1. WHAT DOES LIFE INSURANCE DO?
Life insurance protects survivors against the financial loss associated with dying. There are several other reasons for purchasing life insurance, but it is most often designed to provide financial protection and security for families in the case of the death of a provider. Specifically, it is designed to replace a loss of income for those who are financially dependent upon another person. Life insurance can also be considered a means of saving or investing, but its primary purpose is always protection against financial loss.
WHO NEEDS LIFE INSURANCE? People with dependents usually need life insurance.
A dependent is a person who must rely on another for financial support. People one day need to ask the question, “What would happen to the people who are financially dependent on me if I died tomorrow? ” If they could not live financially in the manner in which they lived before your deaths you probably need life insurance. Another common, though far less important, reason for buying life insurance is to assure that there is enough money to cover “final expenses. ” Many people believe that everyone should have enough life insurance to cover funeral and burial or cremation expenses.
WHAT ARE THE TYPES OF LIFE INSURANCE?
Originally life insurance was very simple. You paid a fee (premium) each year and, if you died, your family or heirs were paid a sum of money. Like much of life, it is not as simple now. Insurance companies now offer a variety of plans that meet the different insurance needs of individuals. A recent high school graduate would not have the same life insurance needs as someone who is ready to retire. A young single person has insurance needs that are different from those of a married person with small children. To provide for the different types of protection that are needed, insurance companies offer a variety of policies.
The four basic types of life insurance are term life, whole life, variable life, and universal life. Term Life insurance Term life insurance provides financial protection from losses resulting from loss of life during a definite period of time, or term. It is the least expensive form of life insurance. It is also the only form of life insurance that is purely life insurance; all the rest have savings or investment features added to them. Policies may run for a period of from 1 to 20 years or more. If the insured dies during the period for which the insurance was purchased, the amount of the policy is paid to the beneficiary.
A beneficiary is the person named in the policy to receive the insurance benefits. If the insured does not die during the period for which the policy was purchased, the insurance company is not required to pay anything. Protection ends when the term of years expires. By paying a slightly higher premium, a person can buy term insurance that is renewable, convertible, or both. A renewable policy allows the policyholder to continue term insurance for one or more terms without taking a physical examination to determine whether she or he is still a good risk.
A convertible policy allows the insured to have term insurance changed into another type of permanent insurance without taking a physical examination. Term insurance policies may be level term or decreasing term. With level term insurance, the amount of protection and the premiums remain the same while the insurance is in effect. With decreasing term insurance, the amount of protection gradually becomes smaller, but premiums remain the same during the term. An example of decreasing term insurance is mortgage insurance. It protects homeowners from losing their homes in case an insured dies before the mortgage is paid.
Suppose the Hanson family bought an $80,000 house on which they made a down payment of $10,000 and took a 30-year mortgage for the remaining $70,000. The Hansons want to be sure that the mortgage will be paid if one of them should die, so they buy a $70,000 mortgage insurance policy. The amount of coverage decreases as the Hansons repay what they have borrowed, so the amount of coverage is about the same as the decreasing balance of the debt. Whole Life Insurance Whole life insurance is permanent insurance that extends over the lifetime, of whole life, of the insured. It offers more than financial protection at death.
Whole life builds cash value that can be borrowed to help families meet financial emergencies, pay for special goals, or provide income for retirement years. Cash value refers to the amount of money or sum received should a policyholder decide to give up the protection provided by a policy. All life insurance except term insurance has cash value. The cash value that accumulates is not taxable until you cash in a policy. One type of whole life insurance is called a straight life policy. Premiums for straight life insurance remain the same each year as long as the policyholder lives.
Some whole life insurance policies are intended to be paid up in a certain number of years and are called limited-payment policies. They may also be designated by the number of years the insured agrees to pay on them, such as 20-payment life policies. They are like straight life policies, except that premiums are paid for a limited number of years—20 or 30, for example—or until a person reaches a certain age, such as 60 or 65. Limited-payment policies free the insured from paying premiums during retirement when income may be lower. Variable Life Insurance.
Variable life insurance is a type of life insurance plan that resembles an investment. This plan lets the policyholder choose among a broad range of investments including stocks, bonds, and mutual funds. The death benefits and cash values of variable life policies vary according to the yield on the investments the policyholder selects. The insurance company first designates an amount of the variable life premiums to cover the insured’s expenses. The remaining amount is placed in an investment account. Both the death benefit and the cash value rise and fall with the success of the investment account of your choosing.
A minimum death benefit is guaranteed, but there is no guaranteed cash value. The minimum death benefit, in relation to premiums paid, is well below other types of life insurance. On the positive side, however, a strong rate of return on the investment account can increase the cash value and the death benefit well above the guaranteed level. Universal Life Insurance Universal life insurance provides both insurance protection and a substantial savings plan. The premium that you pay for universal life insurance is divided three ways. One portion of it pays for insurance protection.
