Comprehensive Guide to Life Insurance Policy Types and Characteristics

Overview of Term Life Insurance

Term life insurance is classified as temporary protection because it only provides coverage for a specific period of time. It is often described as pure protection because it provides the greatest amount of coverage for the lowest premium outlay. This type of insurance only pays a death benefit if the insured passes away during the specified term. If the policy expires or the insured outlives the term, no benefit is paid, and the policy lacks any cash value or investment component.

Level Term insurance is the most common variety of term coverage. In this arrangement, the death benefit remains constant throughout the entire duration of the policy. For example, a five-year level term policy maintains the same face amount from the first day through the end of the fifth year.

Annual Renewable Term (ART) is a specific type of term insurance where the policy renews every year without the insured having to provide evidence of insurability. While the death benefit remains level, the premiums increase during every renewal period because they are calculated based on the insured's attained age.

Specialized Term Insurance Variations

Decreasing Term insurance features a death benefit that gradually reduces at predetermined intervals over the life of the policy. This type of coverage is most frequently utilized when the need for financial protection declines over time, such as to cover the balance of a mortgage or other amortized debts. While the face amount decreases, the premium typically remains level throughout the term.

Increasing Term insurance is characterized by level premiums and a death benefit that grows each year. This is often not sold as a standalone policy but is instead used to fund specific riders or increases in coverage. Common applications include the "return of premium" rider or "cost of living" riders, where the benefit amount scales to keep pace with inflation or to refund paid premiums upon death.

Renewable and Convertible Features of Term Insurance

Term policies often include features that allow for flexibility at the end of the term or during the policy's life. The Renewable feature grants the policyowner the right to renew the coverage at the end of the term without providing evidence of insurability. However, the cost of the new premium will be higher than the previous term because it is based on the insured's attained age at the time of renewal.

The Convertible feature allows the policyowner the right to convert a term insurance policy into a permanent whole life policy without providing evidence of insurability. Similar to the renewal feature, the premium for the new whole life policy will be higher because it is based on the insured's attained age at the time of conversion and the fact that whole life insurance accumulates cash value.

Characteristics of Whole Life Insurance

Whole life insurance is a form of permanent protection designed to remain in force until the insured reaches the age of $100$. Unlike term insurance, everything in a whole life policy is guaranteed, including the face amount, the premium, and the cash value. The policy is designed to mature or endow at age $100$, at which point the cash value should equal the face amount of the policy. The accumulation of cash value depends on the amount of premiums paid, the guaranteed interest rate provided by the insurer, and the length of time the policy has been active.

Continuous Premium Whole Life, also known as Straight Life, is the basic whole life model. It requires the policyowner to pay level premiums from the time the policy is issued until the insured's death or until they reach age $100$, whichever happens first. This version provides a level death benefit throughout the life of the contract.

Limited-Pay Whole Life is structured so that premiums are completely paid up well before age $100$. Examples include a $20$-Pay Life policy, where premiums are paid for exactly $20$ years, or a Life Paid-up at $65$ policy, where payments stop when the insured hits age $65$. Although the premium-paying period is shorter, the coverage remains in force until death or age $100$. Because the premiums are compressed into a shorter window, the cash value in a limited-pay policy grows faster than in a straight life policy.

Single Premium Whole Life involves a single, large lump-sum premium paid at the inception of the policy. This payment completely funds the policy until age $100$. One of the primary benefits of this structure is that it generates immediate cash value.

Interest-Sensitive and Indexed Whole Life

Interest-Sensitive Whole Life, also referred to as Current Assumption Whole Life, provides a guaranteed death benefit but offers a fluctuating interest rate on the cash value. The insurer will pay either the guaranteed interest rate or the current market interest rate, whichever is higher. Premiums may increase or decrease over time based on the insurer's current assumptions regarding risk, interest earnings, and expenses. If assumptions are favorable, cash value may accumulate faster or the premium-paying period might be shortened.

Indexed Whole Life, or Equity Indexed Whole Life, ties the growth of the policy's cash value to the performance of a specific equity index, such as the S&P $500$. While the cash value is dependent on index performance, the face amount of the policy typically increases annually to help the death benefit keep pace with inflation.

Flexible Premium Policies: Adjustable and Universal Life

Adjustable Life insurance offers the policyowner flexibility across three specific dimensions: the face amount, the premium, and the type of plan. Generally, the insured chooses two of these variables, and the insurer determines the third. For instance, if an insured wants a specific death benefit and can only afford a specific premium, the insurer will determine if the policy functions as term or whole life. Cash value only develops in an adjustable life policy if the premiums paid exceed the actual cost of the insurance. This flexibility allows the insured to modify the policy as their financial needs change over time.

Universal Life insurance is characterized by extreme flexibility. Policyowners can increase or decrease their premium payments or even skip a payment entirely, provided there is enough cash value in the policy to cover the monthly cost of insurance. The insurance component of a Universal Life policy is always Annually Renewable Term (ART). The cash value is interest-sensitive; while the insurer guarantees a minimum contract interest rate, there is potential for higher returns based on current market rates. Universal Life also allows for partial withdrawals, also known as partial surrenders.

Universal Life offers two death benefit options. Option A is the Level Death Benefit Option, where the death benefit remains level while the cash value grows, effectively reducing the insurer's amount at risk over time. Option B is the Increasing Death Benefit Option, where the death benefit includes the face amount plus the accumulated cash value, meaning the total payout increases over time. Additionally, Indexed Universal Life shares these flexible characteristics but links cash value growth to an equity index like the S&P $500$.

