The death of a loved one is not only emotionally devastating, but can also lead to financial challenges for surviving family members. This is particularly true when the deceased was the primary income earner in the family. Funeral and burial expenses are unavoidable, but when also faced with home mortgages, living expenses, and children's educational fees, survivors may find themselves struggling to make ends meet. A life insurance policy, which often serves to replace the deceased wage earner's income, can protect you and your loved ones from facing such a situation.

Life insurance is a contract between an individual (policy owner) and an insurance company (insurer). The policy owner agrees to pay periodic premium or lump sum in exchange for the insurer's promise to pay a particular sum of money (death benefit) to certain individuals (beneficiaries) upon the death of a specified person for whom the policy is purchased. The person covered by the life insurance policy (insured) may or may not be the policy owner. But, for purposes of this book, we will assume the policy owner and insured are the same.

Life insurance is needed anytime there is a situation where an income earner is responsible for the financial needs of another. In other words, if you do not have any dependents, you likely do not need life insurance. Also, you may not need life insurance if you are not responsible for making a significant portion of your family's income.

You should consider purchasing life insurance if you fall in one of the following categories:

• Parent. Parents are generally financially responsible for their children. In the case one or both parents pass away, the death benefit can help to cover housing, living, childcare, and educational expenses of dependant children.
• Couple. Even if they do not have children, couples typically need coverage. For example, the primary earning partner needs insurance to ensure the financial well being of the other partner in the case of death. Both partners may need insurance if they have significant outstanding loans and debts and to avoid depletion of the couple's savings if one partner dies.
• Single Adult. Coverage is essential if an adult is either a single parent or the primary supporter of another individual such as an elderly parent.
• Child. Children may need life insurance. The death benefit will pay for medical and burial costs.

As the list above makes clear, most anyone can identify a need for life insurance. Coverage will allow loved ones to avoid much of the financial hardship that may incur in the event of death.

There are primarily two types of life insurance that you can choose from, term or permanent.

• Term Life Insurance provides coverage for a specific period of time, typically from one to twenty years. The death benefit is only paid out if you pass away within the term of the policy. If the term ends before you die, you receive no return on the money that you paid for the insurance. The rates for term insurance are generally much lower than a permanent life policy. You usually want to purchase a term life insurance policy if you are planning on reaching a point where you will no longer need life insurance. For example, many people have term insurance until they have paid off all of their debts or they hit retirement. Term life insurance generally provides the largest immediate death benefit at the lowest premium cost.
• Permanent Life Insurance provides coverage for your entire life as long as you continue to pay your premiums. Along with providing for death benefits, permanent life insurance also has a cash value component. You have the option of cancelling your policy and cashing out the policy and the premiums that you have paid into the policy at anytime. Alternatively, if you continue to pay the premiums, you can opt to redeem or borrow part of the cash value, yet keep the policy in effect. Permanent life insurance generally has higher premiums than term insurance.

Within the term and permanent categories, you can select among various policy options in accordance with your immediate and long-term needs.

Term (also known as level premium) insurance is probably the purest of all of the life insurance policies. In exchange for payment of a premium, it provides a set death benefit for a beneficiary if an individual dies during a specified period of time. The maximum length of term life insurance policies is set at thirty years.

Here are two examples of term insurance in action:

• As a single mother, you have one child, age five. You want to make sure that no matter what occurs in your life that your child is able to go to college. You decide to take out a 20-year term policy (because, at 25, she would typically be past college age). You calculate that it might cost about $50,000 per year to educate her so, you determine a death benefit of $200,000 would be right.
• You are 54 and your spouse is 55. Your savings have depeleted due to financial challenges, although you and your spouse continue to earn. You might consider a 10-year term policy, which would cover your wife until she became eligible for social security. After calculations, you determine that to replace your income, comes out to $250,000 over a 10-year period. So, you take out a 10-year term, $250,000 death benefit policy.

Two points to remember about term insurance are:

• Protection - Once the term has expired (or the premiums are not paid), the policy is no longer in force.
• Cost - Term insurance is the least expensive life insurance policy. The premium depends on many factors like age, health, and length of term. However, for a 10 to 20-year term policy, with a $250,000 coverage amount, you might pay between $300 to $500 per year.

