Life policy classifications: group versus individual, permanent versus term, participating versus nonparticipating

Three ways to sort a life policy

Every life insurance policy can be described along three independent axes. The exam likes to mix them up, so keep them separate in your head:

1. Who is covered, and under what contract? Group or individual.
2. How long does coverage last, and does it build value? Term or permanent.
3. Does the policyowner share in the insurer's favorable experience? Participating or nonparticipating.

One policy sits somewhere on all three at once. An employer's basic life plan is usually group and term. A whole life policy bought from a mutual insurer is usually individual, permanent and participating.

Group versus individual

An individual policy is a contract between the insurer and one policyowner. The applicant is usually underwritten individually: health, age, habits and finances are evaluated before the policy issues, although some individual policies, such as one obtained by converting group coverage, are issued without evidence of insurability. The owner receives the policy itself.

A group policy is a single master policy issued to a sponsor, such as an employer, labor union or creditor. The sponsor is the policyholder. Each covered person receives a certificate describing their protection, not a policy of their own. Key features:

• Group underwriting. The insurer evaluates the group as a whole, so members are usually covered without individual evidence of insurability, provided they join when first eligible.
• Usually annually renewable term. Most group life is term coverage, and premiums for the group reflect the ages of its members.
• Conversion privilege. When a member's coverage ends, for example because employment ends, the member can convert to an individual permanent policy without proving insurability, within 31 days. If the member dies during that 31-day window, the death benefit is still payable.
• Incontestability. A group policy is incontestable after two years, except for nonpayment of premium.

Credit life insurance is a common group arrangement: a lender holds the master policy, and each borrower's coverage is tied to the loan.

Term versus permanent

Term insurance covers a specified period: one year, a set number of years such as 10 or 20, or to a stated age. If the insured dies during the term, the face amount is paid to the beneficiary. If the insured outlives the term, nothing is paid. Term generally has no cash value, so it lapses with nothing returned if premiums stop. It is the cheapest pure protection at younger ages, but renewal premiums rise with age. Term can be level or decreasing, and is often convertible to permanent coverage.

Permanent insurance is designed to last the insured's whole life, as long as premiums are paid. It combines a death benefit with a cash value that builds over time. Traditional whole life states its premiums, death benefits and cash values in the policy. Variations include limited-payment and single-premium whole life, along with interest-sensitive forms such as universal life.

Participating versus nonparticipating

A participating (or par) policy pays dividends. Dividends reflect the insurer's favorable experience: investment earnings above assumptions, better-than-expected mortality and expense savings. They are best understood as a return of part of the premium, and they are not guaranteed. Par policies are traditionally issued by mutual insurers, which are owned by their policyowners.

The policyowner may take dividends as:

• cash
• a reduction of the premium
• accumulation at interest with the insurer
• paid-up additions, small amounts of extra paid-up insurance
• one-year term insurance, an option many insurers also offer

A nonparticipating (nonpar) policy pays no dividends. Its premium and face amount are fixed, so its costs are predictable and its premium is usually lower than a comparable par policy. Stock insurers, owned by shareholders, traditionally issue nonpar policies.

Classify each axis separately. "Group" says nothing about whether coverage is term or permanent, and "permanent" says nothing about whether the policy pays dividends.