What is life insurance? Types of life insurance
Life insurance is a contract made between an individual and an insurance company. The insured person pays a premium in exchange for the promise of a lump-sum payment, called “a death benefit”, to a designated beneficiary when the insured person dies.
These policies generally have specific terms describing the limitations of the insured events. This type of insurance is different from general insurance, where the amount paid is proportional to the damage or losses incurred.
For example, some specific exclusions that limit the liability of the insurer may include suicide, fraud, riot and civil commotion.
In this type of, the person being insured and the policy owner can be different (in the case of a son buying a policy for his father). Death benefits from virtually all types of life insurances policy are income tax-free.
Zurich, which has a Beginner’s Guide to Life Insurance, has the following definition of the term:
“Life insurance provides financial help for your family when you die and they can no longer rely on your income.”
“It sounds a little morbid, but you wouldn’t leave your home uninsured, or drive your car without insurance, so why wouldn’t you financially protect your family too?”
Financial advisers say life insurance is a safety blanket that helps you prepare for the unexpected.
There are various different types of life insurance, depending on the needs of the individual.
Life insurance is generally split into two classes: temporary and permanent.
This type of insurance provides financial protection for a certain period (i.e., 30 years). Premiums are usually guaranteed for that time and remain the same. However, after the specified period policies may offer continued coverage at a much higher rate. Term life insurance is less costly than permanent life insurance.
The three main factors to be considered in a term life insurance are:
- how much is given upon death,
- how much the premium(s) cost, and
- the long coverage is for.
Term insurance is useful in replacing any lost income during working years, ensuring that a family’s financial goals (such as mortgage payments and college tuition) are secured.
There are four different forms of permanent insurance: universal life insurance, whole life insurance, limited pay and endowments.
Universal life insurance:
This is a type of insurance which provides coverage throughout a person’s life (with no set period). As opposed to whole life insurance, universal insurance policies let you increase or decrease premium costs.
Because of its lifetime coverage, the universal type is more expensive than term insurance. Universal life insurance is a common way of providing a guaranteed death benefit coverage and replacing long term income.
Whole life insurance:
This type of insurance provides a person with lifetime coverage. Premiums are usually fixed. As opposed to term life insurance, whole insurance has a cash value which acts as a savings component and allows a person to accumulate tax-deferred savings.
In this case the premiums are paid over a certain period, after which no additional payments are due. Pay periods may be 10 to 20 years long and are paid out at around the age of 65.
In this policy the cumulative cash value is equal to the death benefit at a certain age, known as the endowment age.
The cost of life insurance
Insurance companies use rate classes, or risk-related categories to evaluate what the premium costs should be. According to Fidelity, the typical risk-related categories are:
- Standard – Good health and a somewhat low-risk lifestyle.
- Preferred – Very good health and low-risk lifestyle.
- Super-Preferred – Excellent health and a very low-risk lifestyle.
There are other factors that determine a person’s rate class, such as tobacco use and family medical history.