Below is a brief discussion of these types of term life insurance:

• Level Premium Insurance provides constant protection at a fixed premium rate over a specified number of years. In other words, the premium and the death benefit are guaranteed to remain the same over the life of the policy. Generally, the longer the term the premium is constant for, the higher the premium. This is because as you age, you become more expensive to insure, and a longer term must take those years into consideration.
• Increasing Premium Insurance provides a death benefit that increases over time at a fixed rate (usually 2 to 10 percent), as does the premium you pay. You will want to purchase this variation of term insurance if you expect your insurance needs to increase over time, i.e., the financial obligations protected by the policy will grow over the term of the policy. For example, you may opt to purchase increasing term life insurance if you are planning to have additional children in the future.
• Decreasing Premium Insurance provides a death benefit that decreases over time while the premium remains fixed over the term of the policy. You will want to purchase this variation of term insurance if you expect your insurance needs to diminish over time, i.e., the financial obligations protected by the policy will reduce over the term of the policy. For example, you may opt to purchase decreasing term insurance to cover a home mortgage that will continue to decrease.
• Annual Renewable Term (ART) Insurance provides protection that remains fixed over the term of the policy, which automatically renews at the end of each term regardless of your health and/or occupational changes; however, ART is subject to a premium increase each year as you age. Younger individuals may select this variation of term insurance because of its initial low cost, but should be aware that premiums become more costly as you grow older.
• Rate of Premium (ROP) Insurance provides coverage that offers a “cash back” feature that refunds 100% of the premium payments should you outlive the policy. These policies are significantly more costly — from 30-300% - than traditional term insurance. Insurance companies invest these additional dollars to pay for the refunds. Although only a small percentage of term polices purchased each year are ROP policies, this variation of term life insurance continues to increase in popularity.

If you purchase one of the above variations of term insurance, you may opt to add additional features to your policy. These include either a:

• Conversion Privilege, which permits you to covert from term insurance to permanent insurance during a specified period of time without having to prove insurability, e.g., good health; or
• Guaranteed Renewable Privilege, which permits renewal of the insurance policy without having to prove insurability.

There are a few points you should keep in mind when purchasing term life insurance:

• Less than 2% of term life policies are ever claimed.
• The term life insurance death benefit is generally tax-free.
• If you die in a certain countries (like the ones on US State Department's travel warning list), your life insurance may not pay out.
• Employer life insurance is generally not portable. So, the insurance ceases when you leave the job.
• You might be able to purchase life insurance instantly (without an exam) on the internet.
• You might be able to sell your expendable life insurance policy for cash.

Unlike term insurance, permanent life insurance (also known as cash value) stays in force for your entire life. That means that the death benefit will be paid whenever the insured dies. In fact, the policy generally matures when the insured turns 100 (although this can vary and be as high as the age of 121). At that time, if the insured is still alive, the full policy value is paid.

Permanent life has two features. First, like term insurance, it pays out a death benefit. Second, it introduces a new component to the policy, cash value. The policy accumulates cash. Cash that eventually returns to the policyholder.

That means that part of your premium goes to pay for the death benefit and the other parts builds up the cash value. The cash value adds turns life insurance into a tax-free investment vehicle in addition to insuring your life. It is very similar to a retirement plan asset. After some time and after some cash has accumulated, you can have access to the money.

Some points to note:

• If you decide to stop paying the premiums, you will receive the guaranteed cash value of the policy.
• The cash value can be used to continue the current life insurance benefit until it is used up.
• The cash value can be used to fund a reduced life insurance amount.
• You can borrow money using the cash value as collateral. The money can be used as a down payment on a house, to pay for college or to provide retirement income.
• If you borrow against the cash value, there are no specified repayment terms, so you may decide if and when to repay this loan in full. If you pass away before repaying the loan, then the insurance company will deduct the outstanding loan, plus interest, from the death benefit that is paid to beneficiaries.

Following is an example of how cash value works. This applies to all of the permanent life insurance policies:

• You purchase a permanent life insurance policy with a face value of $125,000. The premium is $100 per month. If the death benefit of that portion is $15, then the other $85 would go to the cash value portion. Interest would also be earned on that balance.
• However, for the first 2 to 3 years, that $85 is distributed for commissions and fees. After that the cash value portion of your policy would begin to accumulate. (Fees, expenses and commissions vary by policy. Check with your agent on the specifics of your situation.)

