Decreasing Term Insurance

Decreasing Term Insurance is a type of life insurance that offers a death benefit that decreases over time, usually on a regular basis such as annually. Unlike level term insurance, where the payout amount remains constant throughout the term, decreasing term insurance reduces the sum insured at a predetermined rate. It is often designed to align with declining financial obligations, such as a mortgage or other loans.

Purpose and Use

Decreasing term insurance is typically used to cover a specific liability that diminishes over time. The most common scenario is mortgage protection. As the outstanding balance of a mortgage decreases with regular repayments, the need for a substantial death benefit also diminishes. Here are some key uses:

• Mortgage Repayments: Homeowners often take out decreasing term insurance to ensure that any remaining mortgage debt would be paid off in the event of their death.
• Loan Agreements: Borrowers may use this insurance to cover personal or business loans that diminish over time.
• Income Replacement: Some use it to replace income that decreases over time due to diminishing responsibilities, such as raising children where expenses decrease as children become independent.

Structure and Function

Premiums

The premiums for decreasing term insurance are generally fixed throughout the term of the policy, despite the decreasing death benefit. This makes it easier to budget and plan financial obligations. Because the risk to the insurer diminishes over time (as the payout decreases), these policies can often be more affordable than level term insurance.

Death Benefit

The primary characteristic of decreasing term insurance is the reducing death benefit. The rate at which this benefit decreases is established at the inception of the policy. Commonly, this might be a uniform reduction, for example, 5% per year, though some policies might tailor the reduction to better match specific obligations like a mortgage amortization schedule.

Term Length

The term length of a decreasing term insurance policy can often be chosen to match the life of the financial obligation. For instance, if the insurance is meant to cover a 30-year mortgage, the term of the policy would likely be 30 years as well.

Types of Decreasing Term Insurance

Mortgage Decreasing Term Assurance (MDTA)

This form is specifically tailored to pair with a mortgage. Since most mortgages are structured with decreasing balances over time (especially those utilizing fixed interest rates), MDTA aligns the insurance coverage accordingly.

Credit Life Insurance

Credit life insurance is a specific type of decreasing term insurance designed to pay off a debt in the event of the policyholder’s death. Similar to MDTA, the death benefit reduces as the debt decreases.

Business Loans

Businesses sometimes use decreasing term insurance to cover specific loans they have taken. The logic here is the same: as the loan gets paid off, the required coverage decreases.

Comparison with Level Term Insurance

Benefits

• Cost-Effective: Generally, the premiums for decreasing term insurance are lower than for level term insurance due to the reduced risk over time.
• Budget-Friendly: Fixed premiums make it easier to budget compared to policies with escalating premiums.
• Targeted Coverage: It aligns precisely with declining financial responsibilities, making it a practical choice for specific debts.

Drawbacks

• Reduced Death Benefit: While the premiums remain constant, the payout decreases, which could be a disadvantage if a larger death benefit is needed later in the term.
• Less Suitable for Long-Term Needs: This type of insurance is less effective for long-term financial needs beyond paying off a specific debt, unlike whole life or level term insurance.

Financial Planning Considerations

When considering decreasing term insurance, it’s essential to assess long-term financial needs. This involves calculating the expected reduction in financial obligations over time and considering any other potential needs beyond those covered by the decreasing term policy.

Suitability

Decreasing term insurance is particularly suitable for:

• Individuals with significant debt that will decrease over time.
• Homeowners looking to insure their mortgage.
• Business owners seeking to cover specific loans or lines of credit.

Unsuitability

However, it might not be the best choice for:

• Those needing a consistent and sizeable death benefit.
• Individuals looking to cover lifelong financial responsibilities or estate planning.

Policy Variations and Customizations

Different insurers offer various forms of decreasing term insurance. Some policies may allow for certain flexibilities, such as:

• Recalculation: Option to adjust the rate at which the death benefit decreases.
• Convertible Policies: Ability to convert the policy to permanent life insurance if longer-term coverage becomes necessary.
• Joint Life Policies: Coverage for two lives, often used by couples to cover a mortgage jointly.

Major Providers and Products

Several insurance companies offer decreasing term insurance with differing features and premium structures. Examples of well-known providers include:

• Legal & General: Offers mortgage decreasing term assurance with various customization options.
• Aviva: Provides a range of life insurance products, including decreasing term policies tailored for mortgages.
• Prudential: Offers life insurance policies with decreasing term options to cover specific liabilities.

For example, Legal & General’s MDTA can be found here: Legal & General MDTA.

Pricing and Quotes

The cost of decreasing term insurance can vary significantly based on:

• Age: Younger individuals typically pay lower premiums.
• Health: Those in good health get better rates.
• Smoking Status: Non-smokers benefit from lower premiums.
• Term Length: Longer terms may result in higher overall costs due to the extended risk period, despite the decreasing benefit.
• Coverage Amount: Higher initial death benefits can result in higher premiums.

Conclusion

Decreasing term insurance provides a strategic approach to addressing declining financial obligations through affordable premium structures. It can be a sensible choice for those with mortgages and other diminishing debts, allowing them to ensure financial protection without over-insuring as their obligations reduce. When deciding whether decreasing term insurance is appropriate, it’s crucial to consider both current and future financial obligations to ensure that the policy effectively aligns with overall financial planning goals.