Life Insurance

Life Insurance offers peace of mind for you and your family, which can be the basis of protection and financial stability after one’s death. Its function is to help beneficiaries financially after the owner of the policy dies.

It can also be a form of savings in the long run if you purchase a plan which offers the option of contributing regularly. Additionally, it can be tied in with a pension plan. A person can make contributions to a pension that is funded by a life insurance company. These are considered private pension arrangements.

You should make a list of what you feel needs to be protected in your family. With a life insurance policy in place, you can:

  • provide security for your family
  • protect your home mortgage
  • take care of your estate planning needs
  • look at other retirement savings / income vehicles

Life insurance may be divided into two basic classes temporary and permanent.

Temporary Insurance

Term insurance is one of the most popular types of temporary insurance. Term is coverage for a specified number of years in exchange for a specified premium. The policy does not accumulate cash value. Term buys protection in the event of death and nothing else.

A policy holder insures his life for a specified period of time (term). If the insured dies before that specified term is up (with the exception of suicide), his estate or named beneficiary receives a payout. If he does not die before the term is up, he receives nothing. Suicide used to be excluded from ALL insurance policies, however, after a number of court judgments against the industry, payouts do occur on death by suicide (presumably except for in the unlikely case that it can be shown that the suicide was just to benefit from the policy). Generally, if an insured person commits suicide within the first two policy years, the insurer will return the premiums paid. However, a death benefit will usually be paid if the suicide occurs after the two year period.

There are three key factors to be considered in term insurance:

  1. Face amount (protection / death benefit)
  2. Premium to be paid (cost)
  3. Length of coverage (term)

Various insurance companies sell term insurance with many different combinations of these three parameters. The face amount can remain constant or decline. The term can be for one or more years. The premium can remain level or increase.

Level Term policies have a fixed premium for a period of time longer than a year. These terms are commonly 5, 10, 15, 20, 25, 30 and even 35 years. Level term is often used for long term planning and asset management because premiums remain consistent year to year and can be budgeted long term. At the end of the term, some policies contain a renewal or conversion option. Some companies guarantee renewal, the insurance company guarantees it will issue a policy of an equal or lesser amount without regard to the insurability of the insured and with a premium set for the insured’s age at that time. Some companies however do not guarantee renewal, and require proof of insurability to mitigate their risk and decline renewing higher risk clients (for instance those that may be terminal). Renewal that requires proof of insurability often includes a conversion option that allows the insured to convert the term program to a permanent one that the insurance company makes available. This can force clients into a more expensive permanent program because of anti selection if they need to continue coverage. Renewal and conversion options can be very important when selecting a program.

Return of premium term life insurance

Return of premium term life insurance is a relatively new type of life insurance policy that offers a guaranteed refund of the life insurance premiums at the end of the term period assuming the insured is still living. This type of term life insurance policy is a bit more expensive than regular term insurance, but the premiums are designed to remain level. These return of premium term life insurance policies are available in 15, 20, or 30-year term versions. Consumer interest in these plans has continued to grow each year, as they are often less expensive than permanent types of life insurance, yet, like many permanent plans, they may offer cash surrender values if the insured doesn’t die.

Permanent Life Insurance

Permanent insurance remains active until the policy matures unless the owner fails to pay the premium when due. The policy cannot be cancelled by the insurer for any reason except fraud on the application and that cancellation must occur within a period of time defined by law. Permanent insurance builds a cash value that reduces the amount at risk to the insurance company and the expense over time. This means that a policy with a million dollar face value can be relatively expensive to a 70 year old. The owner can access the money in the cash value by withdrawing money, borrowing the cash value, or surrendering the policy and receiving the surrender value.

Whole life coverage

Whole life provides a level premium and a cash value table included in the policy guaranteed by the company. The primary advantages of whole life are guaranteed death benefits, guaranteed cash values, fixed and annual premiums, and expense charges will not reduce the cash value shown in the policy. The primary disadvantages of whole life are premium inflexibility, and the internal rate of return on the policy may not be competitive with other savings alternatives. The cash values are generally kept by the insurance company at the time of death, and only the death benefit is paid to the beneficiaries. Riders are available that allow one to increase the death benefit by paying an additional premium. The death benefit can also be increased through the use of policy dividends. Dividends cannot be guaranteed and may be higher or lower than historical rates over time. Premiums are much higher than term insurance in the short-term, but cumulative premiums are roughly equal if policies are kept in force until average life expectancy.

Cash value can be accessed at any time through policy “loans”. Since these loans decrease the death benefit if not paid back, payback is optional. Cash values are not paid to the beneficiary upon the death of the insured; the beneficiary receives the death benefit only. If the dividend option is elected, dividend cash values will purchase additional death benefit which will increase the death benefit of the policy to the named beneficiary.

Universal life coverage

Universal Life is a product intended to provide permanent insurance coverage with greater flexibility in premium payments and the potential for a higher internal rate of return. There are several types of universal life insurance policies which include fixed universal life, variable universal life, and equity indexed universal life insurance.

A universal life insurance policy includes a cash account. Premiums increase the cash account. Interest is credited on the account at a rate specified by the company. Mortality charges and administrative costs are then charged against the cash account. The surrender value of the policy is the amount remaining in the cash account less applicable surrender charges.

With all life insurance, there are basically two functions that make it work. There’s a mortality function and a cash function. The mortality function would be the classical notion of pooling risk where the premiums paid by everybody else would cover the death benefit for the one or two who will die for a given period of time. The cash function inherent in all life insurance says that if a person is to reach age 95 to 100 (age varies depending on state and company), then the policy matures and endows the face value of the policy.

Universal life insurance addresses the perceived disadvantages of whole life with flexible premiums. Depending on how interest is credited, the internal rate of return can be higher because it moves with prevailing interest rates (interest-sensitive) or the financial markets (Equity Indexed Universal Life and Variable Universal Life). Mortality costs and administrative charges are known. Cash value may be considered more easily attainable because the owner can discontinue premiums if the cash value allows it. Universal life has a more flexible death benefit because the owner can select one of two death benefit options, Option A and Option B.

Option A pays the face amount at death as it’s designed to have the cash value equal the death benefit at maturity (usually at age 95 or 100). With each premium payment, the policy owner is reducing the cost of insurance until the cash value reaches the face amount upon maturity.

Option B pays the face amount plus the cash value, as it’s designed to increase the net death benefit as cash values accumulate. Option B offers the benefit of an increasing death benefit every year that the policy stays in force. The drawback to option B is that because the cash value is accumulated “on top of” the death benefit, the cost of insurance never decreases as premium payments are made. Thus, as the insured gets older, the policy owner is faced with an ever increasing cost of insurance (it costs more money to provide the same initial face amount of insurance as the insured gets older).

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