Common Misunderstandings in Life Insurance

Life insurance is an important part of your personal finances, but many people do not understand exactly how life insurance works. The team at HealthIQ recently released a quiz all about picking the right life insurance policy. With the results from 200 quiz takers in the can, I noticed some interesting trends and misconceptions about life insurance. Let’s dive into the results and fix some of those common misunderstandings in life insurance.

Guaranteed issue life insurance policies

In the ten-question quiz, the number one missed question was “Who are guaranteed issue life insurance policies designed for?” Only 48 percent of responses were correct. Interestingly, those with a high school diploma and associates degree scored slightly better than those with a master’s degree.

Guaranteed issue policies work as the name explains: everyone who applies is guaranteed to be approved and accepted. This means that anyone with cancer, multiple sclerosis, and other terminal illnesses are approved no questions asked. Guaranteed issue life insurance is designed for those who do not qualify for regular individual policies.

Most life insurance policies are designed for people with average health levels. After completing an application and undergoing a basic, no-cost medical exam, life insurance applicants are assigned to a category like “preferred” or “preferred plus” based on their health history and lifestyle. These categories correspond to a monthly rate for insurance coverage.

Life insurance medical exams save you money in most cases. Even if you have a health condition or two, you still typically qualify for an individual life insurance policy. Term life insurance is typically cheap for high levels of coverage. However, guaranteed issue policies are expensive for low levels of coverage.

Because guaranteed issue policies take anyone, benefit limits are generally low and monthly rates are quite high compared to regular term life insurance. Guaranteed issue policies might be enough to cover funeral expenses, but are unlikely to be enough to protect your loved ones for the long-term.

The end of a term life insurance policy

The second most missed question in the HealthIQ quiz was “What happens when a term life insurance policy expires while the insured is still living?” It turns out that only 64 percent of responses were correct for this question, with the most educated scoring the highest on average.

The best life insurance product for most people is term life insurance. Term life insurance gets its name because it is good for a specific period of time, known as the term. The most popular term is 20 years, though you can get policies for up to 30 year terms. I have a $1 million, 30-year term life insurance policy to protect my family.

At the end of the term with term life insurance, the default is for the policy to expire. It is possible to renew in most cases, but at a much higher rate than you originally paid a decade or more ago. Taking no action, the policy with expire and cease to exist.

While you don’t get a payout when a term life insurance policy ends, you survived the policy period and are still alive. That’s a win on its own! Ideally, you would be able to save enough over the life of a term life insurance policy to no longer need life insurance at the end. If these words sound like Greek to you, learn more about life insurance terminology here.

Life insurance policies are priced based on the likelihood that the insured will pass away during the policy term. Age is one of the biggest risk factors in passing away, so getting a policy as young as possible for the longest term you may need is the best plan.

Whole life benefits compared to other insurance

The third most missed question was “What is the biggest benefit of whole life insurance compared to other types of life insurance?” Only 65 percent answered correctly.

Whole life insurance is sometimes called permanent life insurance because it grows in value over time. Unlike term life insurance, which becomes effectively worthless at the end of the term, whole life maintains a policy value.

Whole life is sometimes called investment grade life insurance. Each time you make a payment, it is added to the value of your policy. The value can increase over time, though do not expect to get the same returns as you could in the stock market or other investment vehicles. I personally don’t like the term “investment grade” for insurance, as it should be look at as an insurance product first, not an investment.

Whole life costs a lot more than term life each month, but the big benefit is that it grows in value. This article from the State of New York Department of Financial Services does a great job at answering common whole life insurance questions.

Test your life insurance IQ

The average score for the first 200 completions was about 72 percent. How do you stack up against everyone else? The only way to find out is to complete this fun, quick 10-question quiz yourself! The quiz is free and only takes a few minutes.

Take the 10-question life insurance quiz here. You may learn something interesting along the way!

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