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Term insurance

This article was last updated by the author in October 2016.

A brief introduction to term life insurance.

Contents

Overview

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. 

Typical cover provided

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 are available:

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 will last.

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 inflation.

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.

Optional extensions

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 maintained.

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 financial difficulties.

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. 

Key exclusions

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.

Rating factors

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. 

Product providers

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.

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