Term Life Insurance
Term Life Insurance
Insurance is defined as shifting the economic risk of an occurrence to another party. Auto insurance shifts the risk associated with a car accident. Homeowners’ insurance shifts the risk associated with a fire, hurricane, or flood. Life insurance shifts the risk of the financial devastation left by a person’s death.
In our previous posting, “what is the best life insurance policy“, we briefly discussed the different types of life insurance; whole life insurance, universal life insurance, variable life insurance and term life insurance. Today we are going to further discuss the advantages and disadvantages of term life insurance.
Term life insurance is the purest form of life insurance. Here’s the deal - if you die during the policy coverage period (or “term”), the insurance company will send a check for the contractually agreed upon death benefit to your beneficiaries. If you don’t die during this period, typically you receive no benefit (we’ll discuss an exception later). That’s it - pretty simple.
However, there are different types of term life insurance (just to complicate things!). There is ten year term, twenty year term, thirty year term, annual renewable term, decreasing term and return of premium term life insurance. We’ll look at each type but first let’s discuss how a premium is calculated.
Insurance companies use very bright people called actuaries to calculate what premiums must be charged so that the insurance company can pay death claims and make a profit. The actuary does this by using an enormous amount of data and statistical probability. If the insurance company knows the statistical probability of, for example, a 40 year old healthy female dying in the next 10 years (and it is very small), they can calculate a premium to accomplish their goals. Common sense would tell you that the probability of dying for a 50 year old would be higher than a 40 year old - so logically, the premium would be higher for the older person for the same amount of insurance.
Ten, twenty and thirty year term life insurance policies are called “level term” policies because the annual premium is the same for the entire period of coverage. You can purchase a tremendous amount of insurance for very little premium if you are young and in good health. This works well for a young couple with small children where the death of either spouse would leave the surviving spouse with a stressful and difficult financial situation.
Annual renewable term life insurance is basically a “one year at a time” policy whereby the premium increases for each year of coverage. This is usually used for a short-term need (1 to 5 years) such as collateral for a loan. Usually, the policy allows for coverage to age 80 or 85 but the annual cost gets prohibitive as you get older.
Decreasing term life insurance is typically sold as “mortgage protection” insurance or some other emotional marketing pitch. The death benefit decreases annually to coincide with your decreasing mortgage balance (that is, if you have an amortized loan). There is nothing wrong with this type of product but typically a good agent will discuss the overall needs (i.e. coverage) of the family, not just a policy to pay off a certain item.
I mentioned earlier that typically with term life insurance there is no benefit if you don’t die during the term period. There is one exception to this rule. Many companies now have “return of premium” term life insurance whereby if you don’t die during the coverage period, the insurance company will refund all of your premiums at the end of the term. It should be obvious that this type of policy would cost more than a traditional term life insurance policy. But if the idea of paying premiums with little probability of a benefit bothers you, this might be an option.
Many agents will tell you that permanent policies are the only type to buy. However, as we mentioned in our previous posting, many factors come into play in determining what type of policy is best for you. If getting the most coverage for the least amount of dollars for a certain period of time is your goal, term life insurance is probably the way to go. Let us help you choose the right policy by using The LIFE Study. To learn how much life insurance cost Click here to start the process.