There are five major variations of permanent insurance that you may purchase:

• Whole Life Insurance provides coverage over your entire life. Whole life insurance (also called ordinary life) is the most popular type of permanent life insurance. It serves two purposes: first, it provides a guaranteed death benefit and second, it posts a guaranteed rate of return on any cash value. A guarantee also exists on the premium the policyholder pays, which is contingent on the insured's age at the time of purchase.
  
  Whole life insurance policies do not need to be renewed because, by definition, they are for your entire life, provided you continue to make premium payments.
  
  There are several types of whole life insurance policies that you may want to consider. The most common variations include:
  • Non-Participating, which disallows you to alter the death benefit, cash value and premium rates of the policy, thereby placing all investment performance risk on the insurer
  • Participating, which pays you a dividend if the insurance company earns higher than expected profits
  • Indeterminate Premium, which specifies a maximum premium below which premium rates will fluctuate in accordance with the insurance company's performance
  • Economic, which allows you to increase the value of the death benefit by debiting the cash value of the policy
  • Limited Pay, which allows the policy to be paid in-full, after which coverage continues but premiums cease
  • Single Premium, which is a single, lump-sum payment for the policy
  • Interest Sensitive, which retains the death benefit at a fixed dollar amount, but accrues interest at varying rates in accordance with the market and may have varying premiums that cannot exceed a policy stipulated maximum
• Variable Whole Life Insurance provides protection similar to traditional whole life insurance in that the premium remains fixed, but the death benefit and cash value of the policy fluctuate in accordance with the performance of the investment account that you select, e.g., stocks, mutual funds and/or bonds. The selected investment account can be altered at your discretion.
• Universal Life Insurance, also referred to as adjustable insurance, allows the policy holder increased flexibility in two areas—premium payments and death benefits. For example, the premiums can be paid at any time and in any amount within certain minimums and maximums. However, the premium payments must generate enough cash value to pay the monthly expense of the policy.
  
  The death benefit can also be increased or decreased as needed, if that is what the policy holder desires. The policy does allow for the certainty of a minimum death benefit as long as the premiums sustain it.
  
  The cash component of this policy is actually an investment vehicle. The funds are invested in stocks, money market funds, mutual funds and bonds selected by the insurance company. Withdrawals and borrowing are also allowed from the cash account.
  
  You may incur higher monthly fees on universal life because of insurance company expenses in managing both the account and the investments.
  
  The interest rate for the cash value is periodically set by the insurers and is subject to a minimum rate, which is generally 3%. Because these policies are interest sensitive, lower interest rates may mean higher premium payments at times, to maintain coverage.
• Variable Universal Life (VUL) Insurance, while similar to universal life insurance, allows the individual to select the investment product--stock, bond, money market funds or a combination thereof--in which to invest. The rate of growth is dependent on the rate of the selected investment, meaning that the policy owners can potentially generate high earnings, but assume greater risk to do so. Cash value may decrease if the rate of the investment product decreases, which will require additional premium payments to retain protection. VUL is an option primarily for those who are comfortable with investment risk and who understand the interdependence of investment products, life insurance and cash value accrual that is inherent to this kind of policy.
• Indexed Universal Life Insurance provides coverage that links the cash value of the policy to a financial index, i.e., an agreed upon basis for assessing interest rate changes. The interest credited to the cash value fluctuates in accordance with the market index of a financial performance such as Standard & Poor's 500 and the amount of change to the cash value is based on the participation rate specified in the policy. For example, a 10% increase in the index for a participation rate of 75% would yield a 7.5% rate of return. The interest rate may be capped at a maximum rate of return as well as subject to no less than a specified minimum rate of return, which is typically zero to avoid a decrease in the principal value in the cash account. Indexation allows policy owners to benefit from gains in market performance without having to assume responsibility for active management of investment products. For this reason, this variation of permanent insurance involves less risk than VUL (which also has more potential gain), but does not have a guaranteed rate of return as does whole life insurance. Among the variations of permanent insurance, it is the choice of compromise on the risk/return spectrum. In addition, the death benefit is flexible for this policy type, depending on the policy owner's decision to either apply the policy's cash value to premium payments or to borrow against it, as well as on the policy owner's decision to add to the premium to increase the death benefit.

