Life Insurance Basics
What is life insurance?
Life insurance is a contract with an insurance company on your life that transfers your financial risk of an early death to an insurance company through an insurance policy. In exchange for your scheduled payments, known as premiums, life insurance pays out after your death to the people you choose as beneficiaries — usually your spouse, children, or other family members. Unfortunately, life insurance is not an investment you personally get to enjoy, but it does provide peace of mind knowing you are taking care of loved ones when you are gone.
Uses of Insurance - Personal and Business
Life insurance is purchased to offset the financial consequences following the death of the insured person. People buy personal life insurance most often to protect survivors against the loss of income the insured’s death causes. Survivors (usually family members) are typically the named beneficiaries of the contract. Often, they need instant money after the death of the bread winner to meet their immediate financial needs and long-term financial needs.
Common needs that survivors face and that life insurance can address include:
• Providing income to meet daily living expense
• Retiring a mortgage on the survivor’s home
• Setting up an education fund for the children of the deceased
• Paying off existing debts
• Paying death expenses, such as medical and funeral costs
Using Life Insurance to Create an Estate
Life insurance is often described as a financial vehicle that can “create an instant estate.” Upon the death of the insured, a specified sum of money is automatically and immediately made available. That sum of money is paid directly to a named beneficiary or the insured’s estate. Moreover, the sum can be used for any purpose. If the proceeds are paid to the insured’s estate, they can:
• Be applied to cover the costs or taxes the estate may face upon death
• Provide an inheritance for heirs named in a will
• Be used to make a charitable donation or gift
Using Life Insurance to Preserve an Estate
Life insurance is also a great way to protect an estate for many people who have substantial assets. A policy’s death benefit removes the need to sell assets to pay estate taxes, other costs, or debts the estate may face upon a person’s death. In this way, life insurance conserves the estate. It allows the estate to be passed on intact to the deceased’s heirs.
Using Life Insurance to Accumulate Cash
As permanent life insurance policies mature, they accumulate cash value. Obviously, the longer the whole life insurance policy stays in force, the greater its cash value. At all times, this cash value is available to the policyowner through a policy loan, withdrawal (in the case of a universal life insurance policy), or surrender. He or she can use the cash value however he or she wants.
For example, the policyowner can use the cash value to:
• Pay for a child’s college education
• Supplement his or her income during the retirement years
• Serve as a source of funds in an emergency
These are the “living benefits” to permanent life insurance ownership.
Using Life Insurance for Liquidity
Liquidity in any investment refers to how easy and inexpensive it is to convert the investment into cash. A life insurance policy with a cash accumulation feature has important liquidity options. For example, many policies allow the policyowner to take out loans or to make withdrawals.
Using Life Insurance for Financial Security
For individuals and their families, life insurance provides financial security. Knowing that one’s finances can meet any challenge the future might bring is priceless. No matter what type of life insurance a person chooses, what he or she is really buying is financial security.
The main wage earner who buys insurance on his or her life finds peace of mind in knowing that surviving family members are taken care of in the event of his or her death. Likewise, the professional who builds cash value in a policy to use at retirement feels protected from financial disaster at a time when he or she can no longer work.
Business Uses of Life Insurance
While life insurance is often thought of only in connection with meeting personal financial needs, a great deal of life insurance is bought to meet the needs of businesses. When life insurance is purchased to meet business needs, it is generally used to provide funds to:
• Enable business owners to meet the financial obligation arising from their contractual agreement to purchase a deceased partner’s or co-owner’s business interest under a buy-sell agreement
• Compensate a business upon the loss, through death, of an important employee (i.e., one considered a key employee)
• Enable a business to meet its contractual obligations under a deferred compensation arrangement
• Retire outstanding corporate debt upon the death of a majority business owner
• Permit an executive to meet personal life insurance needs
Types of Life Insurance
Individual life insurance comes in a variety of forms, including term, whole, universal, and variable life insurance.
Term is specific to a temporary period, while whole, universal, and variable are often known as “permanent” life policies. Several additional benefits can be added through benefit riders to customize a policy to better meet the owner’s needs. Life insurance has a range of uses in both the personal and business markets.
Life insurance is available through several broad categories of policies, including:
• Term Life Insurance
• Whole Life Insurance
• Universal Life Insurance (interest-sensitive life insurance)
• Variable Life Insurance
Term Life Insurance: Is designed to last for a specific period, known as the “term” period. It comes in several different types, each of which serves a specific purpose. Term life insurance can be stand-alone life insurance, or it can be provided as a rider on other policies. The following are typical characteristics:
• Policies do not build cash value
• Coverage for a specified term (i.e. 1, 5, 10, 20, 30 years)
• If you die during the term period, the death benefit is paid to your beneficiary(s). If you survive the term period, the term insurance terminates without further value
• Some polices may provide you the ability to convert, renew, or buy a new policy depending on costs and other factors.
The three main types of term life insurance policies provide a death benefit that is level, decreasing, or increasing.
Whole Life Insurance: Offers the strongest guarantees under any life insurance product and has certain characteristics that are generally not found in other types of life insurance:
• Level death benefit—The death benefit remains level for the life of the policy and is guaranteed to be in force at the insured’s death, assuming the timely payment of premiums.
