Term insurance policies are the oldest form of insurance and are found across the spectrum of insurance contracts, from auto insurance policies to homeowner insurance policies. It is also the most common type of life insurance policy. Most people find that term life insurance meets their needs and it is the most affordable life insurance policy offered. It is very flexible, which enables a policyholder to customize the contract as needed.
Protect your family with an affordable term life insurance policy!
Term life insurance is a contract whereby the policyholder makes periodic premium payments to the insurance company over a specified period of time. Once the contract has been established, the terms are in force for the duration of the policy, unless the policyholder fails to pay the premium when due.
The policyholder is usually, but doesn’t have to be, the person insured. Anyone can purchase a life insurance policy on someone else (even without notifying the individual), though insurance companies usually require that the policyholder have a financial interest in the insured life (in other words, they would incur financial loss or hardship resulting from the insured’s passing). The most common reasons for this are to insure a spouse or other relative, though companies also often engage in this practice for key employees (e.g. Google and Larry Page).
The periodic payments are made by the policyholder in exchange for the commitment that the insurance company will make a payment (for a predetermined amount: aka “the benefit”) to a specified beneficiary (or beneficiaries) upon the premature death of the insured. The phrase “premature death” is used since very few insurance companies would enter into a life insurance contract if the risk of loss is guaranteed (e.g. the insured is dying of an incurable disease). Policies that involve guaranteed payments at time of death are generally the realm of whole life insurance (though anything is possible unless it is illegal), which are effectively an investment vehicle. If the insured does not die during the coverage period (the “term”), the insurance company is released from its obligation and keeps the full amount of the premium payments.
Low Cost Life Insurance
The fact that a payment is not guaranteed is the reason why term life insurance policies are so much cheaper than other cash-value or whole-life insurance policies. Keep in mind though, that very few benefits are ever paid against life insurance policies (some estimates range below 1%). Understanding this fact is critical to choosing the right type of policy. If you are willing to trade a much lower premium for the likelihood that your beneficiaries may never receive a benefit, then a term insurance policy is probably the right life insurance vehicle for you. It is for most people.
Determining the Cost of a Term Life Insurance Policy
The key characteristics of a term life insurance policy are also the same variables that affect the cost of the policy and are established at the inception of the contract. These key characteristics primarily involve:
Term of coverage
Gender
Amount of benefit
Age of the insured
Health of the insured (and related, such as whether the insured smokes tobacco, has a history of disease, etc.)
Family health history
While these are the principal factors, they aren’t the only ones. Insurance companies build sophisticated financial models that incorporate many variables (including actuarial mortality tables) to calculate the risk that the insured will die during the term. While all insurance companies include the above variables in their modeling, each model is proprietarily designed and unique to that institution. The models include information that is publicly available as well as their own specific historic information from policies they have been party to. The central goal of these models is to establish the likelihood that the insurance company will have to pay a benefit (i.e. the insured dies from an insured event while the policy is in effect).
This sparks an important tangent, which is that term life insurance policies only cover certain deaths. While cash-value life insurance policies guarantee some level of payment upon death of the insured (the cash-value at a minimum) regardless of cause of death, term insurance policies do not. Most causes of death are covered by “standard” term life insurance policies, but causes such as undisclosed pre-insured medical conditions, suicide, war, rioting, accidental overdose from illegal drug use, etc. are not covered. While nothing can substitute a detailed review and understanding of the exact terms of your life insurance policy, a general guideline is that if the death is not the result of an illegal or dishonest action, a benefit will be paid.
Returning to the topic of how insurance companies calculate the premium for a given policy, in addition to factoring in the risk of death-related variables, Insurance companies also consider the expected timing of death. As a person ages, the risk of death increases. Therefore, all other things being equal, a 20-year-old purchasing a 20-year life insurance policy is going to pay a lower premium than a 40-year-old purchasing the same policy. That’s just a fact of life, and a central premise of calculating the risk of death for an insured individual.
In addition to determining whether an insured individual will die during the term of the policy, insurance companies need to estimate when that death might occur. This is critical because they earn investment income from the insurance premiums that are collected up to that point. As insurers collect premiums, they invest those funds, which generate profits. The longer they can invest the funds, the greater the profit. Profits from those investments also reduce the cost of the insurance contract since competitive market forces demand that a company can only earn so much profit before lower pricing from competitors capture the respective company’s customers. The point is that the sooner an insurance company has to pay benefits, not only does it miss out on future premium payments, but it also misses out on a greater amount of investment income.
