- How to read, understand a term life insurance illustration
- July 17, 2013
Reading a term life insurance illustration is a lot easier than reading a whole life or universal life illustration.
Being able to read and understand the illustration before making a purchase is a proactive approach to avoiding mistakes or misunderstandings. The following factors are important to consider when evaluating and comparing term life insurance illustrations.
However, only a few of these will apply to a particular policy, and some are rarely if ever used.
Know the Company’s Claims-Paying Safety Ratings
There are four well-known independent rating agencies that provide a valuable claims-paying rating service: A.M. Best, Standard and Poor’s, Moody’s Investors Service, and Fitch Ratings.
It is highly recommended to always buy from a company with an “A” or higher rating, for your own safety and peace of mind, and never buy from an agent whose illustrations have not been rated by any of these agencies.
You are unlikely to see this column in a pure term life illustration because term life has no cash value account or investment promises of any kind.
Ability to Convert into a Permanent Policy
An important but unsung provision on most term life policies is the ability to convert them into a permanent plan of insurance with no medical exam requirement. This convertibility feature becomes extremely important if a term life policyholder becomes ill or uninsurable as they approach the end of their initial term life rate guarantee period.
If the term policy is converted to a permanent policy, typically a whole life or universal life policy, then the new policy will be issued with the same rate classification as the term policy.
Right to Renew Without a Physical Exam
This term life feature, which is commonly misunderstood, allows policy renewal without a physical exam beyond the initial rate guaranteed period. People who, at the time of their initial rate expiration, have become terminally ill and thus cannot get life insurance from any other company typically exercise this right. In this case, the renewal premiums revert to what’s called “annual renewable term”, which cost much more than the expiring premium, but are gladly paid by the family of an insured who is about to die.
For example, say a policyholder has been paying $600 per year for a 10 year $500,000 term life policy, but becomes terminally ill during the 9th year. They could renew their $500,000 policy for a premium of $6,000 per year, which the family would gladly pay in order to secure a $500,000 tax-free payout.
Industry critics who do not understand the practical workings of the automatic renewal provision don’t like the high prices on the renewal. But, they often forget that only people who are uninsurable will pay that premium and that having that option open is often a Godsend for the affected family.
Current Without Re-Entry Premiums
These premiums do not require re-qualification (providing evidence of insurability) after the policy is issued. Future premium rates shown beyond the guaranteed level period are not guaranteed and may be changed by the insurer without notice, subject to the maximum guaranteed premiums.
Dividends are typically non-existent with the modern term life policy, unless the company or issuing organization has a set dividend program.
Guaranteed premiums are the insurer’s published, guaranteed premiums and are those shown under the heading “Guaranteed” or “Maximum” premium rates. At the end of the level period, the “Guaranteed” rates shown are the highest premiums that the insurer will charge the policyholder. Actual premiums will be the then current premiums, which may be less than but never more than the guaranteed rates shown.
Depending on whether a insurer uses insurance age (your actual age plus six months and one day), age nearest birthday (the typical methods used by almost all insurers), actual age, or age last birthday, it will have an effect on the desired effective date of your policy.
Backdating a policy to “save insurance age” can offset this; i.e., having a policy backdated to just prior to an insurance age change, which would mean a lower premium for the life of the policy.
This is a factor applied to the annual premium to derive the premium due for semi-annual, quarterly, and monthly bank draft payments.
The modal factor for semi-annual premiums ranges from 51 percent to 53 percent, which means that you can end up paying an extra 2 percent to 6 percent if you don’t pay the premium annually. The modal factor for quarterly premiums ranges from 26 percent to 30 percent, which means that you can end up paying an extra 4 percent to 20 percent by paying quarterly. The modal factor on monthly bank draft premiums ranges from 8.66 percent to 9 percent, which means that you will pay anywhere from an extra 3.92 percent to 8 percent.
The insurers impose these factors because they do not have the use of the money for the entire year, and because they find that, depending on the mode, there is a higher chance that the policy will lapse.
Typically, the annual policy fee ranges from $45 to $90. The policy fees are added on top of the rate per thousand. The major impact is to the seller of the policy as policy fees are usually non-commissionable.
Premium Level Number of Years
The premium can be for 1, 5, 10, 15, 20, 25, or 30 years; of these options, how many years are guaranteed?
Bands are classes of amount of coverage where the higher the amount of coverage, the lower the cost per thousand dollars of coverage.
The policy is guaranteed to be renewable for a certain number of years (or to a specified age), upon timely payment of the premiums, regardless of any changes in health or finances.
What optional benefits are available? Have these been shown on the illustration? These should be considered separately. Keep in mind that many of these riders are more profitable for the insurance insurer than for the policy owner.
Companies differentiate not only between smoker and non-smokers. Each of these classes is further divided into four or five classes. Recently, available classes were: Best Available, Preferred Better Non-Smoker, Preferred Non-Smoker, Standard Better Non-Smoker, Standard Non-Smoker, Tobacco (Non-Cigarette), Preferred Smoker, Standard Better Smoker, and Standard Smoker.
What does the designated rate class mean? Are there better rate categories? What qualifications must be met to be qualifying for the class illustrated?
Suicide and Contestability Clause
Claims are denied for suicide occurring within one to two years upon issue of the policy, which is the typical range. Claims may also be contested during this period (usually for the same number of years).
About Tony Steuer
Noted insurance author Tony Steuer has spent over 25 years in the life insurance industry. Steuer’s leadership roles include serving on the California Department of Insurance Curriculum board and the National Financial Educator's Council Curriculum Advisory Panel as well as having served as President of the San Francisco Chapter of the American Society of CLU & ChFC, President of the leading Life Insurance Producers of Northern California, and as a board member of the San Francisco Life Underwriters Association. Mr. Steuer is the author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, The Questions and Answers on Life Insurance Workbook and The Questions and Answers on Disability Insurance Workbook - the first two were awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy. Steuer holds a Chartered Life Underwriter (CLU) designation and also holds the Life and Disability Insurance Analyst License, a designation that is held by less than thirty people in California.
Questions & Answers on Life Insurance by Tony Steuer, CLU, LA, CPFFE is licensed under a Creative Commons Attribution 3.0 Unported License.