Term Life Insurance
Term life insurance is a fairly pure type of life insurance (no cash values normally, and premiums rise as you get older) intended to cover temporary insurance needs. Temporary doesn’t neccessarily mean short term however, as term life insurance can provide coverage to age 65 and beyond.
You might consider term life insurance to cover such things as mortgage debt, key man and business insurance, or paycheck replacement to ensure your dependents can continue to live in their current lifestyle upon the death of a breadwinner. Another way to look at this is that term insurance coverage is suitable for needs that will likely disappear before your death.
Term life insurance is less well suited for permanent types of life insurance needs such as estate preservation or tax liabilities. These types of insurance require coverage until you die and do not disappear over time. This requires that you look at two issues – making sure that coverage will be available to you when you’re older and making sure that the premiums are affordable at older ages. See our permanent insurance page for details.
Term Life Insurance Premiums:
Life insurance companies base their premiums based upon risk. With life insurance, your risk of a claim increases as you get older. Thus the simplest form of insurance is pure coverage with rates that increase every year as you get older. This type of insurance is called one year term insurance.
The problem with this is that even in the mid term, premiums can increase dramatically. Most people are not interested in a product with prices that rise rapidly.
The insurance companies have developed term insurance products that level out these increases a bit. Rather than having prices increase every year most term products today are level for an initial period such as 10 or 20 years. These products are called 10 year term and 20 year term respectively. Other term periods are available.
For example 10 year term insurance would provide premiums that are level for the first 10 years of coverage after which premiums would increase. The premiums for the first 10 years should be higher than one year term life insurance initially but lower towards the end of the 10 years. Here’s an example of what you might see:
|1 Year Term||10 Year Term|
Note: numbers are entirely fictitious and intended to demonstrate trends only.
You are paying a slightly higher premium now to level out the later higher premiums. In year one, the 1 year term cost is $250 while the 10 year term insurance premium is $500. Conceptually the insurance company would take the additional $250 from the 10 year term premium and invest it for you. You can think of the 1 year term insurance premium as the actual life insurance cost needed each year to provide your coverage.
In year 5, the one year term premium is now $600 – but the 10 year term premium is still only $500. Where does the insurance company get the additional $100 to pay your premium for the 10 year plan? From the $250 it had from year one (you paid $500, but the insurance company only needed $250 to pay your premium).
Thus you would expect one year term to be cheaper initially but more expensive later. 10 year term insurance should be a bit more expensive now but less expensive later thus levelling out your premiums for the 10 years.
The same premise holds for other term periods. 20 year level term insurance would be more expensive initially than 10 year term, but later on should have less expensive premiums than the 10 year term at that time.
This really boils down to a mathematical calculation called present value. The present value of your insurance premium is the amount you would need to invest today to pay for the premiums. Ideally you should expect that the present value of a 1 year term plan would be overall more expensive over 10 years than the 10 year term. A 20 year term plan should have a lower present value cost over 20 years than a 10 year term plan.
However this is not always the case!
Term life insurance is a very competitive market for insurance companies. Within this arena, 10 year term life insurance tends to be the most competitive product. Thus over a 20 year term, the actual present value cost of a 10 year term product may be less expensive than a 20 year term plan.
There are a number of considerations specific to term life insurance.
- Renewals: These are the premiums after the initial term period. Some companies will renew for another level period, other companies revert to an annual increasing 1 year term type of premium structure after the initial period. If you purchase a 10 year term insurance product, in year eleven some companies may raise your premiums but keep them level for another 10 year period. Others may provide annually increasing premiums for years 11+. Also check how long a product is renwable. Ages such as 65, 70 and 75 are common, after which point your policy will expire.
- Guarantees: Check the length of guarantees. Some companies may fully guarantee their premiums for the duration of the contract. Others may only provide guarantees for the initial level period. And yet other insurance companies may provide a guarantee of premiums charged for only the first 5 years of a 10 year term policy.
- Convertability: Circumstances can change. If you purchase a 10 year plan and later become uninsurable you will probably want to change your insurance to a permanent plan. Companies may offer a convertability option for their term life insurance policies. This allows you to switch over to a permanent product without underwriting. You should investigate whether your policy has this feature and if it does, what permanent products are available to convert to.