What are the different kinds of life insurance policies, and how do they work?

A life insurance policy is a contract between a life insurance company and a policyholder. Typically, the policyholder is also the person insured, but you can buy life insurance coverage for another person. It's important to realize that not every insurance company is authorized to write life insurance policies. States regulate life insurance companies quite closely to make sure they have the financial wherewithal to pay their obligations for many years into the future. Whether it's term life insurance, whole life insurance, or universal life insurance, every policy defines the following items:  

  • Death benefit The amount the life insurance company will pay when the insured dies.
  • Beneficiaries These are the people who will receive the death benefit. It can all go to a single person (e.g., a surviving spouse), or it can be divided by percentage among many different people and entities (e.g., three children could each get 30% and 10% could go to a charity).
  • Policy length The amount of time coverage stays in effect, and the life insurance company agrees to pay a death benefit. The policy length can be a specific term, e.g., 10 or 20 years, or it can be permanent – a policy that lasts for the insured's life1.
  • Premium These are the monthly or yearly payments needed to keep the policy in effect.
  • Cash value Permanent life policies have a cash value component that builds over time and can be cashed out or borrowed against2,3. A term policy has no cash value.

There are two basic types of life insurance: Term and permanent. A term life insurance policy provides coverage for a specific period of time, typically between 10 and 30 years. It is sometimes called a "pure life insurance product” because unlike whole life insurance, there's no cash value to the policy – once the term is over, typically there's nothing left.

Permanent life insurance provides coverage that lasts your entire life. Unlike term, these aren't "pure life insurance" products because they include an added component – the policy's cash value. The life insurance company invests a portion of your premium dollars. That money grows tax-deferred over time, which helps make coverage last indefinitely while providing other financial benefits. However, the entire death benefit is immediately payable from the first day you have the policy.

There are two main types of permanent insurance: whole life and universal life. Whole life insurance policies are more straightforward – the premium remains the same for life, the death benefit is guaranteed, and the cash value grows at a guaranteed rate. Universal life insurance products can be less expensive, but the premiums, death benefits, and cash value growth rates can vary, making the policy more complicated.

The following chart highlights the key differences between the three types of policies.

Term life, whole life, and universal life compared

 

Term Life 
Insurance

Whole Life 
Insurance

Universal Life Insurance

 

Coverage period

Limited to a specific term (typically 10-30 years)

Permanent lifetime protection

Permanent lifetime protection

 

Builds cash value

No

Yes

Yes

 

Cost for a given death benefit

Less expensive than whole life or universal life

More expensive than term

More expensive than term

 

Premiums

Typically fixed

Typically fixed

Can vary

 

Income Tax-free death benefit

Yes, typically

Yes, typically

Yes, typically

 

Investment options

No

Typically no

No – but a version called Variable Universal Life offers investment options

 

Primary uses

Income protection and replacement 

Income protection; tax-deferred asset accumulation; tax-advantaged wealth preservation and transfer

Income protection; tax-advantaged wealth preservation and transfer

 

You can get life insurance as an individual or as part of a group. Many companies provide life insurance protection for their employees. This form of group policy can be an easy and affordable way to get coverage. Often, employers will pay for a basic level of protection and provide the option to pay for additional life insurance through payroll deductions. In most cases, the death benefit is paid to beneficiaries income tax-free.

What are six traits most top life insurance companies share?

All large, nationally known life insurers may seem alike, but they aren't. Some life insurance companies are more financially sound than others. Some are easier to work with. Some are more likely to provide the specific features you need. But only a handful of companies can offer you most of those advantages. How can you find an insurance company that does? There are objective metrics and factors you can use:

High Financial Strength Ratings
Independent companies rate the financial strength of insurance companies to ensure their ability to meet obligations4.

High customer satisfaction scores
There are customer surveys and reviews that can tell you how satisfied others are with a company's services.

Low customer complaints
State regulators and private organizations collect and publish data on customer complaints.

Product selection and customization
Some companies focus on term insurance, while others offer both term and permanent products with a variety of optional riders that tailor a policy to your needs5.

Policyholder dividends 
Some insurance companies pay a dividend on their permanent policies' cash value, and others don't6.

Direct underwriting
Some companies issue their own policies, while others offer policies of other insurance carriers.

1. The importance of high financial strength ratings

One of the main emotional benefits of having life insurance is that it helps provide a level of confidence, especially at a time when few things can be taken for granted. The more assurance you have that the life insurance company will be there when your family needs a payout years down the road, the more confident you're likely to feel. Financial strength ratings from independent ratings companies are an objective way to evaluate an insurance company's ability to pay its obligations. Look for a company with a rating of at least "Superior" (A++) from A.M. Best, a "Very Strong" (AA+) from Standard & Poor's, or an "Excellent" (Aa2) from Moody's. As an example, here are Guardian's ratings:

Ratings are as of 12/31/2020 and are subject to change.

 

2. Customer satisfaction scores: consider the company's reputation

Customer satisfaction is vital for every industry – especially when it comes to life insurance. Is the company easy to deal with? Are they responsive when you want to make a change to your policy? Do they do a good job of explaining what you get? Life insurance policies are complex products, and you want to buy from a company that works hard to earn your business.

