Life insurance is an agreement between you (the policy owner) and an insurer. Under the terms of a life insurance policy, the insurer promises to pay a certain sum to a person you choose (your beneficiary) upon your death, in exchange for your premium payments.
What’s in a Life Insurance Contract?
A life insurance contract is made up of legal provisions, your application (which identifies who you are and your medical declarations), and a policy specifications page that describes the policy you have selected, including any options and riders that you have purchased in return for an additional premium.
Provisions describe the conditions, rights, and obligations of the parties to the contract (e.g., the grace period for payment of premiums, suicide and incontestability clauses).
The policy specifications page describes the amount to be paid upon your death and the amount of premiums required to keep the policy in effect. Also stated are any riders and options added to the standard policy. Some riders include the waiver of premium rider, which allows you to skip premium payments during periods of disability; the guaranteed insurability rider, which permits you to raise the amount of your insurance without a further medical exam; and accidental death benefits.
Types of Life Insurances Policies
The two basic types of life insurances are term life and permanent (cash value) life.
Term policies provide life insurances protection for a specific period of time. If you die during the coverage period, your beneficiary receives the policy death benefit. If you live to the end of the term, the policy simply terminates, unless it automatically renews for a new period. Term policies are available for periods of 1 to 30 years or more and may, in some cases, be renewed until you reach age 95. Premium payments may be increasing, as with annually renewable 1-year (period) term, or level (equal) for up to 30-year term periods.
Generally speaking, term life offers the greatest coverage for the lowest initial premium and is a great solution for people in most circumstances, especially those with temporary needs or a limited budget.
Permanent policies provide protection for your entire life, provided you pay the premium to keep the policy in force. Premium payments are greater than necessary to provide the life insurance benefit in the early years of the policy, so that a reserve can be accumulated to make up the shortfall in premiums necessary to provide the insurance in the later years. Should the policy owner discontinue the policy, this reserve, known as the cash value, is returned to the policy owner. Permanent life insurances can be further broken down into the following basic categories:
- Whole life: You generally make level (equal) premium payments for life. The death benefit and cash value are predetermined and guaranteed. Any guarantees associated with payment of death benefits, income options, or rates of return are based on the claims-paying ability of the insurer.
- Universal life: You may pay premiums at any time, in any amount (subject to certain limits), as long as policy expenses and the cost of insurance coverage are met. The amount of insurance coverage can be decreased, and the cash value will grow at a declared interest rate, which may vary over time.
- Variable life: As with whole life, you pay a level premium for life. However, the death benefit and cash value fluctuate depending on the performance of investments in what are known as subaccounts. A subaccount is a pool of investor funds professionally managed to pursue a stated investment objective. The policy owner selects the subaccounts in which the cash value should be invested.
- Variable universal life: A combination of universal and variable life. You may pay premiums at any time, in any amount (subject to limits), as long as policy expenses and the cost of insurance coverage are met. The amount of insurance coverage can be decreased, and the cash value goes up or down based on the performance of investments in the subaccounts.
Note: Variable life and variable universal life insurances policies are offered by prospectus, which you can obtain from the insurance company. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. These policies have become the center of controversy and scrutiny as of late, and therefore, you should read the prospectus and consider this information carefully before purchasing a variable life or variable universal life insurance policy.
Permanent insurance may make more sense if you anticipate a need for lifelong protection and like the option of accumulating tax-deferred cash values. Permanent Insurance combines life insurance with a tax deferred savings element, but generally it is only recommended to those with sizable estates that have maximized other tax deferred savings strategies.
Whether you should consider adding a rider (for a higher premium) to a policy you’re considering really depends on your specific needs, objectives and budget. The following are typical riders offered by insurers:
- A Disability Waiver of Premium – stipulates that if you become totally disabled for a specified period of time, you don’t have to pay premiums for the duration of the disability. If you become disabled and your income declines or disappears for a period of time, a disability waiver of premium can ensure that your life insurance policy will remain in force.
- An Accidental Death Benefit – will pay an additional benefit in the case of a death resulting from an accident.
- An Accelerated Death Benefit – also known as Living Benefit, allows you, under certain circumstances, to receive the proceeds of your life insurance policy before you die. Such circumstances include terminal or catastrophic illness, the need for long-term care, or confinement to a nursing home.
You must name a primary beneficiary to receive the proceeds of your insurance policy. You may name a contingent beneficiary to receive the proceeds if your primary beneficiary dies before the insured. Your beneficiary may be a person, corporation, or other legal entity. You may name multiple beneficiaries and specify what percentage of the net death benefit each is to receive. You should carefully consider the ramifications of your beneficiary designations to ensure that your wishes are carried out as you intend.
Generally, you can change your beneficiary at any time. Changing your beneficiary usually requires nothing more than signing a new designation form and sending it to your insurance company. If you have named someone as an irrevocable (permanent) beneficiary, however, you will need that person’s permission to adjust any of the policy’s provisions.
Where Can You Buy Life Insurance?
You can often get insurance coverage from your employer (i.e., through a group life insurance plan offered by your employer) or through an association to which you belong (which may also offer group life insurance). You can also buy insurance through a licensed life insurance agent or broker, or directly from an insurance company.
Any policy that you buy is only as good as the company that issues it, so investigate the company offering you the insurance. Ratings services, such as A. M. Best, Moody’s, and Standard & Poor’s, evaluate an insurer’s financial strength. The company offering you coverage should provide you with this information.
Determining Your Need
The purpose of any insurance should be to provide a cost effective protection against any sudden, financially significant events that are infrequent in nature. Your life insurance needs will depend on a number of factors, including whether you’re married, the size of your family, the nature of your financial obligations, your career stage, and your own personal financial goals. While there are many tools available online for free, your best resource to evaluate your life insurance needs is a professional financial planner who understands your unique needs. A professional financial planner can provide an objective evaluation of insurance alternatives and help you:
- Identify the amount needed to pay any outstanding debt obligations, provide a level of income to support survivors left behind with a comfortable lifestyle while in transition, and fund any other discretionary goals.
- Understand the key components and difference between different life insurance products (permanent vs term insurance)
- Provide a framework from which you can evaluate an appropriate amount of insurance for you and your family.
However, be wary of financial planners that sell and are commissioned from life insurance products, which presents a conflict of interest. Life Insurance should be considered and evaluated annually based on your unique circumstances and familial obligations. Reilly Financial Advisors is an independent Registered Investment Advisors, and provides a team of professional planners and advisors that can help you evaluate your needs in order to both define and achieve your individual financial goals. Contact us to learn more.