Perhaps one of the greatest financial tools for creating and preserving wealth is the concept of life insurance. It is a misnomer in the sense it does not produce life–like automobile insurance and homeowner insurance, it does not produce the entities being insured; but it is usable to describe how the cost of living can be met when an untimely death takes life away.
The concept of life insurance has morphed over the years to include various types of policies to meet general cost of living expenses, i.e., mortgage payments, utilities, groceries, etc. to more specific financial circumstances, i.e., funding buy/sell agreements, executive bonus plans, deferred compensation to name a few. It can be honestly stated that life insurance is not a one thing fit all scheme for solving financial issues, but it is an instrument which can be customized as needed.
Term insurance is one general category of policies available to a financial planner to solve a client’s need. Let’s answer a few questions relating to this form of life insurance in an effort to assist you in determining if it is the right tool for you to use in your pursuit of creating and preserving an estate.
How does term life insurance work?
If someone were to approach you with a business offer to pay your family at any time in the next year $10 for every 3 cents you would give them today, how many pennies would you be willing to part with? Then sweetening the offer with saying the offer would be renewed every year for the next 15 years without any increase in the ratio of return to payment received. Your 3 cents would always return $10. At the end of the 15 years if you wanted you could renew the arrangement by increasing your payment to 5 cents for every $10. After that 15 years you could reup the offer by increasing your payment to 50 cents and then renew every 15 years at an increasing rate until you would be paying $10 of deposit for every $10 in return. Of course you wouldn’t do that payment plan, but it is theoretically possible for you to do.
Let’s assume you use this method of payment for the next 45 years. If you did, and lived the 45 years, you would have paid $7.50 for the $10 return. But what would have happened if you had made one payment and got run over by a truck? Here is the miracle of the life contract: the company would send a $10 payment with a return of some of the unearned 3 cent payment.
Skipping medical and other underwriting requirements, that is how term insurance works. It is a simple contract drawn up between an insurance company and an insured. Once it is issued and the payment is made, this contract cannot be rescinded by the insurance company except under certain conditions i.e. material misrepresentation or by suicide. The only way it can be terminated is by a written request of the insured or stop payment of charged premium. Once the contestable period has been met, this becomes a unilateral contract totally under the control of the insured.
What if I outlive the term contract?
Every term insurance policy issued by an insurance company is issued for a specific term of time. The premiums to be charged are established at the outset of the policy with some companies issuing the policy with contractual wording allowing them to increase the premium in the event the projected premium is not adequate any longer to cover the company’s expenses and payout exposure.
The premium being charged is actuarially calculated to include all company expenses and projected death benefits over the lifetime of the policy. If you die during the term of coverage, the death benefit (face amount) is paid to the beneficiary designated by the insured. The contract then is satisfied and there is no longer any financial commitment on either the insured’s side or the company’s side.
However, if you outlive the term contract you simply will have the peace of mind knowing your beneficiary would have received the benefit you paid for had you died. The company closes the books and removes any financial obligation it had committed to. Your premiums are no longer charged and no money is returned to you. Case closed.
What happens when term life insurance expires?
Generally, when a term life insurance policy is issued, there is a contractual provision included in the contract which allows an insured to continue a policy with increased premiums or to convert the plan to a permanent type of life insurance.
When the term of time for the policy is coming to an end, a notice is sent from the insurance company advising you that the coverage is coming close and will terminate unless you take advantage of their contractual provision. This provision to convert usually allows you to do so without any medical requirements or occupational limitations.
If you determine you no longer need the protection provided by the expiring policy and decide not to convert it, then you walk away with the receipts showing you paid a premium for coverage, and that is all.
A sad commentary regarding policies expiring is that less than 2% of term policies written ever show as a death benefit. In fact, the life expectancy of a term policy is about seven years at which time most people just stop paying premiums or convert the policy to a permanent plan which allows them to level off premiums being charged and to begin accumulating a guaranteed cash reserve in the permanent insurance plan.
What does term life insurance not cover?
Unless there is some specific rider on a term policy, one could safely say any form of death would allow the policy to pay the death benefit. However, here are a few exceptions that demand attention: occupational hazards, murder, suicide, and war exclusions. All of these may have some restrictions, if not total denial of claims.
- In today’s modern life policies the only contractual exclusion is suicide, and this only affects the payout for the first one to two years. If death occurs during this suicide time period, only the premiums paid in will be returned to beneficiary.
- Restrictions regarding payment for war and occupational deaths are usually addressed during the underwriting process. If an individual is planning on joining the military and will be on active duty in a war zone, the policy will either not be written, rated up for hazard, or excluded during the time of hazardous exposure. One exception to most companies’ underwriting policy is the Servicemen’s Group term policy which will pay for death caused by war exposure.
- Occupational hazards are also addressed in the underwriting process, i.e., scuba diving, skydiving, competitive vehicle racing, underground mining, aviation, etc. These activities are considered as to their effect on the mortality risk factor outside the normal activity of an insured. Again, there can be exclusions applied, premium increased, or denial of coverage just like war exclusion provision.
- Murder is not in and of itself a reason for denial of death benefit. This is, however, going to require a considerable amount of discovery surrounding the incidence. Who was involved? What was the motive? Did the beneficiary play a role in the death? Who will benefit from payout? Who will suffer a loss if payment isn’t made?
- Another possible exclusion could be applied if the policy has a civil disobedience or terrorist activities clause in it. This will be an exclusion we may hear more about if civil commotion continues impacting our society.
Who can purchase term insurance?
This can easily be answered with a positive answer to three questions:
- Is there a financial need? Will someone suffer a financial loss in the event of death?
- Can you medically qualify for it? Certain ailments may keep you from being able to purchase term life insurance.
- Can you afford it? The life insurance company is not going to issue a large sum death benefit to someone who does not have the capacity to pay the premium over the lifetime of the policy.
If these three questions are answered in the affirmative, then anyone can purchase term insurance.
Why buy term life insurance?
This brings us to the question as to why someone would want to purchase term insurance. There are as many answers to this question as there are individuals who desire to obtain the coverage provided.
It may best be answered with this thought: if I have a financial loss which would jeopardize my family’s standard of living and I can hedge against it, then I would want to consider term insurance. If I determine my financial loss would only be on a temporary basis–i.e., mortgage on my home, paying off education debt, a large temporary debt to start a business–then term insurance would be enticing.
Usually people who purchase term life insurance are purchasing it because they feel they can eventually be financially capable of meeting any financial obligations from accumulated assets, pensions, and savings.
Another sound reason for purchasing term insurance is the moral obligation one feels to provide for his/her family in the event of an untimely death and the peace of mind one feels when that obligation has been fulfilled.
A final thought regarding term insurance has to do with one’s walk in life. Most want to leave something behind in this old world besides just their footprints in the sands of time. Term life insurance is one way of creating immediately the size of an estate you would envision if you had a whole life to complete your dream. The size of your estate dream is only limited by your ability to pay for it and your being able to medically qualify for it. The life insurance policy supersedes the factor of time by instantly creating the estate you would create if you had the time right at the signing of a life insurance contract, approval by the insurance company, and committing yourself to your only obligation of paying for it.
Hope this is helpful in your decision on the type of life insurance you would want to have in your financial plan.
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