December 18, 2003    Copyright © 2003, Greenwich Financial Management Inc.

Demystifying Insurance, Part 4:

Term Life

Term life is the most basic form of life insurance.  It has a defined termination date, as opposed to permanent life (whole life or universal life).  It is in that sense temporary.

With term life, again unlike permanent life, the premiums increase according to age.  A common form is one year term. At the end of each year, the policy comes up for renewal, and the premium rises.  In ten year term, the premium is held constant for ten years, after which it will rise sharply in year eleven and incrementally each year thereafter; likewise with 20 and 30 year term, etc.; however.  The annual premium on ten year term is usually lower than for one year term, and it's level for nine additional years-you can generally drop coverage earlier if you wish; however, to qualify for the best rate if you renew after ten years, you generally will have to face a fresh underwriting.

Term life policies typically offer an option to renew.  This option could be valuable if your health status were to deteriorate while the policy is in force; you might not be eligible for a new insurance policy anymore, or only at a much higher premium.  Term life normally carries a maximum age of renewal, usually around 75 years old. 

Notably, the death benefit from any life insurance policy, including term life, does not create taxable income for the beneficiary.  However, term life, unlike permanent life, never develops "cash value."  Therefore, it lacks the benefit of accumulation of the cash value amount without taxation; there is no investment aspect.  Also, because there is no cash value, there is no store of equity to borrow from if desired in the future.  However, for all people, but particularly for young people, term life insurance is the cheapest way to obtain any given level of death benefit.  Sometimes a blend of term and permanent insurance makes the most sense.

The increases in the cost of term life each year are not steady; instead, they grow exponentially larger as the insured ages.  These increases mirror the actuarial risk of death.  For this reason, the term life premium, which could seem cheap when you are thirty, may be forbiddingly costly when you are sixty; in addition, the cost of converting to permanent life will be much greater by then. 

            If you have a life insurance benefit at work, it is almost certainly term life.   Under federal tax law, the first $50,000 of term life insurance coverage given to you as an employee is not taxable.  If your employer provides you with additional free coverage, income will be attributed to you and reported based on its "imputed" value.  Your employer may also give you the option to purchase additional term life through payroll deduction.  This insurance, if given without underwriting examination, is typically more expensive than you could purchase on your own, assuming you are a good risk candidate.  This is because of "adverse selection"; those employees who have the highest risk of death may be more likely to exercise the option, and the insurance companies price this risk into the group coverage.   Also, if you leave your company, you may be offered the right to convert your term life to permanent life insurance and pay premiums thereafter to keep it in force.  The pricing of this option is usually unattractive to employees in good health, also because of the adverse selection problem.  You would be better off to check on obtaining a policy underwritten to your particular case.

            Insurance companies have different strengths.  Some are better at term life, some at whole life, some at disability; others may be marginal or unacceptable for any purpose.  Your agent should help you make the best tradeoff of premium cost, credit rating/financial strength, and policy features.  To achieve this result, you will need to deal with a "general agency" rather than one captive to a particular insurance company. 

Next: Whole Life

Andy Szabo, CFA, is Managing Director of Greenwich Financial Management Inc., a Registered Investment Advisor, which advises individuals and companies on investments, insurance and employee benefits.  Questions or comments welcome by phone (203-531-2877) or e-mail: Szabo@GreenwichFinancial.com.