Term Life Insurance

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Term Insurance

Term life insurance is temporary insurance that essentially provides a death benefit only. The benefit is paid only if the insured person dies before the end of the specified term (whether it be one year, five years, ten years or some other term). If the insured lives beyond the end of the term coverage, the policy simply expires.

Since term insurance does not build cash value, a policy owner only has to pay for the death benefit and policy expenses. For this reason, it is usually the least expensive form of life insurance for a short term period of coverage. It may be used as an inexpensive tool to satisfy a variety of temporary insurance needs, such as a mortgage obligation or the need to protect insurability until an insured can afford permanent protection.

Term insurance makes sense if you:

• are strapped for cash . do not ~heed insurance for more than fifteen years
• are young
• think like a renter rather than a buyer
• are in a low income tax bracket

The terminology of naming term insurance may refer to the death benefit or premiums. It is important to understand the difference. Level death benefit provides a consistent amount of insurance. Decreasing death benefit, which is an ideal type of insurance to cover any shrinking debt obligation (like a mortgage), starts with a specified face amount which decreases annually until it reaches zero at policy expiration.

Increasing death benefit provides a growing amount of insurance over the course of the term. This type of policy is rare.

Other common names of term life insurance reflect the premium structure:

• Annual Renewable Term
• Yearly Renewable Term . 5 Year Level Term . 10 Year Level Term . 15 Year Level Term . 20 Year Level Term
• Mail Order Term . Association Group Term . Employer Group Term The most common of these is the 10 Year Level Term policy.

Yearly renewable term and annually renewable term are two names for the same plan. The premiums increase annually and the death benefit remains level.

Five, 10, 15 and 20 year level term reflect the periodof level premiums. At the end of the period the premiums increase dramatically and medical evidence or insurability may be required.

Level premium term solved three problems for insurance companies:

• Demographics. With baby-boomers entering their thirties in the 1980s, there was a huge increase in demand for life insurance. The size of the policies purchased grew The typical policy of $100,000 or $250,000 in the 1960s and 1970s gave way to policies of $500,000 and $1,000,000 in the 1980s.
• Cash strapped young families. With inflation increasing housing costs during the 1980s, the size of mortgages outpaced income growth. S~ the need for family security and income continuation increased while income for most families remained fairly steady.
• Falling prices. Term insurance rates started falling in early 1980 and have continued falling through the 1990s. Any term policy purchased five years ago could be replaced with a new cheaper one. And many were. This move to cheaper premiums had a chilling effect on the entire insurance market.

As a result of these market factors, a handful of cheap term carriers dominated the marketplace. They fell over each other-slashing prices and increasing commissions-to increase sales. Level term helped the market stabilize in the wake of these price-cutters.

Among the things you should do when selecting level term insurance:

• Select a company with high financial ratings (even if it is slightly more expensive).
• Compare level period costs.
• Compare premiums after the level period (both if you qualify and if you don't).

Many term policies are renewable, which means they may be renewed without providing evidence of good health until a specified age. A one year renewable term policy expires after one year but is renewable for other one year periods. A five year renewable term policy can be renewed for subsequent five year periods.

• Find out whether the premiums after the level period are guaranteed or illustrated.
• Ask whether you call convert to all products offered by the company during the level period.
• Ask whether the standards for medical requalification at the end of the level period will be the same for all applicants-and whether this is clearly written in the contract.
• Avoid tricky contract clauses by buying from top quality carriers and avoiding mail order plans and association group plans.

Renewal and Conversion

Many term policies are also convertible, which means they may be exchanged for another type of policy-such as whole life. If the conversion privilege is exercised it will be at the attained age-meaning the premium paid for the new policy will be based upon the insured's age at the time of conversion.

Assuming the level term policy is issued as renewable and convertible, every time the policy renews for a subsequent term period, the policy's premium will increase due to the increased age of the insured.

