insurance chapter 5: life insurance underwriting and policy issue

An example of naming a beneficiary by class would be

"To the children born of my union with Ned Jackson"

Interest adjusted cost indexes are designed to provide information on these four items:

(1) premiums; (2) death benefits; (3) cash value; and (4) dividends. These are the variables that must be considered in evaluating cost, and they are the basis for the life insurance policy cost comparison methods.

per capita

(by the person or by the head) Evenly distributes benefits among all named living beneficiaries, typically the surviving children

per stripes

(meaning by the bloodline) Distributions are made according to the family line, branch, or root. In the event that a beneficiary dies before the insured, and no changes are made to the policy, benefits from that policy will be paid to that beneficiary's heirs.

life settlement contracts do not include:

- An assignment of a policy as collateral for a loan; - The making of a policy loan, or the paying of surrender benefits or other benefits, by the issuer of a policy with respect to that policy; - A 1035 exchange of life insurance policies as described by the Internal Revenue Code; - An agreement where all the parties are closely related to the insured by blood or law or have a lawful substantial economic interest in the continued life, health and bodily safety of the person insured, or are trusts established primarily for the benefit of such parties; or - Legitimate corporate or pension benefit plans.

examples of acceptable beneficiaries include

- Individuals (a person identified by name and relationship): "my spouse Mary," "my son Tom," etc. - Class designations: a group of individuals such as the "children of the insured," "all of my siblings." - Businesses: Businesses often have life insurance policies on the owner or key person to help mitigate the expense involved in finding a replacement. - Charities: As a lump sum donation or to create continued funding such as a scholarship fund. - Trust: Provides management of the proceeds. - Estate: While a policyowner could choose to list an estate as a beneficiary, that is usually not advisable.

There are several life income options available from which the beneficiary may select, including

- Single, pure, or straight life income option - refund life income option - life income option with a period certain - joint and survivor option

additional premium factors

- age - sex - health - occupation - hobbies - habits - benefits - options and riders - premium mode

most common life insurance living benefits

- cash value - accelerated (death) benefit - policy dividends - viatical settlement - life settlement

expense factor includes

- death benefits paid; - commissions or salaries to producers and other employees; - other administrative costs (i.e. rent)

2 standard methods of changing a beneficiary

- filing/recording method - endorsement method

death benefit settlement options include:

- lump sum (cash payment) - interest only - fixed amount* - fixed period* - life income* The last three settlement options available are simplified versions of an annuity. (*)

factors in premium calculations

- mortality factor - morbidity rate - interest factor - expense factor

distribution by descent

- per capita - per stripes

distribution by order of succession

- primary beneficiary - secondary or contingent beneficiary - tertiary beneficiary

tax consequences of life insurance

- tax treatment of individual life insurance - Taxation of Proceeds Paid at Death - Economic Benefit Doctrine - Taxation of Cash Values - Taxation of Policy Loans - Taxation of Accelerated Death Benefit - Taxation of Policy Dividends - 1035 exchange

tonya has replaced her whole life policy with an annuity without incurring a tax penalty. this transaction is a(n)

1035 exchange

distribution to a minor

A life insurance company typically will NOT pay policy proceeds directly to a minor beneficiary. While any entity can be named as a beneficiary, many States do not permit proceeds to be paid to a minor since he or she lacks "legal capacity." In addition to a minor potentially not being competent to handle a large sum of money, a minor may not be able to receive the payment and return a receipt legitimately. For these reasons, a guardian or trustee will typically need to be appointed. In some cases, the insurance company may hold the proceeds, paying interest on them until the beneficiary reaches legal age.

tertiary beneficiary

A tertiary beneficiary is third in line to receive policy proceeds when the insured dies if they survived the primary and contingent beneficiaries. Technically speaking, the policyowner may continue the succession by listing a fourth in line, fifth in line, etc. There is not a limit to the depth of the succession.

