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Term life insurance provides pure or temporary protection and is the simplest form of life insurance coverage; it essentially offers the maximum amount of life insurance at the lowest initial outlay. Term life provides low-cost insurance protection for a specified period and pays a benefit only if the insured dies during that period. Term life insurance is often called temporary life insurance because it provides protection for a limited period.
The period (or TERM) for which these policies are issued can be defined by years (e.g., one-year term, five-year term, or 20-year term) or age (e.g., term to age 65, term to age 70). Term policies issued for a specified number of years provide coverage from their issue date through the end of the period specified. Term policies issued until a certain age provide coverage from their date of issue until the insured reaches the specified age.
Term insurance provides the insured with peace of mind against financial loss that an early death may cause. However, if the insured outlives the coverage period, the policy expires, and no benefits are paid. Term life policies can offer fixed, or constant, level premiums because premiums are averaged over the policy term.
The primary advantage of term life insurance is that the premium or cost of the policy is substantially lower than the premium or cost of a permanent, whole life insurance policy that's issued for the same face value amount. However, unlike permanent (whole) life insurance, term life insurance policies don't build cash value. An insurer may offer several different types of term life insurance policies, primarily distinguished by the characteristics of their face value (death benefit): level term, decreasing term, and increasing term.
Decreasing term life insurance policies have benefit amounts that decrease gradually over the term of protection and level premiums. Decreasing term life insurance is commonly used to pay off the insured's debt in the event of death.
For example, a 20-year $50,000 decreasing term policy will pay a death benefit of $50,000 at the beginning of the policy term. That amount gradually declines over the 20-year term and reaches $0 at the end of the term. The premium for these policies remains level throughout, even as the death benefit declines.
Mortgage redemption insurance is a decreasing term life insurance policy, and its purpose is to provide policy holders with a way to have their mortgages paid off if they die before they're fully paid. Mortgage protection prevents the full burden of paying the mortgage from falling on the shoulders of the surviving family members. With this design, the face value decreases as the balance remaining on the mortgage decreases.
Credit life insurance is a limited benefit (term) policy designed to cover the life of a debtor and pay the amount due on a loan if the debtor dies before the loan is repaid. The beneficiary of this type of policy is typically the lender. The type of insurance used is decreasing term, with the term matched to the length of the loan period (generally limited to 10 years or less) and the decreasing insurance amount matched to the outstanding loan balance. Credit life may be issued to individuals as single policies; however, it is most often sold to a bank or other lending institution as group insurance that covers all of the institution's borrowers. The cost of group credit life insurance (or any credit life insurance) is typically paid entirely by the borrower.
The maximum benefit for a credit life insurance policy — regardless of whether it is an individual or group policy — is the loan amount. The lender has insurable interest in the insured only up to the value of the indebtedness. A life insurance policy is not a legal contract if it allows the lender to profit from the debtor's death.
While credit life or mortgage insurance may be required as a condition of a loan, the creditor cannot require the borrower to purchase the insurance from the organization granting the loan or another specific organization. A lender that requires a borrower to purchase insurance from a specific company as a condition of providing a loan is considered coercion, which is an illegal practice.
Increasing term life insurance provides a death benefit that increases at periodic intervals over the policy's term. The increase is typically stated as a specific amount or as a percentage of the original amount. The amount may also be tied to a cost-of-living index, such as the Consumer Price Index (CPI). Increasing term insurance may be sold as a separate policy, but is generally purchased as part of a package or cost-of-living rider attached to a policy. Increasing term life insurance is often used to account for anticipated income growth as individuals advance in their careers, and may also be referred to as incremental term life insurance.
For example, a 30-year-old physician may take out a term-to-age-65 life insurance policy with a $100,000 face value, which increases by $100,000 every five years to account for growth in income. This allows for a maximum of six $100,000 increases over the life of the policy: the face value would increase to $200,000 at age 35, $300,000 at age 40, $400,000 at age 45, $500,000 at age 50, $600,000 at age 55, and $700,000 at age 60. If the physician dies before age 65, the policy pays the face amount associated with the insured's current (attained) age. At age 65, if the physician is still alive, the policy terminates and no death benefit is paid.
The most common form of term life insurance — level term life insurance — provides a constant or fixed amount of coverage for as long as the policy remains in force. This form is characterized by a level face amount (death benefit) for a specified period. A level term policy expires at the end of the policy period. Remember, the "level" part of the name refers to the death benefit — the premium payments are also fixed (or level) for the term of the policy, as a standard characteristic of term insurance.
| Policy Type | Coverage Details | Effect of Owning this Policy |
|---|---|---|
| Level term for a set number of years | Q, a 30-year-old woman buys a 10-year level term policy with a $250,000 death benefit | The policy lasts for 10 years until Q reaches age 40. If Q dies before age 40, the beneficiaries get $250,000. If Q dies at age 40 or later, there is no coverage because the policy has expired. |
| Level term up to a specified age | R, a 30-year-old man buys a level "Term to Age 65" life policy with a $250,000 face value | The policy lasts until R reaches age 65. If R dies before age 65, the beneficiaries get $250,000. If the insured lives to age 65 or later, there is no coverage because the policy has expired. |
Level Term Insurance Examples
Assume an exam question is referring to a level term life insurance policy if the question doesn't specify the type of term policy and simply indicates "a term policy."