What is term life insurance and what does it mean?

The term life insurance, pure life insurance or term life insurance (in English) is a life insurance that guarantees the payment of a death benefit during a certain period. Once the term expires, the policyholder can renew the policy for another term, convert the policy to permanent coverage, or allow the policy to terminate..

How term life insurance works

The term life insurance has no other value than the guaranteed death benefit. There is no savings component like that found in a whole life insurance product. The purpose of this policy is to provide insurance to individuals in the event of loss of life.

This cash benefit can be used by the beneficiaries to pay for the insured’s funeral, debts with different creditors, mortgage debts, among others..

Term life insurance is not used for estate planning or charitable purposes. All premiums cover the cost of underwriting the insurance. As a result, term life premiums are typically lower than permanent life insurance premiums.

Characteristics of term life insurance

Term life premiums are based on a person’s age, health and life expectancy, which is set by the insurer. If the person dies within the specified term of the policy, the insurer will pay the face value of the policy. If the policy expires before the owner’s death, there is no payment. Policyholders can renew a term policy when it expires, but their premiums will be recalculated based on their age at the time of renewal.

Because it offers a limited-time, death-only benefit, term life insurance is often the least expensive life insurance available. A healthy 35-year-old non-smoker can generally get a 20-year policy with a face value of $250,000 for $20 to $30 a month. Purchasing a whole life equivalent will have significantly higher premiums, possibly $200 to $300 per month. Because most term life insurance policies expire before paying a death benefit, the overall risk to the insurer is less than that of a permanent life policy. Reduced risk allows insurers to pass cost savings on to clients in the form of reduced premiums.

Key information:

  • Term life insurance or term life insurance guarantees the payment of a death benefit to the beneficiaries of the insured during a certain period.
  • These policies have no value other than the guaranteed death benefit and do not have any savings component like that found in a whole life insurance product.
  • Term life insurance is based on the person’s age, health and life expectancy, which is set by the insurer.
  • If the insured dies within the term specified in the policy, the insurer pays their face value.
  • If the policy expires before the insured dies there is no payment of any kind.

Term life insurance example

George, 30, wants to protect his family in the unlikely event of his untimely death. He buys a $500,000 term life insurance policy at a premium of $50 per month. If George dies within 10 years, the policy will pay George’s beneficiary $500,000. Otherwise, if George does not die in his 40s, his term policy will have expired. If he chooses not to renew and subsequently dies, his beneficiary receives no benefit. If he decides to renew the policy, the new policy will base the premium on his current age of 40.

Given the nature of these policies, if an insured were diagnosed with a terminal illness during a term, after that term the individual would probably not be insurable, although some policies offer guaranteed reinsurability (without proof of insurability). Those features, when available, tend to drive up the cost of the policy.

Term life insurance premiums

The age, sex and health of the insured are the main determinants for the calculation of the policy premium. Depending on the nominal amount of the policy, a medical exam may be necessary. Other common factors are the insured’s driving history, current medications, smoking status, occupation, hobbies, and family history.

The premiums are fixed or leveled for the duration of the contracted term. However, the cost of insurance increases as the life expectancy of an insured decreases. At renewal, the policyholder will likely make a significant increase in premiums. Based on actuarial data, the median life expectancy in the United States is 78.86 years. Thus, a 20-year-old has a remaining life expectancy of 58.86 years compared to a 50-year-old with a remaining life expectancy of 28.86 years. The risk of taking out insurance for a 20-year-old is less than the risk of covering a 50-year-old.

Term life insurance tends to be the least expensive way to purchase a major death benefit based on coverage versus premium dollars over a defined period.

Interest rates, insurance company finances, and state regulations can also affect premiums. In general, companies often offer better rates at “break point” coverage levels of $100,000, $250,000, $500,000 and $1,000,000.

Three types of term life insurance

Term insurance offers three different options, depending on what each person needs.

