Life Insurance Terms You Must Know
To better understand life insurance, you should probably be familiar with some of the basic language and concepts. Here is a general outline plus some terms to get you started. We thought it’d be useful to help make sense of them.
Types of insurance
Term life insurance. This type of life insurance is very common. Term life insurance is often the most affordable option, but it is designed to provide coverage for only a specific period of time, such as 10, 20, or even 30 years in some cases. The most popular term life insurance policies have premium amounts that stay level.
Permanent life insurance. There are several types of permanent life insurance designed to provide coverage for your entire lifetime. These include whole life insurance, universal life insurance, and variable life insurance. Permanent insurance policies generally have higher premiums than term life insurance policies, and many build cash value over time. That means you could eventually borrow from your policy for many different reasons, including to help pay for college, supplement your retirement income, or provide cash for emergencies. There can be negative consequences to tapping a policy’s cash value, however. The move will reduce the policy's death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.
Life insurance pricing and cost
Death benefit. Also referred to as face value, this is the amount guaranteed by the insurance company to go to your beneficiaries at the time of your death. The higher the death benefit, the more you will pay for the policy. Depending on the type of policy and the length of time it was in force, the death benefit could be higher. Conversely, any loans or surrenders of the policy could reduce the death benefit as well.
Underwriting. Depending on the amount and type of life insurance you’re buying, you’ll need to go through an underwriting process. This involves completing an application and giving the company access to your medical information. It may also require a brief medical exam, which is normally done at your home. The information collected is evaluated to determine if you qualify for coverage and your rate class.
Premium. This is the amount you pay the life insurance company for your policy. For term policies it is typically an annual payment made each year during the length of the policy’s coverage. Some permanent policies can be paid up in as few as 10 annual premium payments. Others are designed to spread premium payments out over the time it would take for the covered person to reach a certain age. In addition, annual premiums can be divided into quarterly or monthly payment plans.
Premium rate class (also known as underwriting or risk class). The price for your life insurance (the “premium”) is generally determined by your age when the policy is issued and your rate class. Rate class will depend on a number of factors, including your family medical history, current health, and tobacco use. Generally, the younger you are and the healthier you are, the less expensive your premiums will be.
Options and riders
Life insurance policies can provide additional options and benefits, albeit for additional cost. But such added features allow you to customize a life insurance policy to individual needs and concerns.
Here are some of the more common.
Conversion option. Some term life insurance policies give you the option to convert to permanent life insurance without going through a second underwriting process. This allows you to lock in your insurability at your current state of health and can help you get the permanent insurance you ultimately want. However, this option is only available for a limited period of time. When selecting a term life insurance policy, you should consider a company that offers competitive permanent policies to convert to at a later date.
Guaranteed insurability option. If you think you may eventually need to increase your coverage, you might want to consider a policy with a guaranteed insurability option. This option allows you to purchase additional coverage without having to go through the underwriting process all over again. It is generally only available through permanent life insurance policies.
Disability waiver of premium. This is a rider that can be added to your life insurance policy to ensure that your premium will be waived and your coverage will continue if you are totally disabled and unable to work. (The chance that you will become disabled at some point in your working life is higher than you might think.)
These are just some of the basic terms involved in life insurance. Other more complex terms and concepts can quickly creep into discussions and considerations, which is why many people turn to a financial professional. But these terms should help get the discussion started.