LIFE INSURANCE CHOOSING THE RIGHT PROTECTION PLAN

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1 HM 679 April 1991 $ $$ Southern Selection LIFE INSURANCE CHOOSING THE RIGHT PROTECTION PLAN Life insurance provides protection against financial losses caused by a person s death. Individuals who do not have a spouse, children, or others who depend on their income for support, or do not have large debts to be repaid, may not need life insurance other than the amount necessary for burial and final expenses. However, the death of the primary breadwinner in a family with young children has the potential to cause financial losses far beyond burial and final expenses. Income and fringe benefits that person provided are lost. Also, repaying installment debts may be difficult. The death of the primary child care giver may cause a financial burden for the family when they have to replace that person s services with hired help. The careful purchase of life insurance may protect loved ones from these devastating financial situations. TYPES OF LIFE INSURANCE In addition to providing death benefits, life insurance can be purchased to include a savings element. Term, whole life, endowment, universal life, and combinations of these various types of insurance provide ways of meeting different protection needs. Term Insurance. This type of insurance is known as pure protection insurance. Benefits are paid only if the insured dies during the contract time period, the policy term. Term insurance provides maximum death protection with the lowest premium cost. A level-term contract is issued for a specific time period, usually for 1, 5, 10, 20, or 30 years. The face value, or death benefit, of the policy remains the same and the premiums are equal throughout the term. In a decreasing-term contract the amount of death protection gradually decreases each year. The premiums may be equal for the policy term, but are generally less expensive than for other term policies. Convertible term insurance allows the insured to change a term insurance policy into a permanent form of coverage at or before the expiration date, without further evidence of insurability, such as a medical examination. Whole Life or Cash Value Life Insurance. In addition to protection, this type of insurance provides a savings element as cash value accumulates in the policy. This savings factor allows the pay-

2 ment of benefits before the insured s death. The amount of the cash value depends on the size of the premiums and the rate of return paid by the insurer. Usually a guaranteed minimum interest rate is stated in the policy. The cash surrender value is the amount of money the insured would receive if the policy were dropped. With an ordinary life or straight life policy, premiums are paid as long as the insured wishes the policy to be in force, or until it expires, but not past the insured s age of 100. During the period the policy is in force, it is not necessary to have another medical examination to prove insurability. Annual premiums are usually the same from year to year. A modified life contract provides whole life insurance with lower premiums in the early years of the contract. Higher premiums are paid after one to five years, when the insured is better able financially to pay. This policy helps young families obtain adequate protection during a time when they are least able to pay. In a limited payment life policy, the insured pays a higher premium for a set period, after which no further payments are due. Typically, twenty pay life (premium paid for twenty years) and paid at age sixty-five policies indicate when premiums are no longer paid, after which coverage continues for the life of the insured up to age 100. Endowment Insurance. This is primarily a savings contract with a small protection element that covers those insured if they die before the savings plan is completed. At the end of the policy term, the policy matures for the face amount. Endowment insurance is the most expensive form of protection coverage. A limited-term endowment contract may extend for 5, 10, 15, 20, or 30 years. It is generally set up as a savings plan for a specific purpose, such as education, travel, or retirement. If the saver dies before the plan is complete, the insurance completes the savings fund. A retirement income contract is an endowment policy arranged so that its cash value amounts to a total which will provide $10 a month of retirement income for each $1000 of policy face amount. Package Contracts. Insurance policies may combine or alter the basic types of insurance to meet special needs for individuals or families. A family income policy will provide a large amount of protection when children are young and will also allow for some permanent insurance. It is usually ordinary life insurance that has a decreasing-term rider. This rider is generally available for 5, 10, 15, or 20 years, but usually is selected to expire when the youngest child reaches a certain age, such as 21. Income from the policy is payable to a family for the period of time between the insured s death and the predetermined end of the policy. At that time, the ordinary life insurance portion ends. A family maintenance policy combines ordinary life insurance and level-term insurance. This policy provides protection that does not decrease during the policy term. If the insured has a 20-year policy and dies at any time during that term, the family will receive income for a full 20 years. A multiple protection insurance contract uses term insurance to provide double, triple, or some multiple of the face amount of a permanent insurance policy. After a set period, from 5 to 20 years, the protection is reduced to the original face amount of the permanent policy. Several insurance companies have package contracts available to provide life insurance for children. When considering the purchase of this

