Life insurance may be one of the most important purchases you’ll ever make. In the event of a tragedy, life insurance proceeds can help pay the bills, continue a family business, finance future needs like your children’s education, protect your spouse’s retirement plans, and much more. This section can help you gain a better understanding of life insurance and its role within a sound financial plan, and answer many of your questions.

Who need’s it? Most Americans need life insurance. To figure out if you need life insurance, you need to think through the worst-case scenario. If you died tomorrow, how would your loved ones fare financially. If someone depends on you financially, chances are you need life insurance. Life insurance provides cash to your family after your death. This cash (known as the death benefit) replaces your income and can help your family meet many important financial needs like daily living expenses, mortgage payments and college savings. What's more, there is no federal income tax on life insurance benefits.

Would your loved one’s have the money to pay for your final expenses (e.g., funeral costs, medical bills, taxes, debts, lawyer’s fees, etc.)? Would they be able to meet ongoing living expenses like the rent or mortgage, food, clothing, transportation costs, healthcare, etc? What about long-range financial goals? Without your contribution to the household, would your surviving spouse be able to save enough money to put the kids through college or retire comfortably?

The truth is, it's always a struggle when you lose someone you love. But your emotional struggles don't need to be compounded by financial difficulties. Life insurance helps make sure that the people you care about will be provided for financially, even if you're not there to care for them yourself.

Before You Buy Insurance

The purchase of life insurance is an important decision for both you and your family. There are many reasons why life insurance is purchased, but these reasons should be based upon your needs or wants. Your marital status, number of dependents, family size, income, and wealth all play a role in determining the amount of life insurance that is right for you. The first step is to determine your current need for life insurance and how much you can afford to spend. It is a good idea to consider future needs too, because unlike most purchases, you can’t always buy life insurance when you need it; you have to be in reasonably good health to purchase most types of life insurance products.

The Purpose Of Life Insurance

Your need for life insurance will vary with your age and responsibilities. The amount of insurance you buy should depend on the standard of living you wish to assure your dependents. You should consider the amount of assets and sources of income available to your dependents when you pass away. Social security benefits, available cash and other sources of income and investments may not provide the standard of living you have in mind. Life insurance helps bridge the gap between the financial needs of your dependents and the amount available from other sources, is the amount to be provided by life insurance.

Analyze Your Life Insurance Needs

One approach to determine how much life insurance one should carry is to analyze the various needs of the family in the event of the death of a wage earner. Life insurance satisfies a number of these needs by providing a fund that can be used to:

• Pay off an individual’s last debts such as medical bills and funeral expenses
• Meet estate taxes and other expenses in settling an estate
• Provide life income for the spouse
• Pay off a mortgage
• Pay for the children’s education
• Provide funds for retirement
• Provide an income for the policyholder’s spouse to give the family time to readjust to a new standard of living
• Draw interest to provide funds for some special purpose
• Provide a monthly income until the children are grown and out of school

For the most part, there are two types of life insurance plans - either term or permanent plans or some combination of the two. Life insurers offer various forms of term plans and traditional life policies as well as "interest sensitive" products which have become more prevalent since the mid-1980’s.

TERM INSURANCE: Term insurance provides protection for a specified period of time. This period could be as short as one year or provide coverage for a specific number of years such as 5, 10, 20 years or to a specified age as high as 80. Policies are sold with various premium guarantees. The longer the guarantee, the higher the initial premium. If you die during the term period, the company will pay the face amount of the policy to your beneficiary. If you live beyond the term period you had selected, no benefit is payable. As a rule, term policies offer a death benefit with no savings element or cash value.

Premiums are locked in for the specified period of time under the policy terms. The premiums you pay for term insurance are lower at the earlier ages as compared with the premiums you pay for permanent insurance, but term rates rise as you grow older. Term plans may be "convertible" to a permanent plan of insurance. The coverage can be "level" providing the same benefit until the policy expires or you can have "decreasing" coverage during the term period with the premiums remaining the same. If you do not pay the premium for your term insurance policy, it will generally lapse without cash value, as compared to a permanent type of policy that has a cash value component. Currently term insurance rates are very competitive and among the lowest historically experienced.

