Types of policies
Term life policies cover you only for a "term"-or a specific period of time-usually for one, five, 10, 15, or 20 years or until a specified age, such as 65.
Most term life policies provide only death benefits in the form of a check to your beneficiary for the amount of the policy if you die. Because they usually have no savings feature, term life policies generally are less expensive initially and easier to understand than cash value life policies. Except for people past middle age, term life policies usually offer the best value for your money by giving you the biggest death benefit for your premium dollar. The price of a term life policy increases as you grow older. At the same time, your insurance needs may decrease as children grow up and savings and investments increase in value.
Because term life expires at the end of the term, you should look for a renewable policy with a guaranteed term that will cover the duration you will need life insurance. A renewable policy allows you to continue your insurance as long as you pay the premium, regardless of your health. However, renewal rates increase significantly if you cannot pass a physical exam.
Some term insurance policies are convertible. This means that as your insurance needs change, you can exchange your term life policy for a cash value policy without taking a medical exam or answering health questions. You may choose to convert your term life policy if your health declines and it becomes difficult to qualify for a new term policy at standard rates. You also may convert your term life policy if you decide to use insurance as a way of accumulating funds instead of providing only death benefits. Insurance companies usually allow conversion until age 65.
Annually Renewable Term (ART) - You may renew most ART policies up to age 95. However, ART premiums are extremely high for middle and older age consumers. If you're paying high premiums, you may want to shop around for a better value.
An ART provides a fixed premium and death benefit for one year. When the term ends, you may renew your policy, but the premium will probably increase. To avoid yearly increases, some people look for five-, 10-, or 20-year renewable term policies.
Decreasing Term - This policy provides death benefits that decrease each year. Mortgage insurance and credit life insurances are examples of decreasing term policies. The initial death benefit may equal or approximate the amount of your loan, with the benefit decreasing as you pay off your loan. If you die, the insurance benefits pay off or reduce your loan balance.
Cash Value Life
Cash value life policies provide a death benefit and a way to accumulate funds over time. However, the primary purpose of a cash value policy is to provide permanent life insurance protection, not to be a savings or retirement plan.
Cash value life policies differ from term life policies in several ways, including
- Higher initial premiums. You pay not only for a death benefit but also for the cash value feature of the policy. Initially, cash value policies offer less insurance protection per premium dollar than term life policies.
- Greater flexibility. You can use the cash value as collateral for a loan or use some of the cash value by surrendering a portion of the policy through a policy loan. Some people buy cash value policies as a tax-deferred way to build an estate. Dividend-paying policies usually provide an option to apply the dividends to pay all or part of the premiums. Other cash value policies such as universal life provide for payment of the cost of the policy if the policy has accumulated sufficient value.
- Much higher agent commissions. Keep this in mind if an agent continues to recommend a cash value life policy when you ask about term life.
Remember that surrender charges and other expenses may consume all or most of a policy's cash value if you cash it in early. It usually takes at least three to five years to build any cash value. If you buy a cash value policy, try to continue your premium payments for at least 15 to 20 years.
Illustrations Life insurance agents use charts or illustrations as sales tools to show how a life policy's cash value might grow. You should confirm that the illustration shows the guaranteed values based on the guaranteed interest rate the company promises to pay. Don't buy a policy based on projected future or current values. These are only estimates and may be higher than what you will actually receive. Understand the pattern of policy values, surrender charges, and other expenses. Ask your agent for this information if the illustration doesn't show it. Get copies of all the illustration pages, including those showing the guaranteed values.
Paid-Up additions - This is additional insurance purchased with interest or dividends paid on your policy. Some policies include a column showing the paid-up additions increasing the death benefit over time as its based on dividends which are not guaranteed. Remember, this additional insurance is not guaranteed.
Vanishing premium - Be careful if an agent tells you that interest or dividends on your policy will cause your premiums to "vanish" during the life of the policy. If interest rates or dividends drop, you may have to pay additional premiums for a longer time. Also, the amount you pay may be greater than you estimated.
