Term Life Insurance Basics

A close look at this popular low cost life insurance product.

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Term life insurance provides the largest immediate death benefit for the minimum premium dollar. When compared to traditional whole life policies, term life insurance is substantially cheaper. Its reasonable rates allow for the purchase of much larger coverage than can be afforded from permanent life insurance. Term insurance covers you for a specified period of time, usually 5, 10, 20, or 30 year periods. As the name implies, term insurance is temporary, for a set period of time. Unlike universal or whole life insurance it does not accumulate cash value.

When planning for your families financial future it’s important to keep in mind that term life expires and it is possible to outlive your policy. If you’re looking for permanent insurance that builds cash value whole life insurance may be the answer for you. Term life insurance on the other hand is often referred to as pure insurance protection because it builds no cash value. Its primary purpose is to provide for the financial responsibilities of the insured in an affordable manner.

Determining How Much You Need

There are several methods used to calculate an individual’s need for life insurance. They include but are not limited to, rule of thumb, human life approach, and needs based approach.

Rule of Thumb
The most agreed upon rule of thumb is that an individual should be insured for about 10 times his or her annual salary. If the insured makes $50,000 a year, a policy in the amount of $500,000 would be appropriate. This is the simplest of all the methods for obvious reasons.

Human Life Approach
This method determines what your economic contribution to your family would be over your expected lifetime.

Needs Approach
The most comprehensive method. All upcoming expenditures are reviewed to determine the amount of insurance needed. Total assets are subtracted from the total financial obligations to determine the amount of life insurance needed. These obligations commonly include mortgage payments, future educational expenses, future income for family, funeral expenses, and more.

Types of Term Life Insurance

After settling on a suitable policy amount it’s important to find the type of policy that is best for you.

Term or Straight Term
The amount of death benefit you purchase remains uniform for as long as the policy is in force. The premiums also stay the same for the life of the term chosen. Level term is by far the most popular types of term insurance.

Decreasing Term
The amount of death protection you purchase decreases over time, but your premiums stay level throughout the term of the policy. Decreasing term is typically purchased by those who expect their insurance needs to diminish over time. Some examples would be to cover a mortgage or a business loan. Both of which would have decreasing obligations over time. Families with younger children often utilize decreasing term insurance; as the children age the need for insurance diminishes up until they leave the nest.

Annually Renewable Term
The amount of death protection you purchase will stay the same, but your premiums increase every year. These policies are typically purchased by younger individuals looking for an inexpensive policy when they’re young, but as they age the premiums become more costly.

Convertibility Privileges
Many term life insurance policies offer a convertibility privilege. This is a nice feature that allows you to convert your term policy to permanent life insurance for an equal, or lesser amount of coverage. The big benefit to this is that you can do so without any evidence of insurability. With no required medical exam you could complete the conversion, even if diagnosed with a terminal illness. Insurance companies often hedge against this by establishing a maximum age.

Buy Sell Agreement

Term insurance is often purchased by business associates to cover anything from a deceased partner’s share of a company to outstanding debts. This is often referred to as a “buy sell agreement“. This binding contract is negotiated between key business partners and covers future ownership issues. It is also utilized for key employee insurance. This is designed to protect the company against the hardship that may result from the possible loss of a valuable contributor. Key employee insurance is very common in small businesses where there are a small number of employees and the loss of a “key” employee could prove detrimental to the business.

Return of Premium Life Insurance (ROP)

Would you like term insurance that refunds your money if you don’t die? Well now you can—it’s called Return of Premium Life Insurance. One of the biggest objections to buying term life insurance is that people see themselves outliving the specified term and often think of the premiums as wasted money. The insurance industry has answered that objection with the recent introduction of Return of Premium term life insurance.

Return of Premium or ROP combines the benefits of traditional term life insurance with a return of premium feature. Simply put your family receives a lump sum death benefit if you die, otherwise if you win your bet with the insurance company and you live the insurer returns all your premiums. This money-back guarantee can be particularly comforting for those that believe death will not occur during the term of coverage.

What’s the catch? Well it does come at a cost. Since the insurance company is obligated to pay you back at the end of your term, Return-of-Premium life insurance does cost more than regular term insurance. A typical ROP policy may cost approximately 25 percent to 50 percent more than standard term life insurance. And policies typically have to be held for the 10 to 30 years to receive a return of all premiums, though many insurers offer a pro-rated return if held for a few years. In some cases taking the extra premiums that would have been paid and applying them to a disciplined investment approach may provide more flexibility.

Conclusion

Without a doubt straight term offers the best bang for the buck of all the life insurance types. Combine that with the fact we’re living longer healthier lives and you’ve got a pretty attractive arrangement. The number of deaths in individuals age 25 to 44 has decreased significantly over the past ten years, resulting in individual life insurance premium price drops of 5 percent on average since 2000, according to the Insurance Information Institute. Making term life insurance more affordable than ever.

Term life insurance may be one of the best deals in town, but it pays to shop around when looking for a term insurance quote. You’ll want to find a qualified agent that isn’t tied to just one single insurance company. This provides you with the ability to choose the most competitive rate from a number of high rated carriers. It is highly recommended that you choose an “A” rated company or higher. After all you’ll want your insurer to be around when you’re 20 years into your policy. You can check the insurers rating at A.M. Best or Moody’s.