Types of Insurance

Life Insurance

Life insurance is designed to make a payout to beneficiaries after the death of a primary income earner. When beneficiaries are financially dependent on the earnings of the insured, this creates a risk to them of being left without support. Life insurance is often also used to meet short-term liquidity needs after the occurrence of a death. For example, legal fees, funeral and memorial services, and payment of inheritance taxes are all examples of payments that arise after a death. Life insurance can help cover these costs. Life insurance premiums can reduce the taxable estate of an individual as the premiums are paid out. The payout of the policy is, therefore, often a tax-advantaged event.

Temporary (Term) Insurance

This type of life insurance is only good for a ‘term’ or designated period. Often, increments of 1,5,10 years are used. This insurance, all else equal, is cheaper. This is because the risk of mortality is lower over shorter periods and also lower for younger workers.

Permanent Insurance

In contrast to temporary life insurance, permanent life insurance is a more expensive option that has no termination date. These policies tend to build value over time.

Whole Life

Whole life is a type of life insurance that is often desirable when purchased earlier in an insured's life. Whole life has fixed annual premiums and cannot be canceled by the insurer as long as the premiums are paid. The policy may reach a ‘fully paid’ status and not require any more payments afterward. Participating whole life shares in insurance company profits and may increase in value more quickly.

Universal Life

This type of insurance provides the flexibility to increase or decrease premium payments during its life. This will, in turn, increase or decrease the value of the policy. There are often choices about how the premiums are invested.

Other Types of Insurance

• Disability income insurance: Provides protection against a possible loss or diminution of income.
• Property insurance: Provides protection against loss in value of physical assets. Including:
  • Homeowners
  • Automobile
• Health and medical insurance: Covers health care expenses.
• Liability insurance: Covers losses that result from lawsuits or legal proceedings.

Question

Which of the following, all else equal, would be the most expensive type of insurance?

1. Whole.
2. Universal.
3. Permanent.

Solution

The correct answer is B.

Universal life insurance provides the most flexibility and options for the insured. These extras come at the cost of a higher premium.

A and C are incorrect. Permanent and whole insurance also provide more flexibility and coverage as compared to temporary, but less than universal.

Reading 9: Risk Management for Individuals

Los 9 (f) Describe types of insurance relevant to personal financial planning