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Term Life InsuranceAs its name implies, a term life insurance policy provides insurance protection for a finite time period. Term periods typically range from one to twenty years.
If after the term expires the lapsed policy is replaced with a new policy, there will be a new two-year period during which the insurance company can contest the policy for any misstatements found in the policy application. There is also likely to be a new 2-year suicide clause as well.
With term insurance, policy premiums increase yearly because the odds of death increase with age. Some term policies also offer a guaranteed level premium for the term period (usually 5, 10, 15 or 20 years), but when the term period expires the premiums for future terms can increase dramatically, depending on the health of the insured.
Another popular feature which is available with many term policies is a “conversion privilege”. This rider allows the insured person to convert the term policy to a permanent insurance policy prior to its expiration without demonstrating insurability. Of course, if the conversion privilege is exercised, the premium from that point forward will increase to an amount which is commensurate with a permanent insurance contract at the insured’s attained age as of the date of conversion.
As is the case with all types of life insurance policies, the proceeds paid at the insured’s death under a term insurance contract are not income taxable to the policy’s designated beneficiary. Insurance proceeds can escape estate taxation as well, provided the proceeds are not payable to or for the benefit of the insured’s estate, and provided the insured does not possess a “incident of ownership” with respect to the policy within 3 years of his or her death.
The principal advantage of term insurance as compared to other types of life insurance is its short term cost. Generally speaking, term insurance will have the lowest cost over the initial years of the contract when compared to other types of insurance. The administrative expenses associated with the acquisition of a term insurance policy (such as commissions) are also significantly lower than with other types of policies. As a result, term insurance is most appropriate when there are cash flow limitations and a significant amount of death benefit required.
These situations include:
When insurance is needed by a young family with a limited budget;
When insurance is needed to secure individual or business debts;
When corporate insurance is needed (for buy-sell agreement funding, key person insurance, etc.) but corporate cash flow is tight due to low profit margins, expanding operations, etc.
The principal drawback associated with term insurance is that term insurance is often more costly over the long haul since the premiums for a term policy can increase dramatically as the insured ages. As a result, over 90% of term policies are allowed to expire before the insured dies. [ Based upon actual actuarial experience of a major North American mutual life insurance company.] An additional potential drawback is that many insurance companies provide for more favorable underwriting for whole life and universal life insurance contracts than they are willing to provide for term insurance policies. As a result, term insurance may be less attractive for some clients with health problems.
