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What is Life Insurance?
Life insurance provides financial benefits in the event a covered individual passes away. The beneficiaries of the policy are generally third parties rather than the insured or the insured’s estate. An insured must provide permission or consent for a third-party to purchase a policy covering her. The following are common categories of life insurance:
⁃ Whole-Life Plan – A whole-life policy provides a benefit to a named beneficiary upon the insured’s death. Coverage lasts for the remainder of the insured’s life. Because of the certainty of payout of the policy, the policy has an accumulated cash value that can be cashed out or used to secure a loan during the insured’s life. The owner of the policy pays regular premiums (that are generally locked in at a fixed rate) until the time of the insured’s death. Generally, there is no medical exam required for issuance of the whole-life policy to individuals below a specified age. The policy applicant will be evaluated upon answers to specific health questions. You may also be interested in an article by Nerd Wallet on How to Find the Best Whole Life Policy.
⁃ Limited-Payment Life – This is a variation upon the whole-life policy. All things are similar under these plans, except that the policy becomes fully funded after a certain number of payments. Once these payments are met, the owner of the policy no longer pays a recurring premium. TopWholeLife.com does an excellent job of explaining the Limited-Payment Life policy.
⁃ Term-Life Policy – Term life insurance provides benefits to a named beneficiary for a specific term from the initiation of the policy. The owner of the policy pays premiums until the end of the term. At the end of the term, if the insured is alive, the policy ends and no longer offers benefits. The premiums for the policy are generally locked in for the entire term. Some policies are renewable for one or more terms after the original terms has expired. Most policies have an age limit for policy renewal. Renewing a policy, however, generally increases the available premiums. Many term policies allow for conversion of the policy to a whole-life policy. This is known as a “convertible term policy”. These policies allow the policyholder to elect to exchange the policy for a whole-life policy or endowment policy after a certain period of coverage. The premiums for term policies are generally far lower than those of a whole-life policy. Wikipedia has a great explanation of the various provisions attributable to a Term Life Policy.
⁃ Endowment Insurance – This is a less common form of life insurance in which the owner of the policy pays premiums for the term of the insurance. At the end of the term, a fixed amount is paid to the beneficiary on a certain date. See Wikipedia for more information on Endowment Policies.
⁃ Life Annuity Policy – This form of policy requires the owner of the policy to make a single lump-sum payment or a series of premium payments to the insurer. The insurer agrees to begin making recurring payments to the beneficiary after a certain date. The payments will last until a specific date or (more commonly) until the end of the insured’s life. The lump sum is paid at one time and recurring payments to the beneficiary generally terminate upon the death of the insured. For more information, look to Wikipedia for an explanation of Life Annuities.
⁃ Universal Life Policy – This type of policy combines term and life insurance into a combination policy. Wikipedia provides an in-depth look at the various provisions of a universal life policy.
These policies often exclude specific causes of death, such as suicide, war, criminal death sentence, or murder of the insured by the beneficiary.
⁃ Discussion: Why do you think people seek to purchase life insurance? Why do you think an insured’s consent is required for a third party to insure her life?
⁃ Practice Question: John is considering purchasing life assurance. He has specific plans to leave funds for individuals after he passes away. What are some of John’s options of life insurance policies?
John should choose a whole-life policy or some other form that allows for whole-life coverage or certainty of payment. Term policies expire at a specific point in time in the future. This is not true for whole-life policies. We cannot be sure as to when John will pass away, so a term-life policy would be risky. A whole-life policy will be more expensive and will pay a smaller amount upon death. Nonetheless, it is a sure payment. Also, the whole-life policy generally has a cash value that can be borrowed against or cashed out in the future if necessary. Another option may be the endowment policy, which provides certainty of payment upon death. Normally, these policies are also more expensive than term policies and provide a lower payout upon death.