2 – TERM LIFE INSURANCE

2.1 What “Term” Means
2.2 Policyholder vs. Life/Lives Insured
2.3 Death Benefit
2.4 Term Insurance Premiums
2.5 Renewable vs. Non-Renewable Term Insurance
2.6 Convertible Term Insurance
2.7 Advantages and Disadvantages of Term Life Insurance
2.8 Using Term Insurance

2.1 What “Term” Means

Term life insurance is a contract between an insurance applicant and a life insurance company. In exchange for the payment of premiums, the insurer agrees to pay a death benefit to a named beneficiary if the life insured dies during a specified period of time, known as the term.

The term is the length of time for which the coverage is guaranteed to remain in force, provided that premiums are paid as required. If the life insured dies after the term expires, no death benefit is paid.

2.1.1 Typical Terms

Term life insurance is available for a variety of fixed periods. The most common terms include:

1 year
5 years
10 years
20 years

Some policies are also issued to a specific age, such as to age 60.

Depending on the insurance company, additional terms may be available, such as:

3 years
15 years
30 years

The choice of term is usually based on the length of time a financial obligation exists, such as a mortgage, income replacement need, or child dependency period.

2.1.2 Age Limits

Most insurance companies impose maximum age limits for term life insurance coverage due to the increased risk of death at older ages.

Key points to remember:

Coverage is often not available beyond age 75 or 80
New term policies are usually not issued after age 65 or 70, depending on the term length
Premiums for older applicants are significantly higher than for younger applicants because of the increased mortality risk

Age limits are an important consideration when selecting an appropriate term length and when planning long-term insurance strategies for clients.

2.2 Policyholder vs. Life/Lives Insured

The policyholder is the person who owns the life insurance contract. The policyholder may be the original purchaser of the policy or may acquire ownership later through gift or assignment.

The policyholder has full control over the contract, including the authority to:

Name or change the beneficiary
Pay premiums
Cancel the policy
Assign the policy

The life insured is the person whose life is covered by the insurance policy. If the life insured dies during the term of the policy, the insurance company pays the death benefit to the beneficiary. Some insurance products may also refer to the life insured as the annuitant.

The policyholder and the life insured can be the same person, but this is not required. The policyholder can also be both the life insured and the beneficiary. In this case, the death benefit is paid to the estate of the policyholder.

The policyholder is sometimes referred to as “the insured”, which can be confusing. In this context, “the insured” refers to the person who purchased the policy, not necessarily the life insured.

2.2.1 Single Life

Most term life insurance policies are single life policies.

Key characteristics:

Only one person is the life insured
The death benefit is paid only if that person dies during the term of the policy

2.2.2 Joint First-to-Die

A joint first-to-die life insurance policy covers two or more lives under a single amount of coverage.

Key features:

One death benefit is payable
The benefit is paid upon the first death, usually to the surviving life insured
The policy usually terminates after the first death

Common uses include:

Covering shared debts (e.g., mortgage)
Situations where one person is financially dependent on the other
Funding business buy-sell agreements (discussed in Chapter 8)

Some joint first-to-die policies allow the surviving life insured to:

Continue the same level of coverage under a new policy
Do so without providing evidence of insurability

This option must usually be exercised within a short period (e.g., 30 days) after the first death and can be especially valuable if the survivor’s health has deteriorated.

A joint first-to-die policy is typically less expensive than purchasing two separate single life policies with the same coverage amount, because the insurer is only exposed to one death benefit payout.

Important distinction:
Joint life insurance should not be confused with combined insurance, which is a marketing arrangement where two individual policies are issued under a single contract. Combined insurance:

May reduce administrative fees
May provide small premium discounts
Pays two separate death benefits if both lives insured die

2.2.3 Joint Last-to-Die

A joint last-to-die life insurance policy also covers two or more lives, but the death benefit is paid only upon the death of the last life insured.

This type of policy is used when the financial risk does not arise until the second death, most commonly for estate planning purposes.

A common application is funding the income tax liability that arises upon the death of the second spouse. While assets may transfer to a surviving spouse on a tax-deferred basis, taxes are typically triggered when the surviving spouse dies.

