What it means
The policy starts at a chosen sum insured and steps down each year on a set schedule. If the insured person dies during the term, the insurer pays whatever the cover has reduced to at that point.
If they survive the term, nothing is paid and the policy simply ends. The obvious use is mortgage protection.
A $300,000 repayment mortgage over 25 years falls steadily towards zero, so paying for a flat $300,000 of cover for the whole period means insuring a debt that no longer exists. Decreasing cover tracks the debt downwards and cuts the premium accordingly.
The reduction schedule is normally straight line or set to mirror an assumed interest rate. That second version matters, because if your actual mortgage rate is higher than the rate the insurer assumed, the cover can fall faster than the debt and leave a gap.
Reading the schedule, not just the headline sum, is the part most people skip. Businesses use the same idea for loan protection on directors and key staff.
A company that borrowed $500,000 over ten years can insure the shrinking balance rather than the original amount, keeping the premium down while the lender stays protected. The policy is often written so the benefit goes straight towards repaying the facility.
The main alternative is level term insurance, where the sum insured stays constant and the premium is higher. Level cover suits interest-only mortgages, family income needs and inheritance planning, because the underlying liability does not shrink.
Many households sensibly hold both: decreasing cover for the mortgage and level cover for everything else.
In practice
Real-world examples.
Example
A couple with a $250,000 repayment mortgage choose decreasing term cover over 20 years and pay roughly half what level cover would have cost. The saving goes into their pension contributions instead of the insurer's pocket.
Example
A haulage business takes a $500,000 equipment loan over eight years and insures the managing director with a decreasing policy assigned to the lender. As the loan amortises, so does the cover, and the annual premium reflects the smaller average risk.
Example
A homeowner on an interest-only mortgage is sold a 30-year decreasing policy by mistake. Twelve years in, the debt is still the full $180,000 while the cover has fallen to $108,000, and the adviser has to arrange a top-up policy.
Formula
Calculation
Straight-line cover in year n = Original sum insured - (Original sum insured / Term in years) x n.
A borrower takes out $300,000 of decreasing term insurance over 25 years on a straight-line schedule.
Annual reduction = $300,000 / 25 = $12,000 a year. After 8 years the total reduction is $12,000 x 8 = $96,000, so the remaining cover is $300,000 - $96,000 = $204,000.
If the outstanding mortgage at that point is $214,000, there is a shortfall of $214,000 - $204,000 = $10,000, which the household would need to meet from savings or from a small separate level policy.Case study
Seen in the real world.
Rowan Vale Joinery is an illustrative firm invented to show the point. Its two owners borrowed $400,000 over ten years to fit out a new workshop, and the bank asked for life cover on both of them as a condition of the facility.
Level cover of $400,000 each would have cost the business around $2,400 a year in total. Decreasing cover matched to the loan came in at roughly $1,300 a year, because the average amount at risk across the ten years was closer to $200,000 than $400,000.
Five years in, one owner died and the outstanding loan balance was $196,000. Under the straight-line schedule the policy still carried $200,000 of cover, so the loan was cleared and the surviving owner kept the workshop. The numbers are fictional, but the structure is exactly how loan protection is meant to work.
Watch out
Common mistakes.
- Buying decreasing cover for an interest-only mortgage, where the debt never falls but the cover steadily does.
- Assuming the cover falls at exactly the same speed as the mortgage, when the insurer's assumed interest rate may differ from the rate actually paid.
- Treating the policy as a savings product, when a term policy that runs to the end of its term pays nothing at all.
Questions
People also ask.
Does the premium fall as the cover falls?
Usually not, the premium is normally fixed for the whole term and only the sum insured reduces.
Is decreasing term insurance cheaper than level term?
Yes, typically much cheaper, because the insurer's average exposure across the term is roughly half the starting sum.
Can the policy be moved to a new mortgage?
Often yes, since the policy belongs to the person rather than to the loan, although the remaining cover and term still have to fit the new debt.
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