Insurance is a contract between two parties, in which one of the parties agrees to protect the other party against a financial loss. This of course, isn’t free so the insured party pays a payment called a premium to the insurer. If the financial loss does occur as specified in the initial contract then the insurer pays the insured party the money to compensate for the loss. The role of the insurance for the insured party should be for protection purposes in most cases.
So how does life insurance play into this?
Most people want to protect their assets that they hold valuable. In life insurance the insured party is protected against the financial impact the loss of lives may have. There are many things to consider when buying this type of coverage. The buyer needs to make sure they are properly protected. We need to determine what factors go into determining coverage and who is involved in the coverage policy.
Which Parties take part in an individual insurance contract?
The insurer pays the money when the covered financial risk occurs.
The policyholder is the owner of the insurance contract. This party pays and determines the beneficiaries of the contract.
The life insured is the person on whose life the contract of life insurance is taken. If this person loses their life. The benefit is paid due to the financial risk caused by this party death.
The policyholder can designate a beneficiary. This individual receives the money when the financial risk occurs.
Types of insurance
Mainly there are two types of insurance.
Term Life Insurance
Term insurance is temporary insurance. This insurance only covers a specified period of time. This specified period is usually specified for a certain number of years. This could be 5, 10, 15, 20, ect. This type of policy can be renewed without proof of health with increased premium rates. This term policy can also be converted to a permanent life insurance policy without proof of health.
There also different types of term insurance. This can be decreasing term life insurance or mortgage insurance. In this type of insurance the capital insured decreases on an annual basis, but the premium remains the same until the contract expires. This type of insurance can be used in paying a mortgage of a house. Let’s say you brought a house worth $120,000, and you lost your life halfway through paying the mortgage off. The remainder of the loan will be paid off by the insurer. In this case the capital was decreasing annually as you were paying off the mortgage while you were alive.
The other type of term insurance is with a uniform or fixed life insurance. The insurance amount that the benefactor receives is fixed for the contract period in this case. Usually the premiums are increased with each renewal of the contract.
A term insurance coverage is best for those who need coverage for a short period of time. This type of insurance is also the cheapest. This type of insurance is well suited towards business partners, young couples, new parents, and people that have a limited budget. Overall I personally would recommend this type of coverage for most people. Since coverage is highly required during your working years. After a certain age coverage become nonessential and expensive. But that is just my opinion.
Permanent Life Insurance
As the name suggests this type of insurance is either permanent or until death. However there are multiple types of permanent life insurance that one can come across. This can include things like whole life, term to 100 and universal life insurance. A whole life insurance is an insurance where premiums are either due for the life’s insured’s entire life or the premiums are payed only for a specified time period. The fewer payments lead to higher annual premiums and cash value. This type of insurance policy usually has a death benefit, fixed premium rate and a cash value. Since it is permanent it will not have a renewal period. Which means it will have a fixed premium.
A cash value is portion of the premiums used as savings which accumulate within the insurance contract and are payable when the policyholder terminates the contract. This cash value is separate than the death benefit payout. This saving is taxable when withdrawn from the policy and may or may not be payable if the insured dies. This amount is usually known in advance when is contract is drawn up. The cash value also gives a non-forfeiture option by being able to miss premium payments by using up the accumulated savings in cash value also known as Automatic premium loans. This gives the policyholder room for error.
Other non-forfeiture options
Reducing the value of the policy
We can eliminate premiums by reducing the value of the contract. This means the face value of the contract is reduced in exchange for eliminating premiums until death. This is also known as reduced paid-up insurance. This is useful for those with limited coverage.
Extended term insurance
Here we covert the whole life insurance into a term insurance policy with the same face value. This allows us to eliminate the premiums but the contract is not only for a limited period of time. The cash value accumulated in the contract is used to also determine the length of time the contract will last.
Automatic premium loans
This allows the cash value to substitute for premium payments. This can be used each month until there is no more cash value remaining.
This is similar to automatic premium loans. The insurer loans the insured the cash value for the whole life policy up to 90%. This allows the policyholder to not be bound by a strict payment schedule. However this method of loan has interest rates and the loan is transferred directly to the policyholder’s bank account.
Other types of permanent insurance
A term- 100 life insurance provides coverage until the age of 100, this type of insurance usually doesn’t have any cash value attached to it. Therefore the premiums are much lower.
Universal life insurance combines investments and insurance into a single contract. The investment portion is not guaranteed as in the cash value in the whole life insurance. These investments can change over time depending on the market. The premium can vary depending on the cost of insurance and investments. One can also make withdrawals from this policy without it being considered a loan, unlike the whole life insurance. Gains earned with the investment portion are not taxable within the policy. It can only be taxed if it is withdrawn while the insured is alive. After death the returns are considered a death benefit and are not subject to tax.
Overall life coverage is important to protect families and businesses against financial loss. Most average families should consider to take the cheaper term insurance and invest the difference between a term and whole life insurance into a viable investment opportunity. This will overall insure you make more money than the cash value saving gimmick has to offer. In many cases accounts like ETF and mutual funds can easily out compete the cash value saving by a mile.