Term insurance provides life insurance protection for a limited period only. The face amount of the policy is payable if the insured dies during the specified period, and nothing is paid if the insured survives. The period may be as short as one year, or it may run to age 65 or above. The customary terms are one, 5, 10, 15, and 20 years. Such policies may insure for the agreed term only, or they may give the insured the option of renewing the protection for successive terms without evidence of insurability. Applications for term insurance are carefully underwritten; various restrictions may be imposed on the amount of insurance, the age before which it must be obtained, the age beyond which it cannot be renewed, and the like.

Term insurance may be regarded as temporary insurance and, in principle, is more nearly comparable to property and casualty insurance contracts than any of the other life insurance contracts in use. If a person insures his or her life under a 5-year term contract, no obligation is incurred by the insurance company unless the death of the insured occurs within the term. All premiums paid for the term protection are considered to be fully earned by the company by the end of the term, whether or not a loss has occurred, and the policy has no further value. This is similar to auto and homeowners insurance.

The premium for term insurance is initially relatively low, despite the fact that it contains a relatively high expense loading and an allowance for adverse selection. The reason premiums can be low is that most term contracts do not cover the period of old age when death is most likely to occur and when the cost of insurance is high. In other words, a term policy insures against a contingency only and not a certainty, as do other kinds of policies.

Many term insurance contracts contain an option to renew for a limited number of additional periods of term insurance, usually of the same length. The simplest policy of this type is the yearly renewable term policy, which is a one-year term contract renewable for successive periods of one year each. Longer term contracts, such as the 10-year term, may also be renewable. The following is a typical renewal provision:

The key to the renewable feature is the right to renew the contract without a medical examination or other evidence of insurability. Where the term policy contains no renewal privilege, or where it can be renewed only upon evidence of insurability satisfactory to the company, the insured may find that coverage cannot be continued as long as needed. Because of poor health, a hazardous occupation, or some other reason, the insured might be unable to secure a renewal of the contract or to obtain any other form of life insurance protection. The renewal feature prevents this situation. Its chief function is to protect the insurability of the named insured.

Under a term insurance the premium increases with each renewal, based on the attained age of the insured at the time of the renewal. The term insurance premium for a person aged 50 or above, for example, is higher than the premium for a whole life contract acquired before age 35. Within the contract period, however, the premium is level. Over a long period of time, punctuated by several renewals, the premium will consist of a series of level premiums, each series higher than the previous one. Moreover, the rate will continue to increase with each renewal. The scale of rates at which the insurance can be renewed is published in the original contract and cannot be changed by the company as long as the contract remains in force. Evidence of renewal is usually provided in the form of a certificate to be attached to the original contract, although some insurance companies issue a new contract with each renewal.

Insurers have mixed feelings about renewable term insurance. There is no question that, properly used, it fills a real need. However, it presents certain problems to the company that writes it. Whether the policy is on the yearly renewable term plan or a longer term basis, there is likely to be strong selection against the company at time of renewal, and this adverse selection will become greater as the age of the insured�and hence, the renewal premium�increases. Resistance to increasing premiums will cause many of those who remain in good health to fail to renew each time a premium increase takes effect, while those in poor health will tend to take advantage of the right of renewal. As time goes on, the mortality experience among the surviving policyowners will become increasingly unfavorable. While dividend adjustment can provide for adverse mortality experience, it requires substantial margins in the premium rates. As a result, each dollar of protection on the term basis tends to cost middle-aged or older policyowners more than under any other type of contract.

As a further safeguard against adverse selection, companies generally do not permit renewals to carry the coverage beyond a specified age such as 65, 70, or 75 (although some insurers guarantee renewability to age 95 or 99). In addition, limitations on yearly renewable term are usually more stringent; coverage is frequently restricted to 10 or 15 years or, occasionally, 15 years or to age 65, whichever is earlier. Renewable term insurance therefore is satisfactory for individual coverage to both the policyowner and the company when coverage does not extend into the higher ages.

In addition to the renewable privilege, a term policy may contain a provision that permits the policyowner to exchange the term contract for a contract on a permanent plan, likewise without evidence of insurability. In other words, a term insurance policy may be both renewable and convertible. The convertible feature serves the needs of those who want permanent insurance but are temporarily unable to afford the higher premiums required for whole life and other types of cash value life insurance. Convertibility is also useful when the policyowner desires to postpone the final decision as to the type of permanent insurance to be purchased until a later date when, for some reason, it may be possible to make a wiser choice. Thus convertible term insurance provides a way to obtain temporary insurance and an option on permanent insurance in the same policy.

Insurability is protected by the convertible feature in an even more valuable manner than under the renewable feature since convertibility guarantees access to permanent insurance�not just continuation of temporary protection. The two features together afford complete protection against loss of insurability.

