Financially savvy people would tell you to buy term policies for your insurance coverage needs, but did you know there are quite a few different types of term coverage?
Here are the four different types of term policies you should know about:
The word “level” refers to the fact that the premiums and coverage of level term policies are the same throughout the policy tenure. If you purchase $500,000 of coverage and it costs $500 annually, both figures will remain the same for the term of the policy.
It’s quite the default form of term policy one would encounter in Singapore, but there are other options you can pick from.
As with most other term policies, you can add riders to get coverage such as total and permanent disability, critical illness (traditional and early variants), as well as disability income (from the rare couple of companies that provide it).
Some level term policies come with a convertibility feature that allows the insured to convert the policy into a whole life or savings plans at a future date without medical underwriting. Despite my reservations about whole life and savings plans, having this option can be useful for people who are undecided about whether they want a whole life plan. Buying a term policy when they are younger and healthier allows them to convert it to a whole life plan at a later date, even if their health is not as good at that point of time.
Premium return term
Premium return policies tend to be level term but significantly pricier. If no claim is made, the premiums one has paid would be refunded at the end of the coverage term.
This sounds great on paper; having free insurance coverage is pretty awesome! the reality is that such policies have already priced in the refund of premiums. The inflated cost of a premium return policy is used by the insurer to invest, and over the couple of decades of the term policy the amount would have grown to cover for the total cost of the policy, and then some which the insurer pockets.
There’s no “free” coverage actually since the premiums are paid for by the investment returns. It’s actually little different from a whole life policy, which is also pricier than pure term coverage in order to generate enough return to make it seem like the insurance coverage was free once the cash value has grown to cover the total cost of premiums paid.
Both are replicable with a “buy term invest the rest” strategy which would likely net you better returns in the long time horizon of the term policy.
An increasing term policy, also known as renewable term, as the name suggests, increases in premiums as the insured ages.
It is commonly seen in regular premium ILPs which are basically a yearly renewable term attached to investment funds (plus lots of added fees), and it is quite widely deemed to be a bad thing because premiums get very cost prohibitive as one reaches an old age (about 65 onwards).
Increasing term is actually a good thing if one does not expect to continually get coverage from it during the later years of one’s lifespan. When the insured is young, premiums for an increasing term policy is very cheap and typically much lower than a level term policy. This allows the insured to realise the time value of money because the savings in premiums can be channeled towards investments.
As one reaches an advanced age, they can and should stop renewing the term policy to avoid paying the escalating premiums. After the years of investing and benefiting from the lowered costs of their increasing term policy during their younger ages, they should be in a good position to self-insure with their investment returns.
My fantasy insurance cum investment product (you don’t fantasise about insurance cum investment products?) is an ILP with a decently priced increasing term coupled with low-cost investment funds. It’s the perfect buy-term-invest-the-rest product which unfortunately no insurer would likely offer because of the low margins.
Decreasing term, or mortgage reducing term
The existence of an increasing term suggests that decreasing term might be a thing, and it certainly is. In fact, it is quite commonly used for mortgage insurance. Since one’s mortgage is paid off with each passing month and reduces in quantum over the years, decreasing term policies also reduce in the coverage as time goes by.
This is useful not only for mortgage, but also for liabilities that decrease over time such as financial dependents. A sum of $500,000 to $1 million may be needed in case of your untimely demise if you just had a newborn, but it seems overkill if your child is now approaching his graduation from university and about to enter the workforce. A decreasing term is hence suitable for such a scenario because the decreasing nature of its coverage reflects your decreasing liabilities as time goes by.
As a result of a decreasing coverage over the years, the premium for a decreasing term tends to be lower than that of a level term, and therefore suitable for people who wish to save on their insurance premiums yet get a high amount of coverage when their present circumstances require it the most.
Do compare and see if the premium savings is worth going for a decreasing term over a level one, and remember that inflation actually does make your level term decrease in coverage over time in real terms. $500,000 in 20 years time will not hold the same value as it does today.
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