Level-Premium Insurance

What Is Level-Premium Insurance?

Level-premium insurance is a type of term life insurance. With this type of coverage, premiums are guaranteed to remain the same throughout the contract, while the amount of coverage provided increases. As a result, the coverage can be advantageous over a long period of time: a policyholder keeps paying the same amount but has access to increased benefit coverage as the policy matures.

The most common terms are 10, 15, 20, and 30 years, based on the needs of the policyholder. Level-premium policies are different than standard term life insurance policies, which have premium rates that rise as the policies age.

How Level-Premium Insurance Works

Level-premium insurance premiums are initially higher than other policies with similar coverage. However, by the end of the contract, the premiums often end up as a better bargain. This is because the higher premiums have typically been offset by an increase in coverage during a time period when a policyholder typically has more medical issues.

Policies with similar coverage and lower premiums usually don't see an increase in coverage as they mature. For some investors, this limits any advantages that come from having initial lower premium payments. The appeal of better coverage at a later time — with no increase in premiums — is a key reason why investors will sometimes choose level-premium insurance (provided they are able to financially tolerate the higher payments).

This policy is included under term life insurance, meaning it provides coverage only for a specified duration and it has only a death benefit, as opposed to a savings component (as in whole life coverage). To determine whether level-premium insurance is preferred, consider the length of coverage needed.

For example, if the primary purpose of the death benefit is to provide income to support very young children and fund college expenses, a 20-year level-premium might be appropriate. However, if these children are already in their early teens, a 10-year level-premium may be sufficient.

Some forms of life insurance are vulnerable to rate hikes. With level-premium insurance, premiums are guaranteed and will never be subject to change (unless the policyholder requests a change). The payout for the policy also remains the same throughout the term, unless the policyholder requests otherwise.

If the policyholder passes away during the term of the policy, the person's family could receive a cash payout to be used to pay off an existing mortgage, help with ongoing household bills, and help with other basic needs — or even pay for the policyholder's funeral or memorial service.

Level-Premium Insurance vs. Decreasing Term Life Insurance

While level-premium insurance and decreasing term life insurance are similar, there are several key differences. They also are appropriate in different circumstances.

With level-premium insurance, the policy pays a benefit if the policyholder passes away during a fixed period (whatever the term of the insurance is). If death occurs outside of this term timeframe, there is no payout.

With decreasing term life insurance, the amount of coverage declines over time, similar to the way a repayment mortgage decreases over time. Decreasing term life insurance is usually purchased to pay off a specific debt, like a repayment mortgage. The policy ensures that, upon death, the repayment mortgage (or other specified debt) gets settled.

Other specialty types of life insurance include "over 50s life insurance," which is a specialized kind of insurance geared toward people between the ages of 50 and 80. There is also joint life insurance, in which two people in a relationship take out individual policies. The policy will cover both lives, usually on a first-death basis.

Example of Level-Premium Insurance

The age and timeframe of the policyholder are both crucial factors in determining if a guaranteed, level-premium policy is optimal (versus an annual renewable term (ART) policy, which increases as the policyholder ages). The average term length and premium that customers often choose is 20 years and $600,000, respectively.

For example, suppose two female friends, Jen and Beth, both 40 years old and in good health, opt to buy life insurance. Jen buys a guaranteed level-premium policy at $37 per month, with a 20-year horizon, for a total of $440 per year. But Beth figures she may only need a plan for three-to-five years or until full payment of her current debts. Instead, she opts for a yearly renewable term (YRT) policy that starts at $20 per month and holds steady for the first five years. She initially pays $240 per year.

In years two through five, Jen continues to pay $444 per month, and Beth continues to pay $240 per year. If Beth cashes out her policy at year five, she will have saved a lot of money relative to what Jen paid. But what if Beth doesn't stop at year three? What if she buys a house and wants to hold on to her policy a bit longer. Now, she's at a disadvantage because, in year six, Beth will be 45 and fall into a higher risk category.

In many cases, her annual rate will jump close to 200%. So now in year six, she is paying $654 per year, versus Jen's $444 per year. After age 45, the rates tend to go up each year, sometimes as much as 10% per year. After age 56, they tend to go up even more. By year 20, at age 60, by picking and sticking with a policy with an annual renewal rate, Beth could be paying more than $2600 per year, versus Jen's $444 per year.

Over 20 years, Jen paid $440 per year, every year, for a total of $8,880 with her guaranteed level-premium plan. But Beth, who opted for an annual renewal plan, held steady at $240 per year for the first five years and then saw her premiums rise 10% per year for the last 15 years, ended up paying more than $24,000 over the term of the policy.