Life insurance may be divided into two basic classes, temporary and permanent or it can be divided into following subclasses - term, universal, whole life and endowment life insurance.
1. Temporary term
Here life insurance coverage is for a specified term of years for a specified premium. The policy does not accumulate cash value. Term is generally considered pure insurance, where the premium buys protection in the event of death and nothing else.
The three key factors to be considered in term insurance are face amount death, premium to be paid , and length of coverage. Various insurance companies sell term insurance with many different combinations of these three parameters. The face amount can remain constant. The term can be for one or more than one years.
A policy holder insures his life for a specified term. If he dies before that specified term is up, his named beneficiary receives a payout. If he does not die before the term is up, he receives nothing.
2. Permanent Life Insurance
Permanent life insurance is life insurance that remains in force until the policy matures and unless the owner fails to pay the premium when due. The policy cannot be canceled by the insurer apart from fraud in the application, and that termination must occur within a period of time defined by law. Permanent insurance builds a cash value that reduces the amount at risk to the insurance company and thus the insurance expense over time. The four basic types of permanent insurance are whole life, universal life, limited pay and endowment.
a) Whole life coverage
Whole life insurance provides for many premium, and a cash value table included in the policy guaranteed by the company. The main advantages of whole life are guaranteed death benefits, cash values, fixed and known annual premiums, and mortality and expense charges will not reduce the cash value shown in the policy. The primary disadvantages of whole life are premium inflexibility.
Cash value can be accessed at any time through policy loans.These loans decrease the death benefit if it is not paid back, payback is optional. Cash values are not paid to the beneficiary upon the death of the insured; the beneficiary gets only the death benefits
b) Universal life coverage
Universal life insurance is a somewhat new insurance product intended to provide permanent insurance coverage with greater flexibility in premium payment and it gives higher internal rate of return. There are several types of universal life insurance policies which include interest sensitive, variable universal life insurance, and equity indexed universal life insurance.
A universal life insurance policy also includes a cash account. Premiums will increase the cash account. Interest is paid within the policy on the account at a rate specified by the company. Mortality charges and administrative costs are then charged against the cash account.
In all life insurance, there are basically two functions that is mortality function and a cash function. The mortality function would be the classical notion of pooling risk where the premiums paid by everybody else would cover the death benefit for the one or two who will die for a given period of time. The cash function inherent in all life insurance says that if a person is to reach age 95 to 100 then the policy matures and endows the face value of the policy.
In this type of life insurance, all the premiums are paid over a specified period. Common limited pay periods include 10-year, 20-year, and paid-up at age 65.
Endowments are policies in which the cash value developed inside the policy equals the death benefit at a certain age. The age this commences is known as the endowment age. Endowments are considerably more expensive than whole life or universal life because the premium paying period is shortened and the endowment date is earlier.