Level Term Life Insurance
Level term life insurance is the most popular variant of term insurance. Term insurance is the oldest and least expensive form of life insurance. Like other forms, it provides a tax-free death benefit to one or more beneficiaries upon the death of the insured. Its most basic form is called annually renewable term (ART), which adjusts premiums upward yearly to reflect the insured’s increased risk of dying. Level term life insurance attained its popularity by borrowing a feature of whole life insurance – premiums that remain constant, or level, for the term of the policy. By offering the combination of temporary insurance and level premiums, level term life insurance has become the insurance of choice for those seeking pure life insurance protection.
Details of Level Term Life Insurance
The defining feature of term life insurance is its temporary character. The underlying premise is that most insurance need is not permanent and has a clearly-defined duration. The most important single purpose of life insurance is to replace income earned by the insured prior to death. This need lasts only as long as the insured’s working life; it expires at retirement. A key component of the income-replacement need derives from the need to educate children. This need expires with graduation from college or graduate school. Similarly, the need to provide for long-term debt, such as a mortgage, expires with the liquidation of the debt.
Level term life insurance policies are offered for terms of 5, 10, 15, 20 and 30 years. In order to escape the remorseless yearly increase in premiums, level term life insurance imposes one level annual rate. (The annual rate can be broken up into monthly, quarterly or biennial payments.) This rate is an average of the ART rates that would apply over the term selected. That averaged rate also reflects the time value of money and is higher for longer terms. All types of life insurance employ the same mortality tables; ART and level term life insurance generate the same aggregate volume of premiums but do it different ways.
Like most forms of term insurance, level term life has no cash-value or investment component. Its purpose is starkly simple: pure diminution of mortality risk through the medium of life insurance.
Advantages of Level Term Life Insurance
The first advantage of level term life insurance is the most obvious – the privilege of paying a constant premium of the full term of the policy. This greatly simplifies financial planning. An important secondary advantage derives from the level premium feature. ART requires an annual appraisal of insurability as the basis for calculating mortality risk. Any unexpected change in medical status – due to a chronic or terminal illness, or an accident – would cause a premium increase. Level term life insurance transfers this risk from the insured to the insurance company.
These advantages have given level term life insurance an edge over ART. Level term life insurance also boasts the same advantages as regular term insurance over other forms of life insurance. Alternative types of life insurance generate a cash value, which requires the life insurance company to hold and manage reserves and incur additional administrative costs. The premiums and administrative costs of level term life insurance are kept as low as possible by the fact that the insured has no investment program and pays only for mortality risk.
Term insurance is also used in combination with permanent forms such as whole-life insurance. Companies frequently offer whole-life policies that can be supplemented by the addition of additional term insurance in the event that insurance need increases over the term of the policy. The likely sorts of increase in insurance need, such as childbirth, lend themselves to satisfaction via term insurance. Group term insurance also is easy to supplement in this manner.
Disadvantages of Level Term Life Insurance
The same features that make level term life insurance so desirable also constitute its major disadvantage. At the end of the term, an insured with a continuing insurance need must renew the policy at a premium rate reflecting higher age and increased mortality risk. Since the level term life insurance rate averages the sum of ART rates, which gradually rise each year, this new premium will be substantially higher than the previous one.
This drawback is important because it is likely to be relevant. An insured acquiring level term life insurance at (say) age 25 – a time of life when insurance need is at its apex – might purchase a 30-year level term policy. Even this longest of level terms will not last all the way to retirement age. Thus, the need to qualify for insurance and pay a higher premium is very likely to arise.
Some policies partly address this eventuality by guaranteeing the ability to renew the level term life insurance policy at a premium rate specified in the original contract. This rate will be an average of ART premiums beginning at a point 30 years later than the policy origination date. Once again, this feature transfers the risk of worsening health from the insured to the insurance company. Nonetheless, the renewal rate will be much higher than the original level rate. Moreover, the second term may or may not be the same as the initial 30-year term.
The level-premium feature has a drawback that would arise if the policy were lapsed; namely, that premium averaging causes higher premiums in the early years of the policy than would result with, say, an ART. Of course, one benefit of term insurance in general is that its lower premiums reduce the pressure to drop the policy.
Level term life insurance is the most popular form of pure life insurance protection because it substitutes a constant premium rate for the annual increases imposed by annually renewable term insurance. Not only does this aid the financial-planning process, it allows the insured to avoid the risk of worsening health over the term of the policy. Although the need to renew the policy and face a stiff premium increase is a drawback, this can be partially alleviated by a feature guaranteeing the ability to renew at a pre-specified rate.
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