Basic Life Insurance Terms
Eileen St. Pierre, The Everyday Financial Planner
This column is the third in a series on life insurance. It’s a good idea to familiarize yourself with these basic terms before you go talk to a life insurance agent. A little bit of knowledge can save you a lot of money and get you the right policy.
Name, age, and sex of the insured: The insured is the person on whose life the policy is issued. The age stated on the policy is the insured’s age on the day the policy was purchased (date of issue). If this age is misstated, the benefits will be adjusted to reflect the correct age (referred to as a misstatement of age clause).
Policy classification (standard, preferred, or substandard): This refers to the amount of risk the company is assuming. Most policies are standard. A preferred risk is someone who is likely to live longer (e.g., a non-smoker). A substandard risk is someone who is likely to die sooner (e.g., someone with a heart condition).
Face value: The amount the company will pay at the death of the insured.
Beneficiary: The person (or persons) named in the policy to receive the proceeds at the death of the insured. Keep beneficiary designations up-to-date; review whenever you have a change in life status such as a divorce.
- Do not name minor children as beneficiaries.
- The insurance company will keep the money until the child turns 18.
- If the proceeds are needed for the child’s upbringing, name either a guardian or create a life insurance trust to be named as the beneficiary.
Premiums: The amount of payments to keep the policy in force. Reinstatement clauses explain what will happen if you do not pay the premiums. You may be able to start the policy again (reinstate the policy) by paying the overdue premiums plus interest. If you wait too long to seek reinstatement, you may have to prove insurability.
Grace period: An additional time, usually 31 days after the due date, to pay the premium.
Policy loan provision: Allows the policyholder to borrow on the cash or investment value of the policy. This provision is not available for term insurance. It does not add to the cost of the policy.
Dividends: Many life insurance companies pay dividends to policyholders (generally not paid on term insurance). They are a return of part of the premiums paid. You can:
- choose to take them in cash.
- apply them to future premiums.
- use them to purchase paid-up additions of whole or term life insurance.
- reinvest them to increase the cash value of the policy.
Incontestability clause: This sets a time limit during which a company can refuse to pay all or part of a claim. The company can refuse to pay if false statements were made on the application for insurance. After a set time limit (usually two years), the company must pay claims even if mistakes were made on the application.
Suicide clause: Sets a period during which the company will not pay death benefits if the insured commits suicide. The insurer is only liable for the return of premiums paid.
There are riders that can be added to a life insurance policy for an additional cost. The most common are:
- Accidental death (also referred to as double indemnity): This rider doubles or triples the face value of the policy for accidental death. This extra benefit amount should not be included in your needs analysis.
- Disability waiver of premium: This rider states that the company will pay premiums on the policy if the insured becomes disabled. This is a low-cost rider. When comparing polices, check the policy definition of total disability. Polices also vary on the ability to convert the policy to another type if disability occurs.
- Guaranteed insurability: This rider allows the policyholder to purchase additional insurance at specific times, regardless of health. This rider is a good idea if you expect your insurance needs to increase as your family grows.
- Accelerated benefit rider: This pays a portion of the death benefit early if the insured is medically certified to be terminally ill. Some policies also allow accelerated benefits for those considered chronically ill (like those needing long-term care services). Consult the policy for the company’s definition of chronically ill. The death benefit payable is reduced by the amount of the accelerated payments.
When you buy a life insurance policy, you generally get a free look period, during which you have the option of changing or canceling your policy without penalty. Make sure you take full advantage of this benefit.
Visit my Estate Planning page to read my other life insurance columns and fact sheet.