Term insurance is one of the most common forms of life insurance. Chances are you, family members, and the people in your social circle own it. Odds are that you and most term insurance owners are pressed on the who, what, & why of your policy and would struggle with those answers. Let's review key facts of term policies so you can assess the if your term policy fits your financial objectives.
- Types of Term Insurance
- Key Provisions
- Pros & Cons
- Common uses
1. Most common characteristics of term policies are:
- They provide no cash value.
- They are for a predetermined period.
- They may be renewable. This feature allows the owner to continue coverage past the initial term for an increased premium.
- They may be convertible. This feature allows the policy owner to convert the policy to a permanent policy without proving insurability.
2. There are three type of term insurance:
Each type of term insurance performs how the name would suggest. Level-term provides the same amount of protection for a specified term, 5 years, 10, years, 20 years etc. In addition to the level protection amount, the premium will also remain the same.
Decreasing term starts at a set value then decreases over-time until it reaches zero. The most common type of decreasing-term utilized is straight line. With straight line the amount decreases in a uniform fashion. An example would be a one-million-dollar policy with a term of 10 years would decrease $100K per year until it reaches $0.
Increasing term often accomplishes the increased value by implementing a rider. The rider will increase face value of a policy as well as the premiums. Another typical characteristic of an increasing term policy is that there is often a third-party interest in the policy. The third party is often an employer, who values the insured as integral part of their business. This type of policy is also referred to as a split dollar policy. Over time, the business increases the amount of the premium payments increasing the benefit and the share of the death benefit. Because of the corresponding increases to the death benefit from the premium payments, the insured personal beneficiary retains a steady death benefit in the policy.
As the name "term" suggests, this type of policy is only for a specified period. To receive the benefit in a non-renewable policy, the insured would have to die during the original period of the contract. As you can see, having options to maintain coverage can be valuable. With that in mind, it makes sense for anyone considering a term policy to check for renewability or convertibility provisions.
A renewability provision will allow the policy owner to continue to extend coverage after the original term has concluded, provided they act to do so within a stated period. That period is typically during the original term.
A convertibility provision allows the policy owner to exchange the term policy to a permanent policy sponsored by the issuing company, without going through underwriting anew. Insures offer two types of convertibility; attained age and original date conversions.
Attained age convertibility simply has the insured begin making premiums on the converted policy based on the age they are when the conversion takes place.
Original date conversion allows the insured to pay premiums based on the age they were when they took out the initial policy. Obviously, being able to convert to a permeant policy, and being able to pay premium based on younger age is more beneficial on it's face for the insured. However, for this to make financial sense for the insurer, the policy owner is expected to pay the aggregate difference in premium between the term and permanent policy from the original issue date.
Like most financial products, there are no definitive good or bad products, only good and bad uses. Let's review those for term insurance.
4. The Pros:
- It's the cheapest type of insurance one can purchase per $1000
- It can be purchased for a specific amount of time
- It's flexible. It can be a stand-alone policy or add a rider to another policy
- Premiums can increase over time which could make the policy unaffordable
- No cash value
- Renewability and convertibility options typically have time constraints and increased cost.
5. Finally, reviewing most common uses:
- Declining policies are great for covering mortgages and other known expenses that will reduce over time, like education cost.
- Term riders are a wonderful way to control cost when purchasing a whole life policy, but want to add additional face value at a reduce cost
- Level term for extended periods like 20+ years allow young families with limited cashflow to access substantial amounts of coverage at an affordable rate.
Now that you know what to look for, and what questions to ask, have the conversation with your insurance agent to see if a term policy fits your family's needs.