life insurance

Example (Dividend Payout Options)

A $50 dividend may purchase $123 of paid-up whole life insurance at age 40. At the insured's death, the beneficiary receives the sum of the paid-up additions, plus the face amount of the policy. Even if the insured has become uninsurable, the owner still may acquire more life insurance using this dividend option. If the insured decides at a later date that he or she would like to take some of his or her accumulated dividends in cash, he or she can redeem some of the paid-up additions for the original cash dividend amount. Since this option provides a good benefit for beneficiaries upon death while still allowing access to the cash during life, most insurers use the paid-up additions as the default option.

Example (Convertibility Feature)

A husband, age 30, and wife, age 32, had just purchased their first home. Since both of their incomes ($35,000 & $40,000, respectively) were vital to paying the new mortgage, they wanted "mortgage" life insurance coverage. As the mortgage was a new expense, they wanted to keep the premiums on this coverage to a minimum. They realized that as they started a family and acquired more assets, their need for life insurance would probably increase for a period of time, even though the mortgage would decrease. They also felt they would eventually want some portion of their life insurance to be permanent to cover their final expenses at life expectancy. With a tight budget, they knew such permanent coverage would have to wait. There also was a history of high blood pressure and heart disease in the husband's family, making future insurability a real concern. Based on these factors, the solution was for each to purchase a $150,000 20-year renewable term policy, convertible within the first ten years. This provided them with: enough coverage to protect the current mortgage; the ability to keep the full amount so that as the mortgage decreased, there would be additional coverage for future needs; provided some guaranteed future insurability via the renewal; allowed for guaranteed conversion to some permanent coverage later; and fit their current budget constraints.

Lapsed Policy

A lapsed policy means the insured voluntarily has given up the life insurance contract by not paying the premium within the grace period.

Most whole life insurance sold worldwide is participating

A significant proportion is non-participating but with some non-guaranteed element. The amount of guaranteed-cost, non-par whole life sold is small in most countries. This small share is not surprising because companies are understandably unwilling to offer liberal pricing guaranteed for decades into the future. Conservatively priced products providing long-term guarantees do not compete well against those where the insurer does not guarantee every policy element.

contribution principle

A widely accepted equitable concept is known as the contribution principle. It holds that insurers selling participating policies must distribute surplus accumulated on behalf of a block of policies in the same proportions as the policies are considered to have contributed to the surplus. Dividends actually paid usually will exceed illustrated dividends in periods when investment returns are generally higher during the period after policy issuance than they were during the period before. Of course, the opposite also applies. For example, during the high-yielding 1980s in the United States, high dividends were illustrated. The dividends actually paid, however, were less than illustrated, giving rise to disappointment and even lawsuits.

Example (Entire Contract Provision)

A young insurance agent had been approached by a woman who wanted to purchase a life policy on her husband. Each time he stopped by their home, the husband was never there to sign the paperwork. Finally, the wife told him to leave the papers and she would have him sign. Though he was supposed to meet every applicant and witness all signatures, he saw this as the only way to complete the sale. To his embarrassment, what he had done was easily caught by the underwriter. It turned out that the husband was a well-known crime figure who had been sitting on death row all this time!

Reinstatement Provisions

After a policy lapses, the insured has an opportunity to reinstate it if specified conditions are met. The opportunity to renew a lapsed policy is called the reinstatement provision.

Whole Life Cash Values

All whole life policies involve some prefunding of future mortality costs. The degree of prefunding is a function of the premium payment pattern and period. Because of this prefunding, all whole life policies sold in the United States and some other markets are required to have cash values, which must build to the policy face amount, usually by age 100.

Survivorship Whole Life or Universal Life

Also called "second-to-die" policy, this product insures two people and costs much less than two separate policies. Some insurance companies will accept an uninsurable spouse so people with medical issues may be able to get coverage. The policy insures two lives and pays the death benefit only at the second death, so the survivor needs to plan on still paying premiums.

