- Term life insurance is the most affordable type of life insurance
- Whole life insurance offers a lot of benefits and flexibility but at a price
- Universal life insurance allows you to invest in a variety of funds
What is Term Life Insurance?
Term life insurance (most affordable product) lasts a specified number of years and pays out a death benefit if you die to your beneficiary (usually your family).
Understanding term life insurance
Getting the best possible life insurance policy can quickly become a hassle for many people due to their lack of familiarity with the terminology. Never fear! If you are one of these people (or even if you are not), you've come to the right place to find answers. In this article, we will take an in-depth look at what exactly is term life insurance, as well as everything you need to know before you decide to make a purchase.
Term life insurance is a form of life insurance that lasts a specified number of years (called the term) before it expires. If you die before the end of the term, your beneficiary (usually your family) receives a tax-free lump-sum death benefit that can be used for funeral expenses, to pay bills, or for any other purpose.
How term life insurance works
As the name itself states, term life insurance is an insurance policy that provides a policyholder (you) with coverage that lasts a specific number of years. In exchange for the coverage, you must pay a premium (most often fixed) for the entire duration of the term. To receive the benefit of the policy, the holder has to die during the term of the policy. If that does not happen and the policy's relevant term ends, the holder of the policy either stops paying and gets nothing or can renew the policy for another term. The policy is typically renewed with the same terms and conditions but with a higher premium rate.
As far as life insurance policies go, term life is pretty much the cheapest of all, with the most significant ratio of benefit to premium among all life insurance policies. It is the complete opposite of policies like whole life, permanent life or universal life where the policyholder pays a fixed rate of premium throughout his or her lifetime, and at the time of death, the beneficiaries receive a guaranteed benefit. Whole life policies can also be given a fixed lapse/maturity date, meaning that if the person does not die by that time, the policy will be considered complete and the benefit attached will be given to the holder of the policy.
Typical uses and applications of term life insurance
It is quite clear that the purpose of term life is not to make charitable donations or to be used in estate planning. As you may have noticed, we used the word application (singular)in the title because there is pretty much only one way that this policy is used. It is a very straight forward tool designed to protect any individual looking to secure the future of their dependents at a relatively low cost. The important aspect when choosing to purchase term life insurance is not to be looking for lifetime coverage. Let's use someone who purchases term insurance to protect themselves until retirement as an example. The policyholder is confident that if they survive until they retire, they will have accumulated sufficient wealth to provide for their children and other dependents after retirement. Therefore, eliminating the need for whole life or permanent insurance policy. Things that may be paid for With the death benefit of a term policy are children's college fees, a mortgage, outstanding debts, funeral expenses etc. The most frequent use of a term policy payout, however, is to replace the lost income of a primary caregiver or provider.
Due to its primary focus being to protect family income and the fact that the insurer may or may not have to pay (the death needs to occur during the term), it is relatively cheap. In comparison to other types of life insurance policies, and it is, therefore, a cost-effective choice.
Types of term life insurance
While term life insurance is the most fundamental, outspoken type of life insurance, there are still varieties on it so you can get the insurance policy that suits your requirements. These include:
- Level term life insurance
The premiums remain the same for the life of the policy. Learn more about level term life insurance.
- Annual renewable term life insurance
Renews on a year-by-year basis; premiums usually start lower than a standard term life policy and increase each year.
- Decreasing term life insurance
Premiums remain the same, but the benefit amount decreases each year.
- Return of premium term life insurance
Allows you to get your money back at the end of the term.
- No medical exam term life insurance
Allows you to skip the medical exam and still receive coverage.
- Group term life insurance
Offered through the workplace, but not portable from employer to employer.
- Mortgage term life insurance
A type of decreasing term insurance where the beneficiary is your mortgage provider and the term is pegged to your mortgage length.
Annual renewable term
The minimum amount of time for which a person can get term life insurance is one year. What this means is that after paying the premium for the year, the coverage will be in effect precisely one year onwards, not a day more. Therefore, if a person dies on the first day of next year, they will not be covered. Since the likelihood of death is low for practically anyone during the laps of a single year, it is infrequent for anyone to get insured for a single year.
Proof of insurability being a requirement to get reinsured, having to provide proof of health every time, can become quite a hassle, especially if one's health deteriorates. A particular form of term life insurance called annual renewable term is purchased. While the premium paid in this policy is for one year, the insurer and policy buyer come to a mutual agreement for a certain number of years where the buyer can get reinsured without requiring any additional proof of insurability. Typically, the period is set somewhere between 10-30 years. Still, sometimes, it can also be set for a more extended period, such as till the age of 90 or 100, making it equivalent in theory to a Whole life insurance policy. However, every year, the price of the premium increases, therefore becoming more expensive as the person ages'. There comes a time when the rates for this term based policy exceed the rates one would have paid if they had chosen a whole life policy initially.
The three main assumptions that are taken into consideration when an insurance company prices its life insurance policies are as follows:
- Mortality rate: This takes into account the number of individuals that will die during a year for a particular group of people. The size of the group is usually quite large, and actuarial calculations determine the statistics of expected deaths in the population. While different levels of government typically calculate these statistics, the real rates used by companies are always the ones they figure on their own. They take into consideration their history of mortality based on past customers to determine their rates.
- Assumed Net Investment Return: this is the amount of money the insurance company expected to earn by utilizing the funds received from premiums and interest earned.
- Administrative expenditure: this includes all costs related to the sale of the policy, including commissions of salespeople and processing expenses.
Knowing these factors can help us understand the different prices when looking to buy a term life insurance policy. It's the only type of life insurance where there is no cash value option included in the policy. Since the only benefit that a person can get is upon their death, the goal is to make sure you get the coverage you need while spending the least amount of money possible on premiums.
Level term life
This is the most commonly used type of term insurance since it guarantees that the premiums will remain the same for the duration of the chosen term. The length can be anywhere from 10 years to 30, even 40 years! The rule is quite simple; the longer the term, the higher the price will be since the company factors in higher future premiums and then creates an average value with current costs. The expected depreciation due to inflation of the value of money is also considered.
Just like any other long terms renewable policy, it is not a requirement for the holder of a policy to provide insurability proof upon renewal at the end of the term, however, if a person wants to increase their coverage upon renewal.
Then it might be possible that the insurance company will demand proof of insurance before adding a new term to the policy.
In most term insurance policies, there is an option to convert their level term policy into a whole life policy. This is useful when someone's financial goals change or when their budget increases and their health has deteriorated, allowing them to purchase a whole life policy without any proof of insurability.
Return Premium Life Insurance
Out of all types of term life insurance, the most expensive one is the one with the option to receive the complete return of all the premium paid by the policyholder. The way it works is that the buyer and the insurance company make an agreement that if he or she can outlive the period for which the policy is bought, then they will have the premiums paid returned to them. Since the company must refund an amount of the premiums paid, they charge a much higher rate to ensure that they maintain their profitability.
To conclude, buying a life insurance policy can often be a pain, especially for young families who are new to the whole process and looking for a safe and easy way to protect their family's livelihood in case of premature death. The most frequent problem expressed by young buyers is finding the time to sit down with a life insurance professional and going through the entire process. Services like Emma, an online life insurance company and independent broker make sure that you're able to make this decision with ease while sitting in the comfort of your home, without an agent breathing down your neck and making you nervous. The process is entirely online and can be done either by chat or by phone, making it easy to get the policy you always wanted for yourself and your family.