Oran Hall | Life insurance policy options

There are several types of life insurance policies to meet the wide-ranging needs of the population. Some give permanent coverage, and some give coverage for a specified period, but they all give some form of protection.

Permanent life insurance is intended to be in force for the whole of the insured’s life. Some permanent policies have fixed premiums and guaranteed increases in the cash surrender value. They have very low investment risk because the insurance company guarantees both the death benefit and the cash surrender value. These are called traditional whole-life policies.

Another type of permanent policy allows both the insurance company and the policy owner to share the risk. The insurance company guarantees to pay the death benefit but does not apply a guaranteed interest rate every year. Instead, the cash value is based on interest rates for a specified period. In some cases, the insurance company sets a floor for the rate of interest to be applied.

Another type of permanent policy allows for a portion of the premium to be invested in the securities markets, and the insurance company provides no guarantees of investment return, so it is the policy holder who bears the risk. In other cases, the death benefit is guaranteed, but benefits in excess of the sum assured may be paid where there is a provision for the investment value of the policy to be added to the sum assured.

A universal life policy is a permanent contract. The premium is divided into three parts covering the costs the insurance company incurs for issuing and maintaining the policy, the portion invested and the mortality charge, which takes care of the death benefit. The premium is level, meaning it is fixed for the life of the policy, but the mortality charge increases as the policyholder gets older. If it increases to the point where the money required to pay for the full cost of maintaining the policy exceeds the stated premium, the insurance company withdraws money from the investment account by surrendering units to cover the shortfall.

The following are some features of these policies: death benefits and premiums may be increased or reduced, policyholders may pay regular additional investment premiums as well as make ad hoc deposits, and may sometimes have the option of selecting the feature which offers inflation-indexed returns.

Additionally, units may be surrendered for cash at current unit values. Although this is useful for providing short-term liquidity, it generally erodes the long-term investment value and thus the death benefit of the policy, and may cause it to lapse if there are not sufficient funds in the investment account to draw on when the mortality charge increases. Like other types of permanent insurance, future insurability is assured, but premiums tend to be lower than those of other forms of permanent insurance.

Term insurance is temporary insurance purchased for a specific length of time, offers coverage only, and has no cash or investment value. The insurance company pays a death benefit to the beneficiary if the insured dies. Premiums are generally low, and there are several kinds of term insurance policies – level term, the premium being fixed for the life of the policy; increasing term; renewable term; and convertible term, for example. Renewing a policy leads to a higher premium due to the increase in the policy holder’s age.

There is another alternative to permanent life insurance policies – endowment policies, which are issued for a limited time, 15 years, for example, making them suitable to save for specific goals like education. Their premiums are generally high. How much risk the policyholder is exposed to depends on the type of fund into which the premiums are invested, and these range from conservative funds to funds focused on capital growth. Upon their maturity, the insurance company pays the proceeds to the policyholder, but if the policyholder dies before, pays to the beneficiary.

Individuals should consider the cost of insurance. The older people are, the higher their premiums. Put another way, if two people pay the same premium, the older person gets a lower coverage. Factors like gender and the state of health of the insured also determine the cost of coverage.

If the primary reason for buying insurance is to provide funds to settle a sizeable estate, perhaps a term policy may be the best option,because of its higher coverage per premium dollar.

It is useful to understand the terms of the policy. For example, for some policies, the sum to be paid when a death claim is made is the higher of the sum assured and the value of the investment portion of the policy. For others, it is the sum of both.

Affordability should not be overlooked when considering buying a policy. It is better to buy term insurance now and convert to permanent insurance later, but at a higher premium, or to buy what permanent insurance is affordable now and buy more later, but at a higher premium, than risk losing the policy by buying and not having the ability to pay the premiums consistently.

People should buy insurance. It should not be sold to them. They should see the need for the product and make a commitment on that basis. It is the interest of the prospective insurance customer that is paramount.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com