Introduction to Life Insurance

If you are going to make a good choice when purchasing life insurance, you need to understand what type of policies are available. If one type of policy does not fit your needs, then ask and find out about other available policies, many of which are described in this brochure. You can research more information on life insurance policies by checking with a licensed life insurance agent or a licensed life insurance company. You can also consult life insurance books that are available in your public library, as well as life insurance information available on the Internet. The California Department of Insurance (CDI) has a toll-free Hotline and Web site that can provide further information and assistance on life insurance. Please see the many ways to contact the CDI on the last page of this brochure.

Defining Your Needs

When you buy life insurance, you want a policy that fits your needs at a reasonable cost. Your first step is to determine how much life insurance you need. Next, you need to decide how much money you can afford to pay. Finally, you must choose the type of policy that meets your coverage goals and fits into your overall financial plan. Once you have completed these steps, you will be able to move ahead and contact several life insurance companies (through an agent or broker) to shop for the right type of policy for you.

There are many reasons for purchasing life insurance, among which are the following:

• Insurance to provide family protection and financial security to surviving family members upon the death of the insured person.
• Insurance to cover a particular need such as paying off a mortgage or other debt upon the insured’s death.
• Business insurance to compensate a company on the death of a key employee or to provide a surviving partner the resources to buy out the deceased partner’s share of the business.
• Insurance to provide funds to pay estate taxes or other final obligations necessary to settle a deceased person’s estate.
• Insurance to provide the funds necessary for the deceased person’s burial expenses.

Choosing the Amount

Simply stated, you should elect an amount of life insurance that is determined necessary to meet the needs you are trying to satisfy. To be overinsured can negatively affect your budget and long range financial goals almost to the degree that being underinsured can. While each person must individually assess their responsibilities, life situation and comfort for risk, it is important to be careful to choose an amount of life insurance that reflects your specific circumstances without underinsuring or overinsuring.

Choosing the Type of Life Insurance

There are two basic types of life insurance: term life insurance and cash value life insurance. There are many policy variations on these two types of life insurance.

• Term Policies provide life insurance for a specified period of time. These policies provide benefits in the event of death, but they generate no cash value. If you have a limited amount to spend, and only need insurance for a finite period of time, you may be able to get more coverage by buying term insurance than by buying cash value insurance. Keep in mind that the cost of term insurance increases as you get older, which may make it more expensive than cash value insurance in the long run. Today’s term policies usually have two sets of premiums -guaranteed maximum premiums and current premiums. Current premiums are usually much lower, but they can be changed by the insurance company. The insurance company cannot increase the current premium above the guaranteed maximum premiums shown in the policy. When you buy term insurance, you need to make a choice as to how long you want the protection. You may renew the policy without a physical examination for the period of years specified in the policy. Some term insurance can be converted to cash value insurance up to a specified age with no physical examination. Premiums for the converted insurance will most likely be higher than the premiums you would be paying for the term insurance.
• Cash Value Insurance combines death benefits with an accumulation feature. The buyer of a cash value policy pays more in the early years than for term insurance, but the premium not needed to pay for the cost of the death benefit accumulates at interest. If the policy is surrendered before the insured person dies, there may be a cash value paid to the owner. Make sure the agent/broker provides you with the method by which the cash value is determined and that they obtain this information based on the policy’s guaranteed value. As a general rule, it is not a good idea to buy a cash value life insurance policy if you plan to surrender early. If all premiums are paid, cash value insurance usually lasts for the whole life of a person and pays death benefits to the beneficiaries named in the policy upon the death of the insured. The cash value can be used as loan collateral for borrowing funds at the interest rate specified in the policy. Any outstanding loans are deducted from policy proceeds at death or at policy surrender.

Some of these products may enjoy tax advantages. A policy lapse or surrender may create a taxable event and may generate a Form 1099. Be sure to check with your tax advisor. Some of the most popular types of cash value insurance are described below:

• Whole Life Insurance (also known as straight life, ordinary life, and traditional permanent insurance) has guaranteed premiums and death benefits, and a minimum interest rate, which will be credited to the funds accumulated in the policy. On some whole life policies, higher interest rates may be credited to those funds depending on the future performance of the insurance company’s investments.
• Universal Life differs from whole life insurance in that it allows the policy owner to vary, with limitations, the amount and timing of premium payments and the death benefit. Cash values are accumulated by crediting premium payments and interest to a fund from which deductions are made for expenses and cost of insurance. The rates at which the interest is credited are declared by the company or may be specified in the contract. Like term insurance, universal life insurance policies usually have two sets of premiums—guaranteed maximum premiums and current premiums. Current premiums may be lower, but they can be changed by the insurance company up to the maximum. They also can include a minimum interest guarantee. Because of its flexibility, a universal life policy can also be structured to operate like term insurance.
• Variable Life differs from whole life insurance and universal life insurance in that policy owners direct the distribution of their premium payments among several different accounts or funds rather than by the company’s choosing. Typical account choices for variable life are common stock, bond, mortgage, and money-market accounts. With this type of policy, the death benefit and cash value benefits vary in relation to the value of the investments underlying the policy. If the value of the account increases, so will the benefits; if the value of the account decreases, so will the benefits, subject to a minimum guarantee. Variable life insurance is more risky to the policy owner than the other forms of cash value insurance, but there is a possibility of greater returns.
• Variable Universal Life Insurance combines the flexibility of universal life insurance with the investment account features of variable life insurance.

