Module 3: Life Insurance and Annuities

Life Insurance Goals

-providing liquidity at death for the estate -establishing an income fund for dependents -establishing an education fund -accounting for final expenses (e.g., funeral, unpaid medical, etc.) -providing an adequate emergency fund.

Five Common Dividend Options

1. Cash 2. Reduced Premium 3. Accumulate at Interest 4. Paid-Up Dividend Additions 5. One-Year Term (Fifth Dividend Option)

Extension of Benefits Riders

1. Disability Waiver of Premium 2. Presumptive Disability 3. Universal Life Variations on Waivers of Premium 4. Disability Income Rider 5. Critical Illness Rider 6. Long-Term Care Rider 7. Accelerated Death benefit Rider 8. Family Income Benefit Rider 9. Return of Premium Rider

Universal Life Policy Benefits

1. Flexible Premium Payments 2. Adjustable Death Benefit 3. Unbundled Structure 4. Full Disclosure 5. Costs

Methods of Calculating Insurance Need

1. Multiple of Salary Method 2. Human Life Value Method 3. Personalized Needs Approach (LIFE)

Types of Insurance Replacements

1. Replacing one term policy with another 2. Replacing term policy with a cash value policy 3. Replacing a cash value policy with another cash value policy 4. Replacing a cash value policy with a term policy

Additional Insurance Riders

1. Term Rider 2. Cost of Living Rider (Increasing Death Benefit) 3. Accidental Death Benefit 4. Guaranteed Insurability Option 5. Spouse or Children's Rider

Key Facts Relevant to Clients

1. client profile 2. client goals and objectives 3. survivors' needs 4. estate liquidity 5. risk tolerance 6. existing insurance 7. amount of insurance needed

Settlement Options

A lump sum payment is the most commonly applied method of distribution. Sometimes, however, other methods of distribution are better suited to the needs of the recipient and policies offer numerous distribution options.

Modified Endowment Contracts (MECs)

A policy becomes a MEC if it fails the seven-pay test, policy loans and withdrawals are subject to taxes and penalties. A policy is classified as a MEC if the policyowner deposits the equivalent of more than total net annual premium payments at any time during the first seven years. MEC status means that any withdrawals from the policy (e.g., loans, partial cash withdrawals, pledging as collateral, etc.) will be taxable as ordinary income

One-Year Term (Fifth Dividend Option)

A policyowner may elect to have the annual dividend buy one-year term insurance. This option allows for a small dividend to buy a much larger amount of death benefit protection.

Modified Whole Life Insurance

A whole life policy preceded by a period of term insurance. These policies have low, term-like premiums for a number of years that automatically increase to whole life levels.

Equity-Indexed Universal Life (EIUL)

Also known as indexed universal life, is another form of fixed permanent life insurance. These policies provide for a minimum fixed interest rate, but also allow policyowners to use an index option to potentially earn better returns than the guaranteed rate. They are not variable policies, but they blend the security of fixed rate UL with the growth potential of market-indexed returns.

Private Placement Life Insurance (PPLI)

Are offered by insurers in the United States and abroad to high net worth individuals. These policies are anything but "off-the-shelf." They are highly customizable and in many ways structured as much (or more) to be investment vehicles than to be typical life insurance policies.

Limited Pay Policies

Are whole life policies with a shortened premium-paying period. Even though premiums cease at some point, the death benefit continues for the life of the insured or to age 120 when the policy matures or endows.

Technical and Miscellaneous Revenue Act of 1988 (TAMRA)

Created Modified Endowment Contracts (MECs)

UL Policy Option 2 or Option B

Death benefit equal to the initial face amount plus the cash value.

Guaranteed Minimum Income Benefit (GMIB)

Guarantees a minimum income to the annuitant, regardless of adverse investment performance. Sometimes the guarantee requires annuitization of the contract, and in other instances the guarantee allows for systematic withdrawals based on the guaranteed value.

Guaranteed Minimum Withdrawal Benefit (GMWB)

Guarantees that either a return of principal or payout of a protected amount through systematic withdrawals over a specified time period in years (not covering a life expectancy). The insurer must permit withdrawals not to exceed a specified percentage independent of adverse investment performance.

Guaranteed Minimum Accumulation Benefit (GMAB)

Guarantees that there will be a minimum account value at the end of a specified guaranteed date. Variations can include a step up with a new guarantee period.