Joint last-to-die insurance can provide liquidity to:

Pay capital gains tax
Preserve assets such as a cottage or business
Allow property to pass to children without forcing asset sales

Because estate planning needs usually arise later in life, and because term insurance is often unavailable or prohibitively expensive after age 65 or 70, joint last-to-die coverage is more commonly provided through permanent life insurance, such as:

Whole life
Term-100
Universal life

2.3 Death Benefit

The death benefit is the amount paid by the insurance company to the beneficiary if the life insured dies while the policy is in force.

Life insurance policies are issued with an initial amount of coverage called the face amount. Depending on the type of term policy, the death benefit may:

Remain level
Decrease over time
Increase over time

The death benefit structure chosen should reflect how the insurance need is expected to change during the term.

2.3.1 Level Term

A level term policy provides a level death benefit, meaning the death benefit remains equal to the initial face amount throughout the entire term of coverage, regardless of when death occurs.

Key points:

Most common form of term insurance
Simple and widely promoted
Appropriate when the insurance need is expected to remain relatively stable over time

A common issue is that policyholders may not reassess their needs. As a result, they may become:

Under-insured if needs increase
Over-insured if needs decrease

2.3.2 Decreasing Term

Decreasing term insurance provides a death benefit that declines over the term, while the premium remains level.

Key characteristics:

Initial face amount is higher than the benefit at later years
Premiums are lower than for an equivalent level term policy
Reflects a declining amount at risk for the insurer

Most common use:

Covering a mortgage, where the outstanding loan balance decreases over time

Mortgage insurance offered by banks is essentially decreasing term insurance, typically sold as group insurance through a bank-affiliated insurer.

Few insurers now offer individual decreasing term policies; it is most commonly available through group arrangements.

2.3.3 Increasing Term

Increasing term insurance provides a death benefit that increases over the term of the policy.

The increase may be:

A fixed dollar amount (e.g., $50,000 every five years)
A fixed percentage (e.g., 5% annually)
Less commonly, tied to inflation (e.g., CPI)

Premiums usually increase proportionately with the death benefit. For example, a 10% increase in coverage typically results in a 10% increase in premium.

Restrictions usually apply, such as:

A maximum death benefit (e.g., 150% of the original face amount)
A limit on the number of increases

Increasing term insurance is now rare in Canada, but similar results can be achieved using riders, which are discussed in Chapter 5 – Riders and Supplementary Benefits.

Increasing term insurance is useful when the insurance need is expected to grow over time, such as due to:

Inflation
Increasing income
Rising tax liabilities

A key advantage is that increases in coverage typically do not require proof of insurability, even if the life insured’s health has declined, provided premiums are paid.

2.4 Term Insurance Premiums

A premium is the amount the policyholder pays to the insurance company in exchange for the insurer’s promise to pay a death benefit if the life insured dies during the term of the policy. By paying premiums, the policyholder transfers the risk of premature death to the insurer.

With the exception of increasing term insurance, term life insurance premiums are typically level throughout the term. Premiums are usually payable:

Monthly
Quarterly
Semi-annually
Annually

Payments may be made by cheque or pre-authorized bank withdrawal.

Most provinces and territories impose a premium tax on life insurance premiums, generally ranging from 2% to 5%. This tax is built into the premium charged to the policyholder and remitted by the insurance company to the provincial or territorial government.

2.4.1 How Premiums Are Set

Term life insurance is considered pure insurance, meaning its value is derived solely from the death benefit payable if the life insured dies. Premiums reflect:

The cost of insuring the life insured
The expenses incurred by the insurance company

Premiums are typically classified as:

Substandard – higher premiums due to higher-than-average risk
Standard – based on average risk
Preferred – lower premiums for individuals with lower-than-average risk (e.g., better health)

Risk classification is determined during underwriting and is discussed further in risk classes and their impact on premiums.

2.4.1.1 Cost of Insurance (COI)

The cost of insurance (COI), also called mortality cost, represents the insurer’s expected cost of paying death benefits.