Single Premium Life

Another example of a product variation designed to meet a market need, but then eliminated by tax law changes. Insureds buy a Whole Life policy and then pay a large Single premium which creates an immediate cash value that is sufficient to fund the cost of death benefits over the life of the policy. Earnings accumulate tax-free until the policy is cashed in, or the policy owner can borrow cash up to the cost basis. New tax rules passed in 1988 eliminated the tax advantages of these policies.

A MEC means:

Any funds withdrawn are subject to "last-in, first-out" taxation so investment income is withdrawn first a 10% penalty applies to cash withdrawal or loan before age 59 ½.

Extended Term Option

As a second option, Johann may choose to convert to a term insurance policy providing the same $400,000 face amount as his whole life policy. The insurer will determine how long the $400,000 of term insurance will continue if a $166,800 premium were paid. Assume the answer is 14 years and 4 months. Thus, without paying another premium, Johann could continue with $400,000 of life insurance protection. However, at age 74 and 4 months, the insurance protection and the cash value would be gone and the term insurance retains no cash value.

Reduced Paid-Up Option

As a third non-forfeiture option, Johann may choose a reduced amount of paid-up life insurance. That is, he currently has a $400,000 whole life policy with $166,800 cash value. If he stops paying premiums, he may choose a fully paid-up policy of $212,500 face amount. This option is called the reduced paid-up insurance option. A policy lapsed under this option also is subject to the reinstatement provisions.

Cash Surrender Value

Assume 60-year-old Johann Bach has a continuous-premium whole life insurance policy on which he has paid premiums for 20 years. The contract requires payments until age 100. Johann decides to stop premium payments. The face amount of his insurance is $400,000 and the cash value is $166,800. When he stops his premium payments, Johann may ask for the $166,800 in a lump sum from the insurer. This is the first non-forfeiture option, taking the cash surrender value. If the cash is withdrawn in this manner, the policy may not be reinstated.

Example (Grace Period)

Assume the policyholder has a stroke and is hospitalized on December 10th, and that the anniversary date of the policy is January 1st with an annual premium of $10,000 on a $450,000 Whole Life policy. If the $10,000 is not paid on January 1st and the policyholder dies on January 18th, the beneficiary of the policy will receive a death benefit of $440,000, as the premium is outstanding less than 31 days (January 1st - January 18th). If the policyholder makes the premium payment in time, the beneficiary will receive the entire $450,000 death benefit.

universal life insurance 2

Assuming premiums are paid as planned, and based on interest rate performance, funds should typically grow over time. However, due to the flexible nature of the policy, the insured assumes some risk that the fund will actually decline, because of skipped premiums, loans or lower than expected interest rates, creating a future need to pay more premiums to cover the increased cost of insurance.

Variable Life Insurance

During the 1980s, some universal life policies added separate investment accounts from which insured's could choose in addition to the fixed interest rate. This increased the opportunity for the fund to grow, but with greater risk to the insured. The death benefits may vary directly with the insured's investment results. While these new variable universal life policies provide more options, they still operate in a similar capacity to the basic universal policy.

Special Forms of Life Insurance

Endowment Life Insurance Survivorship Whole Life or Universal Life Single Premium Life Modified Endowment Contracts Adjustable Life Insurance Joint Mortgage Redemption Policy

Endowment Life Insurance

Endowment policies promise to pay the policy face amount on the death of the insured during a fixed term such as 20 or 30 years, as well as the full face amount at the end of the term if the insured survives the term. This is in contrast to term policies, which provide for the payment of the full policy amount only if the insured dies during the policy term. Though these policies have a maturity date set before expected mortality and thus appear to be a form of temporary coverage, they are actually considered a form of permanent insurance.