A second portion is taken by the insurance company for its expenses. The third portion is placed in interest-earning investments for the policyholder. The most important feature of universal life insurance is that the savings portion of the policy earns a variable (and usually higher) interest rate than is paid on other cash value insurance. The yield on the savings portion tends to rise or fall with the Consumer Price Index. Figure 1 compares the features of the different types of life insurance. Figure 1 Alternative life insurance programs Comparison of Alternative Life Insurance Programs|
| Term Insurance| Straight Life| Limited Life| Variable Life| Universal Life| Premium| Starts out low but increases every few years on a preset schedule| High but usually stays constant| Higher than straight life insured but constant| Fixed and regular | Varies (within limits) at the discretion of the policy-holder| Payment Period| Specified number of years – normally 5,10 or 15 years| Life of the insured| Specified number of years – normally 20 or 30 years | Specified period| Specified period|.
Cash Value| None | Some cash value| More cash value than straight life but less than variable life| Varies with the rise or fall in the value of the investment account | Varies with the interest rate paid on the cash value, which the company can change from time to time | Death Benefit| Fixed | Fixed | Fixed | Death benefit always exceeds cash value | Can vary (within limits) at discretion of policy-holder | Purposes| Protection for a specified period of time; to cover specific and temporary risks|.
Protection for life; some cash value for insured | Protection for life; some cash value for insured| Life insurance plus an opportunity to select different cash value investment options| Life insurance with a fairly high rate of return on cash value| Combination Life Insurance Policies The life insurance policies you have just read about can be combined or modified by an insurance agent and his or her company to meet your special needs.
A combination plan that is popular with many people is a variable universal life policy. Variable universal life insurance combines features of variable and universal life policies. This policy combines the investment options of variable life insurance with the flexible premium and death benefit of universal life insurance. It is a good way to have insurance and to accumulate assets while deferring taxes on those assets.
2. WHAT ARE THE ECONOMICS OF LIFE INSURANCE? Virtually everyone needs life insurance of some sort. Few of us have the financial resources necessary to pay the costs that can overtake us as the result of someone’s death. The Purchase of Life Insurance.
In order for a life insurance program to be most effective for you, it must be suited to your needs and your family’s. The answers to the following questions will help to determine that suitability: * How much money do you want to leave your dependents? * How much income will you need when you retire? * What can you afford to pay for your life insurance needs?
Answers to these questions will help you purchase the best life insurance program for you. To buy life insurance, you frequently apply for a policy through an insurance agent. Normally you will be required to take a physical examination so that your state of health can be determined. Assuming that you have no serious health problems, you then pay a premium and receive your life insurance policy.
If you are in poor health or work in a dangerous occupation, you may be considered a poor risk. For example, if you drive racing cars to earn a living, you are in a dangerous occupation. Even if you are in poor health or work in a dangerous job, you may be able to obtain insurance. However, you will probably pay higher premiums than people who are in good health and are employed in less hazardous occupations. When you buy life insurance, you will be asked to name a beneficiary. This is most often a spouse or one or more children. You may insure not only your- own life, but also the life of any other person in whom you have an insurable interest.
To have an insurable interest in the life of another person, you must receive some kind of financial benefits from that person’s continued life. You have, for example, an insurable interest in the lives of your parents. You do not have an insurable interest in a stranger’s life. A partner in a business has an insurable interest in the life of his or her partner. The insurable interest must exist at the time the policy is started, but generally it need not exist at the time of the loss. The Cost of Life Insurance In addition to the health and occupation of the insured, the cost of a life insurance policy depends on the type of life insurance being purchased and the age of the person being insured.
In purchasing a whole life policy, the premiums for straight life insurance are higher than those for term insurance, but the annual premium stays the same throughout the insured’s life. The premiums on limited-payment life insurance are higher than those for straight life insurance, but they are payable for only a limited number of years. Although the premiums on a 20-payment life policy are payable for only 20 years, the policy remains in force for the lifetime of the insured. An insurance policy that covers a group of people is called group life insurance. The group acts as a single unit in buying the insurance. The cost of group life insurance is less than the cost of a similar amount of protection bought individually because insurance covering many people can be handled economically in one policy.
Most group life insurance contracts are issued on a term basis through employers. Some policies, though, are available through unions, professional associations, and other similar organizations. Group life insurance is most often issued on a term basis, but whole life policies may also be purchased. The amount of protection available to an individual under a group insurance plan is generally limited. Many people, therefore, supplement their group insurance with policies of their own.
The Cash Value of Life insurance As long as they are kept in force, whole life policies, variable life policies, and universal life policies accumulate cash value. The longer you keep your policy, the higher its cash value will be.
If you give up or surrender your policy, you are paid the amount of the cash value. If you need money but do not wish to cancel your policy, you can borrow from the insurance company an amount up to the cash value. If you should die before the loan can be repaid, the unpaid amount will be deducted from the face value of the policy when your survivors are paid.
Face value is the amount of insurance coverage that will be paid upon the death of the insured. Cash value life insurance can be seen as a savings plan as well as financial protection for beneficiaries. The return on your money in the cash value portion of life insurance is often not large.