The primary purpose of life insurance is to provide financial security for your family. Life insurance provides cash that can help to ensure that, when you die, your family will have the financial resources necessary to protect their home, assets, and to provide additional income.
In choosing a life insurance policy, the division recommends that you consider the following:
- the type of insurance product that best suits your needs
- the length of time you need insurance
- how much insurance you need, considering current and future debt, income, and expense requirements such as burial, hospital, taxes, college tuition, and any others
- what you can afford to pay
After you have purchased a life insurance policy, the division recommends that you:
- periodically review your policies and the selection of your beneficiaries, keeping in mind that your financial situation and family needs change
- be aware that revising your will does not revise your life insurance policy and death benefits will be distributed according to the provisions in your insurance policy and not according to the provisions in your will
- request any change of beneficiary in writing and keep a copy of the request until the requested change has been made
Types of Life Insurance Policies
Described below are some of the most common types of life insurance policies. It is important to keep in mind that the life insurance policies offered by an insurer frequently change. Policy terms can vary significantly from one insurer to the next.
Term life insurance pays a predetermined death benefit if the insured dies during the period of time the policy is in effect. The term can range from a single year to a period ending at a specific age, such as 65 or 70. If the insured does not die during the term of the policy, the policy expires with no payment. The amount of death benefit can be a level, decreasing or increasing amount to match your insurance needs. For example, a decreasing term policy may provide a death benefit that matches the decrease in your mortgage loan balance.
Term life insurance is generally less expensive than other forms of life insurance, since a benefit is provided only upon death and only for a limited period of time. Also, unlike many other life insurance policies, no penalties are assessed if you decide to terminate the policy before the end of the term. Since term life policies provide no accumulation of cash values or dividends, they can generally be compared to one another on the basis of their premium.
Term insurance allows a higher death benefit to be purchased for less money than other types of life insurance policies. This may be particularly important for young families with limited income and a higher need for insurance. Term insurance is also useful for protecting the family members in the event of the death of a wage earner during periods of high debt, such as during the terms of a mortgage or car loan.
You may want to consider the following when shopping for a term life insurance policy:
- Most shorter term policies offer an option to continue or renew the policy for an additional period of time. One advantage of this option is that the insured does not have to show evidence of insurability in order to maintain the policy for additional periods of time. The premium charged each renewal will be based on the insured’s age at the time of the renewal.
- Most term policies also offer an option to exchange or convert the term policy for a cash value or whole life insurance policy without providing evidence of insurability. This option provides flexibility to those who may have preferred a policy with cash value accumulation, but could not afford it at the time of purchase. This option becomes valuable if an insured develops a medical condition during the policy term which renders them uninsurable or insurable but only at a higher premium rate.
- Credit life insurance is a type of term insurance that pays the balance due on a loan or debt if you die. In Alaska, the death benefit on a credit life insurance policy is required to match the remaining balance of the loan. Credit insurance is usually sold through a bank, store, or auto dealer at the time of a loan transaction. If you purchase credit life insurance and decide to pay off your debt early, the insurer is required to give you a refund of unearned premium. Note that a standard term life policy can be used for the same purpose as a credit life policy, but often at a much lower cost.
Permanent life insurance provides insurance protection for the entire life of the insured, unlike term policies that expire after a predetermined period of time. As long as you make the premium payments, the policy will pay a death benefit. Most permanent life insurance policies build cash value which can:
- provide a lump sum of money, if you cancel your policy.
- pay premiums, if you need to stop paying premiums on the policy.
- be used as collateral for a loan from the insurance company.
Cash values develop from the premiums that you pay for the insurance policy. The premiums you pay are generally higher than the amount needed to cover the risk of your death and the insurance company’s expenses for acquiring and maintaining your policy. The amount of this excess premium is accumulated with interest. Generally, interest earnings are based on your insurance company’s investment experience. Most policies will have little or no cash value in the first few years due to the large expenses involved in acquiring and setting up your policy.
Permanent life insurance policies are intended to be kept for a long period of time. Premiums for permanent life insurance policies are higher than term insurance policies in the early years of the policy. Therefore, if you do not intend to keep the policy for a long period (at least 15 years), term insurance may be a better choice.
