Life insurance isn't just for dummies
Term life insurance is temporary. It provides coverage for a specified amount of time, known as the term. Life insurance companies offer their customers term life because it is less expensive than a permanent life insurance product like whole life. Term life insurance does not have a cash-building feature like permanent life. It does, however, pay a death benefit to a beneficiary that can provide enough cash for final expenses or bills. Term insurance policies are available in a variety of term lengths, from as short as one year to as many 30 years.
Term life insurance is “pure” insurance. The premium paid to the insurance company by the insured is applied only to the death benefit. This is different than a permanent whole life or universal life policy, for which part of the premium is invested in stock or bond funds to build value. Term life policies are often referred to as “one time benefit” policies, because the only time the insurance company makes a payment is upon the death of the policyholder.
Is Term Life Insurance Affordable?
A young, healthy individual seeking to protect his or her family for a defined amount of time makes up the biggest portion of the term life insurance market. As with all kinds of life insurance, if most of the people insured are young and healthy, the premiums will be lower for the whole group. This is because there is less risk to the insurance company of paying a claim.
While statistics on claim payment vary among different reporting agencies, it is widely estimated that 1% to 5% of all term policies issued pay the death benefit to the beneficiary. If a policyholder does not die during the term, or, if he or she stops paying the premiums before the term ends, the insurance company will have taken in the premiums without paying a claim. This is why term life insurance efficient, cost-effective and profitable for the insurance companies.
Because it is affordable, term insurance is also purchased as supplemental life insurance. A policyholder with other policies in force, such as one offered by an employer, may choose a term policy for additional coverage. For example, a 38-year-old mother of a ten-year-old daughter may choose a 15-year term life insurance policy in order to make sure the child will have sufficient funds for college tuition. A young married couple may select a term life insurance policy for 30 years, or long enough to cover outstanding mortgage payments.
Almost every life insurance company offers the option of converting a term policy to a permanent policy before the end of the term. A term permanent policy would then be in force for the remainder of the insured’s life. A whole life policy is sometimes more cost effective than serial renewal of a term life policy. In addition, a whole life policy also has the separate investment component that builds cash value over time, which can be very helpful for estate planning and providing a child or grandchild with an inheritance.
Types of Term Life Insurance
Term life insurance policies are available with two types of terms: Term life with an annual renewable term and term life with a level term.
Annual Renewable Term
This type of policy has a term length of 12 months. The premium is for one 12-month period only. The premium will increase if the policy is renewed for an additional 12 months. An insurance company determines the price for the premium on its cost to insure the policyholder for one year. While that might not seem like much of an age difference, all risk factors being equal, a 58-year-old woman will always pay more than a 57-year-old woman. As she gets older, the risk to the insurance company is higher because the risk of paying a claim is greater.
Premiums for an annual renewable term policy can become very costly as the policyholder gets older. For example, a 63-year-old woman who paid $825 for 12 months of term coverage may pay $840 for one more year of coverage when she renews the policy at age 64.
A term life policy with a level term can usually be bought in term lengths of between five and 30 years. The premium amount charged for a level term policy remains the same each year the policy is in force. Unlike the premium charged on an annual renewable term policy that will increase each year, the premium on a level term policy remains level. Premiums are based on the cost of providing the insurance over the number of years in the term. In other words, the age of the policyholder at the time he or she buys the policy and the length of the term are used to determine the amount of the premium.
The important distinction between the two policies is this: An annual renewable term policy reflects the real cost of providing insurance coverage for one year at the age of issue. A level term policy averages the cost of providing the insurance over the duration of the term. If the cost of the first year of the term is $700 and the cost of the last year is $1,000, the premium might be $850. The policyholder overpays at the start of the term but underpays at the end.
Who Benefits from Term Life Insurance?
Term life insurance is an excellent choice for young families with children and for those who don’t have cash to spare on insurance premiums. Because younger families have financial concerns that make permanent insurance cost prohibitive, term life is an affordable alternative for financial security and stability. A term policy can usually be converted later if insurance and financial needs increase.
Term life is also a good choice for senior citizens who need to ensure that a spouse or family member will have enough to cover final expenses and any debt payments.
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