Demystifying Life Insurance - Permanent Insurance

Permanent insurance is a financial arrangement little understood by the general public. What people think they know about permanent insurance is often bad information. There are several flavors of permanent insurance. Each performs in a different way. Let's start by identifying the two major sub-categories of permanent insurance: whole life and universal life. Whole life was the first type of permanent insurance, meant to insure the individual for his entire life. Generally, premium payments are established and fixed when the policy is issued and often remain unchanged for the life of the insured, much like a fixed mortgage. Universal life insurance was introduced by the insurance industry to give the consumer some flexibility in paying for permanent life insurance coverage. The key difference between whole life and universal life is the premium payment arrangement. As indicated before, whole life payments are generally fixed and unchanged for the duration of the policy. On the other hand, universal life insurance contracts have variable payment schedules. As long as there is enough cash to keep the policy in force, the purchaser of a universal life contract may pay more or less than the scheduled payment, within limits. After the advent of universal life, the industry came out with variable universal life and indexed universal life. All three types of universal life have the variable payment feature. However, VULs, as they are called, have separate accounts where the cash values in the policy are separately accounted for and invested, generally in mutual funds. Therefore, VULs carry market risk. In good markets, the cash can grow substantially. In down markets, you may find yourself reaching for your checkbook to avoid a lapse in your policy. Many VULs during the 2000-2002 market down turn experienced just such an issue. Ultimately, the insurance industry produced indexed universal life, or IULs. For IULs, rather than invest the cash values directly in the market, the insurance company issuing the policy credits the cash account based on the performance of a pre-determined market index such as the S&P 500. Many IULs have minimum and maximum cash value credit guarantees, generally ranging from 0%-14%, depending on the performance of the underlying index. Therefore, IULs can participate in the upside if market performance is good, but will never receive a credit less than the minimum guaranteed by the insurance company. Hence, IULs never lose cash value due to market risk. So, there you have it... a basic description of the types of permanent life insurance policies. Next month, I'll write about the features and benefits of permanent insurance and how you may benefit by owning a permanent insurance policy.