Permanent life insurance takes on many different forms with a variety of features. Following is a brief description of the most common forms.
- Whole life insurance policies have fixed level premiums and level death benefits for the life of the insured. This type of policy generally provides no flexibility for adjusting the premiums or the amount of death benefit. If premiums are not paid, the policy terminates. Cash values are predetermined and will not vary over the life of the policy based the insurance company’s experience. Whole life is often referred to as ordinary life or straight life.
- Participating whole life insurance policies have the fixed level premiums, level death benefit, and predetermined cash values of a whole life policy. However, participating whole life provides a return of some portion of the premium, called a dividend, if the insurance company’s investment, mortality or expense experience is better than expected. These dividends provide flexibility to the policy, since they can be used for a number of purposes. Dividends could be used to purchase additional insurance, pay premiums, or just accumulate with interest. Note that there is no guarantee that you will actually receive a dividend.
- Variable life insurance policies have a fixed level premium with a death benefit that varies based on the experience of a selected set of investments. You may specify which investments your cash value is to be invested in. Most insurance companies offer several investment options, including money market funds, common stock funds, and bond funds. A higher rate of return on the selected fund will cause the cash value and death benefit to increase, while a low or negative rate will cause the cash value and death benefit to decrease. These policies provide a guaranteed minimum death benefit, but no guarantee of cash value. Therefore, variable life is more risky than other permanent life insurance policies because it is an investment-type product. Variable life policies are subject to federal securities laws.
Universal life or flexible premium life insurance policies allow you to pay premiums at any time, in any amount, subject to certain maximums and minimums. These policies also allow you to adjust the death benefit. With a universal life policy you will be able to actually see the interaction of premiums, death benefit, interest credits, mortality charges, expenses, and cash values. A presentation will generally be given to you at the time you purchase the policy and at least annually showing how the cash values and death benefits develop. In general, a universal life policy will develop cash values as follows:
Cash value = cash value from prior period + premiums paid – expense charges – mortality charges + interest
In a universal life policy, the insurance company generally guarantees that it will not charge you more than the stated maximum mortality charges. Most insurance companies charge less than the stated maximum mortality charges. Universal life policies provide a guarantee that not less than a stated minimum interest rate will be credited. These rates are low and insurance companies generally credit a higher rate based on their investment experience or some-times based on the performance of a stock market index such as the S&P 500. It is important to remember that in most cases the higher interest rate is not guaranteed to be credited in the future.
As long as the cash value is large enough to cover the mortality charges and expenses, no premium payment is required. However, you may still make premium payments which will be added to the cash value. Federal law includes some restrictions on how high your cash value may be in relation to the death benefit before your policy will become subject to certain federal taxes. Your insurance company will generally verify that your cash value is within the federal standards and if it is not they will adjust the death benefit automatically.
Under a universal life policy you are able to choose between two primary death benefit options. One option is a level death benefit and the other is a death benefit that increases with the increase in cash value. Regardless of the death benefit chosen, you will be allowed to adjust the death benefit at a later date. If you decide you want to increase the death benefit at a later date, you will likely be required to provide evidence of insurability.
If you decide to cancel (referred to as surrendering) your universal life insurance policy, your cash value may be reduced by surrender charges. Surrender charges are specified in the insurance policy and will vary significantly from one policy to the next depending on what expense charges were already assessed on your policy. Surrender charges help the insurance company offset some of the expenses of acquiring and maintaining your policy. You will generally pay for the flexibility provided by universal life policies. In order to assess the actual cost of these policies, the expense charges including surrender charges, mortality charges, and interest crediting rates should be reviewed. One of the most important considerations will be what the insurance company’s historical experience has been. Do not just compare the interest crediting rates since mortality and expense charges can easily offset any additional interest credits.
- Universal Variable Life is a variable life policy but with the flexible premium structure of a universal life policy. Unlike a universal life policy that provides a guaranteed death benefit if premiums are paid, a universal variable life insurance policy pays a death benefit that varies with the experience on the selected fund. Universal variable life may be appropriate, if you are looking for a life insurance policy that treats cash values more as an investment than a savings account.