Different Types of Life Insurance Policies and Provisions
Life Insurance PoliciesLife insurance policies contain seemingly countless provisions, clauses and options that determine the type and scope of coverage as well as what will happen if premium payments lag or a claim is made. It is important to understand the provisions of the policy you have or any one you're considering.
Incontestable ProvisionWith this provision, the insurance company may not contest any claims following a specific period of time from the initiation of the policy. Of course, this is not a license to commit fraud, and the discovery of fraud will lead the company to contest any claims and possibly pursue criminal charges.
Suicide ProvisionWith this provision, suicide within a specific period of time after the initiation of the policy will result only in the return of premiums plus interest.
Reinstatement ClauseWith this provision, if premiums are not paid in a timely fashion and the policy lapses, it may be reinstated within a specific period of time if the policy holder remains insurable. This option must be weighed against the potential benefits and downsides associated with a new policy. These might include changes in premium costs and the resetting of provisions for contestability and suicide.
Excluded RisksDepending on the policy, death under circumstances like war or an aviation accident may or may not be covered. Be sure that all risks you are looking to protect against are covered in your policy.
Settlement OptionsThere are a variety of options available for payout. The simplest is a lump sum payment of the value of the policy. It is also possible to leave the entire settlement with the insurance company and collect interest, retaining the right to withdraw principal funds at any time. Payment schedules are also available based on payment amount or duration. In either case, interest will accrue on the money that remains with the insurance company. There are also a range of options that pay benefits over the entire life of the beneficiary. Any decision on settlement options must take into account the current and future financial prospects of the beneficiary and his or her dependents, so the best option will vary from case to case.
Types of Policies
Term LifeTerm life insurance covers the insured for what is usually a relatively short period of time. All of the money from the premium is used to pay for the insurance itself. Therefore, at the end of each term, the policy must be renewed. The policy does not accrue equity for the insured. There is no penalty for not renewing a term life policy because the insurance company is not in possession of an asset. If the insured dies during the term of the policy, the policy pays off at its face value. Term life policies are generally tax-free and may even allow for a partial payout upon diagnosis of a terminal disease.
For young people, term life insurance is often the cheapest option. However, the price will increase as you age because health problems show up over time, and, for the simple reason that the older you are, the higher the chance that the insurance company will have to pay a settlement. Another downside is that if health problems materialize and your policy is non-renewable, your premiums may increase or you may no longer qualify for insurance. This problem can sometimes be avoided by paying higher rates for renewable term life, allowing you to renew the same policy without re-qualifying. A policy may also be designated convertible , which means that the insured can convert the policy to permanent life at a later time.
Another choice related to term life is the option for level or decreasing term. Level term pays the same amount of money upon death at any point during the policy. Decreasing term pays less and less as the term progresses. The latter is most effective for protection against a mortgage or any other steadily decreasing financial obligation. Level term life is not to be confused with level premium term life, which specifies that premiums will not increase over the course of the term in exchange for slightly higher premiums early in the term.
People choose term life when they need insurance for only a short period of time, or they need insurance, but cannot afford the premiums associated with permanent insurance. Some people choose term life and then invest the difference between the premium and a permanent life premium on their own. These people are confident that their investments will outperform those of the insurance company.
Cash Value (also called Permanent Life)Cash value insurance is an umbrella term for a variety of plans that combine a death benefit similar to a term life plan with tax-sheltered savings arrangements. Permanent life policies, as their name implies, are meant to be held and paid into for the duration of the insured's life. Because of this, there are significant fees associated with setting up the policy. Despite these fees, the tax advantages can make permanent life a valuable investment over a long period of time. The policy is always renewable and premiums are fixed and calculated based on the age of the insured when the policy is initiated. If the death benefit is paid early in the policy, the money will come mostly from the insurance policy, and, if the death benefit is paid late in the policy most of the money will come from the savings account. As the savings become more and more significant, less insurance is needed to hold down the cost of insurance as the holder ages.
The cash value portion of the policy is invested in a savings account. Accordingly, value accrues in the policy over time. This portion of the money paid by the insured was originally intended to pay insurance premiums in retirement. Because the account is an asset belonging to the policy holder, however, it is assignable, meaning that it can be transferred to another person or used as collateral for a loan. Policies may even be converted to an annuity to provide income during retirement. Any balance remaining in the account when a settlement is paid is passed on to the beneficiary of the policy. Removing money from the account before settlement for expenses other than the insurance premium is not recommended because taxes and fees will be incurred.
Despite potential benefits, cash value plans must be carefully investigated because their value to insurance companies exceeds term life, and unscrupulous agents may attempt to push them on customers more suited to term life.
Whole LifeWhole life is the most basic form of cash value life insurance. The insurance company essentially makes all of the decisions regarding the policy. Regular premiums both pay insurance costs and cause equity to accrue in a savings account. A fixed death benefit is paid to the beneficiary along with the balance of the savings account. Premiums are fixed throughout the life of the policy even though the breakdown between insurance and savings swings toward the former over time. Management fees also eat up a portion of the premiums. The insurance company will invest your money primarily in fixed-income securities, meaning that your savings investment will be subject to interest rate and inflation risk.
Single Premium LifeSingle premium life is the simplest form of whole life insurance. In exchange for a lump sum, an insurance company provides an insurance contract that requires no future payments in order to remain valid. The death benefit paid by this contract depends on the same factors that determine term life rates (age, health, etc.) as well as the amount paid for the contract. The money is invested in a savings account, and interest accumulates in the account. Fees are charged when money is removed from the account prematurely, but loans may be taken out against the saved equity.
Universal LifeUniversal life was created to provide more flexibility than whole life by allowing the holder to shift money between the insurance and savings components of the policy. Additionally, the inner workings of the investment process are openly displayed to the holder. Details of whole life investments tend to be quite scarce. Premiums, which are variable, are broken down by the insurance company into insurance and savings. Therefore, the holder can adjust the proportions of the policy based on external conditions. If the savings are earning a poor return, they can be used to pay the premiums instead of injecting more money. If the holder remains insurable, more of the premium can be applied to insurance, increasing the death benefit. As opposed to whole life, the cash value investments grow at a variable rate that is adjusted monthly. There is usually a minimum rate of return. These changes to the interest scheme allow the holder to take advantage of rising interest rates. The danger is that falling interest rates may cause premiums to increase and even cause the policy to lapse if interest can no longer pay a portion of the insurance costs.
Variable LifeVariable life is still another version of whole life that allows investors to select investment vehicles for the savings portion of their policy. Options range from low-risk fixed income funds to high-yield stock and bond funds. These accounts are typically accompanied by higher fees. Returns are generally not guaranteed and investment risk is assumed by the policy holder instead of the insurance company. Premiums remain fixed under this arrangement. As would be expected, the better the investments perform, the larger the death benefit will be. However, the death benefit will not drop below a certain minimum, regardless of investment performance.
Variable Universal LifeVariable universal life adds to the flexibility of universal life by allowing the holder to choose among investment vehicles for the savings portion of the account. The only differences between this arrangement and investing individually are the tax advantages and fees that accompany the insurance policy.
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