THERE are two categories of life insurance: One is term policies, which are pure life insurance.

The other is whole life and endowment policies, which combine investments and insurance.

These go heavy on investments and light on insurance. This was noted in a poll last year by the Life Insurance Association. It showed that most of us are under-insured.

The study calculated that the average employee needs $480,000 in 'term' coverage, which pays your beneficiaries if you die.

On average, however, we only have about 25 per cent of that, with $118,000 in coverage.

Increasing the coverage with more whole life and endowment insurance would be quite expensive.

Buying term insurance is more economical. (See report below.)

Investments for whole life and endowment policies go into a huge policyholders' fund managed by the life insurer.

Insurers disclose the fund's gross, but not net returns, which makes it difficult to know if these are good investments.

The costs are high in the early years. You must pay an average of 16 months of premiums as commission to whoever sold you the policy.

The average cost of commissions decline the longer you hold the policy, which explains why the policies are sold as 'long-term financial commitments'.

A main attraction is that unlike term insurance, the investment component 'gives you something back at the end'.

It can be misleading, however, since whole life and endowment policies include (i) an investment, and (ii) term insurance. Only the investment gives back something at the end. The term insurance is like any other and expires with no value.

Another feature is these policies are a useful form of 'forced savings' for people who enjoy the threat of a hefty financial penalty to encourage them to save.

As the table on the right shows, we own a lot of these policies.

The total is $66 billion and averages $66,000 per household. Most households own more than one policy.

Whole life policies are very long-term. You must pay premiums for your whole life.

Endowment policies are for a fixed period, like 5, 10 or 20 years. A popular type of endowment insurance is an education policy.

It has a specific saving goal and usually matures when the child is ready for university, often in 20 years.

It also bundles term insurance with investments.

The investment money is set aside for the child's education while the term policy insures the lives of the parents.

Whole life and endowment insurance are nearly equal in popularity.

We own 5.2 million of these policies, of which 52 per cent are whole life and 48 per cent are endowment.

How term insurance works

TERM insurance pays your beneficiaries if you die. It covers a fixed time period like 5, 10 or 20 years.

When the insurance term ends, it can often be renewed automatically.

Another option is convertibility, whereby the term insurance converts to a whole life policy, often at favourable rates.

Term insurance gets more expensive as you get older.

It is also more expensive for men than women and for smokers than non-smokers.

Term insurance is needed only if there is an insurable interest, such as a loss of income resulting from death. People who do not earn an income - such as children, housewives and retirees - do not need it.

If you don't need term, you should probably not buy whole life or endowment policies either, since these come bundled with term insurance.

You must pay for the term coverage whether you need it or not.

A less expensive variation is called 'decreasing term'. The life insurance coverage starts high in the early years and decreases as you approach retirement.

At retirement, it falls to zero, which is appropriate since you no longer have an insurable interest once you stop working.

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