On a per-policy basis, the annual COI is estimated by:

Multiplying the face amount of the policy
By the probability of death of the life insured for that year

The probability of death depends on factors such as:

Age
Gender
Health status

During underwriting, insurers estimate this probability by grouping individuals with similar characteristics and known mortality experience.

2.4.1.2 Expenses

Premiums must also cover the insurer’s operating expenses, including:

Marketing and sales costs
Agent commissions or salaries
Underwriting and medical examinations
Policy issuance and administration
Claims investigation and payment

Insurance companies may be:

Publicly owned, with shares traded on stock exchanges
Mutually owned, where policyholders are the owners

Regardless of ownership structure, insurers invest premium income (after expenses and reserve requirements). Investment income helps offset expenses and contributes to overall financial stability.

2.4.2 Sample Premiums

Sample premium tables show that age is a major driver of term insurance premiums.

Key observations:

Premiums change very little between ages 20 to 35 for shorter terms
Premiums begin to rise noticeably around age 40
Premiums increase dramatically after age 55

This highlights two important planning considerations:

Term insurance is generally cheaper when purchased at a younger age
For younger clients, longer terms (e.g., 20-year vs. 10-year) often offer better value, as the premium difference is relatively small in early years

2.5 Renewable vs. Non-Renewable Term Insurance

Term life insurance policies can be either renewable or non-renewable.

A renewable term insurance policy guarantees the policyholder the right to renew coverage at the end of the term without providing proof of insurability. This right is usually limited to a maximum age, such as age 70.

A non-renewable term insurance policy ends at the conclusion of the term. If the policyholder still requires coverage, a new application must be submitted. If the life insured’s health has declined, premiums may be higher or coverage may be denied altogether.

Renewable policies generally have higher premiums than non-renewable policies because the insurer assumes the risk of continuing coverage even if the life insured’s health deteriorates.

2.5.1 Renewal Provisions

The premium payable upon renewal depends on the renewal provisions set out in the policy.

2.5.1.1 Renewable with Guaranteed Rates

With a renewable policy, the policyholder is guaranteed the right to renew, but the premium at renewal is based on the attained age of the life insured.

Most renewable policies include a guaranteed schedule of renewal rates that is provided at issue. This allows the policyholder to know in advance how premiums will increase at each renewal.

2.5.1.2 Re-Entry Term with Adjustable Rates

Some insurers offer re-entry term insurance, which is a form of renewable term insurance with two possible renewal rates:

A guaranteed renewal rate
A lower re-entry rate, available if the life insured demonstrates good health at renewal

At renewal, the insurer reassesses the life insured’s health:

If health is good, the policyholder may qualify for lower renewal premiums
If health has declined, the policyholder can still renew, but must pay the higher guaranteed renewal rate

Because the policyholder retains some of the risk, initial premiums are usually lower than for standard renewable term insurance.

Re-entry policies may be appropriate when:

Coverage is only needed for a short period
The life insured expects to remain in good health

If long-term renewability is important, a standard renewable term policy may involve less risk for the policyholder.

2.6 Convertible Term Insurance

Convertible term insurance allows the policyholder to convert a term life insurance policy into a form of permanent life insurance (such as whole life, term-100, or universal life insurance) at a future date.

A key feature of convertible term insurance is that conversion does not require proof of continued insurability. This allows the policyholder to obtain lifetime coverage even if the life insured’s health has deteriorated and new insurance would otherwise be unavailable or unaffordable.

Because the conversion option exposes the insurer to additional risk, convertible term insurance premiums are higher than those for non-convertible term policies. This is largely because individuals who experience declining health are the most likely to exercise the conversion option.

Insurance companies may also impose age limits on when conversion can occur.

2.6.1 Incontestability and Suicide Provisions

When a term policy is converted, the new permanent policy is usually treated as an extension of the original policy, rather than a brand-new contract.

As a result:

The contestability period is not reset
The suicide exclusion period is not reset

Under the mandatory incontestability provision, the insurer has two years from issue to void a policy due to a misrepresentation of a material fact (e.g., smoking status, health condition, age). After this two-year period, the policy becomes incontestable unless fraud can be proven.

