Paul Sanchez
Life insurance is a contract between an insurance company and a policyholder (the person or entity who owns the policy), where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. The purpose of a life insurance policy is to provide financial support to an individual, organisation, or entity after the policyholder's death. Life insurance can be an important part of long-term financial planning for a family, and it can be used for everything from long-term care to wealth transfer strategies. It can be divided into two basic classes: temporary and permanent; or subclasses such as term, universal, whole life, and endowment life insurance.
Characteristics and Values of Life Insurance
| Characteristics | Values |
|---|---|
| Type of contract | Legal contract |
| Parties involved | Insurance company, policyholder, beneficiaries |
| Payment | Regular premium payments |
| Purpose | Financial safety net for beneficiaries |
| Payment conditions | Upon the death of the insured person |
| Classes | Temporary, permanent, term, universal, whole life, endowment |
| Riders | Supplemental coverage, e.g., accidental death insurance |
| Tax implications | Special rate of corporation tax on profits in some countries |
| Exclusions | Suicide, fraud, war, riot, civil commotion |
| Insurable interest | Required for persons not related by blood |
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What You'll Learn
Term life insurance
Life insurance is a type of contract between an insurance policyholder and an insurer or assurer. The policyholder makes regular payments to an insurance company, and in exchange, the insurance company acts as a financial safety net for your family. If you die while the policy is active, your insurance company pays a sum of money to the people you've named in your policy (your beneficiaries).
Life insurance can be divided into two basic classes: temporary and permanent. Temporary life insurance is sometimes referred to as term life insurance. Term life insurance provides coverage for a set period, usually 10, 15, 20, or 30 years. The policyholder chooses the term length that makes the most sense for their unique lifestyle. The premiums remain the same for the entire length of the policy, unless the policyholder chooses to change them.
There are several types of term life insurance policies:
- Fixed-term: The most popular choice, this is the most basic version and lasts 10, 20, or 30 years. The premiums remain static.
- Increasing term: This type of policy allows you to scale up the value of your death benefit over time, but your premiums will slightly increase. These policies tend to cost more but usually deliver a larger payout.
- Decreasing term: This type of policy reduces the premium payments over time, which can result in a smaller death benefit. This option makes sense for those who predict they will have fewer financial obligations as they age.
- Annual renewable: This type provides coverage on a yearly basis and must be renewed by the end date to continue coverage. The premiums usually increase each time the plan is renewed, and this option tends to be more expensive.
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Permanent life insurance
There are several types of permanent life insurance policies, including whole life insurance and universal life insurance. Whole life insurance covers the policyholder for their whole life, with premiums that don't change over time. Universal life insurance offers more flexibility, allowing policyholders to adjust their premium payments over time. Variable universal life insurance offers even more flexibility in how the cash value is managed, allowing policyholders to invest their cash value in sub-accounts tied to the market. Indexed universal life insurance is another type of permanent life insurance policy, where the cash value grows based on a chosen stock market index.
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Whole life insurance
Life insurance is a type of contract between an insurance policyholder and an insurer or assurer. The policyholder makes regular premium payments to the insurer, and in exchange, the insurer promises to pay a sum of money to the beneficiaries named in the policy upon the death of the insured person. This acts as a financial safety net for the policyholder's family.
In addition to the death benefit, whole life insurance policies have a cash value component that grows over time. This cash value can be used to fund significant expenses, such as a down payment on a home or college tuition, or to supplement retirement income. Policyholders can borrow against the cash value, withdraw funds, or end the policy and receive the accumulated cash value. The cash value grows tax-deferred, and the policyholder can also earn dividends.
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Universal life insurance
Life insurance is a legal contract between an insurance policyholder and an insurer or assurer. The policyholder makes regular payments to the insurer, and in exchange, the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Life insurance acts as a financial safety net for the policyholder's family.
One of the main advantages of UL insurance is its flexibility. Policyholders can adjust their premium payments, have more input on how the cash value accumulates, and access the cash value through policy loans, withdrawals, or surrendering the policy. The cash value can be used to help build assets, deal with unexpected expenses, and even pass on wealth to the next generation. UL insurance can also provide a substantial death benefit, although underpaying for too long or poor investment performance can affect this benefit.
However, there are also some disadvantages to UL insurance. The interest rate on the cash value is not guaranteed, and if the interest rates drop, the cash value may not perform well. Additionally, policyholders need to carefully manage their policy to ensure it remains active. If the cash value falls too low and the premiums don't cover the cost of insurance, the policy can lapse. UL insurance can also be more complex than other forms of life insurance, and policyholders need to make investment choices that may involve risk.
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Endowment life insurance
Life insurance is a type of contract between an insurance policyholder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. The policyholder makes regular premium payments to their insurer for as long as the policy is active.
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Frequently asked questions
Life insurance is a contract between an insurance company and a policyholder (the person who owns the policy). In exchange for regular premium payments, the insurance company promises to pay a designated beneficiary a sum of money upon the death of the insured person.
The insured is the person whose life is insured.
A beneficiary is the person or entity named in the policy to receive the insurance money upon the death of the insured. Anyone can be named a beneficiary, but they must have what the insurance industry calls "an insurable interest" in the life of the insured.
