Types of Life Insurance Explained
How life insurance functions and offers coverage seems pretty simple. The practice has always been to supply those that rely on you, like your children or spouse, with financial protection if you, as the policyholder, pass away. This would seem pretty easy to navigate alone, if not for several different types and subtypes of life insurance.
Finding the life insurance policy that’s right for you can be a confusing process if you’re not familiar with at least the basics. Insurance companies use factors such as policy life, cost, and actual cash value to group their different life policies. At this point, you may not be sure what half of those refer to. This post isn’t just a dictionary of what life insurance policies are and the associated vocabulary, but also a shopping guide to what life policy best fits you.
What Are The Basics of Life Insurance?
Before divining into the specifics of life insurance, let’s first go over the basics. These would be what every life insurance has regardless of the type.
Every life insurance has a:
- Death benefit - A life insurance policy’s payout is officially called a death benefit, which is paid out when the policyholder passes away.
- Beneficiaries - These are the people who are listed on the policy as receivers of the death benefit when it is paid out. It can all go to one person or be divided among multiple, usually family or spouse.
- Term - The life insurance policy term refers to how long it will be active and provide coverage for. Some policies can last for a couple of decades, while others can last for life.
- Premium - A premium, or rate, is the amount a life insurance policyholder pays on a monthly basis to upkeep their coverage. Every type of insurance like auto and homeowners has premiums of their own.
- Cash value - Life insurance policies have an investment component that may increase over time based on the type of coverage. It can be cashed out or borrowed at any time. Life policies which aren’t permanent are typically exempt from a cash value.
What Are The Two Main Types of Life Insurance?
This post can pretty much be summed up like an iceberg diagram, wherein the most general details are the tip, and as we go deeper, it becomes larger and more complex. At this point, we are at the tip of the two major categories that life insurance falls into.
These are the two broad categories that life insurance falls into:
- Term life insurance - In the simplest way to explain it, a life insurance policy is considered a term when it doesn’t last for life. These are the policies that stay active for a couple of decades. When the policy expires, a new one must be bought.
- Permanent life insurance - This is sometimes called whole life insurance. Quite literally, permanent life insurance is permanent when it comes to its lifespan. The policy expires when the policyholder dies.
What Are The Differences Between Term Life Insurance And Permanent Life Insurance?
The key differences between term and permanent life insurance go beyond just how long they remain active. More differences lay in the cash values and monthly premiums. Naturally, a term life insurance policy loses its cash value when it expires, while a permanent one remains constant until payout. Premiums for permanent life insurance tend to be higher than those of term, as it’s simply the pricier option. But for a lot of policyholders, all that money and time is worth it in the end. Permanent life insurance’s cash value can also act as an investment and tax-exempt, which accrues interest over the years. The exact details of how much depend on the specific policy type you choose.
What Are The Specific Types of Life Insurance Policies?
Term and permanent are just the basic categories in which life insurance policies are classified as. At this point, we’re moving down from the tip of the metaphorical iceberg and finding out the specific names of such life policies that are defined as such.
The specific and common types of life insurance are:
- Basic term life insurance - A basic term policy would look exactly as discussed in the previous sections -the cheapest way to have life insurance for a period of time. Policy life can range from one year to three decades.
- Basic whole life insurance - A general whole life policy lasts until death and builds cash value with interest while premiums remain constant. Naturally, it’s more costly.
- Universal life insurance - This permanent life insurance comes in two sizes -indexed and guaranteed. Life insurance policies that are guaranteed ensures that the death benefit will be received with no change in premiums. Indexed life insurance policies link their actual cash value to a stock market. More on indexed and guaranteed life insurance is in the next section.
- Variable life insurance - Variable policies are permanent, which allow flexibility with the death benefit. Variable life insurance also has a universal policy option that allows for adjustable premiums. At the same time, both variable life insurance types are tied to investment and mutual funds accounts of the policyholder.
- Simplified issue life insurance - Underwriting refers to when an insurance company looks at the risks of issuing anyone a life insurance policy. They can do this in the form of medical exams or questionnaires. A simplified issue life insurance policy is one such underwriting policy that doesn’t require a medical exam and can either be term or permanent.
- Guaranteed issue life insurance - Another underwriting life insurance. However, a medical questionnaire or exam isn’t necessary. It’s impossible to be turned away as it’s quite literally guaranteed, making it a great option for older people with underlying conditions. However, coverage is low for the high price. This type of life insurance can be either term or permanent.
- Group life insurance - Employers sometimes offer group insurance for their employees which can be term or permanent -but more often term. Coverage tends to be basic as it is for a group. Premiums tend to be higher because it’s based on a group as well.
- Mortgage life insurance - Mortgage-based life insurance policy covers the policyholder’s mortgage and pays the lender rather than the beneficiaries. This can be both term and permanent.