Most policies also contain a suicide exclusion clause, which states that the death benefit will not be paid if death by suicide occurs within a specified period (typically two years) after issue.

By converting a term policy:

The permanent policy inherits the original issue date
The policyholder avoids restarting the two-year contestability and suicide periods

This is a major advantage of convertible term insurance.

2.6.2 Attained-Age vs. Original-Age Conversions

Attained age refers to the age used to calculate premiums. Depending on the insurer, it may be based on:

Last birthday
Next birthday
Nearest birthday

With an attained-age conversion, premiums for the permanent policy are based on the life insured’s age at the time of conversion.

With an original-age conversion (also called a retroactive conversion), premiums for the permanent policy are based on the life insured’s age at the time the original term policy was issued.

Original-age conversions result in lower permanent insurance premiums, but:

The initial term premiums are higher
The policyholder may be required to pay a significant lump sum at conversion

This lump sum may represent:

The cash value that would have accumulated had permanent insurance been purchased initially, or
The difference between actual premiums paid and what would have been paid under permanent insurance

Due to the cost and complexity, most insurers:

Do not offer original-age conversions, or
Restrict conversion to the first 5–10 years of the policy

2.7 Advantages and Disadvantages of Term Life Insurance

Term life insurance provides temporary coverage for a defined period of time. Understanding its advantages and disadvantages helps an agent determine when term insurance is appropriate and how it compares to permanent life insurance.

2.7.1 Advantages of Term Life Insurance

Term life insurance offers several important benefits:

Lower initial cost for an equal amount of coverage compared to permanent insurance
- Premiums in the early years are significantly lower, making term insurance affordable for individuals who cannot afford permanent insurance
Guaranteed premiums during the term
- Premiums remain level for the duration of the term
Renewable and convertible options
- Coverage may be extended or converted to permanent insurance, depending on policy provisions
Flexible term length
- The term can be selected to match a specific financial need, such as income replacement or mortgage coverage
Simple and easy to understand
- Term insurance is straightforward and commonly used

2.7.2 Disadvantages of Term Life Insurance

Despite its advantages, term life insurance has several limitations:

Premiums and coverage are not guaranteed beyond the term or renewal period
- Renewal premiums can increase significantly
Higher premiums at older ages
- Policies issued to older life insureds are more expensive due to increased mortality risk
Coverage is usually unavailable past a certain age
- Term insurance is typically not offered beyond age 75 or 80
No value at the end of the term
- If the life insured survives the term, the policy expires with no payout
Defined period of financial commitment
- Coverage only exists for a limited time and must be renewed or replaced if ongoing protection is needed

2.8 Using Term Insurance

As a general rule, term life insurance is intended to be temporary coverage. It is best suited for risks that are expected to end before the life insured reaches age 60 or 70. If a risk is expected to continue for life, some form of permanent life insurance should be considered instead.

This section outlines common situations in which term insurance is appropriate.

2.8.1 Short-Term Risks

Term insurance is well suited for short-term risks with a known duration.

Examples include:

Temporary income replacement needs
Time-limited financial obligations

If there is a possibility that the risk may extend beyond the expected time frame, the policyholder should consider a renewable term policy to maintain flexibility.

2.8.2 Decreasing Risks

Term insurance is also appropriate for risks that decline over time.

Common examples include:

Mortgages
Loans with a defined amortization period

In these situations, decreasing term insurance may be used to match the declining financial exposure.

2.8.3 Limited Cash Flow

One of the most common reasons individuals choose term insurance over permanent insurance is limited cash flow. Term insurance provides a higher amount of coverage at a lower initial cost, making it accessible during periods of tight budgets.

Some individuals prefer term insurance because they plan to invest the premium savings compared to permanent insurance. This strategy is commonly referred to as “buy term and invest the difference.”

This approach can be effective if:

The policyholder consistently invests the savings
Investments perform well over time

However, it requires financial discipline and does not provide the guarantees associated with permanent life insurance.