Whole life policies are a type of cash value life insurance that offer protection throughout a lifetime-that is for a person's "whole life." You pay the scheduled premium from the day you buy the policy. As long as you pay the premium when due, the policy remains in force throughout your life or until you cash it in. The scheduled premium may be level or increase after a fixed time period, but the premium is determined when issued and will not change from the amounts shown in the policy schedule. It is important that you look at the policy schedule and understand what your premium payments will be and that you can afford them. An insurance company will base the premium on your age and insurability at the time of purchase. Initially, the premium for a whole life policy will be higher than that for a term policy. You likely will pay a lower premium when you are older, if you keep the policy for a long time. Part of each premium payment goes to the cash value growth, part for the death benefit, and part for expenses such as commissions and administrative costs.
There are two types of traditional whole life policies:
- Nonparticipating policies provide a schedule of guaranteed premiums and death benefits and a table of guaranteed values, but they pay no dividends.
- Participating policies guarantee premiums, death benefits, and cash values, and also may pay policy dividends. Because of the dividend feature, premiums tend to be higher.
- Consumers have several options for using policy dividends, including letting the dividends accumulate with interest, taking the dividends in cash, using the dividends to pay toward the premium, buy permanent paid-up additions, or buy a combination of one-year term and additional permanent paid-up additions.
Some companies fail to pay dividends at the originally projected rate, while others exceed their original projections. When making your purchase decision, remember that dividends are not guaranteed and may differ from those shown in illustrations. Ask for a company's history of projected dividends versus paid dividends.
Flexible Premium Universal Life
The key characteristic of a universal life policy is flexibility. Within limits, you can choose the amount of insurance and the premium you will pay. Later, depending on the policy value and your financial needs, you can change your premium amount. The policy stays in force as long as its value is enough to pay its costs and expenses. The policy value is "interest-sensitive," which means the cash value grows in response to the general financial climate.
The flexible premium feature of the policy allows you to change your premium payments, depending on the policy value and your current financial needs. For example, you may be able to skip a premium payment or decrease/increase your premium payments.
Lowering the death benefit and raising the premium will increase the growth rate of your cash value. Raising the death benefit and lowering the premium will slow the growth of your cash value. If insufficient premiums are paid, the policy could lapse without value before it reaches a maturity date. The maturity date is the date your policy ceases and its cash surrender value is payable if the policyholder is still living. Therefore, it is your responsibility to consistently pay a premium that is high enough to ensure that your policy's value is adequate to pay the policy's monthly cost. The company must send you an annual report and notify you if you are in danger of losing your policy because of insufficient value.
Other Insurance Coverage
A variable life policy allows the owner to invest the policy values in a selection of separate accounts similar to mutual funds. Separate accounts could include money market funds and mutual funds invested in stocks and bonds. A variable life policy presents a higher risk to the owner because the cash value varies based on the investment performance of the separate account. The value of a variable policy is directly related to the investment funds and is not protected by the Guaranty Association.
A group life policy provides coverage to a group of people under one contract. Most group life contracts are sold to businesses to cover their employees. Associations buy group life policies to cover their members. Lending institutions will offer a group policy to cover real estate loans. Most group life policies are for term insurance.
Generally, an insurance company issues a master policy, and each person in the group receives a certificate of insurance.
If you terminate your employment, you may be able to convert to an individual whole life policy and keep your coverage.
A group life policy isn't always a low-cost policy. Compare the cost of your coverage under a group policy to the cost of an individual policy and shop around for the best deal. Employers should compare prices and coverages to get the best group policy for their employees.
An accidental death benefit can be a policy or a rider attached to another type of life or health policy. It can be individually purchased or part of a group policy. The important thing to remember is that this coverage pays only if you die from an accident. You also need to read the exclusion section because there are certain accidents it will not cover, such as deaths while participating in a hazardous sport, accidents involving alcohol or illegal drugs, and participating in riots.