In the world of life insurance – term life insurance is the easiest to understand and it is the type of coverage most people need.
Term life insurance is designed to provide coverage for a predetermined period of time. You decide how long you want the coverage too last when you apply.
Life insurance carriers generally offer 1-year, 5-year, 10-year, 15-year, 20-year, 25-year, and 30-year term policies.
Unlike its counterpart permanent life insurance – term life insurance only has 2 components: premium and death benefit.
Your premiums are guaranteed over the period of the chosen term as long as they are paid on time.
For example, take Joe. He is 45-years old and needs $2.5 million of coverage to protect his young family. He applies for a 10-year term policy, and is approved for coverage. The monthly premium is $148.
Because it is a 10-year term policy, the premium is guaranteed for the next 120-months or 10-years.
If Joe passes away during the 10-year period, his beneficiary will receive the entire $2.5 million death benefit – provided premium payments are made on time.
When evaluating term life insurance there are four criteria we look at before making any recommendations.
1. Your Health and Lifestyle History
The life insurance policies we work all require underwriting. All this means is the life insurance carrier is going to evaluate a few different things to determine your health class.
Your health class is what ultimately determines your premium (or cost).
Each insurance company has different “underwriting” requirements. If you have any medical conditions, family history, or participate in hazardous activities – it makes sense to address them up front to determine which carrier is going to be most favorable.
To make it easier to understand check out the following example:
Let’s say you used our life insurance coverage analyzer and it turns out you need $5 million of 20-year term life insurance. You want to know what the cost of policy would be on a monthly basis.
Before we just randomly quoted you numbers we would want to ask you a few questions to determine what health (or underwriting) class you would likely receive from an insurance company. The question and answer session would go like this:
Do you have any health or medical conditions?
Your answer – No.
Do you smoke or use other tobacco products?
Your answer – No.
Do you scuba dive, rock climb, pilot or jump out of airplanes, or do anything else that may be considered a hazardous activity?
Your answer – No. I gave all stuff up when we had kids.
Are both of your parents still living?
Your answer – Actually, no. My dad passed away at age 56 because of a heart attack.
Now understand, we get that you are perfectly healthy. But, there is a family history of heart disease.
Since your dads passing occurred at such a young age (prior to age 60 – if death occurred after age 60 it typically has little no impact on health class rating), it places you in a different risk category then someone whose history is identical to yours, but whose father is still living.
This doesn’t mean you won’t be able to get coverage. It simply means the cost of coverage may be slightly more based on your family history.
For instance, some carriers may view you as one health class, while others view you as another health class.
By knowing how an insurance carrier is going to interpret your history – we can narrow the focus up front to provide you with an accurate quote and save you time.
There are a lot of advisors out there who will show you a premium payment based on the best rates in the marketplace. In some cases, it is a rate you would likely never qualify for.
Whether they are doing this knowingly or unknowingly – it is completely irresponsible.
I will be completely up front and tell you when this happens most people end up choosing our competitor over us. It is human nature to want to get something for less.
What ends up happening is you end up paying more. It’s a bait and switch.
We believe in being your advocate. It starts the second we meet and continues in perpetuity.
2. Policy Pricing (or Premium)
The premium for a term life insurance policy is determined by four components: health class (or underwriting class), face amount, length of term, and date of birth.
By doing our job and learning about your health and family history up front we can provide you with the pricing you will likely receive when coverage is applied for and approved.
Most insurance carrier offer term life insurance. However, not all companies choose to be competitive in the marketplace.
In any given scenario there are anywhere from 3 to 10 carriers who are competitive from a pricing perspective.
By identifying who these carrier are from an underwriting and pricing perspective we can move to next step.
3. Carrier Financial Strength
We all want to know the carrier we choose will have the financial strength to pay a death benefit claim. It’s important!
Rating agencies provide an “independent” opinion of an insurer’s financial strength and their ability to meet its ongoing financial obligations.
I personally am not aware of a single carrier who hasn’t been rated by at least one of the following rating agencies:
- Standard and Poor’s
- A.M. Best
- Moody’s Investors
- Fitch Ratings
- Weiss Ratings
Each rating agency has their own scoring system. For instance, Standard & Poor’s best rating is AAA, while Moody’s best rating would be Aaa. Any company with an “A” rating should be considered an insurance company with excellent financial strength.
We prefer to take things a step further.
We use a different, yet readily available metric. It’s called Comdex. The Comdex score is a composite ranking from 1 – 100 of all the ratings a company receives. The higher the Comdex score the greater the financial strength of the carrier.
Once we determine the Comdex score for each of the insurance companies in our “Top 10” pricing list, we eliminate each carrier with a Comdex score of less than 90.
Before moving to the fourth and final step let’s take a second to review the criteria thus far for deciding on term life insurance policy that’s right for you:
- We completed our due diligence up front to project the carriers who will provide the best offer based on our health and lifestyle information.
- From there, we analyzed the marketplace to determine which carriers will offer the best pricing based on your assumed underwriting class.
- After that, we analyzed and narrowed down the list carriers based on the financial strength of the best priced policies.
…and now for the final piece of the puzzle.
4. The Right to Convert
Most term insurance companies and policies provide the policy owner with the option to convert (or exchange) their term policy to a permanent life insurance policy provided:
- The conversion takes place during the guarantee period, and
- The insured is under a certain age (typically age 75 with most carriers)
You’re probably wondering why we consider this option to be so important.
Let’s say your 55-years old and have a 10-year term policy. You purchased your policy more than 9-years ago (you’ve got less than 1-year of guaranteed premium left on your policy).
