Decreasing term insurance is a unique form of term life insurance designed to offer a death benefit that reduces over time, typically at a predetermined rate or according to a specified schedule. This type of insurance is often aligned with the decreasing financial liabilities of the policyholder, such as a mortgage.
Detailed Definition
Concept and Mechanics
In a decreasing term insurance policy, the coverage amount decreases over the life of the policy while the premium generally remains level. This means that although the insured pays the same amount annually, the death benefit paid out upon their passing decreases every year. For example, a $100,000 policy over 20 years might decrease by $5,000 every year until it reaches zero.
Types of Decreasing Term Insurance
- Mortgage Protection Insurance: The most common form, which reduces alongside the principal balance of a mortgage.
- Credit Life Insurance: Tied to the balance of a personal loan or credit, decreasing as the loan is repaid.
Special Considerations
- Premium Stability: Premiums remain constant even as the death benefit decreases.
- Policy Termination: Once the term ends, there is often no further coverage or payout.
- Renewability: Some policies may be renewable, but typically at higher premiums.
Example of Decreasing Term Insurance
Consider a homeowner who buys a 20-year decreasing term insurance policy with an initial death benefit of $200,000. The policy is designed to mirror their mortgage decreasing balance. Each year, the death benefit reduces proportionally to the remaining mortgage balance until it reaches zero at the end of 20 years.
Pros and Cons
Pros
- Affordability: Generally more affordable than level term insurance.
- Purpose-Specific: Ideal for covering diminishing debts like mortgages or loans.
- Simplified Planning: Matches the timeline of specific liabilities.
Cons
- Decreasing Coverage: The payout reduces over time, meaning less coverage as years go by.
- Lack of Flexibility: Not suitable for needs that don’t decrease over time.
- No Cash Value: Unlike whole life or universal life insurance, there is no cash value component.
Historical Context
Decreasing term insurance became popular as homeownership rates increased and more individuals sought mortgages. The policies provide a strategic way to ensure financial protection aligns with reducing liability, such as a home loan, making it a favored choice among homeowners.
Applicability and Usage
This type of insurance is particularly useful for:
- Homeowners with mortgages.
- Individuals with other significant debts decreasing over time.
- Families wanting to ensure specific debts are covered if the primary earner passes away.
Comparisons
Decreasing Term Insurance vs. Level Term Insurance
- Coverage: Level term maintains the same benefit amount throughout the policy term, whereas decreasing term reduces.
- Premiums: Premiums for decreasing term may be lower.
- Purpose: Decreasing term is more specific to diminishing liabilities.
Related Terms
- Renewable Term Insurance: Can be renewed without medical underwriting.
- Convertible Term Insurance: Allows conversion to permanent insurance.
- Whole Life Insurance: Provides lifetime coverage with a cash value component.
Frequently Asked Questions (FAQs)
Is decreasing term insurance worth it for young families?
It can be, especially if they have large initial debts that diminish over time, like a mortgage.
Can I convert a decreasing term insurance to a whole life policy?
Generally, no. Decreasing term policies usually lack conversion features.
Will my premium payments decrease as the death benefit decreases?
No, the premiums usually remain level throughout the policy term.
References
- “Understanding Term Life Insurance”. Insurance Information Institute.
- “The Basics of Life Insurance”. National Association of Insurance Commissioners.
Summary
Decreasing term insurance is a cost-effective option tailored to cover specific, diminishing financial responsibilities. It is a practical choice for those with liabilities like mortgages, offering a straightforward and financially efficient means to ensure debts are covered in the event of the policyholder’s death.
