Why would I/when should I stick with decreasing term life insurance?

Question

I have been approved for some decreasing term life insurance, with a 25 year term and a decreasing payout by 8% each year. I can leave the contract at any time and take out new life insurance.

What I don't understand is, why would you let insurance like this run for its full time period given the decreasing payout each year (after 10 years it will pay less than half of what it would originally, with the same premiums), when you could just cancel it and get new insurance?

Does it get hard to be approved again for life insurance if you leave a contract and try to get new insurance, or will doing this keep raising the premiums making this not generally worthwhile?

Are there best practises for when you should keep decreasing term life insurance in place year-on-year, vs amending it or canceling it and taking out new cover?

(This is in the UK, if that makes a difference).

Answer 1

• Life insurance premiums do go up with age. A quick google found a claim that they go up 8-10% per year on average, but they go up slower when young (about 5% per year in your 30s) and faster when older (12% per year in your 60s).
  • Note that 8% decrease in payout per year is equivalent to an 8.7% increase in premiums per year: 1/(1-0.08). That's still in the range of 8-10% as above.
• You may become uninsurable or face unexpectedly higher costs, for instance if you are diagnosed with a serious illness terminal or not, take up a risky sport, changes in the insurance marketplace, or who knows what else.

From what I read about this product, it's generally only good when you have a predictably decreasing liability you want to cover, such as a mortgage you're paying down, or business startup costs. If you think having half the coverage in 10 years will be a problem, that means you think you'll need the full amount of coverage in 10 years, and you should just get a regular level term policy.

Answer 2

why would you let insurance like this run for its full time period given the decreasing payout each year (after 10 years it will pay less than half of what it would originally, with the same premiums), when you could just cancel it and get new insurance?

I'm not in the UK, so I don't know of anything specific to the laws/regulations there, but from a pure insurance standpoint, having decreasing value insurance should be cheaper than level term since the expected payouts would be lower. Now why would someone do that? Imagine you have 4 kids at home and a spouse that all depend on your income (which is what life insurance is supposed to replace). You need to have life insurance that will provide enough to replace your income over some time period (10 years is a typical rule of thumb in the US). As kids grow up and move on their own, they are no longer dependent on your income (they should have their own) so your insurance need decreases. In addition, as you build retirement savings, you can "self insure" as you grow closer to retirement, so your need for life insurance decreases over time from that as well.

So, yes, you could cancel and get a new smaller level term policy every now and then, but having that built in to a contract removes risks like unexpected illnesses, etc. that would affect your ability to get new insurance.

Answer 3

Because generally, the amount of money required by life insurance goes down as you get older.

If you're 30 with a wife and two kids? Then your salary suddenly disappearing would have a monumental impact on your family. Your income towards daily life disappears. There are mortgage payments to be handled. Car payments to be handled. College funds to try to build. Etc. Etc.

If you're 70 and retired with your wife? Then the financial requirements suddenly get way less. It might be as low as simply funeral costs.

Now, add the following data point: the older you get, the more likely it is that you'll die... which means that the older you are, the larger (percentage-wise) that the insurance will cost you.

So, putting that all together... how would you create an insurance plan for yourself?

You could say, "I'm going to get a whole-life policy." Which will cover you until you die. Which is fine... but both of those factors above make things suboptimal. The plan has to be priced so that your payments when younger subsidize the higher cost for when you're older - which is why 'Term Life' is cheaper than 'Whole Life'. And the "I need more coverage!" factor when you're younger requires you to be insured for more than you'd absolutely require when you're older.

You could say, "I'm just going to get Term Life." Which, again, is fine. Except you'd bear increasing costs for each term, assuming you kept the same coverage level each time.

Or you could say, "I'm going to get Term Life... except I'm going to reduce the coverage for each term I buy."

... which is pretty much the decreasing payout term life insurance is that you're describing. They're reducing the coverage for you - and doing so in a way that will keep your payments consistent from year to year.

Don't get me wrong - their reductions might not actually align with what the costs might be. You'd be smart to check each year whether a fresh Term Life policy would be cheaper (aka, if your cost-to-insure didn't actually go up 8% per year) and whether the proposed payout makes sense for your financial situation (if you have more financial need from a life insurance payout, such as from having another kid.)

But as it is? The scheme is generally a smart way of balancing those factors to try to keep the cost low: it covers you more now (when you need it) and reduces the coverage when it gets more expensive (and you don't need as much of it.)

Answer 4

Well you say this is completely your option to drop the insurance so each year (or whatever your tolerance is) you could shop for new insurance and if the new quotes come out to be cheaper than what you have now then cancel the existing and replace. If the new quotes are more expensive then throw the new quotes away and keep what you have.