There are a few points you should keep in mind when purchasing term life insurance:

• 70% of all life insurance sold is some form of permanent life policy.
• The premiums for permanent life can be over ten times higher than term insurance.
• You do have to pay back what you borrow against your life insurance but the rates are usually very low.
• After death, any amount that you owe on a loan is deducted from your death benefit.
• No credit checks or other loan qualifications are required to borrow against your life insurance.

See Appendix B for a summary of the different term and permanent life insurance policy variations for easy comparison.

Other than term and permanent life insurance and their variations, you can purchase survivorship and first-to-die life insurance.

• Survivorship Life Insurance, also called last-to-die or second-to-die, insures the lives of two people instead of one. It pays a benefit up on the death of the second insured so it is usually less expensive than two policies. An example of its use would be for estate planning. The idea would be that today's premium dollars could be used to fund estate taxes or benefit a charity in the future.
• First-to-Die Life Insurance, insures the life of two people and pays a benefit on the death of the first insured. It might be appropriate for covering large debt obligations like a mortgage.

You can opt to either expand or to limit either your term or permanent life insurance coverage through riders, which are optional provisions that can be added to the original policy. In most instances, riders are purchased to add benefits that are not included in the policy. Examples of riders include:

• Accidental Death Benefit - An additional death benefit would be paid if the insured dies from a defined accident.
• Disability Income Rider - If the insured become disabled, the insurance company will provide a monthly income.
• Long-term Care Rider - If the insured meets criteria defined in the policy, such as confinement to a long term care facility, the insurance company pays benefits.
• Guaranteed Insurability - Additional insurance can be purchased in the future without the insured having to show proof of insurability.
• Waiver of Premium - Under certain circumstances (usually disability after age 65) a policy owner will not have to pay premiums. Note: if the insured were subsequently released from disability, the premiums would have to be paid.
• Double Indemnity - If the insured dies from an accident, double the amount of the death benefit is paid out.
• Cost of Living Adjustment - Coverage is increased in relation to increases in the Consumer Price Index without having to provide evidence of insurability.
• Other Insured's Rider - Other family members can be insured on the same policy (as opposed to issuing separate ones). Examples of other insured's riders include spouse riders and child riders.
• Return of Premium - When the insured dies, in addition to the death benefit, an amount equal to the premiums paid in will also be paid out.

The amount of insurance you need depends on the purpose for which you are purchasing the policy. While the purpose behind purchasing life insurance is unique for each individual, policies are commonly purchased to meet one of the following four objectives:

1. Annual Income Objective: Many purchase life insurance with the intent of providing their loved ones with a replacement for any income that will be lost due to the insured's death. Thus, they insure for the amount of money needed to ensure those dependent on the deceased's income can live comfortably and maintain their standard of living.
2. Interment Objective: Some purchase life insurance for the purpose of covering funeral and burial costs. Rather than burden loved ones with interment expenses, a death benefit can be used to pay for most, if not all, of these expenses.
3. Educational Objective: Others purchase life insurance to ensure that if they die, their children will still be able to pursue and complete their education without financial strain. Thus, they insure for the amount of money needed for the schooling of children, e.g., private K-12 and post-secondary education. Death benefit funds can either subsidize or pay in full the costs of tuition, books and related fees.
4. Charitable Objective: Still others purchase life insurance with the purpose of making a charitable donation upon their death. In this case, insurance is for the amount of money that an individual would like to bequeath to organizations, e.g., nonprofits and philanthropic entities, to support specific causes and initiatives. For example, this might include applying either a portion or all of a death benefit towards a scholarship fund, an arts program or a community initiative.

Typically the death benefit of a life insurance policy serves to replaces the income of the deceased earner. Calculating the death benefit in such a case is a little more involved.

To determine how much life insurance you might need, use your net monthly income as a starting point. Then move to expenses. Total all of the expenses your income covers. From this amount, subtract your personal expenses. These would include clothing, food, club memberships, hobbies, etc. The resultant amount is what you want your benefit to be.

