Life Insurance Types
To help you understand life insurance, we have provided a brief, general description of some commonly available types of life insurance. Note that policy terms may vary from company to company, from state to state, and from policy form to policy form, even between forms of the same company. Always consult your policy for the exact terms of your coverage.
Term Life Insurance
Term life policies pay only a death benefit and build no cash values. The coverage lasts only as long as the policy stipulates (e.g., 5, 10, 15, or 20 years).
Permanent Life Insurance
This type of life insurance lasts for the entire life of the insured - as long as premium obligations are met. The policyowner may pay premiums as long as the insured lives, or only for a set amount of time. Permanent life policies usually build cash values in addition to providing a death benefit.
Whole Life Insurance/Ordinary Life Insurance
This is permanent life insurance that usually requires premiums to be paid for the entire time the insured is living.
Universal Life Insurance
This is a permanent life insurance policy that may have flexible premiums, cash values and adjustable death benefits.
Let's take a more detailed look at these different types of insurance.
Term Life Insurance is much simpler to understand than permanent life insurance. It is designed to provide life insurance coverage for a limited period of time. Coverage might be for one year, five years, 10 years or longer, but the face amount of the policy is payable only if the insured dies during the "term" specified in the policy. If the insured lives beyond the term of the policy, the insurance company has fulfilled its part of the contract and no benefit is paid.
There is no cash value accumulation in most term policies. When the term ends, the coverage ends and the insurance company keeps all the money it received in premium payments. In addition, should the policyowner stop paying premiums on a term policy before the term ends, the coverage ends and the insurance company likewise gets to keep the premium payments without having to return them.
Why Do People Buy Term Insurance?
Sometimes people buy Term Insurance to cover a short-term need, such as a home mortgage. But usually it's because they can buy more coverage at a lower premium, especially at younger ages. As people grow older, they tend not to purchase or renew term life insurance policies because the premium rates become very expensive.
The "Level" in Level term insurance refers to both the death benefit and the premium in most common term policies. With a level term policy, the amount of insurance protection remains constant for the entire period stipulated in the policy. The premiums for a level term policy may also remain the same for the length of the policy.
Level term insurance is simple and straightforward. The insured wants a death benefit amount that may be too expensive if provided by permanent insurance. Or the insured may need the coverage only for a certain period of time and is not interested in permanent insurance.
Decreasing Term Insurance provides a decreasing amount of coverage during the term of the policy. The policy's death benefit begins at a certain amount and then gradually decreases over time according to a formula that is included in the policy.
There are several reasons for desiring Decreasing Term Insurance. The most common is providing coverage while paying off a mortgage or other installment debt. As the debt is being paid off and the amount outstanding becomes less, the coverage provided by the decreasing term policy is likewise reduced.
There may be other debts that are significant and that are paid for on an installment basis - an automobile, new furniture or large balances on credit cards. All of these would have to be paid by an individual's estate if he or she should die before they were fully paid off. Credit Life Insurance is designed to meet these obligations.
Credit Life Insurance consists of Decreasing Term Insurance that matches the full amount of the debt at the onset, then gradually diminishes at the same rate that the debt is paid off. Once the debt is discharged, coverage ends.
To combat inflation or to meet additional responsibilities in the future, Increasing Term Insurance provides a death benefit that begins at one amount and then increases at stated intervals over the policy term. Premiums will also increase due to higher death benefits and attained age (the age of the insured at the time of renewal).
FEATURES OF TERM INSURANCE
Term Life Insurance policies may include a renewability provision that allows the policyowner to renew coverage at the end of the term for the same coverage or less without having to prove insurability. There are, however, conditions attached to renewability.
First, when a term life policy is renewed, the premium increases. This is in contrast to a level term policy in which the premium remains the same as long as the coverage is in effect. When renewed, however, the premium is based on the attained age of the insured. Each time the policy is renewed, the insured is older, the mortality risk is greater and therefore, the coverage is more costly.
Term Life Insurance policies may also contain a convertibility provision that allows the policyowner to convert to permanent coverage without having to prove insurability. Not all term life policies offer this provision, and those that do may charge an extra premium for the right to convert to permanent coverage. In addition, to prevent adverse selection, most insurance companies usually limit the conversion privilege by one of these methods:
- Prohibiting conversion after the insured has reached a specified age (e.g., age 70)
- Prohibiting conversion after the term policy has been in force a certain number of years (e.g., seven years in a 10-year term policy)
Should the conversion option be exercised, a new policy of permanent insurance is issued. The premium for this new policy will be higher than that for the original term insurance because permanent insurance builds cash values and the attained age is higher than when the policy was issued.
Convertible and renewable provisions are not automatically a part of every term policy issued. They must be specifically included in the policy that is purchased.
Permanent Life Insurance
Permanent life policies last for the entire life of the insured - as long as premiums are paid when due.
Premiums paid to the insurance company for a permanent life policy can be viewed as split into two parts:
- One part goes to the insurance company to pay for the insurance protection the policy provides. Insurance protection can be simply defined as the risk the insurance company takes that it will have to pay the face amount or death benefit of the policy. The longer the insured lives, the less risk the insurance company takes.
