The Essentials of Life Insurance

Life Insurance Defined
Insurance providing for payment of a sum of money to a named beneficiary upon the death of the policyholder. In other words, it is insurance of a risk (death) to replace the financial loss suffered by those dependent on the deceased.

History of Life Insurance
Life insurance is nothing new, its history spans back several hundred years. The original policies were simple term insurance policies. The contract was for the term of one year. Each year it renewed, with an increased premium because the person was a year older, and presumably closer to death.

To address this increasing premium dilemma—the older you became the more difficult it was to pay the premiums. About 100 years ago, insurance companies issued policies that insured for entire lifetimes (hence the term “whole-life”) with a level premium, which means the premium payments did not change. These whole-life policies have a cash value that provides the ability to borrow or access cash values.

Historically, life insurance existed to pay the cost of the funeral and last expenses, such as debt. Most people could not afford to purchase a policy that provided for much more. Neighbors and relatives pitched in to help after a death. Churches, Widow and Orphan Societies, and Fraternal Organizations were social service organizations that also helped.

The later part of the last century witnessed an explosive evolution in the life insurance industry. The reason is simple: The rapidly evolving post WWII society. Life insurance rode the wave of the biggest population growth ever seen. Our society has changed from agricultural to industrial and white-collar. People are living longer with vastly larger incomes and savings. Life insurance has evolved to keep pace with the ever-changing needs driven by all of this change.

The Special Treatment of Life Insurance
Life insurance is not only unique because it provides a sum of money when you die; it receives special treatment by the tax code and regulatory agencies. This has provided opportunities for insurance companies to provide a wide array of options. These diverse options confuse many consumers.

Tax Code: Life insurance has historically been an “insurance” product. Meaning it existed for safety and security. Therefore, the insurance industry has always been successful at maintaining favorable tax status, meaning they could lobby for continued favorable tax treatment. They have found it easy to appeal to legislators in Washington DC to keep life insurance from being threatened by tax law changes.

Life Insurance’s favorable tax status includes a tax-free death benefit, tax-deferred cash value accumulation, and tax-free borrowing of cash value (as long as the policy is not a modified endowment contract that remains in force until death).

Regulatory Agencies: The insurance and securities regulatory agencies provide life insurance companies an advantage over providers of other investments: Insurance companies can provide sales literature with futuristic computer illustrations of cash values.

Types of Life Insurance: An Overview
The simplest way to illustrate the different types of life insurance is to compare them on a grid.

Insurance Brief Description Advantages Disadvantages Other
Term Lowest initial premium. Most financial experts and commentators recommend term as the best alternative for most people. Low initial cost leaves more cash flow available for other financial planning needs. No cash value buildup. If someone wants to continue it for a long period of time, the cost will be high. Premium can go up annually or be guaranteed level for 5, 10, 15 and 20 years or longer to match the length of time you need the protection.
Universal Life Can provide protection for a longer period of time than term, and build up cash value. Not as expensive as variable universal and whole life, but may provide life insurance for a longer period of time than term and provide cash value for borrowing (or if surrendered). Higher initial cost than term insurance. Cash value accumulation may not be a good investment. There are many variations of universal life available today. For example, some have a low premium for a long period of time but with little cash value, while others are designed for cash value growth.
Variable Universal Life Same as universal life except that it allows for the cash value to accumulate in separate sub-accounts. In addition to the features mentioned for regular universal life, it also allows for accumulation of cash value growth potentially higher due to sub-account options. Cash value may have fewer guarantees than universal life and whole life. The policy’s internal charges can be quite high. Some proponents of this insurance promote the tax advantage opportunities for growth and income.
Whole Life Highest premium life insurance available, most types provide guaranteed protection for lifetime and cash value buildup. Maximum guarantees. High premium not affordable to many. High net-worth people sometimes utilize whole life insurance to help pay for their estate taxes. Universal and Variable universal are also used for this purpose.
This is a very brief synopsis to aid in your insurance education. There may be exceptions to some of these generalizations due to state regulations and insurance company policy design.


  1. Evaluate Life Insurance Needs: Only purchase additional life insurance if you have a need for it. First examine the amount of life insurance that you need to provide for those financially dependent on you. A later blog will discuss various means for calculating your needs, younger families often use the rule of thumb of the death benefit should equal 10 times income, but you should talk to a financial planner, use planning software like eFinPLAN or use an insurance professional to help you arrive at the right amount for you.
  2. Purchase Life Insurance for Protection: The first priority for purchasing insurance should be for protection. It is most important that people, who need insurance purchase it and start their coverage without delay. At the very least, procure term life insurance with an appropriate death benefit, and term period, at a competitive premium. Term insurance provides the most economical decision for most middle-income people today. Most financial experts and commentators recommend term insurance for most people since it provides the most amount of protection at the lowest cost, enabling you to save and invest.
  3. Purchasing Cash Value Life Insurance: The decision to purchase cash value life insurance should be made in tandem with the outcome of your financial plan. Most people’s first priorities are the proper funding of their retirement and other plans. After people have implemented the proper action steps in their financial plan, they may want to consider cash value life insurance for longer term needs. Seek advice from a trusted financial professional to help evaluate the appropriate options. A close examination of a contract should include not only attractive illustrations and sales literature, but a thorough analysis of their prospectuses and fully disclosed information. Insurance agents should provide best, good and worst case illustrations. Remember insurance agents are paid vastly more commission for permanent cash value insurance, so some may feel pressure to sell this.
  4. Life Insurance as an Estate Planning Vehicle: People with large net worth may want to consider life insurance as a viable legacy planning tool to aid in liquidity and estate and tax planning. They should consult their estate planning attorneys and financial planners for direction.