Life Insurance

Life insurance provides a monetary benefit to a decedent's family or other designated beneficiary, and may specifically provide for income to an insured person's family, burial, funeral and other final expenses. Life insurance policies often allow the option of having the proceeds paid to the beneficiary either in a lump sum cash payment or an annuity.

Annuities provide a stream of payments and are generally classified as insurance because they are issued by insurance companies, are regulated as insurance, and require the same kinds of actuarial and investment management expertise that life insurance requires. Annuities and pensions that pay a benefit for life are sometimes regarded as insurance against the possibility that a retiree will outlive his or her financial resources. In that sense, they are the complement of life insurance and, from an underwriting perspective, are the mirror image of life insurance.

Certain life insurance contracts accumulate cash values, which may be taken by the insured if the policy is surrendered or which may be borrowed against. Some policies, such as annuities and endowment policies, are financial instruments to accumulate or liquidate wealth when it is needed.

In many countries, such as the US and the UK, the tax law provides that the interest on this cash value is not taxable under certain circumstances. This leads to widespread use of life insurance as a tax-efficient method of saving as well as protection in the event of early death.

In the US, the tax on interest income on life insurance policies and annuities is generally deferred. However, in some cases the benefit derived from tax deferral may be offset by a low return. This depends upon the insuring company, the type of policy and other variables (mortality, market return, etc.). Moreover, other income tax saving vehicles (e.g., IRAs, 401(k) plans, Roth IRAs) may be better alternatives for value accumulation.

Types of life insurance policies

There are two basic kinds of life insurance policies: whole life and term insurance.

Whole-life policies, a type of permanent insurance, combine life coverage with an investment fund. Here, you're buying a policy that pays a stated, fixed amount on your death, and part of your premium goes toward building cash value from investments made by the insurance company.

Cash value builds tax-deferred each year that you keep the policy, and you can borrow against the cash accumulation fund without being taxed. The amount you pay usually doesn't change throughout the life of the policy.

Universal life is a type of permanent insurance policy that combines term insurance with a money market-type investment that pays a market rate of return. To get a higher return, these policies generally don't guarantee a certain rate.

Variable life and variable universal life are permanent policies with an investment fund tied to a stock or bond mutual-fund investment. Returns are not guaranteed.

The other type of coverage is term insurance, which has no investment component. You're buying life coverage that lasts for a set period of time provided you pay the monthly premium. Annual-renewable term is purchased year-by-year, although you don't have to requalify by showing evidence of good health each year.

When you're young, premiums for annual-renewable term insurance are dirt cheap - as low as a few hundred dollars per year for $250,000 worth of coverage.

As you get older, premiums steadily increase. Level-premium term has somewhat higher - but fixed - premiums for longer periods, anywhere from five to 30 years.

Life insurance

Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money (the "benefits") upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger payment. The policy holder typically pays a premium, either regularly or as a lump sum. Other expenses (such as funeral expenses) are also sometimes included in the premium; however, in Australia the predominant form simply specifies a lump sum to be paid on the policy holder's death.

The advantage for the policy owner is "peace of mind", in knowing that the death of the insured person will not result in financial hardship for loved ones.

Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; common examples are claims relating to suicide, fraud, war, riot and civil commotion.

Life-based contracts tend to fall into two major categories:

• Protection policies – designed to provide a benefit in the event of specified event, typically a lump sum payment. A common form of this design is term insurance.
• Investment policies – where the main objective is to facilitate the growth of capital by regular or single premiums. Common forms (in the US) are whole life,universal life and variable life policies.