Life Insurance Basics

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.

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; and Beneficiary. In the event of death of a key employee, the business would use the money for the additional costs of running the business and replacing the employee. The business cannot take a tax deduction 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 agreements or contracts are needed except that the employee(s) would need to give permission for this coverage.

Buy-sell Funding

A buy-sell agreement is a legal contract that determines what will be done with a business in the event that an owner dies or becomes disabled. This is also referred to as a business continuation agreement. There are several types of buy-sell agreements that can be used for partnerships and corporations: Cross Purchase - used in partnerships when each partner buys a policy on the other; Entity Purchase - used when the partnership buys the policies on the partners; Stock Purchase - used by privately owned corporations when each stockholder buys a policy on each of the others; Stock Redemption - used when the corporation buys one policy on each shareholder.

Estate Creation

A person may create an estate through earnings, savings, and investments, but all of these methods require disciplined action and a significant period of time. 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.

Policy Summary

A policy summary is a written statement describing the features and elements of the policy being issued. It must include the name and address of the agent, the full name and home office or administrative office address of the insurer, and the generic name of the basic policy and each rider. A policy summary will also include premium, cash value, dividend, surrender value and death benefit figures for specific policy years. The policy summary must be provided when the policy is delivered.

Suitability in Life Insurance and Annuities

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. It is a producer's responsibility to make sure that annuity transactions address consumers' needs and financial objectives. To ensure suitability, producers must make a reasonable effort to obtain relevant information from the consumer and evaluate the following factors: Age; Annual income; Tax status; Financial needs and timeline; Investment objectives; Liquidity needs and liquid net worth; Existing assets; Intended use of annuity; Financial experience; and Risk tolerance. When producers or insurers recommend an annuity replacement, they must make sure the replacement is suitable for the consumer, and must consider whether the consumer will: Incur a surrender charge or be subject to a new surrender period; Lose existing contractual benefits; Have tax penalties for contract surrender; Have increased fees, investment advisory fees or charges for riders; or Have replaced another annuity in the preceding 36 months; or Benefit from annuity contract enhancements and improvement. Insurers must make sure that producers are adequately trained to make recommendations and must supervise producers' compliance.

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.

Planning for Income Needs

Besides taking care of immediate expenses after the death of the insured, the family may need to plan for an income source long term, so the needs approach to life insurance will factor in the following concerns: Replacing Insured's Salary or Lost Services — the surviving spouse who was the caregiver of the children may have to train to enter the job market. If the spouse works outside the home, a new expense for day care must be considered. Social Security Income "Blackout" Period — Social Security blackout period is the time during which the surviving spouse and/or children do not receive any social security survivor benefits. Blackout period begins when the youngest child reaches the age of 16, and ends when the surviving spouse qualifies for retirement benefits, as early as age 60. (Unmarried children under the age of 18 or up to 19 if they are attending secondary school full time can also receive benefits. Technically, the social security check will be made payable to the surviving spouse until the youngest child is 16, and directly to the child between the ages of 16 and 18.) Liquidation vs. Retention of Capital — Under the retention of capital approach, enough insurance is purchased so that when added to other liquid assets, there is enough to pay income benefits without jeopardizing the insured's principal asset (such as a home).

Business Continuation

Business continuation plan is an arrangement between business owners that provides for shares owned by any one of them who dies or becomes disabled to be sold to, and purchased by, the other co-owners or the business.

Business Uses of Life Insurance

Businesses use life insurance for the same reason individuals use life insurance: it creates an immediate payment upon the death of the insured. The most common use of life insurance by businesses is as an employee benefit, which serves as a protection for employees and their beneficiaries. There are also other forms of life insurance that can serve business owners and their survivors, and even protect the business itself. These include funding business continuation agreements, compensating executives, and protecting the business against financial loss resulting from the death or disability of key employees.

Advertisements

First and foremost, advertising 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, form, 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, presented, or distributed them. Insurance agents, brokers or other persons cannot use an advertisement or public announcement in this state if it does any of the following: Calls attention to any unauthorized insurer; or Publicizes the financial condition of any insurer. Every agent of any insurer and every insurance broker must state the full name of the insurer referred to and the name of the city in which it has its principal office. This rule applies to all advertisements, public announcements, signs, pamphlets, circulars and cards that refer to an insurer.

Gross Annual Premium

Gross annual premium is the one year cost for mortality, plus the cost of operating the company (or expense loading). Loading includes commissions, taxes, advertising, and while not an expense, includes the amount added to a pure or basic rate to provide for a profit margin to the insurer.

Classification of Risks

In classifying a risk, the Home Office underwriting department will look at the applicant's past medical history, present physical condition, occupation, habits and morals. If the applicant is acceptable, the underwriter must then determine the risk or rating classification to be used in deciding whether or not the applicant should pay a higher or lower premium. A prospective insured may be rated as one of the three classifications: standard, substandard, or preferred.

Determining Lump-sum Needs

Insurance proceeds paid in a lump-sum may be needed for any of the following expenses: Costs Associated with Death (Post Mortem) — taking into account the final medical expenses of the insured, funeral expenses, and day-to-day expenses family maintenance; Debt Cancellation (as an alternative to Estate Liquidation) — paying off debts of the insured such as home mortgage, or auto loans. (Most lenders require a collateral assignment of life insurance as a condition for a loan.); Emergency Reserve Funds — paying for unexpected expenses following the death of the insured, such as travel expenses and lodging for family members; Education Funds — paying for children's education expenses so they can remain in school, or for a surviving spouse who may need additional education or training in order to re-enter the job market; Retirement Fund — as a source of retirement income; Bequests — leaving funds to the insured's church, school, or a charity.

