapping into the principal.  That means the death benefit should be 20 times the annual income you need to replace.  If the goal is to replace $50,000 in annual income, you would want to buy a $1 million policy.” – Suze Orman on the SelectQuote Blog.