Level Term Life Insurance

Level term life insurance is term life insurance under which the premium and the death benefit both remain unchanged for a stated period, commonly ten, fifteen, twenty or thirty years. Nothing about it is unusual, which is the point: it is the standard shape of individually purchased term coverage, and the other term designs are described by how they depart from it.

The label belongs to a regulator-defined category of label. NAIC's Life Insurance Disclosure Model Regulation defines a "generic name" at section 4.C as "a short title that is descriptive of the premium and benefit patterns of a policy or a rider," and requires the policy summary to state "the generic name of the basic policy and each rider." Level term is exactly that: a two-word description of a premium pattern and a benefit pattern, rather than a term any body defines substantively. Reading it as a description of two patterns is also what stops the common mistake, which is to hear only the premium half. A decreasing term policy also has a level premium; what it does not have is a level death benefit.

What the number of years actually names. A twenty-year level term policy guarantees the premium for twenty years. It does not follow that the contract ends in year twenty-one, and NAIC's Life Insurance Buyer's Guide is direct that most term coverage can be continued: "Most term life insurance coverage can be continued ('renewed') at the end of the term, even if your health has changed. If you renew a term policy, the new premiums are higher. Ask what the premiums will be before you renew the policy. Also ask if you'll lose the right to renew the policy at a certain age. A nonrenewable term policy can't be continued. You'll have to apply for a new policy if you still want coverage." Washington's Office of the Insurance Commissioner adds the mechanism: on a renewable policy "you may buy it for another term at a rate guaranteed in the policy, without providing health information and some other proof of insurability," but "the renewed policy will usually cost more. Over time, it may be too costly to renew." So the useful questions at purchase are three: is it renewable, at what rate, and up to what age.

Why the renewal price jumps so far, which is the part that surprises people. The risk of dying rises every year, so the true annual cost of a death benefit rises every year. A level premium does not change that; it averages it. Over a twenty-year period the buyer pays more than the current cost of the coverage in the early years and less in the later ones, and the early overpayment is what funds the later shortfall. At the end of the period that prefunding is spent. Whatever the contract charges next has to cover the cost of insuring the insured at their attained age with nothing set aside against it, which is why a renewal rate can be a multiple of the expiring premium rather than a modest step up. The same arithmetic explains why buying a longer level period costs more per year at the outset: more of the expensive later years are inside the average.

Level does not automatically mean guaranteed, and the disclosure rule is the place to check. NAIC's disclosure model defines "nonguaranteed elements" at section 4.D to include "the premiums, credited interest rates (including any bonus), benefits, values, non-interest based credits, charges or elements of formulas used to determine any of these, that are subject to company discretion and are not guaranteed at issue." Premiums are the first item on that list. The model then requires at section 7.D that "any reference to nonguaranteed elements shall include a statement that the item is not guaranteed and is based on the company's current scale of nonguaranteed elements." A contract can therefore quote a current premium below a higher guaranteed maximum, and the two numbers are both in the policy. Where the model has been adopted, the quoted figure has to be labeled; the buyer's job is to find the guaranteed maximum and decide whether the coverage is affordable at that number rather than at the illustrated one. NAIC models are not law until a state enacts them, and the disclosure model does not apply to group life, credit life or variable policies at all.

Where it sits among the other patterns. Annually renewable term charges a premium that rises every year, which is the underlying cost stated honestly and is cheapest in year one and unaffordable eventually. Decreasing term holds the premium level while the death benefit falls, which suits a shrinking debt and nothing else. Return of premium keeps both level and refunds the premiums if the insured survives, at a substantially higher price. Level term holds both steady and refunds nothing, which is why it delivers the most death benefit per premium dollar of the four. How much coverage to buy, and whether to stagger several policies with different end dates, are questions about the coverage rather than about the pattern, and belong with the general term material.

The applicant chooses a face amount and a period, is underwritten once, and is issued a contract that fixes both the premium and the death benefit for that period. Nothing about the policy needs attention while it runs. At the end of the period the contract does whatever its own terms say, which is usually either to expire or to continue at an age-based rate the policy already specifies.

A hypothetical, to show the averaging that makes the pattern work. Suppose the true annual cost of insuring a particular life for $500,000 is $260 in the first year of a twenty-year policy and $2,900 in the twentieth, climbing steeply in between, so that the annual costs across the twenty years average roughly $1,100. A level premium has to be set near that average, so suppose the insurer charges $1,100 a year for the whole period. In year one the buyer pays $840 more than the coverage costs that year. In year twenty they pay $1,800 less than it costs. The surplus from the early years is what pays for the deficit in the later ones, and the two sides balance because the level figure was the average of the stream in the first place. When year twenty-one arrives, that surplus has been used up, so a renewal has to be priced at something near the current annual cost of a 21st year, which is why it is a different order of number from $1,100. The figures are invented for the arithmetic and a real insurer also allows for interest earned on the early surplus and for policies that lapse, but the direction is the mechanism rather than the illustration.

The consequence for a buyer is that the period is the decision. Choosing a level period that ends while the need still exists means meeting the renewal price at an older age, or applying for new coverage with whatever health history has accumulated. Choosing one that runs well past the need means paying for years of averaging that were never required.

Pros

• The premium is fixed and the death benefit is fixed, which makes it the simplest life insurance contract to budget for and to compare across insurers.
• It delivers the most death benefit per premium dollar of the common term patterns, because nothing is refunded and nothing accumulates.
• Underwriting happens once, so a health change during the level period does not reprice or end the coverage.
• The flat death benefit keeps pace with a need that does not shrink, which a decreasing policy does not.

Cons

• The level period, not the need, sets the date the price changes, and the two rarely line up exactly.
• The renewal price after the level period is materially higher, because the prefunding that held the premium down has been spent.
• The quoted premium may be a current scale rather than the guaranteed maximum, and the two figures can be far apart.
• Buying a longer level period costs more each year from the start, so overbuying the term is a real and recurring cost rather than cheap insurance against uncertainty.
• Nothing is paid if the insured survives the period, which is the ordinary and intended outcome but is what sends buyers toward more expensive designs.