Term life insurance is very simple: You pay premiums – either annually, quarterly or monthly. In return, the life insurance company promises to pay a large cash death benefit – usually tax free – in the event the insured dies during the term. This last phrase is important: Term life insurance holds no cash value and provides no residual benefits. If the term expires and you don’t renew, and the insured dies even one day later, the insurance company is not liable for the claim.
Because the basic structure of term life insurance is so simple, though, it’s tempting to think of life insurance as a commodity. If that were true, you could buy life insurance simply by shopping for the cheapest premium. But all life insurance contracts are not the same, and finding the lowest premium is only part of the picture. There are a number of other important considerations to consider.
How strong is the issuing company? A life insurance policy is a promise to pay a very large amount of money, perhaps decades into the future. The life insurance company, in issuing a term policy, is making a bet that the insured is not going to die during the term. But you, as the policy owner, are making a big bet of your own: You are betting that the insurance company is going to be around years from now and able to keep its promises.
Look at the financial strength ratings issued by companies like Standard & Poor’s, Fitch and Moody’s on various life insurance companies. The specific letters and language each ratings company uses is different. But the more “A’s” you see, the better. The higher ratings indicate that in the view of the ratings agency, the insurance company has strong cash flows, a safe investment portfolio and reserves more than adequate to cover its risk, even in the event of a severe market downturn or large scale disaster, such as an influenza outbreak or major war that would increase claims. Stronger companies are more likely to survive – and less likely to leave you scrambling for coverage later if the company fails while you still need life insurance.
What happens when the term runs out? Does the insurance company just drop you? Do you have to reapply for coverage? Will you have to take a medical examination to renew coverage? Or do you have the guaranteed option to extend coverage for another year, five years or ten years?
The guaranteed option to renew has value. If you have a guaranteed renewable term policy expiring in two months and you get diagnosed with cancer, you are probably not going to let your policy lapse, if you can help it. The insurance company knows this, and knows it’s taking on more risk. Premiums on guaranteed renewable policies are slightly higher, but are frequently worth the extra premium.
Term insurance provides a temporary death benefit. But it may come to pass that you want a permanent death benefit rather than a temporary one. Or you may want to buy a life insurance policy that builds up cash value over time. These policies have important uses in estate planning, business succession planning, retirement planning and personal financial planning. But their premiums are higher, as well.
Some companies give you the guaranteed option to convert a term policy to an equivalent face value permanent policy. Again, these convertible policies may charge slightly more than policies that don’t give you the conversion option.
What happens if you become disabled? If you can’t work anymore, what will happen to your ability to pay life insurance premiums? That’s where premium waiver comes in. Premium waiver is an optional rider, or additional feature, on the insurance policy. It guarantees that if you become disabled, the insurance company will waive your premiums. That is, they will pay them for you. So you don’t lose your life insurance coverage just when you get sick or hurt.
Again, there is a cost for this feature. But it’s generally a very small monthly cost compared to the potential benefit.
Mutual vs. Stock Companies
There are two basic life insurance company structures: Mutual ownership and stock ownership. Mutual companies are owned jointly by policyholders; stock companies are owned by stockholders, and are generally traded on Wall Street.
When a life insurance company makes a profit, it sends a share of the profits to all of its owners. Mutual companies issue dividends to policy holders. For term policy holders, this dividend frequently takes the form of a discount on term insurance premiums, which is non-taxable. Stock companies, on the other hand, send their profits to owners of stock, rather than to policyholders.
Mutual companies may have higher initial premiums – but since excess premiums are ultimately routed back to policyholders, it’s theoretically a wash, and the overall lifetime cost of a policy issued by a mutual company can be very low, despite higher premiums. Stock-owned companies, on the other hand, frequently offer lower initial premiums, but as a policy holder, you don’t get a dividend. Those go to stockholders, not policyholders.
This is an underappreciated factor, but there are large differences between carriers in how they assess and price risk. For example, some companies charge much less for women than men, while others charge a uniform rate for both genders. Companies may charge very different premiums for the same application, based on differing approaches to underwriting risk from smoking, high blood pressure, depression, medications, diabetes, pregnancy, occupation, your motorcycle racing and helicopter skiing hobbies, and other health factors.
Experienced agents know what companies may offer the best deals for specific health situations. This is where using a veteran insurance agent is valuable. In practice, life insurance can be highly variable from company to company, and from individual to individual. As such, it’s not a commodity at all.