Term Life Insurance Owners Beware 6/24/07

Stewart H. Welch III, CFP, AEP
Founder, The Welch Group, LLC
6/24/07

Term Life Insurance Owners Beware
6/24/07

“Term Life Insurance Owners Beware!”

6/24/07

Billions of dollars worth of term life insurance is sold each year as a way to protect families from the premature death of a breadwinner.  Term insurance is a relatively inexpensive and straight-forward product.  You pay a premium that covers you for a certain period of time (month, quarter, 6-months or a year) and if you die during that time, the insurance company pays your beneficiary the face amount of the policy.  You have the option of maintaining coverage by continuing to pay premiums for as long as the contract allows.  Most term policies provide level premiums for periods of 5, 10, 15, 20 or 30 years, after which time the premiums jump to exorbitantly high term costs. 

“While term life insurance seems like a very straight-forward product, it does contain some nuances that can trip up the unsuspecting policyholder.  Pay particular attention to the conversion agreement in your policy”, says Babs Hart, an insurance specialist with The Hart Group in Tuscaloosa, Alabama.  Most term policies allow the policyholder to convert from term insurance to permanent insurance without the requirement of medical evidence of good health.  This provision ‘guarantees’ that if you own a term policy and your health takes a turn for the worst, you can convert to a permanent policy and maintain your coverage.  The premiums for the permanent policy will be much higher and the policy will typically begin building cash value as well.  However, there are three potential traps related to the conversion agreement that you should be aware of:

1. The conversion period.  While most term policies allow you to convert to permanent life insurance as long as you own the policy, some companies permit conversion to occur for only a limited number of years. For example, you buy a 15-year level term policy but you can only convert during the first 12 years.  While I recommend only buying term coverage that allows conversion throughout the entire contract period, you should review your existing policies to make certain you’re aware of your policy’s conversion provision, particularly if you have had a change of health status.
2. Conversion limited by age.  Many contracts only allow you to convert the policy up to a certain age, typically 65, 70 or 75.  For example, at age 57, you buy a 15-year level term policy for $1,000,000.  At age 72, before your 15-year term policy expires, you decide to convert to a permanent policy in order to maintain your coverage because you are now in poor health.  Unfortunately, you are unable to do this because your conversion privilege expired at age 70.
3. No grace period on conversion.  Virtually all policies allow a grace period for paying your premiums.  Typically, the insurance company will accept your premium up to 31 days beyond the date the premium was due.  However there is no grace period for converting your policy.  What often happens is something like this:  You are paying your premiums by monthly bank draft and the end of your 15-year term policy comes.  Your $120 monthly premium jumps to $3,000.  You call your insurance company or agent only to find that the policy has completed the 15-year level premium period, your term premiums have sky-rocketed and you can no longer convert the policy to a less expensive permanent policy.

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