There are three major categories and many different types of life insurance policies within each category. The major types are term, whole and universal. Whole and universal life insurance are considered permanent types of coverage because they cannot be cancelled by the insurance company except for default or non-payment of premiums. In the following article, we will discuss the characteristics of the 3 main types of life insurance, as well as their respective pros and cons to help you determine which policy is best for you and your family’s financial needs.
Term Life Insurance
A standard term life insurance policy has a fixed death benefit and fixed premiums over a pre-set period of time. At the end of the term period, which can be 3 months, 1 year, 10 years, 20 years, 30 years or anything in between, the policy expires. If the insured person does not die during the term, the insurance company retains the premiums paid throughout the life of the policy, no insurance claim is filed and no death benefit is paid out.
While other types of term life may vary significantly from the standard policy, all term life insurance policies are temporary and expire at the end of the term period (with the exception of convertible term coverage), with no cash value or investment returns. The difficulty in making wide ranging characterizations regarding term life insurance is that companies offer dozens of riders and ways to customize your policy to your specific needs.
Term Life Insurance Pros and Cons
Term life insurance has two primary advantages compare to permanent coverage: term life policies are cheaper and are more flexible since they can be used to cover a relatively short span of time. Term life insurance can be purchased as supplemental insurance or as debts and liabilities increase over time, and can be cancelled or allowed to expire when obligations decrease, such as paying off your mortgage or having kids graduate college. Finally, because term is the cheapest type of life insurance, you can buy more coverage for less.
The disadvantages are that term life has to be renewed or replaced and does not provide protection for life. Furthermore, if you do renew after a 10, 20 or 30 year term period, your rates will be significantly higher based on your older age, increased health risks and medical history. If the insured person becomes ill or uninsurable during the initial term, he/she may be unable to qualify for a new policy and be left without life insurance protection in the future. Lastly, term policies do not build up a cash value and offer no investment options.
Types of Term Life Insurance
While term life insurance does not build cash value like whole and universal, there is a return of premium term life policy which refunds the premiums paid if the insured person survives the term. Other types of policies have decreasing or increasing death benefits to better meet different needs and budgets.
There are a variety of term plans offered by life insurance companies, each one catering to policyholders who need different rates or premiums, death benefits, coverage flexibility, and term periods. The number of riders available in the market today allows consumers to find custom coverage tailored to their specific financial needs.
Before comparing rate quotes, it is important that consumers compare life insurance to find the best protection for their family. Below, we have divided term life insurance plans into three categories based on premium costs, term lengths, and the insured party.
Cost or Premium Rates
Level Term Life Insurance – A life insurance policy with a fixed premium throughout the term period, which is commonly 10, 15, 20 or 30 years.
Decreasing Term Life Insurance – A plan with a death benefit that decreases over the life of the policy, but the premiums stay the same. Decreasing term is usually used to cover a financial liability that will decrease over time, like your mortgage or small business loan. Decreasing term life insurance is sometimes also called mortgage life insurance.
Increasing Term Life Insurance – Insurance coverage that starts out with a small death benefit and cheap premiums, and both gradually increase over time, usually coinciding with increases in your income. Increases in the death benefit are between set limits, usually 2% to 10%, and directly correlate to increases in rates.
Guaranteed Term Life Insurance – A type of coverage that allows policyholders to buy life insurance without a medical exam or answering medical questions. Companies usually only ask your age, and as long as you pay your premiums, you have coverage. Learn more about guaranteed life insurance.
Return of Premium (ROP) Life Insurance – A plan that requires the company to refund your premiums at the end of the coverage period, if the insured person is still alive. Learn more about ROP life insurance.
Modified Life Insurance – A policy that is completely customizable in terms of options, allowing increasing or decreasing premiums, automatic renewals and the ability to convert into permanent life insurance.
No Load Life Insurance – Protection that suspends upfront fees, such as agent and broker commissions or underwriting costs.
Renewable Term Life Insurance – A policy that allows you to automatically renew coverage without a medical exam or application. Rates typically renew at a higher premium.
Convertible Term Life Insurance – A plan similar to a standard term life insurance policy, but with the option of converting the coverage into a permanent policy.
Short or Instant Term Life Insurance – Coverage that offers short term life insurance when you need a small amount of coverage relatively quickly and cheaply.
Fixed Life Insurance – Protection for a fixed, finite period of time, such as 10, 20, 25, or 30 years. You decide the period of coverage when you buy the policy.
Who Is Insured?
Group Life Insurance – A plan offered by employers and businesses to their employees where group coverage guarantees lower rates. Death benefits are relatively low, but the premiums are usually paid for by the company as part of a benefits package.
High Risk Life Insurance – A high risk policy is ideal for individuals with dangerous occupations, hobbies or pre-existing health conditions such as high blood pressure, cholesterol, diabetes, congestive heart failure, HIV or AIDS, who may not qualify for traditional life insurance coverage. Learn more about high risk life insurance.
Joint Term Life Insurance – Protection that allows both spouses to be insured under one policy instead of purchasing each spouse or partner separate coverage. The death benefit can be paid out upon the death of the first or second spouse.
Survivorship Life Insurance – A life policy that insures 2 people and only pays out the death benefit when the second person dies.
Second To Die Life Insurance – Also known as survivorship life insurance.
Senior Term Life Insurance – Coverage specifically aimed at seniors who are looking for a small death benefit to cover final expenses such as burial costs, a funeral, and minor medical bills. Check to see if you qualify to buy life insurance for seniors.
