Term Life Insurance
Term life insurance provides coverage over a specific amount of time. Term insurance is relatively very cheap and very affordable.
Brand: Woodman of the World, Genworth, Allstate, American General
Term life insurance is the original form of life insurance and can be contrasted to permanent life insurance such as whole life, universal life, guaranteed universal life and variable life, which guarantee coverage at fixed premiums for the lifetime of the covered individual. Term insurance is not generally used for estate planning needs or charitable giving strategies but for pure income replacement needs for an individual. Many permanent life insurance products also build cash value over the life of the contract, available for later withdrawal by the client under specific conditions. However, on most cash value policies like Whole Life insurance, the only way to receive the cash value is to cash out the policyin most cases but some companies will allow you to withdraw the cash value at a specific rate of interest. The beneficiaries receive the face value of the insurance and possibly the cash value as well considering the contract with the company. Some financial advisers advise buying term life insurance and investing the difference elsewhere to those who still qualify to contribute to other tax-deferred investment growth such as IRA’s or 401k’s, but this strategy can backfire if you need to renew your term policy and are unable to do so due to health reasons or a payment is missed and you have to repurchase at a much larger premium due to a change in age.
Term insurance functions in a manner similar to most other types of insurance in that it satisfies claims against what is insured if the premiums are up to date and the contract has not expired, and does not expect a financial gain if no claims are filed. As an example, auto insurance will satisfy claims against the insured in the event of an accident and a home owner policy will satisfy claims against the home if it is damaged or destroyed. Whether or not these events will occur is uncertain, and if the policy holder discontinues coverage because he has sold the insured car or home the insurance company will not refund the premium. This is purely risk protection. 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 generallychosen in favor of permanent life insurance because it is usually much less expensive. Many financial advisors or other expertscommonly 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. 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. Some term policies offer a feature called guaranteed reinsurability that allows the insured to renew without proof of insurability.
A version of term insurance which is commonly purchased is annual renewable term (ART). In this form, the premium is paid for one year of coverage, but the policy is guaranteed to be able to be continued each year for a given period of years. This period varies from 10 to 30 years, or occasionally until age 95. As the insured ages, the premiums increase with each renewal period, eventually becoming financially inviable as the rates for a policy would eventually exceed the cost of a permanent policy. In this form the premium is slightly higher than for a single year’s coverage, but the chances of the benefit being paid are much higher.
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.
Most term life policies include an option to convert the term life policy to a Universal Life or Whole Life policy. This option can be useful to 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. The new policy is issued at the rate class of the original term policy. Note that this right to convert may not extend to the end of the Term Life policy. It may extend a fixed number of years or to a specified age, such as convertible to age 70.
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, some permanent programs have built in cash accumulation vehicles to force the insured to “self-insure”, making the programs many times more expensive.
Other permanent life insurance policies do not have built in cash values. The policy owner may have the option of paying additional premium in the early years of the policy to create a tax deferred cash value. If the insured dies and the policy has a cash value, the cash value is often paid out tax free in addition to the policy face amount.
Insurance industry studies have shown that the probability of filing a death benefit claim under a term insurance policy is unlikely. The low payout likelihood allows term insurance to be relatively inexpensive. The low payout percentage is a combination of there being a low likelihood 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 may offer more coverage per premium dollar.
The insurance industry is constantly changing. There are now term coverages that will pay the insured a partial face amount of a policy if you are diagnosed with a terminal disease. Some polices contain riders that will pay in case of disability and even in some cases will pay out if unemployed. The life insurance product is constantly changing so it is always best to tell your Financial Advisor or Insurance Agent your coverage needs so the proper policy that can address those needs can be evaluated.
