All life insurance is not the same. Life insurance is divided into two basic categories — “term” and “permanent”. Term life insurance provides coverage for a specific period of time, while permanent life insurance provides coverage for the insured person’s entire life. Both types pay a death benefit, which is the amount of money paid out upon the insured’s death. This money is paid to a beneficiary.
Term life is the simplest form of life insurance. It provides a pure death benefit. The policy will cover the insured for a specified period of time (the “term”), such as 10 or 20 years, or until a specified age. If you purchase term life insurance at a younger age, you can usually buy more at a lower cost.
Term insurance generally does not build a “cash value.” At the end of the term period, the policy typically terminates without any remaining benefits or monetary value.
Term insurance is ideally suited to cover specific needs that may decrease or disappear over time
Following are two common provisions of term insurance policies you may wish to consider during the purchase of a term life insurance policy.
- Guaranteed Renewable Privilege — allows the insured to renew the policy without having to prove insurability. (You do not have to be in good health.)
- Conversion Privilege — guarantees the insured the right to convert a term policy to a permanent policy, without having to prove insurability.
There are three major types of term life insurance:
- Level — The death benefit stays the same throughout the policy term and premiums typically remain constant.
- Increasing — The death benefit increases by specific amounts and at intervals as specified in the policy. Premiums normally increase along with the benefit.
- Decreasing — The death benefit decreases periodically as specified by the policy. Premiums typically remain constant throughout the policy term.
Permanent life insurance is designed to provide protection for the entire life of the insured person, as long as the premiums are paid. There are many different versions and variations of permanent insurance and offer features that are different than those found in term life insurance policies:
- Cash Value — The cash value is an amount available to a policyowner if the policy is canceled (surrendered). Cash value may also be used as collateral on a policy loan. Cash value generally increases over time as premiums are paid.
- Policy Loans — A policyowner may borrow an amount up to the maximum loan value of the permanent policy. Loan interest will be charged in accordance with the policy provisions. The loan may be paid back in a lump sum or installments. If at any point the amount of the loan plus interest exceeds the policy’s cash surrender value, the policy may be terminated without further value. At the insured’s death, any outstanding loan and interest will be deducted from the death benefit.
- Participating versus Non-Participating — Participating policies may pay dividends. Non-participating policies do not. Dividends are refunds of the insurance company’s excess or unused premiums. Dividends are not usually distributed until the second policy year; however, they are never guaranteed.
There are typically several available dividend options, such as:
- Cash Payment — The dividend can be paid directly to the policyowner in cash.
- Premium Reduction — The dividends can be used to pay part of the premium. The insurance company will send a statement showing the amount of the dividend and balance of premium due, if any.
- Interest Option (Left on Deposit) — The dividends can be left with the insurance company to earn interest. All or part of this money may be withdrawn at any time.
- One Year Term — This option allows for the purchase of one year term insurance that will be payable in addition to the face amount of the policy.
- Paid-up Additions — The dividends can be used to purchase paid-up additional life insurance.
Permanent insurance is available in a variety of forms, including:
- Traditional Whole Life - This policy, sometimes called ordinary life or straight life, covers the insured for life as long as premiums are paid. This is the most basic permanent policy. Typically, the premium remains the same throughout the life of the insured. Some variations of these policies permit the premiums to be paid for a shorter period, such as 10 years, 20 years or until age 65.
- Universal Life - Sometimes referred to as Flexible Premium Adjustable Life, this policy is more flexible than a traditional whole life policy. Premium payments may vary within certain limitations stated in the policy. For example, premium payments may be increased, decreased or skipped altogether, as long as the policy’s accumulated value remains sufficient to keep the policy in force. Also, the death benefit may be raised or lowered more easily with universal life than with a traditional whole life policy. Universal Life policies are interest sensitive, meaning the accumulated value earns interest. Reduced interest rates may require additional premiums to maintain the policy in force. Make sure you understand which values are guaranteed by the contract and which are not. Universal life policies are appropriate for individuals who need the guarantees provided by a whole life policy, but want the possibility of earning higher rates of interest on their policy values.
- Variable Life - Variable Life differs from traditional whole life and universal life insurance in that the policyowner chooses how to invest the policy’s accumulated value. There are typically a variety of choices for allocating the funds, including stock, bond, and money market accounts. The prospectus should be studied carefully, as it will describe the variable policy and the available investment options. In a variable life policy, the death benefit and accumulated value will vary according to the amount of premiums paid and the performance of the policyowner’s investment choices. If the chosen investments perform favorably, the accumulated value and death benefit may increase. If the investments perform poorly, the policy’s accumulated value and death benefit may decrease and possibly be lost. The policyowner bears this risk.
Some policies may have optional guarantees available for an additional premium.