Types of Life Insurance
Types of life insurance include “term” life which pays a fixed death benefit amount and many “whole” life types which build cash value through investments. Beyond these two main types there are a number of different life insurance policies that differ by duration, funding mechanisms, benefits, and how investments are handled. Each type can be further customized with riders and options.
Even when comparing two very similar policies aspects of the policy like duration, premiums, and payouts can be adjusted up-front. This means, for example, two equivalent term policies with the same riders can differ greatly depending upon insurer and customization.
Term Life and Whole Life
There are two basics types of life insurance policies. In general all life insurance policies are either:
Term life – A temporary policy that pays an amount upon death occurring during the duration of the contract.
Whole life (permanent life) – A lifetime policy that pays an amount upon death and includes a tax-advantaged investment account that builds “cash value” over the policy holders lifetime.
Variable and Universal
Beyond the two basic types there are also two common sub-types of whole-life policies that are combined in a number of different ways.
Variable – A policy that has the ability to invest in separate accounts whose values “vary”—they vary because they are invested in stock and/or bond markets.
Universal – A policy that has an adjustable premium and can have adjustable benefits. This allows the policy holder to contribute more or less in premiums at a given time by adjusting benefits.
The Many Different Sub-Types
A life insurer can combine any two or more of the above terms and create a policy out of it, often you will find odd hybrid policies called by different names depending upon the insurer. This can lead to an overwhelming amount of life insurance products. However, the names are little more than a distraction. All policies will have the same features and by understanding the above terms and understanding how to read your policy you’ll be able to choose the life insurance policy that meets your needs (even if the exact name of a rider or product differs slightly between insurers).
Below we look at the different types of whole life policies and the different types of term life policies. We will also discuss other riders and options added to both term and whole life policies which can further differentiate between life insurance products.
Advice: It’s important to read the fine print of any contract, but this is even more important with life insurance subtypes than traditional types as the fine-print leaves more room for loopholes.
Types of Whole Life Policies
The most popular whole life types are: Whole life, universal life, and variable life. However there are a few common subtypes of these:
Variable Universal – A universal policy (allowing the policy holder to adjust premiums and benefits mid-policy) and also a variable policy allowing the policy holder to allocate portions of premiums to different accounts which each have a unique risk / reward. Since the policy holder has control over investments variable universal life insurance policies are considered securities and are subject to SEC regulations as well as oversight by the state insurance commissioner.
Indexed Universal – A policy that allows the policy holder to allocate cash value amounts to both fixed accounts managed by the insurer and an equity index account (like S&P 500 and the Nasdaq 100). The policy holder can choose what percentage is invested in the fixed account and what percentage of premiums funds the indexed account. Typically the insurer will guarantee the principal amount in the indexed portion, but cap the maximum return that a policy holder can receive.
Single Premium Whole Life — You pay one premium. Your investment fund is fully funded from the get-go allowing money to build more quickly.
Guaranteed Universal life — Guarantees that you are locked-in to larger death benefits for a specific duration of time, usually in exchange for a larger premium.
Types of Term Life Policies
There are three main types of term life policies: renewable, non-renewable, and convertible. Aside from this the main difference is in duration and whether or not the premium can be adjusted mid-term.
Renewable — A policy that can be renewed regardless of health status, up to a specific age. Premiums increase on renewal. (Typically included as a Guaranteed insurability rider).
Non-renewable — A policy that is not guaranteed to be renewable.
Convertible — A policy holder has the right to “convert” the term policy into a whole life policy without additional “evidence of insurability”. (Typically included as a Term conversions rider).
Other Life Insurance Riders and Options
There are a number of other riders and options that can be added to whole or term life policies. The names can change between policies, but the functions are consistent between insurers. Be aware that each rider can have variations depending upon the insurer and the policy its attached to, so read the fine print. Some riders may also come as non-optional provisions on certain policies.
Spouse Insurance Rider — Allowing term insurance for a spouse as a rider on the main policy.
Child Term Rider — Allowing term insurance for a child as a rider on the main policy. Can include the option for being a convertible policy “evidence of insurability” upon a certain age.
Family Income Benefit Rider — Allowing regular monthly payments rather than a lump-sum payment upon death. This rider can ensure a family is supported consistently throughout time and avoid potential tax issues with receiving lump-sum taxed benefits or cash value.
Withdrawal Rider — Allowing the insured to withdraw accumulated cash value. There is a a penalty for withdrawing before a certain age (typically retirement age) and withdrawing cash value typically results in a reduction to the policies payout upon death as well.
Fix-premium / non-fixed premium — A policy holder may have a fixed premium for the duration of a policy. Longer policies may adjust the premium at regular intervals. Typically this will be set in the policy of term life insurance, but all universal life policies allow for adjusting premium amounts as well as benefits.
Return of Premium Rider — Some higher premium term policies allow a “return of premium” if no claim has been made by the end of the “term” of the contract. Typically you’ll have to continue the policy through the whole term to claim the return. Some contracts allow the return of all premiums, others allow the return of only the initial premiums (not the cost of the return of premium rider).
Waiver of Premium Rider (Disability Income Rider) — If a policy holder is “totally disabled” this rider waives the need to make premiums. This can be a major benefit if there is only one main source of income in the family. This can protect against a policy lapsing in the later stages of life where one’s ability to pay higher premiums may be diminished. Make sure to understand what qualifies as “disabled” and understand exclusions.
Accidental Death or Double Indemnity Rider — This rider pays a double death benefit in the event of a qualifying accident. For example if the policy holder dies due to bodily injury the policy will pay out double the death benefit. As would be assumed only certain “accidents” trigger the double benefit rider, so make sure to read the fine print and understand exclusions.
Long-Term Care Rider — A rider that replaces the need for long-term care insurance. This offers monthly payments (living benefits) in the event that the policy holder needs long-term care.
Accelerated Death Benefit Rider (Critical Illness Rider) — An advance death benefits up to a percentage (defined in contract, but typically 25 – 40%) in the case of terminal illness. This money is typically loaned by the insurer from the death benefit with interest. Thus this can lead to a lower payout upon the death of the insured. Check fine print for what counts as a “terminal illness” and make sure to understand exclusions.