Also, factor in one-time items such as college expenses, paying down debt, funeral costs and any others you can think of. Add these to the continuing expense amount. That will be optimal benefit amount you may want to consider.

The calculation might work like this:

• Take the median US household income (one earner in this case) of about $48,000. Subtract 25% for taxes. What remains is $36,000. After subtracting your personal expenses, that comes to $30,000. To spin that off each year using 5% return on the money, the life insurance payout would have to be about $600,000. Add another $50,000 for college and other expenses and you would want to insure your life for about $650,000.

Another approach suggests insuring for a death benefit amount that is somewhere between 5 to 10 times your annual salary.

Individual needs, your budget, and the economy can also determine the final benefit amount you select.

See Appendix C for a worksheet that can help you calculate how much insurance you need to purchase.

The cost of life insurance is primarily dependant on:

• the type of coverage selected, i.e., either term or permanent life insurance
• the amount of death benefit desired

But in addition, the following factors play a role in determining cost:

• the age of the insured
• the gender of the insured
• the health of the insured, e.g., chronic medical conditions and use of alcohol and nicotine
• the family medical history of the insured
• the lifestyle of the insured, e.g., involvement in high-risk professional and recreational activities.

By evaluating these kinds of factors, insurance companies classify individuals in one of three risk classes:

• Preferred Risk individuals are those whose life expectancy is greater than average for their age group; they pay lower premium rates.
• Standard Risk individuals are those whose life expectancy is average for their age group; they pay average premium rates.
• Substandard Risk individuals are those whose life expectancy is less than average for their age group; they pay higher premium rates and may be restricted to how much coverage they are allowed to purchase.

Premiums are then determined based on the risk class and the desired insurance type and death benefit.

When selecting a life insurance company, shop around. Insurance rates vary from insurer to insurer.

Whether you find a life insurance company yourself or go through an agent, consider these three criteria when selecting a life insurance company:

• Financial Responsibility - What you want to know is whether the firm possesses the financial strength to meet its financial obligations. You can find this out by finding out what their financial ratings are. Financial ratings on life insurance companies are developed and posted by A.M. Best, Moody's and Standard and Poor's rating services.
• Past Performance - If you review financial reports from prior years, you can also get a good feel for how the company operates. Check their website. Do searches to uncover any adverse postings.
• Experience and Reputation - Have you heard of the company? How long have they been in business? Do they pay their claims promptly and per their obligations? These are some of the questions you might ask.

Furthermore, the National Association of Insurance Companies (NAIC) has developed standards that most states have adopted to provide potential policy owners with details about the policies that they are considering. Life insurance agents should be able to provide sales illustrations to help you compare and contrast items across various policies and across insurers so that you can make an informed decision about what how much to spend on what type of life insurance policy. A sales illustration indicates a policy's expected premium rates, projected earnings and any possible fluctuation in death benefit. These are nonguaranteed elements based on the insurer's assumptions on future mortality experience and investment performance. It is important to recognize that since interest rates and administrative costs may change over time, actual premium rates and cash value in the future may differ from what a sales illustration suggests. To better understand a sales illustration that an insurer provides, you should ask the following questions:

• How current are the data provided in the illustration?
• Does this illustration reflect the insured's personal risk class?
• Which elements are guaranteed and which elements are nonguaranteed?
• What, if any, factors will affect the death benefit?
• Can premium rates fluctuate?
• If the policy accumulates enough cash value to cover all premium payments, will there be any other out-of-pocket expenses to retain coverage?

You should make an informed decision about life insurance needs and coverage to ensure the best possible benefits. It is important that you are thoughtful when choosing a policy as well as pragmatic after you purchase it.

