In general, two types of life insurance exist – term plans, permanent plans or something that combines both. A variety of term plans are offered by life insurers, as well as the traditional ‘interest sensitive’ options which have become more common from around the mid-1980s onwards.
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Under term protection, a specific period of time is covered. The period may be short, for instance just one year, or it may cover a set number of years such as 5 years, 10 years and so on. The term may also be to a specified age such as 80, or at times it may go as far as the oldest age shown in the insurance mortality tables.
Each policy will have a premium guarantee, this will vary with the policy. The initial premium will be higher when the premium is longer. In the event of your death during the period of the term, the insurers will make a payment to your beneficiary of the face amount. If you outline the term period, a payment will not be made. In general, term policies will have a death benefit but will not have a cash value or savings factor to them.
The policy terms will stipulate that premiums are to be locked in for a set period of time. During the earlier ages, the premiums are lower in comparison with what you will pay for permanent insurance, however, they do increase as you get older.
You may be able to convert your term plan into a permanent plan. You may be able to get ‘level’ coverage, in other words, you will receive the same benefit until the policy runs out, or you may be able to have ‘decreasing’ cover for the period of the term which will keep your premiums the same.
In the event that you don’t pay the premium for a term policy, you will likely not see a cash value, in contrast to a permanent policy where the cash value factor is normally present. We are currently seeing very competitive rates for term insurance, in fact, they are at an all-time low.
It is worth noting that, in general, term insurance is seen as the most inexpensive pure life insurance cover. It is important to carefully review the terms of the policy to ensure that you choose the option which best meets your specific needs.
A Look At The Types Of Term Insurance:
Renewable Term Insurance: With this option, you will be able to renew for a further period when the term finishes, this is not dependent on your health. Each new term sees an increase in the premium cost. One significant advantage to this option is your right to renew the policy without needing to prove insurability. If not, you may find that your health deteriorates and you are not able to secure a policy, or at least not at the same cost, resulting in you and your beneficiary being without cover.
Convertible Term Insurance: In these plans, you can generally convert your term policy into a permanent plan. During the conversion period, you will be able to take up on this option. The type of policy you choose will determine the conversion period. If you make the conversion within this set time, you will not need to provide any further health details. Normally, the new rate will be calculated using your ‘current attained age’, this being how old you are on the date you make the conversion. Often, this choice allows you to benefit from the best protection with the least expense.
Level Or Decreasing Term Insurance: Within the level policy, you will have the same face amount for the complete period. In a decreasing policy, the face amount will decrease as time goes by. You will have the same premium each year. You will often see these policies being sold as mortgage protection as the insured amount goes down as the mortgage balance decreases. In the event that the insured person dies, the policy payout can be used to pay the mortgage in full.
Adjustable Premium Insurance: The tradition has been that insurers cannot change a premium once they have sold a policy. Hence when calculating the premium insurers may make use of interest rates, expense rates, and conservative mortality. Under an adjustable premium the insurer can offer a lower ‘current’ premium price based on set assumptions, however, they are able to change the premium amount in the future. That being said, they cannot increase the premium to exceed the specified maximum premiums which are set out in the policy.
Permanent Insurance (Ordinary Life or Whole Life)
Term insurance is all about giving cover for a set period of time, whereas permanent insurance provides an entire lifetime of cover. So that the rate is level, the premium paid at a younger age is greater than the real protection cost. This means that a reserve (a cash value) builds up which then assists with the premium payments later on since the actual cost of protection will increase.
In whole life policies, the insurance cost is spread over a more extended period of time which levels out what would be an increase in cost. Some policies will stipulate that payments must be made for a specified number of years. Other policies will allow for payments throughout the lifetime of the insured. The excess premium dollars are invested by the insurers.
This policy type is at times referred to as cash value life insurance and has a savings factor to it. For permanent insurance, having a cash value is essential. How the cash value increases will be dependent on the company chosen. At times, the cash value amount and the premiums paid may not correlate. While the insured is still alive, they are able to access the cash value of the policy.
The vital elements of a policy are the premium paid each year, the death benefits offered and the cash surrender value which would be paid to the insured if they decided to surrender their policy while still alive. It is possible to take out a loan against a policy’s cash value, however, if the loan remains outstanding this will decrease the death benefit.
Several adjustments were made to tax laws during the year of 1984 that affected permanent insurance plans. Policies now had to provide coverage up to age 95, limit their premium payments, and establish a certain ration between the face amount of the policy and the cash value.
