How can so many different products all be called life insurance? Here's a primer on the four basic types, as well as several other terms you're likely to run across as you search for the best policy.
So called because it covers policyholders for a fixed span of time, this is pure life insurance, no MSG or other additives. It always costs much less than whole life policies for everyone except the very advanced in age. There are two types of premiums: level term and annual renewable. Level-term premiums remain constant throughout the life of the policy and can be bought in increments up to 30 years, while premiums for annual renewable increase as you age. Ordinarily, level premiums are higher than renewable premiums in the early years of the policy and lower in the later years. These days the best bargains are to be found in level-term policies of 10 years and more.
Many term policies have a conversion feature that allows you to convert the policy to a whole life product later on without having to submit to a medical exam. That may be a good choice if you're in poor health, but it's a lousy one for just about everyone else.
Whole life combines term insurance with an investment component. A whole life policy has two elements: the mortality charge, the part of your premium that pays for the insurance coverage, and a reserve, the investment component that earns interest. As you age, the portion that goes into the reserve decreases while the portion that pays for the mortality charge increases. In addition to interest, many companies credit the reserve with an annual dividend, depending on the insurer's loss experience and investment performance.
The cash surrender value (which is also called the cash value) is what you'd get if you cashed in your policy. If you decide to give up your policy, your cash surrender value can be paid in cash or paid-up insurance. There are several problems with using whole life as a savings vehicle, however. One is that the policy's advertised rate of return, as disclosed in a set of hypothetical numbers called the policy illustration, can have little or no relation to reality. In fact, the policy's returns will fluctuate with the markets -- and will usually trail returns available from other investments like equity mutual funds. Another problem is that whole life is extremely expensive, and if you're on a limited budget, you may not be able to afford all the insurance coverage you actually need.
Wealthy people sometimes use whole life policies as an estate-planning vehicle. They can set up an insurance trust, which applies the proceeds of the policy to their estate taxes when they die. That can save their heirs the considerable expense of settling the estate with Uncle Sam.
Universal, like whole, combines insurance with savings. The savings component, called an accumulation fund, earns interest monthly and is used to pay the mortality charge. The oft-repeated sales pitch for universal is that premiums are flexible -- as long as you pay enough to maintain the mortality charge, you can skip adding to the accumulation fund if money is tight. And if you contribute enough to the accumulation fund in the policy's early years, it can throw off enough income to pay your premium in later years.
But there are significant drawbacks to universal policies. If you skimp on premiums in the policy's early years, you can be socked for higher charges later on, when you expected to be paying little or nothing. The alternative is to drop the policy and withdraw the savings you may have built up. If you drop the policy, you may have to pay a surrender charge.
Variable-life insurance combines a mortality charge with a savings vehicle that you choose from among a number of alternatives offered by your insurer. The savings vehicle is usually one of several investment portfolios that are structured like mutual funds. On average, most companies offer 10 different portfolios, including stock, bond and money-market funds. The insurers often manage these funds themselves, collecting fees for administering the insurance and managing the portfolios.
There are two basic types of variable life. One demands a fixed premium payment. The other, variable-universal life, has a flexible premium like universal life. Remember, though, that variable returns can fluctuate with the financial markets. If the stock market takes a hefty dive, you may find the cash-value portion of your policy in the tank. Variable life is not appropriate for people who are on a tight budget or are likely to need to tap their savings on short notice. Many variable buyers would be better off buying term and making a separate investment in a mutual fund.
Return of Premium
This type of life insurance is essentially a hybrid between term life and whole life. You buy a return of premium policy for a set amount of time -- say, 30 years. You make your payments every year, and in the event that you pass away, your heirs are paid the face value of your death benefit. Here's the part that appeals to a lot of people. Should you outlive your policy, the insurer sends you a tax-free check for the full amount that you've spent on premiums over the lifetime of your coverage. In the words of one agent, it's a win/win situation. There is a downside. Price. In order to guarantee you your premiums at the end of the 30 years, the insurer charges you an additional 50% over the cost of a standard term policy
The reason why many insurance companies would rather go to you than have you come to them. People with poor health are more apt to apply for or continue insurance than those with average or better-than-average health expectations.
The person or persons designated by the policyholder to receive the proceeds of an insurance policy upon the death of the insured. The policyholder can name both a primary and secondary beneficiary.
How much money you would be paid at any given time if you cancel your whole life policy. It's also the amount you can borrow from the policy, or its loan value.
The time period during which the insurer is not obligated to pay a claim (usually two years), because of material misrepresentations found in the application. A policy becomes "incontestable" when the contestability period is over.
A proposal showing a policy's future payments, cash value and death benefits. Non-guaranteed values are based on the company's current rates of interest, mortality and expenses. Watch out for these because they often contain unrealistic assumptions.
Medical Information Bureau
A private company that collects medical information on behalf of life insurance companies who are members of MIB. Member companies are required to provide brief, coded reports of individual medical histories of customers to MIB on a confidential basis. These reports do not include indication as to whether or not an application is issued, rated or declined.
The cost of the insurance protection on a whole life product. On an illustration, mortality charges referred to as "current" are not guaranteed. Those stated as "maximum" are the contract guarantees. The mortality charge is similar to a one-year term rate and increases with the insured's attained age. For example, a typical $100,000 whole life policy for a 40-year-old male carries a premium of about $2,000 a year. Of that, roughly $350 is the mortality charge, and the rest of the premium goes toward the investment portion.
Insurance companies used to have just three classes -- standard (the lowest), select (middle) and preferred (the best rates). But some insurers have been slicing classes into many more categories. That's why it pays to shop around because you may be placed in the best rating class by one company's criteria and a notch below by another.
A type of life insurance policy that insures two lives. The death benefit is payable at the second death. Generally, this product is used as a funding vehicle for estate taxes payable at the second death when the unlimited marital deduction is utilized. Also referred to as survivorship policies. Be sure to compare the cost of two separate policies before signing on for one of these.
Single Premium Life Insurance
Requires one lump-sum, up-front premium and is often guaranteed to remain paid-up throughout the insured's lifetime. Beware. These policies sometimes don't come with a guarantee that future payments will never be required, a fact the agent may gloss over.