There are many types of life insurance products available for consumers. Although all life insurance products offer death protection, each type also includes its own unique features and benefits and is designed to serve different insureds’ needs.
Regarding the length of coverage, all life insurance policies fall into 2 categories: temporary and permanent protection.
A. Term Life Insurance
Term insurance is temporary protection because it only provides coverage for a specific period of time. It is also known as pure life insurance. Term policies provide for the greatest amount of coverage for the lowest premium as compared to any other form of protection. There is usually a maximum age above which coverage will not be offered or at which coverage cannot be renewed.
Term insurance provides what is known as pure death protection:
- If the insured dies during this term, the policy pays the death benefit to the beneficiary;
- If the policy is canceled or expires prior to the insured's death, nothing is payable at the end of the term; and
- There is no cash value or other living benefits.
There are three basic types of term coverage available, based on how the face amount (death benefit) changes during the policy term:
- Level;
- Increasing; and
- Decreasing.
Regardless of the type of term insurance purchased, the premium is level throughout the term of the policy; only the amount of the death benefit may fluctuate, depending on the type of term insurance. Upon selling, renewing, or converting the term policy, the premium is figured at attained age (the insured's age at the time of transaction).
1. Level Term
Level term insurance is the most common type of temporary protection purchased. The word level refers to the death benefit that does not change throughout the life of the policy.
Level Premium Term
Level premium term, as the name implies, provides a level death benefit and a level premium during the policy term. For example, a $100,000 10-year level term policy will provide a $100,000 death benefit if the insured dies any time during the 10-year period. The premium will remain level during the entire 10-year period. If the policy renews at the end of the 10-year period, the premium will be based on the insured’s attained age at the time of renewal.
Annually Renewable Term
Annually renewable term (ART) is the purest form of term insurance. The death benefit remains level (in that sense, it’s a level term policy), and the policy may be guaranteed to be renewable each year without proof of insurability, but the premium increases annually according to the attained age, as the probability of death increases.
In New York, the maximum age above which coverage will not be offered is 80.
2. Special Features: Renewable and Convertible
Most term insurance policies are renewable, convertible, or renewable and convertible (R&C).
The renewable provision allows the policyowner the right to renew the coverage at the expiration date without evidence of insurability. The premium for the new term policy will be based on the insured's current age. For example, a 10-year term policy that is renewable can be renewed at the end of the 10-year period for a subsequent 10-year period without evidence of insurability. However, the insured will have to pay the premium that is based on his or her attained age. If an individual purchases a 10-year term policy at age 35, he or she will pay a premium based on the age of 45 upon renewing the policy.
The convertible provision provides the policyowner with the right to convert the policy to a permanent insurance policy without evidence of insurability. The premium will be based on the insured's attained age at the time of conversion.
B. Whole Life Insurance
Permanent life insurance is a general term used to refer to various forms of life insurance policies that build cash value and remain in effect for the entire life of the insured (or until age 100) as long as the premium is paid. The most common type of permanent insurance is whole life.
Whole life insurance provides lifetime protection, and includes a savings element (or cash value). Whole life policies endow at the insured's age 100, which means the cash value created by the accumulation of premium is scheduled to equal the face amount of the policy at age 100. The policy premium is calculated assuming that the policyowner will be paying the premium until that age. Premiums for whole life policies usually are higher than for term insurance.
The following are key characteristics of whole life insurance.
- Level premium: the premium for whole life policies is based on the issue age; therefore, it remains the same throughout the life of the policy.
- Death benefit: the death benefit is guaranteed and also remains level for life.
- Cash value: the cash value, created by the accumulation of premium, is scheduled to equal the face amount of the policy when the insured reaches age 100 (the policy maturity date), and is paid out to the policyowner. (Remember: the insured and the policyowner do not have to be the same person.) Cash values are credited to the policy on a regular basis and have a guaranteed interest rate.
- Living benefits: the policyowner can borrow against the cash value while the policy is in effect, or can receive the cash value when the policy is surrendered. The cash value, also called nonforfeiture value, does not usually accumulate until the third policy year and it grows tax deferred.
The three basic forms of whole life insurance are straight whole life, limited-pay whole life and single premium whole life; however, other forms and combination plans may also be available.
