Term insurance is appropriate in three situations. First, if the amount of income that can be spent on life insurance is limited, term insurance can be effectively used. Because of mortality improvements and keen price competition, term insurance rates have declined sharply in recent years. Substantial amounts of life insurance can be purchased for a relatively modest annual premium outlay.
Second, term insurance is appropriate if the need for protection is temporary. For example, decreasing term insurance can be effectively used to pay off the mortgage if the family head dies prematurely.
Finally, term insurance can be used to guarantee future insurability.
A person may desire large amounts of permanent insurance, but may be financially unable to purchase the needed protection today. Inexpensive term insurance can be purchased, which can be converted later into a permanent insurance policy without evidence of insurability.
Limitations of Term Insurance
Term insurance has two major limitations. First, term insurance premiums increase with age at an increasing rate and eventually reach prohibitive levels. Thus, term insurance is not suitable for individuals who need large amounts of life insurance beyond age 65 or 70.
Second, term insurance is inappropriate if you wish to save money for a specific need.[1] Term insurance policies do not accumulate cash values. Thus, if you wish to save money for a child’s college education or accumulate a fund for retirement, term insurance is inappropriate unless it is supplemented with an investment plan.
Decreasing term insurance also has several disadvantages. If you become uninsurable, you must convert the remaining insurance to a permanent plan to freeze the remaining amount of insurance. If the policy is not converted, the insurance protection continues to decline even though you are uninsurable.
More over, decreasing term insurance does not provide for changing needs, such as birth of a child. Nor does it provide an effective hedge against inflation. Because of inflation, the amount of life insurance in most families should be periodically increased just to maintain the real purchasing power of the original policy.
Whole Life Insurance
If the insured wants lifetime protection, term insurance is impractical because the coverage is temporary, and the premiums are prohibitive in cost at the older ages. In contrast, whole life insurance is a cash-value policy that provides lifetime protection.
A stated amount is paid to a designated beneficiary when the insured dies, regardless of when the death occurs. Several types of whole life insurance are sold today. Some policies are traditional policies that have been widely sold in the past, whereas new variations of whole life insurance are constantly emerging.
Sources:
1. Cases and Materials on the Law of Insurance by Edwin W. and Young, William F. Jr. Patterson (1961)
Ammenda Michle - After graduating from The University of Liverpool Ammenda worked her way up in both fields of finance and journalism as an editorial ...