The best life insurance companies are masters at predicting the likelihood of death as well as the timing of death. In the morbid world of life insurance, perhaps you can take some comfort (or at least have a chuckle) at the fact that the insurance companies are rooting for you to stay alive!
While it may be daunting, don't avoid reading the fine print of your term life insurance policy!
Health Assessments
Insurance companies go to great lengths to assess an insured’s health. They will perform physical examinations, request (accurate and honest!) personal and family health information, request access to physicians’ records, etc. in order to gather all of the information possible to analyze this. Note that insurance companies are not required to provide coverage to individuals (unless the denial is illegal, such as would be the case with a violation of the United States Civil Rights Act).
Investment Income and Credit Ratings
Additionally, as previously mentioned, the top insurance companies are masters at investing. If they can maximize profits from investment income, they can afford to collect lower premiums, which in turn means they attract more business, which then generates more premiums, which can be used to generate more investment income and so on and so forth. In fact, most insurers borrow money to make investments in order to “lever” their equity and make even more investment profit than could be made off the premiums alone. However, as the saying goes, “no pain, no gain” and so it is with investments. Increasing investment income is usually the result of taking on additional risk.
While the insurance companies may be comfortable taking on additional risk for a higher profit, as the policyholder, your principal concern is that they are able to make their contractual payment if an insured event occurs. The last thing you want is for your insurer to “have a bad year” and be unable to pay the death benefit they owe your beneficiaries. This is where the credit rating agencies come in to play.
The credit rating agencies are private institutions who are paid to rate the credit worthiness of financial instruments. Since insurance companies issue debt, their credit rating is measured by the credit rating of their debt. Just as with your policy and the associated death benefit, rating agencies are concerned about the life insurance company’s ability to repay their public debt. They analyze the respective insurance company’s investments (including how risky they are) and obligations. Based on these analyses, they issue a credit rating. A higher credit rating means a company is more likely to meet its financial obligations.
Therefore, while you want the lowest cost life insurance policy available, you also need to look at the company’s credit rating to make sure that it isn’t sacrificing its ability to pay your benefit for a lower premium. If you are comfortable taking on that risk, then you may be comfortable with a lower premium. Generally speaking, most insurance companies have very high credit ratings. They have to because of government regulation, which helps to ensure that the companies are able to meet their obligations. These companies need to have the liquidity and financial fortitude to be able to weather a major event or a string of “bad luck” that results in massive payments.
In its simplest form, the formula for the cost of the policy is: the amount of the death benefit times the likelihood that it will need to be paid less a profit margin. This cost is then spread over the life of the policy, usually in monthly installments.
Now that we have covered how a policy is priced (i.e. the premium a policyholder pays) let’s touch on other considerations, such as how much insurance you should purchase and for how long.
Determining the Size of the Life Insurance Benefit
Most people who purchase a term life insurance policy are insuring for a specific obligation or to replace lost income. For instance, you may take out a policy to pay-off a mortgage for your beneficiaries or to supply them with an equivalent of five times your annual income (allowing them to recover from your loss and take steps to replace your income or reduce their cost of living). Only you can determine how much insurance you want. What do you want to do for your beneficiaries? How much would they need to “make it” without you? What can you afford?
Many insurance companies “cap” the amount of insurance, meaning that they won’t allow someone making fifty-thousand dollars per year to take out a policy with a benefit payment of one-hundred-million dollars. This helps mitigate the risk of fraudulent behaviors (though so do the exorbitant premium payments that a one-hundred-million dollar policy would require).
Determining the Life Insurance Policy’s Term
How long of a term should you purchase is also generally tied to financial obligations or to replace lost income. Are you hoping to replace income to a point where your beneficiary can begin receiving social security payments or accessing a retirement account? Are you hoping to provide income through the point where the kids move out? Or are you hoping to replace the mortgage payments until the mortgage is paid off? The answer to these and similar questions usually dictates the term, which is then compared to the cost and benefit payment to ensure that the price is affordable.
When choosing a term, it is important to understand the risk of re-pricing. Since the risk of death increases as individual’s age, a longer term policy will result in higher premiums. While you may want to avoid these higher premiums, a longer term also allows for some price protection.
