Sunday, March 13, 2016

4 Types Of Permanent Life Insurance


Permanent life insurance is life insurance that is designed to pay a death benefit when you die no matter how old you get. Some permanent life insurance is contractually guaranteed to last until you die while other permanent life insurance may or may not if you don't manage it properly.







Now that you know a little about what permanent life insurance is and how it works, I wanted to talk about the specific types of permanent life insurance policies you can get and how they work.

I break the the different types of permanent life insurance policies into four categories. Those are:

  • Whole Life
  • Universal Life
  • Variable Life
  • Second To Die (Survivorship Life Insurance)

Let's take a look at each of these types of permanent insurance.

Whole Life Insurance


Whole life insurance is at the top of the heap of permanent life insurance because of its guarantees. The premium, the face amount, the cash value and death benefits are all guaranteed as long as you pay your premium. 

As such, whole life insurance is the most expensive type of permanent life insurance that you can buy. That's because you aren't just paying for the life insurance, you are also paying for the insurance company to guaranteed all of the features of the policy as well.

I always tell people not to underestimate the importance of guarantees and also to pay that extra premium to have them.

There are different types of whole life insurance. I put the whole life insurance policies into three categories. They are:

  • Ordinary whole life insurance Ordinary whole life insurance pays no matter how old the insured gets as long as the premium is paid.
  • Endowments An endowment pays the face amount if the insured dies or lives to a specific age. An endowment at age 95 would pay the face amount when the insured died or if the insured didn't die, the insurance company would pay the full value of the policy when they reached the age of 95.
  • Limited pay life insurance Limited pay whole life insurance pays the face amount if the insured dies no matter how old they get. The premiums would only be paid for a part of the insured's life. An example would be 20 pay life insurance. In that example, the premiums would be paid for 20 years and then the policy would be paid up or paid for and no other premiums would be due.

Given a choice between whole life insurance and other types of permanent life, I'd choose the guarantees of whole life over all of the others.

Universal Life Insurance


Universal life insurance was created in response to the high interest rates in the early 1980's. When rates were double digits, policyholders asked why they had to receive much lower rates in the traditional whole life policies than was available in the market place.

Insurance companies responded by creating universal life policies that were tied to short term interest rates. This allowed for policyholders to take advantage of the high short term interest rates of that era.

In addition to connecting the policy to short term interest rates, insurance companies also allowed owners of those policies to have flexible premiums. These flexible premiums were less expensive than the old boring whole life insurance policies.

Buyers of permanent life insurance certainly loved the lower flexible premiums but when the insurance company allowed the lower premiums, they removed the traditional guarantees in ordinary whole life policies.

Agents selling these policies were also allowed to illustrate the higher interest rates out to show higher cash value accumulations that made these policies look more attractive than whole life too.

The only problem was that interest rates began declining and today interest rates are almost non-existent. The result was that a lot of these policies were underfunded. And eventually, judgment day would arrive for those policyholders in the form of premium due notices.

The bottom line is that someone who bought a universal life policy could pay all of their scheduled premiums when due and still lose their life insurance because the insurance company transferred the risk from the insurance company over to the policyholder.

TIP! If you own a universal life insurance policy, one thing you'll want to do is keep on top of the value inside the policy each year compared to the illustration you received when you bought it. If you see the cash value is where it supposed to be each year, then that's great. If you don't, and the actual value of your policy is less than what was illustrated, then your policy is in danger of lapsing at some point. You'll want to work closely with your agent to make sure it's funded properly. The problem is that most people don't take the time to do that and find out when it's to expensive to catch it up. The result is they let the policy lapse.

Variable Life Insurance


Variable life insurance was created for many of the same reasons that universal life insurance was. After realizing that a long term vehicle like a permanent life insurance policy connected to a short term interest rate vehicle wasn't as attractive in a low interest rate environment, insurance companies responded again.

This time, they gave the policyholder the opportunity to self direct the cash value into investment options similar to what you might see in a retirement plan.

But again, the same problems of underfunding encountered with universal life insurance policies would crop up with variable life insurance policies as well.

I know my mom had a policy with a major national insurance company and she paid every premium on time. Yet, when she turned 65, they determined that there wasn't enough money in the policy to support the policy at the same premium for the rest of her life. Because there wasn't, they tripled her premium.

The end result for her was she had to let the policy go.

NOTE: Just like universal life insurance, as long as you understand how these sophisticated policies work and you keep track of the values each year to make sure it's properly funded, you'll be fine. But if you don't pay attention or understand your policy, then just like my mom, you could pay all of your premiums on time yet still lose your policy.

Second-To-Die Life Insurance aka Survivorship Life Insurance


While not necessarily an evolution of permanent life insurance as we've seen from traditional whole life to universal life to variable life, second to die life insurance policies are a form of permanent life insurance that I wanted you to know about. 

Second to die policies are used in estate planning to pay estate taxes that come due upon the death of the last spouse to die. Instead of only insuring one person, a second-to-die policy will actually cover both spouses. 

When the first spouse dies, the policy continues until the second spouse dies and then the face amount is paid.

Also called a survivorship policy, these policies are usually only purchased by those with large estates who would have an estate tax bill at some point.

Conclusion


Those are the four major types of permanent life insurance you'll find that you can buy. Over the years, you can see that what's really happened is that the insurance company has transferred the interest rate risk of the policy from the insurance company to the policyholder.

If you want to avoid this interest rate risk, you'll want to buy whole life insurance. If you are comfortable with interest rate risk and keep tabs on your policy from year to year, then universal life or variable life insurance policies are more viable options.

Because of the turnover of agents in the life insurance industry and the aversion to talking with life insurance agents most people have, I strongly encourage people to stay traditional with their permanent life insurance and stick with whole life insurance to protect themselves.

If you have any questions, feel free to let me know in the comments.

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Michael is a champion of guaranteed issue for employees in the workplace. He's been an insurance agent since 1992 and has worked with thousands of employees.


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