Term vs. Fixed Life Insurance

Term life insurance is widely regarded as the cheapest pure life insurance coverage you can buy. However, not all term policies are the same, and some types of policies offer more value than what a term policy can give you. If you buy your insurance by price alone, you could end up purchasing the wrong type of policy for your needs.

Annual Term Life Insurance

An annually renewable term life insurance policy is the most basic form of life insurance. It provides death benefit coverage for just one year, and you only pay premiums to support the death benefit for that year. When you renew your policy for the same coverage amount, your policy premiums are guaranteed to increase. Your death benefit coverage remains in force, however, as long as you continue paying the premiums according to your policy's contract.

Fixed Life Insurance

A fixed life insurance policy fixes the death benefit and the premium payment. With this type of policy, the insurer collects more than what the death benefit costs for one year. The policy's death benefit costs technically increase every year, since you're getting older and present a greater risk of dying. However, the excess premiums collected in the early years of the policy are invested and used to pay for those rising insurance costs as they occur. By structuring a policy in this way, insurers can keep your premium fixed for the life of the policy. Fixed policies include any life insurance with a fixed premium amount. These policies would include 5-, 10-, 15-, 20- and 30-year level term life policies, where the premium remains the same for the length of the policy. Most whole life and universal life policies also offer level premium payments.

Benefits

The benefit of an annual renewable term policy is that coverage is generally cheaper in the early years of the policy than an equivalent level-premium policy. If you just can't afford the higher premiums of a level-premium policy, then the annual renewable policy gives you a way to buy affordable life insurance one year at a time. However, level term life, whole life and universal life all have advantages, too. Level term policies give you the ability to pay for insurance coverage for many years without the need to pay increasing premiums each year. Whole life and universal life require higher premiums than level term policies, but give you a cash value component that you may use during your lifetime for any reason. You may access this cash value through policy loans or by surrendering the policy to the insurer for its cash value, thus terminating your death benefit coverage.

Disadvantages

The disadvantage of the annual renewable term is that the premiums eventually become more expensive than the level-premium policy type. All other things being equal, the annual renewable policy would be cheaper than all other policy types when you're younger. However, if you were to renew the policy into a very advanced age, the premium would increase until it came close to equaling the death benefit you're purchasing. In addition, with an annually renewable term policy, you receive nothing when the policy terminates or you can no longer afford coverage since there is no cash value to distribute upon policy termination. The disadvantage to level-term policies is that you may not qualify for renewed coverage when the term ends, and like annual renewable term, you normally receive nothing when the policy terminates since there's no cash value. Finally, the disadvantage for whole life and universal life is that these policies require substantially higher premiums because of the cash value -- that is, the savings and investment -- component. It may be difficult to afford the death benefit coverage you need when buying this type of policy.

References

• "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu and Robert A. Crane; 2007
• "Actuarial Aspects of Individual Life Insurance and Annuity Contracts"; Albert E. Easton and Timothy F. Harris; 1999
• New York Insurance Department: Basic Types of Policies