Types Of Permanent Life Insurance Policies

With any type of permanent or whole life insurance policy, there are three components which insurance companies can vary in order to compete with each other and to get you to sign up with them.

These components are mortality costs, expense costs and a cash value reserve. Each of these factors will affect the cost of your policy, so it is worth being aware of them if you are planning on taking out a permanent life insurance policy one day.

Below we will take a quick look at each of these three factors, and then afterwards, we will review the different types of policies that are available.

Policy Components

The first component is mortality costs. This cost is based on your current age and the likelihood of you dying within a certain period of time. The older you are, the higher your mortality costs will be. In addition to your age, mortality costs can also be affected by your current level of health, and in some instances, your family history of disease may also be taken into consideration.

Next, there is policy expense costs. These costs are basically administration costs and include things such as rent, staff wages and agent commissions. Policy expense costs can vary depending on the insurer that you take out your policy with. This is why you are likely to find that different companies are able to offer you different deals at the “lowest price they can offer”.

Finally, there is a cash value reserve. This is money that is saved for you by your life insurer in an account which you can later draw upon once you retire or withdraw completely should you choose to end your policy agreement early.

Because of this cash value reserve, you will find that whole life insurance policies tend to be more expensive at the very start of the policy compared to term life insurance policies. It is also worth noting that your saving are tax deferred, so you won’t have to pay any tax until you withdraw your money similar to how a 401k plan operates.

In general, you will find that insurance companies vary the guarantee that they give you on mortality and expense costs. They tell you up front how much they are going to be, and how much they will change over time if they are subject to change. You will also find that insurance companies will give you a guarantee on the yield that you will receive from your cash value reserve.

These three factors which have just been listed can be used to assess different policies and to find the best policy for your needs at the lowest price. Be sure to take them into consideration when shopping for life insurance or when discussing a policy with your agent or broker.

Policy Types

There are three main types of permanent life insurance policies that you can choose from:

• Whole life (whole life coverage)

• Universal life (universal life coverage)

• Variable life (variable life coverage)

Each of these policies varies in different ways, which makes them uniquely suited to particular needs and requirements. Lets have a look at each of these in turn.

Whole Life Insurance

Whole life insurance is generally seen as a low risk type of policy. This is because your monthly costs stay the same regardless of external factors and influences which would normally raise the cost of the other policies.

Having your monthly costs stay the same can either work for you or against you. For example, if a new disease becomes a serious health threat and people begin to die from it, then the mortality costs for universal or variable life policies will rise. But if you have a whole life policy, then your mortality costs will not change.

Conversely, if new medical advances cause a reduction in the number of deaths from a disease, or prolong human life expectancy, then mortality costs will eventually decrease. But if you have whole life insurance, then your costs will stay the same.

The same also applies to expense costs. If for example, your life insurance company’s operating expenses rise, then this increase in cost will not be reflected in your policy because your expense costs stay the same throughout the duration of your policy. Likewise, if your insurer’s expense costs fall due to more efficient operating procedures, then you will not see any reduction in the cost to maintain your policy.

Finally, a whole life insurance policy pays out a guaranteed rate of interest on your cash value reserve. This is usually set at somewhere between 2-4%. Depending on the current economic situation this may seem high, reasonable or very low. But you are guaranteed a set amount regardless of what happens, which subsequently makes any financial planning or forecasts that you do much easier and more accurate because you will know the rate of return that you can expect on your investment.

Advantages

Whole life insurance tends to be a very good option for those who want to minimize the amount of financial risk that they are exposed to.

With a whole life coverage policy you will benefit from premiums that remain at the same level throughout the duration of your policy, a cash value reserve that you can draw upon anytime you like and one that will increase in value at a set rate. In addition, like all permanent policies, your dependents are guaranteed to receive a death benefit regardless of when you die and your premium payments will build equity in your policy over time.

Some people describe whole life coverage policies as a “set it and forget it” type of insurance, as providing you continue to pay your premiums, you can very accurately predict the costs and benefits associated with such a policy both now and in the future. This helps to eliminate any unwanted surprises and so makes long-term financial planning or budgeting very easy to do.

Disadvantages

A major downside to having a whole life coverage policy is that due to the risk reduction which it offers, it is extremely inflexible once you have signed up for your policy agreement. This means that if you want to change something in your policy you may not be able to do so, or may have to pay extra to do it.

