Life Insurance - Available Coverage

It is often most effective to use policy contracts which have both of the following features:

1. guaranteed renewability; and
2. fully guaranteed renewal premiums.

In addition it is often best to assure that any life insurance coverage purchased will be in full force and effect for at least the expected duration of your life.

TERM INSURANCE:

A term insurance policy provides for a specified amount to be paid on the death of the insured. Premiums charged under most term insurance policies increase as the insured ages because, as time goes by, the probability of the insured dying during the term of the contract increases. The increasing premium is merely a function of the increased likelihood of the insurer having to pay the claim.

Some term insurance contracts may provide for an experience rated refund. This is basically a rebate of premiums already paid when the actual mortality experience of the pool of lives insured by the insurer is more favourable than that contemplated at the time premiums for the contract were determined.

Guaranteed renewable term and guaranteed convertible term are variations on the basic term insurance contract. Under a renewable contract, the insurer is obligated to renew the contract each year until the contract period has expired. Both the renewal of the contract and the renewal premium are guaranteed. This is contained as the only premium in the contract.

Convertible policies allow the policyholder to elect at any time, while the policy is in force, subject to a maximum conversion age, to convert the contract to a 'superior' contract of insurance then issued by the same insurer. (Superior contracts are essentially those with longer periods of indemnity, or with cash values, or with increased cash values, or with higher premiums.)

WHOLE LIFE (and Term to Age 100):

Whole Life and Term to age 100 insurance policies are more traditional forms of insurance coverage and is often referred to as "permanent insurance".

Under Term to age 100 contracts premiums remain constant over the term of the policy and may, in some cases be considered as "paid up", by the insurer, after a fixed number of years (often 20 years). Most "paid up" term to age 100 contracts will contain provisions for either a refund of premiums paid or a cash surrender value after the policy has been "paid up".

A whole life policy can be regarded as an escrow account established by an individual where the insurance company agrees to insure the difference between the capital accumulated under the contract and the ultimate amount specified by the policyholder in the event that the insured dies before the goal is reached. Premiums remain constant over the term of the policy and consists of an equity component and an insurance component. The insurance component pays the insurance company for assuming the risk under the policy which, at any point in time, is the difference between the escrow target amount and the amount of equity in the contract.

The balance of the premium is the reserve component and increases the equity value of the policy, thus reducing the financial exposure of the insurance company as it increases. As time passes, the probability of the insured dying increases which by itself would result in a higher premium. This is offset by the reduced financial exposure of the insurance company as the equity accumulates in the policy. This permits the insurer to charge a level premium throughout the premium payment period specified in the insurance contract.

The cash accumulations in the policy (savings plus interest) build up the cash surrender value of a policy and can be used to fund policy loans or surrenders and these funds may then be used to fund a living buy out.

UNIVERSAL LIFE:

A universal life insurance policy has no fixed premium and no fixed policy reserve. Subject to certain minimum requirements the policyholder is able to determine the amount and frequency of premium payments over the life of the contract. The policy may be for a specified face amount or for a specified amount of death benefit plus cash reserves. Any cash value will equal the net premium ( the amount paid less mortality costs, sales and administrative charges ) at the beginning of any policy year. Monthly increases in the cash value are credited for interest at current rates ( options from daily interest to five and even 10 year rates are now available ), and monthly deductions are made for mortality risk charges.

To maintain the policy in-force the owner must deposit enough premium to create reserves at least equal to the current month's risk charge. In order to avoid loss of status as an "exempt life insurance policy" (one which is exempt from annual or triennial reporting of interest for income tax purposes), a minimum amount of insurance must be maintained, and this, together with the cash value of the policy contract will be the amount paid on the death of the life insured. (some universal life contracts pay only the face amount at death, reducing the risk to the insurer by using the cash value of the contract as a partial 'self insurance'. Once again the nature of the contract should be investigated prior to purchase.

Universal life policies form the basis of most 'full cost recovery' insurance programmes. Under these programmes the insurer undertakes to reimburse for the full amount of premiums paid, and the stated death benefit at the death of the insured:

Universal life policies provide a measure of flexibility which allows a policyholder to vary the ratio of insurance and accumulation at almost any time to adjust to economic, lifestyle, and other changes occurring during the lifetime of the insured. The premiums may be altered to increase or decrease the percentage of premium dedicated to insurance protection. Premium payments may be missed where circumstances change, and cash withdrawals are possible where reserves are sufficient. Policies of this type may also be prepaid at any time, and after mortality costs have been set aside premiums may be permanently discontinued.

POINTS OF INTEREST:

1. In times of high inflation and high interest rates a more flexible plan with a variable return is recommended;
2. In times of low inflation and low interest rates a traditional whole life plan may produce a greater return and a lower net cost;
3. All proposals for universal life policies are not created equal. Each company prepares quotations with different interest rate assumptions (which are neither projections nor guarantees) and the merits of each may be distorted by the insurer's assumptions. When comparisons assume only those rates and charges which are fully guaranteed by the insurer a more accurate comparison will generally be the result;
4. Many renewable term contracts have two, different, renewal premiums. One rate which is guaranteed, and the second, which is normally called select or preferred which is not guaranteed. Fully guaranteed contracts provide greater certainty;
5. Convertible term plans from different insurers have different definitions of "convertible". Many companies have internal conversion rules which restrict conversion options. Some insurers allow conversion to one or two specific plans. In general, the larger the insurer the more liberal their conversion regulations.