Life Insurance Today
Insurance - Past to Present
History shows that as early as 2500 B.C., Chinese combined oral agreements and practical work procedures to transfer risk. Later, Phoenicians and Babylonians used written agreements to provide insurance-type benefits. Yet, not until the 1600s did Pascal lay a cornerstone of modern-day insurance with his theory of probability and law of large numbers. Around this time, a second industry cornerstone was lain, too.
The historically renowned firm, Lloyd's of London, traces its origins to a coffee house in London, circa 1688. Merchants and others, with commercial risks to layoff, sought at Lloyd's information on shipping schedules and matters of news across and upon the high seas.
Based partly on such information, brokers would offer specific risks to individual underwriters acting in groups in exchange for premium dollars. Some of the more prominent underwriters formed the Society of Lloyd's, the precursor to the firm, Lloyd's of London. These and future Lloyd's underwriters became known as Names.
Since then, it has been said that insurance brokers and company agents earn their living by introducing superstitious clients to optimistic underwriters.
RightNow, life insurance provides cash, usually income tax free, and often for pennies on the dollar. More importantly, the cash life insurance provides arrives when money at work must replace a man or woman at work.
There are two categories of life insurance coverage, temporary and permanent. Many policy types exist under each. We'll look at the predominant ones after we consider something more important.
The first thing to understand about any policy, regardless of type, is what, if anything, is guaranteed. Is the death benefit guaranteed? Is the premium guaranteed? Is there a guaranteed minimum rate of return on paid-in premium, etc.? Another way to say the same thing is what policy features are subject to change, and what could cause that change?
The guarantees are so important because insurance is merely a promise to pay a claim upon a future contingency in exchange for premium. Though the future is unknown, history has clearly shown there are always periods of calm in life. Then crisis arises. It is during periods of crisis that policies with more guarantees do better than those with less guarantees.
Temporary Insurance versus Permanent Insurance
Temporary insurance, most commonly known as, term insurance, has been likened to renting, where you forever make payments but where you don't ever receive equity. Further, as time passes, the cost of both life insurance and rent continually rise. This can reach crisis proportions for some people late in life. This is when the monthly payments for each have risen to a height where they are too high to hang on comfortably; but, because of their need, they can't let go.
The second category of life insurance coverage, permanent insurance, has been likened to buying a home. You make monthly payments which are, initially, more expensive than renting and are less expensive later; and where, like a home, you build equity.
Certainly, both types of coverage are useful and one type should not be purchased where the other is more appropriate. First and foremost, life insurance is the death benefit. Where a designated amount of death benefit is needed to do a job, and the only way the required volume can be paid for is with less expensive term insurance, it is unwise to buy the more expensive permanent insurance.
Yet, when permanent insurance is appropriate and affordable, other attributes of permanent insurance which distinguishes it as good property (besides its equity build up) are . . .
. . . it
generally offers income tax-free proceeds at death,
Essentials of Term Insurance
As well as finding a suitable type of term policy and a suitable amount of coverage, with a term policy, you should be concerned with the quality of the contract, a company's ratings for capital strength, and the insurance company management's past actions.
Essentials of Permanent Insurance
Permanent insurance used to be synonymous with whole life insurance; but, perhaps, now is more synonymous with universal life insurance. Either way, suitable policy type and amount of coverage, the contract, ratings, and management are all equally important to the soundness of this category of coverage. Yet, with permanent insurance, a buyer must also be concerned with a fourth matter; namely, the policy's financial performance.
Financial performance rests on three things: a company's claims, its administrative expenses and its income, both premium and investment. Then, if the permanent policy is a variable life policy, the expense charges and the investment returns of the policy's money managers weigh in, too.
Forgetting, for now, the type of insurance known as variable life insurance, which we will look at later; with permanent insurance, value is more important than cost, at least to a point.
For example, consider two companies' permanent policies, A and B. Think of each as a bathtub into which money is being filled from the tap. A is filling at a rate of ten dollars ($10) of premium a year. B is filling at a rate of nine dollars ($9) of premium a year. Consequently, B may look like the preferred policy. Yet, in a long-term commitment, the annual premium, though important, is not paramount. Say bathtub A's drain-plug leaks at four dollars ($4) a year in mortality and administrative expenses. Bathtub B's drain-plug leaks at just a dollar more, five dollars ($5) a year. At the end of year one, A has the advantage of six ($6) accumulated tax-deferred dollars, while B has only accumulated four ($4). Compounded over the years, the difference is real money.
Term Insurance vs. Whole and Universal Life
RightNow, the two most common types of individual life insurance are probably term insurance and universal life insurance. Term insurance pays a benefit only if you die during the term of coverage. It has more guarantees right now than in years past. As the name implies, it is designed for a specific period of time, perhaps 20 or 30 years. Some examples of why term insurance is often purchased are to . . .
Whole Life and Universal Life
Whole Life (WL) was originally offered in the 1800's and Universal Life (UL) in the 1970's. Whole Life, typically, has more guarantees than Universal, but Universal has more flexibility. With both, the policies build cash value which grows tax-deferred at rates set by companies. You can borrow against accumulated cash at favorable rates. If too much cash is borrowed, the policies will terminate and deferred income tax is then owed. It is particularly important to understand the guarantees in a UL (Universal) contract. Since its inception, Universal Life has become increasingly popular at the expense of Whole Life. Modern UL policies can sometimes be found with 20, 30 or more years guarantees. Naturally, the quality of the company making the guarantee is to be considered carefully with such policies.
Other Types of Policies
There are many variations of term insurance, such as group term. Interestingly, many an insured right now have life insurance through an employer or professional association. Group term often makes it easier for an insured to qualify medically for coverage. However, that very benefit for the less fit can cost the more fit more money than necessary. A healthy insured often can get better coverage from an individually owned policy. Besides lower cost, the individual policy is portable and able to accompany an insured after a departure from an employer.
Other cash value policies
There are also life insurance policies that offer cash value returns dependent directly on the stock market. One policy type, called the Index UL, is tied to a market index, such as the Standard & Poors 500. Typically, Index UL guarantees policy owners a minimum return and offers the possibility of a better return if the performance of the applicable market index is good.
Another type of policy is called variable life. Variable life insurance can be variable whole life or, more commonly, variable universal life. Variable life allows the policy owner to invest policy cash values in mutual fund-like accounts within the insurance policy. In this way, a policy owner participates directly in market gains and losses. Again, such gains are tax-deferred during accumulation and are, generally, tax-free at death.
The contract owner, not the insurance company, assumes the market risk and reward. The death benefit may fluctuate with investment results. Caution in this area is prudent. Usually insurance is meant to be a financial safety net, so purchase of these policies is subject to suitability requirements.
The Unique Beauty of all Types of Life Insurance
Regardless of the type of life insurance owned at death, the unique thing about life insurance is that it, instantly, underwrites dreams which normally take time to fulfill. With a signature and a few pennies on the dollar, it often creates more financial security than a lifetime of effort.
In other words, life insurance creates capital. There lies the beauty of life insurance. Other types of financial instruments must accumulate capital, which takes time.
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