Life Insurance and the Law. A layman's introduction.


 Life Insurance and the Law. A layman's introduction.

If you're reading this, chances are you've been asked to consider buying life insurance. This doesn't have to be a difficult decision.
There are three main kinds of life insurance: term, whole-life, and universal (often called "universal life or variable). Just like each car is designed for a different purpose and driver style, there is an appropriate type of plan for every individual. If your needs are straightforward and predictable - namely that you need to replace income that would be lost in the event of death - then term life insurance may suffice all your needs at a much lower monthly cost than whole-life or universal. Life insurance policies also include riders for disability protection in case illness should arise.
Term policies pay a death benefit to the beneficiary when coverage expires. Your premium is linked to the amount of insurance you buy, so if you stay with term insurance until it expires, your monthly payments will also stay constant. At that point (unless you've opted for an accelerated term policy), the death benefit will be paid on a prorated basis; i.e., if your life insurance coverage was $100,000, there might be a 2% chance that you would die in any given year (total males age 55-64 in 2000 had a 1 in 87 chance of dying that year), so 20% of $100,000 leaves you $20,000 for your family (assuming they do not need the money right away). That's coverage. That's insurance.
However, if you are not going to die at least ten years from now, you can roll over your life insurance policy from one of the existing companies into a whole-life or universal policy with a much higher death benefit. So say you take out a $100,000 term policy today. When it expires ten years later, your family beneficiary would still get the $100,000 death benefit payment - only they will must then manage their own payout: it could be less than what you had intended for them (maybe they did not need the money right away) or even more (maybe they did need that money). Yes, all that money could be gone.
However, either you die in those ten years or you don't. If you don't - i.e., if you live to be 90-years-old - then no problem: your family can simply let the policy lapse and not worry about paying life insurance premiums for ten years. But if you do die during that time, it will be a great relief: no need to worry about cash levies, no need to pay out premiums, and the insurance company will take care of everything. That's a win-win situation.
That's the case for whole-life and universal policies as well. With whole-life, you will be paid a death benefit that is usually far higher than the amount you have paid into it, often over five times, so say $100,000 of life insurance is under your existing $10,000 term policy. When it expires at age 90, you can simply roll over your $100,000 whole-life policy into another term policy for $50,000 or whatever you want (Universal policies are pretty much the same way). If you are still alive at age 95+, then it will be paid out to your beneficiaries - not just once but every year thereafter; i.e. your whole-life policy will continue to pay a death benefit annually until you die, which is another huge benefit.
There are other advantages of whole-life over term insurance as well:
First of all, you do not have to pay any premiums if you decide to close the policy within any pre-set time limit (usually 10 years). However, there is always a lapse premium when you don't buy a new term policy. Also, with an accelerated term insurance policy, the death benefit may be paid before the original lifetime limit has been met - even if 20 years has been shortened by its early payout. With whole-life insurance, there are no such limits: the death benefit will be paid out for as long as you live.
Second, you get more protection than with a term policy. The difference is that with a term policy, if you get seriously ill or injured during the life of your policy, then your disability protection may be limited by what is possible (for example, if you become totally disabled in the 10th year after your life insurance policy expires and you do not apply for an extension). With a whole-life policy, however, disability protection will be automatic until the date of death.
Third, your whole-life policy will continue to pay a death benefit if you die as a result of an accident (such as in a plane crash and even during an act of war or terrorism). If you die in an accident, your family will still receive the death benefit if they are the policy's beneficiary. However, with a term insurance policy, the death benefit may not be paid if you die within a certain time limit (typically two years) from when the coverage started.
Fourth, your whole-life policy is guaranteed renewable: that means that for any reason whatsoever (such as health reasons or job loss), it can never be canceled - no matter how old you are. This means that the insurance company cannot ever impose unreasonable or onerous conditions to receiving a death benefit payment. It will remain in force until the date of death. You will be able to cash out your life insurance policy at any time or can change the beneficiary(ies) without problem as well.
With term insurance, if you give up your job and collect unemployment benefits, it must be reported to the insurance company and premiums may increase as a result. However, with whole-life policies, no such requirement applies (see also below). If you are unemployed for a long period of time than your monthly premiums may go down automatically. There are no pre-existing conditions limitations (as with all health insurers) either.
Also, with term insurance, if you want to increase coverage later on, it usually requires a medical exam and it will generally be expensive. With whole-life insurance, on the other hand, you can get as much coverage as you want. Finally, because you buy a whole-life policy for an indefinite period of time (until death) there is no need for any pre-payment or advance planning: the premiums are fixed and you can cancel your policy at any time without fees or penalties.
However, there are some disadvantages as well - but by far the biggest is that most people simply do not live long enough to reap many of the benefits: they die before their whole life (term) policy expires. Thus, the whole-life/universal life insurance policies that are typically available today only cover about a quarter of the population. Yet, that is still a very large market domian. So why aren't more people buying long-term insurance?
The disadvantages
Most people think that whole-life and universal life insurance policies cost too much . However, when you compare it to term insurance and what you pay for cash value retirement accounts at banks, it is not so bad: many of those benefits (such as guaranteed benefits and tax free investment income) are not available with cash value savings accounts.

Universal life insurance (also called "universal life with a cash value component" or "Gross/Whole Term") is an alternative to whole-life insurance. It is essentially a combination of term and whole-life insurance, thus it has the best of both worlds: the lower cost and limited monthly premiums of term insurance (which can be canceled at any time) combined with the guaranteed benefits of a whole-life policy that will continue to pay at death.

The usual coverage term (limitation) period for universal life policies, whether cash value or whole / gross term are 10, 15, 20 years. The term is often determined by age of the policyholder when first issued and re-issued to that individual on renewal.

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