Episode 3: Life Insurance
Hello there and welcome to business Basics the podcast designed to give some information about how financial markets work and some accounting practices in order to give you the tools to make smarter financial decisions. Whether you're looking to learn something brand new or just want asome refresher on basic economics, There's a place for everyone on our podcast. I'm Archit Junnarkar, and I'm your host. our topic for today is life insurance. There are all kinds of insurance out there. Auto Insurance Cellular Insurance Home Insurance and travel insurance. But today we're going to be diving deep into one specific type of insurance life insurance. Why do some people buy it? And what are the different types of life insurance out there? So let's jump right in I we're GONNA be looking into. Why do people buy Life Insurance? Why do some financial advisers out there say that life insurance is a must well? The basic premise behind why people are recommended to buy life. Insurance is that should anything happen to you? Then you're at least. Your family is protected. If you have a mortgage and you pass away then your spouse or your family or your partner can have some money paid out by the Life Insurance Company to cover that mortgage if they're still dependent on your income so before we get into the different types of life insurance. I rejoice going to go over. Some basic definitional terms relating to life insurance and the first term that we're GONNA go. Premium and premium applies to all types of insurance not just life insurance but premium is the amount of money that you pay to the insurance company in order to keep the policy alive. So you pay the insurance company a set amount each month or each year and that's the premium and in order to if something should happen to in order for your family to get that money then you have to make sure that that premium is consistently paid and generally but not always as we'll see is the case today. Generally premiums for life insurance tend to increase as a person ages and the reason why that is because the older a person gets more likely it is that the wind have health problems and the more like leaders that they might die so therefore there's greater risk implied there for the insurance companies. So they're going to generally but not always charge a higher premium. The older you get and this H. distribution with life insurance is similar to how car insurance companies have aged distribution so for families that added teenage driver onto their policy. They generally have to pay a higher premium or a higher amount. Each enya lear monthly in order to be eligible for the auto insurance policy and that's because teenage drivers are at a higher risk to damage the car or have an accident so therefore car insurance companies will charge teenage families with teenage drivers higher premiums and that's similar to how life insurance companies charge older people higher premiums. Okay so would that being said. Let's get into the first type of life insurance and the first type of life insurance is term insurance and the important characteristic about term insurance is that it has a determined period of coverage so for example if you are still alive in twenty years but you've been paying term insurance then then that term insurance policy will expire at the end of twenty years so it has that determined period of coverage. So if you die within the next twenty years then only will the insurance company pay out the policy to your family and term insurance actually has four different subtypes of insurance or four different types within a type that we're going to discuss and that I sub- type is called annual renewable term insurance or a rt for short art so annual renewable term insurance like its name implies lasts for one year so the important caveat of air tea is that it's renewable each year but at a higher price. So you pay a premium rate. Let's say you you pay monthly so you pay. Let's say twenty dollars a month for one year and then at the end of that one year if you want to continue the policy then you're going to have to renew it but rather than paying twenty twenty bucks a month that next year the insurance companies to raise the price and make thirty dollars a month. And eventually what you see if you see a person. Renew it every year. Is that if you graph the price over time you're going to have an exponential growth of the price increasing because insurance companies are gonNA charge low amounts initially during those first few years. But the longer you stick to the policy the higher that price is going to get so our next sub type of term insurance is level term insurance and it is the exact opposite of annual renewable term insurance in that rather than annual renewable term insurance CH- having increasing premium level term. Insurance is going to charge the same amount for a set period of time so with level term insurance. You have something called. The term length and this term length is usually five ten twenty or thirty years so the level term insurance is going to charge you twenty five dollars a month for for sixty months if it's a five year policy and that twenty five dollars a month won't change for that five for those five years and the way it's the opposite of annual term of annual renewable term insurance is that it's built to be an average of a RT so with annual renewable term insurance. Let's say that a person is twenty years old and they're paying a thousand dollars a year annually but then by the time they get to the age of thirty they're paying fifteen hundred dollars so it increased in ten years by five hundred dollars whereas with level term insurance. If you're going to have a term length of ten years from the age of twenty to thirty you're going to end up paying twelve fifty because it's the average of one thousand and fifteen hundred so