Buying Insurance: What You Need To Know
Buying insurance can be confusing. What exactly do you get when you buy a policy? The outline of the basic types of insurance will be outlined.
Insurance is one of the most important things that anyone can have, but what do we really know about it? Term, Whole Life, Annuity, Decreasing Term all have something to do with insurance and can be confusing to the uninitiated.
What exactly do you get when you buy a policy? Well that depends on the type of insurance you buy! The basic types of life insurance are; Whole Life, Term, and Decreasing Term. Annuities are another form of insurance, but in actuality they are more correctly classified as investments, and for the purposes of this writing will be separated out.
Insurance in its purest form is a purchase made to guarantee against risk of loss. This insurance has no "savings or investment" component attached. The best example of this is Term insurance.
Term Life Insurance offers protection without claim of savings or investment. While some "Term" policies offer loan value, this value is at the expense of higher premiums.
Decreasing Term Insurance offers a decreasing amount of insurance as the term of insurance comes closer to the end of the policy. This form of Insurance is used basically as debt insurance. It offers no loan value, savings or investment. Mortgage and Credit life plans are basically decreasing term policies for a specific debt. This is the most inexpensive form of insurance, but usually the least cost effective.
Whole Life Insurance is a combination of insurance with some form of savings or investment. This is the most expensive and confusing form of insurance. The life insurance company basically insures the individual's life and take an additional portion of money to invest. The insurance company then decides what rate of return it will pay the insured on the investment portion. The profits from investments are disposed of depending on the type of insurance company.
Generally Whole Life is a poor way to invest. If you want to see what is going on take the difference between the premium cost of a Whole Life Policy and a Term Policy from the same company. Take that difference and project it as an investment over the same number of years as you'd pay in your policy. The result will tell you if a Whole Life Policy is worth it or not.
Decreasing Term insurance policies are cheap and convenient, but it you are already looking to insure yourself over a period of 40 years, doesn't it make sense to get a higher level of insurance that remains level throughout your life?
Suppose you were to become uninsurable later in life?
While the best use of money would probably be the purchase of Decreasing Term insurance and some type of investment. Human nature makes it unlikely that you would be consistent enoungh to keep investing and paying your insurance at the same time uninterrupted over say 40 years. The insurance alone probably. This is why most people look to Whole Life, it gives insurance and investment in the same package. The most logical use of insurance in combination with investment would be Term Insurance with some form of savings or investment.
Annuities are a form of insurance which is really an investment that agrees to pay the insured so much a month for life. The insurance company bases the amount of payment on the amount of money invested, the age of the annuitant (the person being paid), and the rate of return on the investment. Annuities are guaranteed and that makes them attractive. They also can be written to include a "life insurance" provision which guarantees that the investors surviviors will be paid for a specific term following the death of the annuitant.
With the increase awareness of mutual funds, IRA and 401 retirement plans, insurance companies are forced to disguise and package policies so they can be marketed competitively as investments. Many companies combine features and adjust returns. The key question that must be asked by the purchaser is: How much do I want to pay to get (blank) dollars of insurance?