Understanding Term Life Insurance Policy Terms & Options
by Jim Tobin, CFP
If you are looking to shop for the best term life insurance policy you have landed the right place.
If you've ever listened to the radio for an extended period of time, you know that Term life Insurance commercials are the reason some people fell in love with the idea of commercial free radio.
So what is term insurance? And why are they always advertising on my radio?
While the basic premise of term insurance is straight forward, this page is meant to provide guidance on the "ins & outs" that are often overlooked when consumers shop for life insurance. For a really cool way to compare term carriers check out my friend Chis Huntley's rating tool.
What is Term Insurance?
Term life insurance is the most widely recognized (and advertised) life insurance product. Most term policies run for a period or "term" of 10-30 years.
Depending on the policy provisions, at the end of the term, the policy will either expire or offer the option to be continued as an annual renewable term or ART.
For a look at an interesting snapshot of how Americans use and view life insurance see the Life Insurance Market Research Association (LIMRA) survey.
How is term insurance priced?
The reason the best term life insurance policy underwriters look so closely at every detail of your health is that they are assessing how much risk your health poses to the company's profitability. The simple fact is that if you die too soon, they lose money. They get paid to limit that possibility.
With that simple premise of life insurance company's perspective in mind, it's worth noting that the process of applying for life insurance is virtually the same regardless of your existing health condition. So, whether your risk is a previous heart attack or recreational scuba diving the application process is the same.
In total, risk portion of the calculation is based on gender, age, health, lifestyle and any additional benefits offered such as conversion opportunities.
Is The price guaranteed?
The cost of term insurance is guaranteed for the length of the policy term.
So, if you purchase coverage for 20 years, the payment stays the same for all 20 years.
If you have the option to keep the policy beyond the 20 year period, it will adjust every year as an annual renewable term policy (ART). Annual renewable is generally not a situation you wish to be in as the payment increases may dangerous to your wallet.
What are the major benefits of term life insurance?
There are really three major benefits to the best term life insurance policies.
Cost: For healthy applicants, term life insurance is remarkably inexpensive. After all, a healthy 40 yr. old mom can get half a million bucks in protection for 20 years @ ~$28~ or the price of pizza for the family.
While applicants who are older or in less than great health will pay more, a term policy may still be far better than the alternative of passing without any life insurance.
Income/Debt Protection: for most people the hope is that the benefit received from a term policy is "piece of mind".
However, if you do meet an untimely end, your term policy will be there to provide income that you no longer will. It will also be there for debts like the mortgage on the family house or college tuition bills.
Some, but not all term policies have the option to convert to a permanent policy. This becomes important if your health declines, for ANY reason, during the conversion term of your policy.
Some policies allow conversion only in the first 5 years, others will allow conversion until the last day of the policy.
Further, some policies only allow conversion to specific permanent products, while others allow conversion to any permanent policy offered by the carrier.
What is the most affordable term length?
The answer to "what term is most affordable?" depends on your goal. If it's immediate cash flow- spending the least today- then it is hard to beat a ten year term. That healthy 40 year old mom would only pay $17/mo.
However, if your goal is to spend the least amount over a longer period of years (say, til age 60) then the 20 year term would be a safer bet.
While the dollar cost works out about the same if she were to get another ten year policy at age 50 -$38/mo, she would be gambling on getting the best health class again . This is a bad gamble as only about 10% of applicants wind up in the best underwriting class.
What is policy laddering?
Policy 'laddering" is a life insurance protection strategy that involves the purchase of multiple policies over multiple time frames.
For instance if our healthy 40 year old mom needed a $500000 policy now, but only 250 after age 50. She could take one policy for $250000 for 20 Years and one $250000 policy for 10 years.
This would get her the $500000 she needed for the first ten years, while only paying for what she wanted for the last ten. Using current rates, this strategy would save $3200 over the life of the policy.
What are the considerations when deciding on the best term life insurance policy?
If you are in excellent health and solely concerned with cost, it really can be that simple.
However, if you have any health concerns or want to know about conversion options, so called "non-med policies or financial strength of the carrier, you're better off speaking with an independent Agent.
When I refer to risk tolerance, I am speaking about the risks that a company is willing to take by offering insurance to an applicant.
Many carriers will not make any offer on an application if the applicant has a specific health or lifestyle condition they are not comfortable underwriting.
For instance if you are a sky diver, you will have more limited options than a school teacher.
Pretty obvious, I know. But, you have to take the opportunity to get skydiving images in when you can!?
Financial Strength Ratings for the best life insurance companies
Simply put, they are well run and can pay their debts.
There are occasions where the only option to get coverage is to use a lower rated (or unrated) carrier.
Typically, a Low/No rating carrier situations come up with so called "final expense" policies. These are immediate issue, small face amount policies with no exams.
Like beauty, convenience is in the eye of the beholder. Speed of coverage, avoiding needles, a phone call that gets picked up by a human being...these things all have unique values to different people.
I hope this guide has left you with the conclusion that , done right, term life insurance can be a super deal.
I also hope that you came away with an appreciation that the details really do matter. From price and underwriting to conversion options and convenience, knowing what you want is half the battle.