General Goals 1) to be debt free in 3.5 years 2) save lots of money

Tuesday, May 31, 2011

Part III: Term Insurance, Whole Life, Term-100 and Universal Life

It’s important to keep in mind that all insurance is either term insurance or permanent insurance. With term insurance there is an expiry date if the insured doesn’t die before the policy expires than there is no refund premiums and no payment made by the insurer (insurance company). Where as permanent insurance is generally insurance for life. This means that the policy expires on the day the life insured dies and the insurer pays the death benefit to the beneficiary (Death benefit).

Term Insurance

Term insurance is the perfect policy to insure temporary needs. It is insurance for a specific period of time usually 1, 5, 10, 15, or 20 years. Because of the short time period of this insurance it is not available to those over 70 years of age. This insurance has flexible payment options it can be purchased with a single premium or a series of premiums paid monthly, quarterly, semi-annually or annually.

This insurance is ideal for a young person for a vary of reasons. First because of a person’s age the premiums are low because the risk of premature death is very low. As such a large amount of insurance coverage can be bought with a low premium cost.  As a result within the insurance world term insurance is considered an entry-level product.

Term insurance has three sub-types to it:
1)   level term insurance
2)   increasing term
3)   decreasing term

When a person buys level term insurance they know exactly how much the insurance will cost, how much it will pay out, who will receive the death befit and when the insurance expires.

Increasing term insurance is a less common form of insurance. The idea is to provide premiums that will increase over the term as the face value of the policy increases over time. Essentially increasing term insurance covers a life that us increasing in value.

Decreasing term insurance provides the policy holder with a level premium over a long term, such as 20 to 65 years. However the face value of the policy decreases over time.  This insurance was once popular to insurance decreasing financial obligations, such as a mortgage. It is not as common today.

One of the befits for a young person starting out is the option of adding on a rider within the policy.  A rider is a policy extra which can be added on to the policy to customise it. it often increases the premiums of the insurance based on which one is added.

Two riders are available with term insurance: Renewable Term Insurance and Renewable and Convertible Option (R&C).

Renewable Term Insurance gives the policy owner the ability to renew the policy. When this rider is kicked into effect the policy owner can expect higher premiums on renewal. This new premium is called guaranteed renewal rate because the life insured is guaranteed to be insured regardless of his or her health. Despite the increase in premiums the face a mount of the policy still says the same. It is most common for this rider to be used to extend the policy for an additional 1, 5, 10 or 20 years. Unless the term insurance policy has this rider included into it is a non- renewable policy which terminates on the expiry date.

Renewable and Convertible option (R&C) allows the policy owner to covert the term insurance to permanent life insurance for the same or decreased face amount without evidence of insurability. This rider must be but in place when the application is made. As such a higher premium is paid to the insurer, as the insurer takes on the added risk of the policy owners deteriorated health.

Whole Life insurance

This product is available in two different kinds of payment forms: whole insurance which means the premiums are paid until the life insured dies and limited payment life which requires premiums to be paid over a specified period of time or to a specified age. There are two main features to this kind of policy: policy reserve and policy dividends.

Policy reserves are a really interesting feature of whole life insurance. During the early years of a policy, the policy owner pays more for the premiums than coverage requires. This builds up a reserve. One of the benefits of this reserve is if the policy owner no longer wants insurance coverage than part of the value of the policy reserve can be received by the policy owner via the policy’s cash surrender value (CSV). Unlike term insurance which we I just went over the policy owner can reserve ‘money back’ if the policy is discontinued.

Another great feature of the policy reserve is it provides the policy owner with the ability to 1) borrow from the CSV with a policy loan and 2) use a non-forfeiture option.   Using the CSV to take a policy loan allows up to 90% of the CVS to be borrowed from the insurer by the policy owner. Interest on the loan is changed at a interest set by the insurer which is usually competitive with rates offered by banks or other lending institutions.

There are 3 kinds of non-forfeiture option: automatic premium load (APL), extended term insurance(ETI) and reduced paid up option (RPU). Each provides the policy owner with a way of maintaining insurance coverage as an alternative to surrendering it if they can no longer afford the premiums.

Automatic premium loan (APL) is when the a policy owner forgets to pay the premium or is short of money when the premium is die, the policy will remain in force by using an automatic loan.

