In Canada we have two basic types of life insurance; term life insurance and permanent life insurance.
Two common adages in the life insurance industry are:
- All life insurance is term insurance.
- All life insurance is the same, you only pay for it differently.
These two expressions highlight an important point about life insurance – it’s easier to understand if you ignore the marketing material and the emotional triggers and treat this as ‘insurance’. Plain old insurance, just like your car insurance. You pay a premium each year for your car/life insurance. If you have a car accident/die the insurance company pays the claim. Otherwise, they pool your premiums inside the company with everyone else who paid their premiums and use that money to pay whoever did have a car accident/die.
Just like car insurance, your rates go up if you’re a bad driver or a bad risk. In life insurance what makes us a bad risk mostly is our age. Every year we get older, we’re a year closer to having a claim. So the underlying cost of all life insurance products have premiums that go up every year as you get older. Such an insurance product (with rates that increase every year based on your age) is called 1 year term life insurance. And as that’s the underlying costs to the company for all life insurance products, that’s where the phrase comes from that all life insurance is term insurance – all life insurance products have an internal cost that increases each year.
But you don’t want costs that go up each year. So the insurance companies take those costs (and along with other expense factors) smooth out those costs over a period of time. If the insurance company smooths out those costs in 10 year increments, so your insurance premiums are level for 10 years then premiums increase and are level for another 10 years, that product is called 10 year term life insurance.
There are many variations of term life insurance, all centered around how long the insurance premiums remain level for. 10 year term and 20 year term are both very common products though 30 year term is starting to make some inroads into the Canadian market.
That’s term life insurance in a nutshell.
Now if the insurance company smooths the costs or the premiums out over your entire life expectancy so that premiums are now level for your entire life rather than increasing every 10 or 20 years, then the resulting insurance is called permanent life insurance. There are three main types of permanent life insurance in Canada, whole life insurance, term to 100, and universal life. However again the underpinnings of these insurance products have to be costs that increase every year.
All life insurance products have two primary attributes – the premiums and the death benefit. The death benefit for all individual life insurance products is the same – a cheque for $500,000 cashes the same whether you had term insurance or permanent insurance when you died. So the primary difference to look at is the premiums. Term insurance premiums increase over time, permanent insurance premiums are level for life – that’s the biggest difference between them for most people. If you need insurance for a period of time, term insurance will be less expensive in the short term. If you need insurance ‘forever’, then permanent insurance in most cases will be less expensive in the long term.