Five Different Types Of Life Insurance Policies And What They Mean For Individuals

Post by Sharat on May 15, 2009 · Under Featured Articles, Hints and Tips, Life Insurance, Personal Finance, Self Help, Wealth Management, insurance, investments · Comment

Life Insurance is an extremely dry topic at the best of times, and everybody at some point will have been pitched for a policy. Individuals need to take the time to establish whether it is something they need, and like with things that tend to be boring, but important, the sooner the better, otherwise it may be too late.

Not everyone needs to buy life insurance; it fulfils specific purposes which may not be required. For those people that do need to have some kind of life insurance policy they need to be careful about taking out a policy which fulfils the individuals needs and provides the security in death or retirement that the individual needs. Here are a number of things to consider.

Does The Individual Need Life Insurance?

The answer to this question depends, ironically, on whether anyone depends on the individual.

Individuals who have families they support, children wives or husbands, probably do need life insurance, because those people often depend on the individual financially and the loss of the main bread winner should be insured to some degree.

Even for those individuals that do not work, housewives for example, provide for families in a way that cannot really be quantified properly, raising children, keeping house, doing the cooking are all functions that are extremely important and therefore in a family, both parents or husband and wife should be insured.

One of the main reasons for taking out a life insurance policy is when spouses hold a joint mortgage, and may have trouble making payment in the event the other spouse dies. Having an insurance policy will go a long way to making sure that homes are kept and obligations to the bank are met.

Types of life insurance

There are three key types of life insurance:

1) Level Term Assurance.

This type of life insurance lasts for a specified period which needs to be renewed at the end of each term. After that period, the insured can either drop the policy or pay annually increasing premiums to continue the coverage.

In fact every time the word term is used in the context of insurance, then it means the insurance is only valid for the duration of a term.

A version of term insurance which is commonly purchased is annual renewable term (ART). In this form, the premium is paid for one year of coverage, but the policy is guaranteed to be able to be continued each year for a given period of years. This period varies from 10 to 30 years, or occasionally until age 95. As the insured ages, the premiums increase with each renewal period, eventually becoming financially unviable as the rates for a policy would eventually exceed the cost of a permanent policy. In this form the premium is slightly higher than for a single year’s coverage, but the chances of the benefit being paid are much higher.

The simplest form of term life insurance is for a term of one year. The death benefit would be paid by the insurance company if the insured died during the one year term, while no benefit is paid if the insured dies one day after the last day of the one year term. The premium paid is then based on the expected probability of the insured dying in that one year.

Because the likelihood of dying in the next year is low for anyone that the insurer would accept for the coverage, purchase of only one year of coverage is rare.

One of the main challenges to renewal experienced with some of these policies is requiring proof of insurability. For instance the insured could acquire a terminal illness within the term, but not actually die until after the term expires. Because of the terminal illness, the purchaser would likely be uninsurable after the expiration of the initial term, and would be unable to renew the policy or purchase a new one.

This issue is frequently overcome by a feature in some policies called guaranteed re-insurability included on some programs that allows the insured to renew without proof of insurability.

Term insurance is often the most inexpensive way to purchase a substantial death benefit on a coverage amount per premium dollar basis.

In terms of payout in the event of a death, dependants receive a lump sum payment from the insurer. The amount is constant or level and stays that way for as long as the policy is in effect. Payouts can be changed or negotiated once the term expires, obviously a larger premium, resulting in a larger payout.

2) Decreasing Term Assurance.

As the name suggest the payout from this type of insurance decreases as time progresses and is best suited to borrowers such as mortgage holders who are concerned that the debt should be paid of in the eventuality of their death. Since the amount owed decreases over time, it makes sense for those individuals, worried that the debt should be paid off, to have a policy which also has a decreasing payout as time progresses. Obviously as the payout decreases, so too does the premium that needs to be paid.

This type of insurance is best suited for borrowers on repayment mortgage deals. For those on an interest-only mortgage deal, decreasing term assurance would not suit them, since instead of gradually reducing the amount owed each month, individuals only paying the interest on that debt, and therefore the size of the debt stays the constant. That means for those types of borrowers wanting to ensure that in the event of their death their debt is paid, then the payout level needs to stay constant as well..

3) Whole of Life Assurance

Whole Life is a life insurance policy that remains in force for the insured’s whole life and requires (in most cases) premiums to be paid every year into the policy. There are a number of different types of Whole Life Assurance, to simplify the discussion we confine it to two

Non- Participating

All values related to the policy (death benefits, cash surrender values, premiums) are usually determined at policy issue, for the life of the contract, and usually cannot be altered after issue.

This means that the insurance company assumes all risk of future performance versus the actuaries’ estimates. If future claims are underestimated, the insurance company makes up the difference. On the other hand, if the actuaries’ estimates on future death claims are high, the insurance company will retain the difference.

Participating or With Profits

In a participating policy the insurance company shares the excess profits (variously called dividends or refunds in the USA, bonus in the Commonwealth) with the policyholder. Typically these refunds are not taxable because they are considered an overcharge of premium. The greater the overcharge by the company, the greater the refund or dividend. For a mutual life insurance company, participation also implies a degree of ownership of the mutuality.

4) Universal Life Insurance

Universal Life is a type of permanent life insurance based on a cash value. That is, the policy is established with the insurer where premium payments above the cost of insurance are credited to the cash value. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance (COI) charge, and any other policy charges and fees which are drawn from the cash value if no premium payment is made that month. The interest credited to the account is determined by the insurer; sometimes it is pegged to a financial index such as a bond or other interest rate index.

5) Variable Universal Life

Variable Universal Life Insurance (often shortened to VUL) is a type of life insurance that builds a cash value. In a VUL, the cash value can be invested in a wide variety of separate accounts, similar to mutual funds, and the choice of which of the available separate accounts to use is entirely up to the contract owner. The ‘variable’ component in the name refers to this ability to invest in separate accounts whose values vary–they vary because they are invested in stock and/or bond markets. The ‘universal’ component in the name refers to the flexibility the owner has in making premium payments. The premiums can vary from nothing in a given month up to maximums defined by the insurer. This flexibility is in contrast to whole life insurance that has fixed premium payments that typically cannot be missed without lapsing the policy.

Variable universal life is a type of permanent life insurance, because the death benefit will be paid if the insured dies any time as long as there is sufficient cash value to pay the costs of insurance in the policy. With a typical whole life policy, the death benefit is limited to the face amount specified in the policy, and at endowment age, the face amount is all that is paid out. Thus with either death or endowment, the insurance company keeps any cash value built up over the years. With a VUL policy, the death benefit is the face amount plus the buildup of any cash value that occurs (beyond any amount being used to fund the current cost of insurance.)

	Insurance Type	Premium	Death Benefit	Cash Accumulation	Investment Choice
Term	Level Term Insurance	Relatively low, fixed	Fixed during the term, then zero	No	No
	Renewable Term Insurance	Relatively low, increasing	Fixed	No	No
	Decreasing Term Insurance	Relatively low, decreasing	Decreasing during the term, then zero	No	No
Permanent	Whole Life Insurance	Relatively high, fixed	Fixed minimum amount, some upside	Yes	No
	Universal Life Insurance	Relatively high, flexible	Variable	Yes	No
	Variable Whole Life Insurance	Relatively high, fixed	Fluctuates with the performance of the investment	Yes	Yes
	Variable Universal Life Insurance	Relatively high, flexible	Fluctuates with the performance of the investment	Yes	Yes