Well-crafted life insurance policies have long been a mainstay of the United States’ insurance landscape. Initially sold by door-to-door salespeople, life insurance products are now available through full-service agencies such as Insurance Office of America (or IOA). Policyholders of varied ages can purchase individual life insurance policies. Employers often provide basic group coverage as part of the company’s benefits package. IOA Co-Founder John Ritenour explains how life insurance works and outlines commonly issued policies and their respective provisions.
How Life Insurance Works
A life insurance policy is an agreement between the policyholder (the insured) and his or her life insurance company. The insured makes regular premium payments to keep the policy in force. When the insured dies, the insurance company pays the policy beneficiary (or beneficiaries) a tax-free lump sum payment (the death benefit).
Some life insurance policies contain provisions that allow the insured to receive additional benefits while he or she is alive. To illustrate, the insured can access an applicable policy’s cash value. The funds can be used as a down payment on a house. However, this action reduces the policy’s death benefit and cash surrender value.
Finally, an insured with significant health care expenses can accelerate the issuance of the death benefit. These funds can be used to pay the health care costs.
Uses of Life Insurance Proceeds
People purchase life insurance for several different reasons. In addition to covering the insured’s final expenses, the policy proceeds can be used for other purposes.
Payment of Insured’s Final Expenses
When the insured’s family receives the life insurance proceeds, he or she can use the funds to pay the insured’s final expenses. In addition to funeral costs, other remaining debts might include medical bills, estate taxes, and student loans, among others.
Living Expenses for Insured’s Family
The life insurance proceeds can replace the insured’s income for a certain period of time, depending on the coverage limit. If children are involved, the insured can choose their guardian, if necessary. The proceeds can then be dedicated toward the children’s basic living costs, medical expenses, or college tuition.
Proceeds Allocation to Varied Parties
When completing the life insurance policy application, the insured will designate one or more policy beneficiaries. Although most people choose their spouse and/or children, other people may also receive part of the policy proceeds. Alternatively, the insured might donate some of the proceeds to charity or contribute toward a child’s college education.
Wealth Accumulation Vehicles
Some life insurance policies can be used as investment vehicles. In addition to building wealth, applicable funds can be transferred to another person. Finally, the life insurance policy may also provide the beneficiary with specific tax advantages.
John Ritenour on Types of Life Insurance Products
Life insurance companies offer two primary types of products. Insurance expert John Ritenour notes that an experienced insurance agent can determine each client’s needs and recommend the policy that provides the best (and most affordable) fit.
Term Life Insurance
A term life insurance policy contains a death benefit for a specific period, usually between 5 and 20 years. It’s fairly common to see coverage amounts in excess of $1,000,000. If the insured does not die within the specified interval, the policy expires without the beneficiary receiving a payout.
A level premium term insurance policy guarantees the same premium for the policy’s entire term. An annual renewable term insurance policy covers one year at a time. This policy generally renews at a higher rate every year.
Certain term policies are convertible to a permanent policy at a specified time. If the insured’s coverage needs to change, this could be a good option.
Permanent Life Insurance
A permanent life insurance policy stays in effect for most (or all) of the insured’s life. However, the insured must keep the premiums current for the coverage to remain active. It’s also important to note that policy guarantees can vary.
Most permanent life insurance policies also contain a cash value feature. This enables the insured to withdraw funds from the accumulated value or borrow against the policy while they are still alive.
Whole Life Insurance
A whole life insurance policy, according to John Ritenour, remains in effect until the insured dies, provided they keep the premiums current. The premiums should not change, and the death benefit will remain constant.
In addition, the insured receives a guaranteed rate of return on their policy’s cash value. On the downside, a whole life policy generally costs more than a term life or another permanent policy.
Universal Life Insurance
A universal life insurance policy is another type of permanent life insurance. Here, the insured retains coverage throughout his or her life if he or she keeps premiums current and complies with other coverage requirements. When the insured dies, his or her beneficiaries receive the policy’s death benefit.
With a universal life insurance policy, the insured can accumulate a cash value that earns interest. He or she can withdraw available funds or take out a loan against the cash value. Finally, universal life policies offer an adjustable death benefit. The insured may also receive some premium flexibility.
Variable and Variable Universal Life Insurance
These two universal life policies contain a cash value linked to investment accounts such as mutual funds and bonds. Variable life policy premiums are generally fixed. In addition, a variable life policy has a guaranteed death benefit that is not affected by the investments’ performance.
However, variable universal life premiums are adjustable. In addition, the policy’s death benefit is not guaranteed. The insured may withdraw some of the cash value funds or borrow against them.