tax treatment of individual life insurance

According to the Internal Revenue Code, premiums paid for individual life insurance policies are considered to be a personal expense, and as such, are not tax-deductible. Just because a premium is used to buy life insurance on a spouse or in a third-party ownership situation does not mean that the premiums will be tax-deductible. Premiums paid on life insurance may be tax-deductible to an employer if the insurance is used as an employee benefit. Premiums may also be tax-deductible if the policy is to provide for charitable contributions. Additionally, premiums for an insurance policy to benefit an ex-spouse as court-ordterm-113ered alimony are tax-deductible.

expense factor

Also known as the loading charge, is a measure of what it costs an insurance company to operate. each state sets a minimum reserve (or funds) the insurer must set aside to pay future claims. Additionally, companies need to build in profit, also referred to as surplus. If a company isn't making a profit, they are probably going to raise premiums while companies exceeding profits will probably maintain premiums, or possibly even lower them.

paying premiums from policy values

Depending on the type of policy, a policyowner may be able to use the policy's cash value and dividends to pay the premium. With dividends, a policyowner could choose to pay down premiums on the existing policy or buy additional coverage in the form of paid-up whole life additions or one-year term. While using the policy (cash) value to pay premiums is an option, this funding method also decreases the value of the policy. The policy will lapse if the policy's value becomes insufficient, and the policyowner does not pay the required premium.

Taxation of Policy Dividends

Dividends paid on a whole life policy are tax-exempt as they are considered to be a return of overpaid or excess premiums. While unlikely to happen, any dividends received over the premiums paid are taxable as ordinary income. If dividends are left with the insurer to accumulate interest, the interest earned will be taxable as ordinary income in the year received. If the life insurance policy is determined by the IRS to be a Modified Endowment Contract (MEC), dividends will be taxable unless they are used to purchase paid-up additional insurance. In addition, dividends payable under a MEC may be subject to a 10% penalty tax (applying to premature distributions before age 59½).

Taxation of Policy Loans example

For example, assume Bob is the owner of a $100,000 whole life insurance policy on his own life. The cash surrender value is $45,000. He has paid $35,000 in premiums over the years. If Bob borrows $40,000 against the policy, he will not be subjected to tax consequences as long as the policy stays active. Bob will repay the loan from the insurer plus interest. The interest is not tax-deductible. If Bob surrenders the policy, he will have a taxable gain of $10,000 (the difference between $35,000 in cost basis and $45,000 in surrender value) that he must report as taxable ordinary income.

Uniform Simultaneous Death Act and the common disaster provision examples

For example, assume that John has a life insurance policy covering his life. He designates his wife Mary as the primary beneficiary and all of his children equally as the contingent beneficiaries. John and Mary are involved in a plane crash on their way back from a weekend getaway. When the paramedics arrive, John is found dead at the scene of the crash. Mary is found alive and is rushed to the hospital. Unfortunately, Mary succumbs to her injuries and dies on the way to the hospital. Mary definitively outlived John. Under the Simultaneous Death Act, since John technically died first, the proceeds for John's life insurance policy would be paid to Mary's estate, potentially getting tied up in probate, taxed, and subject to creditors. However, since John's policy also contained the common disaster provision, the insurance company will act as if Mary died first and pay John's death benefit directly to his children.

distribution to an estate example

For example, assume that Mr. Jones purchases a life insurance policy covering his life in the amount of $100,000. He designates his spouse as the primary beneficiary. His only daughter is designated as the contingent beneficiary. However, Mr. Jones fails to designate any of his four sons as beneficiaries. If his spouse and daughter are killed in an auto accident, and five years later, Mr. Jones dies himself and has not made any alterations to the life insurance contract, the death benefit or policy proceeds will be paid to his estate, not to the sons.

interest only example

For example, if the policyowner selects the interest only settlement option, they could also choose that the beneficiary has the option to pull out 100% of the principal at any time or cannot withdraw any of the principal until after a set age or number of years.

comparative interest rate method example

For example, let's say Greg is 30 years of age and wants $150,000 in permanent insurance coverage. One insurance agent shows Greg a $150,000 whole life insurance policy that requires annual premiums of $2,000 a year, for thirty years. A second insurance agent shows Greg a $150,000 decreasing term life insurance policy that costs $500 a year. The second agent further explains that Greg could place the $1,500 difference in premium in an investment account to grow. This second account can be used to offset the decreasing term policy or replace it entirely when it expires, essentially allowing him to have permanent coverage.

