Ch. 2: Life Insurance Basics

Ways to determine amount of personal life insurance

- Human Life Value approach - Needs Approach

Business uses of Life Insurance

- buy-sell funding - key person - executive bonus

Cash accumulation

Life insurance may be used to accumulate specific amounts of monies for specific needs with guarantees that the money will be available when needed. For example, some life policies (those that provide permanent protection, such as whole life) accumulate cash value that is available to the policyowner during the policy term.

suitability

part of solicitation and sales presentations. An insurance producer may not recommend the purchase, sale, or exchange of an insurance policy or annuity contract without the reasonable belief that the transaction is in the best interest of the insured.

advertising

part of solicitation and sales presentations. Must be accurate and not misrepresent the facts. Advertising rules apply to any insurance advertisement intended for presentation, distribution, dissemination or other advertising use when used or made either directly or indirectly by or on behalf of the insurance company. Every insurance company must establish and maintain a system of control over the content, for, and method of dissemination of all advertising of its policies. The insurer whose policies are advertised is responsible for all its advertisements, regardless of who wrote, created, or presented, or distributed them.

Needs approach

Based on the predicted needs of a family after the premature death of the insured. Some of the factors considered by the needs approach are income, the amount of debt (including mortgage), investments, and other ongoing expenses. Lump-sums needs: - costs associated with death (post mortem) - Debt cancellation (as an alternative to Estate Liquidation) - Emergency Reserve Funds - Retirement Fund - Bequests Income Needs - Replacing Insured's salary or lost services - social security income "Blackout" period - Liquidation vs Retention of capital

Personal Uses of Life Insurance

1. Survivor Protection 2. Estate creation and conservation 3. Cash accumulation 4. Liquidity

Estate creation and conservation

A person may create an estate through earnings, savings, and investments, but all of these methods require disciplined action and a significant time period. The purchase of life insurance creates an immediate estate. Estate creation is especially important for young families that are getting started and have not yet had time to accumulate assets. When an insured purchases a life insurance policy, he/she will have an estate of at least that amount the moment the first premium is paid. There is no other legal method by which an immediate estate can be created at such a small cost. Life insurance proceeds may be used to pay inheritance taxes and federal estate taxes so that it is not necessary for the beneficiaries to sell off the assets.

the process of issuing a life insurance policy - producer responsibilities

- solicitation and sales presentations -advertising -illustrations -buyer's guide -policy summary -suitability - field underwriting -notice of information practices -application procedures

Field Underwriting

Underwriting is the risk selection and classification process. It involves a careful analysis of many different factors to determine the acceptability of a

valid insurable interest exists between policyowner and the insured when the policy is insuring:

- policyowner's own life - the life of a family member (spouse or close blood relative) - the life of a business partner, key employee, or someone who has a financial obligation to the policyowner (such as debtor to creditor).

Liquidity

As a result of the cash accumulation feature, some life insurance policies provide liquidity to the policyowner. That means the policy's cash values can be borrowed against at any time and used for immediate needs.

Executive bonus

arrangement where the employer offers to give the employee a wage increase in the amount of the premium on a new life insurance policy on the employee. The employee owns the policy and therefore has all control. Since the employer treated the premium as a bonus, the amount is tax deductible to the employer and income taxable to the employee. It is assumed that if the employee were not willing to accept these conditions, the employer would not provide the benefit.

Solicitation and Sales Presentations

the process of issuing a life insurance policy beings with solicitation. In simplest terms, solicitation of insurance means an attempt to persuade a person to buy an insurance policy, done orally or in writing. This includes providing information about available products, describing the policy benefits, making recommendations about a specific type of policy, and trying to secure a contract between the applicant and insurance company. includes: advertising illustrations buyer's guide policy summary suitability

buy-sell funding

Legal contract that determines what will be done with a business in the event that an owner dies or becomes disabled. (Business Continuation Agreement) Several types of buy-sell agreements: -cross purchase: in partnership when partner buys a policy on the other -entity purchase: when the partnership buys policies on the partners -stock purchase: in privately owned corp when each stockholder buys a policy on each of the others -stock redemption: when the corp buys one policy on each shareholder

Survivor protection

The death of a primary wage-earner will usually stop the flow of income to a family. The death of a non-earning spouse who cares for minor children can also cause great financial hardship for the survivors.

Human Life Value approach

The human life value approach gives the insured an estimate of what would be lost to the family in the event of the premature death of the insured. It calculates an individual's life value by looking at the insured's wages, inflation, the number of years to retirement, and the time value of money. Example: Let's assume that a 40-year-old insured earns $50,000 a year and is expected to earn the same amount until he retires at age 65. Out of his annual income, $40,000 is spent on family needs, and $10,000 goes to the insured's personal expenses. This means that the human life value of this insured to his family is $1,000,000 ($40,000 a year spent on the family's needs x 25 years to retirement). Based on this assumption, and taking interest and inflation into consideration, the insurance company will determine the right amount of insurance to produce the same annual amount of income for the family if the insured were to die.

Insurable interest

To purchase insurance, the policyowner must face the possibility of losing money or something of value in the event of a loss. This is called insurable interest. In life insurance, insurable interest must exist between the policyowner and the insured AT THE TIME OF APPLICATION; however, once a life insurance policy has been issued, the insurer must pay the policy benefit, whether or not an insurable interest exists. Not required of beneficiaries. Since the beneficiary's well being is dependent upon the insured, and the beneficiary's life is not the one being insured, the beneficiary does not have to show an insurable interest for a policy to be purchased.

Key person

a business can suffer a financial loss because of the premature death of a key employee - someone who has specialized knowledge, skills or business contacts. A business can lessen the risk of such loss by the use of key person insurance. With this coverage, the key employee is the insured, and the business is all of the following: -applicant -policyowner -premium payer -beneficiary The business would use the money for the additional costs of running the business and replacing the employee. The business can't take a tax reduction for the expense of the premium. However, if the key employee dies, the benefits paid to the business are usually received tax free, No special arrangements or contracts are needed except that the employee would need to give permission for the coverage.

Illustrations

part of solicitation and sales presentations. illustration means a presentation or depiction that includes nonguaranteed elements of a policy of individual or group life insurance over a period of years. A life insurance illustration must: -distinguish between guaranteed and projected amounts -clearly state that an illustration is not a part of the contract - identify those values that are not guaranteed as such An agent may only use the illustrations of the insurer that have been approved, and may not change them in any way.

Buyer's Guide

part of solicitation and sales presentations. provides basic, generic information about life insurance policies that contains, and is limited to, language approved by the Department of Insurance. This document explains how a buyer should go about choosing the amount and type of insurance to buy, and how a buyer can save money by comparing the costs of similar policies. Insurers must provide a buyer's guide to all prospective policy applicants prior to accepting their initial premium. If the policy contains an unconditional refund provision of at least 10 days (free-look period), a buyer's guide can be delivered with the policy.