Many people are torn between the benefits offered by term life insurance and those offered by whole life insurance. They appreciate the affordability of term life. They also like its flexibility. Term life policies can be canceled with no significant penalties, and new ones started at for different death benefits and different premium amounts.
On the other hand, whole life offers something term life does not: coverage until death. The policy will not expire after a certain number of years, as it will with term life, so the consumer never has to reapply for coverage. As a result, coverage cannot be denied later in life due to age or poor health. The premiums will not rise, either. Because of these guarantees, however, whole life is not flexible. The death benefit and premium amount is fixed at the time the contract is signed.
The solution for many people is universal life insurance. Universal life has been described as a hybrid between term life and whole life, but that is a misnomer. Universal life insurance is a type of whole life insurance, period. It offers greater flexibility and a lower cost than traditional whole life, but it shares whole life’s chief characteristics: permanent coverage, premiums that do not change based on age or health, and the accumulation of cash value.
The chief distinction between term life and whole life is the duration of coverage. With a standard term life policy, the coverage is limited to a specific time frame-the term. At some point, either the policyholder expires or the coverage does. If the policyholder dies during the term, the death benefit is paid to the beneficiary. If the policyholder outlives the term, the coverage will cease on the policy end date. Some term life is renewable without a physical examination, but premiums increase based on the age of the insured at the time of renewal. With whole life, the coverage continues indefinitely, until the policyholder dies. Universal life insurance shares this characteristic with whole life insurance. Both are forms of permanent life insurance.
A person can use a succession of term life insurance policies to gain coverage into his or her eighties or nineties. Each time a person renews a term life policy or applies for a new one, however, the cost of insurance goes up, due to the increased death rates among older people. For example, a 30-year-old man get a twenty-year, $500,000 term life insurance policy for as little as $245 a year, assuming he is in excellent health, does not smoke, does not partake of extreme sports or hobbies, and does not travel to dangerous areas of the world. By contrast, a 60-year-old man in similar health and meeting the other criteria still must pay at least $2,525 a year for the same twenty-year, $500,000 policy. A 70-year-old will pay $10,680 a year for the same policy. If a person develops any sort of health problems during the term, the term life insurance premiums stay the same. If the person does not have “renewable” term life insurance, then when the term expires and the person applies for new term life coverage, the premiums increase dramatically. If the person has developed or experienced a serious health problem, such as cancer or a heart attack, he or she may not be insurable at all.
The cost of permanent life insurance does not increase with the passage of time or changes in health. Coverage cannot be terminated, no matter what health problems the insured encounters. The guarantee of insurability accounts for the higher cost of permanent life insurance.
Another main difference between term life and whole life is that whole life offers savings features, while term life does not. Term life, is “pure” insurance. It insures against death, and that is all. Whole life also insures against death, but it also provides a mechanism for the accumulation of cash value, or savings. Universal life also offers savings features.
Early in the life of a whole life or universal life insurance policy, the cost of insuring against premature death is much less than the premium amount. The insurance company deposits the excess amount–less the company’s profits and fees–into a tax-deferred savings account. This amount is known as “cash value.” These funds are invested by the insurance company. Proceeds from the investments are credited to the account, increasing the cash value. These funds are available to the policyholder in the form of a loan or as a withdrawal. If the policyholder cancels the policy, he or she receives the cash value as the policy “surrender amount.”
Universal life differs from whole life in the amount of flexibility the policyholder has to make adjustments in the policy. With whole life, the death benefit, premiums, and cash value accumulation is fixed at the outset. With universal life, the policyholder has the option to increase or decrease the premium amount (within limits) and increase or decrease the death benefit. For example, the policyholder can decrease the premiums, should the beginning price become unaffordable. If the policy holder wishes to build up more cash value or increase the death benefit, he or she can pay a higher premium.
With whole life, the cash value accumulation rate is guaranteed. With universal life, the cash value accumulation is determined by the performance of the insurance company’s investments. If the investments perform well, the cash value increases more quickly than it would with a whole life policy. If the investments perform poorly, the cash value will grow more slowly or not at all. Because of the added risks of whole life insurance, it costs less than traditional whole life insurance does.
Many consumers who want the guaranteed insurability of whole life but are afraid of being locked into fixed premiums or death benefits find universal life to be an ideal form of permanent life insurance.