Life Insurance Basics

By Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, [email protected]

Compared to their civilian counterparts, service members at any age (as well as police and fire fighters) have a greater need to understand and purchase life insurance. When your job requires you to “put yourself in harm’s way,” it is important to protect dependents and/or co-signers of your loans should “the unthinkable” happen.Below are ten key concepts about life insurance that service members need to know:

1. Life insurance pays a benefit when the person whose life is covered (typically the policy owner) dies. Policies are purchased to financially help family members who are left behind and would suffer financial distress (e.g., inability to make monthly mortgage payments) resulting from the policy owner’s death.
2. The insurance company promises to pay a lump sum (death benefit) to one or more named beneficiaries when the policyholder passes away. The dollar value of insurance protection (e.g., $400,000) is called the face amount and is used to calculate the policy premium.
3. In addition to providing continued income to pay bills, other reasons to buy life insurance are: to pay off a mortgage or debts, provide an education or income for children, continue a business after key personnel die, and set up an estate plan (e.g., fund trusts with life insurance).
4. Insurance companies use mortality tables to predict the odds of policyholders dying based on their age and gender. Premiums are based on life expectancy with older people paying higher premiums than younger people because they will die sooner (i.e., lower life expectancy).
5. Life insurance can be temporary (e.g., term insurance) or permanent insurance with a cash value. Cash value policies usually have policy loan provisions.
6. Life insurance is purchased individually or through a group plan. Group life insurance, such as SGLI for service members, is issued to members of a group (e.g., co-workers) rather than to individuals. Group life insurance policies are often provided as an employee benefit and may be tied to a worker’s salary.
7. The incontestability clause in an insurance policy states that, after a policy has been in force for a specified period (usually 2 years), the company cannot dispute its validity for any reason. A suicide clause states that benefits will not be paid if a suicide occurs within a certain time period after purchasing a policy.
8. Term (temporary) life insurance is generally the least expensive type of life insurance because it contains no cash value. Rather, it is like “renting” insurance for a specific period of time (e.g., 5 to 30 years). Term insurance gets more expensive with age because people have a lower life expectancy.
9. Permanent life insurance combines life insurance coverage and an investment account. The amount of the premium is based on a policyholder’s age when the policy is purchased. Specific types of permanent life insurance include straight (whole) life, variable life, and universal life. Individual policy features vary.
10. The best way to estimate the amount of life insurance needed is to calculate family needs. Factors to consider include funeral costs, mortgage/debt balances, needs of beneficiaries (e.g., college), the income earning potential of a spouse, and the amount of other financial assets available to family members.

For additional information about life insurance, watch the recording of our recent webinar Insurance Principles and Resources: What Financial Educators Need to Know.