What is the point of term life insurance?

Question

I am in USA.

I am trying to understand term life insurance. My husband makes $150K a year and wanted to get a term life. I believe the rule is 10 times your yearly salary so for us it would be term life insurance for 1.5 million. We called Zander insurance and got the rates for example $50 a month for next 40 years. My husband is 40 right now. If my husband lives more than 80 years then the term life insurance will not cover since he is outside the term. If we want to renew it then it will be super expensive.

So I am not understanding that: What is the point of term life insurance? Are we betting that the person will die without the time period he/she has originally suggested?

Answer 1

I think the part you are missing is that the insurance isn't there to replace your husband, it is to replace his income.

The implicit assumption is that when your husband is 80 he is no longer earning a salary. At 80, he is most likely living on a combination of savings, pensions, and social security. Also, probably at that point he has fewer dependents, because the children would be adults living on their own.

However, if you expect he will still have a job supporting other people on his employment income at 80 you might consider other options like whole life or a longer-term policy.

Answer 2

The goal of term insurance is to replace a stream of income if somebody dies. At some point after a person retires, the stream of income that needs to be replaced isn't wages and salaries it is money from social security, pensions, and retirement accounts.

Many people find that at some point they no longer need as much life insurance, they may even find that they don't need any life insurance. Hopefully this happens before the costs explodes.

Regarding the amount of coverage and length of term, that takes a financial analysis. It depends on the other sources of income and how much it will take to support the surviving family members. You may find that the amount needed now, will be different from what is needed in 10 years. Many people find they need to reevaluate as kids are born, grow up, hit college, and then move out.

Answer 3

The point is to provide a safety net in case of unexpected event. After the age of 80 death becomes somewhat expected, so you should be prepared. Generally term insurance is good for a term where the unexpected event would be in particular disruptive. For example: for the duration of your mortgage, or until the kids finish college and become self-sufficient, etc.

Answer 4

You seem to be asking, in essence, about term vs. whole-of-life (WOL) insurance. The major difference is that, since everyone dies, all WOL policies are guaranteed to pay out in the end, so the pricing of the premium is completely different.

For example, your $50pm premium may offer a payout of $1,500,000 in the event of your husband dying in the next 40 years (a very generous premium/payout ratio bearing in mind 80 is an above-average mortality age), but if you paid $50pm for WOL, you wouldn't expect to be covered for much more than $18,000 - $20,000 by the end of the term (($50 * 12) * 40 = $24,000 income for the insurer, calculated on an expected age at death of <= 80).

For WOL the numbers only make sense if the payout is very small compared to the premiums; for term they only make sense if the insurer can write lots and lots of policies that don't pay out, compared to only a few that do (to pay out one $1.5M term policy on a maximum of $24,000 income, the insurer would need ~62 other policies to not pay out just to break even on income/expense, without any margin for paying staff, admin costs, profits, offices, taxes and so on).

You can have tailored WOL policies that start out with a big payout while the insured is young but with that payout dropping as the insured ages - these are known in the industry (UK, anyway) as "reducing" or "decreasing" policies and are a reasonable compromise (for some definition of reasonable).

I don't ever offer advice (I'm not qualified) but I will say that as a note, the life reinsurance company I work for won't touch non-reducing, low-premium WOL policies (often known as "over 50 plans" in the UK) with a barge pole; the CEO believes they are a rip-off for the consumer, with no upside: if the policy is guaranteed to pay out then by definition, the average payout will always be less than the premiums paid, so you're better off saving/investing the premiums instead.

EDIT: to answer you last question directly:

So I am not understanding that what is the point of term life insurance? Are we betting that the person will die without the time period he/she has originally suggested.

You are betting that the insured will die before the end of the policy term; the underwriter is betting the insured won't.

Answer 5

The point of insurance in general is to protect yourself against an unexpected event.

In the case of (term) life insurance, the idea is to protect yourself against the possibility that your husband will die, and thus no longer be bringing in an income to support the family.

If you somehow knew for an absolute fact that your husband will live to be 80, there would be no reason to buy term life insurance. You'd almost certainly be better off to take the money you would pay in premiums and invest it.

But, sorry to be bring up unpleasant possibilities, but you don't know that your husband will live to be 80. He might be killed in an accident tomorrow. The point of term life is that if something like that happened, if your husband died young, you would be protected.

Life insurance is a sort of gamble. You pay in money every month. If you die, the insurance company pays off. If you live a long time, you pay more in premiums than the insurance company pays when you die. If you die young, the insurance company pays more than you paid in premiums. When someone gets term life, he's protecting his family against the possibility that he will die young.

If he lives to be old, everybody is happy. You and your husband had many happy years together. (Well, hopefully you're happy that you and your husband had many years together, but if not that's another story.) He had lots of time to earn and save money. And the insurance company is happy because they collected a lot in premiums.

If he dies young, the insurance company is unhappy that they collected little in premiums but had to make a big payout. The family is presumably unhappy that dad has died. But at least you have the insurance benefit to cushion any financial problems.

