What is term insurance, and why would you buy it?

Let’s say you buy a $500,000, 20-year level term policy, and the best premium you qualify for is $500 a year. This policy will pay your heirs $500,000, income tax free, if you die anytime during the next 20 years, whether that occurs tomorrow, or 19 years and 364 days from now.  And the premium will always be $500 a year.  This is a great bargain if your sudden death sometime in the next 20 years would cause a financial hardship to your heirs.  But that is extremely unlikely to occur (unless you are very old or extremely ill, in which case the premium would not be $500.  It would be more like $100,000, and most likely not make sense.)

Assuming that this is all you want, you should buy, (from an “A” rated carrier), the least expensive policy you qualify for.  There is no point in paying more. If you live past 20 years, it will be worth nothing, and if you need cash before the 20 years are up, it will provide you nothing.  It is a simple contract: pay the premiums on time, and die within the “term” (in this case, 20 years), and somebody you designate collects the death benefit (in this case, $500,000), income tax free. It is a great financial return, under the worst of all possible conditions—your death.  That’s why I call this “God forbid” or “death insurance” insurance—in the unlikely and tragic scenario that you die within 20 years, your family gets some money.  

Some term policies have an annually increasing premium.  These are great for when you will only need the policy for a few years, and you are 100% certain that after those few years, you will not need or want the coverage. This situation rarely arises, but many people are suckered into these policies by agents promoting the low premium in the early years.  For a few years, it makes sense, but after that, the annual increase in premium makes these bad financial products.  Surprisingly, many agents are successful in selling these policies, often as “term to 80” policies.  Their strategy is that they hope they that in a few years that the dramatically rising premiums will serve as an impetus for you to convert your policy to a “permanent” policy, which carries a much higher level premium and the promise of the possibility of access to cash while you are still alive.  The problem is that these “sucker” term policies are only convertible to certain types of policies, which are invariably policies you would never voluntarily elect to buy in the first place, because they are expensive and inferior to most other options that you would have considered.  

What most people fail to understand is how the conversion from term to permanent policies works, and that is too complicated to explain here. Just know that if you plan to convert a term policy, read about the details, in the policy specification form or the company produced literature, which tells you all the details.

(Note of clarification: Some term policies may allow you to draw down on a portion of the death benefit if you are certified as being terminally ill, and about to die.  This happens rarely, and it is one of two ways that you may a payout on a term policy when you are alive.  Also, nearly all term policies allow you to continue coverage after the initial term, at a dramatically higher premium. Usually, this only makes sense if you are diagnosed as having just a few more years to live.  Again, this rarely happens, so, as a rule, do not expect a payout from a term policy unless you are unfortunate enough to die during the term.)

Some term policies give you the right to convert to a variety of permanent policies for a number of years, (at whatever rate is then in force for a person at your attained age), at the same health class as you were originally.  If you stay healthy, and nothing changes, this is immaterial—you don’t need to convert from term to permanent, you just go buy a permanent policy.  But for many people, the passing of 10 or 19 years will affect their health, and insurance companies may assign you to a higher, more expensive, risk class.  But if your health does deteriorate, and you have the conversion option, they have to sell you a policy at a better rate than you would actually qualify for.

The catch is that your right to convert is limited to products offered by that company, which vary in quality, selection, and value from company to company.  Unlike term insurance, permanent insurance has many features, benefits, and options that make some more desirable than others. The payout at death will also vary widely, even if two policies from two companies start out at the same initial death benefit.  And the options and consequences of taking money out when you are alive also vary.

So if you intend to switch to a permanent policy, which has value while you are alive, at some point in the future, you will definitely want to pay a little bit more for a term policy now, with a company that has the product you want to buy later.  The least expensive term policy is not usually offered by a company that you want to buy a permanent policy from later.  This is the only exception to buying anything but the least expensive term policy.

One last caveat:

There are two prices for term insurance: the quoted price, and the offered price.  The quoted price is what you get when you shop online, or with an agent, or by mail.  You give someone (or a machine} general details about your health, and an accurate weight, height, and age, and it spits back a rate.  Then you fill out a form with more details when you actually apply, have a blood and urine test, let the insurance company check your medical records, and you get an actual offer.  And guess what?  Those two numbers may be different.  And the term they use to “rate” you may be different. One company may describe you as “standard,” or “plus,” or “super preferred,” while another gives you a different rating.  When you go back to the list of quotes that you originally looked at, you may find that, based on the actual offer and actual risk class assigned to you, you no longer have the least expensive rate.  For instance, if you had decided that you might be a “preferred” candidate, and applied to the lowest cost carrier based on that on that, you may discover that the carrier you selected thinks you are “standard” while another carrier agrees that you are “preferred.” So the original low cost carrier may be more expensive.  If you have only applied to one carrier, or did not “shop around” your medical records, you may just accept the higher price because you think everyone with “rate” you similarly.

That is why you want to use a live, independent agent, and not the Internet.