There are many different types of life insurance policies.
In fact, they can be so different from one another, they could be thought of as completely different financial products.
The life insurance industry has designed many different policies to better accommodate the needs of consumers.
Before buying a life insurance policy, you should make sure it’s the type that will best provide for your specific needs.
What Are The Different Types of Life Insurance Policies?
While there are many different types of life insurance policies, in this guide, we’re going to focus on eight of the most popular:
- Term Life Insurance
- Whole Life Insurance
- Universal Life Insurance
- Indexed Universal Life Insurance (IUL)
- Variable Life Insurance
- Variable Universal Life Insurance (VUL)
- Simplified Issue Life Insurance
- Guaranteed Issue Life Insurance
Term Life Insurance
Term life insurance may very well be the most popular policy type there is.
There are several reasons why this is true, cost being perhaps the most important.
But before we get into that, let’s first take a look at what term life insurance is and what it can do for you.
Term life insurance is sometimes referred to as “pure life insurance.”
Unlike most of the policy types, we’ll be digging into, term life insurance does little more than provide life insurance.
It is also the easiest to understand.
The purpose of the policy is a fixed death benefit for a specific term. For example, policies typically have terms ranging from 5 years to 30 years.
If you die within that term, the death benefit will be paid to your beneficiaries.
However, if you don’t die before the end of the term, the policy will simply expire, though many term policies do provide for automatic renewal after the original term expires.
For example, when a 20-year term policy expires, you may have the option to renew your coverage annually, or in increments of five years at a time.
Now there is a catch with the renewal.
While your premium payments will remain constant during the original term of the policy, they’ll increase at renewal.
That’s because the new premiums will be based on your age at the time of renewal.
If you purchased the original policy as a 20-year term when you were 25, the new premium will be based on your age at the time of renewal, which will be 45.
Term Life Insurance Pros:
- Term is the cheapest type of life insurance, costing only about 1/10 as much as an equivalent amount of whole life insurance coverage.
- Because it’s cheaper, you can purchase a larger amount of coverage.
- Term can be customized to your needs at the time—you have large amounts when you have young children, then reduce the coverage when they’re adults.
Term Life Insurance Cons:
- Even though you can convert your policy at the end of the term, the premium will be considerably more expensive than the original.
Whole Life Insurance
Whole life insurance is a type of permanent life insurance.
That’s because, once you sign up for a policy, it can’t be canceled except for nonpayment of the premium.
It won’t even matter if your health deteriorates after signing up for the policy.
You can literally maintain a whole life insurance policy for the rest of your life.
Meanwhile, both the death benefit of a policy and the annual premium will remain fixed.
But perhaps what most distinguishes whole life from term—is that it offers a cash value.
In that way, whole life insurance adds a savings provision to your life insurance coverage.
While you’re making your premium payments, some of the money is going toward the life insurance coverage, but the rest goes into your cash value.
That will build over time and even comes with an interest rate.
Moreover, the interest accumulation on your cash value builds up on a tax-deferred basis, much like an IRA.
As the cash value grows, it can either be withdrawn or taken as a loan while you’re still alive or paid out to your beneficiaries upon your death.
Whole Life Insurance Pros:
- Your policy will remain in force for your entire life.
- The premiums will never increase.
- The cash value provides a forced savings plan in conjunction with your life insurance coverage.
Whole Life Insurance Cons:
- Whole life insurance is about 10 times as costly as term insurance.
- There are several fees connected with the policy, including surrender charges if you cancel the policy and withdraw your cash value.
- Cash value accumulation is notoriously slow in the early years to cover the cost of administrative fees and commissions.
- All life insurance cash values generally provide poor investment returns.
Universal Life Insurance
Universal life insurance is most closely related to whole life insurance, except that it provides options that can change the terms of the policy, even after it’s in force.
For example, though it provides a cash value, you can adjust the premium allocation.
You can choose to increase the death benefit and lower the cash value accumulation, or vice versa.
And if your cash value is high enough, some of the funds can be allocated to pay your policy premiums.
