Life Insurance Basics
This topic explains why people buy life insurance, how much they need, and the broad families of policies: term (temporary) and permanent (whole and universal). Understanding these building blocks makes every specific policy easier to analyze.
The Purpose of Life Insurance and Needs Analysis
Life insurance replaces the economic value lost when a person dies, providing money to cover final expenses, pay off debts, replace income, fund education, and create an estate. Two common methods estimate how much coverage is needed. The human life value approach calculates the present value of the insured's future earnings that the family would lose. The needs approach adds up specific obligations (final expenses, debts, income replacement, education, and other goals) and subtracts existing resources. Both aim to right-size coverage so the family is neither underinsured nor over-insured.
Term Insurance: Temporary Protection
Term insurance provides a death benefit for a specified period (for example, 10, 20, or 30 years) and generally builds no cash value, making it the least expensive way to buy a large amount of coverage. If the insured dies during the term, the benefit is paid; if the term ends, coverage stops unless renewed or converted. Common forms include level term (level face and premium), decreasing term (declining benefit, often used for a mortgage), and increasing term (growing benefit). Many term policies are renewable (continue without new evidence of insurability) and convertible (exchange for permanent coverage without proving insurability).
Whole Life: Permanent Protection with Guarantees
Whole life is permanent insurance that covers the insured for life (as long as premiums are paid) and builds a guaranteed cash value. Traditional (ordinary) whole life has a level premium and level death benefit. The cash value grows tax-deferred and can be borrowed against or surrendered. Because it combines lifelong protection with a savings element, whole life costs more than term for the same face amount but offers guarantees and living benefits. Participating whole life may also pay non-guaranteed dividends that the owner can take as cash, use to reduce premiums, or use to buy paid-up additions.
Universal Life: Flexible Permanent Protection
Universal life (UL) is permanent insurance built for flexibility. Within limits, the policyowner can adjust the premium amount and timing and can raise or lower the death benefit (subject to insurer rules and possible evidence of insurability for increases). Premiums, net of expense and cost-of-insurance charges, flow into a cash value that earns interest at a declared rate with a guaranteed minimum. UL offers a level death benefit option (Option A, roughly the face amount) and an increasing option (Option B, face amount plus cash value). The owner must monitor the policy, because insufficient premiums or rising insurance costs can cause it to lapse.