Non-Forfeiture Options example

If a life insurance company were allowed to cancel a cash value life insurance policy for non-payment of premiums, it would work to the serious disadvantage of the consumer. Insureds in poor health and unable to make payments would be clear losers. Insureds with large savings accumulated in the life insurance policy would also be losers. To prevent such injustice, the law provides that life insurance policies having a savings value are not forfeited if the policies are lapsed.

universal life insurance

In 1979, a new type of policy, called universal life insurance, was created in an attempt to meet the interests of those consumers who liked the low cost nature of term insurance and the cash value features of whole life insurance. This new hybrid product was to be more flexible than its predecessors with features that allowed the insured to determine whether it would function more like term or more like a whole life policy. The name universal was used to describe how it could be tailored for many people's different needs. Some even touted universal life as the "last life insurance policy you ever need to buy."

Dividend Illustration 2

Insurance companies usually provide a dividend illustration to prospective purchasers of participating policies. This illustration shows the proposed insured dividends that would be paid under the policy if the mortality, expense and interest experience implicit in the current scale of illustrated dividends were to be the actual basis for all future dividends.

utmost good faith

Insurance contracts are contracts made in utmost good faith. This means an applicant may not answer questions untruthfully or conceal information an honest person would reveal. If an insured is untruthful or conceals material facts, the insurer may go to court and contest the policy for the purpose of voiding the policy.

Adjustable Life Insurance

Introduced in 1971, as a way to allow the insured to adjust the amount of the death benefit and premium over time. The relationship between the premium and the amount of protection determined the cash value. When premiums paid exceeded the cost of protection, the cash value increased. This seemed like a concept that would work, but it never got popular and was not marketed by the major insurers.

The entire-contract provision serves two purposes:

It allows the insured a chance to review the answers as they are recorded in the application. It prevents the insurer from making any hidden document or undisclosed restrictions a part of the contract. Historically, some companies incorporated their by-laws in their contracts by reference only, thus frustrating beneficiaries seeking death proceeds.

ulia pays a premium of $1,000 per year on her whole life insurance policy. After two consecutive years of timely payments, the cash value of Julia's policy will equal $2,000. T OR F

Julia's cash value does not equal $2,000 in year three. The insurer deducts a number of costs from the premiums paid, such as the cost of selling and underwriting the policy, taxes paid to the government, mortality charges, and administrative costs. In addition, the government requires that certain cash reserves be set aside to ensure that future death claims can be paid.

Life Insurance

Life insurance policies provide protection against the financial problems associated with premature death. It is available on a group or individual basis. Individual insurance can be further classified into industrial insurance, ordinary insurance, and credit insurance.

Policyholder Loans

Life insurance policies with cash surrender values have a loan provision. This provision gives the policy owner the ability to take a loan from the cash value of the policy. The company generally has the right to delay making the loan for up to six months. The interest rate charged for the loan is stated in the policy. Unless the policy provides for variable rates, it remains unchanged, even though general interest rates fluctuate. Interest rates typically range from 6% to 8%. Since 1980, life insurers typically have used variable rates that change with general interest rates.

Suicide Clause notes

Many insurance companies have a one-year restriction that is more favorable to the policyholder and permissible under law. If, during the underwriting process, there is a history of mental illness that causes the insurer to be concerned about possible suicide, the policy will not be issued.

Settlement Options

Most death benefits are paid in lump sum. Typically, the insurance company sets up a money market account for the full amount and delivers a checkbook to the named beneficiary. However, the policy owner can designate settlement option before death (e.g., to prevent unwise spending). The settlement options provide additional flexibility.

Reinstatement Provisions state examples

New York has a limit of three years from the date of default in which the owner may reinstate the policy. Massachusetts does not allow for the reinstatement of term life insurance policies. The state has decided that, since term insurance is akin to renting coverage, it does not make sense to pay "back rent" when you know you did not use the policy

Non-par policies

Non-par policies do not pay dividends to policyholders at the end of the year, but modern forms credit excess interest payments if the insurer earns investment returns beyond the guaranteed rate.

