Decreasing Term Insurance: Definition, Example, Pros & Cons
Decreasing term insurance is a type of renewable term life insurance in which coverage decreases at a predetermined rate over the life of the policy. Premiums are typically constant throughout the contract, with coverage reductions occurring monthly or annually. The insurance company's plans have terms ranging from one year to thirty years.
In most cases, decreasing term life insurance is used to guarantee the remaining balance of an amortizing loan, such as a mortgage or business loan, over time. It differs from level-premium term insurance.
Understanding Decreasing Term InsuranceÂ
Term life insurance is a type of coverage that provides a death benefit for a limited time. A 20-year term life insurance policy, for example, would have level premiums and the same death benefit throughout its term. Decreasing term insurance, on the other hand, has a decreasing death benefit over time as well as decreasing premiums. When the life insurance policy is purchased, these amounts will be set to a schedule that may conform to a standard schedule or be customized between the insurer and the insured.
The theory behind decreasing term insurance holds that as people get older, certain liabilities and the need for high levels of insurance decrease. Many in-force decreasing term insurance policies take the form of mortgage life insurance, which attaches its benefit to an insured's home's remaining mortgage.
Individuals' life insurance needs may not be met solely by decreasing term insurance, especially if they have a family with dependents. Standard term life insurance policies are reasonably priced and provide the security of a death benefit for the duration of the contract.
Benefits of Decreasing Term Life
The most common application of decreasing term insurance is for personal asset protection. A decreasing term life policy is also used by small business partnerships to protect indebtedness against startup and operational costs.
In the case of a small business, if one of the partners dies, the death benefit proceeds from the decreasing term policy can be used to fund ongoing operations or to pay off a portion of the remaining debt owed by the deceased partner. The security enables the company to affordably guarantee commercial loan amounts.
Term life insurance is less expensive than whole life or universal life insurance. The death benefit is intended to resemble the amortization schedule of a mortgage or other personal debt that cannot be easily covered by personal assets or income, such as personal loans or business loans.
Unlike a whole life insurance policy, decreasing term insurance provides a pure death benefit with no cash accumulation. As a result, this insurance option has low premiums for benefit amounts comparable to either permanent or temporary life insurance.
Example of Decreasing Term Insurance
For example, a 30-year-old male nonsmoker might pay a monthly premium of $25 for the life of a 15-year $200,000 decreasing term policy tailored to match a mortgage amortization schedule. The monthly fee for the level-premium decreasing term plan remains constant. The carrier's risk rises as the insured ages. This increase in risk justifies the decrease in death benefit.
A permanent policy with the same face value of $200,000 may necessitate monthly premium payments of $100 or more. While some universal or whole-life policies allow for face amount reductions when the insured uses the policy for loans or other advances, most policies have fixed death benefits.
Frequently Asked Questions
Who might benefit from decreasing term life insurance?
Small businesses may find it useful to protect their debt against startup and operational costs. For example, if one partner dies, the death benefit proceeds from the decreasing term policy can be used to fund ongoing operations or to pay off a portion of the remaining debt owed by the deceased partner. The protection also enables the company to affordably guarantee commercial loan amounts.
Why might decreasing term life not be the best fit for me?
The main disadvantage is that the death benefit decreases over time, which is why it is less expensive than standard term life or other policies. Furthermore, if something happens in the future, decreasing term life insurance may not provide the necessary coverage. Saving a few dollars in the short term may leave you vulnerable in the event of a future event.
Is decreasing life insurance cheaper than regular term?
Yes, because the corresponding premiums decrease as the death benefit decreases over time.
What happens at the end of a decreasing term life policy?
When a decreasing term life policy expires, so does the death benefit coverage.