For instance, while a 20-year policy will require a considerably higher monthly premium payment than a 5-year policy, the 20-year policy provides price protection for 20 years, whereas the 5-year policy only provides price protection for 5 years. After the initial 5 years, the policyholder must purchase another policy at the current market price (which may be higher) and after the insured has aged 5 years. This would need to be repeated two more times to garner a full 20 years of coverage and in addition to the insured’s overall aging during this period, the individual also risks illness or some other factor that might negatively affect the cost of their policy.
In the case of a terminal illness, where the insured doesn’t die before the policy expires, they would become un-insurable under term life insurance.
A longer-term policy will reduce the risk, since premium payments are contractually defined over the life of the policy. While there are term life insurance policies with graduated premium payment scales (in other words premiums reprice every year, but the term is for a longer period), the most common term life insurance policy is called a “level term life insurance policy,” which is where the premiums are constant over the entire term. The most common life insurance terms are 10, 15, 20 and 30 years, though policies can be customized to virtually any term.
Term Extensions
Some policies allow the policyholder to extend the term at the end of the initial period, though the premiums are established at that time. This feature is valuable if the insured becomes terminally ill or otherwise become un-insurable on the open market. While the premiums are going to be extreme, at least coverage is offered. Review the terms of the policy to see whether this feature is offered.
Compare term life insurance quotes to find a low cost policy that fits your family's needs!
Compare Term Life Insurance Quotes
Once you have analyzed the amount of coverage you need and the term you would like the policy to cover (taking into account the repricing risk), you are ready to request and compare life insurance quotes. We applaud you for your selfless act. While you won’t see any of the benefit, hopefully you will find peace of mind knowing that your loved ones are financially secure. Our services exist to help you request and compare life insurance quotes and our partners and their agents are customer-oriented and ready to serve you.
* Note that this article should be used as general information pertaining to term life insurance policies. While we endeavor to provide accurate and valuable information, it is not, nor should it be construed as, a substitute for a detailed review of the specific terms of an insurance policy or for consultation with a trusted and knowledgeable financial advisor. We assume no responsibility for the use of this information or for the actions of our customers or the contracts that they enter into.
Understanding Term Life Insurance
Term insurance policies are the oldest form of insurance and are found across the spectrum of insurance contracts, from auto insurance policies to homeowner insurance policies. It is also the most common type of life insurance policy. Most people find that term life insurance meets their needs and it is the most affordable life insurance policy offered. It is very flexible, which enables a policyholder to customize the contract as needed.
Protect your family with an affordable term life insurance policy!
Term life insurance is a contract whereby the policyholder makes periodic premium payments to the insurance company over a specified period of time. Once the contract has been established, the terms are in force for the duration of the policy, unless the policyholder fails to pay the premium when due.
The policyholder is usually, but doesn’t have to be, the person insured. Anyone can purchase a life insurance policy on someone else (even without notifying the individual), though insurance companies usually require that the policyholder have a financial interest in the insured life (in other words, they would incur financial loss or hardship resulting from the insured’s passing). The most common reasons for this are to insure a spouse or other relative, though companies also often engage in this practice for key employees (e.g. Google and Larry Page).
The periodic payments are made by the policyholder in exchange for the commitment that the insurance company will make a payment (for a predetermined amount: aka “the benefit”) to a specified beneficiary (or beneficiaries) upon the premature death of the insured. The phrase “premature death” is used since very few insurance companies would enter into a life insurance contract if the risk of loss is guaranteed (e.g. the insured is dying of an incurable disease). Policies that involve guaranteed payments at time of death are generally the realm of whole life insurance (though anything is possible unless it is illegal), which are effectively an investment vehicle. If the insured does not die during the coverage period (the “term”), the insurance company is released from its obligation and keeps the full amount of the premium payments.
Low Cost Life Insurance
The fact that a payment is not guaranteed is the reason why term life insurance policies are so much cheaper than other cash-value or whole-life insurance policies. Keep in mind though, that very few benefits are ever paid against life insurance policies (some estimates range below 1%). Understanding this fact is critical to choosing the right type of policy. If you are willing to trade a much lower premium for the likelihood that your beneficiaries may never receive a benefit, then a term insurance policy is probably the right life insurance vehicle for you. It is for most people.