It should be noted that it is a widely held belief that term insurance is the least expensive pure life insurance coverage available. One needs to review the policy terms carefully to decide which term life options are suitable to meet your particular circumstances.

PERMANENT INSURANCE: (Whole Life or Ordinary Life). While term insurance is designed to provide protection for a specified time period, permanent insurance is designed to provide coverage for your entire lifetime. To keep the premium rate level, the premium at the younger ages exceeds the actual cost of protection. This extra premium builds a reserve (cash value) which helps pay for the policy in later years as the cost of protection rises above the premium. Whole life policies stretch the cost of insurance over a longer period of time in order to level out the otherwise increasing cost of insurance. Under some policies, premiums are required to be paid for a set number of years. Under other policies, premiums are paid throughout the policyholder’s lifetime. The insurance company invests the excess premium dollars

This type of policy, which is sometimes called cash value life insurance, generates a savings element. Cash values are critical to a permanent life insurance policy. The size of the cash value build-up differs from company to company. Sometimes, there is no correlation between the size of the cash value and the premiums paid. It is the cash value of the policy that can be accessed while the policyholder is alive.

The policy’s essential elements consist of the premium payable each year, the death benefits payable to the beneficiary and the cash surrender value the policyholder would receive if the policy is surrendered prior to death. You may make a loan against the cash value of the policy at a specified rate of interest or a variable rate of interest but such outstanding loans, if not repaid, will reduce the death benefit.

In 1984 a new federal tax law required that for permanent insurance to enjoy preferred tax treatment it must provide coverage up to at least age 95, limit the amount of premium that may be paid in relation to the face amount of coverage and establish a minimum ratio between cash value and face amount of insurance. Many permanent policies will contain provisions, which specify these tax requirements.

Universal Life:  The universal life policy is actually more than interest sensitive as it is designed to reflect the insurer’s current mortality and expense as well as interest earnings rather than historic rates. Universal life works by treating separately the three basic elements of the policy: premium, death benefit and cash value. The company credits your premiums to the cash value account. Periodically the company deducts from the cash value account its expenses and the cost of insurance protection, usually described as the mortality deduction charge. The balance of the cash value account accumulates at the interest credited. The company guarantees a minimum interest rate and a maximum mortality charge. Some universal life policies also specify a maximum basis for the expense charge. These guarantees are usually very conservative. Current assumptions are critical to interest sensitive products such as Universal Life. When interest rates are high, benefit projections (such as cash value) are also high. When interest rates are low, these projections are not as attractive. Universal life is also the most flexible of all the various kinds of policies. Because it treats the elements of the policy separately, universal life allows you to change or skip premium payments or change the death benefit more easily than with any other policy.

VARIABLE LIFE – Most types of both traditional and interest sensitive life policies can be purchased on either a fixed-dollar or variable basis. On a fixed-dollar basis, premium, face amount and cash values are specified in dollar amounts.

On the variable basis, face amount and cash value are specified in units, and the value of the units may increase or decrease depending upon the investment results. You can allocate your premiums among various investment pools (like stock, bond, money market, mutual funds and real estate pools) depending on the amount of risk you are willing to assume in the hope of a higher return.

Traditional variable life provides a minimum guaranteed death benefit, but many universal variable life products do not, and should investment experience be bad, coverage will terminate if substantially higher premium payments are not made. Variable life is also made available on a single premium basis but if investment experience is poor additional premiums will be required.

OTHER COVERAGES– Variations on the Basic Plans

Modified Life Plan:  A modified life plan is similar to whole life except that you pay a lower premium for the first few years and a higher than regular whole life premium in later years. This plan is designed for those who cannot initially afford the regular whole life premium but who want the higher premium coverage and feel they will eventually be able to pay the higher premium.

The Family Policy: The family policy is a combination plan that provides insurance protection under one contract to all members of your immediate family – husband, wife and children. Usually family policies are sold in units (packages) of protection, such as $5,000 on the main wage earner, $1,500 on the spouse and $1,000 on each child.

Joint Life and Survivor Insurance:   Joint Life and Survivor Insurance provides coverage for two or more persons with the death benefit payable at the death of the last of the insureds. Premiums are significantly lower under joint life and survivor insurance than for policies that insure only one person, since the probability of having to pay a death claim is lower.

