Life insurance probably is the most misunderstood financial instrument in the United States today.

Contrary to popular belief, the insurance companies have not banded together to confuse the public.

When you purchase a life insurance policy, the insurance company, in return for the payments of premiums, agrees to pay a predetermined sum of money upon the death of the insured. The sum of money, or death benefit, will be an individual, group of individuals, corporation or trust, among others.

While beneficiaries can expect to receive the death benefits, they have no rights under the policy. The person who controls the policy is the owner. In most cases, the owner is the insured; however, the owner also can be the beneficiary. The owner has the right to change the method of premium payments, assign the policy or cover a loan, borrow from the policy, or transfer ownership to another individual.

Life insurance can be divided into two general categories: term and whole-life, also known as ordinary or permanent insurance.

Term insurance initially is the less expensive of the two. Of all the types of term policies available, the most popular, and initially the most economical, policy is yearly renewable and convertible term insurance. This type of policy has a level death benefit. It may be renewed each year, without a physical examination, at a predetermined cost that increases each year. The biggest drawback to this type of policy is that the premiums become very expensive in later policy years; in some cases, the policy will terminate at a set age.

Term insurance provides no benefits in the event you elect to terminate the policy. An individual who feels that he or she is going to keep a policy for more than 15 years should consider whole life insurance. If, however, you cannot make that determination, or if ability to pay for the policy is a consideration, you can start out with term and convert the policy later to whole life. This coversion is automatic and can ben accomplished without a physical examination.

There are many different types of whole life insurance and individual can consider. Two types are most commonly purchased, however. The first is regular whole life. Different companies use different names for regular whole life: a common descriptive name is "life paid up at age 100." Translated into English, this means that if you were to pay premiums until you reached age 100, you could stop making premium payments and be insured for the face amount for the rest of your life.

The cash value enables the premiums to remain constant. The cash value can be borrowed from the policy at a predetermined interest rate or can be taken outright by the policyholder if he or she elects to cancel the policy. That cash value also has a corresponding "paid-up" insurance value which, in the "life paid up at 100" policy, will equal the face amount of the policy at age 100. If an individual wishes to stop paying premiums prior to age 95, which is likely to happen, he or she would be insured for an amount less than the face amount of the policy.

Graded premium whole life is similar to regular whole life, except that the premiums initially are smaller. They increase by a fixed amount each year until the 11th policy year, when they level off and then stay the same for the remainder of the life of the policy. The purpose of graded premium whole life is to provide the benefits of whole life insurance at an initial cost similar to term insurance.

The first thing an individual must do is determine how much insurance is needed.

Most young people purchase insurance to cover expenses in the event of premature death. A major misconception that many people have is the assumption that as they get older they can reduce the amount of their insurance coverage.

If no untimely death occurs, the ultimate purpose of insurance becomes the payment of federal estate taxes, estate inheritance or transfer tax and the probate and administrative costs of settling an estate.

If an estate has liquid assets, such as stocks and bonds, they can be sold to cover expenses. The sale will be made either for a profit (which will generate a capital gains tax) or will be sold at a loss. Illiquid assets, such as real estate or stock in a closely held corporation, may not have a market in which they can be sold. If saleable, they would be subject to the same adverse conditions as the liquid assets. Life insurance is the only financial vehicle which will provide the cash necessary to pay those expenses.

There are many different ways in which an individual may acquire insurance without paying for it personally in after-tax dollars. Such coverage comes under the broad heading of the employee benefit plans. In many cases, the employer establishes a plan that primarily benefits him or herself as the most important employe. The following is a brief description of some available employe insurance alternatives.

GROUP TERM -- Life insurance paid with tax deductible dollars covering all employes, according to a predetermined schedule. An employe can receive up to $50,000 worth of insurance without any tax implication.

RETIRED LIVES RESERVE -- A method of providing a pool of money which is accumulated, tax-free, to keep an employe's term policy in force after retirement with no additional payment by the employee.

SECTION 79 INSURANCE -- a method of providing term or whole life insurance in excess of group term for select employes. The premiums are tax deductible, and there is some minimal tax implication for the employe.

SECTION 162 INSURANCE -- a system in which an employer pays an employe a bonus in excess of salary to pay insurance expenses, while employes declare it as income.

SPLIT DOLLAR INSURANCE -- Life insurance policy where all or part of the premiums are paid by a loan from the employes to the employer. While the payments are not tax deductible, the employer will recover his money because there is an assignment of policy values to cover the loan.

DEATH BENEFITS UNDER A PENSION PLAN -- Life insurance held by a pension or profit-sharing plan. The purpose is to prefund the retirement plan in the event of a premature death. The premium payments are tax deductible in that they are payments to a pension or profit-sharing plan.

KEY PERSON INSURANCE -- Insurance held by a corporation on the life of a key employe. The benefits will be paid to the corporation upon the employe's death and not to the employe's family. Its purpose is to provide funds to help the corporation overcome th economic loss of the employe.

BUY-SELL INSURANCE -- Life insurance used to fund a business buyout in the event of the death of a partner or stockholder in a closed corporation.