However, you’ll need to maintain a certain minimum cash value in the policy at all times, otherwise, it can be canceled.
But in one major departure from whole life insurance, universal life provides a variable interest rate return.
The rate will be based on a recognized index and adjusted higher when the index rate rises, and lower when it falls.
Universal Life Insurance Pros:
- Gives you the ability to adjust the death benefit and your cash value.
- Interest rates adjust based on prevailing rates.
Universal Life Insurance Cons:
- Universal life is a complicated policy type.
- Your interest rate return will drop with prevailing rates; there is no guaranteed rate of return.
- It’s possible that the policy will be canceled if you deplete the cash value.
Indexed Universal Life Insurance
Indexed universal life is a variation of universal life insurance, as discussed above, but adds more of an investment angle to the policy mix.
The keyword in the title is “indexed.”
That’s because the investment return within the policy is loosely based on common investment indexes, like the S&P 500 index.
In that way, the interest rates paid on your policy will more closely approximate those of the financial markets.
But even though investment returns are correlated with specific indexes, they don’t match exactly.
The policy may use the performance of the S&P 500 index as a basis for calculating returns in the policy.
The policy will come with both caps and floors on your return.
For example, if the policy has a cap of 8%, that’s the most you’ll be paid even if the S&P 500 increased by 15% during the year.
But if it has a floor of 2%, you’ll be paid that rate even if the S&P 500 index falls by 10%.
In a way, it limits your gains, but it also prevents catastrophic losses.
IUL Insurance Pros:
- Gives you the ability to participate in a higher return based on the performance of the financial markets.
- Returns will be higher than those on whole life and universal life policies during times of multiyear growth in the financial markets.
IUL Insurance Cons:
- Returns will be lackluster if the selected index enters a multiyear bear market.
- This is another example of a complicated life insurance product that is not easily understood and may include multiple fees.
Variable Life Insurance
Variable life insurance takes indexed universal life insurance to a new level.
Rather than basing the return on your cash value on a single investment index, a variable life insurance policy can use several.
For example, you have a basic life insurance death benefit, but your cash value will be invested in several insurance company-sponsored mutual funds.
These are funds managed by the insurance company that doesn’t trade on public exchanges, but they work in much the same way as publicly traded funds.
As is typical of life insurance cash values with investment provisions, your cumulative investment returns grow on a tax-deferred basis.
And since you’ll be invested in multiple funds, you may get a higher return than other cash value policies that only pay interest.
The downside is that the investments within a variable life insurance policy can lose money.
Variable Life Insurance Pros:
- There’s real potential to outperform fixed-interest investments.
Variable Life Insurance Cons:
- Investments held within the policy have a risk of loss.
- You can’t choose the specific funds your cash value will be invested in; the insurance company does that.
Variable Universal Life Insurance
Variable universal life insurance is another type of universal life insurance, one that adds features of variable life policies.
Just as the name implies, variable universal life insurance allows you to adjust the premium and the death benefit of your policy.
Just as is the case with a variable life insurance policy, you can change the allocation of the premium to add or subtract contributions to the cash value.
Otherwise, it works with the investment format of a variable life insurance policy, investing your cash value in multiple fund options.
In fact, after reading the terms of variable universal life insurance and its similar namesakes, you’ll begin to appreciate the saying, “buy term, and invest the difference.”
That is, it’s much simpler to buy a term life insurance policy and put the additional savings into a mutual fund or exchange-traded fund than to take on one of these policies.
VUL Insurance Pros:
- There’s real potential to outperform fixed interest investments.
- You can adjust your premium between the amount of death benefit and cash value contribution.
VUL Insurance Cons:
- Investments held within the policy have a risk of loss.
- You don’t get to choose the specific funds your cash value will be invested in; the insurance company does that.
- This is a complicated policy with multiple provisions and fees.
Next, we’re going to move into the different types of life insurance policies designed for very specific circumstances.