life income option with a period certain example

For example, let's say the settlement option is designed as life income for 20 years with period certain. If the primary beneficiary dies after 15 years, the insurer will continue monthly payments to the second beneficiary for the remaining five years.

unearned premium example

For example, let's say your insurance policy costs $120 a year, and you pay the full amount on January 1. On April 1, the insurance company has only earned $30 ($120 / 12 months X 3 months of coverage). If you were to cancel your policy with an effective cancellation date of 7/1, the insurance company would owe you a refund of $60 for unearned premium ($10/month 6 months remaining of the amount paid in advance).

minimum deposit (financed) insurance example

For example, the policyowner is allowed each year to borrow, subject to certain tax restrictions, that year's cash value increase, and use it to pay the premium.

mortality rate example

For example, when determining the premium amount per $1,000 worth of coverage for a standard risk 35-year-old male, the company will consult the mortality table to view the average number of deaths per thousand standard risk 35-year-old males.

succession process

If the primary beneficiary clearly died first, and then the insured died, the benefits would be payable directly to the contingent beneficiary. If the insured died first, the death benefit is payable (i.e., due) to the primary beneficiary. If the primary beneficiary then died shortly after that, the face amount will be paid to the estate of the primary beneficiary and not directly to a contingent beneficiary. Again, possible death taxes and probate charges may be assessed before the heirs receive what remains.

interest factor

Insurance companies invest the premiums they receive in an effort to earn interest. This interest is one of the ways an insurance company can lower the premium rates. Premium calculations are made in the expectation that the company will earn an assumed rate of interest. A higher assumed (predicted) rate will lead to lower premiums. The actual interest earned may be higher or lower than the assumed rate. The interest factor is a reflection of an insurer's return on their investments. Insurers invest the premiums they collect in a myriad of investment vehicles. The wiser their investment decisions, the better return they will realize.

distribution to an estate

It is important that a policyowner lists all desired beneficiaries and keeps the designations updated as needed. The policy proceeds will be paid to the estate of the insured if none of the listed beneficiaries are still alive at the time of the insured's death. Benefits paid to an estate are subject to possible federal and state death taxes as well as probate fees prior to being passed on to anyone else. Additionally, creditors may have a right to funds in an estate and, therefore, a right to the proceeds of a life insurance policy paid to an estate.

death benefit settlement options and payments of claims

Life insurance policies contain a provision that settlement shall be made upon receipt of proof of death (death certificate). Most states require insurers to pay interest on any proceeds not paid within a specific amount of time. Death benefits can be paid out in a variety of ways. These methods are known as settlement options. The policyowner may select a settlement option at the time of the application and may change the option at any time during the life of the insured. If the policyowner chooses to select a settlement option, it cannot be changed by the beneficiary. In most cases, however, the settlement selection is made by the beneficiary at the time of the insured's death. Unless the policyowner specifies an irrevocable settlement option, the beneficiary always possesses the right to withdraw proceeds at any time in the future. Under any option selected where the policy proceeds are left "at interest" with the insurer, the beneficiary is protected against the claims of creditors.

mortality rate vs morbidity rate

MORTALITY RATE refers to the frequency of deaths in a defined population at a specific time interval. MORBIDITY RATE refers to the occurrence of diseases in a defined population at a specific time interval. Higher morbidity and mortality rates translate to higher insurance premiums.

who is minimum deposit (financed) insurance best suited for

Minimum deposit financing is a method of financing life insurance best suited for individuals in high marginal tax brackets.

premium collections and reserves

Producers generally collect the initial premium from the applicant at the time of application. All future premiums are billed to the insured by the insurer and are remitted by the insured to the company. Insureds who cannot afford premiums may sometimes use a premium financing organization that will function similar to an installment loan.