3 type of insurance, remember the wisest use of life insurance is protection against financial losses resulting from the death of a breadwinner. Coverage to provide burial and final expenses is often sufficient for a child. Insurance cannot protect parents against the emotional loss suffered from a child s death. Carefully consider the purchase of juvenile life insurance as a way to save for a child s education. Other investment choices usually provide a better savings fund for your child. This will then allow limited life insurance premium dollars to buy more protection for the primary breadwinner(s). Juvenile life insurance coverage often is provided as a rider on some other form of permanent insurance, such as for the parent. In many policies, coverage may be established before a child is born, but does not become effective until the child is 7 days or 14 days old. Jumping juvenile insurance is issued in units of $1,000 when a child is very young. This amount automatically increases at a specific age, for example to $5,000 at age 21. The premium does not increase and evidence of insurability does not have to be furnished. This policy provides permanent life insurance protection even though a child may become otherwise uninsurable. term insurance and is generally the least expensive form of life insurance for qualified members. Many employer group plans also cover dependents and often extend coverage to members after retirement. Mortgage and credit life insurance is offered by many financial institutions to consumers who obtain mortgages, installment sales contracts for automobiles, or other large purchases. This is decreasingterm insurance that will expire when the installment contract is paid off. The premiums are added to the loan principal and financing costs becoming part of the monthly installments made on the purchase. If the insured dies before the loan is repaid, the credit life insurance pays the balance owed on the installment contract. This protects both the insured s dependents and the lender. However, a lender cannot require that credit life insurance be purchased from them. In addition, it is often more expensive coverage than regular term insurance. The wise consumer will shop around for the least expensive insurance to cover large debts. A payor clause may be added to a juvenile policy. The clause states that if the owner (usually the parent) dies before the policy matures, all additional premiums will be waived until the child reaches age 21. A family group policy allows each member of a family to be insured for a different amount. Usually the highest coverage is provided for the primary wage earner with decreasing amounts for a second wage earner and children. A single premium is charged for the entire package that has been custom designed for a family. Group life insurance is offered by employers, employee associations, unions, professional associations, savings or investment groups, and fraternal societies. Group life insurance is usually a form of Two new types of insurance have been made available in response to current marketplace changes in inflation and interest rates. They have variable rates of return that change along with general market rates. Universal Life Insurance. This provides both protection and a savings element. However, the face amount, premiums, rate of return, and rate of cash value accumulation vary according to a designated market interest rate. In addition, the consumer can make changes in the premiums paid,

4 savings amount, and level of protection. This is similar to a combination of whole life protection with a savings plan that is tied to interest rates currently being paid in the financial market. The rate of return on universal life policies is generally higher than other forms of cash value policies. Variable Life Insurance. The insured may choose the investments that are made with the premiums and the cash value that accumulates in the individual s insurance policy. The face amount of the policy, a basic death benefit, usually remains constant. However, the cash value will increase or decrease based on the rate of return for those investments. This type of insurance should only be used by individuals who are knowledgeable about investments. Unprofitable investments will slow the growth of the policy s cash value. Another product often sold by insurance companies is an annuity. However, these contracts are not insurance policies. Often sold as a way of investing proceeds from endowment policies, annuities are designed to provide income for a set period of time in return for the payment of a premium or premiums. Annuities can help protect individuals from outliving their income. However, they are only another form of investment. Careful consideration should be given to alternate forms of investment for this purpose. TERMS TO REMEMBER Conversion - many term policies may be turned into a permanent form of coverage at or before the date the term policy expires, without providing proof of insurability. Double-indemnity - a rider that will provide two times the face amount of the policy if the insured dies from an accident. Mortality tables - a table that shows the number of deaths per thousand and expectation of life at various ages. Renewability - allows you to renew a term policy without undergoing a physical examination. Suicide clause - requires payment of face amount of policy if the insured commits suicide after the policy has been in force two years, but no payment during the first two years except for the return of premiums. Uninsurability - a person s physical condition does not meet minimum medical and other standards such as occupation, which are listed in mortality tables. INSURANCE POINTERS 1. The owner of an insurance policy is the person who has the right to change the beneficiary, the right to take a loan, or the right to receive the dividends. Ownership of insurance policies needs to be considered in estate planning or in divorce settlements. 2. Best s Insurance Report evaluates insurance companies for consumers. A copy of this guide is usually found in the public library. You should select a company that has at least an A rating. 3. It is very important to select an insurance agent who will be around in the future when you need to reevaluate insurance needs, make policy changes, or collect on a policy. 4. When you are young, term insurance will provide the largest amount of protection insurance for the least cost. Convertible term policies may be turned into whole life as your income increases.

