Innovating Term Life Insurance

My husband and I recently purchased 20-year term life insurance policies on each other and, in the process of geeking out and obsessively learning everything about the term life insurance industry, I got an idea that might help the insured and insurance companies.

I should warn there is a fair amount of morbidity in this article. When you talk about life insurance, you instinctively talk in terms of death, which isn’t the most comfortable subject. You’ve been warned.

Before I launch into idea mode, let’s talk a bit about life insurance for those of you not in the know. The purpose of life insurance is to protect those who are dependent on your income. If someone would be significantly harmed financially if you were to die, you really need to think about getting life insurance. In our household, my husband would be in a bit of financial trouble if I were to die and vice versa. That means, if either my husband or I die, the other would need cash to cover the lost income the deceased would typically bring in to the household to cover the bills. The common heuristic people use to figure out this coverage is 7 to 10 years of the deceased’s income as the money a life insurance policy would bring in (called the “face value” of the policy) if the insured would die. Going beyond heuristics to your reality, what you want out of a life insurance policy taken out on yourself is a chunk of money that would protect the people who are dependent on your income without needing to touch the principal of that money. Meaning, if the face value of your life insurance policy was invested in dividend-paying stocks or an ETF paying between 4% to 5%, your dependents could live off of that dividend money comfortably.

After doing some number crunching, my husband and I figured out it would take a face value of $500,000 to protect the other. So we got ourselves $500,000 20-year term policies on each other.

But there’s a problem. While my husband and I might need $500,000 to cover our expenses today if the other were to die, that amount might not necessarily be true in the future. Things change. Later in life, our expenses could be dramatically different than they are today.┬áSpecifically, in our situation, we don’t plan to have kids and are aggressively paying down our debt and saving money. As we save more money and pay off more debt, the amount of money a deceased spouse would need to cover becomes less and less.

Let me be even more concrete just to illustrate this point. Currently, we have 8 months of expenses saved, no debt beyond two mortgages in our house, and have a surplus per month after we pay our bills. We are using the surplus to aggressively pay off the second mortgage. After we are finished with that, we will put extra towards the first but also invest a chunk of it in the market. Over years, those investments will net us market gains and dividends, which will help us cover our bills, which reduces our need for insurance. $500,000 makes sense today. In 10 years, maybe only $250,000 would be right for each of us.

But term life insurance is a one-shot deal. You get a face amount and, based on a number of variables, a set premium over the life of the policy. For my husband, the face value is $500,000 and the premium is $350 per year. Once his insurance policy took effect until 20 years after that date, if he were to die, I would receive $500,000, regardless of our financial situation.

In many cases, people cancel policies early after it becomes apparent your dependents aren’t counting on your income to be financially sound. What if, instead of set premiums and face amounts, they decreased year-over-year?

Take my husband’s $350 per year, $500,000 20-year term policy. If he had what I am branding a “20-year term diminishing returns” policy (and yes, that is a crappy name for it. The marketing people can handle that.), his premium and face amount schedule might look something more like this.

Year Premium Face Amount
1 $350.00 $500,000
2 $332.50 $475,000
3 $315.00 $450,000
4 $297.50 $425,000
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17 $70.00 $100,000
18 $52.50 $75,000
19 $35.00 $50,000
20 $17.50 $25,000
$3,675.00

Yes, my husband is only paying $3,675 over the life of the policy instead of $7,000, but he has more of a chance to keep it for the full term instead of canceling after he feels $500,000 is too much insurance. Also, this is a flat $17.50/$25,000 reduction per year, but the reduction could be logarithmic, diminishing slowly at first and more rapidly later matching the insured’s assumed compounded gains in the market.

YEAR PREMIUM FACE AMOUNT
1 $350.00 $500,000
2 $348.25 $497,500
3 $344.75 $492,500
4 $339.50 $485,000
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.
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17 $112.00 $160,000
18 $82.25 $117,500
19 $50.75 $72,500
20 $17.50 $25,000
$4,672.50

If anyone knows a term life insurance product specialist I could geek out with about this, please let me know. I think this would be a fantastic innovation for the industry.

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