Types of Life Insurance

There are two major types of life insurance—term and whole life. Whole life is sometimes called permanent life insurance, and it encompasses several subcategories, including traditional whole life, universal life, variable life and variable universal life. In 2003, about 6.4 million individual life insurance policies bought were term and about 7.1 million were whole life.

Life insurance products for groups are different from life insurance sold to individuals. The information below focuses on life insurance sold to individuals.

Term Life Insurance

Term Insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy, which is usually from one to 30 years. Most term policies have no other benefit provisions.

There are two basic types of term life insurance policies—level term and decreasing term.

Level term means that the death benefit stays the same throughout the duration of the policy.
Decreasing term means that the death benefit drops, usually in one-year increments, over the course of the policy’s term.

In 2003, virtually all (97 percent) of the term life insurance bought was level term.

Types of Term Life Insurance

Term insurance comes in two basic varieties—level term and decreasing term. These days, almost everyone buys level term insurance. The terms “level” and “decreasing” refer to the death benefit amount during the term of the policy. A level term policy pays the same benefit amount if death occurs at any point during the term.

Common types of level term are:

yearly- (or annually-) renewable term
5-year renewable term
10-year term
15-year term
20-year term
25-year term
30-year term
term to a specified age (usually 65)

Yearly renewable term, once popular, is no longer a top seller. The most popular type is now 20-year term. Most companies will not sell term insurance to an applicant for a term that ends past his or her 80th birthday.

If a policy is “renewable,” that means it continues in force for an additional term or terms, up to a specified age, even if the health of the insured (or other factors) would cause him or her to be rejected if he or she applied for a new life insurance policy.

Generally, the premium for the policy is based on the insured person’s age and health at the policy’s start, and the premium remains the same (level) for the length of the term. So, premiums for 5-year renewable term can be level for 5 years, then to a new rate reflecting the new age of the insured, and so on every five years. Some longer term policies will guarantee that the premium will not increase during the term; others don’t make that guarantee, enabling the insurance company to raise the rate during the policy’s term.

Some term policies are convertible. This means that the policy’s owner has the right to change it into a permanent type of life insurance without additional evidence of insurability.

“Return of Premium”

In most types of term insurance, including homeowners and auto insurance, if you haven’t had a claim under the policy by the time it expires, you get no refund of the premium. Your premium bought the protection that you had but didn’t need, and you’ve received fair value. Some term life insurance consumers have been unhappy at this outcome, so some insurers have created term life with a “return of premium” feature. The premiums for the insurance with this feature are often significantly higher than for policies without it, and they generally require that you keep the policy in force to its term or else you forfeit the return of premium benefit. Some policies will return the base premium but not the extra premium (for the return benefit), and others will return both.

Whole Life/Permanent

Whole life or permanent insurance pays a death benefit whenever you die—even if you live to 100! There are three major types of whole life or permanent life insurance—traditional whole life, universal life, and variable universal life, and there are variations within each type.

In the case of traditional whole life, both the death benefit and the premium are designed to stay the same (level) throughout the life of the policy. The cost per $1,000 of benefit increases as the insured person ages, and it obviously gets very high when the insured lives to 80 and beyond. The insurance company could charge a premium that increases each year, but that would make it very hard for most people to afford life insurance at advanced ages. So the comapny keeps the premium level by charging a premium that, in the early years, is higher than what’s needed to pay claims, investing that money, and then using it to supplement the level premium to help pay the cost of life insurance for older people.

By law, when these “overpayments” reach a certain amount, they must be available to the policyowner as a cash value if he or she decides not to continue with the original plan. The cash value is an alternative, not an additional, benefit under the policy.

In the 1970s and 1980s, life insurance companies introduced two variations on the traditional whole life product—universal life insurance and variable universal life insurance.

Types of permanent policies

Whole or ordinary life
This is the most common type of permanent insurance policy. It offers a death benefit along with a savings account. If you pick this type of life insurance policy, you are agreeing to pay a certain amount in premiums on a regular basis for a specific death benefit. The savings element would grow based on dividends the company pays to you.
Universal or adjustable life
This type of policy offers you more flexibility than whole life insurance. You may be able to increase the death benefit, if you pass a medical examination. The savings vehicle (called a cash value account) generally earns a money market rate of interest. After money has accumulated in your account, you will also have the option of altering your premium payments – providing there is enough money in your account to cover the costs. This can be a useful feature if your economic situation has suddenly changed. However, you would need to keep in mind that if you stop or reduce your premiums and the saving accumulation gets used up, the policy might lapse and your life insurance coverage will end. You should check with your agent before deciding not to make premium payments for extended periods because you might not have enough cash value to pay the monthly charges to prevent a policy lapse.
Variable life
This policy combines death protection with a savings account that you can invest in stocks, bonds and money market mutual funds. The value of your policy may grow more quickly, but you also have more risk. If your investments do not perform well, your cash value and death benefit may decrease. Some policies, however, guarantee that your death benefit will not fall below a minimum level.
Variable-universal life
If you purchase this type of policy, you get the features of variable and universal life policies. You have the investment risks and rewards characteristic of variable life insurance, coupled with the ability to adjust your premiums and death benefit that is characteristic of universal life insurance.

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Types of Life Insurance