Child Term Life Insurance – Very cheap term life insurance customized to cover your children’s lives. This policy is not recommended by many financial planners and advisers since there is usually no legitimate financial reason to buy life insurance for kids.
Family Life Insurance – The name of this policy is misleading because there is no contract that covers your entire family like a group plan. Family life insurance is simply another name for traditional term insurance, which in itself protects your family. Most of the above plans are technically forms of family life insurance.
Key Man Life Insurance – business insurance on key persons within a company. Learn more about key man life insurance.
Whole Life Insurance
Whole life insurance is a kind of permanent coverage and features a fixed, level premium and guaranteed death benefit with a cash value that allows policyholders to save for retirement. The cash value builds from a portion of the premiums paid into the policy and has a guaranteed minimum rate of return on investment, similar to a savings account but with a higher interest rate. The cash value can be used as security for low interest loans, so the insured person can borrow money from the policy while he or she is living without canceling their protection. Other types of whole life insurance policies have similar features but different payments or costs.
Whole Life Insurance Pros and Cons
The two biggest disadvantages of various types of whole life insurance policies are the cost and the lack of flexibility. Policy limits or death benefits cannot be changed as needs change because coverage is permanent and active for your lifetime. Additionally, because rates are constant for your entire life, whether you age gracefully and maintain a healthy lifestyle or get sick at 30, whole life insurance quotes are not initially as affordable as term.
On the other hand, whole life insurance advantages begin with the cash value that accrues, making whole life a steady long term investment, especially since returns are guaranteed and tax-deferred until they are withdrawn from the policy. Since all types of whole life are permanent, the company cannot cancel the policy due to the insured person’s age or health and the coverage is continuous and never needing renewal.
If life insurance will be a part of your long term financial and retirement planning, consider the fact that financial advisers, planners, and experts have reported that, on average and over the long term, whole and term life insurance rates are comparable once you add in the fact that whole life has a cash value feature that acts as an investment.
Types of Whole Life Insurance
The different types of whole life insurance all maintain the same basic characteristics, but have various payment options. Limited payment whole life insurance and endowment life insurance are paid over a set term, perhaps 20 years, and remain in force for the balance of the insured person’s life. Single premium whole insurance is paid off in a lump sum at the policy’s inception and no further payments are due. Again, the cash value can be used for low interest loans with no repayment terms so money in the policy can be used during the insured person’s life.
Other popular whole life insurance policies include the following:
Graded Benefit Whole Life Insurance – a whole life policy where the death benefits are not level and increase with time. For example, if you were to die in year one, a certain percentage of the death benefit would be paid out. For year two, your beneficiaries would be eligible for a larger percentage, and so on. By year five, most policies have a fully vested death benefit and remain fixed.
Modified Whole Life Insurance – a plan that lets you buy coverage with cheaper premiums for the first 5 years. Every year during the first 5, the premiums will increase until you are caught up and paying full price for coverage. Modified whole life makes permanent protection more affordable, but the cash value builds slowly in the first 60 months due to the lower premiums paid.
Limited Payment Whole Life Insurance – permanent insurance that allows you to pay premiums for a predetermined number of years (i.e. 20 years), and afterwards, the policy is paid off for the rest of your life.
Single Premium Whole Life Insurance – permanent coverage that is paid off in one lump sum when it is issued, and stays in effect for a lifetime.
Universal Life Insurance
Universal life insurance is a permanent policy with characteristics taken from both term and whole coverage. With universal, you have two parts: term insurance and an investment or cash value feature.
The premiums are flexible/adjustable with a minimum and maximum payment, allowing you to pay the minimum rate when your budget requires, or to pay the maximum and contribute to the cash value when discretionary income permits. The more you pay into the policy, the more premium dollars are diverted to the investment component.
From the cash value, the company deducts the current cost of term coverage (the mortality charge), administrative expenses, and charges for any custom options or riders. Finally, the company pays you interest on your remaining balance.
As with whole life, universal protection offers a guaranteed minimum interest rate on your cash value, though some carriers offer a tiered interest rate that pays you a fixed percentage up to a certain amount, and then a higher interest rate on balances above the threshold.
If the cash value ever reaches zero due to investment failures or withdrawal of cash by the policyholder, the policy is cancelled, so types of universal life insurance policies are less permanent than whole life insurance policies.
Universal Life Insurance Pros and Cons
This form of permanent life insurance is more affordable than whole life, has adjustable premiums and may pay higher returns. Since all investments have risks, you face the risk of losses and some universal policies do not guarantee a rate of return. However, if the market performs well, universal life insurance offers high rates of return and can help you grow your nest egg for retirement faster than any other type of insurance policy.
Types of Universal Life Insurance
Some universal life policies, such as guaranteed universal life insurance, also known as GULs, guarantee a minimum rate of return on investment. A special policy called variable universal life insurance (VUL) allows you to diversify your cash value between several accounts similar to mutual funds and make investment choices from a menu provided by the company. Because VULs allow you to invest in stocks and bonds, they offer higher growth rates coupled with greater risk.
Some types of universal policies offer no-lapse guarantees, meaning that even if the universal cash value reaches zero due to investment failures, the policy remains in force.
Life Insurance Types
The first step in buying a life insurance policy is to decide which category best meets your personal needs and financial goals. Once a decision has been made as to term, whole or universal coverage, consumers should review all the different types of life insurance policies within that group to see which ones are affordable and offer the best long-term protection for their families.