What is a decreasing term life insurance policy?

Decreasing term life insurance is similar to level term with one significant difference – the amount of insurance reduces over time roughly in line with the way a repayment mortgage decreases. It’s usually purchased to help clear a specific debt – such as a repayment mortgage. As this debt decreases over time, so will the amount of insurance.

Essentially, on death, the product is designed to help make sure the repayment mortgage is settled. The amount paid is reflective of how long has passed since the policy was bought.

It’s important to note that your policy may not completely pay off your outstanding mortgage. You’ll need to make sure your amount of insurance is adjusted to match any new mortgage arrangements. You must also check that the length of the policy is long enough to cover the duration of your mortgage term and that the interest rate applied to your mortgage doesn’t become higher than the interest rate applied to your policy.

Your payments stay the same throughout the length of your policy unless you change your policy.

The payout amount for this type of policy decreases over time. It is set for a fixed period of time and is generally a cheaper form of life insurance.

This section will cover:

·  What is Decreasing Term life insurance?

·  What is Decreasing Term cover used for?

·  Combining Decreasing Term cover with Critical Illness cover

·  Joint cover

·  How much does it cost?

What is Decreasing Term life insurance?

Decreasing Term life insurance is a type of policy that pays out less as time goes on. So, if you pass away near the beginning of the term, your loved ones will receive more money than if you pass away nearer to the end.

Decreasing Term insurance can provide peace of mind that your loved ones will have enough financial support to pay off outstanding debts.

What is Decreasing Term cover used for?

The policy is typically taken out to cover a specific debt; usually a capital repayment mortgage. The amount of cover reduces in line with your outstanding mortgage liability. This means your loved ones will have enough to cover the amount left, should you pass away during the term of the policy.

It is better suited to a repayment mortgage, not an interest-only mortgage. This is because a repayment mortgage is the type of loan that reduces over time.

Combining Decreasing Term cover with Critical Illness cover

Taking out more than one policy can offer you more protection against different circumstances. You can take out Critical Illness cover with Decreasing Term life insurance if you wish. You have a choice whether to take both as combined cover or as standalone policies.

Critical Illness cover can be incredibly beneficial in offering financial support if you were diagnosed with a critical illness. It can mean you and your family are able to pay off outstanding debts such as a mortgage.

Combined cover means you take both policies out at the same time, and you only pay one monthly premium. The cost of your premium will increase to reflect your increased cover. Combined cover usually only pays out once; so if you claim on the Critical Illness part of your policy, you will no longer be covered for life insurance.

You can take out both policies separately, which means you will pay for two policies but you will be covered for both circumstances.

Joint policies for Decreasing Term life cover

As this type of policy is usually designed to help pay off the mortgage, you may want to consider taking out a joint policy. This is because the mortgage will only ever need to be paid off once.

Joint policies can be cheaper than two single policies and means that whoever passes away first will leave behind enough money to pay off the mortgage. The remaining partner can then take out their own life insurance policy according to their financial needs.

How much does Decreasing Term cover cost?

The cost of Decreasing Term life insurance is usually dependent on how much is left on your mortgage. Your cover will be aligned with the length and amount left on your mortgage, and will decrease throughout the term. 

Decreasing Term cover is usually a cheaper option because the policy becomes less expensive to insurers over time.  

Understanding How DTA Insurance Works

The payout structure is a key difference between a DTA insurance policy and a standard term policy or term life insurance. An example of the payment structure of a decreasing term life insurance policy would be as follows:

A client purchases a 30-year decreasing term life insurance policy. The policy comes with a face value of $850,000 and an annual 6% reduction. Should unforeseen circumstances occur and the client passes away in the first year, their beneficiaries would receive the full $850,000 payout or death benefit.

Should the client pass away in the second year, the death benefit to their beneficiaries would be the face value minus the reduction of 6% ($51,000), which is $799,000. The reduction will continue yearly until the client passes away and the policy pays out, or the 30-year term comes to an end.

In terms of a standard term policy (or a level term life insurance), the face value of $850,000 would remain constant over the policy’s life.

Both policies come with term lengths, which can go up to 30 years, and they both charge constant premiums over time.

Reasons to Consider or Purchase Decreasing Term Insurance

1. Allows the purchases to cover their financial obligations, debt, or loans

Choosing the ideal cover is dependent on one’s financial situation and the reasons for seeking the purchase of insurance coverage. Decreasing term insurance is ideal for individuals who wish to cover their financial obligations, debt, or loans. The instrument is ideal because it complements the size decrease of the debts and financial obligations over a fixed period of time.

2. Provides beneficiaries with a means to settle debt obligations

Decreasing term insurance provides aid for one’s beneficiaries to settle debt obligations should anything happen. Examples of debts that can be covered with decreasing term insurance include personal loans, business loans, loans for vehicles (or auto loans), and mortgage loans.

