3.2 Term Insurance
Characteristics of Term Life Insurance
Term life insurance is considered pure insurance because it provides only a death benefit. It does not accumulate cash value and does not offer living benefits. Premiums paid under a term policy purchase protection only; no portion of the premium is allocated to savings or investment components. As a result, term insurance typically has a lower initial premium compared to permanent life insurance policies.
Term insurance provides coverage for a specified period. The term may be as short as one year or extend for a defined number of years, such as 5, 10, or 20 years. Coverage may also be structured to remain in force until a specified age, such as age 65. During the stated term, premiums are generally level and reflect the average mortality risk over that period.
The policy expires either at the end of the stated term (e.g., 10-year term) or upon reaching a specified age (e.g., term to age 65). If the insured dies during the coverage period, the face amount is paid to the designated beneficiary. If the insured survives the term, no benefit is payable unless the policy includes a return-of-premium or other rider.
Although initial premiums are relatively low when the insured is younger, costs increase upon renewal because premiums are recalculated based on the insured's attained age. As the insured ages, renewal premiums can rise significantly.
Term insurance may be purchased as a standalone policy or added as a rider to a permanent policy to meet specific financial needs. Premium rates are determined by underwriting classification, age, gender, and the length of the coverage period. Generally, longer level-term periods (e.g., 10 years) carry higher premiums than shorter terms (e.g., 5 years), reflecting the extended duration of guaranteed protection.
Types of Term Policies
Level Term: A type of term life insurance in which the death benefit remains constant for the entire duration of the policy term. The premium is also fixed (level) throughout the specified coverage period, providing predictable cost and consistent protection.
Decreasing Term: A form of term life insurance in which the death benefit gradually declines over the policy term, while the premium remains level. This type of coverage is commonly used for mortgage protection, as the face amount decreases in proportion to the outstanding loan balance. If the insured dies during the term, the policy proceeds can be used to satisfy the remaining mortgage debt. Because the death benefit reduces over time, premiums for decreasing term policies are generally lower than those for comparable level term policies.
Credit Life Insurance: A specialized form of decreasing term insurance designed to protect a lender against the risk of a borrower's death. Unlike a standard decreasing term policy, credit life automatically designates the creditor as the beneficiary. The amount of coverage may not exceed the outstanding loan balance, since the creditor's insurable interest is limited to the amount owed. As the debt is reduced, the policy's face amount decreases accordingly, and coverage terminates once the loan is fully repaid.
Although credit life insurance may be issued as an individual policy, it is most commonly offered on a group basis to creditors such as banks, finance companies, or retailers that extend installment credit. Upon the borrower's death, the policy pays the remaining balance of the debt, subject to any policy limits.
Common debts covered by credit life insurance include:
- Personal loans
- Installment loans for appliances, automobiles, mobile homes, or farm equipment
- Educational loans
- Bank credit and revolving loan arrangements
- Mortgage loans and similar real estate financing arrangements
Increasing Term: A form of term life insurance in which the death benefit gradually increases over the policy term, while the premium remains level. This type of coverage is commonly added as a rider to a base policy and is often used to address inflation concerns or to provide benefits such as cost-of-living adjustments or return-of-premium features.
Annually Renewable Term: The most basic form of term life insurance provides coverage for one year at a time. The death benefit remains level, but the premium increases each year as the policy renews, based on the insured's attained age. Coverage may be renewed annually up to a specified maximum age.
Annually renewable term is typically very inexpensive at younger ages compared to other types of life insurance. However, because premiums increase each year, the cost can become significantly higher over time. The insurer pays the face amount to the designated beneficiary if the insured dies while the policy is in force.
Re-Entry Term Option: A feature available on certain term life insurance policies that permits the insured to renew coverage at the end of the original term based on attained age, with the opportunity to qualify for a reduced premium rate by providing evidence of insurability.