- Credit life insurance - A term life insurance policy that is sometimes offered when a loan is taken out. This insurance payout covers the loan when the policyholder dies.
- Accidental death and dismemberment life insurance - This type of term or permanent life insurance pays out when the policyholder is killed or loses limbs or senses in an auto accident.
- Joint life insurance - This term or permanent life insurance covers two policyholders at the same time. The payout occurs when one or both of the policyholders pass away. Because of this, this kind of life insurance isn’t in very high demand.
What Does it Mean When Life Insurance is Indexed And Guaranteed?
From that last section alone, there seems to be a lot to unpack with all the life insurance policies that were discussed. At this point, you probably realized that term and permanent is really just terms used to describe the life span of a given policy. When a life insurance policy is indexed or guaranteed, the premiums and actual cash value vary as opposed to lifespan. We’ve touched on indexed and guaranteed life insurance in the previous section about universal life insurance, but here’s a more in-depth look at the two.
Universal life insurance is the only type of life insurance that can be indexed and guaranteed based on what the interested policyholder chooses. When an agent refers to an indexed or guaranteed policy, they are more than likely talking about universal coverage. Guaranteed universal life insurance means that the cash value will always be guaranteed and doesn’t change until payout. Indexed universal life insurance is when the actual cash value can increase due to a fixed or indexed rate. If the policyholder desires more freedom with their actual cash value, such as investing it, they can opt for a variable universal life policy.
What is Underwritten Life Insurance?
At this point in the reading, the word “underwriting” or “underwritten” has been thrown around with little to no detail. It’s an easy thing to understand due to the fact that policyholders and customers aren’t the ones doing the underwriting; rather, it’s the insurance providers. Underwriting is the process which they use to calculate and gauge the risk of insuring any given person with a guaranteed or simplified life insurance policy. They can do this with a medical exam or questionnaire. You’ll be required to do one or both based on the type of underwritten life insurance policy you choose.
Underwriting policies include:
- Fully underwritten life insurance - This kind of life policy would be best for healthier policyholders and is the cheapest option. The application includes both a medical exam and a questionnaire.
- Simplified issue life insurance - This is the option for those with some degree of medical history. The application only includes a medical questionnaire with no exam. This type of life coverage is sometimes referred to as instant-approval life insurance since there is a waiting period when an examination is involved.
- Guaranteed issue life insurance - This is the life policy option for those ages 40 to 85 with or without both a medical exam and questionnaire. The insurance quotes are literally guaranteed regardless of the person, but it isn’t the cheapest underwriting life insurance policy.
What Are The Pros And Cons of All The Different Types of Life Insurance?
There is a lot to unpack with all the different types of life insurance. So much so that comparing all of them can make your head spin. For your head’s sake, let’s spend the rest of the post going over each life insurance policy based on its pros and cons. From there, you’ll be able to make a more informed and less stressful decision about how you want your life insurance.
What Are the Pros And Cons of Term Life Insurance?
Let’s start with the good that a term life insurance policy can do. Because of its limited lifespan of up to 30 years, term life is naturally cheaper than full or permanent life insurance. Term policyholders are also given the option of either a level premium or an annual renewable. A level premium would stay the same during the policy’s lifespan, while an annual renewable is a one-year policy that must be renewed every year.
The main issue with a term life policy isn’t that it isn’t enough coverage, but the fact that you may outlive it, especially if you’re young. Once a policy expires, so do the coverage and death payouts.
What Are The Pros And Cons of Permanent/Whole Insurance?
It’s a plus that permanent insurance lasts for the entire life of the policyholder. It’s super easy to purchase an insurance policy then pay no mind to it unless it has to be changed. The cash value of the policy is also subject to a rate of return that builds it while the death benefit remains constant.
Naturally, a permanent or whole life insurance policy will cost significantly more and carry higher rates.
What Are The Pros And Cons of Guaranteed Universal Life Insurance?
Many policyholders favor the idea of a guaranteed death benefit payout and constant premiums and rates that never change. What’s more, the policyholder can choose when the policy expires based on their age. Universal life insurance is cheaper than whole life insurance. When the universal coverage is indexed, it will cost more.
A guaranteed universal life insurance policy has little to no cash value. This means that if a payment is missed, coverage will be dropped with no value payout.
What Are The Pros And Cons of Indexed Universal Life Insurance?
As previously mentioned, an indexed universal life insurance policy allows more financial freedom and privileges than a guaranteed one. The cash value is linked to a stock market index and may be subject to gains if the stocks are in your favor. Your payments and death benefit are also flexible.
Investment caps prevent cash value from more serious gains from the stock market. At the same time, you’ll have to monitor the stock market like a broker for any changes as that can have an effect on your insurance cash value.
What Are The Pros And Cons of Variable Life Insurance?