Nonparticipating whole life policies

Nonparticipating whole life policies are life insurance policies issued by insurance companies that are owned by stockholders, rather than policyholders. Non-participating policies fix policy elements, that is, the premium, the face amount, and the cash values, if any, at policy inception. These elements are guaranteed and make no allowance for future values to differ from those set at inception. Non-participating (non-par) policies use more realistic projections of operating results and require a lower initial premium, although, in the long run, participating policies may prove less costly.

Dividend Options

Participating life insurance policies pay dividends to the policy owner. Owners may exercise a choice as to what form the dividends take. There are five potential dividend payout options.

Endowment Life Insurance 2

Policies payable only in the event of death are purchased chiefly for the benefit of others. On the other hand, endowment policies, although affording protection to others against the death of the insured during the fixed term, pay to the insured if he or she survives the endowment period to maturity.

A beneficiary receives the life insurance proceeds when the insured dies. A person, trust, estate or a business may be a beneficiary of a policy. A person cannot be both the insured and a beneficiary, however. A beneficiary is a revocable beneficiary when the owner can change the initial beneficiary selected, but an irrevocable beneficiary cannot be changed. Generally, the revocable beneficiary has no rights in the policy while the insured is alive, while an irrevocable beneficiary has a vested or guaranteed interest in the death benefit. An irrevocable beneficiary can prevent the policy owner from taking any action that would reduce their own interest in the policy, such as borrowing from the policy or assigning the policy as security for a loan.

Policy owners should name primary (first) or contingent (second, third, etc.) beneficiaries. A common example of successive beneficiary designations is: "Proceeds to my wife (Mary Smith). If my wife predeceases me, then to my children (Huey, Dewey and Louie Smith) share and share alike. If both my wife and children predecease me, then to the American Red Cross." If a primary beneficiary is living when the insured dies, the contingent beneficiary has no rights to the death benefit proceeds. Contingent beneficiaries will only have death benefit rights if the primary beneficiary predeceases the insured.

Automatic Premium Loans

The automatic premium loan provision, which is typically found in policies having a cash surrender value, requires the insurer to advance a loan to the insured for the purpose of premium payment. Thus, if an insured does not pay the premium when due and the grace period expires, the insurer makes an automatic loan to pay the overdue premium, if the policy has sufficient cash value. This provision is included in most cash value policies at no cost.

Why, then, would a consumer want to reinstate a policy rather than purchase a new one?

The consumer avoids being charged for the large initial expenses of a new policy for the second time by reinstating a lapsed policy. The cash value is restored immediately after a policy has been reinstated. The premium will be lower on the reinstated policy because it was issued at an earlier age. There may be a change in policy terms from one series of policies to the next, with the original policy having more favorable terms. For example, the maximum interest charge on loans may be 5 percent versus 8 percent in a new policy. The suicide clause time period does not restart. Only statements made for the purpose of reinstatement are contestable until a new time period expires.

Non-Forfeiture Options

The development of the non-forfeiture option is associated with one of the first insurance commissioners of Massachusetts, Elizur Wright. Wright was a champion of the insurance consumer.

Dividend Illustration 3

The dividend illustration is usually based on the recent mortality, expense and interest experience of the company. Important differences exist in the way insurers allocate amounts to be paid as dividends, and these differences can have a major impact on the dividend levels illustrated as well as on the dividends that are actually paid.

Limited-pay whole life policy

The face amounts payable under whole life policies typically remain at the same level throughout the policy duration, although some policies pay dividends to increase the total amount paid on death. In most whole life insurance policies, the premium also remains at the same level throughout the premium payment period. Exceptions do exist, however, such as Graded Premium whole life policies, which have lower initial premiums that gradually increase for the first 10 to 15 years. Another variation is a Limited-pay whole life policy with higher premiums payable for a shorter time, e.g. until age 65.

Fixed amount option example

The fixed-amount option is useful for a client who wants to know she will get a certain needed amount, for example, a monthly check to cover her mortgage payment.

