Term conversion riders

In short

A friend of mine bought a term life policy at thirty and forgot about it for twenty years. If you are holding a term policy and wondering what happens when your health changes, a conversion rider may matter more than you think. It lets the policyholder swap the term policy for a permanent one without a new medical exam. The insurer must honor that swap only inside a window written in the contract. After the window closes, the right is gone. So read your own policy for the date, the allowed products, and the price. Then you can decide with a clear head, and nobody has to hurry you.

The whole of it

What it is

I once watched a neighbor sign for a loan on his farm, and he read every line first. It struck me as old fashioned. It also saved him a headache. A term conversion rider deserves that kind of reading.

Term life insurance pays a death benefit only if the insured person dies within a set number of years, such as ten, twenty, or thirty. It costs little because the insurer expects most policies to end with no claim. Permanent life insurance, such as whole life or universal life, is built to last for the insured's whole life as long as the premiums are paid. It costs far more for the same death benefit.

A conversion rider is an add on clause, or sometimes a built in right, that lets the policyholder trade the term policy for a permanent policy from the same company. The key word is without evidence of insurability. That means the insurer does not ask for a new exam, new lab work, or new health questions. The insured person's health today does not change the answer. Only the original policy's underwriting, from the day it was first issued, counts.

That is the whole appeal. Health can turn on a person fast. A policy that already exists, with a right to convert, can be worth more than a new policy the person could no longer qualify for.

How it works

If you have ever refinanced a house, you know the feeling of a deadline attached to a good deal. A conversion right works much the same way. It has a clock.

The contract names a conversion period. Some policies allow conversion for the first ten years. Some allow it until a certain age. Some allow it only during part of the term. The policy page, often called the schedule or the rider page, states the exact limit. The insurer is bound by that language, and the policyholder has to act inside it.

When the policyholder asks to convert, the insurer must offer permanent coverage at the insured person's current age and the original health class. A health class is the rating the insurer gave at the start, such as preferred or standard. Premiums for the new policy are based on the age at conversion, not the age at purchase. So the bill is higher than the old term bill, sometimes by a wide margin.

Companies also limit which permanent products are open for conversion. A policy might allow a move into one specific whole life plan or a short list of plans. Some allow a partial conversion, where only a piece of the death benefit changes over and the rest stays as term. Others require the whole amount. The contract says which.

Some policies may add a credit toward the new premium when the policy converts. Whether a given company offers one, and what it is called, is written in that company's own contract.

The numbers, and where to find yours

Your own policy holds the numbers that matter, and nobody else can read them for you. Look for these on the policy contract itself, usually in the first pages and again near the riders.

The first is the conversion deadline. It may be written as a number of years, an attained age, or a date. The second is the list of allowed permanent plans. The third is the current rate for those plans at your age. The insurer can give you a conversion quote in writing, and asking costs nothing. The fourth is whether the rider is included or whether it costs an extra charge each year. Some riders carry a small fee. Others come free with the policy.

For the rules that sit behind the contract, the state insurance department where the policy was issued oversees these products. Each state's insurance code sets certain consumer protections. The National Association of Insurance Commissioners, known as the NAIC, publishes model laws that many states follow. Your state department of insurance website is the right place to check what applies to you.

Tax rules matter too. The Internal Revenue Code, in section 7702, defines what counts as life insurance for tax purposes. A permanent policy that qualifies generally lets its cash value grow without yearly tax. The specific tests and the dollar limits behind them can change, so the current figure is the current figure, which the official source publishes each year. Always confirm the present rule on the IRS website before relying on it.

A worked example

Picture a woman named Margaret who bought a twenty year term policy at age 35. These figures are made up for the story, not a quote from any company. The death benefit was $500,000. She paid $480 a year. Her policy carried a free conversion rider that lasted until her 15th policy year, which was age 50.

At age 49, Margaret was told by her doctor that she had a heart condition. A new term policy would now be hard to get, and the price would be high if it came at all. But her old policy was still alive, and so was her right to convert.

She asked her insurer for a conversion quote. The company offered a whole life policy for the full $500,000. In this made up case, the new premium at her age of 49 was $9,100 a year. That is a big jump from $480. Her new bill is $9,100 minus $480, which is $8,620 more each year.

Margaret could not carry that cost forever, so she asked about a partial conversion. She converted $150,000 of the benefit to permanent coverage and left $350,000 as term. The rate on the permanent piece was $9,100 times $150,000 divided by $500,000, which is $2,730 a year. Her term piece cost the same $480 until the term ended, and now it is lower because part of the benefit moved away. Her total was about $3,000 a year, close to $2,730 plus the reduced term charge.

Margaret kept coverage she could never have bought new. She paid more, and she knew it. That is the honest trade. Nobody got fooled, and nobody was rushed. She just acted before the window shut.

Where it goes wrong

I have noticed that people rarely lose money by acting on a plan. They lose it by missing a date. The biggest mistake with a conversion rider is simply letting the deadline pass. The right does not wait, and the insurer need not remind anyone.

A second mistake is assuming the permanent policy costs about the same as the term one. It does not. The jump can be steep, and some people convert and then cannot pay the new premium. A policy that lapses leaves them with nothing. Convert only what the budget can carry year after year.

A third problem is the narrow menu. The allowed plans may be limited, and they may be pricier than similar plans sold on the open market. A healthy person might find a better price elsewhere with a new exam. Conversion is most useful when health has slipped. When health is fine, shopping around is worth a look.

A fourth is the fine print on the rider itself. Some riders end earlier than the term does. Some stop at a certain age. Some need a written request before a set date, not just a phone call. The policyholder has to follow the written steps exactly.

Last, a conversion may bring fees, surrender charges, or a new contestability period on the converted policy. Ask about each one. Skipping the questions saves nothing.

Questions to answer before you leave this page

Do you know the exact date your conversion right ends, and have you found it in your own contract? Does your policy include a conversion rider, and is it free or does it cost extra each year? Which permanent plans does the insurer allow, and can you convert only part of the death benefit? What would the new yearly premium be at your current age, and could you pay it for decades without strain? Have you asked the insurer for a written conversion quote, and compared it with what a new policy might cost if you are still healthy? Does your state department of insurance have anything to say about your policy type? And who in your family would be hurt if this coverage quietly ended, and have you talked with them about it?