Types of Life Insurance

All life insurance falls into two broad categories: 

  1. Term Life Insurance, which provides temporary protection for the specified term (length of time).  If the insured dies within that term, the insurance company pays the death benefit.  Otherwise, the coverage terminates unused
  2. Cash Value Life Insurance, which provides lifetime protection as long as the policy is kept in force.  As a result, the insurance company is obligated to pay a death benefit, regardless when death occurs.  These policies accumulate cash value which can also be used during the insured’s lifetime.  However, withdrawals and loans will reduce the policy’s death benefit and may have tax implications.

Obviously, term coverage is cheaper to purchase because there is no guarantee that the insurance company will pay a death benefit.  It’s well-suited to temporary needs such as income replacement or the elimination of temporary debt.

One objection that many people have with term insurance is that usually they don’t get anything for their money.  In other words, the odds are very good that you’ll outlive the term of the policy.  This objection can be met with a Return of Premium Rider (ROP).  This rider obligates the insurance company to refund all of your premiums paid, plus interest, at the end of the term.  Term coverage with a ROP rider costs more than basic term insurance, but it allows you to “hedge your bets.”  In other words, “If something happens to you, your family is protected.  If you outlive the policy, you get your money back with a guaranteed rate of interest, which can sometimes be attractive.”

There are three basic types of cash value life insurance.  They are:

  1. Whole Life Insurance, which requires a set premium and cash values accumulate at an interest rate guaranteed by the insurer.  In return, the insurer pays a set death benefit upon the insured’s death
  2. Universal Life Insurance, which allows the insured to pay more or less premium over time.  The premium which does not immediately go toward insurance earns interest (often at a current rate higher than that used for whole life insurance) to accumulate cash
  3. Equity Indexed Universal Life Insurance, which allows the insured to pay more or less premium over time.  The premium which does not immediately go toward insurance earns interest at a rate indexed to a stock-market index such as the S&P 500 with the hope of accumulating cash at a rate greater than that seen with fixed interest rates