The ‘term’ of a policy is the number of years that the policy’s insured is covered with a specific ‘face amount,’ or amount of principal payable to the policy’s beneficiary in the event the insured dies within the policy’s term. Policy terms can range from 10 years to 30 years, or longer.
Term life coverage expires once the term has ended and can either be renewed for an additional term or be allowed to expire. Assuming death has not occurred, the policy simply ends and the insurer assumes no further responsibility to the policyowner or beneficiary. It is common for a term life policy to be renewed for additional terms, or converted to a whole life or other cash value policy.
Guaranteed vs. Non-Guaranteed Level Premiums
Term life policy premiums are based on the insured’s age, tobacco use, and health at the time of application. Once issued, a term policy’s premium rate is either guaranteed to remain constant, or ‘level’ for the entirety of the term; or the policy’s premium rate is non-guaranteed, which enables the insurer to increase the premium rate during the contract period.
A guaranteed level premium policy is most commonly purchased. This type of policy calculates the total premium payable for the term of the policy and divides payments evenly to keep the premium rate level over the policy’s term.
A non-guaranteed level premium policy might provide for a lower premium initially with the possibility of a rate increase after a set period of time within the policy’s term.
Indeterminate Level Premiums
A term life policy can also include an ‘adjustable premium’ schedule which is indeterminate at the time of policy issuance and can fluctuate over the term of the policy. The policy’s premium rate is determined by the insurer’s current mortality rates, interest earned from premium investments, and company expenses.
Policy premiums are guaranteed to never exceed a certain amount; however, if the insurer’s profits are greater than at the time of policy issuance, the ‘current’ premium will be lower than at the time of issuance. If profits are lower, the premium will be higher than at the time of issuance, but the premium will not exceed the policy’s guaranteed maximum rate.
Types of Term Life Insurance Policies
In addition to the premiums paid for a term life policy, benefits provide from the policy can also vary. The policy’s face amount can remain level, it can decrease, or it can increase over the term of the policy. In addition, term life policies can provide a policyowner with the option to renew, purchase additional coverage, or convert to a whole life policy in the future.Level Term
A level term life policy’s face amount remains constant, or ‘level,’ for the term of the policy. The only aspect that changes, if renewed, is the increase in premium due to the increased age of the policyowner.
Decreasing Term
A decreasing term life policy’s face amount decreases over the term of the policy. For instance, a decreasing term insurance policy with a face amount of $100,000 and a 10-year term will provide the full $100,000 of coverage if the insured dies within the 1st year, $90,000 of coverage the 2nd year, and so on until the benefit amount reduces to zero at the end of the 10 years.
This type of coverage is often purchased to protect against home mortgages, student loan debt or any situation in which the need for insurance is greater at the beginning of the policy, as opposed to the end of the policy.
Increasing Term
In comparison, an increasing term life policy’s face amount increases over the term of the policy. Although this type of policy is not often sold as a stand-alone insurance product, it is typically incorporated into a whole life policy as an added rider.
Special Features of Term Life
RenewableA renewable term life policy does not require evidence of insurability at the time of renewal; however, premium rates increase according to the age of the insured at the time of each renewal. This type of premium rate increase is often called Step-Rate Premiums.
Re-entry Option
An option that allows an individual to reapply for, or ‘reissue’ his or her term life policy every few years (usually 5 years) and receive a premium lower than their guaranteed renewal rate. However, in order to receive this lower rate, evidence of insurability must show that the policyowner is maintaining good health. If not, the policyowner will instead have to pay the guaranteed renewal rate if they want to continue their coverage.
Convertible
A term life policy can also be ‘convertible,’ meaning that a policyowner can convert his or her term policy to a whole life or other cash value policy in the future without being required to provide evidence of insurability. The ‘option to convert’ is provided to the policyowner who may or may not elect to convert to a long-term policy in the future.
When converting to a long-term plan, the policyowner can use either his or her current age, referred to as his or her ‘attained age,’ or the whole life policy can be written using the original age of the policyowner used at the beginning of the original term policy. If a policyowner’s original age is used when converting to a whole life policy, he or she will pay a lower premium based on the younger age in comparison to his or her current age; however, the insurer will require interest to be paid, as well as an additional payment amount equal to the difference in age that the insurer would normally charge for a policy written using the current age of the policyowner.
Although both methods of conversion seem to add up to the same amount for the policyowner, instead of incurring a higher premium, the policyowner is actually building up his or her cash value quicker than would occur if he or she paid a higher premium using his or her current age. Essentially, instead of paying a higher premium, the policy’s cash value increases quicker as a result of the bulk payment and increased interest.
Interim Term
A type of convertible term policy, referred to as an Interim Insuring Agreement, is commonly provided by insurers to ensure immediate temporary term life protection during the underwriting of a whole life policy. Referred to as ‘interim term’ coverage, an individual who wishes to purchase a whole life policy in the near future, or who is waiting for his or her whole life policy to be underwritten by the insurer, may be temporarily covered under a term policy which is then automatically converted to a whole life policy within a short period of time.
An interim term policy is commonly issued for a period of 1 month up to 11 months, at which time the policy automatically converts to a whole life policy. As a result of this short period of time before conversion, premiums for the whole life policy are based on the age of the policyowner when the interim policy converts to the whole life policy, not the age of the policyowner at the time the interim term began.
Return of Premium (ROP) Term Life Policy
A Return of Premium Term Life, or ROP, policy is a more expensive type of term life insurance that provides an ‘end benefit’ to the policyowner at the expiration of his or her policy’s term by returning 100% of the premiums paid into the policy when the insured survives the policy’s term.
For example, if an insured survives past a 35-year return of premium term life policy and the policyowner does not surrender it beforehand; the policyowner would receive 100% of the premiums paid into the policy upon the insured satisfying the 35-year term.
Although a return of premium provides extra incentive to purchase, deciding to purchase an ROP term life policy should be considered carefully as the extra premium costs involved might be better invested in an interest-bearing retirement account, such as an IRA.
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