Types of Life Insurance
Term life insurance contracts, also known as pure insurance
policies, provide life insurance coverage to individuals for a
specific period of time, or term, commonly issued with five-,
10-, 15-, 20-, 25- and 30-year terms. Because an expiration
date exists, term insurance is considered temporary coverage. Individuals who obtain a term insurance policy enter into a contract with the life insurance carrier that guarantees a specified death benefit in exchange for a specified level premium throughout the term of the contract. Should a policyholder pass away during that term, his beneficiary receives the total death benefit as a tax-free payout.
Term insurance coverage is best-suited for individuals who want coverage for a short-term need, such as replacement of income during working years, funding a child's college education, or protecting the remaining balance of a business or mortgage loan. Young families often choose term insurance as their primary policy type, and business owners select this type of policy during the startup phase to cover key personnel. Because of their temporary nature, term insurance premiums are far less expensive than permanent policies with a comparable death benefit.
Whole life insurance policies fall under the purview of permanent life insurance contracts, which means coverage lasts throughout a policyholder's lifetime, regardless of how long he lives. Also known as cash value life insurance, whole life is the most common type of permanent coverage on the market because of the guarantees it provides to policyholders. An individual who enters into a whole life insurance contract with an insurance carrier agrees to a specified death benefit amount in exchange for a fixed level premium. As long as the premium is paid in accordance with the policy contract, the insured individual's beneficiaries are paid the total tax-free death benefit at the time he passes away.
Permanent life insurance contracts differ from term not only in their duration but also in providing policyholders a benefit that can be used while they are still alive, known as a policy's cash value. With a whole life policy, a portion of premiums paid are siphoned off into the cash value account within the policy, creating a type of savings for the policyholder. Balances within the cash value account of a whole life policy are guaranteed to receive a set rate of return throughout the life of the policy. Funds within a cash value account held in a whole life policy are tax-deferred and may be borrowed against during the policyholder's lifetime. Any unpaid loan balances against the cash value account are withheld from the final death benefit paid out to beneficiaries.
Whole life insurance is far more expensive than term insurance because of the built-in guarantees for the death benefit, the premiums and the interest rate applied to cash value accumulation. Because of the cost associated with whole life insurance coverage and its lifetime guarantees, this type of policy is best-suited for individuals with long-term protection needs, such as retirement income for a spouse.
Universal life insurance coverage also falls under the permanent life insurance category, but differs slightly from whole life. As a form of permanent coverage, universal life policies provide a guaranteed tax-free death benefit to policyholder beneficiaries based on the amount of premiums paid over time. A universal life contract provides access to cash value accumulation like that of a whole life policy; however, cash value within a universal life policy includes a guaranteed minimum interest rate plus an additional interest payment if and when the life insurance carrier experiences higher returns on its own investments.
In addition to the potential for higher earnings on cash value balances, policyholders of universal life contracts have flexibility in terms of the level of total death benefit, premium amounts paid and payment frequency. After the first year of ownership, universal life policyholders have the option to increase, decrease or skip premium payments, so long as the cash value balance is sufficient to cover all policy expenses. Additionally, policyholders of universal life contracts have the option to select a fixed death benefit payout or an increasing death benefit payout for their beneficiaries. The latter is the equivalent of the pure insurance death benefit plus any accumulation in cash value balances.
Universal life policies are less expensive than whole life policies because the guaranteed minimum interest rate is lower for universal contracts, but premiums are more expensive than term policies. Individuals who are in need of coverage for mid- to long-term financial objectives, or those who want more flexibility in premium frequency and amount, may find universal life more fitting than term or whole life coverage.
Another option within the permanent life insurance category is variable life insurance, which provides policyholders the same long-term coverage and cash value benefits as whole and universal life policies. Variable life insurance premiums are fixed like they are with whole life policies, but cash value balances and death benefits fluctuate. This is because variable life insurance cash value balances are invested in various tax-deferred subaccounts provided by the insurance company. Once policy expenses and charges are paid, the remaining premium amount is moved to the cash value account where it is invested based on the policyholder's investment selections. When the subaccounts perform well, a policyholder's cash value and death benefit rise; when they perform poorly, both the death benefit and cash value fall.
Variable life insurance contracts are best-suited for individuals with a long-term need for coverage. The policyholder takes on the risk of the subaccount performance rather than the insurance carrier, creating a policy that is most appropriate for individuals who want to manage their own cash value accounts and risks associated with them. Cash value balances still grow tax-deferred and are available as a policy loan while the insured is still living. Policyholders of variable life pay similar premiums as those who hold universal life contracts.
Variable Universal Life:
Variable universal life insurance coverage is a hybrid of universal life and variable life contracts. Under a variable universal life contract, policyholders have numerous investment subaccounts available to them like they do with variable life policies but also have the flexibility in premium payments and frequency offered by universal life policies. Premium amounts above and beyond the total policy charges and expenses are covered first, with the remaining amount deposited into the cash value account based on the policyholder's investment selections. As with other permanent life contracts, the cash value within a variable universal life policy grows tax-deferred and is available through a policy loan while the policyholder is alive.
The combination of universal life and variable life allows an individual to create a custom policy that suits specific insurance needs for the long-term. However, variable universal life policyholders assume the risk of the underlying investments within the cash value portion of the policy, and death benefit and total cash value can rise or fall over time. Because of the flexibility afforded by a variable universal life policy, policyholders pay slightly more in premiums than universal or variable life policyholders but less than whole life policyholders.