You go to the doctor and your diagnosed with some form of cancer. While the cancer isn’t life threatening, there isn’t a life insurance company in North America that will offer new coverage before your existing coverage expires.
What do you do?
If your term policy has a conversion option, you can convert to a permanent policy – WITHOUT UNDERWRITING. This means the insurance company has to honor the health class they gave you when the term policy was originally issued.
If the ability to convert didn’t exist the insured would not have any life insurance coverage or would have to pay extremely high premiums.
There are life insurance companies that are primarily term life insurance companies. They either don’t have a permanent policy to convert to or the policy they make available for conversion is extremely expensive.
As a part of this step we want to eliminate the companies that exist only serve the term life insurance marketplace.
We then look for companies who offer both competitive term and permanent life insurance policies.
Once we’ve narrowed down our list to include only convertible policies with carriers who have a comprehensive permanent product portfolio – it becomes very easy to choose the carrier who is right for you.
Who Is Term Life Insurance For?
Term life insurance can be applied in any number of situations. Each scenario is unique, and there is no one size fits all. There are exceptions to every rule. The areas where we see term life insurance applied most often are for:
Term life insurance is the most common and least expensive way to make sure a family is protected from financial loss resulting from the death of a loved one. Many times it makes sense to consider insuring both spouses in the event they have children who are under the age of 18, regardless of whether or not they both work.
In some divorces it is the requirement of the court for one of the spouses to maintain some level of life insurance for the benefit of the ex-spouse.
There are a few scenarios where business owners can benefit from term life insurance:
- If you have employees whose loss would create a significant economic impact to the revenue and profitability of the company, then term insurance may make sense. This may occur where an employee generates a large amount of revenue or where an employee would be extremely difficult and costly to replace due to specialized training and/or experience.
- When a company has two or more shareholders – term life insurance can be used to provide the liquidity necessary to purchase a deceased shareholders interest in the company from their estate or heirs.
- As a part of an employee compensation package, an employer may incentivize an employee by offering a salary continuation plan. This would provide the employees family with continued income for a period of time due to the unforeseen death of the employee.
Advantages of Term Life Insurance
- Inexpensive life insurance protection
- Ability to purchase more coverage for less money than you would be able to with permanent coverage
- Most policies are convertible to permanent coverage based on your health when the term insurance policy was originally issued
- Great way to insure against the loss of income of a family member
- Coverage is guaranteed for the period of term as long as premiums are paid on time
Disadvantages of Term Life Insurance
- You outlive the coverage and receive no death benefit
- If you have health issues (and the policy contains no conversion privilege) you may not be able to secure additional coverage after the term or guaranteed period expires
Life insurance companies love term insurance. Since such a small percentage of death claims are paid out on term insurance coverage it can be a very profitable line of coverage for an insurance carrier.
The reason why is many people get rid of the coverage once the guaranteed period ends or end up replacing the policy with another.
Now, I know what you’re thinking. If an insurance company only pays out on a small percentage of policies why should I buy coverage. I’ve got two answers for you:
- You love and care about the people you are considering buying the insurance for, and you don’t want them to suffer financially if something happens to you. You are responsible and you care about them.
- The life insurance company has the benefit of insuring and collecting premiums from thousands of people. If they have to pay a claim on five percent of them in any given year, then they have more than enough premium coming in from the other ninety-five percent to cover claims.
Essentially, insurance companies are able to offset their risk by insuring multiple lives. You and I are just one person. We don’t know if it will be our family or someone else’s family who will end up needing the death benefit.
Things Too Be Aware of and Keep an Eye On
When you reach the end of the term (or guarantee period), the life insurance carrier has no contractual obligation to continue offering coverage at the same premium you’ve been paying.
In fact, many times, they have the legal authority to increase the premium by a significant amount (think 10 times your level premium).
Many people who own term insurance coverage pay for it monthly via a bank auto draft. If you’re not paying attention, your $200 monthly premium could jump to $2,000 a month.
And, don’t even think about contacting the carrier for reimbursement. They’re going to tell you (or me) they would have had a legal obligation to pay a death benefit if something had happened to you during the time you were completely unaware you were grossly overpaying for coverage.
At this point, I like to let the insurance carrier know you didn’t die, and instead of us calling to ask for the death benefit, we’re just calling to get the premium back.
You would think if the insurance company were acting ethically they would shut off the auto draft at the end of the term or have to receive permission from you to continue it.
The bottom line is make sure you evaluate all of your life insurance options before the end of guarantee period of your existing term policy. It could end up costing you a significant amount of money.
FINAL THOUGHTS ON TERM LIFE INSURANCE
Life insurance is a critical asset for many people. It provides financial support for a family or business in an otherwise extremely chaotic time.
Term life insurance coverage does not have to be expensive. Don’t avoid getting coverage because you think it will cost too much or because you think you’ll never use it.
I will tell you this. I have car insurance. As do you. I hope I never have to use it. I should be so lucky. If I’m not so lucky, I’m glad I have it.
About Jason Mericle
Jason Mericle is the founder of Mericle & Company. Partnering with a specialized team of advisors, he is able to help business owners significantly reduce taxes, protect assets, and create tax-favorable income.
He compliments his extensive knowledge of tax strategies and products with an in-depth understanding of the different tax and legal structures for which they are used.
About Jason Mericle
Jason Mericle is the founder of Mericle & Company. He has partnered with a unique team of professional advisors specializing in helping business owners significantly reduce taxes, protect assets, and create tax-favorable income.
Jason compliments his extensive knowledge of tax solutions and products with an in-depth understanding of the different tax and legal structures for which