Simplified Issue Life Insurance
Though this policy type can go by that exact name, it’s also frequently known as a “no medical exam policy“.
Basically, it’s a type of life insurance that can be issued without requiring the applicant to undergo an insurance medical exam.
It’s generally constructed as a whole life insurance policy.
Since no medical exam is required, the policyholder is a greater risk to the insurance company.
After all, without the medical exam, it’s possible an applicant can have undiscovered health issues.
For that reason, life insurance companies typically charge a higher premium on simplified issue life insurance.
Put another way, this isn’t the type of policy you want to apply for if you’re trying to minimize the premium you’ll pay.
There’s another factor that gives this policy type limited value.
Even though the insurance company doesn’t require a medical exam, you will be qualified based on your health.
Insurance companies can and do regularly access third-party databases including the Medical Information Bureau, or MIB, which is something like a credit bureau, except to keep records of your health history.
Insurance companies can also access your driving history through your state’s department of motor vehicles, as well as criminal records and other information sources.
If they turn up any information indicating serious health conditions, your application may be declined.
Even though there is no medical exam required, this isn’t the type of life insurance policy that will cover someone who has serious health conditions he or she doesn’t want to disclose.
Simplified Issue Life Insurance Pros:
- As a whole life insurance policy, you’ll have a fixed premium, level death benefit, and cash value accumulation with permanent coverage.
- May be a good policy choice if you simply don’t want to submit to a medical exam.
Simplified Issue Life Insurance Cons:
- More expensive than fully underwritten policies, especially term coverage.
- You may not be approved even if you don’t submit to a medical exam.
- It may be better (and cheaper) to apply for a fully underwritten policy, especially with smaller death benefits. With a lower death benefit, the company may not require a medical exam anyway.
Guaranteed Issue Life Insurance
This is a better life insurance policy type if you’re worried about being turned down for health conditions.
Not only does the policy not require a medical exam, but you don’t have to answer any health-related questions on the application.
It is possible to be turned down for guaranteed issue life insurance, if the company determines your health condition to be terminal, once again, based on information derived from third-party databases.
However, nearly all other applicants will be approved.
This is why guaranteed issue life insurance is sometimes referred to as final expense insurance or even burial insurance.
As it is a type of life insurance policy available for those who can’t qualify for traditional coverage.
But that’s not the only reason why guaranteed issue life insurance is sometimes called final expense or burial insurance.
Because the policies carry such high risk, insurance companies strictly limit the death benefit.
A typical policy death benefit will be available for no more than $25,000, and you may even be offered a lower amount.
The premiums are also extremely high. For example, you may pay $5,000 per year for a $25,000 policy.
These policies also come with what’s known as graded death benefits. That’s where the company will limit payment of the death benefit in the first two years of the policy.
For example, the policy may pay no death benefit in the first year, 50% in the second year, and 100% after the first two years have passed.
Guaranteed Issue Life Insurance Pros:
- As a whole life insurance policy, you’ll have a fixed premium, level death benefit, and cash value accumulation with permanent coverage.
- Designed specifically for applicants in poor health.
Guaranteed Issue Life Insurance Cons:
- This is easily—and by far—the most costly type of life insurance.
- You can be turned down if your health condition is determined to be terminal.
- Even if you’re accepted, benefits will be either limited or even non-existent in the first two years of a policy.
- The death benefit of most policies will do little more than pay final expenses, with little left over for your loved ones.
Which Type of Life Insurance Policy Is Best For You?
As you can see, there are many different types of life insurance policies to choose from.
Many are designed to provide for a specific need or set of needs. You can choose whichever you believe will work best for you.
But you should also be aware that not all insurance providers offer all eight types of life insurance policies discussed here.
Many companies today specialize in specific policies, particularly term life insurance, but also guaranteed issue policies.
The established, well-known insurance companies are the ones most likely to provide all the different types of life insurance.
And if you’re considering variable or universal policies, you’ll want to get side-by-side quotes from multiple providers.
The terms, returns, and premiums can vary substantially from one insurance company to another.
