Ever been approached by an insurance agent who offered you insurance that you never really understood? I’m sure it happens a lot. More often than not, we get insurance because of the following reasons: the insurance agent is a good friend and we didn’t want to turn him down or we thought it was an investment. So in this article, let me try to give the low down on some basic concepts about life insurance.
There are 2 major types of life insurance: ordinary life (OL) and variable unit linked (VUL).
Ordinary Life Insurance. There are 2 types of insurance products that are classified under OL: traditional life insurance and endowment.
For traditional life insurance, living benefits come in the form of cash surrender values and/or dividends. Cash surrender value is the monetary amount that you would get in case you surrender your life insurance before the policy’s maturity. Usually cash values start accumulating by the 3rd or 4th year. Thus, it will take a while before the cash values grow bigger than the total premium you are paying for. Policy owners can also take loans from cash values of their OL policies. Dividends, meanwhile, are the non-guaranteed cash benefits given to policy holders depending on the insurance company’s performance. The cheapest type of traditional life insurance is a term insurance where one is covered for a certain period of time or up to a certain age only. Term insurance has no cash values nor is it participating in any dividends distribution. However, term insurance can be converted to a traditional life insurance.
Aside from the traditional life insurance, endowments are also classified as an OL product. Endowments are different from traditional life insurance in that after paying premiums, you can periodically receive cash benefits after maturity. It is a good tool for forced savings. Returns are guaranteed but interests in the returns are most often lower than inflation.
OL products also have non-forfeiture options in case you’d like to surrender your policy before maturity and different settlement options for claims.
Variable Unit Linked. VUL insurance products are probably the most famous insurance product these days. A VUL is an insurance product with an investment component. It is like a term insurance and a mutual fund combined into just one product. Similar to OL, there is a fixed minimum death benefit or face amount. However since VULs have an investment component, the death benefit can grow as your investment grows.
Unlike OL products, VULs don’t have cash surrender values nor dividends. In VULs, a portion of your premium buys you units which have equivalent value called the Net Asset Value per Unit (NAVPU). The NAVPU changes on a daily basis, thus if you multiply your units by the NAVPU, you will get the actual value of your investment or the account value.
A policy holder can regularly add to their investments to their VUL on top of the premium they are paying. These additional investments are called topups.
Usually there are three types of funds where you can invest in: equities fund, balanced fund or bond fund. Since these are investments, the returns you can get are not guaranteed but you can potentially earn from 4%-15% annually from your investment. Policy owners can also withdraw a portion of their investments, but can incur withdrawal charges usually within the first 5-10 years depending on the product. Note though that even if some VULs are considered limited pay, cost of insurance will still be deducted from your account values. It is advised to make regular top-ups so you won’t deplete your account values. Once the account value becomes zero, the policy lapses.
For both OL and VUL, one can also additional coverage that are called riders. Every insurance product can have different riders. These riders can come in the form of additional insurance coverage for death via accidents and disability due to accident, waiver of premiums in case of disability, critical illness coverage and a lot more.
Having insurance is an important aspect of personal finance and understanding the different types of life insurance products is just one step in picking the right one for you. In case you already have one, it might be a good idea to review its features and see what type of insurance you got. In case you’re looking for one, remember that the key to picking the best insurance product for you is making sure it addresses your needs and is aligned to your goals.
*Published in Business Mirror – September, 2014