Example: You have purchased $50,000 of one-year renewable and convertible term insurance. Each year the policy is simply renewed at the same face amount by the payment of the new; higher premium. A new application is not required nor is a new policy issued. The only thing which changes is your age-and, subsequently, the policy's premium.

Decreasing term is also temporary protection for a specified period of time. However, the death benefit decreases but the premium remains level or constant for the term of the policy. Decreasing term is usually written as. convertible but generally is not renewable at the end of the specified term period.

Provisions

In the ordinary term policy, the insurance company agrees to provide insurance on the insured's life and to pay the benefits listed. The benefit, or face amount of insurance shown in the policy schedule, will be paid to the beneficiary upon proof that the insured died while the policy is in force.

The policy schedule for annual renewable term insurance will show a policy date (original effective date) and an expiry date (expiration date), plus renewal premiums for the insured's attained age up to age 69.

An example: If your birthday is March 1 and the policy anniversary date is June 1, it may be renewed after your sixt}';ninth birthday. On the next policy date, your nearest birthday will be the sixt}';-ninth (although coverage in this case will actually continue for three months beyond age 70).

Many term policies will include language that instructs you to contact the company's home office about any change that might affect terms or conditions. This provision encourages the policy owner to contact the insurance company for assistance when changing an address, collecting benefits, or considering exchanging policies.

Participating Term Policies

Some term policies are participating policies. While in force, they will share in any divisible surplus of the company's participating business as determined each year by the company.

The premium may be a little higher, but the net cost (premium less dividend) may be less. Dividends, if any, are due on policy anniversaries. The dividend at the end of the first policy year will be payable only if the premium then due for the second policy year is paid.

The owner of a participating policy has options as to how dividends wilt be received. They may be taken in cash or applied toward premium payments.

If you wish, dividends can be held by the insurance company to earn interest-and you can receive them later. They may also be used to buy one year term insurance additions-as much coverage as the dividend will purchase at the insured person's attained age (this option is_often selected when a policy owner needs more insurance than he or she can afford).

Beware Of Restrictions On Exchanges and Conversions

A term life policy may be exchanged for a whole life policy or endowment policy at any time before the insured reaches an attained age of 70. Evidence of good health is not required. Written application must be made for the desired exchange option.

Under an original age option, a new policy will have the same effective date as the term policy, and the premium will be based on the insured's age as of that date. Since the values of the policy (cash value and net death benefit) are based on premium payments, cash accumulations, and' inter~st earn~d

Example: You purchased the term policy at age 30 and decide to convert it to a whole life policy at age 45 under the original age option. The accumulated difference between the premiums for the two policies is $4,826. Compound interest on the unpaid amounts equals $1,238. The difference between dividends paid and those that would have been paid under the whole life policy is $912 (since whole life would have paid higher dividends, this amount is subtracted). You must pay $5,152 ($4,826 + $1,238 - $912) to have a current whole life policy with all values up to date as if it had been purchased at the original age.

Under an attained age option, a new policy will have a current effective date and the premium will be based on the insured's. attained age when it is issued. The policy owner only needs to pay the currentl'premium, which will be higher than it would have been at the original age. In this scenario, the new policy will not initially have any accumulated cash value. TQis will begin to accumulate only in future years.

Example: You purchased the term policy at age 30 and decide to convert it to a whole life policy at age 45 under the attained age option. By doing so, there is no need to pay any differences in past amounts, but the premiums fora policy starting at ag~ 45' may be considerably higher than they would have been at age 30.

If the term policy includes additional benefits, such as disability or accidental death benefits, similar benefits may be included in the new policy if the insurance company regularly issues those benefits under the plan, rated age, and risk classification of the insured on the effective date.

Conversion Limitations

Your right to convert a term policy to a cash value policy without medical examination is very valuable. When an insurance company restricts this conversion right, you risk not being able to convert the policy in the future.

The bold print on a convertible term policy may read Guaranteed Convertible-but fine print may say for five years only or to age 70. Some policies will have limited conversion timeframes-such as the first three years that you own the policy. Others limit the types of policies to which you can convert.

