Types Of Policies

There are two basic types of life insurance policies -- term insurance and whole life insurance. All other kinds of policies are variations of these two types.

Term insurance offers protection that insures your family for a specified and finite period of time -- usually one, five, 10 or 20 years, or up to age 65. A term insurance policy pays a benefit only if you die during the period covered by the policy. If you stop paying premiums, the insurance stops. At the end of the term, the coverage ends, but it can be continued for another term if you have a "renewable" policy. Under such a policy, you will not have to provide evidence of insurability to renew the policy, but each time you renew, your premiums will be higher because you are older.

If you have term insurance that is "convertible," you can exchange it for a whole life policy without a medical examination, but you should expect to pay a higher premium. The amount of the whole life insurance premium remains the same for the rest of your life.

Term insurance is initially cheaper than other types of policies that offer the same amount of protection. Therefore, it gives you the greatest immediate coverage per dollar. For this reason, it is useful to those consumers who need large amounts of coverage for a known period of time -- for example, home buyers, parents of young children or people with high current obligations.

Term insurance is also available in other forms. One common type reduces coverage over time, paying less to the beneficiary as time passes. It is often used to protect a long term decreasing debt, such as a home mortgage.

Whole life insurance (often referred to as straight life or permanent life) is protection that can be kept in force for as long as you live. By choosing to pay a premium that does not increase as you grow older, you average out the costs of your policy over your lifetime on a yearly basis.

The "cash value" is an important feature of whole life insurance. This is a sum that increases over the years on a tax-deferred basis. If you cancel your policy, you can get the cash value in a lump sum. You pay taxes only if the cash value plus any policy dividends you may have received exceed the sum of the premiums you have paid. Most policies contain a table that enables you to tell how much cash value it has. You should consult your producer or company for further information. Cash value has many uses. For example:

  • Using your policy as collateral, you can borrow from the company up to the amount of your current cash value. If you die and the loan has not been repaid, the amount owed plus interest will be deducted from the death proceeds paid to your beneficiary.
  • If you miss paying a premium, the company can -- with your authorization -- draw from the cash value to keep the policy in force.
  • If you wish to stop paying premiums, the accumulated cash value can be used to fund a paid-up policy that provides a reduced level of protection, or the policy can be continued as term insurance for a specific period of time.
  • You can use the cash value to purchase an annuity that provides a guaranteed monthly income for life.
  • You can give the policy up completely and the insurance company will pay you the cash value.

There are several variations of whole life insurance. One is modified life, with a premium that is relatively low in the first several years but that increases in later years. It is intended for those who want whole life insurance but wish to pay lower premiums in their younger years.

Limited-payment life remains in force for your entire life, but premiums are paid over a shorter period than other whole life insurance policies. For example, you might make payments for 20 years or until age 65 rather than spreading them over your lifetime. Because the premiums are paid within a shorter period, premium rates are higher than for other types of whole life insurance.

A single-premium whole life policy provides protection for the duration of the insured's life, in exchange for the payment of the total premium in one lump sum at the time of application.

Combination plans are simply policies that combine term and whole life insurance in one contract. Frequently, premiums for combination plans do not rise as the insured grows older.

Universal life insurance is protection under which a policyholder may pay premiums at any time, in virtually any amount, subject to certain minimums. The policyholder can also change the amount of insurance more easily than under traditional policies. In a universal life insurance policy, the amount of the cash value reflects the interest earned at current interest rates and the total amount and timing of premiums paid, minus the cost of insurance and expense charges. The level of cash value is "interest-sensitive," which means that the amount you accumulate varies according to the general financial climate. Rates are usually guaranteed for one year, and then a new rate is determined. The rates used can be no lower than a guaranteed rate specified in the policy (typically 4 or 4.5 percent).

Current assumption whole life insurance, which is also known as fixed premium universal life or interest-sensitive whole life, is a variation of universal life insurance. It involves fixed premiums and fixed death benefits, and, as in other universal life policies, its growth in cash value depends on market conditions.

Variable life insurance provides death benefits and cash values that fluctuate according to the investment experience of policy funds managed by the life insurance company. Policyholders decide where their money will be invested. Some investment options commonly offered by insurance companies include stock, bond or money market funds. Thus, policyholders have the opportunity to obtain higher cash values and death benefits than with policies calculating benefits based on a fixed rate of return. Conversely, policy holders also assume the risk of poor investment performance.

Life insurance producers selling variable life must be registered representatives of a broker dealer licensed by the National Association of Securities Dealers and registered with the Securities and Exchange Commission. If you are interested in a variable life policy, be sure your producer gives you a prospectus that includes an extensive disclosure about the policy.

Two types of variable life policies exist: Scheduled premium variable life insurance and flexible premium variable life insurance. Premium payments under a scheduled premium policy are fixed as to timing and amount, while policyholders who own a flexible premium policy may change the timing or amount (or both) of premium payments.

Second-to-die life insurance, which is also called dual life or survivorship insurance, is primarily an estate planning tool that pays a death benefit only upon the death of the insured who survives the longest. Its main purpose is to pay estate taxes upon the death of the second insured. Because it is based on joint life expectancy, its premium is less than the total premiums for individual policies on the same lives. Second-to-die life insurance can take the form of a variety of traditional or interest-sensitive types of products. It may include premium flexibility to allow vanishing premiums or a minimum annual premium. Second-to-die life insurance has both personal and business applications.