Term life insurance: Handle with care
By Steve Kobrin
The Firm of Steven H. Kobrin, LUTCF
When used properly, term life insurance provides maximum protection for the lowest available price.
However, this product does have certain limitations, which every consumer should understand. Let us look at some of the more important considerations for you.
Face amount and guarantee period are fixed
Once a term life insurance policy is issued, neither the face amount nor the premium guarantee period can be extended.
For example, let’s suppose you are purchasing term coverage for the purpose of indemnifying a $1 million business loan with a 10-year payback period. Locking in that exact face amount and guarantee period makes sense.
If you need to take out a second loan, however, then your $1 million 10-year term policy would be insufficient. And it could not be extended. In order to secure the second loan, you would need to go through underwriting all over again.
Therefore, be sure to consider all your future lending needs prior to the insurance purchase. Apply for the face amount and guarantee period that meet the requirements of all anticipated loans. Once your application is approved, you could always decide to purchase less than what is approved. But you cannot purchase more.
Premium guarantee period is limited to 30 years
Term life insurance provides a premium guarantee period of no more than 30 years. After the guarantee period ends, your premium will significantly increase.
For example, let’s suppose you wish to purchase insurance for the purpose of income replacement to protect your family against the loss of your income in the event they lose you.
The question becomes how long would you need to support your family. Today, due to financial necessity, many people continue working well past age 70. Some never retire. In this case, even a 30-year term policy would provide insufficient protection to your dependents.
To avoid this problem, some people purchase permanent life insurance instead. Yet another option is to purchase a term policy with an option to later convert it into a permanent product without the need for additional underwriting.
Either way, it is essential to thoroughly evaluate one's life plans prior to purchasing term life insurance.
No cash value
Term life insurance does not accumulate a cash value. There is no pay-out until the death of the insured.
For example, let us suppose you join a business venture. You wish to enter into a partnership agreement such that, in the event of one partner's death, the surviving partners will purchase the business interest of the deceased partner. The partnership is considering the use of term insurance to fund this agreement.
This could make sense because your partnership has a predefined life span; you have an agreed upon exit strategy, as is customary in business partnerships.
However, what would happen if one of your partners prematurely leaves the business, not due to death, but due to unexpected personal or financial circumstances? How will you purchase his interest in the business?
You want the option of a "living buyout." But term insurance would offer no cash for this purpose.
On the other hand, cash value insurance could provide the necessary funding, immediately and without incurring significant charges for liquidation, if the right product is used.
As you can see, term insurance does have some limitations. While many of my clients purchase term products, others find that permanent products are a better match for their particular circumstances.