This blog post will briefly summarize the four main kinds of life insurance, the pros and cons of each, in order to better help you get a grasp of what is best for your situation.
When it comes to life insurance, there are multiple options in the marketplace available to
consumers. For somebody new to life insurance, the options can be quite confusing. Every
product on the market differs slightly, but in general, there are four kinds of life insurance
available: Term, Fixed, Indexed and Variable. Let’s go over each of them together.
Term Life Insurance
Term life insurance is a policy that lasts for a specific period of time only. It is unique in that it is the only life insurance policy that terminates after a specific time. Policies lasting between 10 to 30 years are the most common, although there are select insurance companies that offer either 5 or 40 year policies.
Example: John is 30, married, and has two young children. He makes $100,000/year. He wants to protect his family in case something happens to him, so he gets a 20-year term policy with $1,000,000 Death Benefit. John will then pay a premium to keep his policy in force. Once the 20 years have passed, John no longer has a policy in place. If he would like to get further coverage, he would need to apply for another policy.
Pros of Term: Affordability. Term is very affordable for most healthy individuals well into their
60s. A 10-year $100,000 policy for a 30 y/o male can be as cheap as $7/month.
Cons of Term: If you outlive a term policy, your premium payments are sunk costs. Term pricing also increases significantly with age. Term is usually not available at all to individuals above 80 y/o.
Also, if you need additional coverage once your term is up, you will need to go through medical and financial underwriting again. If John in the above example was healthy as a 30 year old, but by the time he turned 50 he had some medical complications, then his premiums would increase significantly. Worse yet, he could be deemed uninsurable.
Unless the unlikely happens, rarely is a Death Benefit passed on to beneficiaries.
Fixed Life Insurance
Fixed life insurance is a policy that lasts for life. These policies have an additional component called Cash Value. Cash Value is an accumulated dollar value within the policy that the policyholder has access to. This can be accessed via a loan, withdrawal, or a total surrender. There are two types of fixed life insurance: Whole Life and Universal Life. Both grow in a fixed manner, i.e., with a fixed interest rate. However, Whole Life insurance policies offer guarantees. When you buy a Whole Life policy, you know exactly what premium you need to pay and for how long, in order to guarantee that the desired Death Benefit gets passed on to the beneficiaries. On the other hand, Universal Life offers a flexible premium where the owner can increase, decrease, or stop premium payments as desired. The fixed rate in Universal Life policies may and probably will change, according to the interest rate environment. This may cause your premium required to keep the policy in force to change, depending on how you design the policy.
Pros of Fixed: Guarantees. Especially Whole Life. You know that a Death Benefit will be paid
to the beneficiary regardless.
Cash Value growth every year due to fixed returns.
Cons of Fixed: Limited growth potential and inflexible premium in the case of Whole Life.
Indexed Life Insurance
Indexed life insurance policies also last for life and have the Cash Value component. Cash Value in Indexed policies accumulate through an indexed method that is tied to an external index, such as the S&P 500. Typically, there is a “floor” and “cap” in indexed policies, where if the external index loses value, then the policy is protected from losses by said floor. If the external index shoots up aggressively, then the value only increases up to the cap.
For Example: If the floor of an indexed policy is 0% and the cap is 12%, then if the S&P 500 loses 10% on an annual basis, the policy is protected from the 10% loss and instead returns 0% (the floor). On the flip side, if the S&P 500 increases by 20%, the policy only returns up to the cap (12% in this case).
Pros of Indexed: Flexible premium.
Opportunity for greater returns than Fixed.
Market loss protection.
Index reset feature allows you to ride the market back up following market downturns.
Cons of Indexed: No guarantees. Extended period of low returns can result in additional
premiums required to keep policy in force.
Variable Life Insurance
Variable life insurance policies also last for life and have the cash value component. Cash Value in Variable policies are directly invested into the market through different funds. Different Variable products offer different investment choices. The potential for gain is by far the highest out of all life insurance policies with the Cash Value feature, but it is also the only policy where market losses are possible.
Pros of Variable: Potential for great Cash Value growth.
Cons of Variable: Potential for great Cash Value losses.
Summary
All four kinds of life insurance serve different needs for different clients. While Term might be
ideal for one candidate, Variable may be recommended for another candidate. Be sure to
communicate your goals with your adviser since life insurance can be more complicated than what first meets the eye.
Want to know what kind of life insurance policy best suits you? Contact us today!
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