Types of Life Insurance Policies
You know that you need life insurance. However, with the wide variety of insurance policies available, you may find choosing
the right one difficult. It’s really not as confusing as it seems, however, once you understand the basic types of life insurance policies.
Term life insurance
With a term policy, you get “pure” life insurance coverage. Term insurance provides a death benefit for only a specific period of time. If you die during the coverage period, your beneficiary (the person you named to collect the insurance proceeds) receives the death benefit (the face amount of the policy). If you live past the term period, your coverage ends, and you get nothing back. Term insurance is available for periods ranging from 1 year to 30 years or more. You may be able to renew the policy for a new term without regard to your health, but at a higher rate. Your premium goes toward administrative expenses, company profit, and a reserve account that pays claims to those who die during the term period. As you get older, the chance that you will die increases. To cover this increasing risk, your premiums will likewise rise at regular intervals. For this reason, premiums that were quite inexpensive at the time you initially purchased your term policy will become much more expensive as you get older. Most term insurance also has a conversion feature that allows you to switch your coverage to some type of permanent insurance without answering health questions.
Traditional whole life insurance–guaranteed premiums
Whole life insurance is a type of permanent insurance or cash value insurance. Unlike term insurance, which provides
coverage for a particular period of time, permanent insurance provides coverage for your entire life. When you make premium
payments, you pay more than is needed to pay for the current costs of insurance coverage and expenses. The excess
payment is credited to a cash value account. This cash value account allows the insurance company to charge a level,
guaranteed premium* and to provide a death benefit and cash value throughout the life of the policy. As you make payments,
the cash value account grows. With traditional whole life insurance, the cash value account is guaranteed* and held in the
insurance company’s general portfolio–you don’t get to choose how the cash value account is invested. However, the cash
value can potentially grow beyond its guaranteed amount through the payment of dividends (profits earned by a “mutual”
insurer). The cash value grows tax deferred and can either be used as collateral to borrow from the insurance company or be
directly accessed through a partial or complete surrender of the policy. It is important to note, however, that a policy loan or
partial surrender will reduce the policy’s death benefit, and a complete surrender will terminate coverage altogether. If you live
to the policy’s maturity date, the policy will “endow,” and the insurance company will pay the accumulated cash value (equal at
maturity to the death benefit) to you.
Universal life–openness and flexibility
Universal life is another type of permanent life insurance with a death benefit and a cash value account. Like whole life
insurance, the cash value is held in the insurance company’s general portfolio–you don’t get to choose how the account is
invested. Unlike traditional whole life, universal life insurance allows you flexibility in making premium payments.
A universal life insurance policy will generally provide very broad premium guidelines (i.e., minimum and maximum premium
payments), but within these guidelines you can choose how much and when you pay premiums. Reducing or increasing
premiums will impact the growth of the cash value component and possibly the death benefit. You are also free to change the
policy’s death benefit directly (again, within the limits set out by the policy) as your financial circumstances change. Be aware,
however, that if you want to raise the amount of coverage, you’ll need to go through the insurability process again, probably
including a new medical exam, and your premiums will increase.
Universal life policies reveal all aspects of the policy’s cost structure, including the cost of insurance (the portion set aside to
pay claims) and expenses. This information is not always available with other types of policies. Another feature of universal life
is the option to add the cash value to the face amount when the death benefit is paid. For example, say you die when you
have $200,000 of cash value within your $1 million policy. If you chose the enhanced benefit option, your beneficiary receives
$1.2 million. Keep in mind, however, that nothing is free–the increased benefit is reflected in premium calculations.