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 "pure life insurance" because, unlike permanent life insurance, there's no cash value to the policy – once the term is over, there's nothing left. However, term is typically less expensive than permanent life insurance.
- Permanent life insurance provides coverage that lasts your entire life.1 Unlike term, it's not a "pure life insurance" product because it includes a wealth-building component – the policy's cash value – which helps make coverage last indefinitely while providing other financial benefits.2 A portion of your premium dollars are invested by the company, and your cash value grows tax-deferred over time – but the entire death benefit is immediately payable from the first day you have the policy.3
There are two types of permanent life insurance: whole life4 and universal life.4 Whole life insurance is simpler – the premium remains the same for life, the death benefit is guaranteed, and the cash value grows at a guaranteed rate. Universal life insurance can be less expensive, but the premiums, death benefit, and cash account growth rates can vary, making the policy more complex.5
Life insurance contracts (most states consider the contract to include both the life insurance application and policy) typically have a "definitions" section that defines the specific terms that appear in the policy. Many terms may seem like common words, but their definition in an insurance context differs from how you use a word in everyday conversation. So, it's a good idea to read through this section before reading the rest of the life insurance contract.
Here are some key terms that are typically covered, but be aware that your specific life insurance contract may define them somewhat differently:
- Beneficiaries are the people (or entities) who will receive the death benefit if and when the insured person dies. Life insurance policies can have one or more beneficiaries, and the policyholder can customize the allocation of the overall benefit by person.
- Cash value refers to the component of a permanent policy that builds wealth over time and can be cashed out or borrowed against.6 Term life insurance has no such value.
- Coverage Date or Policy Date is the date the life insurance became active.
- Death benefit is the dollar amount that the insurer will pay when the insured dies.
- Insurance age may refer either to the insured's actual age at the time of the policy or the insured's nearest age (e.g., if the insured is about to have a birthday, the insurance age may round up) depending on the insurance provider.
- Insured is the person who is covered by the life insurance contract.
- Insurer refers to the organization providing the life insurance contract. States regulate life insurance companies quite closely to make sure they are able to pay their obligations for many years into the future.
- Level premiums refers to premium payments that stay the same throughout the policy's life. Both term and permanent policies can have level premiums.
- The policyholder is the person or entity (such as a family trust or a business) who is paying for the policy. The policyholder can be the person who is insured, or it could be another person, such as a parent or spouse.
- Policy length is the period of time that the life insurance contract is in effect, meaning that if the insured dies during that period, the insurer will pay out a benefit. This can be a specific period, or "term," -- e.g., 10 or 20 years -- or it can be a policy that lasts for the life of the insured ("permanent" policy).
- Policy loan is the value of a whole life or universal life policy that you can borrow against.
- Premium is the monthly or yearly payments needed to keep the life insurance contract in effect.
- Variable premiums refers to premiums that will change over time. The policy should include a chart that indicates how this will change.
Your life insurance contract begins with a detailed summary of the coverage and details about the insured. Typically, page 1 will give you the insurance provider's name, the type of policy plan you are purchasing, the insured's name, and the name of the policy owner.
Many life insurance policies have a trial period. This is sometimes called a "free-look period" or "right to return." Depending on the provider and the policy, you may have the ability to cancel your policy without penalty within a certain period, typically 30 days or less.
This section goes over your schedule of benefits and may take a few pages to cover. It will include several key pieces of information:
- Your personal information - Make sure to double-check everything for errors.
- Policy number - The unique number given to your life insurance contract.
- The policy type - This will say whether it is term life insurance or permanent life insurance and more specific information, such as 10-year term, universal life, etc.
- Benefit amount - Sometimes also referred to as the "face amount," this is the dollar amount that will be paid if you die.
- Premium amount - How much is owed to the insurer per month or per year for life insurance coverage.
- Policy issue date - When the life insurance contract was issued.
- Risk class - The insured is assigned a "risk class" based on their medical exam (and/or medical history), tobacco use, and possible other determinants.
- Attached riders - These are extra conditions and/or benefits added to a policy.
- Beneficiary - The person(s) or entity(ies) that will receive the life insurance benefit if the insured dies.
Life insurance policies are documents filled with a lot of dense language. While it may be a bit of a chore, it's worth your while to review the contract completely so that you understand your life insurance coverage and how the policy works. As you read through your policy's details, take note of the following sections:
- The ownership section outlines the policy owner's rights to change beneficiaries or borrow against the cash value (for a permanent insurance policy). It also explains if the policy owner can transfer the policy or convert a term policy to a permanent life policy.
- The contestability period refers to a specified amount of time when the insurer confirms your personal information and policy. Certain findings, such as misrepresentation by the insured or incidents (such as suicide) during the contestability period, may lead the insurer to contest or deny claims. Most policies have a two-year contestability period.
- The premiums section provides details about the policy premiums and payments, including the length of the grace period before the policy cancels and if a policy can be reinstated. Most policies provide a 31-day grace period, then the policy lapses. Many life insurance policies will allow the insured to reinstate the policy if it lapses; others won't. The premium section should include this and explain what conditions must be met to reinstate a lapsed policy, if any. Additionally, the premium section will outline how much you pay. Some life insurance policies have premiums that are level (i.e., they don't change), while others have variable premiums. For those with variable premiums, the policy will include a table of how much premiums will be over time.
- The death benefit section defines the benefit details, including how beneficiaries will make a life insurance claim after the insured's death.
- Exclusions refer to situations that could limit or invalidate payment of the policy benefit. For example, most life insurance policies won't pay out if the insured commits suicide during the contestability period. In addition, misrepresentation of information during the application process may also limit or void payment and potentially be considered insurance fraud.
Table of Illustrations illustrates how the policy's cash value, premiums, and/or death benefits may change over a time period or at specific interest rates. If you are buying permanent life insurance that builds value, you may want to review this part with your financial professional.
The riders section will explain what each one is.7 Examples of common riders include:
- Disability income rider replaces a portion of the insured's income if they become disabled and cannot work.
- Waiver of premium rider allows the policyholder to stop paying premiums for up to 6 months if they become disabled and cannot work.8
- Term conversion rider allows a term policy to be converted to permanent life insurance before the end of the term.
- Accelerated death benefit rider pays out a portion of the benefit amount to cover costs associated with a terminal illness.
- Critical illness rider pays out a lump sum that is subtracted from the benefit amount if the insured becomes critically ill.
When you receive your life insurance contract, your financial professional should sit down and go over these main sections with you. However, it's still a good idea to read through the entire policy yourself, so you have a thorough understanding of how it works. Then, if you have questions, contact your life insurance professional. Financial professionals should always be willing to clarify any questions you may have.
How do you read an insurance policy?
Life insurance policies are full of terminology that can seem like jargon. Be sure to use the definitions portion of the policy to make sure you understand the essential terms used in the document. Review the complete document, double-checking any data about the insured, policyholder, and beneficiaries. Then pay special attention to things such as the policy owner's rights, the premiums section, and any exclusions that the insurer may have.
What is a life insurance policy statement?
It is a type of form that outlines the policyholder's coverage, confirming that the insured was covered starting on a specific date.
How does a whole life policy work?
Whole life policies provide insurance protection for life, or at least to a specific maximum age, which these days is 100+ for new policies. Whole life premiums never change. They also build tax-deferred cash9 that can be used later in life, either as a loan or a withdrawal.
What is included in a policy summary?
This outlines key items in the policy, such as the insured and policyholder's information, the type of policy, the premium amount, the benefit amount, any coverage limitations, a list of riders, beneficiaries, and other vital components to the policy.