level term insurance is built to balance out or be that average of the low end and the high end of annual renewal term insurance and however the downside with level term insurance though is that the rate will go up at the end of each term land so I could be paying. Let's say twelve fifty dollars a month from the age while I am underneath thirty but above twenty so from the ages of twenty to thirty but after thirty and if I choose to renew level term insurance than I'm probably going to end up paying a lot more than twelve fifty. I'M GONNA pay. Let's say seventeen fifty a year. So what you see with level term insurance is that it's a straight line graph for each different term but it's a staircase graph if you zoom out of it and look at it for a person's entire life so our next sub type of term insurance is called mortgage life insurance and mortgage life insurance is based solely on if a person has a mortgage. So let's say that you have a mortgage with your house that you're currently working with your partner to pay off and the idea of mortgage life insurance. Is that if you die. Then the spouse gets the money from that policy and that money will pay off the mortgage completely but the downside to mortgage life. Insurance is that overtime. The pulse the amount ends of decreasing. So it's natural over time over the life of mortgage that the amount that you still have to pay off is going to end up decreasing because you're gradually paying it off every month or every year so the amount left that you have to pay off is going to decrease over time so the insurance policy value is likewise going to decrease because there's less amount of the mortgage that you have to cover or that the insurance company will have to cover. Should anything happen to you? So that's why mortgage life insurance is also known as decreasing term insurance because overtime de policy value is going to decrease and then we have a Ford the sub type of term insurance and has a long name return of premium term insurance and this is actually of beneficial but it does have downside like all the others so if you're still living at the end of the term then you get back the premium. So let's say that the term is twenty years. If you're still living twenty years later then you still get the premium that you paid for those twenty years if you paid a thousand dollars a year. Then you'd get twenty thousand dollars back if you're still live at those at the end of this twenty years but the downside with this is that there's going to be a higher cost involved for premium term insurance because obviously it's not that great financially for an insurance company. So they're going to charge you. A higher cost and insurance companies aren't gonNA offer this policy or offer return premium term insurance to everybody. They're going to be more lucrative or they're going to be more they're going to be more careful with whom they give it to. They're likely going to give it to older people and not necessarily younger people because with younger people there's much higher chance of them living twenty years or thirty years or however long the term length is okay sweet wrapped it up with insurance terms. Were with term insurance subtypes sewer done with term insurance but then you have the opposite end of the spectrum where you had term insurance where you paid or the policy lasted for a term or for a set amount of time but then you have permanent life insurance where lasts for your entire life and permanent life insurance life term insurance several different types that were going to go over. So you have whole Life Insurance. Where the policyholder is going to pay higher premiums but the total value of their premiums exceeding the policy value. So let's say you have a policy for one hundred thousand dollars. And let's say annually that the policyholder ends at putting down four thousand dollars a year to that policy so one hundred thousand divided by four thousand within twenty five years that policyholders should have met the value of his pulse with that hundred thousand. But let's say that policyholder lives for longer than twenty five years after he buys a after here she buys that insurance policy so then you have an exceeding amount and what the insurance company will do with that exceeding amount is. They're going to invest that amount and they will pay you. An interest rate similar to a how bank has a certificate of deposit and they will pay you an interest rate and insurance company will also pay you an interest rate for that difference so that amount of money. That's leftover is called the cash value. And so that the idea is that the accumulated cash value will eventually cover the cost of the insurance. Should you need it? And the benefit with whole life insurance is that it's a fixed premium and the premium won't change over time. No let's look at the next type of permanent life insurance and that is called Universal Life Insurance and universal life insurance works exactly like whole life insurance except with the premium. The universal life insurance has flexible premium. Where the premium will fluctuate depending on your needs and how readily you can pay the money. If let's say you're struggling to pay the money one year you can say to your insurance company okay. Charge me less. Charge me none next year. I'll pay a higher amount and the insurance company will go okay. That's fine. We'll just make sure that you pay higher mountain next year and this is really beneficial for people who are who are have to pay off a mortgage have to pay off student loan debt and so it offers that flexibility to them and the insurance companies find with this as long as the cash value ends up covering the insurance amount. Then they're they're perfectly fine with it okay and now. Let's look at our next type of permanent life insurance. And that is called index universal life insurance