For the most part, there are two types of life insurance plans – either term or permanent plans or some combination of the two. Life insurers offer various forms of term plans and traditional life policies as well as “interest sensitive” products which have become more prevalent since the 1980’s . In New York State, the Department of Financial Services must approve any life insurance policy before a company can issue it to consumers and New York Insurance Law provides for standard provisions that must be included in every policy.
Term Insurance
Term insurance provides protection for a specified period of time. This period could be as short as one year or provide coverage for a specific number of years such as 5, 10, 20 years or to a specified age such as 80 or in some cases up to the oldest age in the life insurance mortality tables. Policies are sold with various premium guarantees. The longer the guarantee, the higher the initial premium. If you die during the term period, the company will pay the face amount of the policy to your beneficiary. If you live beyond the term period you had selected, no benefit is payable. As a rule, term policies offer a death benefit with no savings element or cash value.
Premiums are locked in for the specified period of time under the policy terms. The premiums you pay for term insurance are lower at the earlier ages as compared with the premiums you pay for permanent insurance, but term rates rise as you grow older. Term plans may be “convertible” to a permanent plan of insurance. The coverage can be “level” providing the same benefit until the policy expires or you can have “decreasing” coverage during the term period with the premiums remaining the same. If you do not pay the premium for your term insurance policy, it will generally lapse without cash value, as compared to a permanent type of policy that has a cash value component. Currently term insurance rates are very competitive and among the lowest historically experienced.
Types of Term Insurance
- Renewable Term. Renewable term plans give you the right to renew for another period when a term ends, regardless of the state of your health. With each new term the premium is increased. The right to renew the policy without evidence of insurability is an important advantage to you. Otherwise, the risk you take is that your health may deteriorate and you may be unable to obtain a policy at the same rates or even at all, leaving you and your beneficiaries without coverage.
- Convertible Term. Convertible term policies often permit you to exchange the policy for a permanent plan. You must exercise this option during the conversion period. The length of the conversion period will vary depending on the type of term policy purchased. If you convert within the prescribed period, you are not required to give any information about your health. The premium rate you pay on conversion is usually based on your “current attained age”, which is your age on the conversion date. This type of policy often provides the maximum protection with the smallest amount of cash outlay.
- Level or Decreasing Term. Under a level term policy the face amount of the policy remains the same for the entire period. With decreasing term the face amount reduces over the period. The premium stays the same each year. Often such policies are sold as mortgage protection with the amount of insurance decreasing as the balance of the mortgage decreases. If the insured dies the proceeds of the policy can be used to pay off the mortgage.
- Adjustable Premium. Traditionally, insurers have not had the right to change premiums after the policy is sold. Since such policies may continue for many years, insurers must use conservative mortality, interest and expense rate estimates in the premium calculation. Adjustable premium insurance, however, allows insurers to offer insurance at lower “current” premiums based upon less conservative assumptions with the right to change these premiums in the future. The premium, however, can never be more than the maximum guaranteed premiums stated in the policy.
Permanent Insurance (Whole Life or Ordinary Life)
While term insurance is designed to provide protection for a specified time period, permanent insurance is designed to provide coverage for your entire lifetime. To keep the premium rate level, the premium at the younger ages exceeds the actual cost of protection. This extra premium builds a reserve (cash value) which helps pay for the policy in later years as the cost of protection rises above the premium. Whole life policies stretch the cost of insurance over a longer period of time in order to level out the otherwise increasing cost of insurance. Under some policies, premiums are required to be paid for a set number of years. Under other policies, premiums are paid throughout the policyholder’s lifetime. The insurance company invests the excess premium dollars
The policy’s essential elements consist of the premium payable each year, the death benefits payable to the beneficiary and the cash surrender value the policyholder would receive if the policy is surrendered prior to death. You may make a loan against the cash value of the policy at a specified rate of interest or a variable rate of interest but such outstanding loans, if not repaid, will reduce the death benefit.
There are two basic categories of permanent insurance, traditional and interest-sensitive, each with a number of variations. In addition, each category is generally available in either fixed-dollar or variable form.
Traditional Whole Life
Traditional whole life policies are based upon long-term estimates of expense, interest and mortality. The premiums, death benefits and cash values are stated in the policy.
There are six basic variations of traditional permanent insurance:
- Non-Participating Whole Life: A non-participating whole life policy will give you a level premium and face amount during your entire life. The advantages of such a policy are its fixed costs and generally low out-of-pocket premium payments. The disadvantage is that it pays no dividends.
- Participating Whole Life: A participating whole life policy pays dividends. The dividends represent the favorable experience of the company and result from excess investment earnings, favorable mortality and expense savings. Dividends can be paid in cash, used to reduce premiums, left to accumulate at interest or used to purchase paid-up additional insurance. Dividends are not guaranteed.
- Indeterminate Premium Whole Life: An indeterminate premium whole life policy is like a non-participating whole life plan of insurance except that it provides for adjustable premiums. The company will charge a “current” premium based on its current estimate of investment earnings, mortality, and expense costs. If these estimates change in later years, the company will adjust the premium accordingly but never above the maximum guaranteed premium stated in the policy.
