Any kind of insurance is fundamentally about risk. Risk can be defined as the chance of financial loss due to an unexpected event. Insurance involves the transfer of risk from an individual or from an entity to an insurance company. The insurance company pays compensation for the loss.
It is important to recognize that any kind of insurance, including life insurance, is for protection. Although everyone will die at some point, no one knows when. Therefore, life insurance is purchased to protect against obligations that may exist at death.
What is Life Insurance?
Who are the Parties to a Life Insurance Policy?
The Two Types of Life Insurance
Advantages and Disadvantages of Each Type of Life Insurance
Can and Should an Older Adult Buy Life Insurance?
A life insurance policy insures the life of a human being. A life insurance policy is a “valued policy.” That means that it is purchased in a stated amount, for example, $250,000, and that is ordinarily the amount paid upon the insured’s death. Sometimes, the full amount may not be paid, such as when there is an unpaid policy loan on a whole life insurance policy. We’ll discuss life insurance policy loans later.
In contrast, most property policies are “non-valued policies,” which means that the amount payable is based on the extent of the loss. For example, the collision coverage provided by an auto insurance policy will pay the reasonable cost of repair for a car that is covered by the policy and in a collision. The amount paid will vary based on the extent of the damage.
The loss that is covered by a life insurance policy is the loss caused by the premature death of the person whose life is insured. As we will discuss, life insurance can be used in different ways, so the meaning of “premature” is different depending upon the circumstances of the individual who buys it. Briefly, though, “premature” can refer to death when there remain financial obligations for raising a family, for paying debts, or financial obligations to business partners.
Like other insurance policies, the parties to a life insurance policy are the “insured” and the “insurer.”
The insured is the person whose life may end while the insurance policy is in force.
The insurer is the company that assumes the risk of paying the face value of the policy if the insured dies when the policy is in force. The term “insurance company” is generic because some life insurers are corporations while others are other kinds of entities, such as “fraternal benefit societies.” We won’t discuss the distinctions, but the life insurance products that each issue are similar.
While not, strictly speaking, a party to a life insurance policy, the “beneficiary” is an integral part of a life insurance policy. A beneficiary is a person, or other recipient, of the insurance proceeds. The insured typically names one or more beneficiaries when applying for the policy, and the beneficiaries can usually, but not always, be changed at any time before the insured’s death.
There are 2 broad categories of life insurance, and several variations of each. The broad categories are:
Term Life Insurance. Term life insurance is designed (and priced) to last for a fixed period of time, which is established at the beginning of the policy. Insurers that issue term life insurance policies may offer them for periods ranging from one to 20 or more years. Depending upon the design of the product, the price (or premium) may remain the same over the entire term or may increase at intervals stated in the insurance policy.
The face value of a term life insurance policy is payable if the insured dies while the policy is in force. A term life insurance policy will not be in force if (a) the term of coverage expired and has not been renewed before the insured dies or (b) the policy lapsed due to non-payment of premiums. Payment may also be denied if the cause of death is one that is excluded by the policy.
Permanent Life Insurance. Permanent life insurance is also called “whole life insurance.” A major characteristic that distinguishes it from term life insurance is that permanent life insurance accumulates “cash value.” Cash value can be broadly compared to a savings account built into the insurance policy. It is not a savings account as that term is usually used, but there are some similarities. In general, here’s how it works:
- A portion of each premium payment is applied to the cost of the indemnity benefit. That refers to the mathematically determined amount that the life insurance company must collect to pay the death benefit of the policy.
- Another portion of each premium payment is deposited into a separate account that we can call the “cash value account.”
- Cash value accumulates slowly at first, but it grows more quickly the longer the policy is in force. A permanent life insurance policy will contain a schedule of estimated cash value growth. The cash value can be used for a variety of purposes, as will be discussed in future articles.
The premium for permanent life insurance will be greater than for the same amount of term life insurance. That is because term life insurance does not accumulate cash value, so there is no separate “account” within it. Instead, it pays a death benefit only. However, the premium for a permanent life insurance policy stays the same for the life of the policy. The premium is established at the inception of the policy and is based on factors including the insured’s age, gender and health status. In contrast, the premium for a term life insurance policy remains the same only for the length of the initial term. If the term policy is renewed for another period of time, the premium will be higher because of the insured’s advanced age, changed health condition, or other factors.
Term life insurance and permanent life insurance both have advantages and disadvantages. The pros and cons relate to an individual’s reason(s) for buying life insurance, and to some degree, the point in their life that they buy it.
Above all, it is important to recognize that any kind of insurance, including life insurance, is for protection. Specifically, life insurance is purchased to protect against obligations that may exist at death.
Advantages of term life insurance:
- Term life insurance is comparatively inexpensive; it thereby allows one to buy more insurance when it is most needed.
- Term life insurance is simple to understand because it involves only the payment of a death benefit.
- Term life insurance can be purchased to approximate the period during which protection is needed, such as paying for a child’s education or paying off a mortgage.
Disadvantages of term life insurance:
- Term life insurance lasts for a definite duration. Therefore, you may outlive your coverage while you still need it.
- Renewal of the insurance will be more costly due to advancing age or intervening medical conditions. A medical condition may also cause you to be uninsurable while you still need life insurance.
- Term life insurance does not accumulate cash value.
Advantages of permanent life insurance:
- The premium for permanent life insurance generally does not change for the life of the policy.
- A permanent insurance policy accumulates cash value that grows tax-deferred.
- Cash value can be used for any purpose and does not have to be repaid (BUT: if not repaid, the amount borrowed plus interest will reduce the death benefit).
Disadvantages of permanent life insurance:
- Permanent life insurance is usually much more expensive than term life insurance. Therefore, less insurance can be purchased so that all needs may not be provided for.
- Cash value grows slowly because insurance companies invest money cautiously. You may be able to get a better return by investing the difference between a term life insurance premium and a permanent life insurance premium yourself.
- The interest rate for loans against cash value is stated in the contract. Although it is a liquid source of money, lower interest rates may be available from other sources.
The answer is, “it depends.” There are many considerations.
In the past, an individual aged 65 had raised his or her family, retired from work, perhaps had a secure pension and a fully-paid house. Therefore, the need for life insurance was different. Now, fewer “Seniors” fully retire at 65. Instead, they remain working at long-time jobs or professions, consult, or begin new careers; some because they want to and some because they must.
Economic pressures ranging from unemployment to school loans have created situations where children remain at home. Sometimes, older adults are in the position of continuing to support them, grandchildren and themselves. Therefore, savings can be depleted or mortgages don’t get paid off as early as intended. Life insurance can become a part of the metric in several ways.
First, permanent life insurance can provide a tax-deferred source of income through its cash value. The policy may allow cash value to be withdrawn in a way similar to an annuity and thereby provide a stream of income. If the Senior is insurable (mostly, by age and health status) and has the means to do so, he or she can make a lump-sum premium payment and accomplish this goal.
Second, although a term insurance policy provides a death benefit only, its advantage is that it is usually more affordable. Upon death, proceeds can be used to provide for a surviving spouse, children who remain at home, and whatever other financial needs the Senior has.
Both types of life insurance can be used as part of an overall estate-planning strategy. Age and health status play major roles in the availability of life insurance for Seniors, but there do exist life insurance companies that cater to their special needs. Seniors who are considering the maintenance or acquisition of life insurance as part of their financial or estate-planning strategy are advised to consult licensed professionals for guidance.
For information on the cost of life insurance, see How is the Cost of Life Insurance Determined?