The two primary types of permanent insurance had to include many variations to cooperate with the new legal changes. These two types are known as interest-sensitive and traditional whole life policies. The policies could be either variable policies or fixed-dollar policies.
Traditional Whole Life Policies:
These policies are based primarily on estimates of the expense of the policy over time as well as interest earnings and mortality estimates. These estimates impact the cost of premiums, the available benefits, and the cash value of the policy. Traditional whole life policies can come in six different variations.
A non-participating policy is advantageous for those who prefer constant, standard payments throughout their life. The policy is provided at a fixed cost and the premium payments generally require very little money out of pocket. The only real setback to this particular policy type is that it doesn’t pay dividends to its policyholders.
Think of this as the counterpart to a non-participating plan. The payments are not necessarily fixed and can fluctuate. The primary advantage of this type of plan is that it pays dividends.
The insurance company’s dividends can come from investment earnings, savings, or favorable rates of mortality. Those dividends are then paid to the policyholders using various means. They may come as cash, added to an account to gain interest, or used to reduce the cost of premiums. However, it’s important to know that there is no guarantee of a dividend.
- Indeterminate Premium
In many ways, an indeterminate premium whole life plan is similar to a non-participating plan. The major difference is that inclusion of flexible premiums that can be adjusted at a later time. The premium is adjusted in correlation with the insurance provider’s profit margins as a whole. This means the premiums are lower when the company is doing good and higher when the company is doing badly. The premium should never exceed a guaranteed maximum.
An economatic policy combines a portion of participating whole life with supplemental coverage. The supplemental coverage is gained through the use of dividends. It can be a great policy if the insurance provider can supply sufficient dividends. Those dividends add additional paid-up insurance to the policy. If the dividends are unable to cover the current supplemental coverage, then that coverage will be decreased to a level that the dividends can cover. Therefore, there is some degree of risk with this coverage type.
- Limited Payment
Some people don’t want to spend their entire life worrying about paying premiums. For those people, a limited payment whole life policy would be a great choice. It requires only a limited number of premium payments paid over a short period of time. However, the premium payments will be significantly higher than the average premium. The benefit is that the payments are made and out of the way for good.
- Single Premium
A single premium whole life policy is a step up from the limited payment policy. You only pay for one premium payment and then you receive a whole life policy. It is often viewed as an investment opportunity. The single payment is rather substantial and there are severe fees if the policy is cashed during the first one to three years in most cases.
Many people have turned to single premium whole life policies because the cash value is tax-deferred. You can then borrow on the cash value of the policy and taxes are to be paid on the gains. The only setback is the substantial fees incurred when surrendering the policy.
Interest Sensitive Whole Life Policies:
One of the primary differences between traditional and interest sensitive whole life plans is how investment earnings are allocated. Investment earnings are used to quickly reflect changes in interest rates.
Therefore, changes in interest rates are applied to policyholders at a faster rate. This is both an advantage and a disadvantage depending on which way the interest rates fluctuate.
There are a total of four primary types of interest sensitive whole life insurance policies.
Universal Life Policy
This policy is not only sensitive to interest rates but also quickly reflects changes in the insurance company’s expenses and mortality rates. Each of the three components of a policy is approached separately. These three components are the benefits, the cash value, and the premium. These are also the three components targeted by the 1984 tax laws.
Companies providing this insurance policy have something known as a mortality deduction charge. This is the company’s expense and the cost of the insurance protection. They often deduct this charge from their cash value account. The balance of that account continually accumulates according to the interest that is credited. They also set limits with a minim rate of interest and a maximum mortality charge. The lower the charge and the higher the cash value, the better for the policyholder.
Another charge commonly used is the expense charge, which also has a maximum limit. Most companies will make very conservative guarantees to their clients. Current interest rates play a big role in determining projections. These projections are very important for interest-sensitive policies.
Of all the available policies, universal life is the most flexible. Here, all the elements of the policy are treated separately and you’re allowed to change or skip the premium payments as well as change the death benefit effortlessly compared to other policies. You have two options of death benefits to choose from with this policy.
Under the first option, the beneficiaries can only receive the face amount of the policy. On the second option, the beneficiaries will receive the cash value account and face amount. If you’re looking to get the maximum amount of the death benefit, the second option is more preferable. Once you choose the policy, you will pay a planned premium to keep the policy in place.
It accumulates the cash value which is based upon the interest, expenses and any mortality charges assumed. These assumptions need to be realistic to keep you from paying more just to keep the policy from lapsing or decreasing.
Note that, if the experience is much better then there’s the assumption that in the future you can skip a premium, pay a lesser amount or pay up the plan earlier.