Buying Strategies

Don't be seduced by cheap premiums into giving up control of options. Select your policy as if this is the last policy you will be able to purchase. This will help you to avoid poor quality companies, gimmicks, loss leader pricing and requiring medical requalification.

Most people buy term insurance for one of two reasons:

• They only need coverage for a limited period of time and do not plan to convert to cash value insurance in the future
• They can afford cash value insurance now but may convert to cash value insurance in the future

Price becomes less important and other factors play a more significant role if you want. to keep the insurance longer or convert it. In these cases, you should consider:

The quality of the issuing insurance company

• conversion restrictions (time limits)
• requirements for medical exam upon renewal in the future

You shouldn't assume that your health will be as good as it is now in the future.

A popular development in recent years has been term insurance with a level premium for the first ~. years, 10 years, 15 years or 20 years. After the level period, you’re required to take a medical examination to avoid a dramatic premium increase.

If your health is not perfect, your premium increases dramatically. These policies appeal to some of the worst impulses in buyers:

• consumers want cheap prices today and hope for good health in the future-therefore, millions have purchased policies which they may have to cancel when they most need to keep it
• insurance companies get to keep the consumers' money and dump the risk when a consumer discovers he or she has health problems

Example: At age 59, a successful businessman fmds out that his wife is pregnant with twins. Within a week of this news, he finds out that he has a serious heart problem-which makes him insurable only at a very high premium. His existing insurance was the cheapest term insurance available when he'd bought it-eight years before. This coverage required that he pass a medical in the tenth year. If he didn't pass the medical examination, the premiums would triple in price-and continue to increase from there.

He realized that, since his children would be born when he was 60, they would be entering college when he was in his late 70s. By that time,. premiums for $1,000,000 of term coverage would cost almost $100,000 a year.

This otherwise smart man had purchased the cheapest policy at age 51 thinking he wouldn't need,it ln the future. He guessed wrong. If he had purchased a policy that didn't have a medical re-entry and was a high quality company, he would have had affordable options.

Conclusion

Only a small percentage of people die owning term policies. Why is this? Most people die between the ages of 65 and 85 years old. The premiums for term insurance become so expensive by 60 years old, that people cancel the term policy or convert it to another form of life insurance.

How much should a term life insurance policy cost? That's like asking: How much does a house cost? Or a dress? Or a car?

Let's use the analogy of a house: If the price is loW; there may be problems with the house or the neighborhood. If a term policy is cheap, there will be contract restrictions in the policy or it may be written by a low-quality company.

Are you willing to bet that 5, 10, 15, or 20 years from now you will be perfectly healthy? No problems with heart, cancer, blood. pressure, diabetes, liver functions, psychological problems, etc. That is the bet you make when you purchase level term. Only you can decide whether the risk is worth the savings.

If you only need insurance for the level term period (5, 10, 15, or 20 years), level term is less expensive than annual renewable term. If you need coverage after that time, that insurance may not be the best kind for you. Also, if your health falters, and you don't pass the medical at the end of the level period, level term is more expensive than annual renewable term. A medical exam is usually required at the end of the level period. Negative medical changes (heart, blood pressure, cholesterol, cancer, respiratory, nervous conditions, etc.) will substantially increase your premium. On a lO-year level term policy, the cumulative 10 year premium is almost always lower than 10 year cumulative premium of yearly renewable term.

Term insurance mayor may not be right for your insurance needs. It can provide a ,maximum amount of insurance for a very low cost-but, again, it is only temporary protection. It is important to understand the provisions before choosing a term policy because the adequate insurance that was once provided can cause potential disadvantages at the end of the i1!sured term. These disadvantages include loss of insurability, higher premium costs at renewal, and absence of cash value.

In the next chapter, we will discuss whole life insurance which provides a guaranteed form of protection which unlike term-provides cash value and coverage for your whole life.