Life insurance has been around since the dawn of civilization. When people die, loved ones grieve; and if the recently departed doesn’t have a life insurance policy, loved ones must also bear the brunt of steep funeral costs and suffer the grim details.
Life insurance works as a gift from the policyholder, or the insured, to loved ones. The policyholder makes payments in exchange for coverage terms that protect loved ones from financial duress in the advent of death (i.e. funeral expenses).
There are two fundamental types of life insurance: term and permanent life insurance.
Term Life Insurance
As the name implies, insures the policyholder for a designated period of time—if the policyholder dies within the term of the agreement (e.g. 30 years), the insurer pays the amount specified in the contract. Only in after the policyholder’s death does the insurance company pay out according to the terms of the policy. That means if the policyholder outlives his term life insurance, the coverage ends and he is no longer insured. (Term life insurance oftentimes accompanies mortgages, to protect families with a sole provider, in which case it is called mortgage insurance.) There are no investment vehicles applied to term life insurance.
Permanent Life Insurance
Permanent life insurance, on the other hand, remains until the policyholder’s death, assuming the policyholder pays the premiums as specified in the contract. There are multiple variations of permanent life insurance; each policy offers differently depending on the policyholder’s requirements. Life insurance benefits ensure premium capital gains over the lifetime of the policy—and of the policyholder. There are three basic types of permanent life insurance: whole, universal and variable life insurance.
Whole life insurance is funded by a fixed premium payment that lives the length of the policyholder’s life and pays the beneficiary a solid fixed amount. The advantage of whole life insurance is the ease at which one can budget based on fixed premium outlays. Though, whole coverage is for the risk averse policyholder, rigid contract terms can increase the price of unforeseen term renegotiations.
Universal life insurance is a more personalized option that offers varied premium amounts, investment options, death benefits and access to cash. The contract is, more or less, negotiable over the life of the policy and far less binding. While whole life insurance requires a fixed payment on a fixed schedule, universal does not. But looser terms and investment opportunities could result in a policy lapse.
Variable life insurance allows the policyholder to, theoretically, treat a life insurance policy as an investment portfolio, and also avoid paying taxes. Payments and timetables are flexible and depend on the investment tools the owner chooses. Consequently, variable life insurance policyholders assume the greatest amount of risk.