About 20 percent of the life insurance policies sold in the United States in 2000 were term policies, but these policies represented 42 percent of the amount of death protection purchased. A term policy provides a death benefit over a fixed term, usually one year or five years. Term insurance typically provides pure death protected; there is no savings feature and therefore no cash surrender value.
Almost all term policies are guaranteed renewable, which means that the policy can be renewed at a predetermined premium at the end of the term without proving insurability up to advanced age, such as 65-70. To illustrate suppose that you purchase a one year renewable term policy with a $100000 death benefit. At the end of the year, you can renew the policy for another year with a $100000 death benefit at a predetermined premium proving insurability. Also, again without showing proof of insurability many term policies can be converted to a cash value policy.
The premium for yearly renewable term policies typically increases at the end of each year. For policies that extend over several years, such as five year renewable term policy premiums can increase annually ir they can be constant for the term and then increased upon renewal. Term insurance premiums increase as the policyholder ages because the probability of a person dying generally increases with age. Compared to cash value life insurance, the initial premium per $1000 of face amount is much lower for term insurance, the initial premium per $1000 of face amount is much lower for term insurance, thus allowing a person to buy substantially more coverage for a given premium outlay.
Although the market for endowment insurance in the United States is very small endowment insurance is common in other countries. A basic understanding of endowment policies also will help you understand more common types of policies. For example, the whole life policy described next is just an endowment policy with a very long term. An endowment policy pays the face amount of the policy is the insured dies, but it also pays the face chases a five year endowment policy with a face amount equal to $100000, the insurer will pay $100000 to the beneficiaries if he dies in the subsequent five years. If he survives the five year period, he would be paid $100000 at the end of this period. As you might expect, this policy would require a relatively large premium because the insurer will have to pay $100000 regardless of whether Mr.Cox dies. The main source of uncertainly with an endowment policy is when the benefit payment will occur. Since either Mr.Cox or his beneficiaries will receive $100000 sometime in the future, an endowment policy has similarities to a savings account.
The insight that endowment policies are largely savings vehicles help to explain why endowment insurance has declined in importance in the United States but not in other countries. At one time, savings accumulation through endowment policies int the United States received tax advantages. People could save through endowment policies and not pay tax on part of the implicit returns that they earned. Unlike some other countries, the United States no longer grants this favorable tax treatment to endowment policies unless they have a very long duration, such as whole life insurance.
Whole Life Insurance;
As the name suggests, the contract length of a whole life policy is, om effect the policyholder’s entire life. The death benefit equals the policy’s face amount, which generally is fixed for the insured’s entire life. For example, a $100000 face amount whole life policy holder survives to age 100 and has paid all the required premiums, the policyholder is paid the $100000 face amount that time. Thus, most whole life policies to age 100.
Some whole life policies allow death benefits to be reduced over the course of the contract, and some policies have death benefits that are indexed to inflation. Some whole life contracts are sold with an option, known as the guaranteed insurability option, for the policyholder to purchase additional amounts of coverage at specified times and premium rates without proving insurability. Limits on the additional of coverage and the time at which additional coverage can be purchased help reduce adverse selection.
Whole life insurance policies commonly use a level premium schedule over a fixed number of years. With a single premium life policy, the buyer pays the entire premium in a lump sum when the policy is issued. Alternatively, a level premium may be payable for a 10-20 years period; these policies are called limited pay whole life. However, a substantial majority of whole life policies sold in the United States have level premiums that continue until the policyholder dies, and surrenders the policy or reaches the age of 100-whichever comes first. These contracts are known as continuous premium whole life.
The key feature of the premium payment methods for whole life policies is that the premium generally does not increase over time in conjunction with the increased probability of dying. This feature contrasts with most term insurance policies, where the premium generally increases over time to reflect the higher probability of dying. Comparing premiums for yearly renewable term insurance and level premium whole life insurance premium premium must exceed the term insurance premium for an insured at the same age in order to fund benefits in the future when the level premium is less than the annual cost of coverage.
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