Both universal life policies offer opportunities for significant cash value gains from well-performing investments. However, the insured must actively manage his or her policy to maximize cash value. John Ritenour recommends working with an insurance professional with experience in managing complex policies.
Specialized Life Insurance Products
Five additional life insurance products address specialized market needs. Note that some of these policies pay benefits to other entities and not the insured’s family.
Group Life Insurance
An employer typically offers these policies as part of the company’s benefits. Rather than pricing each policy individually, premiums are reflective of the entire group of employees.
The employer will likely offer basic life insurance coverage at no charge. If the employee wants additional coverage, they can purchase supplemental life insurance.
Credit Life Insurance
When a borrower takes out a loan, the bank may offer them a credit life insurance policy. If the borrower dies, the insurance proceeds are sent to the lender, ensuring that the loan is paid. John Ritenour reminds readers that the borrower’s family does not receive any part of the proceeds.
Mortgage Life Insurance
On or before a home closing, the homeowner’s bank will offer them mortgage life insurance that covers the current mortgage balance. If the homeowner (or mortgagee) dies, the lender receives the policy proceeds rather than the homeowner’s family.
Joint Life Insurance
This two-person policy insures two people (usually spouses) in a single policy. According to long-time IOA leader John Ritenour, a “first to die” policy pays the proceeds following the first policyholder’s death. Then, the policy expires, and there is no coverage for the second person. These policies are rarely issued due to low demand.
In contrast, a “second to die” policy pays the proceeds after the death of both policyholders. These policies are designed to pay estate taxes or expenses for a dependent’s care (such as a child).
Accidental Death and Dismemberment Insurance
This policy offers coverage for the insured’s death in an accident (for example, a car crash). If the insured does not die, but he or she loses limbs and/or sight or hearing, the policy also pays out for those occurrences.
The Link Between Policy Types and Underwriting
After an applicant submits a life insurance application, the document goes to the insurer’s underwriting department. During the underwriting process, trained actuarial professionals calculate the risks of insuring each applicant.
Once those risks have been established, the underwriter determines the amount the applicant (who becomes the insured) will pay for the coverage. Each policy will receive one of three types of underwriting.
Fully Underwritten Life Insurance
This application process generally requires a medical exam and detailed health questions. In addition, the application inquires about the applicant’s family health history.
The applicant must also provide information about his or her hobbies and upcoming travel plans. Collectively, this information helps the insurer to determine the applicant’s risk and life expectancy.
Then, the insurance company can more accurately price the insurance coverage. For a healthy applicant, a fully underwritten life insurance policy will usually be the most affordable option.
Simplified Issue Life Insurance
- This fast-turnaround policy uses proprietary algorithms to streamline the application process. The online application does not require a medical exam. However, the applicant must answer several health questions, and they may be declined based on their answers.
Guaranteed Issue Life Insurance
These policies have several notable pros and cons. On the positive side, the applicant does not need a medical exam, and the application does not include health questions. Therefore, applicants within the eligible age bracket (generally 40 to 85) cannot be denied coverage.
However, these policies typically offer low coverage amounts. The policies also feature a graded death benefit. If the insured dies within the first few years of coverage, their beneficiary only receives a portion of the policy proceeds. Finally, the policy’s premiums are high to compensate the insurance company for its increased risk.
If other insurers have declined an applicant due to health reasons, the person may opt for a guaranteed issue life insurance policy. The person may purchase the policy to cover their final expenses.
Putting Life Insurance Coverage in Place
Choosing the right life insurance coverage is a two-part process. First, the insured must determine how much coverage they will need. Next, they should work with a knowledgeable insurance agent to obtain the right coverage for an affordable cost.
Finding the Right Coverage Amount
Selecting the right coverage amount depends on the purpose of the coverage. As a starting point, assume the insured wants the policy proceeds to pay their final expenses.
In addition, the policy should replace the insured’s income and provide his or her family with enough money for a comfortable life. To arrive at that amount, the insured should take the family’s lifestyle, living expenses, and current debts into account. The insured should also consider his or her spouse’s financial needs and projected income.
Children’s college expenses (if applicable) also figure into the equation. If a new guardian will raise the children, those estimated expenses should also be factored in. Finally, the insured should list their savings and/or investment resources when estimating their life insurance requirements.
Evolving Financial Situations
Know that each family’s financial situation can change over the years. Significant life events, such as the birth of a child or the need to provide care for an aging parent, can result in a need for increased life insurance. Per John Ritenour’s recommendation, insureds should regularly review their life insurance policies with their insurance agent. Knowledgeable Insurance Office of America agents are well prepared to meet the life insurance needs of applicants with diverse life situations and coverage requirements.