Life Insurance Information

In simplest terms, life insurance is an insurance contract  which pays a pre-determined benefit to a named beneficiary upon the death of the insured. The earliest known form of life insurance dates to Roman times, during which communal societies were founded to pay for final expenses. An individual would simply pay a certain amount to the society for the promise  of being buried in a dignified manner. These societies provided no other  benefit.

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Life Insurance History

The modern concept of life insurance dates to the 1600s, when groups of traders, merchants and others began meeting in London to form primitive insurance companies. The most noteworthy of these groups was founded around 1688 and met at Lloyd’s Coffee House in London. This group eventually became the present-day insurance company Lloyd’s of London.

Life insurance first became available in the United States in the 1760s, primarily as societies designed to support widows and orphans and  underwritten by Presbyterian and Episcopal churches.

Term life Insurance

The oldest and still most common form of life insurance is term life insurance. Term life insurance is the simplest and overall least expensive of the major life insurance options. It is designed to provide a level premium for a certain period of time. Term life policies are available in  terms as short as one year or as long as 50, although policy terms longer than  30 years are quite rare and are usually only available in specialized markets.

The main advantage of term life insurance is price. It is  dollar for dollar the most cost effective means to provide a death benefit upon the death of the insured. However because by definition term life insurance is  only in force for a certain time period, it is also by definition a temporary  product. Therefore the insured individual much more often than not outlives the policy term. Even today less than 10 percent of term life policies issued in the United States will ever pay a death benefit.

This causes a glaring drawback inherent with term life. No matter when the policy is written, or how much the face value is for, it is likely neither the insured nor his or her beneficiaries will ever see any return on investment on the product. In the days when term life insurance was the only available option, this fact posed a significant problem for both  consumers and insurers alike. Clearly while term life had distinct advantages, it was not an acceptable solution by itself.

Whole Life Insurance

A more permanent solution was needed. In time insurance companies began to offer whole life insurance as an alternative designed to address the shortcomings term life posed. Whole life insurance is by definition designed to remain in force at a level premium throughout the life of the insured. This is accomplished by both higher premiums as well as a mechanism known as cash value, which operates much like a savings account and helps to offset the cost insurance as the insured individual grows older.

The insured individual can theoretically outlive a whole life policy, but unlike with term the policy would still pay a benefit. A whole life policy ends when it matures, or when its accrued cash value equals its face value. Early whole life policies were designed to mature when the insured reached age 95 or 100, however more recently issued whole life policies may not  mature until age 120. The idea behind maturation is that while it is possible for an insured to outlive a whole life policy, it is highly unlikely by design.

Universal Life Insurance

While whole life insurance successfully addressed the problems associated with the temporary nature of term life insurance, it did so at a much higher cost to the consumer. By the 1970s it became apparent to many insurers that offering a more flexible permanent insurance option may be desirable.

Universal life (UL) insurance is similar to whole life in  that it is designed to be a permanent policy and utilizes a cash value mechanism, but unlike whole life UL allows the insured to pay premiums on a flexible basis. One can pay more in premiums in strong months, less in lean months, and sometimes skip premiums entirely. The cash value mechanism in a UL policy is  designed to offset the differences.

This flexibility is not without its risks. If one pays too  much into a UL policy, he or she risks turning it into a “modified endowment contract,” or MEC, which has adverse tax consequences. If one pays too little, the cash value can evaporate and cause the policy to lapse.

Term Life Insurance Options

Most companies offer a variety of optional amendments, or “riders” on term life insurance. These riders come at an additional charge, but often quite beneficial.

Perhaps the most common rider is the waiver of premium  rider, which keeps the policy in force without further premium payments in the event the insured becomes permanently disabled during the policy term. The additional cost of a waiver of premium rider is often negligible, and many agents include it as part of their quote during the sales process.

The accelerated death benefit rider provides a portion of the death benefit while the insured is still alive if the insured is diagnosed with a terminal condition and given a certain amount of time to live, usually 12 months or less. This allows the insured to address anticipated final expenses before death. Once the insured dies the rest of the face value then becomes payable.

The guaranteed insurability rider allows the insured to purchase additional life insurance coverage based on current age without having to undergo further underwriting. Although usually available only at certain times during the policy term, it can be quite beneficial for individuals who are diagnosed with health conditions which would otherwise severely rate them,  or perhaps render them entirely uninsurable otherwise.

A rider unique to term insurance is the return of premium rider, or ROP, which allows the insured to recover all premiums paid dollar for dollar at the end of the term if he or she outlives the term. While the ROP rider is significantly more expensive than most other riders, a term policy  with ROP is still less expensive than a comparable whole or universal life  policy. It is often an attractive middle of the road option for those who want the return on investment a permanent life insurance policy can provide, but  without permanent life insurance prices.

Permanent Life Insurance Options

As with term insurance, waiver of premium, accelerated death benefit and guaranteed insurability riders are usually available on permanent life policies. There are also other options available on these products that directly affect the cash value mechanism.

Although most commonly associated with universal life, both whole and universal life plans offer a variable contract option. On a universal life policy this is known as variable universal life, or VUL. This option ties the cash value to what are known as “separate accounts,” which operate very  similar to mutual funds. One can choose conservative funds, aggressive funds or a mix based on their suitability.

While these separate accounts can generate cash value quicker than a fixed option, or one in which cash value is determined by a set interest rate similar to a savings account, they can also lose value. As a result it is possible to lose money on variable life insurance products, which can in turn cause policies to lapse. As a result these policies, especially the  VUL, require close and regular monitoring.

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