Under a standard annually renewable term policy, coverage renews automatically each year as long as premiums are paid, with rates increasing based on attained age and without requiring proof of insurability. In contrast, the re-entry option allows the insured to demonstrate continued good health in order to obtain a lower renewal rate than the standard renewable term premium. If the insured does not meet the underwriting requirements, renewal is still permitted, but at the higher guaranteed renewal rate.
Special Features
Renewable Term: A provision that allows the policyowner to continue coverage at the end of the policy term without providing evidence of insurability. The policy may be structured as a 1-year (annually renewable), 5-year, 10-year, or 20-year renewable term contract, typically renewable up to a specified maximum age.
At each renewal, premiums are recalculated based on the insured's attained age and will increase accordingly. The ability to renew without proof of insurability is a significant feature, as it protects the insured from losing coverage due to declining health. Without a renewable provision, an insured who experiences health deterioration may be unable to obtain new coverage or may face substantially higher premiums.
Some level term policies also include a renewable option, which may require an additional premium to secure the renewal privilege.
Convertible Term: A provision that grants the policyowner the right to convert an existing term life insurance policy to a permanent life insurance policy during a specified conversion period, without providing evidence of insurability.
Upon conversion, the premium for the permanent policy may be calculated based on the insured's attained age at the time of conversion or the original issue age, depending on the terms of the contract. Because permanent policies include cash value accumulation and are designed to provide lifelong coverage (often to age 100 or beyond), the premium will be higher than that of the original term policy.
If the conversion is based on the original issue age, the policyowner must pay the difference in premiums (plus applicable interest) that would have been paid had the permanent policy been issued at that earlier age.
These optional features—such as renewal and conversion privileges—are most commonly available with level term insurance policies and generally require an additional premium. As a result, a term policy that includes both renewable and convertible options will typically cost more than a basic level term policy without these features.
Quiz
1. Which statement best describes term life insurance?
A. It accumulates cash value that may be borrowed by the policyowner.
B. It provides lifelong coverage with fixed premiums.
C. It provides pure death benefit protection for a specified period.
D. It guarantees dividend payments each year.
Correct Answer: C
Rationale: Term life insurance is considered pure insurance because it provides only a death benefit for a specified period. It does not accumulate cash value or provide living benefits, which helps keep initial premiums lower than permanent insurance.
2. Under a decreasing term policy, which of the following remains level during the policy term?
A. The death benefit
B. The premium
C. The cash value
D. The policy loan balance
Correct Answer: B
Rationale: In decreasing term insurance, the death benefit declines over time (often matching a decreasing mortgage balance), while the premium remains level throughout the policy term.
3. Credit life insurance differs from standard decreasing term insurance because:
A. The insured selects any beneficiary.
B. It builds cash value over time.
C. The creditor is automatically named as beneficiary.
D. The coverage amount increases annually.
Correct Answer: C
Rationale: Credit life insurance automatically names the creditor as beneficiary and covers only the outstanding loan balance. The coverage decreases as the debt is repaid and cannot exceed the creditor's insurable interest.
4. What is the primary advantage of a renewable term provision?
A. It guarantees level premiums for life.
B. It allows the policyowner to renew coverage without evidence of insurability.
C. It provides automatic cash value accumulation.
D. It prevents premiums from increasing at renewal.
Correct Answer: B
Rationale: A renewable provision allows the insured to continue coverage at the end of the term without proving insurability. Although premiums increase based on attained age, the insured cannot be denied coverage due to declining health.
5. Which statement is true regarding a convertible term policy?
A. The insured must provide evidence of insurability to convert.
B. Conversion always results in lower premiums.
C. The policyowner may convert to a permanent policy without evidence of insurability during the conversion period.
D. Conversion eliminates the need to pay future premiums.
Correct Answer: C
Rationale: A convertible term provision allows the policyowner to convert to a permanent life insurance policy without evidence of insurability during the specified conversion period. Premiums will be higher because permanent insurance includes cash value and extended coverage.