For an underlying discussion on how term life insurance works, please see our Types of Life insurance article.
Most variations on term insurance have a few common attributes:
- Premiums that increase over time. Term insurance is the closest form of life insurance we have to the true underlying cost of life insurance. Insurance costs must increase over time as we get older (more claims = more costs = higher premiums). In other words, costs are based on our age – the older we are the higher the risk is that we may die, so the higher the premiums must be. Rather than increasing premiums every year however, insurance companies smooth these costs out over exact periods of time. So if they smooth the costs out over 10 years (meaning your premiums are level for 10 years, then they increase and are again level for another 10 years) this is called 10 year term. If they smooth the premiums out over 20 years, then the insurance is called 20 year term.
- Renewals. At the end of the initial level term period (i.e. after 10 years for 10 year term) most term policies renew. This means the policy remains in force but the premiums will increase (and typically be level again for another term). Unfortunately current term policies have renewal premiums that most would see as exhorbitant – the premiums increase at renewal by 5 to 10 times what the initial premium was. As a result, it’s important to select a term period where the initial premiums are level for as long as you expect to keep the premiums for. The reason for this dramatic increase in premiums is based on the concept of Select and Ultimate rate tables. During your initial term period you will have taken a medical exam and proven your good health – and your rates are calculated using the ‘Select’ mortality tables which assume good health. At the renewal of your term your health is no longer proven – it’s statistically similiar to the general public. At that point your premiums are calculated using the much higher Ultimate mortality tables. In years past Canadian term life insurance policies used select rates for both the initial term premiums and the renewals. So at your renewal your premiums were the same as someone who just qualified medically and received the better rates. This is no longer the case – term policies in Canada now use the select/ultimate rate tables so again you should assume that at renewal your premiums will increase dramatically and thus you should get a term that’s long enough to ensure you won’t need the insurance at the end of the term. In years past renewal premiums were important because most people would keep their term policy at renewal – this is no longer the case.
- Conversion. The conversion privilege is a policy clause that says you can trade in or ‘convert’ your term insurance in exchange for a permanent insurance policy. That alone isn’t a big deal – you could just go buy a permanent policy if you need one. However the important point is that the insurance company will do this conversion for you with no medical exam and still give you healthy rates (as long as your original policy was at healthy rates). Assuming that you purchase term insurance for the proper duration, with the intention of cancelling the term insurance at the end of the term then the conversion privilege may not be something you need. However if your needs change – or if you become uninsurable, this clause is vital because it guarantees that you can get insurance for the rest of your life, at healthy rates – even if you can’t pass a medical exam. That means that conversion is going to protect you against this worst case scenario, and that means you should only ever purchase a term policy that has a term to permanent conversion clause in the policy (some companies will have term to term conversion – this is NOT the same thing). Note that policies will only let you convert up to a specific age – if you do not convert your policy prior to the stated age (normally around age 65-70) then you lose the ability to convert.
- Expiry. As term insurance is intended to provide protection only during a specific period of time, most term policies in Canada have an expiration period. At that time your policy ceases. In many cases this will be around age 75 or so. However as noted above, you should assume for all practical purposes that the policy is over at the end of the initial term period due to the large increase in premiums.
Common uses for term insurance
Term insurance is often used for insurance coverage that won’t be required forever. Mortgage life insurance, protecting a family while children are financially dependent, debts, these are all common uses of term life insurance. Conversely, if you say ‘I need this insurance no matter how old I am when I die’, then you should investigate permanent insurance.
Types of term life insurance in Canada
There are many different types of term life insurance in Canada – 5 year term, 10 year term, 15 year, 20 year, 30 year, and pretty much everything in between. As previously noted, you should select the term that best fits the length of time that you need the insurance. However there are a couple of modifications to this. First, due to marketplace conditions, 10 year term and 20 year term premiums tend to be the most competitive. If you need insurance for roughly those periods you should consider shopping those products out as well. (For example, in many cases 5 year term will actually cost more than 10 year term. That is because 10 and 20 year term premiums have been pushed down by the marketplace). 30 year term is also available and competitively priced though typically not as aggressively as 20 year term. For younger folks 30 year term does tend to become more affordable. And while 10 year term in many cases is less expensive than 5 year term (so if you need insurance for 5 years you would still buy 10 year term) for males 55 and above this rule of thumb may not work – i.e. 5 year term may be more affordable in that case.