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Life Insurance 101

by Felicia Williams

LifeHave you been thinking about buying life insurance and are overwhelmed with all of the possibilities? Here's a good starting point to learn the basics about life insurance.

What is a life insurance policy?

A life insurance policy is a legal contract between you
(the insured/policy holder) and the insurance company (also known as the insurer). This contract establishes the terms, conditions and amount that a company will pay to your beneficiaries, upon your death.

Why buy life insurance policies?

Generally, life insurance policies provide protection for the surviving family members. I say generally, because there are times when a company may purchase life insurance to cover one of their key employees whose death would cause severe financial strain on the company. Or a credit card company may offer life insurance to the card holder that will pay off the outstanding balance.

There are two types of life polices, permanent and term:

  1. Permanent Insurance Policies: Permanent policies cost more and are more complicated than term policies. As the name suggest, permanent remain in effect for the lifetime of the policyholder (unless the insured defaults on premium payments). In addition to death benefits, permanent policies provide investment opportunities. The value of these policies increases over time and may be borrowed against. Similar to buying a house. The value of the house increases over time and you may borrow against the equity. Tax on the increased cash value is deferred until the money is drawn.

    There are three types of permanent life insurance policies:

    • Whole Life: Whole life policies will accrue cash value over time. These are traditional policies and most of them pay dividends to the policyholder.

    • Universal Life: Universal policies have flexible options that other permanent polices don't have. It allows the insured to modify the amount of insurance and change the premium as the insured's need's change. Of course the changes must be within the company's underwriting terms and conditions.

    • Variable Life: Variable policies are the most risky. The policy value and death benefit are based upon the performance of an outside investment fund. The majority of the policies guarantee that the death payout won't fall below a certain minimum; however, they do not guarantee the cash value of the policy.

  2. Term Insurance Policies: Term is the least expensive and most basic form of life policy. They basically remain in effect for a certain period of time. The policy term may vary anywhere from 1 to 30 years. The death benefit amount does not change. If the policy expires before you die, you may renew the policy or let it expire. No cash back. This is similar to renting an apartment. Once your lease is up, you may either renew or move.

    As a term policyholder you have the option to convert the policy to a permanent policy. If you can't afford a permanent policy initially and your financial condition changes (i.e., a much deserved promotion), you may upgrade to a permanent policy without having to go through another physical exam. This is similar to renting a house with an option to buy; start out as a rental and then upgrade to home ownership.

Do your homework and shop around before signing on the dotted line.

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