High customer satisfaction scores can be a good indicator of that. There are sources for online reviews, but some are more reliable than others. Many in the industry consider J.D. Power & Associates to be the source for the best life insurance satisfaction data because they conduct an annual customer satisfaction survey of more than 5,000 U.S. life insurance policyholders. In J.D. Power's 2019 U.S. Life Insurance Study, Guardian was deemed "Better than most" and received a rating of 4 out of 5 stars. 

3. Find out about a company's customer complaints

When do people get mad enough about an insurance company to lodge a formal complaint? More often than not, it's after a problem with a claim. Of course, you won't be the one filing a claim for your life insurance policy – but your family might. 

For their sake, you should consider companies with a reputation for generating a low volume of complaints. The Better Business Bureau (BBB) collects information about complaints, which can be accessed online. The National Association of Insurance Commissioners (NAIC) also collects data about complaints with state regulators and has resources for insurance consumers to help them better evaluate insurance companies. 

4. Look for a broad selection of products and services

Some companies only offer term coverage. But even if you're set on buying a term life policy, you should consider a company that offers a comprehensive selection of term and permanent life insurance policies. Why? Because you can't be sure what your life will be like a few years down the road. Your needs could change, and you might decide you need permanent life insurance. 

Many of the top insurance companies offer a breadth of products and services, and they let you customize your policy with optional provisions called riders. If you get a term policy with a conversion rider, you'll have an opportunity to convert to a permanent policy without getting a medical exam. On the other hand, if you're looking for a whole life or universal life policy, you may want the flexibility to customize your policy with a selection of riders (e.g., cost-of-living adjustment rider, disability income rider). That way, you and your agent can tailor your coverage to your needs. For example, Guardian provides a range of convertible term and permanent policies and even issues policies to help cover people with certain kinds of pre-existing conditions, such as certain cancers, heart disease, even HIV. 

5. Policyholder dividends can add value to your protection

Some life insurance companies are publicly traded, and others are mutual companies. What's the difference?

A public company is owned by the people and organizations that buy shares in the company. A mutual insurance company is owned "mutually" by its policyholders, who can receive dividend payments. For example, when you purchase a whole life policy from Guardian Life Insurance, you may get paid a dividend on your policy's cash value portion. While dividend payments cannot be guaranteed, Guardian has made dividend payments to customers every year since 1868.  

6. Direct underwriting

Some companies sell products from another insurer, which can add costs to your premiums. It can also add a layer if you decide to change your policy – or down the road when your family needs to collect a death benefit. You may want to consider a company that underwrites its own policies, like Guardian.

How to find the best life insurance policy – and company – for your needs

After you've identified a shortlist of insurance companies with the traits that are important to you, it's time to shop around for a policy that fits your needs. It helps to start by asking yourself two key questions.

How much life insurance do I need?

It's always best to work with a financial professional to get a detailed answer – but for a good starting point, consider these rules of thumb for calculating how much life insurance coverage you need:

1. Multiply your income by 10

Take your annual salary, add a "0" at the end, and there's your amount. $50,000 salary equals $500,000 coverage, $75,000 equals $750,000, and so on. While this estimation method is very simple, it doesn't take into account your true expenses and needs. That leads us to the next formula, which is just a bit more complex.

2. Multiply your income by 10 – and add college for each child

This approach gives you the added reassurance of knowing your children can have more opportunities. How much should you add? Account for somewhere between $100,000 and $150,000 per child. If you split the difference – and have two kids – that's an extra $250,000.

3. Use the DIME formula.

DIME stands for Debt, Income, Mortgage, and Education – the four significant factors to consider when making a detailed estimate of your life insurance needs:

Debt: Total all your debts other than your mortgage – car payments, credit cards, student loans, even personal obligations such as money you may have borrowed from family. And don't forget to add about $7,000 for funeral expenses.

Income: Take your salary and multiply by the number of years you think your family needs protection – or at least as long as you have children at home.

Mortgage: Look at your last statement and get the payoff amount. If you have a 2nd mortgage or HELOC (Home Equity Line of Credit), add that in as well (if you haven't already included it in the debt section above).

Education: The anticipated cost for sending each of your children to college: between $100,000 and $150,000 per child.

Add those four factors up, and that's the amount of coverage you need. If you already have some life insurance (for example, through work), you can subtract that from your coverage amount. This method takes a little more work, but it's also more precise – which can help you feel more confident that your family will be taken care of.

Consider the Human Life Value Formula.

Some financial representatives calculate the amount you need using the Human Life Value philosophy, which is your lifetime income potential: what you’re earning now, and what you expect to earn in the future.

In its simplest form, the philosophy suggests that you multiply your income by a variable based on factors such as age, occupation, projected working years, and current benefits.

As with every individual, the amount of recommended insurance you purchase depends on many factors. A simple way to get that number, however, is to multiply your salary times 30 if you are between the ages of 18 and 40. The calculation changes based on your age group, so please refer to the chart:

Age  Insurance amount
18-40    30 times income
41-50    20 times income
51-60   15 times income
61-65     10 times income
66-70     1 times net worth
71-75     1/2 times net worth

Do I want temporary coverage or permanent coverage?