Joint Life Insurance:   Joint Life Insurance provides coverage for two or more persons with the death benefit payable at the first death. Premiums are significantly higher than for policies that insure one person, since the probability of having to pay a death claim is higher.

Endowment Insurance: Endowment insurance provides for the payment of the face amount to your beneficiary if death occurs within a specific period of time such as twenty years; or, if at the end of the specific period you are still alive, for the payment of the face amount to you. Due to recent tax law changes many endowment plans no longer qualify as life insurance for tax purposes and are generally not being offered by insurers.

Juvenile Insurance: Juvenile insurance provides a minimum of protection and could provide coverage, which might not be available at a later date. Amounts provided under such coverage are generally limited based on the age of the child. The current limitations for minors under the age of 14½ would be the greater of $10,000 or 50% of the amount of life insurance in force upon the life of the applicant. The limitations on a minor under the age of 4 and one half would be the greater of $5,000 or 25% of the amount of life insurance in force upon the life of the applicant. Juvenile insurance may be sold with a payor benefit rider, which provides for waiving future premiums on the child’s policy in the event of the death of the person who pays the premium.

Senior Life Plans: Senior life insurance, sometimes referred to as graded death benefit plans, provides eligible older applicants with minimal whole life coverage without a medical examination. Since such policies are issued with little or no underwriting they will provide only for a return of premium or minimum graded benefits if death occurs during a specified period which is generally the first two or three policy years. The permissible issue ages for this type of coverage range from ages 50 – 75. The maximum issue amount of coverage is $25,000. These policies are usually more expensive than a fully underwritten policy if the person qualifies as a standard risk.

Pre-need Insurance: This type of coverage is for a small face amount, typically purchased to pay the burial expenses of the insured. As previously mentioned within the discussion of monthly debit ordinary insurance, this coverage often carries a higher premium per $1,000 of coverage than larger size policies.

Glossary Of Life Insurance Terms

Agent - An insurance company representative licensed by the state who solicits and negotiates contracts of insurance, and provides service to the policyholder for the insurer. An agent can be independent agent who represents at least two insurance companies or a direct writer who represents and sells policies for one company only.

Annuity - A contract that provides a periodic income at regular intervals, usually for life.

Annuity Certain - A contract that provides an income for a specified number of years, regardless of life or death.

Application - A statement of information made by a person applying for life insurance. It helps the life insurance company assess the acceptability of risk. Statement made in the application are used to decide on an applicant's underwriting classification and premium rates.

Beneficiary - The person named in the policy to receive the insurance proceeds at the death of the insured. Anyone can be named as a beneficiary.

Bonus Rate Annuity - An extra percent of interest credited to an annuity during the first year that it is in force. The extra amount is above the interest rate to be credited beginning the second year and the remaining years that the annuity is in force. The extra rate is paid in the first year in an effort to attract new policyholders.

Cash Surrender Value - The amount available in cash upon voluntary termination of a policy by its owner before it becomes payable by death or maturity. The amount is the cash value stated in the policy minus a surrender charge and any outstanding loans and any interest thereon.

Direct Response - Insurance sold directly to the insured by an insurance company through its own employees by mail or over the counter.

Disclosure Statement - A comparison form required by New York Insurance Department Regulations to be given to every applicant considering replacing one life insurance policy with another.

Dividend - A return of part of the premium on participating insurance to reflect the difference between the premium charged and the combination of actual mortality, expense and investment experience. Dividends are not considered to be taxable distributions because they are interpreted as a refund of a portion of the premium paid.

Evidence of Insurability - A statement or proof of your health, finances or job, which helps the insurer decide if you are an acceptable risk for life insurance.

Expense - Your policy's share of the company's operating costs-fees for medical examinations and inspection reports, underwriting, printing costs, commissions, advertising, agency expenses, premium taxes, salaries, rent, etc. Such costs are important in determining dividends and premium rates.

Face Amount - The amount stated on the face of the policy that will be paid in case of death or at the maturity of the policy. It does not include additional amounts payable under accidental death or other special provisions, or acquired through the application of policy dividends.

Free Look Provision - A certain amount of time provided (usually between 10-30 days) to an insured in order to examine the insurance policy and if not satisfied, to return it to the company for a full refund.