Determining the Cost of a Term Life Insurance Policy
The key characteristics of a term life insurance policy are also the same variables that affect the cost of the policy and are established at the inception of the contract. These key characteristics primarily involve:
While these are the principal factors, they aren’t the only ones. Insurance companies build sophisticated financial models that incorporate many variables (including actuarial mortality tables) to calculate the risk that the insured will die during the term. While all insurance companies include the above variables in their modeling, each model is proprietarily designed and unique to that institution. The models include information that is publicly available as well as their own specific historic information from policies they have been party to. The central goal of these models is to establish the likelihood that the insurance company will have to pay a benefit (i.e. the insured dies from an insured event while the policy is in effect).
This sparks an important tangent, which is that term life insurance policies only cover certain deaths. While cash-value life insurance policies guarantee some level of payment upon death of the insured (the cash-value at a minimum) regardless of cause of death, term insurance policies do not. Most causes of death are covered by “standard” term life insurance policies, but causes such as undisclosed pre-insured medical conditions, suicide, war, rioting, accidental overdose from illegal drug use, etc. are not covered. While nothing can substitute a detailed review and understanding of the exact terms of your life insurance policy, a general guideline is that if the death is not the result of an illegal or dishonest action, a benefit will be paid.
Returning to the topic of how insurance companies calculate the premium for a given policy, in addition to factoring in the risk of death-related variables, Insurance companies also consider the expected timing of death. As a person ages, the risk of death increases. Therefore, all other things being equal, a 20-year-old purchasing a 20-year life insurance policy is going to pay a lower premium than a 40-year-old purchasing the same policy. That’s just a fact of life, and a central premise of calculating the risk of death for an insured individual.
In addition to determining whether an insured individual will die during the term of the policy, insurance companies need to estimate when that death might occur. This is critical because they earn investment income from the insurance premiums that are collected up to that point. As insurers collect premiums, they invest those funds, which generate profits. The longer they can invest the funds, the greater the profit. Profits from those investments also reduce the cost of the insurance contract since competitive market forces demand that a company can only earn so much profit before lower pricing from competitors capture the respective company’s customers. The point is that the sooner an insurance company has to pay benefits, not only does it miss out on future premium payments, but it also misses out on a greater amount of investment income.
The best life insurance companies are masters at predicting the likelihood of death as well as the timing of death. In the morbid world of life insurance, perhaps you can take some comfort (or at least have a chuckle) at the fact that the insurance companies are rooting for you to stay alive!
While it may be daunting, don't avoid reading the fine print of your term life insurance policy!
Health Assessments
Insurance companies go to great lengths to assess an insured’s health. They will perform physical examinations, request (accurate and honest!) personal and family health information, request access to physicians’ records, etc. in order to gather all of the information possible to analyze this. Note that insurance companies are not required to provide coverage to individuals (unless the denial is illegal, such as would be the case with a violation of the United States Civil Rights Act).
Investment Income and Credit Ratings
Additionally, as previously mentioned, the top insurance companies are masters at investing. If they can maximize profits from investment income, they can afford to collect lower premiums, which in turn means they attract more business, which then generates more premiums, which can be used to generate more investment income and so on and so forth. In fact, most insurers borrow money to make investments in order to “lever” their equity and make even more investment profit than could be made off the premiums alone. However, as the saying goes, “no pain, no gain” and so it is with investments. Increasing investment income is usually the result of taking on additional risk.
While the insurance companies may be comfortable taking on additional risk for a higher profit, as the policyholder, your principal concern is that they are able to make their contractual payment if an insured event occurs. The last thing you want is for your insurer to “have a bad year” and be unable to pay the death benefit they owe your beneficiaries. This is where the credit rating agencies come in to play.
The credit rating agencies are private institutions who are paid to rate the credit worthiness of financial instruments. Since insurance companies issue debt, their credit rating is measured by the credit rating of their debt. Just as with your policy and the associated death benefit, rating agencies are concerned about the life insurance company’s ability to repay their public debt. They analyze the respective insurance company’s investments (including how risky they are) and obligations. Based on these analyses, they issue a credit rating. A higher credit rating means a company is more likely to meet its financial obligations.
