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Last Updated 10/5/18
Life insurance provides financial protection for loved ones should the policyholder die. Term life insurance provides coverage over a specified period of time of one or more years. Typically, term insurance policies are written for 1, 5, 10, or 20 years, or to a specified age (such as 65). Term policies only pay a death benefit to the beneficiary if the policyholder dies during the specified term. Thus, term insurance is best suited for policyholders desiring pure insurance protection with no need for creation of a cash value which may be borrowed against to fund college expenses or other short-term financial needs.
As with all life insurance policies, an insurer can only cancel a term insurance policy for non-payment of premium, regardless of health status during the contract’s specified period. In contrast to permanent insurance, term insurance does not build up cash values or have loan values. However, they may include rights to convert to a permanent life insurance policy during a specified period.
Term insurance has the advantage of being more affordable than permanent insurance, particularly in the early policy durations. Thus, it is often the best option for policyholders seeking the highest death benefit amounts at the lowest premiums. Term insurance is a good choice when the policyholder needs protection for a temporary time or for a specific need. Unlike permanent insurance, term insurance has no cash value component, making it a more straight-forward and easy to understand product. The market for term insurance is also highly competitive, with many different term policy varieties and features from which to choose.
Types of Term Insurance Policies
One of the most common term policies sold is level term insurance. Level term insurance policies are characterized by their level policy face amounts over the contract term period, usually 10, 20, or 30 years. The death benefit amount is guaranteed to remain level during this time, regardless of the insured’s health status. Premium amounts are usually guaranteed to remain level for a specified period of time. After the specified time, premiums usually rise to reflect the wearing away of the underwriting selection period and the additional risk due to the insured’s more advanced age. The ability to keep death benefits and premiums level for an extended period of time can be advantageous to a growing family with young children.
In contrast to a level term insurance policy, the policy face amount under a decreasing term insurance policy reduces over the term of the contract. Thus, the death benefit paid to the beneficiary shrinks with the age of the contract term. The premium, however, usually remains level each year, but can be lower later in the contract term. Most policyholders use decreasing term insurance to cover financial obligations that decrease over time, such as a mortgage.
Renewable term insurance guarantees the policyholder the right to renew at the end of the contract period without evidence of insurability. These policies can be renewed annually, within a defined number of years (such as 10), or until a specified age. The policy automatically renews as long as the policyholder continues to pay the premium due. It should be noted annual renewable term life insurance is a one-year contract. The face amount and the premiums paid for the face amount remain unchanged within the contract year. Death benefits are only paid out if the policyholder becomes deceased within the contract year. However, premiums in the next renewal year are usually higher to reflect the policyholder’s older age. Renewable features are important, as they ensure coverage remains in place during key years regardless of health status.
Convertible term insurance allows the policyholder to convert a term insurance policy to a permanent insurance policy. Policies with conversion features are particularly well suited for policyholders with growing young families. They provide affordable protection during the early years and the option to convert to a permanent insurance product that will build cash values in later years. This conversion is allowed within a timeframe or up to a specified age, as defined in the contract. The insurer will examine the policyholder’s health status during the initial term policy enrollment. However, no further evidence of good health is required at the time a policyholder choses to convert to a permanent policy. Typically, the face amount of the permanent insurance policy is equal to the face amount of the original term insurance policy. However, premiums are higher to reflect the additional cost of building up cash value for the policy.
Term insurance policies can also have a Return of Premium (ROP) feature. This feature can be included as an additional provision within the contract or as a rider to the policy. The ROP feature refunds part or all of the premiums paid at the end of a level term period if death benefits are not paid out. Premium refunds do not reflect the time value of money. Policies with this feature are more expensive because the policyholder has the ability to receive cash back. Thus, a ROP feature may be best suited for younger policyholders who qualify for the lowest rates and are likely to outlive their contract term. This feature may also appeal to policyholders who are looking for a more affordable alternative to permanent life insurance. Policyholders can use the return of premium to help fund college or retirement needs, while still receiving life insurance protection through the end of the ROP period.
How much to buy?
Determining how much life insurance protection is needed will depend on each policyholder’s individual financial needs should he or she become deceased. Specific calculations of policyholder needs and determination of term length can be based on a policyholder’s anticipated financial expense obligations. Another method includes basing need on replacement income—or the amount of the policyholder’s income needed to sustain the family’s same standard of living should the policyholder become deceased. This is calculated as the present value of all future income streams needed. In general, insurers suggest a policyholder will need between 5 and 7 times their annual gross income.
Life insurance and annuities are regulated by state insurance commissioners. The NAIC encourages states to adopt model laws and regulations designed to inform and protect insurance consumers. The NAIC Disclosure Model Regulation requires insurers to deliver to purchasers of life insurance information that will improve the buyer's ability to select the most appropriate plan of life insurance for the buyer's needs and improve the buyer's understanding of the basic features of the policy that has been purchased or is under consideration. The NAIC Life Insurance Illustrations Model Regulation provides rules for life insurance policy illustrations that will protect consumers and foster consumer education. The NAIC Consumer Credit Insurance Model Regulation protects the interests of debtors and the public by providing a system of rate, policy form, and operating standards for the transaction of credit life insurance.
The NAIC Life Insurance Illustration Issues (A) Working Group, created in 2016, continues to explore how the narrative summary required by Section 7B of the Life Insurance Illustrations Model Regulation (#582) and the policy summary required by Section 5A(2) of the Life Insurance Disclosure Model Regulation (#580) can be enhanced to promote consumer readability and understandability. This includes how they are designed, formatted and accessed by consumers. The Working Group is currently discussing draft proposals on how to amend Model #580 and Model #582 to incorporate a policy overview requirement that encourages (not mandates) the use of a template by providing a safe harbor if the template is used.
The NAIC Life Actuarial (A) Task Force was formed to identify, investigate and develop solutions to actuarial problems in the life insurance industry. After adoption of the Standard Valuation Law (#820) by 46 states representing 87.5% of industry premium prior to July 1, 2016, the Valuation became operative on January 1, 2017. The Task Force recently adopted revised Generally Recognized Expense Table (GRET) factors for 2019. Additionally, work is continuing on mortality tables for valuation and minimum nonforfeiture requirements for simplified issue forms of life insurance.