Understanding Term Insurance

It was the battle cry of mutual-fund purveyors back in the ’80s and ’90s: “Buy term and invest the difference!” The rationale was to pay less for your life insurance by buying term insurance rather than permanent insurance, then taking the money that you saved on the premium and buying mutual funds or other securities. The goal was to grow the investment fund enough to replace the term insurance amount and then some by the increasing investment fund.

This usually did not work out so well for people. One obvious reason, of course, is that the investments may not have grown and held their value as hoped for. Probably the more common reason was the lack of rigorous self-discipline: It was always easier to spend these excess dollars on some current need or want and plan on making up for the skipped savings the next month. Too often that never happened.

The weakness of term insurance is that, while it is cheap in the short term, it is the most expensive way to buy life insurance in the long term. It is cheap because it almost never pays a death benefit. When the premium goes up after the initial 10- or 20-year guaranteed period, the policy owner can no longer afford the coverage and drops it. And this is done at an age when the risk of dying has never been greater. Insurers love to sell term insurance because only 2 percent of these policies ever pay a death benefit. The rest represent pure profit for the insurers.

Term insurance can be appropriate in some circumstances, when there is an immediate need for a lot of protection but a lack of funds to pay for the better, permanent coverage. For example, a few years ago my married son had a baby on the way and a modest income. It was better for him to get term than to go without. So, he got $500,000 worth, but he needs to convert it to permanent coverage soon

Term insurance gets very expensive by the time people reach their 50s and 60s and that people eventually have to drop these policies because of that cost. But it is exactly at those ages and beyond that people start needing home health care or nursing-home care.

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