The conversion may be effective as of the date of the exchange or as of the original date of the term policy. If the term policy is converted as of the current date, conversion is usually referred to as the attained age method since the current age determines the premium level. A conversion using the original date of the term policy for the conversion is referred to as the original age method or a retroactive conversion.

Some insurers allow a policy to be converted retroactively within the first few years after issue. When the conversion is effective as of the original date, the premium rate for the permanent contract is that which would have been paid had the new contract been taken out originally, and the policy form is that which would have been issued originally. It is these two features that motivate the insured to convert retroactively in most instances. The advantage of the lower premium is obvious, but in many cases, the contract being issued at the original date contains actuarial assumptions or other features more favorable than those being incorporated in current policies.

Offsetting these advantages, however, is the fact that a financial adjustment�involving a payment by the insured to the company�is required, which may be quite substantial if the term policy has been in force for several years. This adjustment may be computed on a variety of bases, but a great number of companies specify that the payment will be the larger of (1) the difference in the reserves (in some companies, the cash surrender values) under the policies being exchanged or (2) the difference in the premiums paid on the term policy and those that would have been paid on the permanent plan, with interest on the difference at a stipulated rate. Under the second type of financial adjustment, an allowance is frequently made for any larger dividends that would have been payable under the permanent form. Some companies require a payment equal to the difference in reserves, plus a charge of up to 8 percent to provide the previously forgone investment return.

The purpose of the financial adjustment, regardless of how it is computed, is to place the insurance company in the same financial position it would have enjoyed had the permanent contract been issued in the first place. Therefore, apart from the possibility of obtaining more favorable actuarial assumptions, there does not seem to be any financial advantage to the insured to convert retroactively. The insured will admittedly pay a smaller premium but�by making up the deficiency in the term premium�will, in effect, pay it over a longer period of time; actuarially, the two sets of premiums are equivalent. Some people are under the mistaken impression that by making the financial adjustment required for conversion as of the original date, they are investing money retroactively and being credited with retroactive interest. The fact is, however, that the insured pays the company the interest it would have earned had the larger premium been paid from the beginning.

The insured should consider many factors in making a choice between the two bases of conversion, one of the most important being the state of his or her health. The insured would be ill advised to convert retroactively�and pay a substantial sum of money to the insurance company�if his or her health were

impaired. The sum the insured pays would immediately become a part of the reserve under the contract and would not increase the amount of death benefits in the event of the insured�s early demise�or ever, for that matter. The payment would simply reduce the effective amount of insurance.

In most cases, if the insured has surplus funds to invest in insurance, he or she should consider purchasing additional insurance or perhaps prepaying premiums on existing policies, including the newly converted one. Subject to certain limitations, most companies permit the insured to prepay fixed premiums, either in the form of so-called premium deposits or through discounting of future premiums. The two procedures are very similar. The principal difference is that under the discount method, credit is taken in advance for the interest to be earned on the funds deposited. Under both arrangements, the funds deposited with the company are credited with interest at a stipulated rate and, in some instances, are credited with the interest earned by the company in excess of the stipulated rate. In the event of the insured�s death, the balance of any such deposits is returned to the insured�s estate or designated beneficiaries in addition to the death benefit of the policy. Some companies permit withdrawal of premium deposits at any time, in which case a lower rate of interest may be credited, while others limit withdrawals to anniversary or premium due dates. A few companies permit withdrawals only in case of surrender or death. Some companies credit no interest or otherwise penalize the insured if the funds are withdrawn.

As previously noted, a retroactive conversion must take place within a specified number of years after issue. If the term of the policy is no longer than 10 years, a conversion as of a current date can usually be accomplished throughout the full term. If the term is longer than 10 years, the policy may stipulate that the conversion privilege must be exercised, if at all, before the expiration of a period shorter than the term of the policy. For example, a 15-year term policy must usually be converted, if at all, within 12 years from date of issue, a 20-year term policy within 15 years.

The purpose of a time limit is to minimize adverse selection. There is always a substantial degree of adverse selection in the conversion process. Those policyowners in poor health as the time for conversion approaches are more likely to convert and pay the higher premiums than those who believe themselves to be in good health. If the decision to convert must be made some years before the expiration of the term policy, a higher percentage of healthy policyowners, uncertain of their health some years hence, will elect to convert. Even so, experience has shown that the death rate among those who convert is higher than normal. This accounts for the fact that premium rates for convertible term insurance are somewhat higher than those for term policies not containing the conversion privilege.

If the policy is renewable, the only time limitation may be that it is converted before age 60 or 65. In other cases, the contract will state that the policy must be converted within a certain period before the expiration of the last term for which it can be renewed. In all cases, conversion may be permitted beyond the time limit, but within the policy term, upon evidence of insurability.

