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Want to provide financial security for your family and loved ones in the event of your death? Life insurance is one way to give your beneficiaries financial security if the unthinkable happens.
Life insurance is a legally binding contract between you and a life insurance company. A life insurance policy guarantees that the insurer will pay a death benefit to your named beneficiaries if you pass away, so long as you pay premiums for the policy while you’re alive and the policy is still active.
There are several different types of life insurance policies and terms and concepts to understand. Take the time to learn how life insurance works, its benefits and costs, and which kind of policy is right for your life insurance needs.
KEY TAKEAWAYS
- There are two overarching types of life insurance policies: term life and permanent life.
- Permanent life policies, such as whole life, are meant for your entire life, while term life only covers you for a period, such as 10 or 20 years.
- Whether term life or permanent life is best depends on many factors, including why you need coverage, how much life insurance you want and whether you want to ensure that you have life insurance in place when you die.
- No exam life insurance policies are available and can be a good option for older people and those with health problems.
Why would you want life insurance?
The death benefit is the amount of money your insurer will pay out to one or more beneficiaries after you die. A life insurance payout can ensure that your beneficiaries have the financial means to pay the bills and achieve personal goals.
Think of life insurance as a financial tool that can safeguard your partner, children, and loved ones in the result of a loss: namely, your death.
“In practicality, life insurance is much more than a contract. It’s a risk planning tool that can provide income replacement upon the death of a breadwinner, protect families from financial hardship, pay for funeral expenses, cover future expenses for a special needs child, help surviving family pay off debts and other liabilities so that these do not become a financial burden, protect businesses from financial hardship, and more. It is a flexible financial instrument that can be beneficial for individuals, regardless of your socioeconomic status,” says Celeste Moya, senior vice president of Lion Street in Dallas.
Put another way, a life insurance policy can give your survivors financial peace of mind if you’re no longer here to support them.
“If you are planning to start a family, purchase a home, or simply need to cover your final expense costs, you are among the perfect candidates for life insurance,” says Christopher Steven, licensed insurance producer with Ethos Life in San Francisco.
Types of life insurance policies
There are two primary types of life insurance:
- Term life
- Permanent life
Term life is typically the more affordable life insurance option, representing the simplest form of life insurance.
“Term life pays out only if death occurs during the term of the policy, which is usually between one and 30 years,” explains Mark Friedlander, director of corporate communications for the Insurance Information Institute in St. Johns, Florida. “Most term policies offer no other benefits than payout upon death.”
There are two basic types of term life insurance policies
- Level term
- Decreasing term
“Level term means the death benefit stays the same throughout the duration of the life insurance policy. Decreasing term means that the death benefit drops, usually in one-year increments, over the policy’s term,” Friedlander says.
Permanent life insurance, which includes whole life insurance, also pays a death benefit when the policyholder dies. But it doesn’t have to have a predetermined duration; instead, it’s intended to remain in place throughout the policyholder’s lifetime.
“Additionally, many permanent life insurance policies have an equity-like component referred to as cash value. Policies that accumulate cash value have a specified interest rate that is credited each year, which compounds over time, building a cash reserve that can be accessed for various purposes,” Moya notes.
There are several subtypes of permanent insurance, including:
- Whole life
- Universal life
- Variable life
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What is term life insurance?
Term life insurance protects you over a limited amount of time or “term” — such as 10, 15, 20, or 30 years.
“Term life insurance is like renting an insurance policy. When you pay for it, you have it. But when you stop paying for it, you no longer have the coverage,” says Christan Hiscock, co-founder/CEO of Kardia Financial Group in Cowichan Valley, British Columbia, Canada.
The advantages of term life insurance include:
- A lower cost (especially when you’re younger) compared to whole life policies.
- The ability to typically obtain a policy more quickly than a whole life policy.
- Possibly a larger death payout to beneficiaries than other types of life insurance.
Term policies can also often be converted to whole life insurance at a later time.
The drawbacks of term life include the fact that:
- It’s only temporary coverage.
- It may be challenging to qualify for a policy if you have serious health issues.
- You have to re-qualify at the conclusion of each term.
- Premiums can rise each time you take out a new term on the policy.
- The policy itself has no cash value.
