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Term insurance is the original and most basic form of life insurance. It is also considered the most affordable of all types of life insurance. There are several types of term insurance and the premium rate differences between them help explain the different functions they perform.
The Annually Renewable Term Insurance Premium
The purest form of term life insurance is the annually renewable term (ART) policy. Its premium rises annually to reflect the insured’s increasing mortality risk. Because term insurance is normally pure protection, with no investment component or cash value, the premium is comprised mostly of the cost of insurance. This is the amount calculated by actuaries to reflect the applicant’s statistical life expectancy. For young insureds, premium increases are gentle at first but begin rising at an increasing rate in middle age.
The Level Premium Term Insurance Premium
Term insurance is temporary insurance that expires along with the insurance need. This temporary need may last for decades, however, which might take ART premiums into stratospheric territory. A level premium that lasts for the duration of the policy avoids the high later-year ART premiums and offers the chance to lock in the premium for 5, 10, 15, 20, 25 or 30 years. The level premium essentially averages the projected ART premiums for the term. (Recently, some companies have begun offering term life policies in single-year as well as five-year increments.) These qualities make level-premium term the most popular form of term life insurance.
Since both the ART and the level-premium term policy are simple policies with premiums reflecting mostly the cost of insurance, they can be sold as homogeneous commodities and compared on the basis of price. The advent of the Internet has made it easy for brokers to assemble databases of different term policies. This facilitates competition among term-insurance sellers and provides buyers with the lowest-possible premiums. These policies are the epitome of discount term life insurance.
The Quick-Issue Term Insurance Premium
Quick-issue term life insurance dispenses with the medical exam of applicants in favor of a series of questions. Favorable answers to the questions can result in policy issue within days or even minutes. Only policy limits ranging from $250,000 to $500,000 (occasionally to $1,000,000) separate these policies from the standard level-term policies. Once again, their homogeneous character makes price competition easy and greatly benefits life-insurance consumers. At one time, quick-issue policies were restricted to young adults, whose low mortality risk made waiver of the medical exam a reasonable gamble. Increased life expectancy and public awareness of health information has persuaded companies to broaden the age range of eligibility for quick-issue policies.
The Decreasing Term Life Insurance Premium
At first glance, the decreasing term life insurance premium may seem like the biggest bargain of all. This is deceptive because the face value of these policies decreases from month to month or year to year. Using a “cost per thousand” basis to compare term-life policies with different face values reveals that decreasing term policies are not cheaper than standard versions such as level-premium term. The real cost of decreasing term increases over time since the face value of the policy declines while the premium remains level. Decreasing term is best viewed as a specialized tool for those whose insurance need is (wholly or predominantly) decreasing. This might include such groups as single adults wanting to prevent a large debt from spoiling their legacy or retirees whose insurance need is created by a mortgage.
The Return of Premium Term Life Insurance Premium
Return of premium term life insurance is the obvious exception to the characterization of term insurance as a discount product. In order to earn the privilege of reclaiming premiums at the end of term, the policyholder must pay premiums that are at least 25-50% higher than those of standard term policies. In effect, return of premium term is a term policy with an investment component. High premiums accompany life insurance products that combine protection with investment, as witness the even-higher premiums of whole life insurance.
Term life insurance enjoys a well-deserved reputation as discount life insurance. The lowest premiums are found in ARTs and their level-premium cousins. Although quick-issue policies have more restrictive policy limits, their premiums can be comparably low. The low premiums of decreasing term insurance are deceptive since the face value of the insurance falls continuously over time. Return of premium term insurance is the outlier among term policies; an insured who survives to end-of-term can reclaim all premiums paid only at the cost of paying significantly higher premiums during the life of the policy.
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