All life insurance policies agree to pay an amount of money when you die. Not all policies are the same;
Some provide permanent coverage;
Some provide temporary coverage;
Some build cash values and others do not and;
Some combine different kinds of insurance, and others let you change from one kind of life insurance to another.
Term insurance is available for periods ranging from 1 year to 30 years or more. You may be able to renew the policy for a new term without regard to your health, but at a higher rate.
Your premium goes toward administrative expenses, company profit, and a reserve account that pays claims to those who die during the term period. As you get older, the chance that you will die increases. To cover this increasing risk, your premiums will likewise rise at regular intervals. For this reason, premiums that were quite inexpensive at the time you initially purchased your term policy will become much more expensive as you get older. Most term insurance also has a conversion feature that allows you to switch your coverage to some type of permanent insurance without answering health questions.
When you make premium payments for Whole Life Insurance, you pay more than is needed to pay for the current costs of insurance coverage and expenses. The excess payment is credited to a cash value account. This cash value account allows the insurance company to charge a level, guaranteed premium and to provide a death benefit and cash value throughout the life of the policy.
As you make payments, the cash value account grows. With traditional whole life insurance, the cash value account is guaranteed and held in the insurance company’s general portfolio–you don’t get to choose how the cash value account is invested. However, the cash value can potentially grow beyond its guaranteed amount through the payment of dividends (profits earned by a “mutual” insurer). The cash value grows tax deferred and can either be used as collateral to borrow from the insurance company or be directly accessed through a partial or complete surrender of the policy. It is important to note, however, that a policy loan or partial surrender will reduce the policy’s death benefit, and a complete surrender will terminate coverage altogether.
If you live to the policy’s maturity date, the policy will “endow,” and the insurance company will pay the accumulated cash value (equal at maturity to the death benefit) to you.
A universal life insurance policy will generally provide very broad premium guidelines (i.e., minimum and maximum premium payments), but within these guidelines you can choose how much and when you pay premiums. Reducing or increasing premiums will impact the growth of the cash value component and possibly the death benefit. You are also free to change the policy’s death benefit directly (again, within the limits set out by the policy) as your financial circumstances change. Be aware, however, that if you want to raise the amount of coverage, you’ll need to go through the insurability process again, probably including a new medical exam, and your premiums will increase.
Universal life policies reveal all aspects of the policy’s cost structure, including the cost of insurance (the portion set aside to pay claims) and expenses. This information is not always available with other types of policies. Another feature of universal life is the option to add the cash value to the face amount when the death benefit is paid. For example, say you die when you have $200,000 of cash value within your $1 million policy. If you chose the enhanced benefit option, your beneficiary receives $1.2 million. Keep in mind, however, that nothing is free–the increased benefit is reflected in premium calculations.
As with both variable and universal life insurance, your policy may lapse if the cash value account falls below a certain level. Low-interest loans can be taken against your cash value account, and cash withdrawals are available. However, keep in mind that your policy’s face amount is reduced by the amount of a policy withdrawal, and withdrawals may be taxable. You have the option of choosing a fixed or enhanced death benefit. Today, most variable universal life policies offer a rider that guarantees the death benefit at a certain level regardless of the performance of the sub accounts, provided that a stated minimum premium is paid for a predetermined number of years.