1. Continuous Premium (Straight Life)
Straight life (also referred to as ordinary life or continuous premium whole life) is the basic whole life policy (illustrated above). The policyowner pays the premium from the time the policy is issued until the insured’s death or age 100 (whichever occurs first). Of the common whole life policies, straight life will have the lowest annual premium.
2. Limited Payment
Unlike straight life, limited-pay whole life is designed so that the premiums for coverage will be completely paid-up well before age 100. Some of the more common versions of limited-pay life are 20-pay life whereby coverage is completely paid for in 20 years, and life paid-up at 65 (LP-65) whereby the coverage is completely paid up for by the insured's age 65. All other factors being equal, this type of policy has a shorter premium-paying period than straight life insurance, so the annual premium will be higher. Cash value builds up faster for the limited-pay policies.
Limited-pay policies are well suited for those insureds who do not want to be paying premiums beyond a certain point in time. For example, an individual may need some protection after retirement, but does not want to be paying premiums at that time. A limited-pay (paid-up at 65) policy purchased during the person's working years will accomplish that objective.
3. Single Premium
Single premium whole life (SPWL) is designed to provide a level death benefit to the insured's age 100 for a one-time, lump-sum payment. The policy is completely paid-up after one premium and generates immediate cash.
4. Fixed (Equity) Indexed Life
The main feature of indexed whole life (or equity index whole life) insurance is that the cash value is dependent upon the performance of the equity index, such as S&P 500 although there is a guaranteed minimum interest rate. The policy's face amount increases annually to keep pace with inflation (as the Consumer Price Index increases) without requiring evidence of insurability. Indexed whole life policies are classified depending on whether the policyowner or the insurer assumes the inflation risk. If the policyowner assumes the risk, the policy premiums increase with the increases in the face amount. If the insurer assumes the risk, the premium remains level.
| TERM LIFE | WHOLE LIFE | |
| Type of protection | Temporary | Permanent until age 100 |
| Premium | Level | Level |
| Death benefit |
| Level |
| Living benefits | Not available |
|
C. Flexible Premium Policies
There are several other types of whole life policies. While they all have the same key characteristics, they may also offer unique features based on how the policyowner pays the premium or how the premium is invested. Flexible premium policies allow the policyowner to pay more or less than the planned premium.
1. Universal Life
Universal life insurance is also known by the generic name of flexible premium adjustable life. That implies that the policyowner has the flexibility to increase the amount of premium paid into the policy and to later decrease it again. In fact, the policyowner may even skip paying a premium and the policy will not lapse as long as there is sufficient cash value at the time to cover the monthly deductions for cost of insurance. If the cash value is too small, the policy will expire.
Since the premium can be adjusted, the insurance companies may give the policyowner a choice to pay either of the two types of premiums:
- The minimum premium is the amount needed to keep the policy in force for the current year. Paying the minimum premium will make the policy perform as an annually renewable term product.
- The target premium is a recommended amount that should be paid on a policy in order to cover the cost of insurance protection and to keep the policy in force throughout its lifetime.
As well as being a flexible premium policy, universal life is also an interest-sensitive policy. Although the insurer guarantees a contract interest rate (usually 3 to 6%), there is also potential for the policyowner to get a current interest rate, which is not guaranteed in the contract but may be higher because of current market conditions.
A universal life policy has two components: an insurance component and a cash account. The insurance component of a universal life policy is always annually renewable term insurance.
Universal life offers one of two death benefit options to the policyowner. Option A is the level death benefit option, and Option B is the increasing death benefit option.
Under Option A (Level Death Benefit option), the death benefit remains level while the cash value gradually increases, thereby lowering the pure insurance with the insurer in the later years. Notice that the pure insurance is actually decreasing as time passes, lowering the expenses, and allowing for greater cash value in the older years. The reason that the illustration shows an increase in the death benefit at a later point in time is so that the policy will comply with the "statutory definition of life insurance" that was established by the IRS and applies to all life insurance contracts issued after December 31, 1984. According to this definition, there must be a specified "corridor" or gap maintained between the cash value and the death benefit in a life insurance policy. The percentages that apply to the corridor are established in a table published by the IRS and vary as to the age of the insured and the amount of coverage. If this corridor is not maintained, the policy is no longer defined as life insurance for tax purposes and consequently loses most of the tax advantages that have been associated with life insurance.