It’s not mandatory for you to pay the planned premium but if you pay a lesser amount you will get a better benefit like term insurance.
Here, the policy is enforced for a limited time without building any cash value. If you pay more with realistic assumptions, you can pay up the policy earlier than planned. By surrendering the universal life policy, you’re going to receive less than the cash value amount.
There are surrender charges in place and they are categorized into two. There’s the front-end type of policy which deducts a percentage of the total amount of premium paid. On the other hand, there’s the back-end type of policy where a substantial charge is deducted once you surrender the policy before a specified period, around 10 years but can be twice as long. If you’re planning on maintaining coverage, the back-end type of policy is the most preferable since the charge decreases every year the policy is in place.
Keep in mind that the interest rate and expense, as well as the mortality charges, are not guaranteed for the entire life of the insurance policy. Yes, this type of policy grants you maximum flexibility but it’s a good idea to manage the policy to guarantee sufficient funding. That’s because there’s a chance that the insurance company can increase expense charges as well as mortality payable. As you get older, you should expect an increase in the mortality charges.
Excess Interest Whole Life
If you’re not pleased with the universal life policy, you can always try out the fixed premium versions, referred to as excess interest whole life. Just like traditional whole life policies, the premiums here are required even when they are past due. When you pay the premiums when they are due, the policy will stay in place.
The cash value of the policy will increase with a fixed premium level, crediting of excess or additional interest and also a better life insurance experience. Note that the premium level is similar to those of traditional whole life policies. For future premium payments, cash value may be applicable. The insurance policy maximizes the deferred tax growth of the cash value.
Current Assumption Whole Life
It is similar to the universal life policy but the insurer determines the total amount of premiums payable. The premium is determined by the current estimate of any future investment earnings and the mortality experience. The insurer also has the contractual right to change the original estimates to decrease or increase the premium payments.
When the premiums increase, you’re allowed to reduce the face amount of the policy, allowing you to pay the original amount. You can credit the current mortality, experience and investment earnings to the insurance policy. It can be done through the premium/dividend structure (if it is a mutual or stock company) or the cash value account.
Some of the characteristics of this policy include the following:
- The premium amounts can change based on the overall experience (the investment, expenses or mortality) of the company. As the policy owner, you don’t have any control over these changes.
- Just like you would with the traditional life insurance policy, you can use the cash value of the policy to make loans.
- Similar to traditional life insurance, there’s a minimum amount of cash value on a guarantee.
- There’s no fluctuation on the death benefit.
Single Premium Whole Life
Here the premium is determined by the assumption of the current interest rate. If the interest rate drops, you might be requested to increase the premium payments, if the coverage is terminated. The first interest rate is fixed for about a year while in some instances it takes about three or five years. The guaranteed rate is also lower, about 4% for elderly parents. There’s also another feature, the no-cost loan. Here, companies set a loan interest rate which is charged on the policy loans, equal to the rate credited to the policy.
Interest sensitive and traditional life policies are purchased on either a variable or fixed dollar basis. In the first option, the face amount, premiums and cash values are specified in dollar amounts. On the second option, the cash value, face amounts are specified in units. Depending on the investment results, the value of these units might go up or down.
With this type of policy, you have various options of allocating the premiums which include money market, stocks, mutual funds, bonds and real estate pools. Of course, it depends on the size of risk you’re willing to take on, hoping for a bigger return. There’s a minimum guaranteed death benefit with the traditional variable life.
Note that, most of the universal variable life products, don’t have this option. If the investment experience is bad, the coverage comes to an end if the higher premiums are not paid in time. The policy is available on single premium options but there are additional premiums if the investment experience is very poor.
Other Life Insurance Basic Plan Variations
Credit Life Insurance
While it is possible to obtain credit life insurance individually, this policy is usually sold to creditors (such as financial institutions, banks, and companies selling pricey items on installment plans) on a group basis. This insurance policy is specially designed to help creditors avoid bad debts by taking care of any outstanding balance should a borrower pass on, or be unable to repay a loan in full.
Some of the debts covered under credit life insurance policy include auto loans, personal loans, mortgage loans, revolving check loans, bank loans, educational loans, and loans to cover farm equipment or mobile home purchases.
Credit life insurance just offers additional protection for loans and pricey purchases to creditors. Under normal circumstances, the lender or company will require you to buy this cover before they can process your loan request or intention to purchase an item using installments.
The insurance policy certificate provided should outline insurance charges and group policy provisions too. The best thing about this type of insurance is that it doesn’t necessarily have to be purchased from the same creditor.