• Before the Purchase
  
  When making the decision to purchase life insurance you should:
  • compare plans across insurers to make certain that your dollars are yielding the best possible coverage for your needs
  • verify that your agent and selected insurance company are licensed within your state of purchase
  • understand the policy and its provisions
  • ask questions for clarity on any component of the policy that they do not understand
  • review the sales illustrations to determine the difference between guaranteed and non-guaranteed elements of the policy
  • consult an accountant to ask questions about any policy-related taxation concerns;
  • determine how much you can afford in premium payments, particularly if it is subject to increase
  • sign the application only after careful review that all answers are complete and accurate
  • pay only with either a check or a money order made payable to the insurance company and not to the agent
  • obtain a receipt for payment rendered.
• After the Purchase
  
  After you have made a life insurance purchase, you should:
  • remember that you are entitled to a grace period during which you may review and/or cancel your policy for a full-refund and no penalty
  • continue to review your policy over the years to make certain that it still meets the insured's needs
  • file your policy in a secure place, e.g., either a fire-proof safe or a safe deposit box
  • file the policy number and the name of the insurer in a secure place other than where the policy is filed in the event that the policy is either misplaced or lost
  • provide beneficiaries the insurance agent's name, contact information and a copy of the policy for record-keeping purposes in the event of the insured's death
  • make certain that the insurer always has your current contact information.

If you wish to obtain life insurance coverage, you must complete and submit application materials that may require the disclosure of your personal and medical history information. This may include details from medical examinations and tests. Because this application will be included in the policy contract, it is critical that it be completed as accurately and as thoroughly as possible. Any inaccurate and/or incomplete responses may result in either coverage denial from the outset or eventual coverage termination or claim denial.

Different types of policies require different amounts of disclosure. If you wish to purchase life insurance, you must decide which of three types of policies they prefer:

1. Underwritten Policies require the insured to undergo a medical examination that is arranged and paid for by the insurer and to answer questions about personal and family medical histories. People who are generally healthy will most likely receive the best premium rate from this kind of policy. Most term and whole life insurance policies are underwritten.
2. Simplified Policies require the insured to answer medical questions about personal and family medical histories, but do not require a medical examination.
3. Guaranteed Policies require the insured to neither undergo a medical examination nor answer personal and family medical history questions.

All life insurance policies whether they are term or permanent life contain the following five basic components:

• Free Look - You can cancel the policy within 10 days and any premium will be fully refunded.
• Grace Period - After the payment due date, there is usually a 30 day grace period. The policy stays in effect and will pay out the death benefit (deducting the premium owed) during this period.
• Incontestable Period - The insurance company can take up to two years to contest the policy (usually used for checking on information provided by the insured). After that, the policy is incontestable.
• Suicide Clause - If the insured commits suicide within two years, the policy is declared null and void.
• Reduced Paid-Up Option - The policyholder can use the cash surrender value of the policy to buy a policy that would be paid-up but with a reduced coverage amount.

If you have experienced the loss of a loved one, have medical bills that need paying, are facing a divorce, or know that the beneficiaries no longer need to be protected, you might not need the life insurance policy any longer.

You could let the policy lapse by not paying the premiums. You also could surrender it for its cash value. However, you might want to consider the fact that many types of life insurance policies are assets that can actually be sold.

Most types of life insurance policies can qualify as long as they have been in existence for over two years. The most common are variable life, convertible term-life, universal life and whole life.

In fact, usually in a life settlement, the selling price is less than the face value of the policy but higher than the cash value. It averages about 15% of the face value of the policy. The value is determined by a number of factors including insurance type, outstanding loans and the age and medical condition of the insured.

Once you sell the policy, you forfeit all rights and obligations to the investor in exchange for the sales price. The buyers are usually institutional investors like hedge funds, pensions or endowments.

There can be significant fees involved plus this one-time cash settlement is usually taxable.

The answer to this question is, quite simply, yes. Not only will coverage provide monetary assistance for beneficiaries who were dependent of the deceased's income, but will also provide a peace of mind. The dollars invested in life insurance will help to cover the necessary living expenses that loved ones will continue to incur after an insured's death, which will enable prudent planning for the future. Moreover, the cash value that a policy may generate can help to support insured individuals when they most need it; it will allow them to borrow funds that they have been earned rather than acquiring a bank loan to meet expenses, thereby eliminating the need for loan applications, approval, and strict repayment terms and conditions. This can prove to be invaluable when the unexpected - such as job loss or illness arises, and these dollars can provide a type of safety net for those with coverage. Life insurance is an essential component for anyone wanting to protect loved ones for the future.

However, as you can see, there are many options available and there is no single right answer for everyone and every situation. You should take the time to learn what each type of policy offers so that you can be sure to get the insurance policy that is best suited for you and your loved ones' needs.