5 5. The fact that the insurance agent makes a higher commission when selling cash value policies than when selling term insurance should be considered when making decisions about insurance purchases. Also, remember that the cash value of a whole life policy builds slowly. Very little cash value will accumulate in the first years. 6. When considering interest rates on cash value policies, be sure to ask about management fees, account fees, and investment fees. These will lower your actual amount of return. SPECIAL CONSIDERATIONS Selecting the right insurance policy, coverage, and company can be difficult whether it is the first time you are purchasing life insurance or whether you are reevaluating your insurance needs. Comparison shopping is very important and well worth the effort that is involved. In addition, individuals should not cancel one life insurance policy to buy another without carefully examining all factors. The new policy may cost you more than its advantages are worth. Before making any decision, be sure you are comparing equal policies and coverage, not just equal premiums. Special discounts and features also need to be taken into consideration. * Some insurance companies may qualify you for a preferred risk policy. For example, their coverage for your life insurance as a non-smoker may be less expensive. * A waiver of premium feature allows the policy to remain in force without the payment of premiums. Most often this feature takes effect upon permanent disability of the insured; however, certain other cases may qualify for a waiver. * Grace periods are the length of time (usually 31 days) following a premium due date during which an overdue payment may be made and still keep the policy in force. * An automatic premium loan provision will pay any premium not paid by the end of the grace period. * Reinstatement allows a lapsed policy to be restored if the insured provides proof of insurability and pays past due premiums plus interest. * Guaranteed insurability permits the insured to buy set amounts of additional life insurance at specific times in the future without proving insurability. Review life insurance needs periodically, especially after the birth of a child, death of spouse, or taking on a large debt. The next page of this publication provides a worksheet you may use to determine the amount of life insurance coverage you need to provide financial protection in the event of your death. This form should be duplicated and completed for each wage earner in your household. The comparison chart on the last page will help you gather the facts necessary to compare three different insurance companies based on their coverage, premiums, and special features for one particular type of insurance.

6 This worksheet was completed for on (date) A Needs Approach to Buying Life Insurance Living Expenses for Surviving Family Members 75 percent of your current annual take-home pay will provide an estimate of how much income your family would need to live in their current lifestyle without you. Include money for fringe benefits that survivors depend on and/or cost of replacing your household services (.75 times annual take-home pay) = $ A Survivor(s) Annual Income Salary, interest on savings, rental income $ Survivor(s) Annual Income from Benefits Social Security, pensions, veteran's benefits. + $ Other Annual Income Trusts, investments, annuities + $ TOTAL = $ B Additional Income Needed A - B =$ C Number of Years Necessary for supplementing income (until spouse is retirement age, or until youngest child is 21) x C =$ D Final Expenses Funeral costs, uninsured medical costs, estate taxes, probate costs Readjustment Expenses Funds to cover period until spouse is able to return to work, seek employment, or obtain further education or job skills, funds for counseling or travel during grieving period Funds Needed to Meet Financial Goals of Family Repayment of debts (mortgage, autos, emergency fund, education fund, retirement fund) Current Assets Held Savings, investments, pensions Face Value of Current Life Insurance Total Additional Life Insurance Needed Beneficiaries Owner of Policy TOTAL +$ E +$ F +$ G =$ - $ - $ =$ Adapted from: Tobias, A The Only Investment Guide You ll Ever Need. New York: Bantam Books.

7 Comparison Chart For Buying Life Insurance Company 1 Company 2 Company 3 Name of Company Face Value/Death Benefit Annual Premium Type of Policy Term Convertible Renewable Endowment Income/$1000 Whole Life/Cash Value Universal or Variable Life Annual Rate of Return Cash Value of Policy In 5th year In 10th year In 20th year Dividends Paid Interest Rate on Policy Loans Payment Options Settlement Options Company Rating by Best's Special Features of Policy

8 Adapted for use in South Carolina by Nancy M. Porter, Extension Family Resource Management Specialist, from materials Dr. Porter originally prepared for the Virginia Cooperative Extension Service. Reviewed by South Carolina Department of Insurance and by Joyce H. Christenbury, Extension Family Resource Management Specialist. The Clemson University Cooperative Extension Service offers its programs to people of all ages, regardless of race, sex, religion, national origin, or handicap and is an equal opportunity employer. Clemson University Cooperating with U.S. Department of Agriculture, South Carolina Counties, Extension Service, B.K. Webb, Director, Clemson, S.C. Issued in Furtherance of Cooperative Extension Work in Agriculture and Home Economics, Acts of May 8 and June 30, 1914

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