Fixed-Amount Option

The fixed-amount option provides the beneficiary with regular, fixed-income payments. Interest income is earned on balances remaining with the insurer. Federal income tax applies to the interest portion of these payments. The payments continue until the death proceeds and the interest thereon is exhausted. This option is a logical choice when people need income for a limited period, such as while social security benefits are unavailable or for an education fund. Using this option, the beneficiary can receive an insurance payment before each tuition bill.

Fixed-Period Option

The fixed-period option is similar to the fixed-amount option. With the fixed-amount option, the choice of the amount of each payment determines how long the payments will last. With the fixed-period option, the choice of the length of the period determines the size of each payment. This option might be used to fund a fixed number of years of a college education.

incontestable clause

The incontestable clause states that, if there is a valid contract between the insurer and insured, the insurer may not contest the policy to void it after the policy has been in force for two years during the lifetime of the insured. Thus, a life insurer has only a relatively short period of time in which to uncover any fraud. Generally, after the specified time has elapsed, even if a notorious fraud is uncovered, the insurer cannot void the policy.

life-income option

The life-income option guarantees, for a lifetime, a series of regular payments to the beneficiary. This is the annuity option. The insurer only makes payments under this option if the beneficiary is alive. Assume that Mrs. Johann S. Bach receives the proceeds of a $400,000 policy under the life-income option. Assume she lives only three years beyond Johann. She received only $75,000 of benefits. The remainder of the money she did not receive is pooled to pay benefits to other annuitants.

interest only option note

The money received in this option is fully income taxable, as it is considered interest only, not a return of principal.

Survivorship Whole Life or Universal Life 2

The original use for this policy was to cover estate taxes payable at the death of a surviving spouse. It can also be a more economical way to cover two parents for minor children, for charitable planning or wealth transfer. Also, it has been used in business situations if the cash would be needed at the second death.

Policyholder Loans 2

The policyholder loan is secured by the cash surrender value of the life insurance policy. There is no legal requirement for the insured to repay the loan. If the loan is outstanding when the insured dies, however, the insurer deducts the amount of the loan from the insurance proceeds. Taking a loan against a life insurance policy is one alternative to surrendering the policy for its cash value. Taking a loan leaves the policy and some of the life insurance protection in force.

The return of the overcharge

The return of the overcharge is not comparable to the payment of common stock cash dividends, and it is not treated as a dividend for tax purposes. It is viewed as merely a return of the insured's overpayment of premium.

Suicide Clause

The suicide clause is commonly included in the life insurance contract and allows a life insurer to exclude payment for death by suicide if the suicide occurs within two years from the policy issue date. The purpose of the suicide clause is to control the moral hazard of a person purchasing a policy in contemplation of committing suicide.

Dividends actually paid

are, as the name implies, amounts actually paid as dividends. Dividends are not guaranteed, and, therefore, may not equal the dividend illustration. Dividends actually paid equal those illustrated only if their experience basis is the same as that implicit in the illustration. Future experience rarely tracks past experience exactly and never over an extended period. On the other hand, some insurers have "frozen" their dividend scales. They have paid dividends almost exactly as illustrated regardless of the developing experience.

Evidence of insurability

beyond the good health of the insured, means, among other things, that the insured must: Not be engaged in any dangerous occupations or hobbies, Not be awaiting execution for a crime, Pay all defaulted premiums with compound interest, and Repay any outstanding loans with interest.

Term insurance

can be compared to property insurance contracts. At the beginning of the policy year, the insured pays a premium for the year's coverage. If no loss occurs during the policy year, the insurer keeps the premium and the insured receives nothing. If the insured chooses to not renew the policy, there is no value paid back to the insured. Term is often referred to as "pure protection" or "pure insurance" because it pays a death benefit only and has no savings component. There is no equity position in the policy. Nothing is paid if death does not occur during the policy term.

When an insured stops paying premiums on a continuous-premium whole life policy, or other policy requiring more payments, the insurer grants three options:

cash, term insurance, and whole life insurance fully paid up, but for an amount less than the original policy.