Extended Term Insurance (ETI) is an option that allows the policy owner who stops paying premiums to keep coverage in force by using the cash surrender vale of the polcy as a lump –sum premium to by term insurance.

Reduced Paid-up Insurance (RPU) this option uses CSV to switch permanent  coverage to term coverage, much like the reverse of the R&C  term option, reduced paid-up insurance uses the cash surrender vale of the who life policy as a lump-sum premium for a whole life policy that is paid-up which means there are no future premiums to be paid. The policy owner sacrifices the amount of coverage that he or she had previously to a lesser face amount but the policy continues as a permanent policy. This option provides many of the features of the original whole life policy including a cash surrender vale and insurance coverage for the life of the insured Dividends, however are not received and riders and other benefits are cancelled.

I mentioned at the beginning of the of this conversation about whole life insurance that this product had dividends now I will shift the conversation over to how dividends are part of a whole life insurance policy.

Dividends are paid to paid to participating policy owners when a surplus of reserves exists with the insurer. That are only available to participating policies and are a distribution of surplus earning held in the participating account established by the insurer that receives premiums from participating polices. Dividends are not guaranteed and vary year-to-year. There are three basic purposes to which policy dividends can be put: 1) savings 2) to acquire more life insurance 3) to reduce premiums.

A major part of whole life insurance is the idea of segregated funds. These funds is a type of investment available through insurers that provides a guarantee to the investor either 75% or 100% (depending on the contract) of deposits will be returned on death of the policy owner or on maturity of the contract in 10 years’ time.

If the person does not choice to use the dividends to buy segregated funds the  person can use the cash to buy more insurance. There are 3 additional insurances that can be bought 1) paid up additions (PUA) 2) special term additions 3) term additions

Paid up additions (PUA): uses the policy dividends to buy additional insurance. This additional insurance is paid up which means no premiums need to be paid. It is usually a participating policy in its own right with its own cash surrender value. Paid up additions add to the face value , cash surrender value and loan value of the original policy. Unlike buying a new policy no additional medical questionnaire is required. 

Special term addition: this is a one year non-renewable term policy that typically equal to the CSV of the policy at the end of that policy year. The deference between the cost of term insurance and the policy dividend is paid in cash.

Term addition: this uses the whole dividend to by a non-renewable one year term addition that will be paid if the life insured dies during that year.

In summery Whole life insurance is a great product that helps answer a variety of problems including: estate planning, creditor protection, the need to build tax deferred savings and the need to build collateral.

Adjustable Premium whole life Insurance

As the name suggests the premiums change over the life of the policy. The premiums and death benefit will be guaranteed for  a limited period, usually five years and then adjusted to keep pace with current investment yields. At the end of each guaranteed period a comparison will be made between the new investment yield and the yield at the beginning of the period. If the yield has increased either: the sum insured increases and the premium stays the same or the sum insured stays the same and the premium is reduced. If the investment yield has decreased either : the sum insured decreases and the premium stays the same or the sum insured stays the same and the premium is increased.

This kind if insurance is popular in an economy where interest rates are rising. But falls out of favour when interest rates decrease and policy owners are confronted with paying more premiums for the same coverage or reducing coverage for te same premiums.

Term –to-100 Insurance (T-100)

This insurance is a hybrid of term insurance and permanent insurance. While it is in force for term (to age 100) and premiums are paid over the same period. When the life insured reaches 100 years of age, this policy either pays out the face amount r is considered paid-up, which means that future premiums are not required to keep the policy in force . Life term insurance T-100 generally has no cash value or dividends. This kind of insurance offers the distinct advantage of lover premiums relative to permanent insurance and other kinds of insurance.

T-100 is an insurance that appeals to those who find the insurance for life aspect of permanent insurance important and yet do not feel the frills associated  with other forms of peppermint insurance important but do not want he frills associated with other forms of permanent polices (like dividends, policy loans and cash surrender value).  This insurance is just as useful for estate planning for individuals and business as other forms of insurance.

NOTE: Sorry for such a long post. If you got to the end THANK YOU!, Please let me know if you have any questions!

Tomorrow: Universal Life, Disability, Accident & Sickness, Critical Illness and Long Term Care

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