Credit life insurance plans offer a maximum coverage of $220, 000 for mortgage loans, and up to $55,000 for other loans/debts.
Should you choose to terminate a group life policy by defaulting or prepaying a loan, or the plan is terminated automatically, you could be entitled to a partial reimbursement for premiums paid. Your certificate should detail how much to expect back from this. If a creditor puts life insurance as a requirement for applying for a loan, you could use an existing life insurance policy to make the application. Experts, however, recommend going for the more expensive group credit life insurance for it is readily available and convenient for all. You also don’t have to provide proof of insurability to qualify for the cover.
Monthly Debit Ordinary Insurance
Unlike many other types of insurance, monthly debit insurance premiums are collected by an insurance agent at your home monthly. Policyholders may, however, choose to mail the premiums to the insurance company or its agent for convenience purposes. Monthly debit insurance policies may at times be costlier than the regular life cover plans.
Some of the factors that contribute to this include:
- Size of the plan: Small sized policies attract higher premium rates per $1,000 worth of insurance as compared to larger sized life insurance policies.
- Policy expiry time: Most debit policies have a shorter expiry time as compared to regular life insurance plans that last more than two years. Going for a plan with a shorter lapse, therefore, attracts higher premium rates.
- Commission rate: With agents required to make home collections, servicing this is considerably more expensive for the insurance company. These costs are however passed down to the policyholder, which again makes it a more expensive option.
Although monthly debit ordinary life insurance may seem affordable on the short-term, the higher lapse rates, smaller amounts, fees, and higher commissions make it an expensive option for most people. If possible, consider the regular life insurance plan that comes at no extra cost and offer more coverage.
Modified Life Plan
Modified life insurance provides almost the same level of coverage as whole life insurance, only that it has been amended to accommodate low-income earners at the start. Policyholders are allowed to pay lower premium rates for the first few years, then pay more after the stipulated time. This plan is specially designed for individuals that need whole life insurance but cannot afford it at the moment, but will be able to pay the higher rates later on in life.
The Family Life Insurance Policy
This insurance policy is best suited for married couples and those with immediate beneficiaries. Family life insurance protects the husband, wife, and children all under one contract. This policy is however sold in protection packages commonly known as a unit. In such, the primary breadwinner gets the highest coverage at say $5,000, $1,500 for the spouse and each child receiving at least $1,000.
Survivor and Joint Life Insurance
This policy provides joint protection for two or more policyholders’ seniors under most instances. If one of the policyholder dies, the other gets the death benefits. Premiums are however much lower as compared to getting individual cover for each. This is mainly because the probability of paying a death claim is significantly reduced.
Joint Life Insurance
Joint life insurance is almost similar to survivor life insurance; only that death benefits are paid at the first death. This policy protects more than two persons (policyholders)at a go. Unlike survivor life cover, insurance premiums for joint life insurance are considerably much higher. This is because chances of one of the policyholders dying are much greater.
This policy provides life cover for a particular set period with a specific face amount tied to the same. If the policyholder dies within the set period, the immediate beneficiaries get the set face amount as payment. Should the fixed period of time elapse, the insurance company is obligated to pay the face amount to the policyholder. Due to the recent tax laws, endowment insurance plans are no longer considered part of life insurance. This makes the lump sum taxable. Most insurance companies have since scrapped this insurance plan.
As the name suggests, this insurance policy is specially designed for juveniles. Death benefits from this cover may, however, vary based on the child’s age.
Children under the age of 15 years, however, qualify for at least $50,000 in a lump sum, with at least 50% of the amount paid if the child survives the juvenile stage.
There are however limitations for children under the age of 4, with the applicant earning 25% of the benefits. Some insurance companies offer additional benefits on juvenile insurance, such as a payor benefit rider. The payor benefit rider waivers future premiums on the policyholder (the child) should the guardian (the person paying the insurance) pass away.
Commonly termed as a graded death benefit plan, senior life insurance plans provide minimal whole life coverage to eligible seniors. No medical exam is needed when applying for this plan. This policy features little to no underwriting, with benefits only paid should death occur within a specified period of time (between two and three policy years).
Only individuals aged between 50 and 90 years are eligible for this cover. This plan offers $25,000 maximum amount in lump sum. Premium rates for senior life plans are considerably much higher than with other life insurance policies that require a medical exam and an underwritten policy.
Pre-need insurance plans are specially designed for a small face amount, mainly for burial expenses. This type of insurance may also fall under monthly debit ordinary insurance as well. As mentioned earlier on, insurance premiums for the same are considerably higher when compared to regular life insurance plans.