What is a life insurance policy?

A life insurance policy is a contract between an insurance company and a policy holder (insured) to pay out an agreed amount to the insured's beneficiaries (usually family) upon the death of the policy holder. The policy holder agrees to pay premiums as calculated by the insurance company.

Life insurance policies are purchased to protect the surviving family members from the loss of income that would occur as a result of the death of a family member.

There are two types of life insurance policies, permanent and term.

Permanent Insurance Policy:

Permanent policies are more expensive and complicated than the term policy. Permanent insurance remains in effect for the policy holder's lifetime (as long as the premiums are paid as agreed by the policy terms and conditions). In addition to paying out death benefits, it provides investment opportunities. A permanent policy's value increases over time and the insured may borrow against the accrued value of the policy. This increase in cash value is tax deferred until the money is drawn.

There are three types of Permanent life insurance policies.

Whole: Whole life policies are traditional permanent insurance that accrues cash value over time. Most whole life insurance policies pay dividends to the policy holder.

Universal: Universal life insurance polices are more flexible than the other permanent policies. It allows the policy holder to change the amount of insurance and premiums as financial needs change (subject to insurance company underwriting terms and conditions).

Variable: With variable life Insurance policies, the death benefit and the value of the policy are based upon the performance of a separate investment fund. Most policies guarantee that the death payout will not fall below a certain minimum, however the cash value of the policy is not usually guaranteed. There is more risk involved with Variable policies.

Term Insurance Policy:

Term is the most basic and least expensive form of life insurance policy. The term policy remains in effect for a designated period of time. The term can be anywhere from 1 to 30 years. There is a set premium and a set death benefit pay out amount. If the policy expires prior to the death of the insured, the insured may either renew the policy for a specified term or let it expire.

With term policies there is the option to convert to a permanent policy. Sometimes an insured may not be able to afford the more expensive permanent life policy initially. As they become more established and their career and their financial situation improve, they may opt to upgrade their term to a permanent life insurance policy . The upgrade does not require the policy holder to undergo an additional physical examination.

The underwriting guidelines for the various insurance companies differ, so shop around and do your homework before purchasing a life insurance policy.