so what the insurance company is going to do with that cash value of index universal life. Insurance is they're going to follow an index. Sooner last episode we talked about how stocks have indexes the Dow Jones the S. and P. Five hundred the Nasdaq Index. So what the Insurance Company is going to do. Is they're going to say okay. Let's follow the S. and P. Five hundred index so they're going to invest that cash value into the S. and P. Five Hundred Index. So let's say in two thousand and the S. and P. Five hundred index grows ten percent. So that means the insurance company will increase your cash value by ten percent however the insurance company is going to set a cap where maximum the cash value can increase annually. So let's say the S. and P. Five hundred gross twenty nine percent like it did in two thousand nineteen then. The insurance company will only pay you a cap maximum amount. So let's say the insurance company capped at fifteen percent so even though grew to twenty nine percent in in two thousand nineteen the insurance company will only increase your cash value by fifteen percent in two thousand nine thousand nine hundred and it'll go up to that cap amount that they set however another benefit of index universal life. Insurance is that you lose money or you can't lose cash value if let's say the S. and P. Five hundred false by twenty percent. You don't lose twenty percent. You just gained zero percent so you can't go down. You can only stay the same. Or INCREASE WITH INDEX UNIVERSAL Life Insurance. Sadat's why permanent life insurance is also known as cash value insurance because the common factor between these last three types of insurance we just talked about. They haven't excess cash value and that excess cash value designed to grow and provide you some benefit as you grow older. And if you live longer and then there's some other unrelated types of life insurance that we're just gonNA talk about accidental death insurance and accidental death insurance usually gets tacked onto other insurance policies and the weight works is if you die in an accident then you have then. Your family gets additional money. So let's say you have a thousand Poles fifty thousand dollar life insurance policy that will pay out to your family and it can be any one of those types we discussed and then you decide to add on top of that accidental. Dutt insurance for fifty thousand dollars so that means that if you happen to die in an accident the new family will get the fifty thousand from the original policy policy and then fifty thousand dollars from the accidental death policy. So in the end your family ends up getting one hundred thousand dollars. If you happen to die for reasons that are not related to an accident then your family would get only fifty thousand dollars from that original fifty thousand dollar life insurance policy so then our next type is joint life insurance and joint life insurance covers two people and this these two people tend to be usually a couple or partners or a civil union and so a joint life. Insurance is set up in two ways. Either I to die or second dining so if once member of a couple dice I and it's the first to die policy. Then the pulse you will pay out to that surviving spouse member that surviving spouse but if it's second to die then the policy will end up paying out to. Let's say the couple's kids or whoever they designate to receive the money and the benefit to joint life insurance is that it is a lot cheaper than had the couple on bought individual life insurance policies for each so they offer better rates if it's a joint life insurance then compared to individual policies then the next types of insurance company of insurance types next to we're going to talk about are done by companies and they're usually done with companies and higher up executives so the first type is key person insurance where a company will buy life insurance for a key person in a business let's say that's the CEO or that's the founder of the company or it's a wealthy financier that has ties to the company and what the company does is they say to the insurance company. Okay if should anything happen to that person? We won't be able to survive without their money or without their expertise so they take out an insurance policy and should that person die then the company will receive money from the insurance poll from the Insurance Company. Our next type of executive or next type of company insurance policy is the executive bonus life insurance so this is where a company pays a premium on a higher ranking executive and the executive can take loans out of the cash value accumulated and so this is a great way for a company to show to an executive or to show them loyalty or to keep them within the job or to keep them within the company. So they're not drawn away by by competitors because this provides a benefit to the executive in that the company will pay the premium but the executive. They can take out a loan for any personal reasons if they want to buy new house or anything like that then the executive has money from which they can take out a loan from and that initial money is paid for by the company that they work for and then our final type of insurance that we're going to talk about today is called final expense insurance. It's our final type of life. Insurance and final expense. Insurance is simply put basically created to cover funeral. Costs should should a person die and family does not have the money to cover. Funeral costs or cover posted. Death costs then. Final expense insurance exists to help that family. Cover those costs if you wait that absurd. Please like and subscribed her podcast. Leave a review. Wherever you get your podcasts from also make sure to follow us on instagram and twitter at be business basics and also check out our website business online. I am arch darker and thanks for listening.