For some reason we always seem to receive a lot of mail this time of year on the subject of “Term Life Insurance”.
Most want to know the benefits or pitfalls of Term Life Insurance over Permanent Life Insurance.
Term Life Insurance is by far the most cost effective way of securing a life insurance policy available to the general public.
Term Life Insurance covers a specific period of time – normally the policy will run for periods of 5, 10, and 20 years. As the age of the insured increases, the cost of the premium will increase. Premiums are calculated on the mortality rate, which is usually dependent on the persons age, sex and whether that person uses tobacco.
This type of policy allows the insured or the owner to pay a set premium for an agreed period. The Insurance company provides monetary benefits to the beneficiary in case of death of the insured during that period. Usually, the benefits received on the death of the insured is income tax free.
There are four parties in term life insurance:
(1) the owner is the one who pays the premium;
(2) the insured is the one on whose death, a death benefit (face value) will go to the beneficiary;
(3) the beneficiary is one who will receive the proceeds of insurance on death of the insured; and
(4) the insurer is the company providing the insurance.
Depending on the Insurance company you choose, the premiums can be paid monthly, quarterly or annually. For example, Fred pays $50 dollars monthly to XYZ Company for insuring the life of Margaret (his wife) for a period of 10 years. Should Margaret die during the 10 years of the agreement, XYZ company will pay $25,000 to Joe (son of Fred and Margaret). Here the insured is Margaret, the owner of the policy is Fred, the beneficiary is Joe and the insurer is XYZ Company. If Margaret does not die during the 10 years, XYZ Company will not be liable to pay any money to any of the parties involved. Often the owner and the insured are same. That is, a person buys a policy to cover his own death and nominates a beneficiary. Husbands and wives often insure each other in case of death.
What is Term Life Insurance?
It is a legal contract with terms and conditions and assumed risks. Sometimes there can be special provisions in the agreement like suicide terms, wherein on suicide of the insured, there is no benefit accrued to the beneficiary.
Term Life Insurance is based on two concepts:
(1) theory of diminishing responsibility and
(2) Buy Term and Invest the Difference (BTID).
With Term Life Insurance, the responsibility or liability of the insuring company reduces as the policy reaches its maturity. What makes Term Life Insurance the most cost effective type of insurance available to the public is that there is no cash value at the end of the period. Studies have shown that the mortality rate in Term Life Insurance can be as low as 1%. Hence the concept of BTID.
Rather than going for permanent life insurance (where on the expiry of the agreed period, the owner will accrue some cash benefit and there is a savings component in it) it is considered cheaper to buy term life insurance and take care of the savings components by investing in other areas.
With the present market giving good returns on investments, buying a term life insurance is a more attractive option than permanent life insurance.