What it means
You pay a premium, a regular fee to the insurer, and in return the insurer promises a fixed payout, known as the sum assured or death benefit, if you die during the term. Because most people outlive the term, the insurer can charge a lower premium than it would for cover that lasts a lifetime.
The product is designed for periods when other people rely on your income. Typical examples are the years while children are growing up, while a mortgage is outstanding, or while a business partner depends on you.
Premiums are normally level, meaning they stay the same for the whole term. They are based on age, health, smoking status and the amount of cover, so buying younger and healthier generally costs less.
Unlike whole life insurance (cover that lasts for life and builds up a cash value), term life has no savings element. This is why it is cheaper, but also why you get nothing back if you outlive the policy.
Many policies let you renew at the end of the term or convert to permanent cover without a new medical check. Those options usually come at a higher price, so it is worth reading the small print before the term ends.
Businesses use term life too, for example to protect against the loss of a key person or to back a loan taken by the owners. The benefit can give the company the cash to recruit a replacement or repay the debt.
In practice
Real-world examples.
Example
A 35-year-old graphic designer with a young family and a 25-year mortgage buys a 25-year term policy. The sum assured is enough to clear the mortgage and cover several years of household costs. She picks term life because it costs far less than lifetime cover. She reviews the amount of cover whenever her family circumstances change.
Example
Two co-founders of a software company each take out a 10-year term policy on the other, worth $1,000,000. If one founder dies, the survivor can use the payout to buy the deceased founder's shares from the family. This keeps control of the company in the right hands. The policy is arranged so that the proceeds are paid to the company or to the surviving founder in line with a written agreement.
Example
A self-employed electrician reaches the end of his 20-year term at age 55 with the mortgage paid off. He lets the policy lapse because his children are independent. He has paid premiums for two decades and received no payout, which is exactly how the product is designed to work. Had he wanted lifetime protection, a different and costlier product would have been needed.
Formula
Calculation
Cost per $1,000 of cover = annual premium / (sum assured / 1,000)
Total premiums over the term = annual premium x number of years
A 20-year policy gives $500,000 of cover for an annual premium of $600.
Cost per $1,000 = 600 / (500,000 / 1,000) = 600 / 500 = $1.20
Total premiums paid over the full term = 600 x 20 = $12,000
If the holder dies in year 5, the family receives $500,000 after paying only 600 x 5 = $3,000 in premiums.
A useful sense-check is the income multiple approach, in which cover is set at a number of years of income. For example, an earner on $60,000 a year who wants ten years of protection would look at $600,000 of cover, then adjust for debts and savings.Case study
Seen in the real world.
Hartwell and Pike Consulting is an illustrative, fictional partnership with two owners who had borrowed $400,000 to fund the business. Each partner worried that the other's death would leave the survivor with the debt and no income.
The firm's finance manager priced a 15-year term policy of $400,000 on each partner. The annual premium was $480 per partner, a total of $960 a year, which was small against the risk it covered.
Fifteen years later, neither partner had died and the loan had been repaid, so the policies expired. The illustrative lesson is that insurance is judged by the protection it gave during the term, not by whether a claim was paid. The partners now review their cover every few years to check that it still matches the size of the business debts.
Watch out
Common mistakes.
- Choosing the shortest and cheapest term, then finding the cover ends while dependants still need it. Think about how long the mortgage and the children's dependence will last, then add a margin.
- Expecting a refund of premiums if you outlive the term, when standard term life pays nothing at the end. Return-of-premium policies exist, but they cost noticeably more.
- Under-insuring by picking a round number rather than adding up debts and the years of income that family members would need. A useful check is to total the debts, add several years of income, and subtract existing savings and cover.
Questions
People also ask.
Is term life cheaper than whole life?
Yes, because it covers only a limited period and has no savings element. Whole life suits people who want lifelong cover and a savings element, but term life usually delivers more cover per dollar.
Can I renew a term policy?
Often yes, but renewal premiums are normally based on your older age and can be much higher. Some policies include a right to convert to permanent cover without fresh medical evidence, which can be valuable if your health changes.
Who receives the payout?
The beneficiaries you name, who are typically family members, a trust or a business. It is wise to name a backup beneficiary and to update the details after major life events such as marriage or divorce.
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