The major types of life insurance contracts are tern, whole life, and universal life. But innumerable combinations of these basic types are sold. Term insurance contracts, issued for specified periods of years, are the simplest. Protection under these contracts expires at the end of the stated period, with no cash value remaining whole life contracts, on the other hand, run for the whole of the insured’s life and gradually accumulate a cash value. The cash value, which is less than the face value of the policy, is paid to the policyholder when the contract matures or is surrendered. Universal life contracts, a relatively new form of coverage introduced in the United States in 1979, have become a major class of life insurance. They allow the owner to decide the timing and size of the premium and amount of death benefits of the policy. In this contract, the insurer makes a charge each month for general expenses and mortality costs and credits the amount of interest earned to the policy holder.
There are two general types of universal life contracts, type A and type B. in type A policies the death benefits is a set amount while in type B policies the death benefit is a set amount plus whatever cash value has been built up in the policy. Life insurance may also be classified, according to type of customer as ordinary, group, industrial, and credit. The ordinary insurance market includes customers of whole life, term, and universal life contracts and is made up primarily of individual purchasers of annual-premium insurance.
The group insurance market consists mainly of employers who arrange group contracts to cover their employees. The industrial insurance market consists of individual contracts sold in small amounts with premiums collected weekly or monthly at the policyholder’s home. Credit life insurance is sold to individual, usually as part of an installment purchase contracts, if the insured dies before the installment payments are completed, the seller is protected for the balance of the unpaid debt. Insurance may be issued with a premium that remains the same throughout the premium-paying period, or it may be issued with a premium that increases periodically according to the age of the insured. Practically all ordinary life insurance policies are issued on a level-premium basis, which makes it necessary to charge more then the true cost of the insurance in the earlier years of the contract in order to make up for much higher costs in the later years, the so-called overcharges in the earlier years are not really overcharges but are a necessary part of the total insurance plan, reflecting the fact that mortality rates increase with age.
The insured is not overpaying for protection, because of the claim on the cash value that accumulate in the early years. The policyholder may borrow on this value or may recapture it completely by lapsing the policy. The insured does not, however, have a claim on all the earnings that accrue to the insurance company from investing the funds of its policyholders. By combining term and whole life insurance, an insurer can provide many different kinds of policies.
Two examples of such “package” contracts are the family income policy and the mortgage protection policy. In each of these, a base policy, usually whole life insurance is combined with term insurance calculated so that the amount or protection declines as the policy runs its course. In the case of the mortgage protection contract, for example, the amount of the decreasing term insurance is designed roughly to approximate the amount of the mortgage on a property. As the mortgage is paid off, the amount of insurance declines correspondingly. At the end of the mortgage period the decreasing term insurance expires, leaving the base policy still in force. Similarly, in a family income policy, the decreasing term insurance is arranged to provide a given income to the beneficiary over a period of years roughly corresponding to the period during which the children are young and dependent. Some whole life policies permit the insured to limit the period during which premiums are to be paid. Common examples of these are 20-year life, 30-year life, and life paid up at age 65.
On these contracts, the insured pays a higher premium to compensate for the limited premium-paying period. At the end of the stated period, the policy is said to be” paid up”, but it remains effective until death or surrender. Term insurance is most appropriate when the need for protection runs for only a limited period; whole life insurance is most appropriate when the protection need is permanent. The universal life plan, which earns interest at a rate roughly equal to that earned by the insurer (approximately the rate available in long-term bonds and mortgages), may be used as a convenient vehicle by which to save money. The owner can vary the amount of death protection as the need for changes in the course of life. The policy offers flexibility and saves the owner commission expense by eliminating the need for dropping one policy and taking out another as protection requirements change.
The death proceeds or cash values of insurance may be settled in various ways. The insured may take the cash value and lapse the policy. A beneficiary may take a lump sum settlement of the face amount upon the death of the insured. The beneficiary may, instead, elect to receive the proceeds over a given number of years or in some fixed amount, such as $100 a month, for as long as the proceeds last. The money may be left with the insurer temporarily to draw interest. Or the proceeds may be used to purchase a life annuity, which in effect is another insurance policy guaranteeing regular payments for the life of the insured.
Life insurance policies contain various clauses that protect the rights of beneficiaries and the insured. Perhaps the best-known is the incontestable clause, which provides that if a policy has been in force for two years the insurer may not afterward refuse to pay the proceeds or cancel the contract for any reason except nonpayment of premiums. Thus, if the insured made a material misrepresentation when the policy was originally obtained and this misrepresentation is not discovered until after the contestable period, beneficiaries may still receive the value of the policy so long as the premiums are maintained.
Another protected clause is the suicide clause, which states that after a given period, usually two years, the insurer may not deny liability for subsequent suicide of the insured. If suicide occurs within the period, the insurer tenders to the beneficiary only the premiums that have been paid. If the age of the insured was misstated when the policy was taken out, the misstatement-of-age clause provides that the amount payable is the amount of insurance that would have been purchased for the premium had the correct age been stated. Many life insurance policies, Known as participating policies, return dividends to the insured. The dividends, which may amount to 20 percent of the premiums, may be accumulated in cash left with the insurer at interest, used to buy additional life insurance, used to reduce payments, or used to pay up the contract sooner than would otherwise have been possible.
The insured may, at a nominal charge, attach to the contract a waiver-of-premium rider under which premium payments will be waived in the event of total and permanent disability before the age of 60. Under the disability income rider, should the insured become totally and permanently disabled, a monthly income will be paid. Under the double indemnity rider, if death occurs through accident, the insurance payable is double the face amount.