Term insurance has long been a controversial type of insurance. Many people, not familiar with or perhaps not sympathetic to the principle of level premium insurance, advocate the use of term insurance in all situations to the virtual exclusion of permanent insurance. There are certain insurance "consultants" who, when they find permanent plans in an insurance program, will advise their surrender for cash and replacement with term insurance. On the other hand, the insurance companies, mindful of the limitations of term insurance and fearful of possible adverse public reaction, tend to discourage its indiscriminate use. This has given rise to a widespread impression that insurance companies are opposed to term insurance, preferring the higher-premium forms that add more to income and assets. It might be helpful therefore to point out the areas that can legitimately be served by term insurance and to analyze briefly some of the fallacious arguments that have been advanced in favor of term insurance.

Term insurance is suitable when either (1) the need for protection is purely temporary, or (2) the need for protection is permanent, but the insured temporarily cannot afford the premiums for permanent insurance. In the first case, term insurance is the complete answer, but it should be renewable in the event that the temporary need should extend over a longer period than was originally anticipated. Theoretically the policy need not be convertible, but since relatively few people carry an adequate amount of permanent insurance and since the loss of insurability is a constant threat, it is advisable to obtain a policy with the conversion privilege.

The second broad use of term insurance requires that the policy be convertible. The conversion privilege is the bridge that spans the gap between the need for permanent insurance and the financial ability to meet the need. In this case, since the insured�s financial situation might persist longer than anticipated, the policy should be renewable as well as convertible. Thus the renewable and convertible features serve quite different functions and, ideally, should be incorporated in all term policies.

Examples of temporary needs that can�and should�be met through term insurance are encountered daily. One of the most obvious is the need to hedge a loan. A term policy in the amount of the loan payable to the lender not only protects the lender against possible loss of principal but also relieves the insured�s estate of the burden of repaying the loan if the insured dies. A mortgage redemption policy serves the same purpose. An individual who has invested heavily in a speculative business venture should protect his or her estate and family by obtaining term insurance in the amount of the investment. If a business firm is spending a considerable sum in an experimental project, the success of which depends on the talents and abilities of one individual or a few individuals, term insurance on the appropriate person or persons will protect the investment. A parent with young children is likely to need more insurance while the children are dependent than he or she will need when they have grown up and become self-sufficient. The additional insurance during the child-raising period can be�and usually is�provided through term insurance. Frequently, decreasing term insurance is superimposed on a plan of permanent insurance.

The second function of term insurance is particularly important to young people who expect substantial improvement in their financial situation as the years go by. Young professionals who have made a considerable investment in their education and training, but whose practices must be built up gradually, are likely prospects for term insurance. Young business executives are also good prospects.

In these times of fierce competition and corporate downsizing, it can be precarious to rely heavily on employer-provided group life insurance to satisfy all or most of a family�s death benefit needs. Individuals should find out how much of the employer group coverage can be converted after an involuntary termination of employment�for example, mandatory early retirement, workforce reduction, plant closing, reorganization after a merger or acquisition, employer bankruptcy, statutory banning of a product (freon, for instance), or chronic health impairment resulting from accident or disease. Individual term insurance may be appropriate to cover the potential net reduction in coverage after postemployment conversion of the existing coverage. The safest way for the individual to cover this risk is to purchase an individual policy while he or she is still employed. The cost of such risk aversion is the amount spent on premiums for coverage in excess of the individual�s current needs between policy formation and a premature employment termination.

Some of the fallacious arguments in favor of term insurance can just as aptly be described as criticisms of level premium insurance. Upon analysis, most of the arguments can be merged into two sweeping allegations: (1) Level premium insurance overcharges the policyowner, and (2) the accumulation and protection elements should be separated.

The basis for the first allegation is the indisputable fact that if a policyowner dies in the early years of the contract, premium outlay under the level premium plan is considerably larger than it would have been under a term plan. It follows, then, according to the term advocates, that the policyowner paid a larger premium than was necessary. Term advocates question whether it is wise for the insured to pay in advance for something he or she may never need or live to enjoy. They argue that it is better "to pay as you go and get what you pay for."

There is no question that insureds would be far better off financially with term insurance if they could be sure that they would die within a relatively short time. On the other hand, they would be far worse off if they guessed wrong and lived to a ripe old age. Although no one knows whether he or she will die young or live to an excessively old age, the chances of living to an age where the total term premiums exceed the total premiums paid under a level premium plan are relatively high.

The level premium plan protects the insured against the consequences of living too long and having to pay prohibitive premiums for insurance protection. In effect, it shifts a portion of the premium burden of those who live beyond their life expectancy to those who die young and produce an exceedingly large return on their premium outlay. Since at the outset no one can know which group he or she will be in, payment of the level premium by all is an eminently fair and satisfactory arrangement.

