Key Life Insurance Terms to Know

Life insurance is a vital way to protect your loved ones, or even your business partners, when you pass away. Needless to say, it’s not a purchase you want to take lightly. 

When shopping online or through an agent, however, you’ll likely come across a lot of confusing industry jargon. Here are definitions for some of the most important life insurance terms, so you can better understand what you’re signing up for. 

It’s important to know basic life insurance terminology to better understand your options.

Beneficiary

The party – whether it be an individual, a charity or a trust – that will receive the death benefit if you die while the life insurance policy is active. You can designate one individual or entity to receive the entire benefit or have it split between multiple parties. Most policies will ask you to designate a primary beneficiary (or beneficiaries) as well as secondary (or “contingent”) beneficiaries, in case the primary beneficiary has since passed away. 

Cash value 

The amount of money that the policy owner can access during their lifetime, whether through a withdrawal or a loan, or by surrendering the policy. In permanent life insurance, part of each premium paid is credited to the cash value of the policy. Depending on the policy, the insurer may also credit the cash value based on prevailing interest rates or the performance of investment sub-accounts. 

Death benefit

The total amount that your beneficiaries will receive if you pass away when the policy is active. If you own a permanent life insurance policy, the death benefit may be reduced by the amount of any withdrawals or loans that were not repaid, The death benefit amount is one of the biggest factors affecting premiums, with larger policies costing more. 

Also known as the policy’s “face value.” 

Face value 

The death benefit that your beneficiaries will receive from your policy. With a permanent life insurance policy, the initial death benefit can decrease if you make any withdrawals or take out loans that you don’t repay. Conversely, the benefit may increase if, for example, you purchase paid-up additions (PUA). 

Insured

The individual whose life is insured by the policy. When this person dies, the insurer pays the death benefit to the policy's beneficiaries. Typically, the insured individual is the same person who owns the policy and pays the premium. However, another individual can purchase a policy on someone else’s life, as long as they receive the consent of the insured. They would also have to demonstrate an “insurable interest,” which means they would be financially impacted if the insured individual were to pass away. 

Lapse

The cancellation of your policy based on failure to pay required premiums. When a policy lapses, your beneficiaries are no longer eligible to receive a death benefit when you pass away. 

Most policies have a grace period that goes into effect when you miss a payment. With a permanent life insurance policy, the insurer will typically use funds from your cash value to pay the premium and keep the policy from lapsing. Once the cash value is exhausted, additional missed payments will result in the policy going into a grace period. 

Term policies don’t have a cash value, so any missed payments automatically put the policy into the grace period. Paying the missed premiums during the grace period enables the insurer to reinstate your policy. 

Paid-up

The status of a permanent life insurance policy in which the owner no longer has to pay premiums to keep the policy active. Some policies are designed to reach “paid-up” status within a set number of years when the owner pays the required premiums. At some point, you may be able to use your cash value – and dividend payments, if applicable – to buy paid-up coverage, although your death benefit may be reduced in the process. 

Paid-up additions

Increases in the amount of the policy’s death benefit and cash value, paid for by cash, insurer-paid dividends or both. The ability to purchase paid-up additions is available as a rider on some permanent life policies. 

Permanent life insurance

A type of life insurance that offers a death benefit as well as cash value that the owner can tap during their lifetime. Unlike term insurance, which is active for a set number of years, permanent life insurance policies are in force for as long as the required premiums are paid. Examples include whole life, variable life and universal life insurance. 

Policy loan spread

The portion of the policy loan interest charge that goes to the insurer. The spread typically ranges from 0.25% to 2.0% of the loan amount. 

Premium

The amount that you pay to keep the life insurance policy active. The premium can typically be paid monthly or annually, depending on the policyholder’s preference. 

In a term policy, the entire premium pays for the cost of the insurance (i.e. death benefit). With a permanent life policy, part of the premium pays for the cost of insurance, and part of it helps build cash value for the policyholder. 

Rider 

Optional features that owners can add to the policy. Adding a rider to a policy increases the premium. 

Examples include an accelerated death benefit insurance rider, which allows policyholders to tap funds from their death benefit if they have a terminal illness, and family insurance riders, which provide a death benefit if a family member passes away. 

Surrender

The intentional cancellation of your permanent life insurance policy. When you surrender your policy, your coverage is no longer active and you receive the policy’s cash value from the insurer.

Some life insurance products have surrender charges –usually on a sliding scale – that kick in when you cancel your insurance within the first few years. If you incur surrender charges, the insurer will pay you the cash value minus this fee. 

Term life insurance 

The most basic type of life insurance. Term life insurance policies pay a death benefit to your beneficiaries, as long as you pass away during the “term,” which is typically 10-30 years from the date you activate the policy. Unlike permanent life insurance, term insurance does not provide a cash value that you can tap during your lifetime. However, they’re typically much more affordable than permanent policies. 

Underwriting

The process of determining your financial risk to the insurance carrier. When you apply for a policy, the underwriting department will determine whether it will offer you coverage and, if so, what the premiums will be. It uses factors such as age, gender and health history to make that determination. 

Universal life insurance 

A permanent life insurance product that, like whole life, offers both a death benefit for beneficiaries and cash value that the owner can tap during their lifetime. However, owners have the flexibility to adjust their coverage and premiums with a universal life policy. Because the death benefit is not guaranteed, universal life policies can lapse if not properly funded. 

Whole life insurance 

A type of permanent life insurance that pays a guaranteed death benefit to the policy’s beneficiaries and has a cash value component that grows over time. Whole life insurance providers credit the cash balance based on prevailing interest rates, with many offering a minimum rate of return.