Many people own life insurance, but let’s face it. It’s probably not a purchase that most people brag about to their friends like they might if they had just purchased a new Corvette, but they made the purchase anyway because they love their families and want their family to carry on living their current lifestyle in the event of the primary breadwinner’s untimely death. While this article doesn’t apply to people who own term insurance, those who bought permanent life insurance, which is life insurance with an additional savings component, will find this information very important.
To understand the problem, I will first give you a brief primer on life insurance, and then explain how something that seems like a sure bet can go so wrong. Life insurance can be separated in to two basic types, term and permanent life insurance. With term insurance a person pays a certain amount of money, called a premium, for a period of time, from one year up to 30 years. During the specified period of time, as long as the insured person is paying the premium, the insurance company is obligated to pay a certain amount of money, called a death benefit, to the insured person’s beneficiary in the event the insured person dies during that time period. If the person does not die in that time period the insurance company keeps the money as well as the earnings on that money.
While there are different types of term insurance nowadays, including “return of premium” term which returns the insureds premium dollars at the end of the term(but not the earnings on the money), the general jist of term insurance is that a person is covered during a certain period of time. If they want coverage beyond that time period they have to buy another policy. Term insurance is really not the focus of this article so if that’s what you have you can stop reading now if you wish, and rest assured that as long as you pay the premium, and the insurance company remains financially solvent, your family will be paid in the event of your untimely death.
The other type insurance is called permanent insurance. Permanent insurance is insurance that has a death benefit to it, similar to term, but also contains a savings “sidecar”, this gives the policy a value called cash value. The premiums are paid on the policy, a portion is pulled to pay for the insurance and the remainder goes into the savings sidecar. There are three primary types of permanent insurance that vary depending on what is done with the savings component. The first type of permanent insurance is Whole Life Insurance. The savings component of Whole Life Insurance is invested in the general fund of the insurance company where it earns interest.
The amount of interest apportioned to a particular individual is depended on how much of the money in the general fund belongs to that individual. Some policies if they are are “participating” policies also earn dividends. Generally speaking whole life policies are not a lapse danger as the amounts that it earns are guaranteed by the insurance company. As long as the insurance company remains solvent it will pay out a death benefit. The only problems a person who owns a Whole Life policy typically runs into is overpaying for insurance, and the death benefit not keeping pace with inflation.