The differences in life insurance: a primer

Whether you want to replace your income for your family in the event you should die young or help preserve an inheritance for your heirs, life insurance can serve as the cornerstone of a sound financial plan. It can also serve as a key component of succession planning by protecting a buy-sell agreement or further your charitable giving program.
Just as the uses for life insurance are diverse, so, too, is the range of products and policy riders from which you can choose. In fact, because life insurance products are now introduced and revised at an alarmingly fast pace, it’s difficult to stay on top of what the industry has to offer. An industry in flux combined with the complicated nature of the product can make the process of choosing insurance seem overwhelming. Understandably, rather than dive in, many put off their analysis and the purchase of life insurance, leaving those they love unprotected. In order to make the best choice for your family, you need to understand the differences between your life insurance options.
There are two major types of life insurance: term life insurance and whole (or permanent) life insurance. As the names imply, term life insurance covers you for a set period of time while whole life offers coverage for your entire life. Let’s look at each type in a little more detail.
Term Life Insurance
As you might expect, there are a variety of term policies from which to choose. Payment is received only if death occurs during the term of the policy so consumers choose a period of time, generally from one to 30 years, when they most need protection. Some choose to insure themselves for the life of a mortgage while others want protection for the number of years they will have dependent children. According to the Insurance Information Institute (III), the most popular type of term insurance is 20-year term.
Although there are two basic types of policies, level term and decreasing term, level term is by far the most popular, according to the III. That’s because the death benefit stays the same throughout the duration of the policy, rather than dropping, usually in one-year increments, over the course of the term.
How much does a term life insurance policy cost? According to a Sept. 26, 2007, press release from III, generally the premium for the policy is based on age and health. As an example, however, the III estimates that the annual premium for a 40-year-old male nonsmoker buying a $500,000 20-year level term life insurance policy in 2008 will be about $725 if he qualifies as a “standard” risk and $350 if he meets the more stringent requirements of a “preferred” risk. Rates for women and younger people would be lower. For example, the comparable rate for a 40-year-old female nonsmoker would be about $600 for a standard risk and $300 for a preferred risk.
Of course, there’s plenty more industry jargon to mystify you when you are comparison shopping. If a policy is “renewable,” you can choose to keep it in force for an additional term or terms, up to a specified age, even if changes in your health would cause you to be rejected if you were a new life insurance applicant. Sometimes the premium remains the same, or “level,” for the length of the term. Other policies permit the insurance company to raise the rate during the course of the policy’s term. So, for example, if you buy a 5-year renewable term policy, it could be level for 5 years, then change to a new rate reflecting your new age, and so on every five years.
If you purchase a “convertible” policy, you have the right to change it into a permanent type of life insurance without additional health exams. Finally, some newer term policies feature a “return of premium” option. As you might expect, the premiums for coverage with this feature are much higher than for policies without the guarantee.
Whole Life/Permanent Insurance
Whole life, or permanent, insurance pays a death benefit when you die, whether it’s next month or 100 years from now. There is also a savings element attached to these policies that can grow on a tax-deferred basis. Note that when the savings element reaches a certain amount, it must be available to you as “cash value” in the event you decide not to continue with the original policy. Because of the potential for the savings element to grow over time, premiums are generally higher for permanent than for term insurance. However, the premiums remain the same while term coverage has the potential to increase substantially every time you renew it.
There are also a number of options to choose from under the umbrella of whole life insurance, including traditional whole life, universal life, variable life and variable universal life insurance.
With traditional whole life insurance, both the death benefit and the premium are designed to stay the same throughout the life of the policy. And, naturally, the cost per $1,000 of benefit increases as the insured person ages. The III estimates that at current interest rates, a life insurance company will pay a $500,000 death benefit to a survivor as an income of about $3,300 a month for 20 years. In the 1970s and 1980s, life insurance companies introduced variations on the traditional whole life product. One of these products is universal, or adjustable, life insurance.
Universal life insurance 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 have the option of altering your premium payments – providing there is enough money in your account to cover the costs.
If you’ve yet to purchase life insurance, you are not alone. According to the III, about 70 million Americans have no life insurance. With the Institute foreseeing a continued downward trend in life insurance premiums, which began a little more than 10 years ago, now may be the ideal time to purchase coverage.
According to the Institute, rates continue to drop because death rates for the 25-44 age group – the primary age range for purchasing life insurance – have decreased. Data the Institute obtained from the National Vital Statistics Reports indicates that in 1996 the death rate per 100,000 for people ages 25-44 was 177.8; by 2004 it had dropped to 161.8. Additionally, life insurers have also profited in recent years from generally favorable investment and interest rate environments, and they are passing these savings along to consumers.

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