A life insurance policy is simply a contract between the policyholder and the insurance company. There is a wide variety of different types of life insurance policies but the concept is simple: by taking out a life insurance policy, you are transferring the risk of your death and the lost earnings this would represent for your loved ones, to the insurance company, at the expense of paying premiums over a certain period. Life insurance provides the policyholder peace of mind, knowing that people he or she cares about will be provided for should he/she die. It also provides those named as beneficiaries to the policy very real security if this happens.
What are the different types of life insurance? There are variations within the two major categories, but as an introduction, here are the different types of life insurance policies of which you should be aware.
In the beginning there was term life insurance (known in some countries as term life assurance). It was the first kind of life insurance. One simply is covered for a pre-defined, limited period (the ‘term’), by paying fixed payments each month (‘premiums’). Theoretically one could buy term coverage for as little as a year, but in practice 10, 15, 20, 30 years are the usual terms. Term cover for longer periods like this is known as level term coverage, but the concept is the same. If the policyholder dies withing the term of the insurance, the death benefit goes to whomever is named in the policy as beneficiary.
The critical thing to understand here is that if the policyholder does not die within the period for which the coverage applies, there is no payout at all. At that point, if the person still wants insurance, he/she will have to find coverage at an age when he/she will be more difficult to insure. Term life is more difficult to obtain after the age of 50 or so, and very difficult once you reach the age of 65. It is something you have to think about: term life insurance is very likely the cheapest of the different kinds of life insurance, but the fact that it is not permanent means that it may not be the best choice for you, even if you are young and healthy now.
So how to get around the expensive dilemma that you’ll face if you survive the term life insurance period? For this, insurance companies invented permanent life insurance, which guarantees a payout at the end of the life of the insured. Whole life insurance was the original form of this permanent cover (it’s referred to less commonly as cash surrender life insurance), set up as a fixed premium payments for a specified, fixed return. As you would expect, the fact of there being a guaranteed payout is going to make the permanent policy a lot more expensive than term cover, all else being equal. Estimates have even been made that it’s 8-10 times as expensive as term life, for similar coverage! That’s price of a guaranteed return.
Now as time went on, policyholders desired greater flexibility in their coverage. So much money is paid into a permanent policy over decades that insurance companies were able to offer some choices because of this accumulated cash value amount. Universal life insurance is a form of permanent life insurance that gives the policyholder some choice as to the premium amounts he must pay, and when he must pay them. A UL policy allows you to withdraw money interest-free from your policy (straight whole life often has provisions for cash withdrawals as well, but usually there is interest).
Many consumers wanted still more control over the investment component of their policies, and variable universal life insurance was created for them. With this type of life insurance, one can invest the policy cash value in different accounts containing a wide variety of investments, like stock or bonds. The fact of the value of these accounts constantly varying is why this insurance is referred to as ‘variable’. Along with the increased financial flexibility, Variable universal insurance has higher potential investment returns, but also greater risks associated with it, because of the fluctuating value of the investment component of the policy.
The purpose of this article was to lay out different forms of life insurance, in the hope that, with different types of life insurance explained, you can begin to narrow down your choices and make the best decision for yourself and your loved ones.