Life Insurance

INDIVIDUAL LIFE INSURANCE

Depositphotos_1622429_originalLife insurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the occurrence of the insured’s death. In return, the policyowner (or policy payor) agrees to pay a stipulated amount called a premium at regular intervals. Life based contracts tend to fall into two major categories: Protection policies – designed to provide a benefit in the event of specified event, typically a lump sum payment. Investment policies – where the main objective is to facilitate the growth of capital by regular or single premiums. # Term Life insurance # Permanent / Whole Life insurance # Universal Life Insurance # Variable Universal Life Insurance # Group Life Insurance Accidental death is a limited life insurance that is designed to cover the insured when they pass away due to an accident. Accidents include anything from an injury, but do not typically cover any deaths resulting from health problems or suicide. Because they only cover accidents, these policies are much less expensive than other life insurances. It is also very commonly offered as “accidental death and dismemberment insurance”, also known as an AD&D policy. In an AD&D policy, benefits are available not only for accidental death, but also for loss of limbs or bodily functions such as sight and hearing, etc.

REASONS TO BUY LIFE INSURANCE

1. Death Benefit: Proceeds used to help the beneficiary. 2. Savings Plan: Permanent insurance creates cash savings. 3. Prepare for retirement: Cash accumulation account with interest applied. 4. Provide collateral for loans: Banks will accept cash value in policy.

BUSINESS USES OF LIFE INSURANCE

  1. Sole Proprietor: Insurance is purchased on the life of the business owner to help pay for any expenses at death. The proceeds may also be used to help pay to continue the business, taxes, bills owed etc.
  2. Keyman Insurance: The insurance policy is purchased by the company to provide funds in the event a key employee such as a sales manager dies. The funds will be used to conduct a search for a new sales manager or to cover for loss of revenue for the business. REMEMBER, the company is always the beneficiary.
  3. Buy/Sell Agreement: Partners in a business would create a buy/sell agreement. In the event of the death of either of them, the agreement would allow the surviving partner to buy out the other partner’s interest from the deceased’s estate. The agreement is usually funded with life insurance!
  4. Split Dollar Insurance: The premiums to purchase the life insurance policy are SPLIT between a key employee and the employer.
  5. Deferred Compensation: This is a non-qualified plan for employees to reduce their salary and to provide savings for retirement. These plans can be funded with life insurance.

APPROACHES IN DETERMINING AMOUNTS OF INSURANCE

  1. Life Value Concept: Take the present value of an individual’s future earnings. First determine the insureds net income (after taxes). Deduct the value of maintenance items such as food. Add an inflation factor to compensate for the reduction in the purchasing power of the dollar.
  2. Needs Approach: Establish final needs at death such as funeral expenses, taxes etc., Used to help insure family’s standard of living. Determine income supplements needed to support children. Provide for special needs such as college education or retirement.

RATINGS ASSIGNED TO INSURANCE COMPANIES

Measures the claims paying ability of the insurance company. AM Best Company: A++ is the highest rating available. Standard & Poor and Moodys: AAA is the highest rating available.

SUBSTANDARD RISKS

These represent greater risks to the insurance company than a normal healthy individual. An individual with high blood pressure, as an example, represents a higher risk, which may demand higher premiums than a healthy individual at the same age. Premiums will be adjusted to insure the additional risk. Permanent extra premiums are charged by the insurance company. The higher premium is based on a percentage above standard rates.

TERM LIFE INSURANCE

The key element to remember about term insurance for the exam is that it DOES NOT ACCUMULATE CASH! Basic life insurance protection taken out on an individual for a definite period of time (term).

Types of Term Insurance

  1. Level Term: Same face amount (death benefit) throughout the term of the policy.
  2. Decreasing Term: Face amount decreases annually. This type purchased for credit accounts, auto loans, mortgage loans etc.
  3. Increasing Term: Face amount increases annually until the policy expires. This type is purchased when circumstances change and responsibilities change such as buying a home, getting married , having children etc.

OTHER FEATURES OF TERM INSURANCE

Renewable Term: Insurance is renewable at the end of the initial term without any evidence of insurability. Convertible Term: Insurance is convertible into permanent insurance without any evidence of insurability. Conversion rules vary but usually can be converted at an attained age which would be listed in the policy. The conversion date can revert back to the age of the original policy issue date. The advantage of this would be lower premiums as it is based on the prior issue age. However, the insurance company would then figure out what the permanent insurance premiums would have been and what were paid and the insured would have to pay the difference. Terms gets more expensive in later years as the insured gets older. Term insurance can be purchased annually or even for 10, 15, 20 or 30 year terms. Level term premiums and death benefits remain the same throughout the life of the policy. Step rate premiums stay level until the end of each term, then they will increase and then stay level until the end of that term, and so on and on it goes. (Just like the following diagram):

PERMANENT / WHOLE LIFE INSURANCE

Whole life insurance, unlike term insurance, can provide insurance with a cash accumulation fund. Some of the features of whole life insurance include:
  • Life insurance protection for your whole life, until age 100.
  • Cash value builds up from excess premium paid.
  • Whole life insurance endows at age 100. At age 100 the past excess premium paid, plus interest accrued, will be equal to the face amount of the policy, and a check will be presented to the insured for the full amount.
  • In a way, whole life insurance provides for compulsory savings.

