Term Life Insurance
Life insurance can be broadly classified as either term insurance or cash-value life insurance. Term insurance provides protection for only a limited time, and has no cash value, whereas cash-value life insurance usually covers much longer terms, up to a lifetime, and builds a cash value for the policy owner.
Term insurance is the cheapest life insurance policy available. It covers a specific time period, and is usually purchased to cover the financial needs of children and surviving spouse until the children are grown. Term insurance can be bought for 1, 5, 10, or 20 years, and is renewable without needing to provide evidence of insurability, but the renewal price increases as the insured ages, since the chance of death also increases with age. However, there are some variations on term life insurance with regard to renewals and premium levels, including the following:
- annual renewable term, which is renewed each year at an increasing premium, but without regard to the insured's health
- convertible term is convertible to another type of life insurance policy — whole life, universal life, variable life, or an endowment policy — without having to prove insurability
- level term maintains the same death benefit and premium level for the entire term of the policy, which can be 5, 10, 15, 20, or 30 years
- decreasing term, where the death benefit decreases over the term, but the premium remains the same
- re-entry term life insurance provides a guaranteed term premium for the initial premium but allows the insured to requalify after a 5- or 10-year period, by undergoing a physical health examination to confirm that the insured continues to be healthy; otherwise, the rates are still guaranteed, but will be higher than re-entry rates.
Some insurers have an age limit for renewing term insurance to limit adverse selection. People in good health will frequently drop life insurance, but people in poor health will renew even at greatly increased prices. However, some insurers will allow the renewal of term insurance at any age.
Most term insurance policies are convertible—they can be converted to a cash-value policy, if desired. There are 2 methods used to determine how much must be paid to convert the policy: the attained-age method and the original-age method. The attained-age method bases the insurance premiums on the age of the insured at the time of conversion. The original-age method bases the premiums on the age of the insured when the term insurance was first acquired. However, the insured must pay the insurer the amount of money that would have been collected had the insured selected the cash-value policy to begin with. Because of the cost of converting a policy based on the original-age method, most insurers either don't offer the original-age method or require the conversion to take place within 5 years of buying term insurance.
Types of Term Insurance
There are a wide variety of term insurance policies, but the most common types are classified according to the terms covered, or the amount of coverage and premiums, and how they change over time.
Yearly renewable term insurance covers 1 year, and is renewable every year up to a certain age limit, without the need to provide evidence of insurability. It can also be converted to a cash-value policy without presenting evidence of insurability. The premiums increase every year.
There is also term insurance for 5, 10, 15, or 20 years or longer, that can be renewed. The premiums remain the same during the period, but increase with each renewal.
There is also a term to age 65 policy which covers the insured to age 65. The premiums are level throughout the term of the policy. The policy holder pays a higher premium at the start of the policy than he would for a shorter term policy. This builds up an extra cash reserve that is used to keep premiums level until the expiration of the policy. The insured can convert the policy to a cash-value policy before he reaches a certain age, specified in the policy.
For most people wanting term insurance, the need for term insurance declines as mortgages are paid down and children grow up and leave home. Decreasing term life insurance serves the needs of these people by providing a level premium over the term while the face value of the policy declines. In many cases, the insured may not even have to pay premiums for the last couple of years of the term.
Increasing term life insurance is available for those who wish to provide a hedge against inflation, especially for parents with children who will be attending college. The face value of the policy, as well as premiums, increases over time at a stipulated rate.
An insured in good health can keep premiums down by purchasing a reentry term insurance. The insured must periodically provide evidence of good health and insurability to qualify for the lower premiums.
Benefits of Term Insurance
The main benefit of term insurance is its low cost. Because term insurance is the simplest type of policy, it is the easiest to sell. It was one of the 1st type of policies to be sold over the Internet, and there is much more competition among insurers, which drives down the price.
Term insurance is also a natural policy to get if life insurance needs are temporary. Many people don't need life insurance once they attain a certain amount of financial reserves to cover the loss of a life. The opportunity cost of buying term insurance, or cash-value policies, may be higher than simply investing the money, or even paying off debt, if the family has little income that is not likely to increase substantially. Paying off debt will also lead to a better standard of living.
If, however, you are interested in getting a cash-value policy later, but simply can't afford it right now, then convertible term insurance can guarantee your insurability later when you are able to afford it.
Drawbacks to Term Insurance
The main drawbacks to term insurance are the increasing premiums with age, and that it cannot easily be changed to accommodate new needs, such as a new child. It also does not develop any cash value.
Increasing premiums and lack of cash value are not necessarily drawbacks. Since term insurance is cheap, the money saved could be invested for greater income. This could more than cover the increasing premiums. When you buy a level-premium whole life policy, you pay more for the policy in the early years than would be required for term insurance, and this money is used later to offset the increased premiums that would otherwise be required to insure your life in later years. So buying term insurance while investing the money that would be used to pay the higher premiums for a whole life policy may be a better use of your money, and you would have greater flexibility.