Under Option B (Increasing Death Benefitoption), the death benefit includes the annual increase in cash value so that the death benefit gradually increases each year by the amount that the cash value increases. At any point in time, the total death benefit will always be equal to the face amount of the policy plus the current amount of cash value. Since the pure insurance with the insurer remains level for life, the expenses of this option are much greater than those for Option A, thereby causing the cash value to be lower in the older years (all else being equal).
D. Variable Life
Fixed life insurance or annuities are contracts that offer guaranteed minimum or fixed benefits that are stated in the contract. Variable life insurance or annuities are contracts in which the cash values accumulate based upon a specific portfolio of stocks without guarantees of performance. Variable annuities keep pace with inflation, and are determined by the value of securities backing it.
Variable life insurance (sometimes referred to as variable whole life insurance) is a level, fixed premium, investment-based product. Like traditional forms of life insurance, these policies have fixed premiums and a guaranteed minimum death benefit. The cash value of the policy, however, is not guaranteed and fluctuates with the performance of the portfolio in which the premiums have been invested by the insurer. The policyowner bears the investment risk in variable contracts.
Because the insurance company is not sustaining the investment risk of the contract, the underlying assets of the contract cannot be kept in the insurance company’s general account. These assets must be held in a separate account, which invests in stocks, bonds, and other securities investment options. Any domestic insurer issuing variable contracts must establish one or more separate accounts. Each separate account must maintain assets with a value at least equal to the reserves and other contract liabilities.
1. Regulation of Variable Products (SEC, FINRA and New York)
Variable life insurance products are dually regulated by the State and Federal Government. Due to the element of investment risk, the federal government has declared that variable contracts are securities, and are thus regulated by the Securities and Exchange Commission (SEC), and the Financial Industry Regulatory Authority (FINRA), formerly known as the National Association of Securities Dealers (NASD). Variable life insurance is also regulated by the Insurance Department as an insurance product.
Agents selling variable life insurance products must:
- Be registered with FINRA;
- Have a securities license; and
- Be licensed by the state to sell life insurance.
The Superintendent has the sole authority to regulate the issuance and sale of variable contracts and to issue related rules and regulations.
| POLICIES COMPARED | |||
| Adjustable Life |
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| Universal Life |
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| Variable Life |
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E. Specialized Policies
1. Joint Life (First-to-die)
Joint life is a single policy that is designed to insure two or more lives. Joint life policies can be in the form of term insurance or permanent insurance. The premium for joint life would be less than for the same type and amount of coverage on the same individuals. It is more commonly found as joint whole life, which functions similarly to an individual whole life policy with two major exceptions:
- The premium is based on a joint average agethat is between the ages of the insureds.
- The death benefit is paid upon the first death only.
A premium based on joint age is less than the sum of 2 premiums based on individual age, so it is common to find joint life policies issued on husbands and wives. This is particularly so if the need for insurance is such that it does not extend beyond the first death. Joint life policies are used when there is a need for two or more persons to be protected; however, the need for the insurance is no longer present after the first of the insureds dies.
For example, a married couple purchasing a house may use a Joint Life policy for mortgage protection if both spouses work and earn close to the same amount of income. If one spouse dies, the insurance pays the mortgage for the surviving spouse.
Joint Life is also used to insure the lives of business partners in the funding of a buy-sell agreement and other business life needs. A buy-sell is a business continuation agreement that determines what will be done with the business in the event that an owner dies or becomes disabled.
2. Survivorship Life (Second-to-die)
Survivorship life (also referred to as "second-to-die" or "last survivor" policy) is much the same as joint life in that it insures two or more lives for a premium that is based on a joint age. The major difference is that survivorship life pays on the last deathrather than upon the first death. Since the death benefit is not paid until the last death, the joint life expectancy in a sense is extended, resulting in a lower premium than that which is typically charged for joint life, which pays upon the first death. This type of policy is often used to offset the liability of the estate tax upon the death of the last insured.
3. Life Insurance for Minors
New York insurance law deems a minor at or above the age of 14½ competent to contract for, own, and exercise all rights relating to a life insurance policy. Minors below 14½ are prohibited from owning life insurance policies. The beneficiary of the policy may be only the minor or the parent, spouse, brother, sister, child or grandparent of the minor.
A policy on a minor under 14½ may not be in excess of $50,000, or 50% of the amount of life insurance in force upon the life of the person effectuating the insurance at the date of issue, whichever limit is the greater. If the person who owns the policy on the minor reduces the amount of insurance on his own life, the amount on the minor will still be considered acceptable. In the case of a child under 4½, the limit is $50,000 or 25% of the amount on the life of the owner of the policy. Any amount over the limit will not be paid as long as the minor is under 14½.
