Advanced Term Life Insurance

Readers of Boomer and Echo are likely familiar with term life insurance (see B&E’s previous article on insurance). In years past, simply going to a life insurance shopping website and comparing premiums was sufficient – and that article talks about doing exactly that.

But things have changed. Companies are tinkering with their term life insurance policies, resulting in a marketplace where different policies may have different options that may have value. Further, a variety of strategies are available that can result in additional cost savings above and beyond just ‘the cheapest’. 

Note: Unlike many products and services, premiums are actually poorly correlated with policy benefits. That means that policies with lower premiums may actually have more benefits than other policies. 

Here’s a collection of things you should be considering when purchasing term life insurance; some are important policy provisions that don’t cost anything, others are strategies that can save you money.

Renewable and convertible term life insurance

Renewable policies are term policies which continue in force after the term, but at a higher premium. Convertible term policies have a provision that lets you exchange the term for a permanent life insurance policy, without taking a medical exam. Both of these are provisions that impact what happens at the end of the term, not the start of the term.

Initially we assume that we need life insurance coverage for the term. At the end of the term we’ll cancel because we don’t need the life insurance any longer. But over the course of the next 20-30 years we split into three groups:

1. The first group are those where everything went well. No need for insurance, no desire for insurance, so we cancel.
2. The second group are those that change their mind and decide they want permanent insurance. For those, conversion is an easy switch over to permanent since there’s no medical exam.
3. The third group are those that become uninsurable during the term. If that’s you, the guaranteed ability to purchase permanent life insurance, at healthy rates, without a medical exam using the conversion option, is huge. 

Related: When life insurance is sold, not bought

We don’t know know which group you will fall into 20-30 years from now, so make sure your term policy is renewable and convertible when you purchase it – that’s your guarantee that if you become uninsurable, you can actually still get life insurance at the end of your term.

Term Layering

A typical term policy assumes both coverage and premiums are level for the term. But what if you want a decreasing amount of coverage over time? Rather than purchasing a term policy and decreasing the coverage later, it’s cheaper to purchase two types of term insurance in one policy (i.e. a term 10 and a term 20). 

Example: We want $1,000,000 for 10 years, and then reducing to $500,000 for the following 10 years. Assume a male 45 nonsmoker:

No Layering:

• First 10 years: $137.61 for Term 20 $1,000,000
• Second 10 Years: $71.87 by reducing the coverage from $1MM to $500K.

Layering:

• First 10 Years: $106.30 ($500K Term 20 + $500K Term 10)
• Second 10 years: $71.87 (Cancel the $500K Term 10 Layer, leaving only the $500K Term 20)

That’s $30/month over the next 10 years!

Backdating

Backdating is a process where you reset the start of a life insurance policy to a date in the past. This is as opposed to starting the policy when it’s issued. 

With backdating, you’ll also pay the premiums for the policy starting from the date you backdated the policy to – so you’re paying premiums for coverage you never had. Why would anyone do this? A: To save premiums based on your age.

Most life insurance companies use your closest date of birth for premium calculation. If you’re 45 on January 1, then on July 1 (six months later) your life insurance premiums will be calculated at age 46. 

So what if we’re purchasing a policy on July 2^nd (now you’re 46 for life insurance purposes), and know that the policy won’t actually be issued for another few weeks? Well, if you’re close to this six months since your last birthday, here’s where backdating comes in. When you purchase your term 20 policy, you request that the policy be backdated to July 1^st – back to when your life insurance age was still age 45. 

Say the policy gets issued on August 1st. If you don’t backdate, your premiums for your policy are $153.45 for 20 years.

But instead, we backdate and tell the company to start the policy on July 1. Now your premiums are $137.61 for the next 20 years – but you had to pay an extra $137.61 upfront for the month of July. You’ve paid $137.61 upfront to reduce your premiums by $16/month for the next 20 years. That’s a fair bit of savings over many years.