More financial freedom and opportunities arise with a variable insurance policy. Insurance cash value is now tied to not just stocks, but bonds and mutual funds as well. Premiums are adjustable, and the death benefit is guaranteed. What’s more, you’re entitled to make withdrawals from your insurance cash value.
Much like indexed life insurance, you’ll have to become a sort of rudimentary stockbroker as you must be hands-on with your policy and managing cash value. Policyholders can sometimes be subject to administrative charges and fees.
What Are The Pros And Cons of Underwriting Life Insurance Policies?
As mentioned in the section about underwriting life insurance, these are the policies that require a medical evaluation or questionnaire by the insurance provider in order to gauge their risk. The good news is that with underwriting insurance, there is a policy for everyone. Fully underwritten life insurance requires an exam and questionnaire and is the cheapest option for any healthy individual. Simplified issue insurance is for those with more underlying health issues and exempts them from a medical exam. Guaranteed issue insurance is for older individuals looking for a policy because they will recieve it nonetheless with no questionnaire or exam.
The cons for each underwriting life insurance policy are simply where they can’t be applied. A 30-year-old would be able to recieve standard underwriting insurance and simplified issue, but not guaranteed issues. Also, guaranteed issue life insurance is the most expensive of the three due to the almost lack of an application process.
What Are The Pros And Cons of Group Life Insurance?
The best part about group life insurance is that it may be provided by an employer. The premiums are based on the group, and rates may be included in an employee’s paycheck or salary.
However, there may be some catches to being provided life insurance through work. Management often provides only basic coverage for their employees. Sometimes, getting full coverage requires purchasing it yourself.
What Are The Pros And Cons of Mortgage Life Insurance?
Mortgage insurance is often considered by those with underlying health issues and who are unable to qualify for certain life insurance policies. Mortgage insurance has a payout that goes to the bank or lender as opposed to listed beneficiaries. A mortgage is just one of many expenses that must be covered in the absence of a homeowner.
A mortgage life policy doesn’t list any beneficiaries, so this isn’t the policy for those looking to provide financial protection for their loved ones in their absence. A mortgage policy also has a short life span, even shorter than term life insurance.
What Are The Pros And Cons of Credit Life Insurance?
Credit life insurance covers both mortgages and loans when the policyholder dies. Some states, like New York, are known to have requirements of how much life insurance you should carry. This insurance is often sold by banks or other financial institutes to cover transactions done with them, so it’s intensely secure.
Because of the limits some states may impose on credit life insurance, there may be instances where credit life insurance just isn’t enough. Let’s say that your mortgage is near twice your credit life insurance coverage, which means you would be in charge of covering the remaining amount.
What Are The Pros And Cons of Accidental Death And Dismemberment Insurance?
Not all accidents or deaths can be due to an auto collision. At the risk of sounding ominous, accidents lurk around every corner, so it helps to be prepared with accidental death and dismemberment insurance. This can cover you and others if you are ever involved in a serious accident. Some of these policies can be offered by employers. Loss of limbs or any senses is also covered.
Because it’s offered through work, purchasing an accidental death and dismemberment policy on its own may seem like a liability. You should be aware of your budget when deciding on whether or not to purchase.
What Are The Pros And Cons of Joint Life Insurance?
Joint life insurance is naturally for people who live a joint life. This could be married couples or life partners. A joint policy would payout after one of the policyholders dies. If both die, then their beneficiaries will recieve the payout. This is an especially good policy for parents looking to leave everything to their kids should anything happen to them.
If you’re single, then there are obviously better and more economical options for life insurance. The insurance is typically more expensive the older the policyholders are. Each birthday brings a premium increase.
How Much Does Life Insurance Cost?
Now it’s time for the answer to the ultimate question -how much does it cost? All across the life insurance board, rates will always be higher the older you are. There are also other factors like health, lifestyle, and even sex that can determine what you will be paying for your life insurance.
Let’s take a look at what the following age groups pay for their life insurance:
- 25 year-olds - A woman could pay around $14.25 a month for $250,000 coverage, $21.26 a month for $500,000 coverage, and $34.54 a month for $1,000,000 coverage. A man could pay more at around $17.13 a month for $250,000 coverage, $27.10 a month for $500,000 coverage, and $45.18 a month for $1,000,000 coverage
- 35 year-olds - A woman could pay an average of $16.48 a month for $250,000 coverage, $25.43 a month for $500,000 coverage, and $42.61 a month for $1,000,000 coverage. A man would pay $18.70 a month for $250,000 coverage, $30.29 a month for $500,000 coverage, and $51.72 for $1,000,000 coverage.
- 45 year-olds - A woman could pay $28.41 a month for $250,000 coverage, $47.52 for $500,000 coverage, and $86.37 a month for $1,000,000 coverage. A man of the same age group may pay $35.31 a month for $250,000 coverage, $60.78 a month for $500,000 coverage, and $113.62 for $1,000,000 coverage.