How to convert a term life policy to permanent life insurance

convert-term-life-to-permanent-life-insuranceAl Lurty, senior vice president and head of U.S. business development for ING’s Life Business Group, scratches his head as he tries to solve the "conversion dilemma." People say they want the option to convert their term life policies to permanent life, but they don't actually do it.

Statistics tell a strange story. Most term life policies, which protect you for a specified period of time as long as you continue to pay the premiums, allow you to convert to a permanent life policy from your insurer, which protects you for life. But according to LIMRA, which tracks life insurance sales, only a paltry 1 to 2 percent of term life policyholders take advantage of this option.

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However, when some insurers tried to cancel or limit the option, consumers went elsewhere or didn't buy.

"Term without the conversion doesn't sell well," says Lurty. When ING restricted conversions to five years before term policies expired, it wasn't well-received by customers. The insurer now permits conversions up to the end of the term. Other large firms such as MetLife and Principal do the same.

Belt and suspenders life insurance

People typically buy life insurance because they want to provide financial security for their loved ones if they die. And the ability to convert "term to perm," whether you use it or not, is another protection – you know you’ll have the option to secure a permanent policy regardless of your age or health. It’s like wearing a belt and suspenders to hold up your pants.

Converting a term policy to perm is “as if you were renting your home and now you own it," says Steve Parrish, a business insurance consultant with Principal Financial Group.

An insurance agent often looks for an opportunity to "up-sell" a client, hoping that as clients grow their incomes they will also increase their insurance coverage. And permanent life, which builds a nest egg for the insured within its cash value account, also carries a much higher agent commission. In some cases, an agent will even offer a "conversion credit," a discount on the first year's permanent premium, to get the client to switch to perm because the policy doesn't have to be rewritten.

Despite the potential to make everyone happy, term to perm policy conversions sometimes have a downside, for both insurers and customers.

Adverse selection for life insurance

For cash-strapped customers facing recession and job loss, it makes sense to stick with term life policies, which can cost only a fraction of permanent policies.

"Term is relatively inexpensive," says Catherine Theroux, a spokesperson for LIMRA. "To move to a permanent policy, either the premium goes up or the insurance has to come down."

Those willing to shop around may also find cheaper options than conversion to a permanent policy, even when there's a conversion credit, because, as people live longer, life insurance rates have come down.

"Policyholders in good health are likely to get better rates by shopping for a new policy than converting," says Theroux. That's particularly true if you’ve stopped smoking and are willing to take a life insurance medical exam. (Here’s more on life insurance medical exams.)

In contrast, those facing ongoing medical problems that may shorten their lives, such as Type 2 diabetes, may want the conversion option because it will not require a medical exam. For insurers, however, this leads to "adverse selection:" They end up insuring the clients they don't want -- unhealthy people who are likely to die sooner.

Avoiding life settlement transactions

Life insurance companies are also wary of what's known as the "life settlements market." Seniors in poor health could convert to a big permanent policy, plunk down the first-year premium, and then sell that policy to a third-party marketer who securitizes it and resells it to investors who make money when the insured dies. This kind of transaction is known as a life settlement.

Whereas insurers make money when the policyholder lives longer and pays premiums, the opposite is true for life settlement investors: The sooner you die, the more investors make.

While life settlements still happen without the conversion feature, insurers are able to take a closer look at new clients in order to ferret out their motives for buying policies.

No more mass mailings

Consequently, life insurers have stopped promoting the option to convert as aggressively as they have in the past.

"In the 1980s and 1990s I saw companies aggressively marketing conversion,” says Parrish. "But in the 2000s there were no mass mailings." Conversion credits are also less common, says Lurty.

While insurers say they notify clients about conversion before their "term runs out," many have tightened the vise. Term policies used to be convertible up until people were in their 80s. Now most insurers limit term to perm conversions to customers between age 65 and 70.

Insurance companies are hungry for capital

Most life insurers say that they still want to convert term policies when possible. While rates have come down on new policies, that trend may be ending, says Parrish, and that will make conversions a better deal.

With interest rates at near record lows, insurers, "like everyone else, will have to work hard for capital and converting policies will be more on the radar of field representatives," he says. And perhaps clients, too. "People's cash flows are now strained, so they are buying term, but they may convert in the future when incomes improve," says Parrish.

Paul Wetmore, a MetLife executive who specializes in life insurance products, says most of MetLife's term policies are convertible to "any currently available" permanent policy. And a conversion credit is available at no charge. "MetLife typically sends a reminder out on the policy anniversary every year," says Wetmore, adding, "and we encourage our representatives to talk about it."

Should you convert term to perm?

According to Wetmore, agents provide policyholders with both the positives and the negatives of conversion. Keep the term policy and ignore conversion to permanent life if:

  • You need life insurance only for a limited time.
  • You can't afford the higher premiums of a perm policy.
  • You buy a separate permanent policy to go along with the current term policy.

Conversely, consider converting your term policy if:

  • You need life insurance beyond your current term policy limits.
  • You want to build up cash value inside a perm policy, either for future needs or for an inheritance.
  • A medical exam would not be to your benefit.

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