There are many life insurance terms that can be confusing. We’ve created this glossary of terms with an explanation of key terms used in life insurance policies. This way when you read an article or get information about coverage,you can go back to the glossary here to look up the correct definition.
1035 Exchange – A tax free exchange from one life insurance policy to another. A 1035 exchange can also be used for exchanging one annuity for another, as well as for exchanging a life insurance policy for an annuity.
Accidental Death Rider – By having an accidental death rider, an insured’s beneficiary will receive a stated multiple of the policy’s face amount (typically two times the face amount) should the insured’s death be the result of an accident as defined in the policy. The insured’s death must typically occur within 90 days of such an accident.
Applicant – The applicant is the individual or entity that applies for an insurance policy. The applicant is typically the intended policy owner once a policy is issued – although with regard to life insurance, the applicant and the policy owner do not have to be the same person.
Beneficiary – The beneficiary of a life insurance policy is the person (or persons) or entity that will receive the death benefit proceeds at the death of the insured. The beneficiary is not a party to the contract until the death of the insured. The beneficiary does not necessarily need to be a person. For example, oftentimes a named beneficiary can be a business, a trust, or an estate.
Buy / Sell Agreement – For closely held business owners, the use of life insurance can be of utmost importance, as it is oftentimes the key source of funding for a buy-sell agreement. Typically, when there are two or more owners of a business, the untimely passing of one is likely to cause significant financial hardship for the entire business. By using life insurance to fund a buy-sell agreement, each of the business owners or partners will set up a plan whereby all individuals purchase a life insurance policy on the other(s). Should one of the individuals then meet an untimely passing, the life insurance proceeds can help to provide the necessary funds for the remaining owner(s) to purchase the decedent’s portion of the business. In addition, these funds may also allow the business to continue operating during this time of transition.
Cash Value – While term life insurance policies provide only a death benefit component, permanent policies provide both a death benefit as well as a cash value or investment component. This “savings” component allows the policy holder to grow their funds on a tax-deferred basis. Funds within this component can be withdrawn or borrowed against. The cash value component of a life insurance policy offers a way to accumulate cash as the premiums that are paid into the policy go towards paying for the death benefit component as well as towards the growth of the cash value. In many ways, policies that offer cash value accumulation can be said to combine the benefits of a term life insurance policy along with a savings account. Over time, as the cash value grows, a policy can accumulate a great deal of funds. Should the policy holder decide to cancel – or “surrender” – the policy, he or she would receive the amount of cash in the underlying cash value component (minus any fees). This amount is often referred to as the “cash surrender value.”
Cash Surrender Value – The amount of cash that is available if the policy owner should surrender the contract before maturity. During the early policy years, the cash value is the amount of the reserve, less a surrender charge. In later policy years, it typically equals or closely approximates the reserve value at the time of surrender.
Child Protection Rider – The child protection rider provides term life insurance benefits that can be used for final expenses in the event that a child passes away. With these riders, basic information about the child’s health is typically required for underwriting purposes.
Critical Illness Rider – With the critical illness rider, the insurer will pay the insured a lump sum of cash if they are diagnosed with one of the critical illnesses that are specified in the insurance policy. Typically, such illnesses will include heart attack, cancer, stroke, and kidney failure. Rather than reimbursing the insured for his or her medical expenses the way a health insurance policy does, the critical illness rider provides funds to use for any purpose that the insured sees fit during their course of treatment.
Death Benefit – A death benefit is present in all life insurance policies – including both term and permanent plans. Term life insurance is the most basic form of coverage, offering just a death benefit, without any type of cash value build-up in the policy. The term death benefit is often used interchangeably with the term “face amount.” Therefore, if a person purchases a life insurance policy with a set $200,000 face amount, the death benefit proceeds received by his or her named beneficiary will be $200,000.
Decreasing Term Life Insurance – With a decreasing term life insurance policy, the death benefit decreases each year, even though the premium remains the same. The decreasing term life insurance policy will end when the death benefit reaches zero.
Final Expense Life Insurance – Final expense insurance is a type of life insurance coverage that covers the cost of burial, a funeral, and other related costs. Often referred to as “funeral insurance” or “burial insurance,” final expense generally provides a benefit of between $5,000 and $50,000.
Grace Period – The time period after the policy’s due date in which a late premium payment may still be made without penalty. With life insurance policies, the grace period is typically 30 or 31 days.
Increasing Term – Increasing term life insurance is a term policy that maintains the same premium throughout the term, but has an increasing amount of death benefit. This type of benefit can oftentimes be purchased as a cost of living rider to a whole life policy.
Insurable Interest – Insurable interest exists when an insured person derives a financial or other kind of benefit from the continuous existence of the insured asset, or in the context of living persons, their continued survival. A person will have an insurable interest in something when the loss or damage to that item or person would cause the other person to suffer a financial or other type of loss.