Taxation of Proceeds Paid at Death

Since the premiums paid are not tax-deductible, the proceeds (death benefit) from the life insurance policy are generally paid income tax-free (tax-exempt) to the named beneficiary, if taken as a lump sum. The exception to this rule is the transfer for value rule, which applies when a life insurance policy is sold to another party before the insured's death. Benefits are generally subject to federal estate tax if they are included in (paid to) the policyowner's gross estate. If death benefits are paid in installments, as opposed to a lump sum, the principal is received tax-free, and any interest received is taxable.

why do customers find modified premium funding advantageous?

Some customers may find this advantageous as it allows them to purchase permanent insurance for a more manageable initial price with a higher percentage of the cost added to a later period when the policyowner's income is expected to be higher.

Economic Benefit Doctrine

The Economic Benefit Doctrine requires that any benefit granted to an individual that has an economic or financial value be included as compensation for income tax purposes in the year the benefit is granted. The key to avoiding the imposition of the Economic Benefit Doctrine is the existence of a substantial risk of forfeiture. Therefore, individual life insurance avoids this doctrine since premature death can cause a substantial risk to a surviving family.

facility of payment

The facility of payment provision permits an insurer to pay a portion (or all) of the policy proceeds to ANY individual who appears to be equitably entitled. Such payment may be provided to a party who paid for the medical or final expenses of the deceased insured. Usually, the facility of payment provision comes into play when a death claim is not filed within two months following the death of the insured. Additionally, this provision may be triggered to assist a guardian when a minor is listed as the beneficiary.

fixed amount

The fixed amount installment option permits the death proceeds to be left "at interest" with the insurer and to pay a fixed death benefit in specified installment amounts until the principal and interest are exhausted. The amount of monthly income selected by the beneficiary, the amount of proceeds, and the interest rate paid by the insurer will all determine the length of time in which the beneficiary receives the monthly income. The larger the installment payment, the shorter the payout period. The fixed amount option allows the beneficiary to designate an amount of income to be replaced, such as $1,200 per month. These payments continue until the principal and interest are exhausted.

when is the fixed period option most valuable

The fixed period option is valuable when the most crucial consideration is to provide income for a definite period of time, for example, until all children graduate high school.

Taxation of Cash Values

The interest paid on the cash value as it increases or accumulates is tax-deferred. The total of the premiums paid into the policy minus total dividends received in cash or used to offset premiums is referred to as the cost basis. According to the cost recovery rule, if the policy is surrendered for its cash value, the portion that exceeds the cost basis, or premiums paid, is considered ordinary income and taxable. As long as the cash value stays in the policy, taxes will never be imposed on any portion, not even the amount that exceeds the cost basis.

joint and survivor option

The joint and survivor option guarantees that benefits will be paid on a life-long basis to two or more people. This option may include a period certain with a reduction in benefits after the death of the first beneficiary. The amount payable is based on the ages of both beneficiaries.

life income option with a period certain

The life income option with a period certain pays a monthly income for as long as the beneficiary lives. However, should the beneficiary die before a predetermined number of years have elapsed, the insurer will continue monthly payments to a second beneficiary for the remainder of the designated period certain (i.e., for a specified period such as ten years).

life income

The life income settlement option liquidates policy proceeds (i.e., principal) and interest with regard to life contingencies. Installment payments are guaranteed for as long as the recipient lives. Therefore, the life income option provides the beneficiary with an income that they cannot outlive. The amount of each installment is based on the recipient's life expectancy and the amount of principal. Using the recipient's life expectance gives the potential for a greater return, or the potential for greater loss, based on how long the insured lives. The life income option is used to ensure the beneficiary receives a payment as long as they are alive.

viatical/viatee

The new third-party owner in a viatical settlement.

single premium funding

The policyowner pays a single premium that provides protection for life as a paid-up policy. Normally associated with whole life insurance. generally too expensive for the average person, so alternative periodic options were developed to be more cost-effective or affordable for the purchaser

purpose of premiums

The premium is both an exchange for insurance protection and a portion of the policyowner's consideration. The consideration is the "binding force" in the contract, which cements the agreement between the insurer and policyholder.