Furthermore, although it can be very beneficial to know what interest rate your cash value savings will accumulate at, this rate might not seem very high if the economy is doing well, in which case, you would have been better off putting that money somewhere else where you could have earned a higher rate of interest.

Overall, a whole life policy is most suited for those who wish to minimize risk and like to know exactly what they are going to be paying and exactly what they are getting out of their policy. If you are willing to take on a bit of extra risk for greater potential returns however, then you may want to consider some of the other types of permanent life insurance that we will be talking about next.

Universal Life Insurance

One of the distinguishing features of universal life insurance policies is that unlike whole life insurance policies, they offer a flexible rate of return on your cash value reserve and a flexible payment structure. This can prove to be advantageous and disadvantageous depending on what is happening in society, with the economy and with the insurance company itself.

If for example, your insurer relocates to a new area and hires new staff, its expense costs are likely to rise which will then be passed on to you. If medical advances cause a reduction in diseases and prolong life, your mortality costs will fall. But if something happens to increase death rates in the general population, then your mortality costs will rise. Likewise, if interest rates are high then you will get a higher rate of return on your cash value reserve. But if they are low, then you will get a lower rate of return.

However, even though there is some variability in these policy components, you will find that most life insurers will set a limit on how much your mortality costs can increase, and they also tend to guarantee a minimum interest rate that they will pay on your cash reserve. This tends to be set around the same rate as that found with a whole life policies, somewhere between 2-4%.

Advantages

Because universal life insurance policies are flexible, you have much greater freedom should you ever wish to change the policy structure at a later date. For example, if you want to raise your coverage level, then you could do so by lowering death benefits whilst still keeping the same policy.

Alternatively, you could raise death benefits without having to buy additional policies if you are able to prove that you are in good health. If you wanted to do any of this with a whole life coverage plan, then you would need to take out an additional policy.

Another major advantage of universal life is the ability to vary your premium payments. You could for example, put a large deposit at any time into your cash value reserve, lower the amount that you pay on your premiums or even suspend your premiums temporarily if you are struggling to make your payments.

Summary

Overall, universal life insurance provides you with much greater flexibility over how you manage your policy. This can be advantageous because it allows you to tailor a policy to your specific needs and requirements, but at the same time, this flexibility exposes you to much greater risk because none of your costs are guaranteed.

You may for example, find that your insurance premiums are low when interest rates are high, but that they rise substantially when interest rates are low. To protect yourself against such rises, you can purchase a policy with a premium payment that is based on the minimum guaranteed interest rate, as this will safeguard you from having to pay increased premium costs later on.

Variable Life Insurance

Variable life insurance is very similar to whole life insurance. The main difference is that it allows you to invest your cash value reserve into an investment vehicle such as in the stock market, bond market, equity funds or money market funds.

This provides the opportunity to make much greater returns on your cash value reserve than you would with a standard life insurance policy, but at the same time, it exposes you to the risks associated with those types of investments.

For example, a poor investment in the stock market could result in very low returns or even negative returns. So unless you are an experienced investor, or know someone who is, then this type of policy could be a very risky option to go for.

If your investments do poorly and your cash value reserve falls below a designated level, then you may be required by your insurer to pay money into your cash reserve to top it up and/or to pay increased premiums.

Policy Summaries

The type of life insurance policy that you take out really depends on how much risk vs. reward you are willing to accept. Below you will find a brief summary highlighting the main points of each of the different forms of life insurance that can be taken out.

Whole Life

• Lowest risk policy available.

• Fixed premiums.

• Fixed interest rate on cash value reserve.

• Fixed costs which can protect you from increased costs over time, or stop you from benefiting from lower costs.

• Good for planning your financial future.

• Very inflexible once set in motion.

Universal Life

• Exposes you to greater risk than whole life.

• Easy to modify/change once set in motion.

• Payment structure can be changed.

• Variable cash value interest rates.

• Can result in lower or greater costs over time.

• Makes you vulnerable to price increases.

• A good plan to have if your income slowly changes over time.

Variable

• Exposes you to more risk than universal.

• Cash value reserve can be invested.

• Ability to make high returns by investing cash value reserve.

• Good for investors or those with investment experience.

• Potential for poor returns due to high risk investment options.