Joint and Survivor Life Insurance – Joint and survivor life insurance policies also cover two lives. In many cases, these policies are used to insure two spouses. With a joint and survivor policy, benefits are not paid until the survivor – or the second person to die, passes away. A joint and survivor policy can be either term or permanent coverage.
Key Employee Life Insurance – The key employee life insurance strategy can offer a way to protect a business in the event of the sudden death of a key employee such as an owner or partner. When a key employee passes away, a company could stand to lose customers or even credit stand, based upon the lost role of the deceased individual. With key employee life insurance, typically a company will purchase a life insurance policy on the life of the employee. The company is both the owner and the beneficiary of the policy. In addition, the company will usually pay the premium as well. The death benefit proceeds of the life insurance policy will be in line with the anticipated amount of loss due to the key employee’s death. Additional amounts of coverage may also be added in order to cover the cost of hiring and replacing a replacement.
Lapse – An insurance policy will lapse due to non-payment of premiums within the grace period given by the insurer. In both universal and variable life insurance policies, the depletion of the cash value below the amount needed to keep the policy in force will also typically result in a policy lapse.
Living Benefits – This is a term that is given to the benefits that an insured can exercise in a life insurance policy that contains cash value. The living benefits consist of cash surrender, loan, and non-forfeiture values. All of these terms relate to the cash value in the policy. The terms simply indicate what is going to be done with the cash value.
Permanent Life Insurance – A permanent life insurance policy is one that can be purchased and maintained for a person’s entire life. These policies contain a guaranteed amount of death benefit that will be paid out to a named beneficiary upon the death of the insured. In return for this benefit, the policy holder will pay a regular premium to the insurance company. In most cases, the amount of the premium will remain constant throughout the life of the policy.
Policy Owner – The policy owner is the individual who retains all of the rights in a life insurance policy. Such rights may include selecting the beneficiary (or beneficiaries), choosing the settlement options, and exercising policy conversion. Typically, the applicant and the policy owner are the same person, however, this does not have to be the case.
Preferred Risk – Those insureds who are considered preferred risks are those who present the insurer with a below average risk of loss. Such risks may be insured at discounted or “preferred” premium rates due to their favorable factors such as healthy lifestyle, good medical history, or non-dangerous occupations. With regard to life insurance, those who are preferred risks will also have above average life expectancies.
Premium – The premium on an insurance policy is the cost of a given unit of insurance coverage. With regard to life insurance, it is typically the price or rate per $1,000 of coverage. The total premium due, then, is the rate multiplied by the number of units of insurance purchased, plus a policy fee (if any). Premiums are also defined as the periodic payment that is required from the insured in order to keep the policy in force and to receive the policy’s benefits if needed. Policy premiums can be considered earned and unearned.
Renewable Term Life Insurance – With renewable term, the policy can be renewed by the insured after each time period – or term – has elapsed. The policy holder can do so without the need to complete a new application for coverage or to pass a physical exam.
Renewal – Renewal is defined as the continuance of an insurance policy beyond its original term. In addition, the payment of premiums after the first year of a policy or the agent’s commissions on such second and subsequent years’ premium are also considered to be a renewal.
Return of Premium Rider – With a return of premium, or ROP, plan, an individual can purchase a policy for a set amount of time such as 20 years. Should the insured die during that time, the death benefit proceeds would be paid to their named beneficiary. However, should the insured outlive his or her policy’s in-force term, then the insurance company will send them a tax-free check for the full amount that the person spent on their policy premiums over the lifetime of their coverage. The return of premium option can be structured in a number of different ways. While some insurers offer this as a packaged term life policy with an endowment, others simply offer ROP as a policy rider.
Rider – The term rider typically refers to a supplemental agreement that is attached to and made part of the insurance policy. Riders are added to a policy in order to add, modify, or delete policy provisions or coverage. (In property and casualty insurance, riders are referred to as endorsements.
Settlement Options – Insurance settlement options refer to the manner in which insurance policy proceeds are paid out to the insured or the beneficiary following a claim.
Single Premium Whole Life – As the name implies, a single premium whole life policy will be paid up after paying just one single lump sum premium payment. Because of the large amount of money initially deposited, single premium policies will typically start out with a substantial amount of cash value as well. In addition, because the premium is all being paid up front, single premium policies generally are purchased at a large discount when compared to the total premium amount of a straight life policy over a number of years.
Standard Risk – Standard risks are those which reflect average exposures and who fall into a normal range. These insureds can be insured for standard rates and premiums. With regard to life insurance, a standard risk is the type of risk that is normally reflected in the insurer’s mortality tables.
Straight Whole Life – The majority of whole life insurance policies are straight life. This means that the premium payments will continue to be due until the insured reaches age 100, or passes away. Straight whole life may also be referred to as pure or continuous whole life.
