Here are some basics about life insurance for a life insurance lawyer to understand.
“Term” policies simply provide a death benefit in return for a premium payment. At the end of the policy year, or “term”, the insurance ends, and the policy has no value. Term policies do not accrue cash value. Because the insured is only paying for the death benefit, term policies are cheaper in the early years. As the insured gets older, the risk of death increases and so does the premium, so term may become more expensive than the other types. Insurers typically sell term policies that promise a fixed premium for a set number of years. For example, an insurer may sell a 10 year term policy that the insured may purchase and renew for the same annual premium during those years, without having to re-qualify.
“Whole life” policies typically charge more in premiums than term policies, so that the premium pays for the death benefit and provides an excess that allows the policy to accrue a “cash value.” This cash value is an investment, in addition to the benefits if the insured. The policies derive their name from the fact that the insurer offers to insure the insured for her “whole life” — based on a certain stream of premiums. An insurer may offer illustrations at the time the policy sold showing how much cash value will accrue based on the premium payments, if the certain interest rates apply. The illustrations usually project the expected value of the policy over time, and often contain disclaimers and numerous assumptions, making comprehension difficult. This complexity causes insureds often to rely heavily on oral explanations by the agent, which may be inaccurate or misunderstood. This can be a source of trouble if the policy’s actual performance does not match the insured’s expectations.
One feature of whole life is that enough value may accrue so that future premiums can be paid from the accumulated cash value, without the insured having any more out of pocket expense. This is an effective marketing tool, showing the insured that after a substantial initial outlay, the insured will have coverage without making further payments. This too can be a trouble spot if the actual performance does not live up to the projections.
Another feature of the accrued cash value is that the insured may borrow against the policy. If the insured does not pay back the “policy loan,” the loan is repaid from the cash value and policy benefits at the time of death.
“Universal life” works like whole life, except the rate of return on the investment portion may be tied to stocks or mutual funds, instead of a certain interest rate. This product was developed so life insurers could compete with other investments by offering more competitive rates of return.
Dividends are another potential feature. If the policy pays dividends, the insured may elect to receive them as a refund, or the dividend may be applied to buy additional coverage or to reduce the next premium.