Insurable Interest - For persons related by blood, a substantial interest established through love and affection, and for all other persons, a lawful and substantial economic interest in having the life of the insured continue. An insurable interest is required when purchasing life insurance on another person.

Lapse Rate - The rate at which life insurance policies terminate because of failure to pay the premiums. When policies are lapsed before enough premium payments are made to cover early policy expenses, the company must make up this loss from remaining policyholders. Therefore, the lapse rate will affect the cost of the policy.

Life Expectancy - The probability of an individual living to a certain age according to a particular mortality table. This is the beginning point in calculating the pure cost of life insurance and annuities and is reflected in the basic premium.

Misstatement of Age - The falsification of the applicant's birth date on the application for insurance. When discovered, the coverage will be adjusted to reflect the correct age according to the premium paid in.

Mortality - The incidence of death at each attained age; frequency of death.

Non-Forfeiture - One of the choices available if the policy owner discontinues premium payments on a policy with a cash value. Options available are to take the cash value in cash or to use it to purchase extended term insurance or reduced paid-up insurance.

Non-Participating - A life insurance policy in which the company does not distribute to policyowners any part of its surplus.

Participating Policy - A life insurance policy under which the company agrees to distribute to policyowners the part of its surplus that its Board of Directors determines is not needed at the end of the business year. The distribution serves to reduce the premium the policyowners had paid.

Policy - The printed legal document stating the terms of insurance contract that is issued to the policyowner by the company.

Policy Proceeds - The amount actually paid on a life insurance policy at death or when the policyowner receives payment at surrender or maturity.

Policyowner - The person who owns a life insurance policy. This is usually the insured person, but it may also be a relative of the insured, a partnership or a corporation.

Premium - The payment, or one of the periodic payments, a policyowner agrees to make for an insurance policy. Depending on the terms of the policy, the premium may be paid in one payment or a series of regular payments, e.g., annually, semi-annually, quarterly or monthly. The premium charged reflects the expectation of loss, expenses and profit contingencies.

Rating - The basis for an additional charge to the standard premium because the person insured is classified as a greater than normal risk usually resulting from impaired health or a hazardous occupation.

Reduced Paid-up Insurance - A form of insurance available as a non-forfeiture option. It provides for continuation of the original insurance plan, but for a reduced amount, without further premiums.

Reinstatement - Restoring a lapsed policy to its original premium paying status, upon payment by the policy owner, with interest, of all unpaid premiums and policy loans, and presentation of satisfactory evidence of insurability by the insured.

Rider - An endorsement to an insurance policy that modifies clauses and provisions of the policy, including or excluding coverage.

Risk Classification - The process by which a company decides how its premium rates for life insurance should differ according to the risk characteristics of individuals insured (e.g., age, occupation, sex, state of health) and then applies the resulting rules to individual applications.

Settlement Options - The several ways, other than immediate payment in cash, in which a policyholder or beneficiary may choose to have policy benefits paid. These options typically include the following:

• Interest Option - death benefit left on deposit at interest with the insurance company with earnings paid to the beneficiary annually.
• Fixed Amount Option - death benefit paid in a series of fixed amount installments until the proceeds and interest earned terminate.
• Fixed Period Option - death benefit left on deposit with the insurance company with the death benefit plus interest paid out in equal payments for the period of time selected.
• Life Income Option - death benefit plus interest paid through a life annuity. Income continues under a straight life income option for as long as the beneficiary lives or whether or not the beneficiary lives, under a life income with period certain option.

Standard Risk - The classification of a person applying for a life insurance policy who fits the physical, occupational and other standards on which the normal premium rates are based.

Substandard Risk - The classification of a person applying for a life insurance policy who does not meet the requirements set for the standard risk. An additional premium is charged on substandard risks to provide for the probability that such a person will have a shorter life span than a standard risk.

Supplementary Contract - An agreement between a life insurance company and a policyowner or beneficiary in which the company retains at least part of the cash sum payable under an insurance policy and makes payment in accordance with the settlement option chosen.

Underwriter - The person who reviews the application for insurance and decides if the applicant is acceptable and at what premium rate.

Underwriting - The process by which a life insurance company determines whether it can accept an application for life insurance, and if so, on what basis so that the proper premium is charged.