This article was last updated by the author in October 2016.
A brief introduction to term life insurance.
The main purpose of term insurance is to provide a lump sum in
the event of the life insured dying during the term of the policy.
Various 'bolt-on' options are available to meet a wide range of
customer needs. The process of buying term insurance involves
completing health questionnaires and medical underwriting. These
enable the life office's underwriting team to assess an
individual's eligibility for term insurance as well as the
appropriate premium to charge. Term insurance is, perhaps, the most
widely available life insurance product.
The policyholder selects the amount of life cover they need (the
sum insured) and the amount of time for which they need the cover
(the term). They then need to choose the most appropriate type of
term insurance policy to meet their needs. The following policies
Level term insurance - this policy has a sum
insured which is fixed throughout the term. There are a number of
variations on this basic level, as outlined below:
Renewable term insurance - allows the
policyholder to effect a term insurance policy for, say, three or
five years, at the end of which the policyholder has the right to
effect a similar policy for a similar term without having to give
the insurance company any evidence that they are still in good
health. Renewable term insurance is used when there is a definite
initial need for life cover but it is not known how long the need
Convertible term insurance - allows the
policyholder to convert the policy to either an endowment or whole
of life policy with up to the same sum insured at any time before
the end of the term of the original policy without further evidence
of health. This is a valuable feature if the policyholder's need is
for additional savings (convert to endowment) or a longer-term
protection (convert to whole of life).
Increasable term insurance - provides for the
sum insured to be increased regularly (without any evidence that
the life insured is still in good health) over the term of the
contract. Such policies enable policyholders to ensure that
their life insurance maintains its value in real terms against
Decreasing term insurance - whereas the sum
insured for a level term insurance remains constant throughout the
term of the policy, the sum insured of a decreasing term insurance
reduces each year by a stated amount, decreasing to nil at the end
of the term. It is normally used to cover a reducing debt, such as
the capital outstanding on a repayment mortgage.
Family income benefit - this is a type of
decreasing term insurance policythat is often used to protect a
family with young children. Instead of paying a lump sum on death,
it pays an 'income' intended to replace the income which the life
insured would have provided for their family. Although called
family income benefit, the policy provides a lump sum payable by
instalments for a selected period. This avoids an income tax
liability. The 'income' is paid each year from the death of the
life insured until the policy expiry date.
For all term insurance policies, if the life insured survives
until the end of the term there will be no further premiums to pay
and no payout from the insurance company. A term insurance,
therefore, is a policy which offers life insurance only, with no
savings element whatsoever. This means no surrender value if the
policy is cancelled early. Term insurance usually offers the
cheapest way to buy life insurance where the need for cover is
likely to last for only a certain length of time.
Many life offices have a number of options which can be added to
their standard policies. These include:
Terminal illness benefit - if the life insured
becomes terminally ill, and in the opinion of the life office their
life expectancy is less than twelve months, then the sum inured is
paid out and the policy ends.
Waiver of premium - the life office waives the
policy premiums (normally after 26 weeks of incapacity) when the
life insured is too ill to undertake their normal occupation or, in
some cases, another suitable occupation. With the provider paying
the premiums, the protection offered by the policy is
Critical illness cover - the sum insured is
paid out if the policyholder is diagnosed with a specified critical
illness. The cash lump can then be used to help maintain their
lifestyle, make alterations to their home and help to avoid
Increasing cover - this option enables the
policyholder to increase their cover by certain amounts at certain
times without further medical evidence, such as on marriage, the
birth of a child, a house move or an increase in an expected
Inheritance Tax (IHT) liability. These are often termed guaranteed
insurability options, as they give the policyholder the right to
further cover in the future if required.
Practice varies between life offices but some policies will not
pay out in the event of death caused by:
- intoxication by alcohol or drugs.
- war or terrorism.
- suicide or self-inflicted injures.
- gross negligence or reckless behaviour.
Typically, suicide will be excluded for the first one or two
years of the policy only.
Most term insurance policies are subject to a medical
underwriting process. The policyholder will complete an application
form detailing their personal details, age, current state of
health, medical history, occupation, hazardous pursuits and
lifestyle. An underwriter may also request completion of a medical
questionnaire, a medical report from the applicant's GP or a
medical examination. Alternatively, a tele-underwriting interview
may take place.
Based on the information obtained through the application
process, the underwriter will classify the policyholder into the
appropriate risk class (preferred, standard, rated, postponed or
declined) and, where the policyholder is accepted, will then offer
standard terms or apply special terms. Generally policyholders who
are older or who smoke will pay significantly more for their life
cover than younger or non-smoking policyholders.
The majority of life offices offer term insurance policies. What
differs is the extent to which they offer options and the
underwriting criteria they apply. Generally pricing is very
competitive. The more options a policy has, the more expensive it
will become. However, some policyholders are prepared to pay higher
premiums in return for such flexibility.