Life Insurance

Term Life Insurance 

Is life insurance that provides coverage at a fixed rate of payments for a limited period of time, the relevant term. After that period expires, coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or potentially obtain further coverage with different payments or conditions. If the life insured dies during the term, the death benefit will be paid to the beneficiary. Term insurance is typically the least expensive way to purchase a substantial death benefit on a coverage amount per premium dollar basis over a specific period of time.

Term life insurance can be contrasted to permanent life insurance such as whole life, universal life, and variable universal life, which guarantee coverage at fixed premiums for the lifetime of the covered individual unless the policy is allowed to lapse. Term insurance is not generally used for estate planning needs or charitable giving strategies but is used for pure income replacement needs for an individual. Term insurance functions in a manner similar to most other types of insurance in that it satisfies claims against what is insured if the premiums are up to date and the contract has not expired and does not provide for a return of premium dollars if no claims are filed. As an example, auto insurance will satisfy claims against the insured in the event of an accident and a homeowner policy will satisfy claims against the home if it is damaged or destroyed, for example, by fire. Whether or not these events will occur is uncertain. If the policyholder discontinues coverage because he or she has sold the insured car or home, the insurance company will not refund the full premium.

Simplified Issue Insurance

 Is a scaled back underwriting process that is simplified. Coverage amounts are lower than traditional fully underwritten policies. Simplified issue policies typically do not require a medical exam and have less application questions to answer. Many of these policies can be approved within several days.[2]

Guaranteed Issue Insurance

Is a life insurance policy that is guaranteed approval. Coverage amounts will be lower than traditional policies. Premiums will be considerably higher. Since there are no medical questions and everyone is approved, these policies will have a waiting period before benefits are paid out. If the insured dies during the initial waiting period, only premiums plus interest will be returned. Once the waiting period has been satisfied, the full death benefit will be paid out to the beneficiary.[3]

Whole Life Insurance

Is sometimes called "straight life" or "ordinary life," is a life insurance policy which is guaranteed to remain in force for the insured's entire lifetime, provided required premiums are paid, or to the maturity date.[1] As a life insurance policy it represents a contract between the insured and insurer that as long as the contract terms are met, the insurer will pay the death benefit of the policy to the policy's beneficiaries when the insured dies. Because whole life policies are guaranteed to remain in force as long as the required premiums are paid, the premiums are typically much higher than those of term life insurance where the premium is fixed only for a limited term. Whole life premiums are fixed, based on the age of issue, and usually do not increase with age. The insured party normally pays premiums until death, except for limited pay policies which may be paid-up in 10 years, 20 years, or at age 65. Whole life insurance belongs to the cash value category of life insurance, which also includes universal life, variable life, and endowment policies.

Universal life Insurance (often shortened to UL)

Is a type of cash value[1] life insurance, primarily in the United States of America. Under the terms of the policy, the excess of premium payments above the current cost of insurance is credited to the cash value of the policy. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance (COI) charge, as well as any other policy charges and fees drawn from the cash value, even if no premium payment is made that month. Interest credited to the account is determined by the insurer, but has a contractual minimum rate (often 2%). When an earnings rate is pegged to a financial index such as a stock, bond or other interest rate index, the policy is an "Indexed Universal Life" contract. These types of policies offer the advantage of guaranteed level premiums throughout the insured's lifetime at substantially lower premium cost than an equivalent whole life policy at first; the cost of insurance is always increasing as found on the cost index table (usually p. 3 of a contract). This not only allows for easy comparison of costs between carriers, but also works well in irrevocable life insurance trusts (ILIT's) since cash is of no consequence.

Variable Universal Insurance Policies

is a type of life insurance that builds a cash value. In a VUL, the cash value can be invested in a wide variety of separate accounts, similar to mutual funds, and the choice of which of the available separate accounts to use is entirely up to the contract owner. The 'variable' component in the name refers to this ability to invest in separate accounts whose values vary—they vary because they are invested in stock and/or bond markets. The 'universal' component in the name refers to the flexibility the owner has in making premium payments. The premiums can vary from nothing in a given month up to maximums defined by the Internal Revenue Code for life insurance. This flexibility is in contrast to whole life insurance that has fixed premium payments that typically cannot be missed without lapsing the policy (although one may exercise an Automatic Premium Loan feature, or surrender dividends to pay a Whole Life premium).

Single Premium

A Single Premium UL is paid for by a single, substantial, initial payment. Some policies contractually forbid any more than the one premium, and some policies are casually defined as single-premium for that reason.[3] The policy remains in force so long as the COI charges have not depleted the account. These policies were very popular prior to 1988, as life insurance is generally a tax deferred plan, and so interest earned in the policy was not taxable as long as it remained in the policy. Further withdrawals from the policy were taken out principal first, rather than gain first and so tax free withdrawals of at least some portion of the value were an option. In 1988 changes were made in the tax code, and single premium policies purchased after were "modified endowment contract" (MEC) and subject to less advantageous tax treatment. Policies purchased before the change in code are not subject to the new tax law unless they have a "material change" in the policy (usually this is a change in death benefit or risk). It is important to note that a MEC is determined by total premiums paid in a 7-year period, and not by single payment. The IRS defines the method of testing whether a life insurance policy is a MEC. At any point in the life of a policy, a premium or a material change to the policy could cause it to lose its tax advantage and become a MEC.

In a MEC, premiums and accumulation are taxed like an annuity on withdrawing. The accumulations grow tax deferred and still transfer tax free to the beneficiary under Internal Revenue Service Code 101a under certain circumstances.[4]

Fixed Premium

Fixed Premium UL is paid for by periodic premium payments associated with a no lapse guarantee in the policy. Sometimes the guarantees are part of the base policy and sometimes the guarantee is an additional rider to the policy. Generally these payments are for a shorter time than the policy is in force. For example, payments may be made for 10 years, with the intention that thereafter the policy is paid-up. But it can also be permanent fixed payment for the life of policy.[3]

Since the base policy is inherently based on cash value, the fixed premium policy only works if it is tied to a guarantee. If the guarantee is lost, the policy reverts to it flexible premium status. And if the guarantee is lost, the planned premium may no longer be sufficient to keep the coverage active. If the experience of the plan is not as good as predicted, the account value at the end of the premium period may not be adequate to continue the policy as originally written. In this case, the policyholder may have the choice to either:

  • Leave the policy alone, and let it potentially expire early (if COI charges deplete the account), or
  • Make additional or higher premium payments, to keep the death benefit level, or
  • Lower the death benefit.
  • Many universal life contracts taken out in the high interest periods of the 1970s and 1980s faced this situation and lapsed when the premiums paid were not enough to cover the cost of insurance.

Flexible Premium

Flexible Premium UL allows the policyholder to vary their premiums within certain limits. Inherently UL policies are flexible premium, but each variation in payment has a long-term effect that must be considered. To remain active, the policy must have sufficient available cash value to pay for the cost of insurance. Higher than expected payments could be required if the policyholder has skipped payments or has been paying less than originally planned. It is recommended that yearly illustrative projections be requested from the insurer so that future payments and outcomes can be planned.  

In addition, Flexible Premium UL may offer a number of different death benefit options, which typically include at least the following:

  • a level death benefit (often called Option A or Option 1, Type 1, etc.), or
  • a level amount at risk (often called Option B, etc.); this is also referred to as an increasing death benefit.

Policyholders may also buy Flexible Premium UL with a large initial deposit, thereafter making payments irregularly.