Perhaps the most affordable way to provide for the financial security of loved ones is by purchasing term life insurance. It's a policy that's oftentimes described by insurance carriers as protection for those that cannot afford permanent insurance. That's because, by nature, term life insurance is usually guaranteed for intervals such as 10, 20 or 30 years.
Features of Term Life Insurance
Insurance companies also like to downplay the value of term policies because it's the most efficient form of life insurance sold. These policies are not nearly as profitable as whole life and universal life insurance. With a term life insurance policy, nearly the entire premium is used to pay for the cost of the underlying benefit.
Cash Balances and Value
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Term insurance is designed to offer a one-time benefit. Unlike whole life and universal life policies, term does not have a cash value associated with the policy. The cash value is often guaranteed on many permanent insurance policies, and the money is available for withdrawal to pay for expenses such as a down payment on a new home.
Insurance Payouts
Another reason term life insurance is relatively inexpensive is the fact that most beneficiaries never receive a payout from their policies. Industry research indicates that only around 1% of all term life insurance policies ever pay a benefit.
This low benefit payout stems from the fact that most term policyholders are relatively healthy individuals that are looking for an insurance policy to protect the financial future of their families in the near term. Low payouts translate into relatively cheap premiums, which make these policies such an efficient way to buy this protection.
Supplementing Permanent Life Insurance
Even if someone decides they need the costlier features of universal and whole life policies, their portfolio might benefit from a term policy too. Since term insurance is so cost effective, and can be purchased over relatively short time intervals, it can be used to supplement other types of insurance.
For example, at certain times family obligations might be larger in terms of financial needs. A term life insurance policy is a good way to provide added security during those times. Since they're tied to a given timeframe, it's possible to purchase a policy that also matches the duration of the family need.
Risks
The one true risk that term insurance carries with it is the fact the policyholder might be uninsurable when the term coverage finally expires. This can happen due to the onset of an illness or a medical condition that developed as the policyholder aged. This might leave someone without life insurance when they need it the most.
Fortunately, some term life insurance policies automatically renew. Other term policies may offer a conversion feature that enables the owner to convert the term policy to permanent life insurance. If these features are important, make sure to speak with an agent so the options at the end of the contract are understood.
Purchasing Term Life Insurance
There are several important features worth evaluating before purchasing a term life insurance policy. One feature to consider is the difference between annual renewable term insurance and level term. A second feature has to do with what are called conversion privileges.
Annual Renewable Term Policies
Annual renewable term, or ART, is the simplest form of term life insurance someone can buy. With this type of policy, the insured is covered for a term of exactly one year. Premiums are based on the cost to supply life insurance for the next 12 months, and will very likely increase each year as the policyholder grows older.
Annual renewable term life insurance is arguably the most efficient policy anyone can buy because they're paying exactly what it costs to provide coverage for the next 12 months. However, as the policyholder ages, the likelihood of a benefit payout occurring rises, and therefore premiums can be very expensive.
Keep in mind the purpose of life insurance is to protect loved ones from a financial hardship. At the advanced ages we're talking about, most policyholders would agree that life insurance is no longer a necessity.
Level Term Policies
Level term policies are the most popular form of term life insurance sold today. As mentioned earlier, terms of 5, 10, 15, 20, 25 and 30 years can be purchased. Unlike ART policies, the annual premiums are exactly the same for each year the coverage is in effect, thereby making this approach less efficient than ART.
For example, let's say that a 30 year old purchases a 30 year term life insurance policy. Since it's more expensive to provide life insurance for a 60 year old (30 years from now), the overall cost of insurance will be factored into the carrier's estimated expense. Therefore, the policyholder will be overpaying the actual cost to provide insurance in the early years of the policy, and underpaying later on.
If the contract is held for all 30 years, the policyholder gets full benefit from these earlier overpayments. However, if for some reason they decide to cancel their policy, these early overpayments were excess profits to the insurance company. That is, the policyholder overpaid for their life insurance.
Conversion Privileges
Some insurance companies allow term life insurance policyholders to convert their policy into permanent life insurance. This conversion privilege usually applies to the early years of a term policy; after which it then expires.
The conversion feature is attractive to those individuals interested in purchasing permanent life insurance, but cannot afford the higher premiums. A person with a relatively young family can provide the necessary financial protection, and leverage the efficiency of a term policy early in life. Later on, as their family income grows, they can decide if they'd like to take advantage of the cash value features offered by permanent life policies.
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