How to convert a term life policy to permanent life insurance

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Most term life insurance policies let you convert to a permanent life policy before your policy ends. However, many policyholders let their term policy lapse before getting permanent coverage. That could leave your loved ones without vital help if the unthinkable happens.

Al 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 term life policies to permanent life, but they don’t actually do it.

Most term life policies, which protect you for a specified period as long as you pay the premiums, allow you to convert to a permanent life policy. Permanent policies protect you for life.

Rather than convert policies, consumers often either drop life insurance or buy a different term policy.

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.

Being able to convert gives people the option to get permanent life 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. The agent hopes that clients will increase their insurance coverage as they grow their incomes.

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, it makes sense to stick with term life policies. Term life can cost 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. That’s because when there’s a conversion credit, as people live longer, life insurance rates have decreased.

“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.

Should you convert term to perm?

Whether to convert to permanent life insurance depends on your situation. 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 to permanent life 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.

If you decide to convert to a permanent life insurance policy, contact your insurance company. Check your policy to see the fine print to make sure you’re able to convert at this time.