- The other part of the premiums paid for a permanent policy goes toward the cash value buildup. This is money that is invested by the insurance company to increase the policy's cash value over the years. This cash value can become available during the life of the insured in the form of withdrawals or loans.
Whole Life Insurance
Whole Life Insurance gets its name because it usually requires premiums to be paid on the policy for the rest of the insureds life. Premiums remain the same while the policy is in force, which is until the insured dies (or reaches age 100). When the insured dies, the policy pays the face amount or death benefit to the beneficiary. As long as the insured lives, however, and continues to pay the premiums, the cash value in the policy accumulates year by year.
Limited Pay Policies
Many people want the lifetime insurance coverage offered by a whole life policy, but do not want to pay premiums for the rest of their lives. A limited pay policy is whole life insurance that requires premiums only for a specified number of years or to a specified age of the insured.
Coverage, however, remains in force for the insureds lifetime.
Limited pay policies are sometimes referred to as 10-pay, 15-pay or 20-pay life depending upon the number of years premiums are to be paid. The premiums for limited pay policies are higher than those for a whole life policy because they are squeezed into a shorter time period
Because the premiums are higher, the cash values of limited pay policies usually build at a faster rate than for whole life policies.
The limited pay policy offers advantages to both the insurance company and to the policyowner:
- The insurance company benefits because the premiums provide more money sooner to be used for investment.
- The benefits to the policyowner are that the limited pay policy accumulates cash values at a faster rate than does the whole life policy. A limited pay policy also provides a lifetime of insurance coverage that may be paid during the earning years, allowing for no further premium payments at retirement.
Single-Premium Whole Life (SPWL)
A limited pay life policy that can be paid for with only one premium is called a single premium policy. The premium for such a policy might be thousands of dollars. The advantage to the insurance company of a single premium policy is that the company saves expenses in the collection of premiums and also has the entire purchase price of the policy available to invest right away.
Juvenile insurance is life insurance written on the life of a child. It is a means of building an insurance program for a child with low premiums and usually at standard rates.
It helps protect a child's insurability if the child should become uninsurable before reaching adulthood. And it can be used to build cash or loan values to help pay for a college education.
Juvenile insurance can be any type of ordinary coverage, for example, whole life, limited pay life, universal life, convertible term, graded premium whole life, or modified whole life.
Universal Life Insurance is a Permanent Life Insurance policy, but may have flexible premiums, cash values, and adjustable death benefits.
A major feature of universal life policies is premium flexibility. The key to this flexibility is the policy's cash value. As the policy acquires a cash value, the amount and the timing of premium payments may be adjusted. So long as there is sufficient cash value in the policy from which to deduct the monthly cost of insurance protection provided by the insurance company, the policy remains in force - even if premium payments are skipped altogether.
Premiums for a universal life policy go into a cash value (accumulation) "account." Deducted from this account, usually on a monthly basis, is the amount needed to pay for the insurance protection supporting the policy's death benefit. When premiums are paid in amounts exceeding the cost of the insurance protection, the cash value accumulates in this account.
Two adjustments are made to the cash value account of a universal life policy, usually on a monthly basis:
- The first is a credit to the account of interest earned. (The policy has a guaranteed minimum interest rate that lasts as long as the policy is in force. This is the least amount of interest that will be earned by the cash value account. If the current level of interest is higher than the guaranteed rate this usually results in an even faster buildup of the policy's cash value account.)
- The second is a charge against the account for the cost of the insurance protection and all expense charges.
Death Benefit Options Of Universal Life
There are two death benefit options in a universal life insurance policy:
- The first option provides a level death benefit that can remain the same throughout most of the time the policy is in force. (However, the policyowner may be able to increase the death benefit without purchasing a new policy, but proof of insurability may be required. The policyowner may also be able to decrease the death benefit.) With all permanent life policies, the death benefit is made up of a combination of insurance protection (the amount the insurance company has at risk) and the policy's cash value. Because the policyowner may be able to adjust the amount of the premium payment, putting in too much premium may bring the policy's cash value close to or equal to the policy's death benefit. Under the definition of life insurance that is written into federal tax law, that cannot happen until the insured is at least age 95. There must always be at least some amount at risk in a universal life policy until the insured turns 95. If there isn't, it ceases to be considered life insurance.
- The second option provides an increasing death benefit that is made up of the face amount of the policy plus the policy's cash value. With this option the policyowner is purchasing more insurance protection under an increasing death benefit option, than under a level death benefit option.
Variable Life Insurance is a securities-based whole life insurance product. That means the policy's cash value is invested in specified securities portfolios and allocated according to the policyowner's choosing. To sell variable life insurance, an agent needs not only a valid life insurance license, but must also be registered with the National Association of Securities Dealers (NASD). This registration may be obtained by taking and passing one or more NASD exams.
Variable Universal Life
Variable universal life incorporates the flexibility of universal life and the investment features of variable life. Like universal life, it offers flexible premium payments, an adjustable death benefit and may offer either a level or an increasing death benefit option. And like variable life, agents who sell variable universal life insurance must be both life licensed and NASD registered.