Life insurance: Encyclopedia II - Life insurance - Types of life insurance

Life insurance - Types of life insurance

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

Life insurance - Term

Term life insurance (Term Assurance in British English) provides for life insurance coverage for a specified term of years for a specified premium. The policy does not accumulate cash value. Term is generally considered "pure" insurance, where the premium buys protection in the event of death and nothing else. See Theory of Decreasing responsibility and Buy term and invest the difference.

The three key factors to be considered in term insurance are: face amount (protection), premium to be paid (cost to the insured), and length of coverage (term).

Various (US) 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. A common type of term is called annual renewable term. It is a one year policy but the insurance company guarantees it will issue a policy of 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. Another common type of term insurance is mortgage insurance, which is usually a level premium, declining face value policy. The face amount is intended to equal the amount of the mortgage on the policy owner’s residence so the mortgage will be paid if the insured dies.

Guaranteed renewability is an important policy feature for any prospective owner or insured to consider because it allows the insured to acquire life insurance even if they become uninsurable.

Life insurance - Permanent

Permanent life insurance is life insurance that remains in force 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 in the application, and that cancellation must occur within a period of time defined by law (usually two years). Permanent insurance builds cash value, providing a type of savings account that the policy owner can access if needed either by borrowing against the policy or surrendering the policy and receiving the surrender value.

The three basic types of permanent insurance are whole life, universal life, and endowment.

Whole life insurance provides for 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 known annual premiums, and mortality 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 in the policy may not be competitive in with other savings alternatives. Riders are available that can allow one to increase the death benefit by paying additional premium. The death benefit can also be increased through the use of policy dividends. Premiums are much higher than term insurance in the short-term, but cumulative premiums are roughly equivalent 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.

Universal life insurance is a relatively new insurance product intended to provide permanent insurance coverage with greater flexibility in premium payment and the potential for a higher internal rate of return. A universal life policy includes a cash account. Premiums increase the cash account. Interest is paid within the policy (credited) on the account at a rate specified by the company. This rate has a guaranteed minimum but usually is higher than that minimum. Mortality charges and administrative costs are charged against (reduce) the cash account. The surrender value of the policy is the amount remaining in the cash account less applicable surrender charges, if any.

The universal life policy addresses the perceived disadvantages of whole life. Premiums are flexible. The internal rate of return is usually higher because it moves with the financial markets. Mortality costs and administrative charges are known. And cash value may be considered more easily attainable because the owner can discontinue premiums if the cash value allows it. And universal life has a more flexible death benefit because the owner can select one of two death benefit options. Option A pays the face amount at death and Option B pays the face amount plus the cash value.

But universal life has its own disadvantages which stem primarily from this flexibility. The policy lacks the fundamental guarantee that the policy will be in force unless sufficient premiums have been paid and cash values are not guaranteed.

A type of universal life is called Variable universal life Insurance in which the rate of return on the cash account is related to stock or bond market fluctuations.

Another type of permanent insurance is Limited-pay life insurance, in which all the premiums are paid over a specified period after which no additional premiums are due to keep the policy in force. The most common kind of limited pay is twenty-year limited pay. Another kind is paid-up when the insured is sixty-five.

Endowments are policies which mature (endow) before the normal endowment age. Endowments are considerably more expensive (in terms of annual premiums) than either whole life or universal life because the premium paying period is shortened and the endowment date is earlier. Annuities are a financial product issued by life insurance companies but are not life insurance policies. They are discussed in annuities.

Accidental death is a limited life insurance that is designed to cover the insured if they pass away due to an accident. Accidents include anything from an injury, but do not typically cover any deaths resulting from health problems or suicide. These policies are much less expensive than other life insurances because they only cover accidents. Often, it does not cover an insured who puts themselves at risk in activities such as: parachuting, flying an airplane, professional sports or involvement in a war (military or not). To be aware of what coverage they have, an insured should always review their policy for what it covers and what it excludes. It is also very commonly offered as a accidental death and dismemberment policy, known as an AD&D policy. In an AD&D policy benefits are available not only for accidental death, but also for loss of limbs or bodily functions such as sight and hearing, etc. Accidental death and AD&D policies very rarely ever pay a benefit because either the cause of death is not covered, or the coverage is not maintained until death occurs. Accidental death benefits can also be added to a standard life insurance policy as a rider. If this rider is purchased, the policy will generally pay double the face amount if the insured dies due to an accident. This used to be commonly referred to as a "double indemnity" coverage.

Adapted from the Wikipedia article "Types of life insurance", under the G.N U Free Docmentation License. Please also see http://en.wikipedia.org/wiki