Some companies issue term policies that are automatically converted at the expiration of the term to a specified plan of permanent insurance. It is doubtful that this procedure is effective in reducing adverse selection since healthy individuals may fail to continue the permanent insurance.

The life insurance industry has developed a term insurance policy intended to charge higher premiums to those in poorer health when they renew their term insurance, thereby reducing the degree of adverse selection. The product is commonly called re-entry term insurance. It is really a policy subject to two different premium schedules. The lower premium rate is based on select mortality (that applicable to an insured who has recently given evidence that he or she is in good health). The select rates are available as long as the insured is able to provide new evidence of insurability at each renewal date and at other dates specified by the insurer.

The higher premium schedule is based on ultimate mortality rates (that applicable to insureds at least 15 or 20 years after they last provided evidence of insurability). The insureds who cannot provide evidence of insurability acceptable to the insurance company when requested or required must pay the higher premium schedule rates to renew their coverage. They are known to be in poorer health and have to pay for the increased risk right away and probably for each subsequent renewal (unless they experience an improvement in their health).

It is hard to argue with the logic or concept of equity in this approach. In order to get the lower premiums while healthy, the individual should be willing to pay the higher premium when his or her health deteriorates. However, it is questionable whether the policyowner knows or realizes the full import of a decision to buy re-entry term insurance. Young people in good health believe they are immortal and will never have to pay the higher rates. Few of them stop to consider that they may actually end up paying the ultimate rates and that when that happens they will usually be precluded from buying coverage from another insurer. The single-premium schedule term insurance they could have bought instead of re-entry term might have been a significant bargain. Unfortunately, when that realization sinks in, it is too late to select that option.

Re-entry term is economical for those who remain healthy into their retirement years, but it may end up being very costly for anyone whose health deteriorates at about the same rate as that of the general population. On average, people start to experience declining health between the ages of 45 and 55. If they reach their life expectancy (at least 50 percent should), they can live 40 to 50 years in an impaired physical condition�paying the higher term rates for many more years than they enjoyed the lower term rates.

It is suggested that the decision to purchase re-entry term insurance should involve comparison of the high rates of competing insurers for similar coverage. Once the insured cannot provide satisfactory evidence of insurability, the lower premium schedule is irrelevant. Helpful in making such comparisons. are pro forma cash flow simulations of the premiums (both high and low rates) for each policy being considered at a range of premium increase dates. Another important point for evaluation is whether the insurer considers the policy a new contract with a new contestable period after the insured fails a re-entry test. Some insurers treat the new premium as an adjustment on continuing coverage, but others impose a new contestable period.

In general it is a good idea to keep existing coverage in force until after the intended replacement coverage has actually been issued and the policy delivered. It is important for the policyowner to realize that new policies remain contestable for at least one year (and often for 2 years). If the insured dies while the policy remains contestable, the claim will be investigated much more thoroughly and take longer to settle than one for a policy that is already incontestable.

While most term contracts provide protection for a relatively short period, subject to renewal for successive periods of the same duration, some term contracts are designed to provide long-period protection in the first instance. These policies often give prospective policyowners the option to purchase waiver-of-premium and accidental death benefits.

A term to 65 contract, for example, provides protection on a level premium basis from the age of issue to age 65. It is not to be confused with yearly renewable or other forms of term insurance that can be renewed until the insured reaches age 65. The period covered by this contract is normally somewhat shorter than the life expectancy, but its termination date coincides with the age generally regarded as the normal retirement age. Hence it probably comes closest to limiting its protection to the years when the insured�s income is derived from personal efforts. Since the term is shorter than that of whole life contracts, the premium will be smaller. It is customary to provide for cash and other surrender values. A conversion privilege may be offered, but if so, it must usually be exercised some time before the expiration of the policy. A typical form requires conversion prior to age 60.

The preceding discussion has presumed that the amount of insurance is level or uniform throughout the term of the policy. This is not necessarily the case since the amount of insurance may increase or decrease throughout the term. As a matter of fact, a substantial�if not predominant�portion of term insurance provides systematic decreases in the amount of insurance from year to year. This type of term insurance, appropriately called decreasing term insurance, may be written in the form of a separate contract, a rider to a new or existing contract, or as an integral part of a combination contract. Mortgage redemption insurance is probably the most familiar form of decreasing term insurance.

Increasing term insurance in the form of a return-of-premium provision has been around for a long time, but in recent years the concept has enjoyed a much wider application in connection with various arrangements, specifically split-dollar plans, which may contemplate borrowing or encumbering the cash value of an underlying policy. In order to provide a uniform death benefit to the insured�s personal beneficiaries, contracts developed for these uses frequently make provision for the automatic purchase of an additional amount of term insurance each year in the exact or approximate amount that the cash value increases. Increasing term insurance may be provided on a year-to-year basis through the operation of the so-called fifth dividend option.