Informed Investor: Evaluating life insurance coverage and needs, Part II: Term insurance

This second of four columns during September discussing life insurance in honor of “Life Insurance Awareness Month” discusses term life insurance and its variations. Term life insurance provides life insurance for a limited period of time, or a term.

The other type of life insurance is called “permanent,” and is designed to protect the insured for an entire lifetime. Permanent life insurance includes whole life, universal life and variable life. Permanent life premiums are higher compared to a term policy for the same amount of death benefit.

Term life insurance may be purchased on an individual basis or as part of a group. An example of a group term insurance policy is the Federal Employees Group Life Insurance (FEGLI) program.

Term life insurance is appropriate for individuals who need life insurance for short periods of time, anywhere from a period of five to 30 years. Premiums are less expensive the younger the policy owner is at the time of application. Premiums usually increase as the policy owner gets older unless the policyholder purchases “level term” life insurance.

The insurance proceeds from a term policy are paid only if death occurs during the policy term. If the life insurance policy owner (normally the insured), stops paying premiums, the policy stops.

There are variations of term insurance, including:

• Annual renewable term. This insurance is characterized by a level death benefit, a premium that increases at each annual policy renewal as the insured gets older and no cash value accumulation.

• Level term. The annual premiums are fixed for a specified period of time, typically 10, 15, 20, 25 or 30 years. Premiums remain the same; the death benefit remains constant with no cash value accumulation.

• Decreasing term. The annual premiums are fixed for a specified period of time but there is a decreasing death benefit with no cash value accumulation.

• Return of premium term. The annual premiums are fixed but larger than a comparable level term policy. The insurance company returns the premiums if the insured survives the policy term. These policies are issued for 20-, 25- or 30-year terms.

Term life insurance is most useful when an insured is relatively young when it is purchased and the need is temporary. Some common uses of term insurance include:

• Family income protection. To provide the funds to support a surviving spouse and/or minor children, or to provide cash for a child’s college education.

• Declining needs. In some instances a debt such as a mortgage is matched with a decreasing term policy. As the debt is paid off, the policy’s death benefit is reduced.

• Funeral and estate expenses. To provide an amount of money to pay final bills such as medical, funeral or other estate expenses.

• Charitable gifts. To provide funds for a gift to a charity.

Besides individual term insurance policies purchased from a private insurance company, there is group term insurance such as FEGLI. New or rehired federal employees can enroll in FEGLI when they are hired and can add to their coverage as certain “life events” such as marriage occur. Employees may have access to other group term policies through professional organizations.

The advantage of group term policies is that unlike individual term life insurance, evidence of insurability does not usually have to be furnished. This means that with most groups' term policies an individual need not go through a medical exam, nor does the insurance company check the potential insured’s medical records. The disadvantage of group term is that a relatively healthy individual will pay more in premiums at some during the policy term compared to what he or she would pay with an individual term policy, especially a level term policy.

The following table illustrates the differences in premium costs between FEGLI (“basic” coverage, plus FEGLI Option “B” - one multiple of salary) and 20-year level term insurance offered by three private insurance companies, using three individual insurance company rating classifications: (1) Preferred (P); (2) Standard Non-Tobacco (SNT): and (3) Preferred Smoker (PS).

* Age at which insured enrolls (in FEGLI) or is approved for individual insurance
** FEGLI Option B premiums increase every five years.

Note that the preferred (P) premiums are always less than the FEGLI premiums, while the standard non-tobacco (SNT) premiums are less than the FEGLI premiums at age 25 and 35. It should also be mentioned that the FEGLI premiums for additional Option B coverage increase every five years and double in cost when an employee becomes age 60.

Employees - especially those who are in relatively good health - who need life insurance coverage for at least 10 years are therefore encouraged to look into purchasing level term life insurance from a private insurance company.