- Economatic Whole Life: An economatic whole life policy provides for a basic amount of participating whole life insurance with an additional supplemental coverage provided through the use of dividends. This additional insurance usually is a combination of decreasing term insurance and paid-up dividend additions. Eventually, the dividend additions should equal the original amount of supplemental coverage. However, because dividends may not be sufficient to purchase enough paid up additions at a future date, it is possible that at some future time there could be a substantial decrease in the amount of supplemental insurance coverage.
- Limited Payment Whole Life If you want to pay premiums for a limited time the limited payment whole life policy gives you lifetime protection but requires only a limited number of premium payments. Because the premiums are paid over a shorter span of time, the premium payments will be higher than under the whole life plan.
- Single Premium Whole Life Single premium whole life is limited payment life where one large premium payment is made. The policy is fully paid up and no further premiums are required. Many such policies have substantial surrender charges if you want to cash in the policy during the first few years. Since a substantial payment is involved, it should be viewed as an investment-oriented product.
Interest Sensitive Whole Life
While insurers guarantee stated benefits on traditional contracts far into the future based on long-term and overall company experience, they allocate investment earnings differently on interest sensitive whole life in order to better reflect current fluctuations in interest rates. The advantage is that improvements in interest rates will be reflected more quickly in interest sensitive insurance than in traditional; the disadvantage, of course, is that decreases in interest rates will also be felt more quickly in interest sensitive whole life.
There are four basic interest sensitive whole life policies:
Universal Life The universal life policy is actually more than interest sensitive as it is designed to reflect the insurer’s current mortality and expense as well as interest earnings rather than historic rates. Universal life works by treating separately the three basic elements of the policy: premium, death benefit and cash value. The company credits your premiums to the cash value account. Periodically the company deducts from the cash value account its expenses and the cost of insurance protection, usually described as the mortality deduction charge. The balance of the cash value account accumulates at the interest credited. The company guarantees a minimum interest rate and a maximum mortality charge. Some universal life policies also specify a maximum basis for the expense charge. These guarantees are usually very conservative. Current assumptions are critical to interest sensitive products such as Universal Life. When interest rates are high, benefit projections (such as cash value) are also high. When interest rates are low, these projections are not as attractive.The policy usually gives you an option to select one or two types of death benefits. Under one option your beneficiaries received only the face amount of the policy, under the other they receive both the face amount and the cash value account. If you want the maximum amount of death benefit now, the second option should be selected.
You generally pay a planned premium designed to keep the policy in force for life, and accumulate cash value, based upon the interest and expense and mortality charges you assume. It is important that these assumptions be realistic because if they are not, you may have to pay more to keep the policy from decreasing or lapsing. On the other hand, if your experience is better then the assumptions, than you may be able in the future to skip a premium, to pay less, or to have the plan paid up at an early date.
Excess Interest Whole Life If you are not interested in all of the flexible features of Universal Life, some insurers offer fixed premium versions called excess interest whole life. The key feature is that premium payments are required when due just like traditional whole life. If premiums are paid when due, the policy will not lapse.
With the premium level fixed, any additional or excess interest credited, or better life insurance experience, will improve the cash value of the policy. The premium level will probably be comparable to traditional whole life policies. Cash value may be applied to pay future premium payments. This type of product maximizes the deferred tax growth of your cash value.
Current Assumption Whole Life Current assumption whole life is similar to a universal life policy but your company determines the amount of premium to be paid. The company sets the initial premium based upon its current estimate of future investment earnings and mortality experience and retains the contractual right to reevaluate its original estimates to increase or decrease your premium payments later. If premiums are increased, some policies let you decrease the face amount of coverage so that you can continue to pay the original premium. Current mortality and experience and investment earnings can be credited to the insurance policy either through the cash value account and/or the premium or dividend structure (depending on whether it is a stock or mutual company). Regardless, this type of policy has the following characteristics:
- The premiums are subject to change based on the experience (mortality, expenses, investment) of the company. The policyowner does not exercise control over the changes.
- The policyowner can use the cash value to make loans just as he/she would with any traditional ordinary life insurance policy.
- A minimum amount of cash value is guaranteed, just as with traditional ordinary life insurance.
- The death benefit does not fluctuate.
Single Premium Whole Life There are a few single premium life products, which determine the premium using the current interest rate assumption. You may be asked to make additional premium payments where coverage could terminate because the interest rate dropped. Your starting interest rate is fixed only for a year or in some cases three to five years. The guaranteed rate provided for in the policy is much lower (e.g., 4%). Another feature that is sometimes emphasized is the “no cost” loan. Companies will set the loan interest rate to be charged on policy loans equal to the rate that is being credited to the policy.
Variable Life
Most types of both traditional and interest sensitive life policies can be purchased on either a fixed-dollar or variable basis. On a fixed-dollar basis, premium, face amount and cash values are specified in dollar amounts.
Traditional variable life provides a minimum guaranteed death benefit, but many universal variable life products do not, and should investment experience be bad, coverage will terminate if substantially higher premium payments are not made. Variable life is also made available on a single premium basis but if investment experience is poor additional premiums will be required.