primary beneficiary

The primary beneficiary is the first or principal person in line to receive income tax-free policy proceeds. A policy owner may designate multiple primary beneficiaries and choose different or equal amounts for each beneficiary (or example, 50% to my son Tom, 25% to my grandson Joe, and 25% to my granddaughter Mary. If one of the primary beneficiaries dies prior to the insured, the face amount is paid to the surviving primary beneficiary(s). Unless specifically requested as part of the contract (per stirpes) or required by law, the estate or heirs of a deceased beneficiary will not receive any payment in this case.

cash value

The primary living benefit that a whole life (permanent life) insurance plan possesses during the life of the policy is its cash value build-up. The cash that accumulates may be borrowed against or may be used as collateral. The cash value may also be utilized as supplemental retirement income or withdrawn for emergencies or other situations where cash is needed. Keep in mind, while the cash value is available to the policyowner, depending on the policy, accessing that cash value can result in additional fees, taxes, interest charges, or a reduction to the death benefit. During the early policy years, the cash value of an insurance policy will typically be less than the premiums paid. Remember, the cash value is different from the insurance company's reserves, money set aside to pay future claims.

refund life income option

The refund life income option, also known as the joint life option, guarantees the return of an amount equal to the principal less any payments already made. In other words, it provides a minimum guaranteed return. Once the primary beneficiary dies, their survivors may receive the refund on an installment basis or in a lump sum, which is referred to as a cash refund. The former is also known as the installment refund.

secondary or contingent beneficiary

The secondary or contingent beneficiary is the second individual(s) in line to receive the death benefit. They receive the death benefit only if the (or all) primary beneficiary has died prior to the insured. The primary beneficiary must predecease the insured in order for this secondary beneficiary to receive any proceeds.

Life Insurance Surrender Cost Index importance

The surrender cost index is important to the consumer who places a high priority upon the growth of cash value in the policy. It aids in cost comparisons if the policy owner plans to surrender the policy for its cash value in ten or twenty years.

distribution to a trust

Trusts may be named as the beneficiary of a life insurance policy and manage the proceeds upon the insured's death. Naming a trust as beneficiary is the most advantageous designation to use when a policy owner wishes to leave policy proceeds to a "minor" child. In this case, a trustee will manage the trust for the benefit of the child or children. Trust administration fees may reduce policy proceeds. - testamentary trusts - inter Vivos trusts

accelerated (death) benefit

This benefit allows the policy owner to access a portion of the death benefit if a physician certifies the insured as terminally ill. This option is typically capped at 50% of the face value. To be considered terminally ill, a physician must certify that the person has a condition or illness that will result in death in two years. The amount of benefit received will be subtracted from the death benefit and is received tax-free.

Single, pure, or straight life income option

Under the single, pure, or straight life income option, like a straight life annuity, monthly installments are paid to the beneficiary for as long as they live. In other words, income payments end upon the death of the recipient (i.e., the beneficiary). No refund or any other payments are made once the beneficiary dies. This option potentially provides the most significant amount of income per $1,000 of proceeds. However, as mentioned previously, it also possesses the most significant amount of risk since there is no survivorship.

lump sum

Under this option, the death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. The lump sum option is the most common option used and is considered the automatic (or "default") option for most life insurance contracts.

interest only

Under this option, the insurance company holds the death benefit for a period of time and pays only the interest earned to the named beneficiary. - A minimum rate of interest is guaranteed, and the interest must be paid at least annually. As always, interest paid by an insurer on policy proceeds is taxable. Again, even when the policy proceeds are left with the insurer, and the beneficiary selects this option, they continue to possess the right to withdraw the proceeds in the future at their discretion unless the policy owner explicitly listed restrictions.

1035 Exchange

When an existing life insurance policy is assigned to another insurer for a new contract, the transaction may be treated for tax purposes as a Section 1035 exchange. Policy exchanges that qualify as a 1035 exchange are not taxable. A Section 1035 exchange enables the postponement of tax consequences.

