The issue of the different types of life insurance commonly encountered in divorce proceedings was a recent subject of conversation in my office, worthy of necessitating a Life Insurance 101 blog, in my opinion.
When our office sends out a blank financial statement form for a client to complete in draft, the issue of the “value” of life insurance is often an area rife with confusion.
Life insurance, as the title implies, insures the life of the insured person. The insured person need not be the policy owner. The policy owner may be anyone with an insurable interest, such as a spouse. So, for example, a husband may own a life insurance policy insuring the life of a wife, and vice versa.
If an insured dies within the policy term, the life insurance beneficiary will be paid the life insurance death benefit. The death benefit is the amount of insurance purchased. In other words, if a person purchases a policy with a $100,000 death benefit, that is the death benefit that the policy beneficiary will be paid.
The death benefit is not the policy cash value. This is an inflection point where confusion abounds. A life insurance policy with a death benefit of $100,000 does not have a present cash value of $100,000. To simplify matters, think of it this way: If the policy had a present cash value of $100,000, it is because the insured is deceased, and the policy has fulfilled its contractual terms and is no longer an insurance policy. In essence, no policy exists any longer; only the cash paid on the death of the insured.
There are three types of life insurance policies, in general. The nuances of each are as follows:
- Whole Life Insurance. This type of policy insures a person for their whole life. You purchase an amount of whole life coverage ($100,000 as in the prior example) and pay level premiums for a term of years, after which the policy is in “paid up” status and there are no longer any premium payments due, but the insurance remains in effect. These types of policies typically will build up a “cash value.” That is, there is an investment component where you may accumulate cash value and may be paid dividends, typically tax-deferred. A policy owner can cash out the cash value from the policy but continue to make premium payments and keep the death benefit in place. If, as and when an insured dies, the death benefit plus any accumulated cash value would be paid to the named beneficiaries.
- Term Life Insurance. As the name of this type of life insurance policy suggests, this type of insurance remains in effect for a specified term, such as 10, 20, or 30 years. The policy owner purchases a life insurance death benefit in a specified amount for that term of years. After the term expires, the insurance is generally lapsed, unless there are benefit continuation/renewal provisions in the policy. Term insurance does not accumulate cash value. Term insurance is less expensive than whole life insurance and will allow a person to purchase a much higher death benefit for a much lower premium and provide a hedge against a premature death prior to a married couple accumulating significant assets through savings. Employer-sponsored life insurance is typically a sort of term life insurance that does not accumulate cash value and is only effective as long as an insured remains an employee of the company providing the insurance.
- Universal Life Insurance. Universal Life Insurance has features akin to a whole life insurance policy but provides flexibility in adjusting coverages and premiums. Like a whole life insurance policy, a universal life insurance policy accumulates cash value.
In the context of a divorce case, the parties’ Rule 410 Financial Statements has a line item under the asset section which provides for a disclosure of the cash value of any life insurance policies a party owns. This disclosure is a requirement by the court and that is why a fundamental understanding of how life insurance works is important. There are, of course, other reasons to understand what kind of life insurance is available, such as when a person has a support obligation that should be at least secured by life insurance to protect a recipient spouse in the event that the payor spouse dies prematurely.
This blog is intended to convey information in a clear and concise manner, only, should the need arise to know what to include in a financial disclosure, in the context of a divorce proceeding.
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