Finding a Good Policy

Guarantees

When shopping for a life insurance policy, you determine the guarantees on premiums, death benefits, expenses, cash value, mortality changes, and cost of insurance. It is critical to get all promised guarantees in writing.

Sales Illustrations

It is likely that an agent will show you one or more life insurance sales illustrations. An illustration consists of a series of numbers indicating how the policy works. The illustration usually shows the guaranteed results under the policy for each year in the future, and the results if all the non-guaranteed items continue at their present level. This will probably not happen as actual results may be better or worse than the non-guaranteed amounts shown in the illustration (but not worse than those that are guaranteed).

Using Indexes

Your chances of finding a good buy on a life insurance policy is better if you use the index numbers that have been developed to aid you in shopping for life insurance. The Buyer’s Guide that each insurer is required to provide to a purchaser explains these index numbers in detail. They are good tools to help you compare the merits of similar policies.

Glossary of Life Insurance Terms

Accelerated Benefit Provision – A provision in many new policies which will allow the policy owner to receive a portion of the death benefit early if the insured person is diagnosed with a terminal illness or permanently confined to a nursing home.

Accidental Death Benefit – A rider added to a policy that provides an additional benefit if the insured dies from accidental causes.

Certificate – A document provided to a person insured under a group insurance policy that provides evidence that the coverage exists.

Evidence of Insurability – Medical and other information about a person applying for insurance that the life insurance company keeps confidential, but uses to decide whether the policy can be issued and what premiums will be charged.

Face Amount – The amount to be paid to the beneficiary when the insured dies. It will be reduced by any unpaid policy loans and interest on those loans, and may be increased by any dividends.

Free Look – The right of the policyowner to have a period of ten or more days to examine an insurance policy, and if not satisfied, return it to the company for a full refund of all amounts paid.

Grace Period –A period of time (usually 31 days) after the premium due date when an overdue premium may be paid without penalty. The policy remains in force throughout the period.

Guaranteed Insurability – An option that permits the policyholder to buy additional stated amounts of life insurance at certain times in the future, without having to provide new evidence of insurability.

Illustration – A document used in life insurance sales presentations showing year-by-year numbers indicating how a policy will work. Usually it assumes that amounts being paid today will continue in all future years.

Insured – The person whose life is covered by a life insurance policy; the policyowner; the policyholder.

Lapse – The discontinuation of insurance without cash value when the required premium is not paid. If cash value exists, there may be nonforfeiture provisions available.

Loan Value – The amount which can be borrowed by the policyowner from the company using the value of the policy as collateral. Usually the interest rate payable on the loan varies based on an index defined in the policy.

Mode of Premium Payment – The frequency of premium payments during the policy year. Premium payments can usually be made on annual, semi-annual, quarterly, or monthly mode.

Mortality Table – A statistical table showing the death rate (probability of death) for each age.

Nonforfeiture Options – A provision in the policy that allows the policyowner to choose how the cash value of the policy will be used if the policy is surrendered or lapses due to nonpayment of premium.

Ownership – All rights, benefits, and privileges under a policy controlled by the owner, who is usually the insured. Ownership may be transferred or assigned to someone else by written request of the current owner.

Paid-Up Insurance – A life insurance policy where all premiums have already been paid, with no further premium payment due.

Participating Insurance – Insurance on which the policyowner is entitled to share in the surplus earnings of the company through dividends, which reflect the difference between the premium charged and the actual earnings and costs of providing coverage.

Policy – The printed document issued to the policyowner by the company stating the terms of the insurance contract.

Policy Year – A one-year period starting on the day and the month the policy was issued. The first policy year starts on the date of issue, and ends on the day before the policy’s first anniversary date.

Premium – The payment a policyowner is required to make to an insurance company to purchase insurance coverage and to keep the policy in force.

Rated Policy – A policy issued with an additional premium to cover the extra risk involved if an insured has impaired health, a hazardous occupation or hobby, or is a private pilot.

Reinstatement – The restoring of a lapsed or surrendered policy to full force and effect. The company requires evidence of insurability and payment of all amounts necessary, including interest, to put the policy into the condition it would have been in had the lapse or surrender not occurred. The company is not obligated to reinstate a policy.

Rider – A provision added to a policy that provides additional benefits, usually accompanied by a corresponding premium increase or change.

Settlement Option – The manner in which the insured or beneficiary may choose to have the policy proceeds paid.

Suicide Clause – A policy provision which reduces or eliminates the amount to be paid if the insured dies from suicide within the first two policy years.

Standard Risk – The classification of an applicant for a life insurance policy who fulfills the physical, occupational, and other requirements on which most of the company’s policies are issued. Someone whose characteristics are more favorable may be classified as a "Preferred Risk." When the characteristics are less favorable, the applicant may be characterized as "Rated" or refused coverage altogether.

Surrender – To voluntarily terminate or cancel a policy for its cash value or other nonforfeiture options.

Underwriting – The process of evaluating applicants for insurance and classifying them fairly, so the appropriate premium rate may be charged. This may involve a physical examination of the applicant.

Waiver of Premium – A rider added to policy that will waive the premium payments required by an insured during the total disability of the insured.

Back to top