“Unless it offers a return of premium feature, which can be costly, at the end of your term, you will have paid premiums into something that does not offer any kind of return or benefit. At that time, your premiums will likely increase substantially as well,” cautions Moya.
How much is term life insurance?
The cost of term life insurance depends on your age, gender, smoking status and health status. Length of policy also factors into term life insurance costs.
Life insurers classify your health, including Regular, Regular Plus, Preferred, and Preferred Plus. Here are some examples of the cost of term life insurance policies.
Average annual premiums for term life death benefit of a 20-year, $250,000 term life plan
| Health profile and term length | Age 30 | Age 40 | Age 50 | Age 60 |
|---|---|---|---|---|
| Female, nonsmoker, Regular health status | $316 | $480 | $961 | $2,324 |
| Male, nonsmoker, Regular | $370 | $567 | $1,232 | $3,149 |
| Female, nonsmoker, Regular Plus | $289 | $432 | $866 | $2,103 |
| Male, nonsmoker, Regular Plus | $337 | $513 | $1,119 | $2,883 |
| Female, nonsmoker, Preferred | $258 | $380 | $758 | $1,853 |
| Male, nonsmoker, Preferred | $301 | $449 | $978 | $2,550 |
| Female, nonsmoker, Preferred Plus | $235 | $343 | $683 | $1,678 |
| Male, nonsmoker, Preferred Plus | $272 | $403 | $881 | $2,314 |
Data source: Compulife Quotation System as of December 2020.
What is traditional whole life insurance?
Whole life insurance offers permanent life insurance protection with guaranteed premiums, cash values, and death benefits.
The base policy death benefit is guaranteed if you pass away, so long as your premium is paid as originally agreed upon. With traditional whole life insurance, both the premium and the death benefit are designed to remain the same throughout the life of your policy.
“The insurer keeps the premium level by charging a premium that, in the early years, is higher than what is needed to pay claims; they invest that money and then use it to supplement the level premium, which helps pay the cost of life insurance for older people,” Friedlander says.
Moya explains that whole life policies classified as “participating” offer the possibility of receiving policy dividends, which represent a portion of the life insurance company’s profits that are paid to policyholders.
“These dividends are generally not guaranteed and are paid at the company’s discretion. A dividend may be taken as cash or a policy may offer several other ways the dividend might be used, such as to reduce current premium payments,” she says.
Other pros besides a guaranteed premium, death benefit, and cash value include:
- The ability for the death benefit to increase over time when your “paid-up additions” option is selected for the dividends or when your cash value exceeds the death benefit.
- Coverage remains in place over your lifetime, unlike term life insurance.
“However, whole life insurance will be more costly upfront because it is a permanent policy,” says Hiscock.
It’s also not very flexible or easily adjustable, Hiscock adds.
What is universal life insurance?
Universal life is a permanent policy that provides more flexibility than traditional whole life policies. That’s because there’s a savings vehicle involved — called a cash value account — that commonly earns a money market rate of interest.
“After money has accumulated in this account, you will also have the option of altering your premium payments — provided there is enough money in the account to cover the costs,” says Friedlander.
Universal life, also known as adjustable life, provides level or flexible premiums and death benefits, with the potential for cash value accumulation. The cash value may rise based on the performance of assets within your account and per the declared crediting rate, which the insurer can increase or decrease at its discretion.
Hiscock equates universal life insurance to purchasing a property you want to build yourself.
“With this policy, you have to choose what kinds of investments you want to put into it to make sure that the policy stands its ground and lasts,” he says. “The con of this kind of insurance is that it is dependent on the market and what you choose to put into the investments. If you choose bad investments, you might have to put more money into the policy in the future to keep it active.”
Universal life provides the added flexibility to modify the policy face amount or premium in response to changing needs and circumstances, according to Moya. She adds that there are several different types of universal life, including current assumption universal life, no-lapse guarantee universal life, index universal life, and variable universal life.
“People like universal life because of its flexible funding options and flexible death benefit that can be decreased, if necessary, to reduce coverage or lower premiums. But unless the death benefit is guaranteed and the premiums have been paid as originally agreed, the policy could lapse early and/or additional premiums may be required to keep the policy in force if it does not perform as originally projected,” Moya says.
What is variable life insurance?
Variable life insurance policies combine death protection with a savings account that can be invested in money market mutual funds, stocks, and/or bonds.