Decreasing Term Insurance

Is a form of term life insurance in which the premium remains level but the amount of death benefit decreases. These policies have generally been sold to cover home mortgages.

Single Premium Whole Life

Is a policy in which a lump sum payment is made and no further premiums are required. If the policy is surrendered within the first few years, there are substantial surrender charges.

Adjustable Life Insurance

Is a unique product encompassing aspects of whole life, term, and UL. It is built on the whole life insurance chassis and provides policyowners the option of making various adjustments to the policy as their circumstances and needs change.

Variable Life Insurance

Is designed to combine the protection and savings functions of traditional life insurance with the growth potential of mutual fund-type investments. The policy's cash value is not guaranteed and is invested in a separate account (not in the insurer's general account). Premiums are fixed, but the cash values vary in relation to the contract's earnings.

Endowment Policy

Is one in which the death benefit and cash surrender value are the same at a specific date. When the insured reaches the age of mortality (e.g., age 120), the reserves equal the death benefit, and the policy is said to have endowed. Endowment of a whole life policy may create an unfavorable tax situation for an insured in which face value is paid out and the amount received exceeding the policy's basis (premium paid) would be taxable as ordinary income.

Guaranteed Lifetime Withdrawal Benefit (GLWB)

Is the most popular rider currently with almost 70% of annuity buyers selecting it. This rider guarantees the right to withdraw up to the specified percentage each year for life. The guaranteed compounding ceases at the first withdrawal or at the expiration of the specified period, frequently 10 years. It may have step-up options.

Personalized Needs Approach

Liabilities Income Replacement Final Expenses Education Funding

Automatic Premium Loan

Many cash value policies have an automatic premium loan (APL) provision in the contract that can prevent a lapse from occurring. At the time the policy normally would lapse, if adequate cash value exists, a policy loan is created to cover the premium due.

First-to-Die Policy

May be used in either a personal or a business situation. It promises to pay the face amount on the death of the first of two or more covered persons. This type of policy arrangement may be used to fund buy-sell agreements.

Multiple of Salary Method

Multiply the wage earner's salary times a number that works for the client. The "six, eight, or ten times salary" rules have been used for quite some time in an effort to make the needs determination process less complex. The concept behind this rule of thumb is that by replacing the salary of the deceased for a period of years, the family will be able to continue as they were.

Reinstatement Clause

Normally follows the grace period clause. With most companies, it provides that once the policy has lapsed, the owner may reinstate it by paying all back premiums, paying off or reinstating any policy loans that existed at the time of lapse, and providing proof of insurability satisfactory to the company.

Equity-Indexed Annuities (EIAs)

Offer some of the growth potential of the stock market with the downside protection of a guaranteed annuity.

Level Term Insurance

Often have the initial premium guaranteed for some period of time, ranging anywhere from 5 to 30 years. The longer the guarantee for the level premium, the higher the premium cost. A policy that has a guaranteed level premium to age 100 or 120 will have a premium approaching that of a whole life policy.

Cash Dividend Option

On the policy anniversary, if there is any divisible surplus credited to a policy, the insurance company sends a check to the policy owner. It is considered a return of premium and is not taxed.

Contestable Clause

Once a life insurance policy is issued, the insurance company has no more than two years (some states specify one year) to determine if there is any reason that it should not have issued the policy.

Exclusion Ratio

Payment x (Benefit/Payment x Life Expectancy)

Reentry Term Insurance

Permit the insured to be underwritten every five years or so. If the insured is still insurable in the same classification, the premium may actually drop in the sixth year, and for other policies the premium will increase minimally

Capital Retention Income Calculation

Preserves the principal and only interest is used to meet the income needs.

Qualified Longevity Annuities (QLACs)

Provide an income stream that begins at an advanced age and continues throughout the individual's life.

Whole Life Insurance

Provides a guaranteed death benefit for the life of the insured and requires premium payments to be made until death or policy maturity.

Annually Renewable Term Insurance

Provides death protection for one year at a time. The policy renews each year with the payment of the premiums due. This form of insurance almost always has the lowest initial premium because the risk of death—the mortality rate—is relatively low when insurance is first sold and the risk is priced for one year at a time.

Entire Contract Clause

States that the policy, along with the attached application, constitutes the entire contract. Furthermore, it states that changes to the contract must be made in writing and must be signed by an officer of the company. You may recognize this last statement, also known as the waiver clause.

