Life insurance protects survivors against financial loss associated with death. Specifically, it is designed to replace a loss of income for family members who are financially dependent upon another person. Life insurance can also be considered a means of saving or investing, but its primary purpose is always protection against financial loss.
The Life Insurance PolicyA life insurance policy is a contract between the insurance company and the person buying the insurance, called the insured. The following are the major elements of a life insurance policy.
You have, for example, an insurable interest in the lives of your parents. You do not have an insurable interest in a stranger's life. A partner in a business has an insurable interest in the lives of other partners.
TYPES OF LIFE INSURANCE
Insurance companies offer a variety of life insurance plans that meet different needs. The two basic types of life insurance policies are term life and permanent, or cash value, life.
Term Life InsuranceInsurance that provides financial protection from losses resulting from a death during a definite period, or term, is term life insurance. This coverage is the least expensive form of life insurance. Term insurance is also the only form of life insurance that is purely life insurance. All other forms of insurance also have savings or investment features.
Term policies may run for a period of 1 to 20 years or more. If the insured dies during the period for which the insurance was purchased, the amount of the policy is paid to the beneficiary. If the insured does not die during the period for which the policy was purchased, the insurance company is not required to pay anything. Protection ends when the term expires.
By paying a slightly higher premium, a person can buy renewable term insurance. This type of policy allows the policyholder to continue term insurance for one or more terms without taking another physical examination.
Term insurance policies may be level term or decreasing term. With level term insurance, the amount of protection and the premiums remain the same while the insurance is in effect. With decreasing term insurance, the amount of protection gradually becomes smaller, but premiums remain the same during the term. This is often appropriate because the need for insurance normally declines as children become independent and other savings and investments grow.
Permanent Life InsuranceThe common characteristics of permanent life insurance are that it has cash value and an investment feature. Part of the premium you pay for permanent life insurance is used for insurance that provides protection. This feature is just like term insurance. The insurance company invests the remaining part of the premium that is not needed to pay for the coverage. It adds to the cash value of the insurance policy.
Cash value refers to the amount of money that the insurance company will pay if the policyholder decides the insurance is no longer needed. The cash value is much less than the death benefit that would be paid to beneficiaries. As long as permanent policies are kept in force, they accumulate cash value in addition to providing life insurance.
The longer you keep your permanent life insurance policy, the higher its cash value will be. If you give up or surrender your policy, you receive the amount of the cash value. If you need money but do not want to cancel your policy, you can borrow an amount up to the cash value from the insurance company. If you should die before the loan is repaid, the insurance company will withhold the unpaid amount from the face value of the policy when it pays your survivors. Face value is the amount of insurance coverage that was originally purchased and that will be paid upon the death of the insured.
The cash value of permanent life insurance can be seen as a savings plan. Usually, the return on your money in the cash value portion of permanent life insurance is not large. Nevertheless, permanent insurance plans have a built-in savings feature that encourages people to save for the future. Permanent life insurance comes in the form of whole life, variable life, and universal life policies. Each type builds up cash value.
Whole Life Insurance
Permanent insurance that extends over the lifetime, or whole life, of the insured is whole life insurance . One type of whole life insurance is an ordinary life policy . Premiums for ordinary life insurance remain the same each year as long as the policyholder lives.
Some whole life insurance policies are meant to be paid in full in a certain number of years. Limited-payment policies may be designated by the number of years the policyholder agrees to pay on them, such as 20-payment life policies. They are like ordinary life policies except that premiums are paid for a limited number of years or until a person reaches a certain age. Limited-payment policies free the insured from paying premiums during retirement when income may be lower.
The Life Insurance PolicyA life insurance policy is a contract between the insurance company and the person buying the insurance, called the insured. The following are the major elements of a life insurance policy.
- Name of the insured
- Amount of coverage, also called the face value or death benefit of the policy
- Cost of the insurance, called the premium amount
- Name of the beneficiary
You have, for example, an insurable interest in the lives of your parents. You do not have an insurable interest in a stranger's life. A partner in a business has an insurable interest in the lives of other partners.
TYPES OF LIFE INSURANCE
Insurance companies offer a variety of life insurance plans that meet different needs. The two basic types of life insurance policies are term life and permanent, or cash value, life.