Those who argue that level premium insurance overcharges policyowners sometimes assert that the reserve under permanent forms of insurance is forfeited to the company in the event of the insured�s death. To correct this "inequity," they contend, the normal death benefit should be increased by the amount of the reserve.

It should be apparent that this argument strikes at the very heart of the level premium plan. As stated before, the essence of this plan is a gradual reduction in the net amount at risk as the reserve increases. If the reserve is to be paid in addition to the face amount of the policy, this reduction in the amount at risk does not occur, and premiums that were calculated on the assumption that the risk is to be a decreasing one will clearly be inadequate. Some companies offer a contract that promises to return the reserve in addition to the face amount of the policy, but the premium is increased accordingly.

The second allegation�that the savings and protection elements of the contract should be separated�is based on the proposition that an individual can invest his or her surplus funds more wisely and with a greater return than the life insurance company can. Those who believe this recommend that individuals buy term insurance and then place the difference between the term premium and the premium they would have paid for level premium insurance in a separate investment program. Some suggest investing this difference in premiums in government bonds, others recommend investment trusts or mutual funds, while others advocate an individual investment program in common stocks. This argument needs to be analyzed in terms of the objectives of any investment program.

The principal investment program objectives are safety of principal, yield, and liquidity.

Regarding safety of principal, the life insurance industry has compiled a solvency record over the years that is unmatched by any other type of business organization. It has survived wars, depressions, and inflations; composite losses to policyowners have been relatively rare. Even the few companies seized by the regulators in recent years have been able to rescue most of their policyowners� contracts. This exemplary record has been achieved through quality investments and concentration on government bonds�federal, state, and local�high-grade corporate bonds, and real estate mortgages, and through emphasis on diversification. Investments are diversified as to type of industry, geographical distribution, maturity, and size. Many of the larger companies have from 100,000 to 200,000 different units of investment. The individual policyowner�s reserve or investment is commingled with all other policyowners� reserves. The insurance company has invested in assets to offset these liabilities (reserves). In effect therefore each policyowner owns a pro rata share of each investment unit in the company�s portfolio. The insured may have as little as one cent invested in some units. Such diversification�which is the keystone of safety�is obviously beyond the reach of the individual investor. Only by investing exclusively in federal and state government bonds, with the consequent interest rate risk and sacrifice of yield, could the individual investor hope to match the safety of principal that his or her funds would enjoy with a reputable life insurance company.

Life insurance companies unquestionably obtain the highest possible yield commensurate with the standard of safety that they have set for themselves. As a group, life insurance companies in the United States earned over 9.0 percent of their mean ledger assets during most of the past decade, reaching 9.87 percent in 1985. This figure, which represents the net investment income (but does not reflect capital gains and losses) after deducting all expenses allocable to investment operations but before deducting federal income taxes, is the highest during the 20th century for the United States life insurance industry. Net rates have been declining since 1985 as general investment returns have sagged for all sectors of the economy. Many individuals therefore may be able to secure a higher yield than that provided by a life insurance company by investing in common stocks or other equity investments, especially if unrealized capital appreciation is taken into account, and some exceptional investors will be able to do it under virtually any circumstances. It is highly questionable, however, that the typical life insurance policyowner can, over a long period, earn a consistently higher yield than a life insurance company, regardless of the type of investment program he or she pursues. Moreover, it should be noted that the annual increases in cash values are not subject to federal income taxes as they accrue, while the earnings from a separate investment program would be taxed as ordinary income.

With respect to the third objective of an investment program, the liquidity of a life insurance contract is unsurpassed. The policyowner�s investment can be withdrawn at any time with no loss of principal. This can be accomplished through surrender for cash or through policy loans. The insured never faces the possibility of liquidating his or her assets in an unfavorable market; nor can the insured�s policy loans be called because of inadequate collateral. Certain types of investments approach the liquidity of life insurance cash values, but no investment whose value depends on the market can match the liquidity of the demand obligation represented by the life insurance contract.

More important perhaps than any of the preceding factors is the question of whether savings under a separate investment program would have been accomplished in the first place. Life insurance that develops cash values is a form of "forced" saving. Not only do its periodic premiums provide a simple and systematic mechanism for saving, but when the savings feature is combined with the protection feature, there is also far more incentive for the insured to save than there would otherwise be. An individual who is voluntarily purchasing a bond a month or setting aside a certain amount per month in some other type of savings account may skip a month or two if some other disposition of money is more appealing. If, however, failure to set aside the predetermined contribution to a savings account would result in loss of highly prized insurance protection that might be irreplaceable, he or she will be far more likely to make the savings effort. The insured saves because it is the only way of preserving his or her protection.

The foregoing is not to disparage other forms of investment. All have their place in an individual�s financial program. Level premium life insurance, however, should be the foundation of any lifelong financial program.