When a policyowner does not choose a non-forfeiture option following the lapse of their life insurance contract, the insurer will automatically select the ___________ option as a default.

extended term

Term Life Insurance

furnishes protection for a limited number of years at the end of which the policy expires, meaning that it terminates with no maturity value. The face amount of the policy is payable only if the insured's death occurs during the stipulated term and nothing is paid in case of survival.

Group Insurance

group insurance is provided to members of a well-defined group of people who are associated for some purpose other than purchasing insurance. Some contracts contain a conversion privilege, which allows the employee to convert the group policy to individual coverage when they leave their employer. Without this provision, the coverage ends when the employment terminates.

Industrial insurance

includes life and health insurance policies issued to individuals. Individuals purchase industrial insurance in small amounts, usually less than $2,000. Usually the premiums are collected at the insured's home on a regular basis, generally weekly or monthly.

The conversion privilege

increases the flexibility of term life insurance. For example, at the time a term policy was purchased, a policy owner may not have selected the type of policy best adapted to his or her needs. He or she may have preferred another type but, because of budget considerations, decided on low-premium term coverage. Following the issuance of the term policy, circumstances may have changed so as to enable the policy owner to purchase an adequate amount of other insurance.

Renewability

is a feature of term life insurance that permits the policy owner to continue, or renew, the policy upon expiration of the term period, for a limited number of additional periods of protection. For example, a 20-year term policy may allow renewal for another 20 years at the end of the initial 20-year period.

Group Insurance 2

is a means through which a group of individuals who usually have a business or professional relationship can gain access to insurance more easily than individual coverage, but usually with less flexibility or reduced optional benefits. The group entity (such as an employer or professional association) is the contract owner and each member is provided with an insurance certificate outlining his or her coverage.

The term renewability means

simply that the policy can be continued beyond the original maturity date to the stipulated termination age, at a preset renewal rate, should the policy owner choose to pay the premium. Therefore, renewable term policies can be viewed as increasing-premium, level-benefit term life insurance.

monthly cost

subtracted from the fund value

Dividends on participating life insurance policies may be:

taken in cash. used to pay a portion of the next premium. left to accumulate interest. used to purchase single-premium, paid-up insurance. used to purchase one-year term insurance (fifth dividend option).

Joint Mortgage Redemption Policy

A Decreasing Term policy, written on two lives, pays the death benefit at the first death. It is designed to cover the mortgage obligation of a two-income couple in the event one dies. The premium is slightly less that separate individual mortgage protection policies on each partner.

The insured is the person whose death causes the insurer to pay the claim. The policy owner is the person who may exercise the rights created by the insurance contract. The owner and the insured can be the same person. Ownership rights in life insurance policies include the right to:

Change ownership of the policy Assign the policy as security for a loan Name beneficiaries Receive dividends Take out cash surrender value Borrow against the policy

Life insurance companies, the insurers, provide any or all of the four classes of coverage.

Death: Life insurance or life assurance. Retirement: Endowments, annuities, and pensions. Incapacity: Disability income insurance or long-term care insurance. Injury or incurring a disease: Health insurance, accident insurance, and medical expense insurance.

life income option 2

Despite the potential for losing some of the death proceeds, the life-income settlement option is often quite practical. A beneficiary's need for income ceases when the beneficiary dies. In some cases, there may be no dependent beneficiaries other than a surviving spouse.

Insured Options

Dividend Options: Allow the policyowner to select the form of dividens received. Non-forfeiture Options: Provide that life insurance policies that have a savings value are not forfeited. Policyholder Loans: Give the policyowner the right to borrow an amount of money lesser than or equal to the cash value. Settlement Options: Specify how death proceeds are paid.

misstatement-of-age provision example

For example, if the insured, Amy Grafton, reported her age to be three years less than it actually was, the benefits, $100,000, would have to be reduced to $92,000, or whatever amount of insurance the premiums would purchase at the insured's true age.

