Thank you for your question and membership. Each life insurance policy type can work differently depending on the contract offered by the insurance company, I will cover the common policy types and how they work below, but because life insurance contracts can vary from provider to provider, we won’t be able to cover 100% of contracts out there.
First, let’s talk Term –
Term insurance typically comes in a few varieties:
Annual renewable term or yearly term insurance is a term policy that has a fixed premium for the contract year but will renew at a higher premium the next.
Level term insurance, which is the most common type of coverage and what USAA offers, has a fixed premium during the coverage period of the policy. Your premium does not change during this time period (10,15,20,25,30 years), however at the end of the coverage period, this can change. Some contracts have a “decreasing tail” – meaning your policy premium could remain the same but each year your coverage amount decreases. Or, it could be the opposite, where your coverage amount remains the same and each year the premium increases – very similar to the Annual Renewable Term described above.
How your policy will work at the expiration of your coverage period is specific to the contract you purchased.
Switching to Permanent Insurance – Universal or Whole Life –
When you pay premiums towards a Universal Life policy, you are paying first for the cost of insurance and a residual amount to the cash value of the contract. The cost of insurance, similar to how the Annual Renewable Term rates work, should be lower when you are younger so more of your premium goes into your cash value, but as you get older, the cost of insurance increases. When your premiums are not enough to cover the cost of insurance, the cash value will be used to make up the difference.
Universal life can be interest rate or investment performance sensitive if you buy a variable universal life variety. Because the policy performance will drive your premiums at some point over the life of the contract, its important to review your contract annually.
Whole Life offers a fixed coverage amount at a fixed premium. There are very straightforward whole life policies and some policies that pay dividends that can be used to reduce your premiums or increase your insurance coverage amount for example.
A quick note about conversion. Most term policies offer a conversion option where you can take all or a part of your term coverage amount and convert it over to a universal life or whole life policy. This is a great option for maintaining life insurance beyond your term coverage period so that your changing needs are protected against.
Life insurance comes in all shapes and sizes, what is important is that you understand your family’s needs and what coverage(s) are best for you. I hope that this is helpful for you. Please let me know if you have any other questions that I can assist with.
Sean Scaturro, MBA CFP®
Advice Director - USAA