|Life Insurance Basics
Life insurance is an agreement between you (the policy owner)
and an insurer. Under the terms of a life insurance policy, the insurer
promises to pay a certain sum to a person you choose (your beneficiary) upon
your death, in exchange for your premium payments. Proper life insurance
coverage should provide you with peace of mind, since you know that those you
care about will be financially protected after you die.
The many uses of life insurance
One of the most common reasons for buying life insurance is
to replace the loss of income that would occur in the event of your death. When
you die and your paychecks stop, your family may be left with limited
resources. Proceeds from a life insurance policy make cash available to support
your family almost immediately upon your death. Life insurance is also commonly
used to pay any debts that you may leave behind. Life insurance can be used to
pay off mortgages, car loans, and credit card debts, leaving other remaining
assets intact for your family. Life insurance proceeds can also be used to pay
for final expenses and estate taxes. Finally, life insurance can create an
estate for your heirs.
How much life insurance do you need?
Your life insurance needs will depend on a number of
factors, including whether you're married, the size of your family, the nature
of your financial obligations, your career stage, and your goals. For example,
when you're young, you may not have a great need for life insurance. However,
as you take on more responsibilities and your family grows, your need for life
There are plenty of tools to help you determine how much
coverage you should have. Your best resource may be a financial professional.
At the most basic level, the amount of life insurance coverage that you need
corresponds directly to your answers to these questions:
What immediate financial expenses (e.g., debt repayment,
funeral expenses) would your family face upon your death?
How much of your salary is devoted to current expenses and
How long would your dependents need support if you were to
How much money would you want to leave for special
situations upon your death, such as funding your children's education, gifts to
charities, or an inheritance for your children?
Since your needs will change over time, you'll need to
continually re-evaluate your need for coverage.
How much life insurance can you afford?
How do you balance the cost of insurance coverage with the
amount of coverage that your family needs? Just as several variables determine
the amount of coverage that you need, many factors determine the cost of
coverage. The type of policy that you choose, the amount of coverage, your age,
and your health all play a part. The amount of coverage you can afford is tied
to your current and expected future financial situation, as well. A financial
professional or insurance agent can be invaluable in helping you select the
right insurance plan.
What's in a life insurance contract?
A life insurance contract is made up of legal provisions,
your application (which identifies who you are and your medical declarations),
and a policy specifications page that describes the policy you have selected,
including any options and riders that you have purchased in return for an
Provisions describe the conditions, rights, and obligations
of the parties to the contract (e.g., the grace period for payment of premiums,
suicide and incontestability clauses).
The policy specifications page describes the amount to be
paid upon your death and the amount of premiums required to keep the policy in
effect. Also stated are any riders and options added to the standard policy.
Some riders include the waiver of premium rider, which allows you to skip
premium payments during periods of disability; the guaranteed insurability
rider, which permits you to raise the amount of your insurance without a
further medical exam; and accidental death benefits.
The insurer may add an endorsement to the policy at the time
of issue to amend a provision of the standard contract.
Types of life insurance policies
The two basic types of life insurance are term life and
permanent (cash value) life. Term policies provide life insurance protection
for a specific period of time. If you die during the coverage period, your
beneficiary receives the policy death benefit. If you live to the end of the
term, the policy simply terminates, unless it automatically renews for a new
period. Term policies are available for periods of 1 to 30 years or more and
may, in some cases, be renewed until you reach age 95. Premium payments may be
increasing, as with annually renewable 1-year (period) term, or level (equal)
for up to 30-year term periods.
Permanent insurance policies provide protection for your
entire life, provided you pay the premium to keep the policy in force. Premium
payments are greater than necessary to provide the life insurance benefit in
the early years of the policy, so that a reserve can be accumulated to make up
the shortfall in premiums necessary to provide the insurance in the later
years. Should the policyowner discontinue the policy, this reserve, known as
the cash value, is returned to the policyowner. Permanent life insurance can be
further broken down into the following basic categories:
Whole life: You generally make level (equal) premium
payments for life. The death benefit and cash value are predetermined and
guaranteed. Any guarantees associated with payment of death
benefits, income options, or rates of return are based on the claims-paying
ability of the insurer.
Universal life: You may pay premiums at any time, in any
amount (subject to certain limits), as long as policy expenses and the cost of
insurance coverage are met. The amount of insurance coverage can be decreased,
and the cash value will grow at a declared interest rate, which may vary over
Index universal life: This is a form of universal life insurance with excess interest credited to cash values. But, unlike universal life insurance, the amount of interest credited is tied to the performance of an equity index, such as the S&P 500.
Variable life: As with whole life, you pay a level premium
for life. However, the death benefit and cash value fluctuate depending on the
performance of investments in what are known as subaccounts. A subaccount is a
pool of investor funds professionally managed to pursue a stated investment
objective. The policyowner selects the subaccounts in which the cash value
should be invested.
Variable universal life: A combination of universal and
variable life. You may pay premiums at any time, in any amount (subject to
limits), as long as policy expenses and the cost of insurance coverage are met.
The amount of insurance coverage can be decreased, and the cash value goes up
or down based on the performance of investments in the subaccounts.
Variable life and variable universal life
insurance policies are offered by prospectus, which you can obtain from your
financial professional or the insurance company. The prospectus contains
detailed information about investment objectives, risks, charges, and expenses.
You should read the prospectus and consider this information carefully before
purchasing a variable life or variable universal life insurance policy.
You must name a primary beneficiary to receive the proceeds
of your insurance policy. You may name a contingent beneficiary to receive the
proceeds if your primary beneficiary dies before the insured. Your beneficiary
may be a person, corporation, or other legal entity. You may name multiple
beneficiaries and specify what percentage of the net death benefit each is to
receive. You should carefully consider the ramifications of your beneficiary
designations to ensure that your wishes are carried out as you intend.
Generally, you can change your beneficiary at any time.
Changing your beneficiary usually requires nothing more than signing a new
designation form and sending it to your insurance company. If you have named
someone as an irrevocable (permanent) beneficiary, however, you will need that
person's permission to adjust any of the policy's provisions.
Where can you buy life insurance?
You can often get insurance coverage from your employer
(i.e., through a group life insurance plan offered by your employer) or through
an association to which you belong (which may also offer group life insurance).
You can also buy insurance through a licensed life insurance agent or broker,
or directly from an insurance company.
Any policy that you buy is only as good as the company that
issues it, so investigate the company offering you the insurance. Ratings
services, such as A. M. Best, Moody's, and Standard & Poor's, evaluate an
insurer's financial strength. The company offering you coverage should provide
you with this information.