  1. Fixed-term or premium-level policies.

They provide coverage for a specific period ranging from 10 to 30 years. Both the death benefit and the premium are fixed. Because insurance companies must account for rising insurance costs over the life of the policy, the premium is comparatively higher than that of annual renewable term life insurance.

  1. Annual Renewable Term (YRT) Policies

YRT or Yearly Renewable Term policies do not have a specific term, but are renewable each year without the need to present proof of insurability. At first, the premiums are low, but as the insured gets older, the premiums increase. Although there is no specific deadline, premiums can become prohibitive as individuals agemaking the policy an unappealing choice for many.

  1. Decreasing term policies

They offer a death benefit that decreases each year according to a predetermined schedule. The policyholder pays a fixed, level premium for the life of the policy. Decreasing term policies are often used in conjunction with a mortgage to match coverage with the decreasing principal of the mortgage loan.

Who will benefit from term life insurance?

Term life insurance is attractive to young couples with children. Parents can get large amounts of coverage at a reasonably low cost. On the death of one of the parents, the significant benefit may exceed the money invested.

They are also suitable for people who need specific amounts of life insurance. For example, the policyholder may calculate that when the policy expires, their survivors will no longer need additional financial protection or will have accumulated enough liquid assets to self-insure.

Term Life vs. Permanent Insurance

The choice between a permanent policy with a cash value insurance product, such as whole life coverage or universal life and term life coverage, depends on the circumstances and needs of the policyholder.

cost of premiums

Term life insurance policies are ideal for people who want significant coverage at a low cost.. Whole life customers pay more in premiums for less coverage but have the security of knowing they are protected for life.

While many buyers favor the affordability of term life, paying premiums over an extended period of time, and not having any benefits after term expiration, is an unattractive feature.

When renewing, term life insurance premiums increase with age, which can make the cost of new premiums very high. In fact, term life insurance renewal premiums may be more expensive than the permanent life insurance premiums that would have been written on the term life policy initially.

coverage availability

As noted above, unless a term policy has guaranteed reinsurability, the company may refuse to renew coverage at the end of a policy term if the policyholder develops a serious illness. Permanent insurance provides coverage for life, as long as premiums are paid.

Investment value

Some clients prefer permanent life insurance because the policies may have an investment or savings mechanism.. A portion of each premium payment is allocated to cash value, which may be guaranteed to grow. Some plans pay dividends, which can be paid into or held on deposit within the policy. Over time, the growth in cash value may be enough to pay the premiums on the policy. There are also several unique tax benefits, such as tax-deferred cash value growth and tax-free access to cash.

Financial advisors caution that the growth rate of a cash policy is often paltry compared to other financial instruments, such as mutual funds and Exchange-Traded Funds (ETFs).. In addition, high administrative costs often reduce the rate of return. However, the performance is constant and with tax advantages.

Other factors

Other factors to consider in this matter include:

  • Is the rate of return on investments attractive enough?
  • Does the permanent policy have a loan provision and other features?
  • Does the policyholder plan to have a business that requires insurance coverage?
  • Will life insurance play a role in the tax protection of a large estate?

Convertible Term Life insurance

Convertible term life insurance or convertible term life insurance is a term life policy that includes a conversion rider. The rider guarantees the right to convert an existing (or expiring) term policy into a permanent plan without having to go through underwriting or prove insurability. The conversion rider must allow you to convert to any permanent policy the insurance company offers without restriction.

Its main features are to maintain the original health assessment of the term policy at the time of conversion. Even if you later have health problems or become uninsurable. The premium base for the new permanent policy is your age at the time of conversion.

Of course, total premiums will increase significantly as this insurance is more expensive than term life insurance. The advantage is that approval is guaranteed without the need for a medical examination. Medical conditions that develop during term life cannot increase premiums. However, if you want to add additional clauses to the new policy, such as the long-term care clause, the company may require a partial or full subscription.

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