Life insurance

What Is Life Insurance?

Life insurance is a contract between an insurer and a policyholder. A life insurance policy guarantees the insurer pays a sum of money to named beneficiaries when the insured policyholder dies, in exchange for the premiums paid by the policyholder during their lifetime.

KEY TAKEAWAYS
  • Life insurance is a legally binding contract.
  • For the contract to be enforceable, the life insurance application must accurately disclose the insured’s past and current health conditions and high-risk activities.
  • For a life insurance policy to remain in force, the policyholder must pay a single premium up front or pay regular premiums over time.
  • When the insured dies, the policy’s named beneficiaries will receive the policy’s face value, or death benefit.
  • Term life insurance policies expire after a certain number of years. Permanent life insurance policies remain active until the insured dies, stops paying premiums, or surrenders the policy.
  • A life insurance policy is only as good as the financial strength of the company that issues it. State guaranty funds may pay claims if the issuer can’t.

Types of Life Insurance

Many different types of life insurance are available to meet all sorts of needs and preferences.

  • Term Life—Term life insurance lasts a certain number of years, then ends. You choose the term when you take out the policy. Common terms are 10, 20, or 30 years. The best term life insurance policies balance affordability with long-term financial strength.
    • Level Term—The premiums are the same every year.
    • Increasing Term—The premiums are lower when you’re younger and increase as you get older. This is also called “yearly renewable term.”
  • Permanent—This stays in force for the insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy. It’s typically more expensive than term.
    • Whole Life—Whole life insurance is a type of permanent life insurance that accumulates cash value.
KEY TAKEAWAYS
  • Whole life insurance lasts for a policyholder’s lifetime, as opposed to term life insurance, which is for a specific amount of years..
  • Whole life insurance is paid out to a beneficiary or beneficiaries upon the policyholder’s death, provided that the premium payments were maintained.
  • Whole life insurance pays a death benefit, but also has a savings component in which cash can build up.
  • The savings component can be invested; additionally, the policyholder can access the cash while alive, by either withdrawing or borrowing against it, when needed.
    • Universal Life—A type of permanent life insurance with a cash value component that earns interest, universal life insurance has premiums that are comparable to term life insurance. Unlike term and whole life, the premiums and death benefit can be adjusted over time.
KEY TAKEAWAYS
  • Universal life (UL) insurance is a form of permanent life insurance with an investment savings element plus low premiums.
  • The price tag on universal life (UL) insurance is the minimum amount of a premium payment required to keep the policy.
  • Beneficiaries only receive the death benefit.
  • Unlike term life insurance, a UL insurance policy can accumulate cash value.
    • Guaranteed Universal—This is a type of universal life insurance that does not build cash value and typically has lower premiums than whole life.
    • Variable* Universal—With variable universal life insurance, the policyholder is allowed to invest the policy’s cash value. Like standard universal life insurance, the premium is flexible. VUL insurance policies typically have both a maximum cap and minimum floor on the investment return associated with the savings component. VUL insurance has investment subaccounts that allow for the investment of the cash value. The function of the subaccounts is similar to a mutual fund. Exposure to market fluctuations can generate significant returns, but may also result in substantial losses. This insurance gets its name from the varying results of investment in the ever-fluctuating market. While VUL insurance offers increased flexibility and growth potential over a traditional cash value or a whole life insurance policy, policyholders should carefully assess the risks before purchasing it.
KEY TAKEAWAYS
  • Variable* universal life (VUL) insurance is a type of permanent life insurance policy that allows for the cash component to be invested to produce greater returns.
  • VUL insurance policies are built on traditional universal life insurance policies but have a separate subaccount that invests the cash piece in the market.
  • As a result, the return to the cash component is not guaranteed year after year.
  • VUL insurance policies will have a maximum cap as well as a floor (usually 0%) on the returns that the investment part receives.
    • Indexed Universal—This is a type of universal life insurance that lets the policyholder earn a fixed or equity-indexed rate of return on the cash value component. Universal life (UL) insurance comes in a lot of different flavors, from fixed-rate models to variable ones, where you select various equity accounts to invest in. Indexed universal life (IUL) insurance allows the owner to allocate cash value amounts to either a fixed account or an equity index account. Policies offer a variety of well-known indexes, such as the Nasdaq-100 or the S&P 500.1 IUL insurance policies are more volatile than fixed ULs, but they are less risky than variable UL insurance policies, because no money is actually invested in equity positions.
KEY TAKEAWAYS
  • Indexed universal life (IUL) insurance lets the policyholder decide how much cash value to assign to either a fixed account or an equity indexed account.
  • IUL insurance policies offer a number of well-known indexes, such as the S&P 500 or the Nasdaq-100.
  • IUL insurance policies offer the possibility of cash accumulation while still providing a death benefit.

IUL insurance policies offer tax-deferred cash accumulation for retirement while maintaining a death benefit. People who need permanent life insurance protection but wish to take advantage of possible cash accumulation via an equity index might use IULs as key person insurance for business owners, premium financing plans, or estate-planning vehicles. IULs are considered advanced life insurance products in that they can be difficult to adequately explain and understand.

Life Insurance Riders

Riders are additional benefits that can be bought and added to a basic life insurance policy. They allow you to customize a policy and can provide several kinds of protection if you meet their conditions. Buying a rider means paying extra, but generally the additional premium is low because relatively little underwriting is required. Here are eight common life insurance riders and what they cover.

KEY TAKEAWAYS
  • Riders are the extra benefits that a policyholder can buy to add on to a life insurance policy.
  • The most common include guaranteed insurability, accidental death, waiver of premium, family income benefit, accelerated death benefit, child term, long-term care, and return of premium riders.
  • In general, the extra premium paid for a rider is low because relatively little underwriting is required.
    • Guaranteed Insurability Rider
    • Accidental Death Rider
    • Waiver of Premium Rider
    • Family Income Benefit Rider
    • Accelerated Death Benefit Rider
    • Child Term Rider
    • Long-Term Care Rider
    • Return of Premium Rider
    • Critical illness insurance riders
    • Chronic illness rider
    • Terminal illness rider