A life insurance policy is a legal contract between you and the insurance company. This contract spells out:
• The rights and duties of you and the company
• How much and how often you pay
• The benefits you are entitled to receive
• The circumstances under which the policy will pay benefits
The best insurance policy is the one that best fits your needs. However, what is best for you right now, may not suit your situation 1 0 years from now. This means you should review your coverage regularly, even on an annual basis to make sure your coverage is current.
Term life insurance and cash value life insurance
Term and cash value insurance are the two basic types of life insurance that companies offer in various forms.
Term life insurance
Term insurance gets its name because it protects you for a specific "term"—usually a year or a limited number of years. You have to pay more for it as you get older because your risk of dying increases with age. Term insurance does not have a cash value and you cannot cash it in. Once the term ends, the policy no longer covers you. If the policy is renewable, you may buy it for another term at a rate guaranteed in the policy, without providing health information and some other proof of insurability, such as a driving record. However, the renewed policy will usually cost more. Over time, it may be too costly to renew.
Term insurance is well suited to fill a temporary need for increased insurance. If you leave one job for another, you may not have group life insurance coverage through your employer for a short time. Term insurance offers an easy purchase to bridge such a gap. It is also provides you with an option to quickly supplement an existing whole life policy with additional coverage.
Cash value life insurance
For this type of insurance, you pay higher premiums at the beginning of the policy. The company uses part of your premium to set up an account under your policy with a cash value that you may use in a variety of ways. For example:
• You may borrow against a policy's cash value by taking out a loan. If you don't pay back the loan and the interest on it, the company will subtract the amount you owe from the benefits when you die. If you cancel the policy, the company will also subtract the loan balance from the cash value you receive
• You can use the cash value to pay an overdue premium on the policy
• You can use the cash value to increase your income in retirement or to provide for other financial needs. However, to build up this cash value, you must pay higher premiums in the early years of the policy
Whole life, universal life, and variable life
These are all considered types of cash value insurance. For whole life and universal life, the life insurance company invests your cash value as a general asset of the company. The interest the company credits to your cash value is based on its earnings.
Whole life insurance
This is the traditional form of cash value life insurance. Also referred to as "ordinary life" or "straight life," whole life insurance provides coverage for your entire lifetime.
The premium depends on your age at the time you buy and stays the same as you grow older. The lowest premiums go to those who buy it when they are young, because they will pay into it the longest. Your cash value grows based on a fixed interest rate set each year in your policy by the company.
Some whole life policies let you pay premiums for a shorter time, such as 1 5 years, or until you reach age 6 5. Premiums for these policies are higher because you make premium payments during a short time frame.
Universal life insurance
This is a type of flexible cash value policy that lets you vary your premium payments. You can also make limited adjustments in the death benefit amount of your policy. The company credits the premium you pay to a policy account that earns interest. The company then deducts the expense charges from the account. If your yearly premiums plus the interest the company credits to your account is greater than the cost of the insurance, your account will grow. However, if your premiums and interest earnings are less than the cost of insurance, your account will decrease. If your account keeps dropping, your coverage will end. To prevent this, you can increase your premium payments or lower the death benefits.
Variable life insurance
As with universal life, the death benefit and cash values of variable life insurance vary. With variable life, the company invests your cash values into separate investment accounts, such as portfolios of stocks, bonds, and other investments. These separate accounts are like mutual funds. The company should provide you with information (also called a prospectus) that describes each separate account. Study the information carefully. As the policy owner, you choose the separate account to invest the cash value. The cash values and death benefit vary due to increases or decreases in the value of the separate accounts. You take the investment risk as the policyholder in return for possible improved benefits.
Life insurance illustrations
For most individual policies, cash values, death benefits, or premiums vary based on factors the company cannot guarantee (such as interest rates). Companies use computer-generated illustrations, such as a table to show how policies perform over the years under given assumptions. The illustrations show how benefits that are not guaranteed will change each year as interest rates and other factors change. The illustrations also show what the company actually guarantees and what could happen in the future. Remember, no one knows what will happen in the future. If the policy does not perform well, be prepared to adjust your financial plans.
You should be aware that due to past sales abuse, companies cannot use the term "vanishing premium" in life insurance illustrations. Vanishing premiums imply that you start out making large premium payments for the first several years of your policy with the possibility of no payments later on. There is NO guarantee this will occur.
Other life insurance policy options
The following are other popular types of life insurance:
Group life insurance
Typically purchased one year at a time, group life insurance gives you very little control over the conditions of the coverage. You buy group life through an association of individuals. For example, an association of individuals affiliated with an employer, labor union or credit union. In Washington state, if you leave a group life plan or your employer drops the plan, the law requires group life insurance to allow you to convert to permanent whole life insurance coverage.
The advantages to group life include:
• Group life insurance may cost less than individually purchased life policies
• Employers may choose to subsidize part of the cost as a fringe benefit for their employees
• It usually doesn't require a medical exam or health history
The disadvantages to group life include:
• It does not typically guarantee premiums
• It does not typically guarantee a renewable policy
• Group life coverage only applies to members of the group
• If you leave the group or drop your association membership, your coverage ends — unless you convert the policy to private insurance at a higher cost
Convertible life insurance policies
This type of policy starts out as term life insurance and then converts to a cash value life insurance policy. Young people who want financial security for their new families, but cannot afford cash value life insurance, may choose a convertible term insurance policy. These policies give you the option to convert your coverage to cash value life insurance for a limited time—without providing health information and some other proof of insurability and at the insurer's current premium rates. Premium rates start fairly low and then rise after you convert. When you shop for term insurance, look for policies that are both renewable and convertible.
Joint life insurance
When a husband and wife or business associates need life insurance, it is often cheaper to buy a joint life insurance policy instead of two or more separate policies. While this type of insurance saves on administrative costs, the policy usually only pays the death benefit on the first to die. However, some companies issue "second or last to die" policies for estate planning.
Family insurance
This is basically a whole life insurance policy on a parent with smaller amounts of additional term insurance on other family members.
Final expense life insurance
Also known as "burial policies" or "senior life insurance packages," these small policies cover or pre-pay a person's funeral costs. Historically, some of these policies had a very high price compared to the death benefit. In response to consumer complaints, Washington created the high-priced life insurance regulation.
This regulation includes a special formula that bans companies from marketing certain high-priced life insurance policies with small death benefits. Companies cannot sell life insurance polices in Washington when the amount paid into them quickly exceeds the possible benefit. For example, during the first 1 0 years of the policy, the death benefit must be greater than the sum of the premiums compounded at five percent interest. Otherwise, you would be better off with your money in a savings account.
Please note: This rule does not apply to policies with a death benefit of $25,000 or more.
Optional policy benefits
Waiver of premium
If you become seriously ill or injured and cannot work, you may not be able to pay your premium. A waiver of premium benefit lets you waive paying your premiums as long as you remain disabled (according the definition in your policy). You must remain disabled at least six months to collect this modest disability income benefit. You can usually add this life insurance extra to your policy for only a few cents more per month per thousand dollars of insurance coverage.
Accidental death benefit
The industry also refers to this life insurance extra, as "double, triple, or additional" indemnity. If an accident causes your death, this life insurance extra allows your beneficiaries to receive double, triple, or even more of your policy's death benefit value.
Accelerated life insurance benefit
This permits life insurance companies to include policy language that allows for an early, discounted benefit payment to terminally ill policyholders. A doctor must certify that policyholders have less than 24 months to live. |
