Why Is Term Life Insurance More Affordable Than Whole Life Insurance?
The two main types of life insurance-term life and whole life-are certainly at different levels. Term insurance is, as its name implies, only carried for a period of time (a "term") prior to expiration. But a lot of people wonder why term life is so much cheaper than whole life (once they're made aware of its existence, that is). Because of that lower cost, people wonder if it's even worth purchasing.
That's because they don't understand why term life insurance is so much cheaper.
Basically, there are two main reasons that term life insurance is cheaper than whole life insurance. Below is a brief exploration of those reasons.
Term Insurance is Not an Investment
Whole life builds up a savings and investments over time - so in addition to the death benefit, there has been an investment and savings component as well, meaning that the insured can use that money for other things (such as paying part of the premiums over time).
But with term insurance, there is no investment portion - the plan is very simple - pay premiums and gets a death benefit if the insured dies prior to expiration of the policy term. However, if the term expires and the person passes away after that term, there is no payout. In most cases, the policy must be converted to either a whole life policy, or renewed at higher premiums for another term.
It's better to think of term life insurance as a service provided rather than an investment-far more similar to insuring a car than anything else. Some (very few) policies do allow a partial payment of premiums that were paid in over the term, but most allow the policy to lapse or be converted.
This is one major reason that term life insurance is more affordable than whole life-the insurer has less involvement, and, less risk.
Lower Risks with Term Life
The shortest terms are going to be the least expensive, because the risk involved for the insurer is far less than with a long term or whole life policy. In other words, a person who purchases a 5 or 10 year term insurance policy will be at a lower risk to pass away than a person who purchases a very long term policy or a permanent policy. Whenever the insurer has a greater likelihood of having to pay out, the higher the premiums will be, in order to protect the insurer's interests.
Additionally, the risks involved with carrying an investment and savings component drive up the costs of whole life policies as there are more costs on the part of the insurers-and, when there are more tasks to complete, the greater the cost-which is passed on to the insured.
Essentially, term life insurance tends to be less expensive than whole life insurance due to its simplicity. It does not carry the investment risks and payouts of a whole life policy, but provides for a beneficiary or beneficiaries should the need arise.