What is Life Insurance
Life insurance is a contract between an insurer and a policy owner. A life insurance policy guarantees the insurer pays a sum of money to named beneficiaries when the insured dies in exchange for the premiums paid by the policyholder during their lifetime.
Key Takeaways
Life insurance is a legally binding contract that pays a death benefit to the policy owner when the insured dies.
For a life insurance policy to remain in force, the policyholder must pay a single premium upfront or pay regular premiums over time.
When the insured dies, the policy’s named beneficiaries will receive the policy’s face value, or death benefit.
Term life insurance policies expire after a certain number of years. Permanent life insurance policies remain active until the insured dies, stops paying premiums, or surrenders the policy.
A life insurance policy is only as good as the financial strength of the company that issues it. State guaranty funds may pay claims if the issuer can’t.
How Life Insurance Works
Death Benefit:
The death benefit or face value is the amount of money the insurance company guarantees to the beneficiaries identified in the policy when the insured dies.
Premium:
Premiums are the money the policyholder pays for insurance.
Cash Value:
The cash value of permanent life insurance serves two purposes. It is a savings account that the policyholder can use during the life of the insured; the cash accumulates on a tax-deferred basis. The policyholder can also use the cash value to pay premiums or purchase additional insurance.
Types of Life Insurance Policies
Term life insurance
Term life insurance lasts a certain number of years, then ends. You choose the term when you take out the policy. Common terms are 10, 20, or 30 years. The best term life insurance policies balance affordability with long-term financial strength.
- Decreasing term life insurance is renewable term life insurance with coverage decreasing over the life of the policy at a predetermined rate.
- Convertible term life insurance allows policyholders to convert a term policy to permanent insurance.
- Renewable term life insurance provides a quote for the year the policy is purchased. Premiums increase annually and are usually the least expensive term insurance in the beginning.
Permanent Life Insurance
Permanent life insurance stays in force for the insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy. It’s typically more expensive than term.
- Whole life insurance is a type of permanent life insurance that accumulates cash value. Cash-value life insurance allows the policyholder to use the cash value for many purposes, such as a source of loans or cash or to pay policy premiums.
- Universal Life (UL) is a type of permanent life insurance with a cash value component that earns interest. Universal life features flexible premiums. Unlike term and whole life, the premiums can be adjusted over time and designed with a level death benefit or an increasing death benefit.
- Indexed universal (IUL) is a type of universal life insurance that lets the policyholder earn a fixed or equity-indexed rate of return on the cash value component.
- Variable universal life insurance allows the policyholder to invest the policy’s cash value in an available separate account. It also has flexible premiums and can be designed with a level death benefit or an increasing death benefit.