My general rule of thumb is that backdating is worthwhile for most people for up to a maximum of two months premiums. After that, most people are unwilling to pay that large of an upfront cost to lower their premiums. But less than two months – absolutely something you should consider if you’re about six months since your last birthday.

Smoking and Temporary Ratings

If your premiums are higher due to smoking or to a rating that could be reconsidered (weight, some activities, etc) then you can take advantage of the ‘exchange option’ available with some companies term policies. The exchange lets you switch from a short term policy to a longer term policy, generally in the first 5 years.

The strategy is as follows; rather than purchasing your preferred longer term at smoking premiums or with the rating, instead go with the shortest term policy you can obtain (which will be a term 10). The term 10 policy at smoking premiums will be cheaper than a term 20 or term 30 at smoking premiums. 

Later, quit smoking and requalify your term policy to non-smoking (or non-rated) premiums. At the same time, take advantage of the exchange option and jump to your longer term. That results in a non-smoking policy with the correct 20 or 30 year term, but until you’re a nonsmoker you’re paying much lower term 10 premiums.

Example: 

You purchase a term 20, $1mm at age 35, smoking premiums, then qualify for nonsmoking premiums at age 37.  Your premiums start at $185/month, then reduce to $54/month for the remainder of the term after you qualify for nonsmoking premiums.

Versus:

You purchase a term 10 at smoking premiums then at age 37 qualify at nonsmoking premiums and at the same time exchange to a term 20. Your premiums are $82/month, then change to $65 for the next 20 years. That’s about $100/month savings until you quit smoking, for the same level of life insurance coverage.

Term Stacking (by The Term Guy)

This is a strategy that I’ve developed recently, and Boomer and Echo is the first place you’ll have seen it. It takes advantage of the exchange option and a peculiarity of some companies pricing – the ones that use your actual age instead of your ‘nearest’ age as I mentioned above. 

So for this strategy, we will assume that you’re 45 on January 1. The strategy works best if you recently had a birthday, so we’ll assume that you’re purchasing a policy on January 2.

What we’re going to do is instead of purchasing a term 20 or term 30, is instead purchase a term 10 policy. Then just prior to your next birthday, we use the exchange option to jump to the desired term 20 or term 30. 

Since your age hasn’t changed for insurance purposes, your premiums are still for a 45 year old. But until your next birthday, you’ve paid term 10 premiums for the same coverage – often a 50% premium savings in the first year.

Example:

Standard Term 20:

You become age 45 on January 1. On January 2 you purchase a term 20 policy for $1mm. Your premiums are $149.40 for 20 years.

Term Stacking:

You purchase a term 10 today and your premiums are only $81.90 until just prior to your next birthday, then exchange to a term 20 – and since you’re still 45, your premiums are now again $149.40. So with term stacking, we have the same coverage, same premiums long term, but we’ve saved $67.50 for about 11 months. 

Bonus: When you exchange to a term 20, you’re getting a new 20 years at that point. So with term stacking not only do you save money, but your term 20 starts in a year and thus extends out another year at the end versus the first scenario. (i.e. you’ve got almost a term 21). 

Or, to rephrase it, 20 years from now you have the option of continuing your life insurance at the same $149.40 for almost another year. And that’s a deal a lot of people would take at the end of their term. 

Note: To implement term stacking, you need three things:

• a recent birthday
• life company uses actual age not age nearest
• life company allows for the exchange option in the first year

It may make sense to do term stacking for two years (i.e purchase a term 10 and the exchange to a term 20 or term 30 in two years instead of one), but you’ll have to run the numbers for your situation to find out for sure.

I’d suggest that readers of Boomer and Echo who are considering using a term life insurance policy use the above strategies as a checklist, run through each one and see which ones make sense for you – and then enjoy your savings on what you may have thought was just a commodity!

Glenn Cooke, BMath, MMT is The Term Guy. He’s an independent life insurance broker in the insurance business since 1986, and working with clients directly since 2006.