Once you have decided on how much life insurance you need, your next decision is whether you are going to use term insurance or permanent insurance to provide it. For many Canadians, while permanent cash value life insurance offers a significant opportunity for them, many initially utilize renewable and convertible term life insurance. Most life companies in Canada offer 10-year, 20-year and 30-year renewable term policies. In deciding which one is right for you, attempt to match the need to the term. While 10-year term might have the lowest entry level cost, the renewal premiums will be significantly higher. If you have a young family, ask yourself, will I still need protection beyond the 10th year? If that answer is yes, then a longer renewal period is more appropriate.
In making your choice, it is important to understand how renewable term policies function. In Canada, the renewal of the coverage is automatic (unless you decide not to renew) and guaranteed. The premium on renewal, however, will increase dramatically. Anyone who has 10-year renewable term insurance, instead of renewing it, should re-write the policy for a new term period. This, of course, will require the individual to provide medical evidence that he or she is still in good health. If the insured has become “uninsurable” he or she still has the option of the guaranteed renewal. To protect itself from being left with only “poor risks” the life insurance company builds a hedge into the guaranteed renewal premium.
For example, Dave, a male age 40 who is a non-smoker can purchase a 10-year renewable term policy with a death benefit of $1,000,000 for $610 per year. At the end of the 10th year, the guaranteed renewal premium for that policy is $ 4,230 per year. If Dave was still a standard risk, a new $1,000,000 10-year term policy would cost $1,550 per year at his age 50. The problem is, what if he was no longer insurable due to an adverse change in his health or other factors? If Dave still needed the coverage, and he didn’t want to convert the policy to a permanent plan such as Whole Life, he would have no other option but to pay the $4,230 annual premium.
Let’s look at Dave’s situation and see if we can come up with a better solution for him. Dave is married and has two children ages 7 and 9. He and his wife have concluded that they do need $1,000,000 of life insurance but their current finances only allow them to consider renewable term insurance. With the ages of their children, it is probable that the coverage will be needed for longer than 10 years, but it is hard to ignore the very low premium on 10-year renewable coverage even though 20-year coverage is more appropriate. Dave studies the numbers shown above and compares them to the 20-year plan which costs $1,120 per year for 20 years.
In a perfect world, if Dave were able to re-write the 10-year term policy in year 11 (assuming the same premium rates are still available) his policy in year 11 would cost $1,550 per year. His average cost over the 20 years would be $1,082.50 per year, not that much less than the annual premium for the 20-year term. The risk Dave would be taking with the 10-year coverage, however, is if he had to accept the renewal premium in year 11. Then the average cost per year would rise to $2,420 over 20 years.
If Dave was still not in a position of having the necessary cash flow to support the higher 20-year premium, all is not lost. Many 10-year renewable term policies now have a provision that the policy can be converted to 20-year term in the first 5 policy years without a medical. When Dave’s income rises or some of his debt is reduced then the increased cash flow can be used to change to policy to a longer term. Remember, while the longer term is more appropriate for most individuals the important thing is to have the proper amount of coverage.
Depending on circumstances, in many situations 20-year term coverage may not even be long enough. Terms of 30 years or longer are available. One common and recommended strategy is to layer your coverage. For example, in Dave’s case, even after 20 years when his children have grown, been educated and left the house (hopefully), there will probably still remain a need for some life insurance to protect Dave’s spouse. With this in mind, Dave could start with a foundation of longer term or even permanent coverage and add to it coverage with a shorter-term period.
Let’s discuss your circumstances, objectives and cash flow to enable you to build an insurance portfolio that will best suit your needs.
*Rates shown are from a major Canadian Insurance company and are current at the time of this article.