• Guaranteed cash value—Whole life insurance builds guaranteed cash value, which can be used for loans, partial surrenders, and retirement income. • Endows at a limiting age—At the insured’s age 120, the life insurance policy endows for its face amount, and the policyowner collects the face amount of the policy even though the insured is living.Whole life insurance is classified with respect to the duration of premium payments. Thus, whole life insurance may be either: continuous premium whole life insurance where premiums paid until the insured dies or reaches the limiting mortality age, or limited payment whole life insurance where premiums paid only for a specified, limited period of time (i.e. 10, 15, 20, years) when the policy is considered “paid up” and no more premiums are made but the insurance coverage continues.
Whole life may be used to meet several needs including:
Universal Life Insurance: is an adjustable, flexible premium form of life insurance that accumulates cash values on which interest is credited at current interest rates. A policyowner can increase or decrease the death benefit without buying a new policy. If the death benefit is increased, then the owner may have to prove insurability. Universal life policies generally have a “back-end load,” which is in the form of surrender charges for early withdrawal or surrender. Universal life insurance cash values are affected principally by:
• Premiums paid – Universal life insurance policies permit policyowners to pay more or less than the billed premium. In fact, a universal life insurance policyowner may choose to pay no premium at all. Despite paying no premium, the policy will remain in force if it has sufficient cash value to cover the insurer’s monthly debits for expenses and the cost of insurance. A policyowner is not required to make up any missed premiums.
• Insurer expenses deducted from the cash value - Each month insurers deduct the cost of insurance and expenses from universal life insurance cash values. The expense portion of the monthly deduction pays for the insurance company’s ongoing expenses that may be increased to reflect the insurer’s actual expenses. However, a maximum expense deduction is guaranteed in the policy.
• Cost of insurance (COI) deducted from the cash value the part of the monthly deduction that represents the cost of insurance is determined by multiplying the COI rate by the net amount at risk in that month. The COI rate is based on the insured’s sex, attained age, and premium class (i.e., standard, preferred, non-smoker, etc.). Universal life insurance policies generally have two COI rates: a current COI rate, and a guaranteed COI rate. If the cash value is sufficient to cover the monthly deduction, the policy will remain in force. However, if the cash value is insufficient to cover the insurer’s monthly deduction, the life insurance policy will lapse.
• Interest credited to the cash value - The rate at which interest is credited to universal life insurance policy cash values depends on the type of universal life insurance. The three broad types of universal life insurance are declared-rate universal life insurance, indexed universal life insurance, and variable universal life insurance. Thus, the applicable crediting interest rate may be based on:
o a periodic interest rate declaration made by the insurer—declared-rate universal life insurance
o the change in the closing level of a specified index—indexed universal life insurance
o the investment performance of the insurer’s separate account—variable universal life insurance
Variable Life Insurance: Variable insurance products are insurance products that offer policyowners the opportunity to allocate some or all their premiums and cash values to the insurer’s separate account. The insurer’s separate account is comprised of variable subaccounts that contain investment portfolios differentiated from each other by asset class, risk, and investment objective. So, an insurer’s separate account is likely to contain one or more:
• bond variable subaccounts
• stock variable subaccounts
• money market variable subaccounts
Variable Life Insurance is a product whose cash value gain or loss is dependent on the investment performance of the variable subaccounts to which the policyowner has allocated premiums and cash value. When applying for the policy, the applicant selects the variable subaccounts and/or the fixed account to which premiums will be allocated. That initial allocation may, of course, be changed by the policyowner.
Riders, worth it or not?
Life insurance policy riders provide additional benefits that are not found in the base policy. Riders are so named because they “ride” on the subject policy. Several types of riders can be added to a life policy. Common riders include:
• Waiver of Premium
• Disability Income Benefit Rider
• Waiver of Cost of Insurance (Universal)
• Accidental Death Benefit
• Cost of Living Adjustment (COLA)
• Accidental Death and Dismemberment
• Payor • Accelerated Benefits
• Guaranteed Insurability
• Guaranteed Insurability
• Return of Premium
• Term Riders
Yep, that’s a lot of options/riders. Set an appointment if you want a better understanding and whether they are worth it for you. CALENDLY
Determine how much you need
Consider your family’s needs and priorities when figuring out the amount of life insurance to purchase. Do you have debts to pay? Will your family have to replace your income to meet everyday living expenses? Do you want to fund a college education for your children?
Life insurance may be available through your employer but is usually a good idea to have your own policy in conjunction with those available through work. Employer policies are typically not portable and end if you leave the company. Additionally, most employer policies do not provide enough death benefit to cover your family’s financial needs.
Here are the calculators to help you determine your needs.
Evaluate life insurance companies
Life insurance is a long-term purchase, and you want a company that can pay claims many years in the future. The large insurers have long track records, the industry has been around a long time, but some smaller insurers are solid contenders as well. Check out an insurers’ financial strength through ratings agencies such as A.M. Best or Standard & Poor’s. When possible its typically better to choose insurers with A.M. Best ratings higher than B.
Also know, not all companies sell the same types of policies, and some focus on specific products, such as life insurance policies for children. Some insurers specialize in certain areas like disability or long-term care, while others provide additional benefits or lower costs for healthy lifestyles. Do not be discouraged is you have pre-existing conditions; some insurance carriers specialize in actually insuring those cases.
Third Party Sources of "Best Life Insurance Companies"
Policy Genius: https://www.policygenius.com/life-insurance/best-life-insurance-companies/