Life Insurance Deep Dive Part II – Products
In the last post we discussed some of the attributes of life insurance, its uses and how to decide how much death benefit to buy. We also elaborated on how to choose the right company and shared some resources for it. Today, we will continue our life insurance deep dive with some more information regarding the different flavors of product offerings.
The two basic product types in terms of life insurance are whole life and term life insurance. The difference is that whole life once bought and premiums paid as scheduled is in effect for the remainder of your lifetime or until you reach the age of 100 when it is paid out in full. Term life insurance acts as a regular insurance contract where you buy protection for a specific time period. Insurance companies took these two broad categories and created many different flavors of term and whole life insurance even sometimes a combination of both. I will explain some of the most popular flavors below.
Let’s start with plain vanilla term life insurance. You can buy life insurance for 1 year at a specific price. Let’s say you are 60 years of age and you want to buy life insurance just for 1 year due to an entrepreneurship venture that will lock a lot of capital for 1 year and you want to make sure if something happens your family will be protected regardless of the success of your venture. At age 60 your premium is most likely going to be substantial for a life insurance contract. You can expect to pay at around $1 per $1000 coverage. So if you want to buy yourself a death benefit of $3 Mil then you will pay $3,000 in premium for the year.
Keep in mind this is the cheapest possible contract you might be able to sign and the probability of dying in this 1 year is relatively small risk for the insurance company. What is more, once the year is gone your contract is expired and your $3,000 are already incurred expenses with nothing for it. If you are 30 years of age you can expect to pay as low as $1,000 for the same insurance contract. There are different flavors similar to the sample contract above that may offer, renewability option, conversion to permanent life option or the benefit of not providing evidence of insurability. Anything that brings optionality or convenience for the buyer of the insurance is usually going to increase its price.
Continuing with the previous example you might want to buy a life insurance product that lasts for at least 10 or 20 years. If you are in your early 30s and think that the critical period of time to have a death benefit is while you are raising your children such contract may serve you well. What insurers will typically offer is a level premium contract that will set in stone your annual premium for the complete term of the contract. If you are in your early 30s you can expect to pay at least $1,500 in premiums per year for the $3 Mil death benefit we discussed above.
In the prior example the death benefit stays the same at $3 Mil throughout the complete term. However, there is a different type of contract that will provide a decreasing death benefit for the specific term. This will make the term life insurance cheaper and might align better with your objectives as with the age some people save enough or decrease their loans and credits, hence reducing their incentive to pay for insurance.
The other general category is whole life insurance. As we noted earlier whole life insurance contracts lasts for the entire life of the insured or (100 years of age) and at the same time the premiums paid are not incurred as expenses but usually accumulate a cash value to the insured.
There are three types of whole life insurance based on the timing of the premiums paid. The straight life contract calls for premiums throughout your entire life (or until the age of 100). The limited pay life contract will have you pay premiums for less than all your life – (e.g. 20 years). After that premium payment period you will own your insurance contract that is paid in full and no additional premium payments are needed. The single premium contract is a whole life insurance that you will pay for in a single lump sum once you sing the contract. You should expect your cash value to increase over time faster in such contract as the premium paid will accumulate interest.
The other group of while life insurance products are based on how your premium amounts are changing throughout the term of the contract. Graded whole life insurance contract is going to require lower premium payments in the first several years of the contract and increase the premium payments gradually in later years. Modified whole life insurance is similar but the premium amounts increase at once rather than smoothly increasing in a couple of years.
A type of whole life insurance that takes advantage of increase in interest rates is the interest –sensitive whole life contract. With this insurance the insured will have his cash value invested on the prevailing interest rates rather than earning a fixed one like in more basic whole life contracts. If interest rates increase the insured will have the benefit of increase gains in the cash value. Usually these contracts will come with fixed minimum interest which is also going to protect the owner of the contract from reduced cash value. Still the premiums paid might be well higher than for a simpler type of contract making this option beneficial only in an increasing interest rate environment.
There are also some flexible premium insurance contracts which provide for the insured to change the premium paid throughout the payment period and still keep the contract active. This convenience though will most probably be included in the price for the contract increasing the comparable premium for a less complex contract. The adjustable life contract will provide for the insured to change premium paid, time coverage, face amount, death benefit. The insurance company will be able to do this by changing the contract from whole life to term life depending on the desired changes. Universal life insurance contract is another flavor that will provide the flexibility of changing premium paid and even skipping payments, taking advantage of increase in interest rates and using the contract as an investment vehicle that might increase the death benefit or the cash value depending on insured desirability and IRS requirements for tax deferred products.
The universal life insurance contract we just talked about has an investment part that affects the accumulated cash value of the contract but usually the interest rate used for the growth of this cash value is either fixed or interest sensitive. A more aggressive product will apply an equity index growth rate like the Indexed whole life insurance contract. These contracts can be separated also into fixed and variable whole life insurance products. In the fixed contract types the agreement will define the benefits in advance. In the variable products the cash value growth will be dependent on a benchmark like a bond or equity index making it a more aggressive product.
I hope this post has helped explain the different choices one has when shopping for life insurance and explore the differences among various products on the market. Keep in mind that different companies may have slightly altered names for contracts and terms. However, you should now be able to recognize how products differ and what the specific contract should offer to satisfy your needs. Stay tuned for the process you should expect to go through once you have decided on a company and product. I will give you good understanding of the underwriting process in my next post.