Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money (the “benefits”) upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger payment. The policy holder typically pays a premium, either regularly or as a lump sum. Other expenses (such as funeral expenses) are also sometimes included in the premium; however, in Australia for example the predominant form simply specifies a lump sum to be paid on the policy holder’s death.
The advantage for the policy owner is “peace of mind”, in knowing that the death of the insured person will not result in financial hardship for loved ones.
Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; common examples are claims relating to suicide, fraud, war, riot and civil commotion.
Life-based contracts tend to fall into two major categories:
- Protection policies – designed to provide a benefit in the event of specified event, typically a lump sum payment. A common form of this design is term insurance.
- Investment policies – where the main objective is to facilitate the growth of capital by regular or single premiums. Common forms are whole life, universal life and variable life policies.
There are many uncertainties in life. That’s for sure. It is generally a good idea to make sure one’s dependents are protected even after death.
There are many different reasons that people should obtain life insurance coverage. One of this would be protecting the family’s income. Families become accustomed to living in a certain manner. When one source of the family’s income dies, their income is no longer forthcoming. Without this, families could be forced to take on a very different life style. Dealing with the death of a loved one is difficult enough without having a major upheaval in one’s life. Having a life insurance policy provides liquid assets that can be used to pay off one’s debts after their death.
Life insurance can also provide income for a surviving spouse. This can be helpful during retirement when one source of income may stop with the death of a spouse.
Often there are major expenses that currently exist, or will come up in the future for the family. Having life insurance can help provide funds to meet these expenses. For instance, a college education can be rather expensive.
Also, life insurance policies may provide funds to pay off the mortgage on a house. This can drastically reduce the financial burden left in the wake of someone’s death.
Life insurance may be divided into two basic classes: temporary and permanent; or the following subclasses: term, universal, whole life and endowment life insurance.
Term assurance provides life insurance coverage for a specified term. The policy does not accumulate cash value. Term is generally considered “pure” insurance, where the premium buys protection in the event of death and nothing else.
Permanent life insurance is life insurance that remains active until the policy matures, unless the owner fails to pay the premium when due. The policy cannot be cancelled by the insurer for any reason except fraudulent application, and any such cancellation must occur within a period of time defined by law (usually two years). A permanent insurance policy accumulates a cash value, reducing the risk to which the insurance company is exposed, and thus the insurance expense over time. This means that a policy with a million dollar face value can be relatively expensive to a 70-year-old. The owner can access the money in the cash value by withdrawing money, borrowing the cash value, or surrendering the policy and receiving the surrender value.
Whole life insurance provides lifetime death benefit coverage for a level premium in most cases. Premiums are much higher than term insurance at younger ages, but as term insurance premiums rise with age at each renewal, the cumulative value of all premiums paid across a life time are roughly equal if policies are maintained until average life expectancy. Part of the insurance contract stipulates that the policyholder is entitled to a cash value reserve, which is part of the policy and guaranteed by the company. This cash value can be accessed at any time through policy loans and are received income tax free. Policy loans are available until the insured’s death. If there are any unpaid loans upon death, the insurer subtracts the loan amount from the death benefit and pays the remainder to the beneficiary named in the policy.
Universal life insurance is a relatively new insurance product, intended to combine permanent insurance coverage with greater flexibility in premium payment, along with the potential for greater growth of cash values. There are several types of universal life insurance policies which include interest sensitive (also known as “traditional fixed universal life insurance”), variable universal life, guaranteed death benefit, and equity indexed universal life insurance.
Endowments are policies in which the cumulative cash value of the policy equals the death benefit at a certain age. The age at which this condition is reached is known as the endowment age. Endowments are considerably more expensive (in terms of annual premiums) than either whole life or universal life because the premium paying period is shortened and the endowment date is earlier.
Accidental death is a limited life insurance designed to cover the insured should they pass away due to an accident. Accidents include anything from an injury and upwards, but do not typically cover deaths resulting from health problems or suicide. Because they only cover accidents, these policies are much less expensive than other life insurance policies.