Term Life InsuranceInsurance that provides financial protection from losses resulting from a death during a definite period, or term, is term life insurance. This coverage is the least expensive form of life insurance. Term insurance is also the only form of life insurance that is purely life insurance. All other forms of insurance also have savings or investment features.
Term policies may run for a period of 1 to 20 years or more. If the insured dies during the period for which the insurance was purchased, the amount of the policy is paid to the beneficiary. If the insured does not die during the period for which the policy was purchased, the insurance company is not required to pay anything. Protection ends when the term expires.
By paying a slightly higher premium, a person can buy renewable term insurance. This type of policy allows the policyholder to continue term insurance for one or more terms without taking another physical examination.
Term insurance policies may be level term or decreasing term. With level term insurance, the amount of protection and the premiums remain the same while the insurance is in effect. With decreasing term insurance, the amount of protection gradually becomes smaller, but premiums remain the same during the term. This is often appropriate because the need for insurance normally declines as children become independent and other savings and investments grow.
Permanent Life InsuranceThe common characteristics of permanent life insurance are that it has cash value and an investment feature. Part of the premium you pay for permanent life insurance is used for insurance that provides protection. This feature is just like term insurance. The insurance company invests the remaining part of the premium that is not needed to pay for the coverage. It adds to the cash value of the insurance policy.
Cash value refers to the amount of money that the insurance company will pay if the policyholder decides the insurance is no longer needed. The cash value is much less than the death benefit that would be paid to beneficiaries. As long as permanent policies are kept in force, they accumulate cash value in addition to providing life insurance.
The longer you keep your permanent life insurance policy, the higher its cash value will be. If you give up or surrender your policy, you receive the amount of the cash value. If you need money but do not want to cancel your policy, you can borrow an amount up to the cash value from the insurance company. If you should die before the loan is repaid, the insurance company will withhold the unpaid amount from the face value of the policy when it pays your survivors. Face value is the amount of insurance coverage that was originally purchased and that will be paid upon the death of the insured.
The cash value of permanent life insurance can be seen as a savings plan. Usually, the return on your money in the cash value portion of permanent life insurance is not large. Nevertheless, permanent insurance plans have a built-in savings feature that encourages people to save for the future. Permanent life insurance comes in the form of whole life, variable life, and universal life policies. Each type builds up cash value.
Whole Life Insurance
Permanent insurance that extends over the lifetime, or whole life, of the insured is whole life insurance . One type of whole life insurance is an ordinary life policy . Premiums for ordinary life insurance remain the same each year as long as the policyholder lives.
Some whole life insurance policies are meant to be paid in full in a certain number of years. Limited-payment policies may be designated by the number of years the policyholder agrees to pay on them, such as 20-payment life policies. They are like ordinary life policies except that premiums are paid for a limited number of years or until a person reaches a certain age. Limited-payment policies free the insured from paying premiums during retirement when income may be lower.
Variable Life Insurance
An insurance plan that resembles an investment portfolio is variable life insurance . This plan lets the policyholder choose among a broad range of investments. These investments include stocks, bonds, and mutual funds. The death benefits and cash values of variable life policies vary according to the yield on the investments that the policy-holder selects.
The insurance company first designates an amount of the variable life premiums to cover the cost of insurance. It places the remaining amount in an investment account. Both the death benefit and the cash value rise and fall with the success of the investment account.
A variable life policy might guarantee a minimum death benefit. There is no guaranteed cash value. The minimum death benefit, in relation to premiums paid, is well below other types of life insurance. On the positive side, a strong rate of return on the investment account can increase the cash value and the death benefit.
Universal Life Insurance
Universal life insurance provides both insurance protection and a substantial savings plan. The premium that you pay for universal life insurance is split in three ways. One portion of it pays for insurance protection. The insurance company takes a second portion for its expenses. The third portion goes into interest-earning investments for the policyholder.
The most important feature of universal life insurance is that the investment portion of the policy earns a variable rate of return. This rate is usually higher than is paid on other types of cash value life insurance. This yield on the investment portion tends to rise or fall based on changing economic conditions. Figure 20-3 compares the features of the different types of life insurance.
Group Life InsuranceSome individuals are fortunate to have an employer or some other group offer the opportunity to buy group life insurance. An insurance policy that covers a group of people is called group life insurance . The group acts as a single unit in buying the insurance.
