Life insurance is a contract between the insurance company (insurer) and the insured (policy owner), where the insurance company agrees to pay a specified amount of money to the designated beneficiary upon the loss of life of the insured due to terminal illness or accidental death. In return, the policy owner pays the insurer, periodic premiums of a stipulated amount.
Life insurance companies offer different types of policy options. These can be broadly categorised into permanent insurance, term insurance and endowment policies.
Permanent insurance policies remain in force throughout the life of policy owner as long as premiums continue to be paid. Types of permanent insurance policies are - whole of life and universal life.
Whole of life insurance: Typically, in whole life insurance, the policy owner is required to pay premium for life. However, some insurers do allow the insured to pay up the policy in as few as five years or in one single premium, meaning no further premiums are required to be paid. Whole of life insurance allows policy owners to obtain loan against the policy as it gains in value with passage of time. Usually insurance companies will guarantee cash value benefits to the holder, without taking into consideration the performance of the company on financial index.
Universal life insurance: In universal life insurance, the value which is above the cost of insurance is credited to the cash account of the policy. The cash value thus credited includes an agreed monthly interest, which is paid by the insurer. However, administrative fees are debited from the accrued cash value if no premium is paid for a particular month. The insurer sometimes attaches the interest element to financial index, which means if interest rates are high, the premium can be reduced with the dividends. The policy owner can be asked to pay additional premium in case of the lowering of interest rates. Knowledge of financial markets is advantageous when one decides for this type of policy.
Term insurance, as the name indicates, are policies which cover the insured for only a specified period of time. Term policies cover the insured for only a specified amount of time, which can be usually ten, fifteen, or twenty years. In event of death of the insured during the period, policy benefits are paid to the beneficiary. This type of policy is the least expensive form of life insurance as the policy does not increase in cash value. Thus one can purchase a substantial death cover at a relatively lower premium. Term life insurance is purely risk protection; hence, if policy owner survives in that term the insurer is not bound to pay any benefit to the survivor.