“This type of policy permits you to allocate a portion of each premium to one or more investment options through separate accounts. As with universal life, the death benefit and premium structure may be modified to meet changing needs,” notes Moya.
One advantage of variable life insurance is that the value of your policy may grow more quickly, as there is uncapped growth potential for cash accumulation. However, it can take on more risk, too.
“If investments do not perform well, your cash value and death benefit may decrease,” says Friedlander. “Some policies, however, guarantee that the death benefit will not fall below a minimum level.”
Another drawback? Unless your death benefit is guaranteed and your premiums have been paid as originally agreed, your policy could lapse early and/or extra premiums may be required to keep your policy intact if it does not perform as expected initially.
If you’re more risk-averse, variable universal life policies offer a more conservative fixed account as an investment option that has a declared crediting rate, which is not guaranteed and which can be decreased at the insurer’s discretion down to a contractually guaranteed minimum.
What is no medical exam life insurance?
No medical exam life insurance lets you get a life insurance policy without a physical exam. People who are older or may have health problems can especially benefit from a no exam life insurance policy. The downside of these types of coverage is that they usually cost more than fully underwritten policies that require a medical exam.
Let’s look at three options:
Guaranteed issue
Guaranteed issue whole life insurance provides life coverage without a medical exam or health-related questions. You can’t get turned down for guaranteed issue life insurance.
The amount of guaranteed issue coverage available is limited and usually more expensive than similar life insurance coverage that requires full or simplified underwriting. Also, most guaranteed policies have a waiting period. If you pass away during that waiting period, your beneficiaries receive no death benefits.
Guaranteed issue policies are often final expense insurance, which offers lower death benefits than other policies. Final expense insurance can provide protection for funeral costs and other final expenses. They can also be called burial insurance or funeral insurance.
“Guaranteed issue is ideal for those who would otherwise not be able to obtain coverage due to health issues or other limiting factors and who just need a small amount of coverage,” says Moya, who adds that the max payout amount is typically $25,000, with most qualified applicants ranging in age from 50 to 80 years old.
Simplified issue whole life insurance
Simplified issue life insurance policies require either a simplified application with limited medical questions or a phone interview with a life insurance company representative. No physical exam is usually needed.
“This is a good option for those who are healthy and need coverage quickly and/or don’t want to complete a paramedical exam. The insurer takes the applicant’s information and provides a modified risk assessment to determine premiums. However, your premiums may be higher than if you had undergone the full underwriting process,” Moya explains.
Accelerated underwriting
The accelerated underwriting process involved is similar to simplified issue coverage but may require completing a lengthier questionnaire and providing more medical information.
Be aware that any of these options come with downsides. Consider that providing only limited information makes it more difficult for the life insurance company to accurately assign a medical classification (risk class) to your policy. You may be able to get a lower premium if you go through full underwriting.
Which is better: term or whole life insurance?
The answer to what’s the best life insurance will depend on several factors and your personal needs and circumstances.
“You should consider term life insurance if you need life insurance for a specific period. For example, if you have young children and want to make sure there will be funds to pay for their college education, you might purchase 20-year term life insurance. Or, if you want insurance to repay a debt that will be paid off over a specified time, buy a term life policy for that,” suggests Friedlander.
“Term life insurance is also ideal if you need a large amount of life insurance but have a limited budget. The rate per $1,000 of death benefit is lower than for permanent forms of life insurance. However, you will not typically build equity in the form of cash savings with a term policy, unlike a permanent whole life insurance policy,” Friedlander adds.
On the other hand, if you desire life insurance for as long as you live, the permanent/whole policy will pay a death benefit whether you die tomorrow or live to be over 100.
“If you want to accumulate a savings element that will grow on a tax-deferred basis and could be a source of funds you can borrow from for a variety of purposes, a whole life policy is worth exploring,” adds Friedlander.
“The savings you earn can be used to pay your premiums or for any other purpose you choose. You can borrow from these funds even if your credit is shaky, as well. The death benefit is collateral for your loan, and if you die before it’s repaid, the insurance company collects what is due before determining what goes to your beneficiary,” Friedlander says.
The major caveat here is that premiums for whole life policies are usually higher than for term life policies. The good news is that whole life premiums remain the same, while term insurance premiums can increase significantly each time you renew the policy.
