Term Life Insurance Definition
Term life insurance is one of the most important and basic products any insurance agent or company can offer. But what is term life insurance, and how does it compare to other insurance options?
As one of the most common insurance products, term life insurance is offered by just about every national and regional life insurance carrier. Before selecting a company, make sure it is properly licensed to do business by visiting the state insurance commission for the state the policy will be sold. The state insurance commission will also be able to provide any information regarding current or recent legal or regulatory problems the company may be embroiled in. Also be sure to verify their most recent A. M. Best rating for financial security. A++ and A+ are the best ratings; steer clear of anything rated lower than a B+.
Term life insurance ranks among the oldest of insurance products. Although a primitive form of burial insurance was sold in Roman times, the modern concept of life insurance dates to 17th Century England, when a group of traders, ship owners and other businessmen met at Lloyd’s Coffee House in London to form the first modern insurance company. This group eventually evolved into the present-day Lloyd’s of London.
Term life insurance as we know it today is a direct descendent of these contracts. As its name implies, term life insurance covers an insured individual for a pre-determined amount of time. This term can be as short as one year or in some cases as long as 40 or even 50 years. Although the term can theoretically be any length of time within reason (longer-term life insurance products tend to become increasingly unavailable as one gets older), it is usually sold in multiples of five years.
One of the fundamental aspects of term life insurance is that it is a temporary life insurance program. At the same time, this is one of its most appealing features and most glaring drawbacks. It is appealing in that since it is not designed to stay in force permanently, insurance carriers are therefore able to charge much lower premiums for it than for comparable permanent life insurance products such as whole and universal life.
The temporary nature is a drawback in the sense that the insured usually outlives the term with nothing to show for it. While today this issue can be addressed by filling the gaps with a permanent life insurance policy, in the early days of the modern insurance industry – when term life insurance was the only option available – this presented a significant problem for both consumers and issuers, and led at least in part to life insurance obtaining a less-than-savory reputation among some.
Indeed this particular shortcoming eventually led directly to the development of permanent life insurance. Even today, over 90 percent of term life insurance products issued in the United States lapse before a death benefit can be claimed. Because of this, term life insurance remains and important and necessary product in its own right, but it is rarely sufficient on its own.
Comparison with Permanent Life Insurance
The two main differences between term life insurance and permanent life insurance – in the form of whole or universal life – are price and permanence. The various forms of whole and universal life are by definition permanent, that is they offer level premiums for life. As a result permanent life policies are invariably much more expensive than comparable term life insurance plans, both because they are designed to stay in force much longer and because they require funding for their cash value mechanisms, a feature term life insurance lacks.
Because permanent life insurance plans are so much more expensive than term life, often with premiums 10 times more expensive (or even more), it is often unfeasible to meet all of one’s life insurance needs strictly with permanent life insurance products.
Comparison with Annuities
Term life insurance is also somewhat comparable to annuity products in that both provide a death benefit. Annuities – particularly fixed annuities – can be comparable in price, or in some cases less in price, than a term life insurance policy.
However, there are nonetheless several stark differences between the two products. By design annuities are designed to provide a stream of income the policy owner cannot outlive. Term policies can provide benefits before death, but only in certain circumstances, namely term policies with the return of premium rider (ROP) or the accelerated death benefit rider.
For the most part, since term life insurance policies lack a cash value mechanism, they do not provide any benefit while in force. Because term life insurance products have no cash value, there are no fixed or variable options available with term life insurance as there are with annuities and permanent life insurance products.
Annuities do not have a predetermined death benefit, with any benefit based on the amount in the annuity at time of death. Therefore they do not require any underwriting unlike term and other life insurance policy options.
Use of Term Life Insurance Products
Term life policies are available in a wide variety of term lengths, ranging from as short as one year to as long as 30. There are longer term policies available up to 50 years, but these are specialized policies which are not widely available, and only then to younger individuals or even children. As a general rule, the shorter the policy term, the lower the premium. Longer term policies tend to become increasingly unavailable after age 45.
Term life insurance is best utilized as a temporary solution to provide for life insurance needs one does not expect to last for a lifetime. For example, the parent of small children may want to consider a 15- or 20-year term policy which would allow his or her children to go to college should an untimely death be met. A longer term policy, such as a 30-year, may be used for similar purposes with the goal of paying off a mortgage.
Term policies may be renewable at the end of the term, but usually only for one year at a time and at premiums based on the insured’s current age rather than age at original policy issuance. This invariably represents a significantly higher premium and one that increases from year to year. Therefore renewing a term policy should be considered only for short-term needs.
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