How Does Term Life Insurance Work?

What Is Term Life Insurance?

Insurance is designed to help manage the unforeseeable and the unexpected. Car insurance helps provide protection in the case of accidents; health insurance helps protect individuals when medical emergencies and needs arise; homeowners insurance can cover unexpected problems in a home. Life insurance provides a benefit for beneficiaries if the policyholder dies during the policy term.

Term life insurance is a life insurance policy that lasts for a specified period of time, during which the policyholder makes premium payments in exchange for the promise of a death benefit. For example, if a policyholder purchases a 20-year term life insurance policy, and makes the required premium payments during that time, their family and other beneficiaries can receive a predetermined amount of money, called the death benefit, upon the policyholder’s death.

A term life insurance policy is a contract between the insurer and the policyholder. The policyholder agrees to pay the applicable premium in exchange for the insurer’s payment of a death benefit, upon the policyholder’s death, to the specified beneficiary or beneficiaries. The death benefit is usually tax-free.

Term life insurance is one of the two main types of life insurance policies. The other common life insurance policy type is permanent life insurance, including whole life insurance and universal life insurance. Both term and permanent life insurance policies involve the policyholder paying premiums in exchange for a death benefit paid by the insurer to specified beneficiaries in the event of death. However, term life insurance is effective only for a set period of time (the term), while permanent life insurance remains in effect for the lifetime of the policyholder.

Because of this crucial difference, term life insurance and whole life insurance polices may operate differently. For example, term life insurance polices typically offer lower premiums because the policy is only effective for a set period of time. On the other hand, whole life insurance, while generally more expensive, is effective for the lifetime of the policyholder and can include cash value. This means that as a policyholder continues to pay into the policy, the cash value compounds and can be borrowed against.

How Does Term Life Insurance Work?

The application process is the first step in seeking a term life insurance policy. An applicant will typically be asked to provide information about their occupation, hobbies, lifestyle, medications, driving record, family history, and anything else the insurance company deems important. Applicants may also need to undergo a medical assessment, which is used to assess the level of risk to the insurance company. Generally, things like a poor medical assessment, high-risk occupations (such firefighting, mining, construction, farming, or fishing) and high-risk hobbies (such as scuba diving, skydiving, or rock climbing) may result in higher premiums.

After the application process has been completed, the policyholder is faced with two important decisions: the policy term length and the death benefit amount. The policy term length will determine how long the policyholder will pay premiums for and for how long the beneficiaries could receive the death benefit. Many factors should be considered in making these decisions. For example, parents may want to choose policies that will provide sufficient benefits for their children until the children leave the home. Some policyholders, however, may choose to purchase a more extended policy. Since it is typically easier to obtain coverage at a younger age, younger individuals may choose a longer-term policy.

The applicant will also need to choose the death benefit amount. When making that decision, a policyholder may consider the amount it will cost to provide for beneficiaries in the event of the policyholder’s death. 

The Different Types of Term Life Insurance

There are several different types of term life insurance. The appropriate type of term life insurance policy will depend on the policyholder’s particular circumstances and needs.

Level premium

Level term is the most common type of term life insurance policy. With this type of policy, the policyholder will pay a fixed premium amount until the term expires. The premium amount will always stay the same, even when the person ages or accumulates more risk.

Yearly renewable term

For yearly renewable term life insurance policies, the policyholder will still set a specific term, but each year, will have to choose whether to renew the policy or not. Essentially, a policyholder will pay premiums for a year, and then they will have the option to continue paying those premiums, generally at a higher cost. Each year, as the policyholder accumulates more risk, their premiums will increase. Over the entire term, yearly renewable term policies could cost more overall than level term.

Guaranteed issue

Guaranteed issue term life insurance policies don't require a medical assessment to qualify, and the individual's health doesn't affect the premium price. As a result, the premiums are generally higher than other life insurance policy types. In addition, many of these policies don't include a death benefit for the first several years of the policy, meaning that if the insured dies within that time, their beneficiaries don't receive any money. These policies are typically best for people who can't find affordable alternatives because of health issues.

Term Life Insurance Policy FAQ

How much does a term life insurance policy cost?

The cost of term life insurance will vary depending on many different factors, including the risk presented by the policyholder and the type of policy selected. Typically, the younger an applicant is, the lower their rates will be.

Insurance companies also take into consideration mortality tables to help determine risk. Term life insurance for men typically costs more than term life insurance for women who, according to the mortality tables, are expected to live longer on average.1

1 https://www.ssa.gov/oact/STATS/table4c6.html

Can you get your money back at the end of a term life insurance policy?

Most term life insurance policies don't include any money back when the policy ends, but a specified type of term life insurance, called a “return of premium” policy, allows for the recoupment of premium payments if the policyholder outlives the policy term. Return of premium term life insurance policies typically cost more than standard term life insurance policies.

How much coverage do you need?

The amount of coverage needed under a term life insurance policy will depend on the specific needs and circumstances of the policyholder and beneficiaries, but these are some things to consider:

Many policyholders may choose death benefits which are at least ten times the policyholder's salary, with a consideration of college expenses for beneficiaries.

The appropriate coverage amount could also change depending on age. For example, younger individuals may want to consider coverage for thirty times their current salary, versus older or retired individuals who may choose a coverage level closer to their net worth.

Can you cash in your policy?

Term life insurance policies do not include cash value. If accumulating cash value is desired, a whole life insurance policy may be more beneficial as whole life insurance policies may be cashed in for cash value.

Can you turn term life insurance into permanent life insurance?

Some policyholders may reach the end of their term and wish they had more coverage. Is it possible to then turn term life insurance into permanent life insurance? Many insurers offer convertibility or the ability to change term life insurance to permanent life insurance like whole life insurance but, in general, most insurers will require the policy to be converted early on during the term—often within five years.

How to Obtain a Term Life Insurance Policy 

A term life insurance policy can be an affordable way to help provide for family and loved ones in the case of the unexpected. Term life insurance can offer a sense of security and peace of mind for policyholders wishing to provide for their beneficiaries after their death.

To review your term life insurance options, contact us at Acrisure. We will help you find the right insurance provider for your term life insurance needs. Or request a life insurance quote online now!