Types of life insurance riders
Life insurance riders are additional benefits that can be added to a basic life insurance policy, usually for a price. These are often available on permanent life insurance policies. Adding one or more riders enables you to customize your policy to your needs.
This allows you and your beneficiaries to have extra financial protection if particular circumstances arise covered by the rider.
Popular life insurance riders include:
- Waiver of premium disability rider –– This rider allows you to stop paying your premium if you become permanently disabled or lose income due to an illness.
- Daily living rider — This rider accelerates a portion of your life insurance policy’s death benefit in the event you’ve been chronically ill for a minimum of 90 days and remain ill for an additional 90 days or beyond. This rider may provide you a daily allowance to cover your long-term care needs, such as assisted living or nursing home care.
- Long-term care rider — This rider helps pay for in-home care, medical equipment, and other health care costs associated with aging.
- Cost-of-living rider — This rider enables you to automatically increase life insurance coverage benefits to your existing policy based on the Consumer Price Index, which counters the effect of rising inflation over your policy’s lifespan.
- Chronic illness rider — This rider provides a way to take out money from your life insurance policy if you’re diagnosed with a qualifying chronic illness.
How to avoid the underwriting process
Many life insurance companies employ accelerated underwriting techniques that allow you to bypass a physical exam and supplement the application process with data from external sources along with new modeling techniques and analytics.
Data analyzed by underwriters include your credit history, motor vehicle record, and medical history from the Medical Information Bureau.
“Then, predictive analytics tools are used to segment and price your risk as an applicant. The result is a significant reduction in the application process timeframe, down from several weeks to one or two business days,” says Friedlander.
The best way to avoid full underwriting is to opt for a guaranteed or simplified issue policy or through an employer-provided group life insurance policy.
“Employer-provided policies insure a group; therefore, the insurance companies price this coverage based on a pooled risk assessment, which allows them to offer coverage without underwriting,” notes Moya.
Two negatives about employer life insurance policies are that the death benefits are small and coverage is usually connected to the job, so you lose the life policy when you leave the job.
Life insurance terminology
It’s smart to become familiar with commonly used words and phrases related to life insurance. You’ill notice these terms mentioned in your policy, and your insurance agent may use them during your conversations.
Here are several of the most important terms to understand:
Accelerated death benefit — This life insurance policy option allows the insured to receive a portion of the policy’s death benefit while they’re still living. These funds can typically be accessed if you have a terminal illness and a life expectancy of 12 months or fewer.
Accidental death and dismemberment — A policy that only pays out a benefit when your death is caused by an accident or when there is the loss or loss of use of a body part. An AD&D policy can be a standalone policy or added as a rider to a life insurance policy.
Beneficiary — The person(s) or entity(ies) you name and a life insurance policy who will receive the death benefit payout when you pass away.
Cash surrender value — The amount, before adjustments for factors like policy loans, that the owner of a permanent/whole life insurance policy is entitled to receive if the policy doesn’t remain in force until the insured’s death.
Coverage period — The period of time during which a life insurance policy remains in force.
Death benefit — The policy proceeds that are paid out to the designated beneficiary(ies) upon the death of the insured.
Group life insurance — A single policy covering a group of individuals, often employees or members of the same organization, and their dependents. Most group policies are owned by an employer and cover their employees.
Insured — The person whose life is covered by the life insurance policy and whose death triggers the payout of the policy’s death benefit.
Living benefits — Benefits that pay out when the insured is still alive, such as in the event of a critical illness or disease for which the policy may pay out a percentage of the benefits.
Living will — A legal document that allows the insured to outline his or her wishes for end-of-life medical care, including procedures or medications desired, in the event they become unable to communicate their decisions.
Mortgage life insurance — A form of decreasing term insurance that covers the life of a person taking out a mortgage loan. Death benefits provide payment of the outstanding balance of the loan. Coverage is in the form of decreasing term insurance, which means the amount of coverage decreases as the debt decreases.
Premium — The payment required to keep a life insurance policy in force.
Rider — An attachment or add-on to a life insurance policy that alters the policy’s terms or coverage.
Underwriting — The process of examining, accepting, or rejecting insurance risks and classifying the ones that are accepted so that an appropriate level of premium can be charged. The underwriting process involves a team of experts who determine if the applicant is qualified or not for the insurance policy.