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.

Premiums with the Application

Most agents attempt to collect the initial premium and submit it along with the application to the insurer. In addition, collecting the initial premium at the time of the application increases the chance that the applicant will accept the policy once it is issued. Whenever the agent collects premiums, the agent must issue a premium receipt. The type of receipt issued will determine when coverage will be effective. The most common type of receipt is a conditional receipt, which is used only when the applicant submits a prepaid application. The conditional receipt says that coverage will be effective either on the date of the application or the date of the medical exam, whichever occurs last, as long as the applicant is found to be insurable as a standard risk, and policy is issued exactly as applied for. This rule will not apply if a policy is declined, rated, or issued with riders excluding specific coverages.

Preferred

Preferred risks are those individuals who meet certain requirements and qualify for lower premiums than the standard risk. These applicants have a superior physical condition, lifestyle, and habits.

Survivor Protection

The death of the primary wage-earner will usually stop the flow of income to a family. The death of a nonearning spouse who cares for minor children can also cause great financial hardship for the survivors. Life insurance can provide the funds necessary for the survivors of the insured to be able to maintain their lifestyle in the event of the insured's death. This is known as survivor protection. Planning for survivor protection requires careful examination of current assets and liabilities as well as determining what survivors' needs may be.

Replacement

Replacement is a practice of terminating an existing policy or letting it lapse, and obtaining a new one. To make sure that replacement is appropriate and in the best interests of the policyowner, insurance producers and companies must take special underwriting measures to help policyowners make informed decisions. Replacement means any transaction in which new life insurance or a new annuity is purchased and, as a result, the existing life insurance or annuity has been or will be any of the following: Lapsed, forfeited, surrendered, or otherwise terminated; Reissued with any reduction in cash value; Converted to reduced paid-up insurance, continued as extended term insurance or otherwise reduced in value by the use of nonforfeiture benefits or other policy values; Amended so as to affect either a reduction in benefits or in the term for which coverage would otherwise remain in force or for which benefits would be paid; or Used in a financed purchase. Replacing insurer is the company that issues the new policy. Existing insurer is the company whose policy is being replaced. Duties of the replacing producer: Present to the applicant a Notice Regarding Replacement that is signed by both the applicant and the producer. A copy must be left with the applicant. Obtain a list of all existing life insurance and/or annuity policies to be replaced including policy numbers and the names of all companies being replaced. Leave the applicant with the original or a copy of written or printed communications used for presentation to the applicant. Submit to the replacing insurance company a copy of the replacement notice with the application. Each producer who initiates the application must submit the following to the insurance company with or as part of each application: A statement signed by the applicant as to whether replacement of existing life insurance or annuity is involved in the transaction; and A signed statement as to whether the producer knows replacement is or may be involved in the transaction. Duties of the replacing insurance company: Require from the producer a list of the applicant's life insurance or annuity contracts to be replaced and a copy of the replacement notice provided to the applicant; and Send each existing insurance company a written communication advising of the proposed replacement within a specified period of time of the date that the application is received in the replacing insurance company's home or regional office. A policy summary or ledger statement containing policy data on the proposed life insurance or annuity must be included.

Application

The Application is the starting point and basic source of information used by the company in the risk selection process. Although applications are not uniform and may vary from one insurer to another, they all have the same basic components: Part 1 - General Information and Part 2 - Medical Information. Part 1 - General Information of the application includes the general questions about the applicant, such as name, age, address, birth date, gender, income, marital status, and occupation. It will also inquire about the existing policies and if the proposed insurance will replace them. Part 1 identifies the type of policy applied for and the amount of coverage, and usually contains information concerning the beneficiary. Part 2 - Medical Information of the application includes information on the prospective insured's medical background, present health, any medical visits in recent years, medical status of living relatives, and causes of death of deceased relatives. If the amount of insurance is relatively small, the agent and the proposed insured will complete all of the medical information. That would be considered a nonmedical application. For larger amounts, the insurer will usually require some sort of medical examination by a professional. It is the agent's responsibility to make certain that the application is filled out completely, correctly, and to the best of the applicant's knowledge. The agent must probe beyond the stated questions in the application if he or she has any reason to believe the applicant is misrepresenting or concealing information, or does not understand the specific questions asked. Any information that is misleading, inaccurate or illegible may delay the issuance of the policy. If the agent feels that there could be some misrepresentation, he/she must inform the insurance company. Some insurers require that the applicant complete the application under the agent's watchful eye, while other insurers require that the agent complete the application in order to help avoid mistakes and unanswered questions.

Insurable Interest

To purchase insurance, the policyowner must face the possibility of losing money or something of value in the event of 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. A valid insurable interest may exist between the policyowner and the insured when the policy is insuring any of the following: Policyowner's own life; The life of a family member (a spouse or a close blood relative); or The life of a business partner, key employee, or someone who has a financial obligation to the policyowner (such as debtor to a creditor). Insurable interest is 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.