3. Allows the purchaser to select their beneficiary and how the funds should be allocated

Decreasing term insurance allows the purchaser to select their beneficiary, and that individual is free to choose how the funds being paid out should be allocated.

In credit or mortgage life insurance policies, however, the lender is usually listed as the beneficiary. Hence, should the policyholder pass away, the funds go directly towards servicing the debts or repayments. It is what makes them different from DTA insurance.

4. Provides small business owners with debt financing

Furthermore, decreasing term insurance is ideal for small business owners who may seek debt financing to support the operations of their businesses. If the business owner passes away, there is a contingency plan for the repayment of the debt.

More Resources

CFI offers the Commercial Banking & Credit Analyst (CBCA)® certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

Decreasing term insurance is a type of renewable term life insurance with coverage decreasing over the life of the policy at a predetermined rate. Premiums are usually constant throughout the contract, and reductions in coverage typically occur monthly or annually. Terms range between 1 year and 30 years depending on the plan offered by the insurance company.

Decreasing term life insurance is usually used to guarantee the remaining balance of an amortizing loan, such as a mortgage or business loan over time. It can be contrasted with level-premium term insurance.

• Decreasing term insurance features a death benefit that gets smaller each year, according to a predetermined schedule that also sees premiums decrease over time.
• Decreasing term insurance is often purchased to provide personal asset protection.
• It may also be required by a lender to guarantee the remaining balance of a loan until its maturity in case the borrower dies.
• A decreasing term life policy is very similar and may mirror the amortization schedule of a mortgage. 
• Decreasing term life insurance is less expensive than traditional term or permanent life policies.
  

Term life insurance is a form of coverage that provides a death benefit for only a certain length of time. For instance, a 20-year term life insurance policy would feature level premiums and the same death benefit over the course of its term. Decreasing term insurance instead features a declining death benefit over time, along with decreasing premiums. These amounts will be set to a schedule when the policy is purchased and may conform to a standard schedule or be customized between the insurer and the insured.

The theory behind decreasing term insurance holds that with age, certain liabilities, and the corresponding need for high levels of insurance decreases. Numerous in-force decreasing term insurance policies take the form of mortgage life insurance, which affixes its benefit to the remaining mortgage of an insured’s home.

Alone, decreasing term insurance may not be sufficient for an individual's life insurance needs, especially if they have a family with dependents. Affordable standard term life insurance policies offer the security of a death benefit throughout the life of the contract.

The payment structure is the primary way this type of insurance is different from regular term life. The amount in the death benefit goes down, unlike other forms of life insurance.

The predominant use of decreasing term insurance is most often for personal asset protection. Small business partnerships also use a decreasing term life policy to protect indebtedness against startup costs and operational expenses.

In the case of small businesses, if one partner dies, the death benefit proceeds from the decreasing term policy can help to fund continuing operations or retire the percentage of the remaining debt for which the deceased partner is responsible. The security allows the business to guarantee commercial loan amounts affordably.

Decreasing term insurance is a more affordable option than whole life or universal life insurance. The death benefit is designed to mirror the amortization schedule of a mortgage or other personal debt not easily covered by personal assets or income, like personal loans or business loans.

Decreasing term insurance allows a pure death benefit with no cash accumulation, unlike, for example, a whole life insurance policy. As such, this insurance option has modest premiums for comparable benefit amounts to either a permanent or temporary life insurance.

Decreasing term policies are sometimes required by certain lenders to guarantee that the loan will be repaid in the event that the borrower dies before the loan matures. For instance, a small business may borrow $500,000 from a bank to expand, with $50,000 to be repaid each year for 10 years. They may ask the business owner to take out a decreasing term policy beginning in the amount of $500,000 and also reducing by $50,000 each year for ten years.

For example, a 30-year-old male who is a non-smoker might pay a premium of $25 per month throughout the life of a 15-year $200,000 decreasing term policy, customized to parallel a mortgage amortization schedule. The monthly cost for the level-premium decreasing term plan does not change. As the insured ages, the risk of the carrier increases. This increase in risk warrants the declining death benefit. 

A permanent policy with the same face amount of $200,000 could require monthly premium payments of $100 or more per month. While some universal or whole-life policies allow reductions of face amounts when the insured uses the policy for loans or other advances, the policies frequently hold fixed death benefits.

Small businesses sometimes find it useful to protect indebtedness against startup costs and operational expenses. For example, if one partner dies, the death benefit proceeds from the decreasing term policy can help to fund continuing operations or retire the percentage of the remaining debt for which the deceased partner is responsible. The protection also allows the business to guarantee commercial loan amounts affordably.

The main drawback is the death benefit declining over time, which is of course why it costs less than standard term life or other policies. Also, should something happen down the road, decreasing term life may not provide the coverage needed. Saving a few dollars in the short term may leave you uncovered should a future event occur.

Yes, because as the death benefit decreases over time, so too do the corresponding premiums.

At the end of a decreasing term life policy, it terminates along with the death benefit coverage.