What it means
Life insurance can be set up so that the payout changes over time, or so that it stays constant. With a level death benefit, the face amount, such as $500,000, is fixed at the start and does not rise or fall.
This certainty makes it simple to plan around, because a family or business knows exactly what cash will arrive. The alternative designs are a decreasing death benefit and an increasing one.
A decreasing benefit is often used to cover a loan, such as a mortgage, that gets smaller each year. An increasing benefit, found in some universal life policies, grows over time, which can offset inflation, but it usually costs more.
Level benefits are common in term life insurance, where cover is bought for a fixed period such as 20 years. They are also standard in whole life policies.
In some universal life policies, the choice is described as an option, where one option keeps the benefit level and another adds the cash value on top. The main weakness is inflation.
A benefit of $500,000 will buy less in 20 years than it does today, so a level benefit loses purchasing power over time. Buyers often deal with this by buying extra cover, layering policies, or reviewing their needs every few years.
Businesses use level death benefits to fund buy-sell agreements, protect against the loss of a key person, or repay a fixed debt. The fixed payout makes it easier to match the policy to a known obligation.
Premiums may be level too, but that is a separate feature, and the two should not be confused.
In practice
Real-world examples.
Example
A 35-year-old father buys a 25-year term policy with a level death benefit of $750,000. The benefit stays at $750,000 whether he dies next year or in year 24. His family plans around that fixed figure for school fees and living costs.
Example
Two business partners buy matching level death benefit policies of $1,000,000 on each other's lives to fund a buy-sell agreement. If one partner dies, the survivor uses the payout to buy out the estate's share at the agreed value.
Example
A small company takes out a $300,000 policy on its sales director, who brings in a large share of its revenue. The level benefit is intended to cover the cost of recruiting, training and the lost sales of a replacement.
Formula
Calculation
Real value of the benefit = Face amount / (1 + Inflation rate) ^ Number of years
Worked example: a policyholder buys a level death benefit of $500,000 for a 20-year term. Inflation averages 3% a year over that period.
(1.03) ^ 20 = 1.8061 (rounded to four decimal places).
Real value = $500,000 / 1.8061 = about $276,840 in today's money.
The benefit is still $500,000 on paper, but its buying power at the end of the term is closer to $277,000 in today's terms, a fall of about $223,000. Someone who wants to keep the real value of the cover at $500,000 would need a face amount of about $903,000 at the end of the period, which is $500,000 x 1.8061.Case study
Seen in the real world.
Whitmore Joinery is a fictional family company with a bank loan of $400,000 and a founder who personally guarantees it. The owner bought a 15-year term policy with a level death benefit of $400,000 to protect his family from the guarantee.
Five years later, the loan balance had fallen to $270,000, but the benefit remained at $400,000. The extra cover meant his family would receive $130,000 more than needed to clear the debt.
The finance adviser pointed out that a decreasing benefit would have been cheaper, but the owner preferred the level design as it also protected the family's income. This is an illustrative story, but it shows how the choice depends on what the cover is for.
Watch out
Common mistakes.
- Assuming a level benefit keeps its real value. It stays the same in dollars, but inflation steadily reduces what the money can buy.
- Confusing a level death benefit with level premiums. One refers to the payout, and the other to the price paid, and a policy can have one without the other.
- Buying cover for a fixed debt without considering a decreasing benefit. If the debt shrinks each year, a level benefit may cost more than necessary.
Questions
People also ask.
What is the difference between level and increasing benefits?
A level benefit stays fixed, while an increasing benefit grows over time, either by a set rate or by adding cash value. The increasing design costs more because the insurer takes on a larger risk.
Which policies have a level death benefit?
Most term life policies and many whole life policies. Check the policy documents to see exactly how the benefit is defined.
Is the payout taxed?
Tax treatment varies by country and by policy type, so it is best to ask a tax adviser. In many places, life insurance proceeds paid to a beneficiary receive favourable treatment.
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