INSURANCE CENTER: Life

What should I look for in a renewable term policy?

Life Insurance
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In addition to the most important feature of a term life policy, guaranteed renewability without a medical exam, there are three other key components to consider:

  1. The policy term
  2. Guaranteed level premiums
  3. Ability to convert to a cash value policy

Before we look at each of these components, it will help to get one basic idea on the table. The key factors that determine insurance premiums are age, cigarette smoking, and general health. As people get older, take up smoking, or decline in health, they become more likely to die, and insurance companies must take in more revenue, in premiums, to cover expenses.

Typically, when you buy a term insurance policy, you lock in a particular rate class that's based on your age, smoking status, and health at the start of the term. When it comes time to renew a term policy, you can't do much about your age. You'll be older, so your rate will be higher. This much is entirely predictable and not worth worrying about or maneuvering to beat.

With this perspective in mind, let's move on to the three key components of a guaranteed renewable term life policy.

1. The policy term
Term policies are either annually renewable (one-year term) or cover terms from five to 30 years (e.g., five, 10, 20, 30). Think of annually renewable term as the basic building block on which longer-term policies are built. If you pick a policy term beyond one year, you get two advantages:

1) The total multiyear premium cost is spread out evenly over the policy term, rather than increasing each year, as you get older. For this reason, these policies are usually called "level term" policies.

2) You can often get a better rate for longer terms, since the insurance company gets better odds that you won't switch policies during the term.

As with everything in life, though, there are trade-offs:

1) When you buy a longer-term policy, it may look like you are paying a level premium, but you are really just over-paying in the early years to cover higher costs in later years. Therefore, if you decide to drop the policy before the term is over, you will have overpaid. For a 20-year term policy, for example, you will have grossly overpaid if you drop it after 10 years.

2) If you have any outstanding questions about your life insurance needs, it's safer to buy a shorter-term policy until you get these questions squared away. It can be tough to accurately estimate how long you will need life insurance, especially if you expect to see a large inheritance, for example, or think you might be able to retire early.

3) As you get older, your income replacement need gets smaller, as there are fewer and fewer years to cover before retirement. Buying shorter-term policies will allow you to reduce the death benefit of your policy accordingly, with each successive term renewal. Reduced death benefits mean reduced premiums.

It's tough to balance all these factors and make a recommendation that fits most individuals. It will always depend on who you are and what you need. In general, though, shorter terms provide more flexibility and the potential for cutting costs at renewal, while longer terms offer a better price for a given level of insurance over a given term, as well as greater predictability in price.

2. Guaranteed premiums
Before you purchase a multiyear term policy, be sure that the premium is guaranteed to be level over the entire term. A surprising number of "level term" policies guarantee this for just a portion of the term. After this partial term is over, premiums might increase, although these increases are usually subject to some guaranteed maximum.

3. Ability to convert to a cash value policy
Getting a "convertible" term policy is generally a good idea. These are priced competitively with similar policies that don't include this provision, so you really have nothing to lose. This feature allows you to convert the policy to an equivalent cash value policy from the same company, without a medical exam, should there be a fundamental change in your health or retirement plans during the policy term.