For people new to life insurance, the information surrounding buying a life insurance policy can all be very confusing. Most people must place a lot of trust in their life insurance agent, and hope that the agent has their best interests at heart. Fortunately, most of the agents out there do in fact have their clients best interest in mind when they make a recommendation to purchase a particular life insurance policy. Unfortunately, if an agent does not have the right intentions, most people will not know about it until it is too late.
For the protection of everyone purchasing a life insurance contract, at Life Ant we always recommend that our clients educate themselves as thoroughly as they can before making a purchasing decision. Understanding the fundamentals of life insurance, including what the major types of life insurance are, and how they each work in different ways to accomplish the same goal of providing protection to the insured person’s beneficiaries.
Types Of Life Insurance
There are four major types of life insurance policies. These types are Whole Life Insurance, Term Life Insurance, Universal Life Insurance, and Variable Universal Life Insurance. Within each of these classes of policy types, there are even further variations that exist, but the vast majority of all policies are one of these four.
Some policies will make life insurance agent’s more money than others. For instance whole life will often make them the largest commission for any given death benefit, and term will usually make them the smallest commission. This means that an agent does not have a very big incentive to sell a policy which is the most beneficial to the vast majority of people. Arguments can be made for the benefits of each type, but each situation is unique and calls for a careful understanding of the costs and benefits involved.
For an in depth discussion regarding the pros and cons of “purchasing term life insurance and investing the difference”, see our article on the subject here.
Here is a description of each type of life insurance policy, along with some benefits and drawbacks of each kind.
Term Life Insurance
Term life insurance is by far the least expensive type of life insurance policy to pay on a yearly basis. This makes it very attractive to people, but if you outlive the length of the term policy you do not receive any death benefit. If the insured person dies will the coverage is “in force”, which is during the covered length of the term, the beneficiaries will receive a full death benefit.
Term life insurance has no cash value, and is of little use to anyone as an investment. A life insurance company statistically expects it’s policy owners to outlive any term coverage.
Term life insurance lasts exactly as it’s name implies, for a specified length of time, or in other words a specified or “term”. Typically policies will last 10, 15, 20, or 30 years, but there are also other increments that some companies may sell. Some companies also sell term life insurance products which will last until a certain age, such as term to age 90 (this may be referred to as T-90 in life insurance parlance). Some policies may have a return of all or a portion of premiums paid if you outlive the T-90, but many also do not.
Term life insurance normally has a level premium, meaning the amount that must be paid is the same each year. Term which lasts until a certain age usually will rise in price a little bit each year, eventually becoming extremely expensive if the person lives to be near the maximum age. Typically an owner has the option to pay yearly, semi-annually, quarterly, and monthly. It can sometimes cost more to make monthly payments than less frequent payment modes.
At a certain point within the life of the policy, a term life insurance may be convertible to a whole life insurance policy. This is known as a “term conversion“. The value of the term conversion is the fact that no further underwriting is needed in order to convert the policy to a whole life policy. This means that if an insured person has health problems during the course of the term policy coverage they will not be left without coverage after the term ends. They can simply convert the policy to a permanent form of life insurance. Each policy may have a different point at which it is eligible for a term conversion.
It is important to understand the specific rules and difference of each product before you purchase the insurance. Each company may have difference between the same product, and each company may sell multiple product types which may appear similar, but they may have nuances which may make a big difference to the owner such as the return of premium clause.
Whole Life Insurance
Whole life insurance is a type of life insurance which is meant to be permanent and last for an insured person’s “whole life”. Whole life insurance has a level premium structure (the premiums due are the same each year), and will build cash value over time. Whole life insurance is also eligible to receive dividend payments from the life insurance company.
Whole life insurance policies guarantee that the cash value will build at least at a certain rate if all payments are made on time, but the dividend payment will increase the rate at which value can build. The amount paid by the dividend payment is dependent upon the performance of the company over the previous year, and the rate paid is multiplied by the existing cash value of the policy.
Many policies will have a dividend payment which becomes high enough to pay the entire premium due after a certain point. The cash value will eventually grow enough so a policy owner has a positive return on the amount of money they put into the policy. This also makes whole life insurance a form of investment.
Whole life insurance policies also allow for loans to be taken against the cash value of the policy. These loans can be taken for any reason, and can be paid back upon the discretion of the owner of the policy.
The big advantage of whole life is that the insured person can never outlive it. Beneficiaries are always protected for the long term. For this reason (and because the death benefits are tax free) whole life insurance is often used for estate planning, and to fund generational trusts.
Universal Life Insurance
Universal life insurance is a permanent form of life insurance. The difference between whole life insurance and universal life insurance is that universal life insurance has a flexible premium structure.
A universal life insurance policy has a cash value account, the the insurance charges are pulled from the cash value account each month. Any amount paid into the policy in excess of the cost of insurance is added to cash value. The cash value then grows at a rate determined by insurance company performance and prevailing interest rates, with a guaranteed minimum of 2% annual growth.
The cost of insurance rises over time with a universal life insurance policy. This means that a policy is of greatest benefit to an owner when it is well funded in the early policy years when insurance costs are lowest. As the costs rise, the growth in cash value will hypothetically more than make up for the rising charges.
Universal life insurance can not legally be sold as an investment. A universal life insurance policy can be surrendered for it’s cash value, or loans and withdrawals can be taken as well. Surrender charges may apply for any withdrawals or full surrenders.
Variable Universal Life Insurance
Variable universal life insurance is similar to universal life insurance in that premium payments are flexible and the cost of insurance rises over time. The big difference between the two kinds of policies though is that variable universal life insurance has a cash value account which does not pay a fixed or guaranteed rate of return.
The cash value of a variable universal life insurance policy is invested in variable “sub accounts” within the life insurance policy. These sub accounts are essentially mutual funds, which represent investments in different asset classes. The policy owner can choose which sub accounts the cash value is invested in. The growth (or loss) of the cash value is dependent upon the market performance of the variable accounts.
The benefit of variable universal life insurance over universal life insurance is that historically speaking, the stock market outperforms the guaranteed accounts of universal life. The risk of a variable universal life insurance policy is that the market will decline, and the owner will end up with a poorly performing policy.
Variable universal life insurance is permanent, and the cost of insurance charges will rise over time. Variable universal life insurance does allow for loans or withdrawals, and the policy can be surrendered for it’s cash value at any time. Surrender charges may apply for any surrenders or withdrawals.
Choosing the Right Policy
No matter which type of life insurance you choose, it is very important to understand the specific rules and terms of each type of insurance and each specific policy. Different types of policies can be appropriate for different people depending upon their age, needs, and appetite for risk. Each type of policy carries a different charge, and it is important to understand how long the coverage is needed, how long each policy will be in place, and how much it will cost in the long run.