The cost of group life insurance is less than the cost of a similar individual policy. This savings results from the insurance company covering many people in one policy.
Most group life insurance plans offer term rather than permanent insurance. The insurance company works with an employer or other organization, such as a union, to develop the insurance plan. Then, each employee or member of the organization may purchase individual life insurance coverage.
An insurance plan that resembles an investment portfolio is variable life insurance . This plan lets the policyholder choose among a broad range of investments. These investments include stocks, bonds, and mutual funds. The death benefits and cash values of variable life policies vary according to the yield on the investments that the policy-holder selects.
The insurance company first designates an amount of the variable life premiums to cover the cost of insurance. It places the remaining amount in an investment account. Both the death benefit and the cash value rise and fall with the success of the investment account.
A variable life policy might guarantee a minimum death benefit. There is no guaranteed cash value. The minimum death benefit, in relation to premiums paid, is well below other types of life insurance. On the positive side, a strong rate of return on the investment account can increase the cash value and the death benefit.
Universal Life Insurance
Universal life insurance provides both insurance protection and a substantial savings plan. The premium that you pay for universal life insurance is split in three ways. One portion of it pays for insurance protection. The insurance company takes a second portion for its expenses. The third portion goes into interest-earning investments for the policyholder.
The most important feature of universal life insurance is that the investment portion of the policy earns a variable rate of return. This rate is usually higher than is paid on other types of cash value life insurance. This yield on the investment portion tends to rise or fall based on changing economic conditions. Figure 20-3 compares the features of the different types of life insurance.
Group Life InsuranceSome individuals are fortunate to have an employer or some other group offer the opportunity to buy group life insurance. An insurance policy that covers a group of people is called group life insurance . The group acts as a single unit in buying the insurance.
The cost of group life insurance is less than the cost of a similar individual policy. This savings results from the insurance company covering many people in one policy.
Most group life insurance plans offer term rather than permanent insurance. The insurance company works with an employer or other organization, such as a union, to develop the insurance plan. Then, each employee or member of the organization may purchase individual life insurance coverage.
BUYING LIFE INSURANCE
Many people need the protection offered by life insurance. Without insurance, few people have the financial resources needed to pay for a funeral and other related expenses when someone close to them dies. For a life insurance program to be effective, it must fit your needs and those of your family.
Coverage AmountAnyone with dependents should consider life insurance. A dependent is a person who must rely on another for financial support. In the future, you will need to ask the question, “What would happen to the people who are financially dependent on me if I die tomorrow?” If they could not live financially in the way in which they lived before your death, you most likely need life insurance.
The following questions will help to determine the need for life insurance.
Many people need the protection offered by life insurance. Without insurance, few people have the financial resources needed to pay for a funeral and other related expenses when someone close to them dies. For a life insurance program to be effective, it must fit your needs and those of your family.
Coverage AmountAnyone with dependents should consider life insurance. A dependent is a person who must rely on another for financial support. In the future, you will need to ask the question, “What would happen to the people who are financially dependent on me if I die tomorrow?” If they could not live financially in the way in which they lived before your death, you most likely need life insurance.
The following questions will help to determine the need for life insurance.
- How much money is required for your dependents' financial stability if your income is lost?
- How much income will you need when you retire and what will be the sources of your income?
- What can you afford to pay for your life insurance needs?
- Answers to these questions will help you purchase the best life insurance program for you.
Life Insurance ApplicationTo buy individual life insurance coverage, you need to complete a life insurance application. You apply for this coverage through an insurance agent representing an insurance company.
You may be required to take a physical exam to assess your health. If you have no serious health problems, you then pay a premium and receive your life insurance policy.
If you are in poor health or work in a dangerous job, you may be considered a poor risk. Even so, you likely will be able to get insurance. You will probably pay higher premiums than people who are in good health and are employed in less hazardous jobs.
Premium PaymentsIn addition to the health and occupation of the insured, the type of policy affects the cost of life insurance. The age of the person being insured also affects premiums. In purchasing a whole life policy, for example, the premiums for ordinary life insurance are higher than those for term insurance, but the annual premium stays the same throughout the insured's life. The premiums on limited-payment life insurance are higher than those for ordinary life insurance, but they are payable for only a limited number of years.