HOW CAN SO many different products all be called life
insurance? Here's a primer on the four basic types, as well as several
other terms you're likely to run across as you search for the best
policy.
Term
So called because it covers policyholders for a fixed span of time,
this is pure life insurance, no MSG or other additives. It always
costs much less than whole life policies for everyone except the very
advanced in age. There are two types of premiums: level term and
annual renewable. Level-term premiums remain constant throughout the
life of the policy and can be bought in increments up to 30 years,
while premiums for annual renewable increase as you age. Ordinarily,
level premiums are higher than renewable premiums in the early years
of the policy and lower in the later years. These days the best
bargains are to be found in level-term policies of 10 years and more.
Many term policies have a conversion feature that
allows you to convert the policy to a whole life product later on
without having to submit to a medical exam. That may be a good choice
if you're in poor health, but it's a lousy one for just about everyone
else.
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Whole
Whole life combines term insurance with an investment component. A
whole life policy has two elements: the mortality charge, the part of
your premium that pays for the insurance coverage, and a reserve, the
investment component that earns interest. As you age, the portion that
goes into the reserve decreases while the portion that pays for the
mortality charge increases. In addition to interest, many companies
credit the reserve with an annual dividend, depending on the insurer's
loss experience and investment performance.
The cash surrender value (which is also called the cash value) is
what you'd get if you cashed in your policy. If you decide to give up
your policy, your cash surrender value can be paid in cash or paid-up
insurance. There are several problems with using whole life as a
savings vehicle, however. One is that the policy's advertised rate of
return, as disclosed in a set of hypothetical numbers called the
policy illustration, can have little or no relation to reality. In
fact, the policy's returns will fluctuate with the markets -- and will
usually trail returns available from other investments like equity
mutual funds. Another problem is that whole life is extremely
expensive, and if you're on a limited budget, you may not be able to
afford all the insurance coverage you actually need.
Wealthy people sometimes use whole life policies as an
estate-planning vehicle. They can set up an insurance trust, which
applies the proceeds of the policy to their estate taxes when they
die. That can save their heirs the considerable expense of settling
the estate with Uncle Sam.
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Universal
Universal, like whole, combines insurance with savings. The savings
component, called an accumulation fund, earns interest monthly and is
used to pay the mortality charge. The oft-repeated sales pitch for
universal is that premiums are flexible -- as long as you pay enough
to maintain the mortality charge, you can skip adding to the
accumulation fund if money is tight. And if you contribute enough to
the accumulation fund in the policy's early years, it can throw off
enough income to pay your premium in later years.
But there are significant drawbacks to universal policies. If you
skimp on premiums in the policy's early years, you can be socked for
higher charges later on, when you expected to be paying little or
nothing. The alternative is to drop the policy and withdraw the
savings you may have built up. If you drop the policy, you may have to
pay a surrender charge.
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Variable
Variable-life insurance combines a mortality charge with a savings
vehicle that you choose from among a number of alternatives offered by
your insurer. The savings vehicle is usually one of several investment
portfolios that are structured like mutual funds. On average, most
companies offer 10 different portfolios, including stock, bond and
money-market funds. The insurers often manage these funds themselves,
collecting fees for administering the insurance and managing the
portfolios.
There are two basic types of variable life. One demands a fixed
premium payment. The other, variable-universal life, has a flexible
premium like universal life. Remember, though, that variable returns
can fluctuate with the financial markets. If the stock market takes a
hefty dive, you may find the cash-value portion of your policy in the
tank. Variable life is not appropriate for people who are on a tight
budget or are likely to need to tap their savings on short notice.
Many variable buyers would be better off buying term and making a
separate investment in a mutual fund.
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Return of
Premium
This type of life insurance is essentially a hybrid between term life
and whole life. You buy a return of premium policy for a set amount of
time — say, 30 years. You make your payments every year, and in the
event that you pass away, your heirs are paid the face value of your
death benefit. Here's the part that appeals to a lot of people. Should
you outlive your policy, the insurer sends you a tax-free check for
the full amount that you've spent on premiums over the lifetime of
your coverage. In the words of one agent, it's a win/win situation.
There is a downside. Price. In order to guarantee you your premiums at
the end of the 30 years, the insurer charges you an additional 50%
over the cost of a standard term policy.
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Adverse
Selection
The reason why many insurance companies would rather go to you than
have you come to them. People with poor health are more apt to apply
for or continue insurance than those with average or
better-than-average health expectations.
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Beneficiary
The person or persons designated by the policyholder to receive the
proceeds of an insurance policy upon the death of the insured. The
policyholder can name both a primary and secondary beneficiary.
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Cash Value
How much money you would be paid at any given time if you cancel your
whole life policy. It's also the amount you can borrow from the
policy, or its loan value.
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Contestability
Period
The time period during which the insurer is not obligated to pay a
claim (usually two years), because of material misrepresentations
found in the application. A policy becomes "incontestable" when the
contestability period is over.
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Illustration
A proposal showing a policy's future payments, cash value and death
benefits. Non-guaranteed values are based on the company's current
rates of interest, mortality and expenses. Watch out for these because
they often contain unrealistic assumptions.
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Medical
Information Bureau
A private company that collects medical information on behalf of life
insurance companies who are members of MIB. Member companies are
required to provide brief, coded reports of individual medical
histories of customers to MIB on a confidential basis. These reports
do not include indication as to whether or not an application is
issued, rated or declined.
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Mortality Charge
The cost of the insurance protection on a whole life product. On an
illustration, mortality charges referred to as "current" are not
guaranteed. Those stated as "maximum" are the contract guarantees. The
mortality charge is similar to a one-year term rate and increases with
the insured's attained age. For example, a typical $100,000 whole life
policy for a 40-year-old male carries a premium of about $2,000 a
year. Of that, roughly $350 is the mortality charge, and the rest of
the premium goes toward the investment portion.
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Rating Classes
Insurance companies used to have just three classes -- standard (the
lowest), select (middle) and preferred (the best rates). But some
insurers have been slicing classes into many more categories. That's
why it pays to shop around because you may be placed in the best
rating class by one company's criteria and a notch below by another.
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Second-To-Die
A type of life insurance policy that insures two lives. The death
benefit is payable at the second death. Generally, this product is
used as a funding vehicle for estate taxes payable at the second death
when the unlimited marital deduction is utilized. Also referred to as
survivorship policies. Be sure to compare the cost of two separate
policies before signing on for one of these.
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Single
Premium Life Insurance
Requires one lump-sum, up-front premium and is often guaranteed to
remain paid-up throughout the insured's lifetime. Beware. These
policies sometimes don't come with a guarantee that future payments
will never be required, a fact the agent may gloss over.
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