While term life insurance typically provides the most coverage per premium dollar, permanent life insurance can offer additional benefits. A term life policy can provide protection, but chances are you'll pay premiums for many years, and you may live longer than your polify term. On the other hand, a permanent policy, such as whole life insurance, provides:

  • Life-long coverage
  • A tax-advantaged cash value component with guaranteed growth
  • Tax-advantaged access to the policy's cash value
  • The confidence that you and/or your beneficiaries will receive a death benefit

Whole life typically costs more than term life,  but the policy's cash value can provide several benefits that you can use while you're still alive: You can borrow against it, use it to pay premiums, or even use it for cash to live on in retirement. With a mutual company, such as Guardian, whole life policies can also earn annual dividends (a portion of the insurer's profits), which can further increase your cash value and provide other benefits. That's why many people feel this type of policy can offer more value than a term life policy with no cash value component – and no financial protection for your family once the term ends. If you decide to get another term policy at that point, you'll need another medical exam, and your rates may be considerably higher.

If the benefits of permanent life insurance are attractive to you, but the premium cost is a barrier, consider looking into a universal life policy. It's a form of permanent insurance that offers the cash value and lifetime coverage benefits of whole life with a key difference: the premiums are variable. With a universal policy, you can raise or lower your premium payments as you see fit within the policy's limits7. While paying in less could eventually result in the need to pay higher premiums to keep your coverage, this type of policy can adjust to your life circumstances while providing the same kind of cash value growth as whole life.

How to take the next step

If you can purchase group life insurance through your employer or a member association, that can be a place to start. You can get a basic level of coverage at attractive rates – but don't assume it's enough. If you don't have workplace coverage – or you want to supplement it – it's easy to shop for term life coverage online. Many companies, including Guardian, make it simple to compare rates by giving you an instant online quote.

On the other hand, if you're not sure what kind of protection may be best for you, that's completely understandable. Life insurance is one of the most consequential financial purchases you can make – and it's worth taking the time to look into all your options to get an individual policy that rounds out your coverage needs. If you have a financial professional you trust, talk to them about your needs. If not, Guardian can connect you with a financial representative who will listen to your needs, tell you about the best ways to meet those needs within your budget, then help you decide. 

Learn more about how to buy life insurance.

Term life insurance calculator

Figure out how much you may need and what it could cost

Frequently asked questions about life insurance companies

How are life insurance companies rated?

Life insurance companies are highly regulated to ensure their solvency so that they can pay their obligations to policyholders. In addition, independent ratings agencies such as A.M. Best, Standard & Poor’s, and Moody’s evaluate their financial positions and issue financial strength ratings

Are there meaningful differences among the big national life insurance companies?

The largest insurers are financially sound and can provide a range of permanent and term life insurance products to fit most needs. Even so, some are more financially sound than others, some have a reputation for providing better customer service, and some tend to have fewer customer complaints, which can indicate that they are easier to work with and may provide a higher quality customer experience.

What are the three types of life insurance?

The three main types of life insurance products are term life, whole life, and universal life:

  • Term life insurance – a policy that covers you for a limited amount of time (typically between 10 and 30 years) without building cash value
  • Whole life insurance – permanent coverage that builds cash value at a guaranteed rate with premiums that stay the same for life
  • Universal life insurance – permanent coverage that builds cash value while giving you the flexibility to raise or lower premiums within certain limits

Which is better, term or whole life insurance?

There is no "best life insurance"; both types of products have value. Whole life insurance provides permanent life-long protection with a tax-advantaged cash value component that grows over time. A term policy provides coverage for a limited term without this added component, so it is typically more affordable.

How much does a $1,000,000 life insurance policy cost?

The cost of life insurance products varies greatly depending on the type of coverage, the insured's health status (as determined by a medical exam), and other factors. Having said that, many people overestimate the cost and are pleasantly surprised by how affordable life insurance can be. For example, a healthy 30-year-old male can get a $1,000,000 Guardian Level Term policy for 20 years, with a monthly premium of just $61.

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Disclaimer

1 All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company. Policy loans and withdrawals affect the guarantees by reducing the policy’s death benefit and cash values.

2 Some whole life polices do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more information.

3 Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.

4 Financial information concerning Guardian as of December 31, 2020, on a statutory basis: Admitted Assets= $68.1 Billion; Liabilities = $60.3 Billion (including $48.9 Billion of Reserves); and Surplus = $7.8 Billion.

5 Riders may incur an additional cost or premium. Riders may not be available in all states.

6 Dividends are not guaranteed. They are declared annually by Guardian’s Board of Directors.

7 Universal Life Insurance may lapse prematurely due to inadequate funding (low or no premium), increase in cost of insurance rates as the insured grows older, and a low interest crediting rate. This does not apply to universal life policies which have a secondary guarantee, but if the secondary guarantee requirements are not met the policy will most likely lapse.

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