Answer 6

Yes, you got it right. If all goes well, you will lose money on term life insurance. You will pay in all those years and never get anything out. Which is great! That's the whole point!

It's just like fire insurance on your house. Are you hoping to get a pay-out on that? I hope not - you just pay for it in case of a fire, and hope to never get a payout.

But if your husband dies early and you lose out on his income, the term insurance is there to patch up the economic damage for you. That's all.

Answer 7

Life insurance is, like all insurance products, designed to provide financial payout in the case of a catastrophic loss. In this case, the loss of (the financial earnings of) a person.

If your husband dies unexpectedly, you will no longer have his income coming in, meaning you need to replace it so you can continue to live in your home, eat, etc. There are several ways to replace his income - you could start working for instance, or marry someone else with their own income. Life insurance is another way.

Term life insurance provides an amount of money ($1.5 million in your example) if the insured dies during the term. It provides no benefit if the insured dies outside of the term. It is provided as a lump-sum payment and you are free to do with it what you want. Many guides will tell you to invest it and withdraw a certain percentage (e.g., 4%) each month as your income. Depending on the percentage withdrawn, this can sustain you for a very long time. Other guides may advise to pay off certain debts (e.g., your mortgage) and withdraw a smaller percentage each month as income. Many people will also pay funeral expenses from the life insurance benefit. In all these cases, how much you have available as income each month is directly related to the amount of the death benefit ($1.5M).

How much coverage you need is dependent on a lot of factors, and there are tools and calculators available to help you determine that. In general, look at how much income you need to replace (nominally $12k per month, but in reality less), how long you would need to replace it for (could you start working soon after your husband died, if needed; how long until your mortgage is paid off or children are gainfully employed), what additional expenses you would incur if your husband died (e.g., child care if you were to start working), and what debts and dependents you have.

For most people, a 20 - 30 year term is popular, as that covers the time when children are small until they are employed and have incomes of their own. If you have no children and no mortgage, or if your children are already out of the house, you may not need (much) life insurance at all. If your children aren't infants / toddlers, you may look at a 15 - 25 year term policy instead.

Answer 8

Other answers do a good job of explaining insurance generally and term life insurance a bit more extensively. One concept missing from the other answers that I think is worth touching on is the word “term” and the rights and obligations of the term.

When you buy 20 year term life insurance the insurer is obligated to continue the insurance as specified in your contract for 20 years. You, the policy owner, can cancel whenever you please.

As people age their health declines, generally. This is why 10 year term insurance on a 40 year old tends to be less expensive than 10 year term on a 50 year old. This decline in health is roughly apparent in the pricing of various terms. 20 year term for the same 40 year old will be more expensive per year than the 10 year term at the same underwriting; because now you’ll also be covering your 50s. However, the second decade of that 20 year term policy will likely cost you less than a 10 year term policy you might buy in your 50s. In your 50s you are less likely to qualify for the same underwriting classification as you did at age 40. Some carriers will offer “guaranteed increase” riders which allow you to buy more coverage at the same underwriting classification. It’s generally not A LOT more coverage but the ability to increase your coverage without friction is something worth considering if you’re a young growing family.

Another consideration is that every new term policy will have a new contestability period where the carrier can investigate the death and potentially rescind coverage. Contestability periods vary by state but are avoided with a single long term policy.

I’m by no means saying everyone should go buy a 50 year term policy, load it up with riders and cancel it as needed, just that there are benefits to buying a longer term policy. There is an immediate cost savings to just buying a 10 year term policy and reviewing this issue again in 10 years because $100k of 10 year term will cost less right now than $100k of 40 year term would.

Just remember that the term is the carrier’s obligation to you and you don’t have an obligation to keep the coverage.

Answer 9

Mary, I think I might be able to help with my example. My wife and I took out a 20-year term insurance policy back when I was 40, thinking along the lines of the statements already made here (kids are graduated and on their own, house is paid off, social security coming in, etc).

But life doesn't always work out so neatly. I had several job changes, often starting lower than when I left. I also work independently (freelance), and that dropped off dramatically from time to time. Our kids both went to grad school and we helped out (we wanted them as debt-free as possible when they started out their careers).

So our kids are gone and doing well, but our house isn't paid off, and we are both still working in our 60's now, and the life insurance on me has expired. We have investments, but have had to tap into them for home repairs in preparation of selling our house and downsizing.

We talked about it and decided that we needed to cover my wife's potential needs with a new policy, and you're right – it is absurdly expensive.

So I think it's not a bad idea to lock in until 80, especially @ $50/mo for $1.5m (if that was indeed the rate). You never know what turns your lives might take, and remember that $1.5m won't seem nearly as much in 40 years.

Answer 10

At a guess, you'll be paying nearer 100x that $50 premium per month if it is going to be going past 70 year old person.

Remember - the insurance companies are there to make money and as you have seen in the above answers, it is a gamble for them that only works out for them if their future statistics follow on from their past statistics - that is what actuaries do.