The Only Primer Needed on Life Insurance

Let's get the basics out of the way: insurance policies are legal contracts; the companies offering insurance to applicants are called insurers. The contract (policy) transfers the risk of financial loss from the individual (or business, entity, etc.) to the insurer. The insurer covers the policyholder for the contracted value when a loss occurs. Insurance companies make money and can offer affordable policies to individuals because insurers manage their risks by covering the potential loss among a multitude of people. In other words, the more people have policies and pay their premiums, the more risks an insurer can take. Insurers take on the risks not because everyone will experience a loss but because everyone will pay their premium! Paid premiums payout for losses that transfer to the insurer.

There are many different insurance types; most Americans own at least three policy types at any time. The common insurances are auto, home/renters', life, health, annuities, accident, travel, professional liability, product, and disability. In this segment, we will focus on life insurance. Life insurance is either term or permanent (whole life). All life insurance policies have a face amount (death benefit) the insurer pays when the insured dies. Many policies offer living benefits that allow the insured individual to utilize money from the face amount during their life if they experience certain medical illnesses. Riders add customized benefits to insurance policies, including accelerated benefits, disability riders, and waiver of premiums. In a later post, I'll delve into riders and how policyholders can use them to tailor-make a policy to fit your needs best.

Rihanna with the wink.

Term policies are pretty basic in that the insurer will pay a death benefit for a specified period (term) should the insured die within the term. Positives about term policies are they tend to be more cost-effective than permanent policies, many policies are convertible, meaning that the policy owner can convert the policy from a term to a permanent policy without reapplying and showing proof of insurability, and many term policies offer living benefits where policy owners can withdraw funds from the policy to cover expenses related to their own critical or terminal medical care. There are drawbacks to term policies, namely, that the policy is time-barred and does not accrue cash value. Cash value is a portion of premiums paid into a policy that serves as reserves to pay the death benefit (insurance protection element) and as a savings element. So, by the end of the term, when the insured has advanced in age to renew for another term (if eligible), the premiums have also increased and often are cost-prohibitive. 

Permanent policies are whole life policies because they remain in force for the remainder of the insured's life so long as the premiums are paid or the policy matures. The premiums are level – the same amount – for the duration that premiums are collected. Whole life policies tend to be costlier because they are level, but it makes sense! When you consider that overpaying on the front end when you're younger and have a lower risk of dying young and underpaying when you're older, and chances of death increase allows the level of payment to stay the same over the length the policy is in effect. While it makes sense, the premium costs can be a disadvantage, especially for those who seek a policy later in age when it costs more to insure. Essential characteristics of whole life policies are that they build cash value that policy owners can withdraw or borrow from, both the premiums and face amount (death benefit) are level and fixed for the life of the policy, and the duration of paying premiums can vary where one can pay for the rest of their life, for 10, 15, or 20 years, or stop paying at a certain age. A policy paid for life will endow (mature) generally when the insured turns age 100 or older. If the insured becomes a Centurian, the policy's cash value is equal to the face amount and is paid to the policy owner, which, as of 2024, would incur taxation.

Flexible policies include variable life (less common) and universal life, with its close cousin, Indexed Universal Life (IUL). The name gives it away, but with these life policies, the policy owner can choose and adjust the face value, premium, and length of the policy's coverage at any time. In many cases, it is often possible to have both a term and whole life policy in one! IULs are newer life insurance products on the scene in the 1990s; they came into existence after the 1980s gave us universal life policies. Universal life policies offer flexibility in premiums and coverage while building cash value. Indexed Universal Life added the ability to earn added interest on the accumulated cash value by tying it to the stock market. Effectively, excess index interest (earnings above the guaranteed minimum rate) are credited to policies in part due to the fluctuation in major stock indexes such as Standard & Poor (S&P) 500.

Now that you're undergirded with the basics of life insurance, you should have a general sense of what type of policy meets your goals and some intermediate-level key terms. When in doubt, especially because every situation is unique, consult a licensed agent who can explain the pros and cons of each policy type to see how it fits into your plans.