Human Life Value Method

Takes into account the income-earning ability of the deceased over their lifetime. Rather than simply replacing lost income, this approach accounts for the changes in wages for the insured's working lifetime, and then discounts this amount to a present value with the assumption that the death occurs imminently.

Conversion Clause

Term insurance policies frequently include a provision that permits the policyowner to convert the term insurance into a cash value form of insurance.

1035 Exchange

The Section 1035 exchange rules make cash value policies even more attractive for younger buyers because they can accumulate the money in the life insurance and then convert it to an annuity or long-term care if the original life insurance is no longer needed. All of these options should be considered if a policy is going to create a taxable event.

Beneficiary Designations

The beneficiary clause in a policy specifies that the beneficiary is as stated in the application or as changed, in writing, subsequent to issue of the policy. The standard provision states that any beneficiaries in the primary beneficiary class receive death benefits before any other beneficiaries.

Common Disaster Clause

The common disaster clause is also referred to as a payment delay clause. Simply stated, if the insured and the primary beneficiary die in a common disaster, even if the deaths occur as much as 30 days apart, the beneficiary is presumed to have died first.

Net Amount at Risk

The difference between the death benefit and the cash value.

Deficit Reduction Act of 1984

The government created a definition for life insurance that related the cash values to the death benefit.

Accumulate at Interest Dividend Option

The insurance company holds the dividends in a separate account and pays a current rate of interest on the accumulated dividends. At death or on surrender, this fund is paid out in addition to the other policy proceeds.

Suicide Clause

The majority of policies will pay a death benefit if the insured commits suicide. Under the suicide clause, if the insured commits suicide within one or two years (again, this varies by state) after the policy was issued, the insurance company need only return the cumulative premiums minus any indebtedness.

UL Policy Option 1 or Option A

The net amount at risk is the difference between the death benefit and cash value.

Owner's Rights

The ownership clause states that the owner of the policy has the right to assign or transfer all or some of the rights pertaining to the policy. No transfer of ownership will be completed until the company has received and acknowledged a written copy of the change. A change of ownership is done with an absolute assignment of the policy.

Superannuation

The risk of outliving client's money

Second-to-Die Policy

The survivorship life (or second-to-die/last-to-die) policy pays when the last person dies, not at the first death. This policy is especially attractive in estate tax planning situations when the unlimited marital deduction is used.

Spendthrift Clause

This clause essentially prevents a beneficiary (who may be presumed to be a spendthrift or otherwise unable to handle money well) from assigning any benefits they may eventually get from the insurance company.

Misstatement of Age Clause

This provides that if, at death, the insured turns out to be older or younger than indicated on the application, the benefit will be adjusted to provide the amount the premium would have provided at the correct age.

Grace Period

This provides that premiums received within 30 (or 31) days after the due date are treated as though received on time. This clause also states that if premiums are not received in that time frame, the policy will lapse.

Accelerated Death Benefits

Those benefits paid by a life insurance company to a terminally or chronically ill person—made under a viatical agreement—are paid to the insured income-tax-free.

Policy Loans

Two types of policy loans can be made against cash value policies: standard policy loans and APLs (previously discussed). A policyowner may borrow the entire cash value of a policy, less an amount that is equal to the interest due on the next policy anniversary. Most insurance companies charge interest in arrears (after the time has passed for which interest is due), though others charge interest in advance.

Capital Utilization Income Calculation

Uses all of the principal over a period of time so that, ultimately, nothing remains.

Graded Premium Life Insurance

Was designed to ease people into a whole life premium. Its premium per thousand dollars of insurance is fairly low the first year; then, it increases each year for five to seven years, at which time it reaches its ultimate premium. The ultimate premium is level for the life of the insured.

Paid-Up Additions Dividend Option

When a dividend is applied to this option, a small amount of insurance is purchased that has a cash value equal to the dividend without any medical or other underwriting required. This small amount of insurance is fully paid up; there are no premiums due to keep it in force.

Nonforfeiture Options

When policyowners no longer wish to pay the premiums on a whole life or other cash value policy, they have three options when deciding what to do with the values remaining in the policy. Over the years of ownership, the policy builds reserves. Because the owner contributed to the reserves, it is the intent of the law governing insurance that they should not forfeit those reserves, thus the term nonforfeiture options.

Reduced Premium Dividend Option

When the reduced premium option is selected, on the policy anniversary, the premium will be reduced by any dividend paid. Whenever the dividend exceeds the premium due, one of the other dividend options is used with the balance.