The policy on the life of a minor under 14½ may exceed the limits stated above for the following reasons:
- If the policy is purchased by and the premiums are paid by a person having an insurable interest in the life of the minor, and
- If the minor is not dependent upon the owner of the policy for support and maintenance.
F. Credit Life Insurance
Credit insurance is a special type of coverage written to insure the life of the debtor and pay off the balance of a loan in the event of the death of the debtor. Credit life is usually written as decreasing term insurance, and it may be written as an individual policy or as a group plan. When written as a group policy, the creditor is the owner of the master policy, and each debtor receives a certificate of insurance.
The creditor is the owner and the beneficiary of the policy although the premiums are generally paid by the borrower (or the debtor). Credit life insurance cannot pay out more than the balance of the debt, so that there is no financial incentive for the death of the insured. The creditors may require the debtor to have life insurance; they cannot, however, require that the debtor buys insurance from a specific insurer.
G. Group Life Insurance
In contrast to individual life insurance, which is written on a single life, and in which the rate and coverage is based upon the underwriting of that individual, group life insurance is issued to the sponsoring organization, and covers the lives ofmore than one individual member of that group. Group insurance is usually written for employee-employer groups, but other types of groups are also eligible for coverage. It is usually written as annually renewable term insurance. Two features that distinguish group insurance from individual insurance are
- Evidence of insurability is usually not required (unless an applicant is enrolling for coverage outside the normal enrollment period); and
- Participants (insureds) under the plan do not receive a policy because they do not own or control the policy.
Instead, each insured participant under the group plan is issued a certificate of insurance evidencing that they have coverage. The actual policy, or master policy/contract, is issued to the sponsor of the group, which is often an employer. The group sponsor is the policyholder and is the one that exercises control over the policy.
1. Characteristics of Group Plans
Group underwriting differs from that of individual insurance, and is based on the group characteristics and makeup. Some of the characteristics of concern to a group underwriter include the following:
- Purpose of the group — The group must be created for a purpose other than to obtain group insurance.
- Size of the group — The larger the number of people in the group, the more accurate the projections of future loss experience will be. This is based on the Law of Large Numbers of similar risks.
- Turnover of the group — From the underwriting perspective, a group should have a steady turnover: younger, lower-risk employees enter the group, and older, higher-risk employees leave.
- Financial strength of the group — Because group insurance is costly to administer, the underwriter should consider whether or not the group has the financial resources to pay the policy premiums, and whether or not it will be able to renew the coverage.
Another unique aspect of group underwriting is that the cost of the coverage is based on the average age of the group and the ratio of men to women. In addition, in order to reduce adverse selection, the insurer will require a minimum number of participants in the group, depending on whether the employer or employees pay the premium.
2. Types of Plan Sponsors
Group life insurance plans may be sponsored by employers, debtor groups, labor unions, credit unions, associations, and other organizations formed for a reason other than purchasing insurance. Insurance companies may establish a required minimum number of persons to be insured under a group plan.
3. Group Underwriting Requirements
Group life insurance is underwritten on a group basis as opposed to an individual basis. Each participant completes a short application that clearly identifies the insured and the insured’s beneficiary. Generally, if the group is large enough, there are no medical questions since the plan will be issued based upon the nature of the group and the group’s past claims experience.
4. Conversion to Individual Policy
Another characteristic of group insurance is the conversion privilege. If an employee terminates membership in the insured group, the employee has the right to convert to an individual policy without proving insurability at a standard rate, based on the individual's attained age. The group life policy can convert to any form of insurance issued by the insurer (usually whole life), except for term insurance. The face amount or death benefit will be equal to the group term face amount but the premium will be higher. The employee usually has a period of 31 daysafter terminating from the group in order to exercise the conversion option. During this time, the employee is still covered under the original group policy.
Other rules that apply to conversion involve the death or disability of the insured, and termination of the master policy. If the insured dies during the conversion period, a death benefit equal to the maximum amount of individual insurance which would have been issued must be paid by the group policy, whether or not the application for an individual policy was completed. If the master contract is terminated, every individual who has been on the plan for at least 5 years will be allowed to convert to individual permanent insurance of the same coverage.