Life Insurance Policy Provisions

Grace period Misstatement-of-age provision Incontestable clause Annual apportionment of surplus Entire-contract provision

Life insurance can be purchased as:

Group insurance, or Individual insurance.

Example (Credit Insurance in Action)

Herb buys a $20,000 car, taking out a $15,000 loan for 4 years. The dealer offers credit life protection so that if he dies during the loan period, his family doesn't have to pay the declining loan balance due. The policy is available for a one-time cost of $500, which can easily be financed into his loan. Is this a good deal? Assuming Herb is 35 years old and in good health, for $125 per year over a 4-year period, Herb could purchase a traditional level term life policy for at least $100,000 coverage. Dollar for dollar, the credit life insurance is much more expensive.

Grace Period

If the insured forgets to pay the premium or decides to end the contract, the grace period provides 31 days to pay the premium without forfeiting any contractual rights and no questions asked.

Individually issued life insurance policies are further classified into:

Industrial insurance, Ordinary insurance, and Credit insurance.

Participating (par) whole life policies

Insurance companies owned by policyholders are called mutual insurance companies. Participating (par) whole life policies, which are typically sold by mutual companies, provide their owners with the right to share in surplus funds accumulated by the insurer because of deviations of actual experience from assumed experience. This provision is known as the Annual Apportionment of Divisible Surplus. If there is a divisible surplus, the insurer must pay dividends. The participating plan involves a relatively large initial premium followed at the end of the year by a dividend.

There are three distinct classifications of interest in an insurance policy.

Insured Owner Beneficiary

Modified Endowment Contracts

Modified Endowment Contracts (referred to as MECs) are life insurance policies with a high amount of cash value buildup. Single Premium Life became popular in late 1980's after other tax shelters were eliminated by the Tax Reform Act 1986. In 1988 Congress passed TAMRA to close loopholes in their definition of insurance. The new rules said: If a policy's premiums equal or exceeds a 7-pay premium, the policy is a MEC. The 7-pay premium is the aggregate amount of premiums required to be paid during the first 7 years of the policy on a level-annual premium basis.

Level Premium Term

Premium remains level for set number of years. Initial premium level is higher than that of annual renewable term policy, but tends to be lower on average over the entire term selected. Either allows for another level premium period upon renewal, or reverts to annually renewable premiums to expiration.

Two features applicable to many term life policies deserve special attention before discussing specific term products:

Renewability Convertibility

Letting a life insurance policy lapse is usually expensive to the insured and to the insurer. Most of the expenses of acquiring the life insurance policy and putting it in force occur in the first year of the policy.

Salesperson's commission, Cost of medical examination, and Home-office administration.

Dividend Illustration

Some life insurance policies represent better purchases than others. Which plan, par or non-par, must a consumer purchase? Cost comparisons must be made intelligently to make the best choice. At this point, the consumer must remember that one comparison is clearly illogical. A consumer cannot make a straight comparison of premium dollars between participating and excess interest life insurance policies.

Policy Illustrations

There are two types of policy illustrations: proposed in-force

convertible feature

This feature is a call option that permits the policy owner to exchange the term policy for a cash-value insurance contract, without evidence of insurability. Often the period during which conversion is allowed is shorter than the maximum duration of the policy.

Interest-Only Option

Under the interest-only option, the proceeds are left with the insurance company. The insurer pays the first beneficiary, such as a widow, regular payments composed entirely of interest earnings. The beneficiary can request the full payment of principal at any time. It can be set up so that at the first beneficiary's death, the insurer pays the death proceeds to a second beneficiary, such as a child. The interest-only arrangement can be useful, for example, if the beneficiary has substantial investment, wage or social security income.