Variable and Specialized Life Insurance Products

Variable Life insurance is a permanent policy with fixed premiums and a guaranteed minimum death benefit. However, the cash value is not guaranteed and fluctuates based on the performance of an underlying investment portfolio. These assets are held in a separate account and invested in stocks, bonds, and other securities. In this arrangement, the policyowner bears the investment risk rather than the insurance company. Due to the investment nature of the product, individuals selling variable life must hold both a state life insurance license and a securities license.

Variable Universal Life (VUL) combines the flexible premium features of Universal Life with the investment component of Variable Life. Although the cash value fluctuates based on market performance, the death benefit cannot decrease below the policy's initial face amount. Selling VUL also requires both a life insurance and a securities license.

Specialized policies include Joint Life, which covers two or more individuals on a single policy. The premium is based on the joint average age of the insureds, and the death benefit is paid out when the first insured person dies. In contrast, Survivorship Life (second-to-die) covers two or more individuals but only pays the death benefit when the last insured person dies. This is often used to offset estate taxes.

Jumping Juvenile insurance is written on the life of a minor. The defining characteristic is that the face amount "jumps" or increases significantly at a predetermined age, usually age $21$, while the premium remains level for the life of the policy.

Group Life and Credit Life Insurance

Group Life insurance is written to cover more than one person under a single master contract. The group must exist for a reason other than simply purchasing insurance, such as an employer-employee group. The employer or sponsor receives the Master Contract, while the individual members receive a Certificate of Insurance. Coverage amounts are determined by nondiscriminatory rules, and rates are based on group underwriting rather than individual health exams. If the coverage amount exceeds $50,000$, the cost of the excess premium is considered taxable income to the employee. Members of a group plan must have the right to convert their coverage to an individual policy without evidence of insurability if they leave the group.

Credit Life insurance is issued on the life of a debtor specifically to pay off a loan balance if the debtor dies before the debt is repaid. It is usually structured as decreasing term insurance. The creditor is both the policyowner and the beneficiary. By law, the policy benefit cannot exceed the total amount of the outstanding debt.

Questions & Discussion

1. An insured owns a term insurance policy in which the amount of protection remains constant during the term period. What kind of term insurance does he own? A. Decreasing B. Annually renewable C. Level D. Increasing Correct Answer: C. Level

2. An annually renewable term policy A. Increases in premium based on the insured’s health B. Maintains a level premium each year C. Renews each year with an increased premium D. Increases in coverage each year Correct Answer: C. Renews each year with an increased premium

3. Which of the following amounts must increase in an increasing term policy? A. Length of Term B. Premiums C. Interest rate D. Death Benefit Correct Answer: D. Death Benefit

4. A $35$ year old insured’s five year level term policy will probably renew to a A. Decreasing term with age $40$ premiums B. $5$-year level term with age $35$ premiums C. $5$-year level term with age $40$ premiums D. Whole life with age $35$ premiums Correct Answer: C. $5$-year level term with age $40$ premiums

5. The type of policy that can be changed from one that does not accumulate cash value to one that does is a A. Convertible term policy B. Level term policy C. Whole life policy D. Renewable term policy Correct Answer: A. Convertible term policy

6. All of the following statements regarding whole life insurance are true EXCEPT A. The face amount of the policy stays the same as long as the policy remains in force B. The shorter a premium period is, the faster the cash value will grow C. The policy’s cash value decreases each year the policy is in force D. Whole life insurance is designed to mature at age $100$ Correct Answer: C. The policy’s cash value decreases each year the policy is in force

7. How long does coverage continue on a limited–pay whole life policy? A. $20$ years on a $20$-pay policy B. $65$ years on a life paid-up at $65$ C. Death or age $100$ D. $10$ years on a $10$-pay policy Correct Answer: C. Death or age $100$

8. If a single premium (lump sum) is paid on a whole life policy, cash value will A. Be available immediately B. Be available in $5$ years C. Be available at age $59 \frac{1}{2}$ D. Never be available Correct Answer: A. Be available immediately

9. An equity-indexed life insurance policy’s cash value is usually linked to an index such as the A. Moody’s Corporate Bond Yield B. Consumer Price Index (CPI) C. Inflation Rate D. Standard and Poor’s $500$ Correct Answer: D. Standard and Poor’s $500$

10. An Adjustable Life policy allows for the policy owner to do all of the following EXCEPT A. Choose the face amount. B. Set the premium C. Choose the period of protection. D. Choose the investment vehicle Correct Answer: D. Choose the investment vehicle

11. Which of the following is NOT true about a Universal Life policy? A. The policyowner can increase or decrease the policy’s face amount B. There is no minimum guaranteed rate of return on a Universal Life policy C. A Universal Life policy permits a policyowner to select from two Death Benefit options D. The policyowner can schedule payments at varying times and in varying amounts Correct Answer: B. There is no minimum guaranteed rate of return on a Universal Life policy

12. When are benefits paid from a joint life policy? A. When the first insured dies B. When the second insured dies C. When both insureds attain age $100$ D. When the last member in the group dies Correct Answer: A. When the first insured dies

13. In a jumping juvenile life, the component that “jumps” is the A. Premium B. Cash value C. Face amount D. Type of coverage Correct Answer: C. Face amount

14. What do employees covered under a group contract receive? A. Certificate of insurance B. Individual policy C. Master policy D. Receive nothing Correct Answer: A. Certificate of insurance

15. Which of the following does NOT apply to credit life? A. Coverage is usually provided by decreasing term insurance B. Benefits are paid directly to the insured C. The outstanding debt is paid if the debtor dies D. Premium payments are paid by the borrower (debtor) Correct Answer: B. Benefits are paid directly to the insured