Substandard Risk – A substandard risk is one that reflects a higher than average risk of loss to the insurer. This can be due to an insured’s health, occupation, and / or habits. These types of risks may still be acceptable to an insurer. However, the underwriters may use some type of rating technique in order to collect a higher amount of premium – or to restrict coverage in some way – in order to compensate for this higher amount of risk that the insurer is taking on. These higher premiums and / or policy restrictions will help to make such losses fall more within a normal range of loss for the insurer.
Term Conversion Rider – Term life insurance provides coverage for a certain period of time such as 15 or 20 years. Permanent life insurance, such as whole life or universal life, will provide coverage throughout one’s entire life (provided that the premiums are paid). By obtaining a term conversion rider, the policy holder will be able to convert a term life insurance policy into permanent coverage without the need to undergo a medical exam. This type of coverage option can be especially attractive for those who are just starting out in their careers and families who need life insurance coverage but don’t have enough funds to secure all of their coverage with a permanent life insurance plan. In most cases, there will be a deadline for when the policy holder must convert their term policy to a permanent plan without the need to provide evidence of insurability.
Term Life Insurance – Term life insurance is the most basic form of all life insurance policies. This is because term life insurance offers only death benefit coverage, without any type of cash value or investment component. Term life has a specific coverage period. These policies are typically purchased for a set amount of time such as 10 years or 15 years. Should the insured pass away during this time, the insurance company will pay out the stated amount of death benefit on the policy. Once the period of time, or “term” of coverage, has elapsed, the insured will need to renew the policy if they wish to continue their coverage. At that time, however, the premium for the new coverage will be based upon the then-current insured’s age and health status. Term life policies generally have lower premiums than permanent policies with the same amount of coverage. This is especially the case for insureds who are young and in good health. The lower premium is due in large part to the fact that the premium payment is going only towards the death benefit coverage and not into a cash or savings component. Therefore, some of the primary characteristics of term life insurance include “temporary” protection, low cost, and no cash value build-up.
Underwriter – The primary goal of a life insurance underwriter is to accept a profitable pool of exposures. Therefore, an underwriter’s job is not to select only those applicants who exhibit the very best characteristics of insurability, but rather to classify and charge the applicants a fair premium that is based upon predetermined statistical assumptions and judgment.
Underwriting – Insurance underwriting is the process of considering each insurance application that will result in either rejecting or accepting the application. When considering an application for life insurance coverage, underwriters will thoroughly analyze all of the data, along with projected life expectancy factors of the applicant. If the insurance company’s exposure to risk is acceptable, then the premium that is collected on the policy must fairly represent the cost of the coverage.
Universal Life Insurance – Universal life insurance, or UL, has been described as offering the low cost death benefit of term life insurance with a cash value component like whole life insurance. With these types of policies, there is a great deal of flexibility afforded to the policy holder. Those who hold universal life insurance are allowed to change, within limits, their death benefit as well as the timing and the amount of their premium payments. Each time that a premium payment is made, the insurance company will deduct a certain amount to cover the cost of the insurance while at the same time crediting another portion of the payment to the policy’s cash value account.
Variable Life Insurance – Variable life insurance is a form of permanent life insurance policy. These policies offer a component with permanent death benefit proceeds to the insured’s beneficiary upon death. However, in addition to this permanent protection, variable life policies also feature an investment component. In fact, these policies are referred to as “variable” because when premiums are paid into the plan, the portion that is allocated to the investment account will be subject to the fluctuations of the market. The investment portion of a variable life insurance plan allows the policy holder to take part in a variety of investment options. This enables the savings component of the policy the potential to grow a great deal, depending upon the market performance of the underlying investments. In addition to the upside potential of the investments contained in a variable life insurance policy, the policy holder will not be taxed on the earnings until they surrender the policy. This allows these funds to grow tax deferred while still inside the account. Some of the investment options that a policy holder may choose from with a variable life insurance plan include stocks, money market funds, bonds, mutual funds, and a variety of other investment vehicles. Because of the investments contained in the policy, variable life insurance plans are considered to be securities and are therefore regulated by the federal securities laws.
Variable Universal Life – Variable universal life insurance is similar to traditional universal life, except that the policy holder is allowed to invest the cash portion of their policy into different types of investments such as mutual funds.
Waiver of Premium Rider – The waiver of premium option can free the insured from having to make premium payments if he or she becomes ill or disabled prior to a certain age and are unable to afford the premium payments on the policy. With this option on a life insurance policy, the policy dividends can continue to be paid and the cash value can continue to grow, just as if regular policy premiums had been paid. Prior to the waiver of premium starting, there is oftentimes a waiting period of six months of disability. In addition, prior to the waiver of premium paying the insured’s premiums, the insured must provide evidence to the insurance company that he or she is in fact disabled.
Whole Life Insurance – Whole life is a type of permanent life insurance that are intended to stay in force throughout the “whole” life of the insured, or until the policy pays out. It is the most simple for of permanent life insurance.