Example (Misstatement-of-Age Provision)

Upon her death, Mrs. Smith's son was reviewing her life insurance policies so that he could submit the claim. While reading one policy, he noticed that the photocopy of the original application indicated his mother had been born in 1905 instead of 1908. For all the years since the policy was purchased, his mother had been paying more than she should have for the policy. She obviously had not reviewed the policy information all these years. Fortunately, upon making his claim and pointing out the error, Mr. Smith received a larger death benefit payment based on the amount his mother had paid and her correct age.

Whole life insurance

Whole life insurance is intended to provide insurance protection over one's entire lifetime. It should be viewed as permanent protection for long-term needs, like estate planning or planning for a disabled child. It provides for the payment of the face amount upon the insured's death regardless of when death occurs.

Renewability premium

although level for a given period, increases with each renewal and is based on the insured's attained age at renewal time. A scale of guaranteed future premium rates is contained in the contract, providing the insured a sense of security in knowing there is a maximum ceiling to future premiums. Usually the insurance company charges a rate lower than that stated in the policy. The stated maximum premium is there as a safety valve for the insurer, should there be a need to raise rates in the future beyond the current scale.

Whole life cash values

are available to the policy owner at any time by the policy owner's surrendering, or canceling, the policy. Alternatively, cash values can be used in other ways, providing flexibility to the policy owner. Whole life policies usually contain cash-value schedules that show for selected time periods the guaranteed minimum amounts that the policy owner could receive from the company on surrender of the policy.

The requirements for reinstatement

are the same as purchasing a new one with respect to insurability. Furthermore, reinstatement usually involves a larger outlay of cash than starting a new policy because all defaulted premiums must be repaid with interest.

Misstatement-of-Age Provision

causes the insurer to adjust the face amount of insurance to reflect the insured's true age, rather than allowing the insurer to void a policy if a misstatement is discovered. There is no time limit on this provision - typically the mistake is not discovered until a death claim is being processed.

Owners of whole life insurance policies

do not have to surrender their policies to have access to funds. Under participating whole life policies in which dividends have purchased paid-up additional insurance, such additions may be surrendered for their attained cash-value with no impact on the policy. Also, policy owners normally can obtain a loan from the insurer for amounts up to that of the policy's cash value. Of course, interest is charged for this loan, and the loan is deducted from the gross cash value if the policy is surrendered, or from the face amount if the insured dies and a death claim is payable. Policy loans may, but need not, be repaid at any time and are a source of policy flexibility.

Credit Insurance

is a special type of life insurance. Lending institutions, such as banks and credit unions, or retail stores selling merchandise on credit, offer credit insurance to their customers to cover debtors' obligations if they die or become disabled.

The participating premium

is relatively large because insurers use conservative estimates of mortality, administrative expense, and interest earnings. For instance, mortality losses may be estimated at 20 percent higher than the actuary's statistics predict. When the bad results do not occur, the unnecessary premium is returned to the policyholder as a dividend.

premiums

less administrative costs are deposited into a fund which is credited with a declared interest rate that can change monthly, on a tax deferred basis.

Term insurance policies

may be issued for as short a period as one year. Previously, they customarily provided protection for at least a set number of years, typically 10, 15, 20, or 30 years or to a stipulated age, such as 65 or 70. Modern policies provide coverage to age 95 or 98.

As the premium rate increases with each renewal

mortality experience increasingly reflects adverse selection. Resistance to the higher premiums and lower-cost product opportunities cause many insureds in good health to fail to renew. The majority of those in poor health will renew even in the face of higher premiums. Insurers try to accommodate this problem in their pricing structure, or through other means, such as through altering dividends, by limiting renewability to stipulated maximum ages, or by product designs that encourage, or require, conversion.

Features

premiums, cash value and death benefit can be adjusted as the insured's needs change

Overall, the incontestable clause

prevents an insurer from avoiding claims payments. It is interesting to note this clause was included voluntarily in the contracts of some life insurers after 1850. The motive behind the inclusion was to establish public confidence. Such a public relations effort was required because a few disreputable life insurers were voiding contracts on the slightest technical grounds.