On its face, level term insurance is pretty cut and dried: you pay a guaranteed premium that secures a death benefit for a set term of years. If you pass away during the term, your beneficiaries receive the death benefit. If you don’t, you’ll likely allow the coverage to lapse when the premiums skyrocket after the term period has expired. There’s no cash value; there’s no volatility; it can’t underperform or, for that matter, overperform. It’s pure protection – pay your premium, get your coverage – and because 99% of term policies lapse without a claim,[1] premiums are comparatively inexpensive.
Typically, competition in the term insurance space has been based on cost, but that should not be the only consideration. By opting for the cheapest option, you may be giving up benefits that are less obvious, but which may be critical to your family’s financial security.
So, before you go online to compare prices, I urge you to consider two factors that inform how we analyze term insurance for our clients.
The first factor that you should consider is the carrier’s financial strength and creditworthiness. If you are paying a premium in expectation of securing a death benefit you should be confident that the life insurance company will be in business and able to pay the claim.
Every insurance company is regularly reviewed and analyzed by the major credit rating agencies, such as S&P, Moody’s and Fitch. Each agency has its own criteria and letter grading scale, so it’s simpler to seek out the Comdex rating, which is an aggregation of all of the analyses conducted by the various agencies. In our view, companies with a Comdex of 80 or above are acceptable, with a preference for those rated 90 and above. The lower you go from there, the greater the likelihood that the carrier in question may lack fiscal staying power.
The second, and nearly as important, consideration is the strength of the contract’s term conversion provision. Term conversion is the contractual right of the policyholder to convert his or her term policy into a permanent plan of insurance without having to provide evidence of insurability. No matter the state of the insured’s health at the time of conversion, the health rating on the new permanent contract will be the same as that on the original term policy. This is a critical benefit, especially for individuals who have experienced a change in health.
Let’s consider a hypothetical example: a client purchases $1,000,000 of 20-year term coverage with Company X at the carrier’s best health rating. Ten years later, the client receives a medical diagnosis that would make obtaining insurance in the future prohibitively expensive or even impossible. However, because the contract has a strong conversion right, the client can convert the term contract, up to the full $1,000,000, into permanent coverage with Company X, the premium for which will be based on the original, excellent health rating.
Almost every term insurance contract marketed today offers some form of conversion right, but they are not all equal. As insurance carriers race to offer lower and lower premiums as a means of attracting more business, many are simultaneously limiting their customers’ conversion rights. These companies calculate that those converting their term policies are less healthy than their overall client base, and that conversions, therefore, negatively impact their mortality experience.
There are a two main ways that insurance companies restrict conversion. Some carriers may only permit clients to convert their term contracts for part of the term duration, for example, for ten years of a twenty-year term policy. Others may only offer one or two products into which their policyholders can convert, which generally tend to be very expensive relative to the overall marketplace. Some companies even employ both strategies.
Limiting conversion appears to be a growing trend and there is no reason to imagine that it will reverse itself any time soon.
Term insurance serves a valid purpose: temporarily securing a significant death benefit for relatively low premiums. It is, and should be, cost-effective. That said, there is a difference between “cost-effective” and “cheap”. The potential cost savings of purchasing cheap term marketed by a poorly-rated carrier, or a carrier offering weak conversion rights may shake out to no more than a few dollars per month. The potential risk – owning insurance with an insolvent carrier or finding yourself uninsurable and having dead-end term coverage that you can’t convert – can have severe ramifications for yourself, your family or your business.
[1] Yellen, Pamela, “Is This the Worst Financial Advice Ever?” Entrepreneur, March 22, 2018.
https://www.entrepreneur.com/article/310731