TYPES OF WHOLE LIFE INSURANCE

1. Ordinary or Straight Life. Basic whole life as described previously. Provides for a level premium which means the same premium for the life of the policy. Cash builds up with time. Loans are available from the cash accumulation account. Whole life can be used as collateral for loans. Cash buildup rules
  • Cash builds up the slowest with ordinary whole life as payments are made monthly for the life of the policy.
  • The lesser the payment pay-in period the greater the percentage of cash build up because of the combined larger premiums of the shorter time period and compounding of the cash in the account.
  • Single premium payments will provide for larger savings as more money is initially placed into the account.
  • Limited pay periods can include 20 pay (20 yrs), 30 pay (30 yrs), paid up life at age 65 etc. These periods will usually provide faster cash buildup as higher premiums are usually required versus traditional pay whole life which is monthly for life. To make sure you understand this concept consider the following pay-in choices and answer which provides the fastest growing cash accumulation account ?
A. Traditional whole life B. 10 pay life C. Single premium D. 20 pay life E. 30 pay life F. Paid up at age 65 while current age is 50 That’s right, choice C. As common sense dictates, this pay-in method will provide the largest sum initially and through interest and compounding the account balance will grow the fastest. 2. Modified Whole Life Combines both term insurance and whole life insurance coverage. Term insurance starts and the policy automatically converts into whole life after a short period of time. (Usually 3-5 years) Major advantage is lower premiums in earlier years due to the term insurance. The major disadvantage is that this policy DOES NOT BUILD CASH VALUES at the beginning, as it starts as term insurance. The market for modified whole life are for those who can’t afford the initial larger premiums. While their earnings will increase over the years they are typically not interested in saving cash while the policy is in the term insurance mode. 3. Graded Premium Whole Life Whole life policy that provides a low initial premium and then gradually the premium increases over the first five years. After the fifth year the premium usually levels out. This is policy consists completely of whole life without any term insurance. Because it is always whole life insurance, cash will start accumulating almost immediately. 4. Interest Sensitive Whole Life Also known as current-assumption whole life. Premiums can be flexible and can vary as the following assumptions are made and changed by the insurance company (as shown below).
  • Death factors
  • Investment factors
  • Expense factors
As a result, if the above factors are more favorable, cash values can accumulate and be greater than the guaranteed levels. For the insured, the policy owner can either lower the premium or have higher cash values. If the factors are less favorable than anticipated, the policy owner will have to pay higher premiums or choose to allow the cash savings to be used to pay the premiums. 5. Adjustable Life Insurance This product was developed for those persons who want to change their insurance coverage, either up or down, while reacting to their changing life situations such as marriage, buying a home, having children etc. The insured can increase or decrease the death benefit. The amount or frequency of premium payments can be changed. The death benefit can be increased but the insurance company may require evidence of insurability. Changes can usually be accomplished at the policy anniversary date. Also, the policy can be converted from whole life to term life, and even back to whole life again.

UNIVERSAL LIFE INSURANCE

This policy is known as an interest sensitive non-traditional life product. Provides flexibility of increasing and decreasing both the death benefit and premiums paid. Cash values build at a declared rate, known as the current rate. A minimum guaranteed rate is also applied. (Usually 4-5%). Cash grows on a cash deferred basis which means current taxes do not have to be paid unless the policy is surrendered either partially or in full. Loans and partial or full surrenders are allowed. The prime feature is its flexibility. You can even skip a payment and it won’t jeopardize your coverage as long as there is enough cash in the cash accumulation account to pay for the actual cost of insurance. Unbundling is a term used only with universal life insurance policies and will be on the exam. It represents the separation of the initial premium payment into two distinct segments:
  • Expense Account: This account includes items such as the agent’s commissions earned, administrative costs, cost of insurance and any other sales expenses.
  • Cash Value Account: What remains of the initial premium payment will then be applied to the cash accumulation account where it will start to accumulate interest on a tax deferred basis. Note: After the initial premium is paid, the cost of insurance and any other fees are deducted directly from the cash accumulation account.

Death Benefits of Universal Life Insurance

  • Death Benefit A or 1: Death benefit A, also known as death benefit 1, represents a level death benefit which is partially paid for with the cash accumulation account. (i.e. You have a $100,000 life insurance death benefit and at the time of death the cash accumulation account is valued at $25,000. While the full $100,000 will be paid at death, the insurance company is only at risk for $75,000 as the cash accumulated of $25,000 is applied to the death benefit paid.)
  • Death Benefit B or 2: Death benefit B, also known as death benefit 2, represents an increasing death benefit. Using the same facts above, upon death, the beneficiary will be paid a total of $125,000 which consists of the $100,000 death benefit plus the $25,000 cash accumulation account. It should be obvious that this benefit would require higher premiums than Death Benefit A.

Miscellaneous Information

A partial surrender of a universal life policy may be repaid but additional front-end load charges may be applied to the reinvested amount. This is true because universal life is a front-end load product which means part of the investment dollars are deducted to pay sales charges. A universal life policy may be surrendered for the full cash surrender value less any surrender charges which may be applied by the insurance company. Illustrations will show actual cash values and cash surrender values. The cash surrender values compensates for any load or fees still left to be taken out over time.

Universal Life Corridor of Pure Insurance

The IRS will not allow the cash value of a universal life policy to go beyond the “Corridor of Pure Insurance”, which separates the cash value accumulated from the stated value of the death benefit. If the cash value gets too close, the earnings in the policy may become taxable and lose it’s tax deferred benefit. To prevent this situation the insured can:
  • increase the death benefit or
  • reduce the cash value.