Life insurance coverage is an integral aspect of comprehensive financial planning and estate planning, but there is no single type of life insurance that is most appropriate for every individual. Instead, an evaluation of total death benefit needed, time frame of coverage, and willingness to take on risk within the cash value account are necessary to determine which type of coverage is best-suited for an individual's specific needs.
Death is a part of life. Understand the basics of life insurance and make the right choices to secure the financial future of your loved ones. AFI will hold your hand through the process and we will ensure your family is financially protected.
Life insurance companies use a variety of factors to arrive at a policyholder's premium cost. The customer's age, geographic location, existing health conditions, desired benefit amount and lifestyle are common criteria that companies plug into the algorithms they use to determine premiums. The most subjective of this criteria is lifestyle. Life insurance companies look at several aspects of a policyholder's mode of living and may consider any number of them as evidence the client presents a higher risk factor. A client who represents a high risk factor, meaning the insurance company's actuaries determine there is an elevated probability he will die sooner rather than later, invariably pays higher premiums than a client deemed lower risk.
Lifestyle factors that often affect life insurance premiums include smoking, obesity, occupation and even hobbies. Enthusiasts of such activities as sky diving, bungee jumping, scuba diving and extreme sports, the kinds of things you see at the X-Games, can expect higher life insurance premiums, all other variables being equal, than someone who fishes and plays golf in his spare time.
Obtaining lower life insurance premiums is a simple and effective way to free up money in a monthly budget. Because everyone likes the idea of paying less for the same thing, the following five tips can lead to lower life insurance premiums.
Avoiding tobacco products is the simplest way to pay less for life insurance. Note the word used was simplest, not easiest. The difficulty of quitting smoking, once addicted, is extensively documented. Most would-be quitters try and fail several times before successfully giving up tobacco for good. In addition to better health, smokers thinking of quitting have an incentive to do it now rather than later. Life insurance is more expensive for tobacco users and often by a huge margin. A sample quote for a $500,000, 20-year term life insurance policy for a 30-year-old male has a monthly premium of $20.88 per month for a nonsmoker and $77 per month for a smoker. For a 50-year-old, the dollar amount difference is even starker: $81.35 for a nonsmoker and $337.75 for a smoker. A person who obtains life insurance as a smoker and subsequently quits does not have to apply for a new policy to receive lower premiums. Almost all life insurance companies lower a former smoker's premiums once he has been tobacco-free for a set amount of time.
Apart from smoking, maintaining an unhealthy body weight is one of the biggest reasons people pay more than they should for life insurance. Obesity is linked to a variety of diseases that can lead to an early death, and therefore constitute risk factors to an insurance company. These diseases include diabetes, heart disease, stroke and cardiovascular ailments.
Insurance companies generally use body mass index, or BMI, to determine whether an applicant's body weight falls within a healthy range. The BMI formula considers only two factors: height and weight. It ignores bone structure, body composition, or ratio of muscle to fat, and other variables that might increase a person's weight without contributing to ill health. The calculation does not even distinguish between males and females. In short, it is a flawed measure of health. Nevertheless, a life insurance policyholder needs to be mindful of his BMI if he wants to pay the lowest premium amount.
For a male of average height, which is roughly 5 foot 10 inches in the United States as of 2015, the healthy weight range, as determined by the BMI calculation, is 132 pounds to 173 pounds. Drawing a quick mental picture of this male adult who weighs 132 pounds, and then realizing the BMI metric considers this healthy, provides a good indication of why it is flawed. Once again, however, insurance companies use BMI despite its shortcomings, which means anyone wanting to save on premiums should be aware of it.
3. Be Safe Behind the Wheel
It is common knowledge that moving violations and at-fault traffic accidents lead to higher auto insurance rates. Many people fail to realize, however, that a poor driving record can raise a person's life insurance rates as well.
Not unlike smoking and carrying excess weight, racking up speeding tickets and demonstrating a propensity to get in fender-benders represent risk factors to an insurance company. A policyholder who is careless behind the wheel is statistically more likely to suffer a serious car accident than someone who drives defensively and carefully. Because a percentage of car accidents are fatal, life insurance companies take this into consideration when setting premiums.
Obeying posted speed limits and all traffic laws, looking out for other drivers and keeping a clean moving vehicle record, or MVR, can save big money on life insurance premiums.
4. Lock It In Early
As of 2015, life expectancy in the United States is about 79 years. The closer a person is to this age when he purchases life insurance, the higher his premiums. It is simple math: when an older person buys a policy, the life insurance company expects to have fewer years to collect premiums before it has to pay a death benefit. Term life insurance policies, which only provide coverage for a fixed number of years, are also less expensive when purchased at a young age. This is because a person is statistically less likely to die in his 30s than in his 50s. Young people often act as if they are going to live forever, and they are loath to consider their own mortality. For these reasons, many of them neglect to secure life insurance at an early age while premiums are still cheap. This is a mistake. The younger a person is when he buys life insurance, the less he pays in premiums for the duration of the policy.
Life insurance comes in two types: term life insurance and whole life insurance. Their names describe them very accurately. Term life insurance covers a person for a fixed term, usually 10 or 20 years, though some companies offer term policies in one-year increments from three to 30 years. Whole life insurance, by contrast, provides coverage from the day a person takes out the policy until the day he dies.
Because most term life insurance policies never pay a death benefit, as the policyholder is usually still alive when the term comes to an end, the insurance company can charge much less in premiums and remain profitable. A young person who maintains a healthy weight and does not smoke or skydive can often obtain $500,000 or more in term life coverage for a monthly premium of under $50.