Therefore, while you want the lowest cost life insurance policy available, you also need to look at the company’s credit rating to make sure that it isn’t sacrificing its ability to pay your benefit for a lower premium. If you are comfortable taking on that risk, then you may be comfortable with a lower premium. Generally speaking, most insurance companies have very high credit ratings. They have to because of government regulation, which helps to ensure that the companies are able to meet their obligations. These companies need to have the liquidity and financial fortitude to be able to weather a major event or a string of “bad luck” that results in massive payments.
In its simplest form, the formula for the cost of the policy is: the amount of the death benefit times the likelihood that it will need to be paid less a profit margin. This cost is then spread over the life of the policy, usually in monthly installments.
Now that we have covered how a policy is priced (i.e. the premium a policyholder pays) let’s touch on other considerations, such as how much insurance you should purchase and for how long.
Determining the Size of the Life Insurance Benefit
Most people who purchase a term life insurance policy are insuring for a specific obligation or to replace lost income. For instance, you may take out a policy to pay-off a mortgage for your beneficiaries or to supply them with an equivalent of five times your annual income (allowing them to recover from your loss and take steps to replace your income or reduce their cost of living). Only you can determine how much insurance you want. What do you want to do for your beneficiaries? How much would they need to “make it” without you? What can you afford?
Many insurance companies “cap” the amount of insurance, meaning that they won’t allow someone making fifty-thousand dollars per year to take out a policy with a benefit payment of one-hundred-million dollars. This helps mitigate the risk of fraudulent behaviors (though so do the exorbitant premium payments that a one-hundred-million dollar policy would require).
Determining the Life Insurance Policy’s Term
How long of a term should you purchase is also generally tied to financial obligations or to replace lost income. Are you hoping to replace income to a point where your beneficiary can begin receiving social security payments or accessing a retirement account? Are you hoping to provide income through the point where the kids move out? Or are you hoping to replace the mortgage payments until the mortgage is paid off? The answer to these and similar questions usually dictates the term, which is then compared to the cost and benefit payment to ensure that the price is affordable.
When choosing a term, it is important to understand the risk of re-pricing. Since the risk of death increases as individual’s age, a longer term policy will result in higher premiums. While you may want to avoid these higher premiums, a longer term also allows for some price protection.
For instance, while a 20-year policy will require a considerably higher monthly premium payment than a 5-year policy, the 20-year policy provides price protection for 20 years, whereas the 5-year policy only provides price protection for 5 years. After the initial 5 years, the policyholder must purchase another policy at the current market price (which may be higher) and after the insured has aged 5 years. This would need to be repeated two more times to garner a full 20 years of coverage and in addition to the insured’s overall aging during this period, the individual also risks illness or some other factor that might negatively affect the cost of their policy.
In the case of a terminal illness, where the insured doesn’t die before the policy expires, they would become un-insurable under term life insurance.
A longer-term policy will reduce the risk, since premium payments are contractually defined over the life of the policy. While there are term life insurance policies with graduated premium payment scales (in other words premiums reprice every year, but the term is for a longer period), the most common term life insurance policy is called a “level term life insurance policy,” which is where the premiums are constant over the entire term. The most common life insurance terms are 10, 15, 20 and 30 years, though policies can be customized to virtually any term.
Term Extensions
Some policies allow the policyholder to extend the term at the end of the initial period, though the premiums are established at that time. This feature is valuable if the insured becomes terminally ill or otherwise become un-insurable on the open market. While the premiums are going to be extreme, at least coverage is offered. Review the terms of the policy to see whether this feature is offered.
Compare term life insurance quotes to find a low cost policy that fits your family's needs!
Compare Term Life Insurance Quotes
Once you have analyzed the amount of coverage you need and the term you would like the policy to cover (taking into account the repricing risk), you are ready to request and compare life insurance quotes. We applaud you for your selfless act. While you won’t see any of the benefit, hopefully you will find peace of mind knowing that your loved ones are financially secure. Our services exist to help you request and compare life insurance quotes and our partners and their agents are customer-oriented and ready to serve you.
* Note that this article should be used as general information pertaining to term life insurance policies. While we endeavor to provide accurate and valuable information, it is not, nor should it be construed as, a substitute for a detailed review of the specific terms of an insurance policy or for consultation with a trusted and knowledgeable financial advisor. We assume no responsibility for the use of this information or for the actions of our customers or the contracts that they enter into.
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