Taxation of Accelerated Death Benefit

When benefits are paid under a life insurance policy to a terminally ill person, the benefits are received tax-free. To be considered terminally ill, a physician must certify that the person has a condition or illness that will result in death in two years.

endorsement method

When the endorsement method is utilized, the policy is returned to the insurer so the new beneficiary designation can be added to the policy. The effective date of the change is the date the new policy is printed

net (single) premium

a premium that makes provision for mortality cost (death benefit) and interest influenced by the assumed interest rate, the proposed insured's gender, the benefits to be provided, and the mortality rate

minimum deposit (financed) insurance

While sometimes lumped in with "types of life insurance," minimum deposit or financed insurance is not an actual policy type. It allows the policy owner to use policy loans to pay premiums due each year. The policyowner only pays the difference between the premium due and the amount borrowed (plus interest on the policy loan). For this payment method to work, the policy owner must make two to three initial premium payments to build up the cash value. Additionally, under IRS rules, at least four of the initial seven annual premiums must be paid from funds other than policy loans to avoid classification as a MEC.

Taxation of Policy Loans

With regard to policy loans, if a contract owner borrows against the cash value in the contract, there are no tax consequences in most situations. However, if a policy is a MEC, distributions are subject to the interest first rule, which states that they are taxable as income if the cash value of the contract, immediately prior to the payment, exceeds the cost basis in the contract. Borrowing against the cash value is sometimes referred to as a partial surrender. This action on the part of the owner, while not resulting in a taxable event, does lower the owner's equity in the policy. If a total surrender occurs, the cash value received is not taxable as long as it does not exceed what the owner paid in premiums (the cost basis). Additionally, when a contract owner borrows against the cash value of a whole life policy, the interest paid to the insurer is not tax-deductible.

graded premium funding

a lower premium in the early years of the contract, however, premiums increase annually or every year for the initial period. It then jumps to an amount higher than what the initial level premium would have been, and then remains level or constant for the life of the policy. The premiums for these policies are predetermined but are not level, in the traditional sense.

terminally ill

a person not expected to survive a medical condition for more than 24 months

chronically ill

a person who needs considerable supervision due to cognitive impairment or cannot perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, or continence)

policy dividends

a refund of part of the premium under a participating policy or a share of surplus funds. Mutual company insurers derive dividends from savings in mortality and expenses. The policy owner may use dividends for cash payments, to pay the insurance premium, to purchase additional paid-up whole life insurance, to purchase one-year term insurance, or as an investment to accumulate interest. Dividends do not reduce the death benefit.

how does life insurance create an immediate estate?

after the first premium is paid, the face amount may be available to the beneficiary

net level annual premium

allows for a small adjustment to the interest rate to account for the fact that most people do not pay the policy's required premium in a single payment, but instead over a period of years.

viatical settlement

allows someone with a chronic or terminal illness to sell their existing life insurance policy to a third party for a percentage of the face value The new owner continues to make the premium payments and eventually collects the full death benefit when the viator dies. Due to the nature of the contract, most states require a special license for viatical settlement providers, and at a minimum, require a viatical company recommends the client consult a tax adviser as the proceeds could be taxable in certain situations. Tax laws require viators to be chronically or terminally ill to receive payments from viatical settlements tax-free.

flexible premium funding

allows the policyowner to adjust the premiums throughout the life of the contract

fixed amount primary factor determining the monthly income amount paid to the beneficiary

amount of income

unearned premium

an amount of premium for which the policyholder has made payment to the insurance company, but coverage has not yet been provided. Unearned premium typically becomes earned premium as an insurance contract progresses, but also would be the amount returned to an insured by the insurer upon policy cancellation

immediate estate

an immediate estate can be created because the face amount may be available to the beneficiary after the first premium is paid

modified premium funding

an initial premium that is lower than it should be during an introductory period of time (usually the first three to five years) After this time, the premium will increase to an amount greater than what the initial level premium would have been and then remains level or constant for the life of the policy

life insurance living benefit

an option for a policy owner to use some of the future death benefit proceeds before the insured's death The policyowner (typically the insured) is the only party that can initiate a living benefit. Beneficiaries do not receive any of the living benefits. In fact, living benefits are typically subtracted from the death benefit or change the benefits altogether.

fixed/level premium funding

averages the "single premium" over the policy period. The policyowner pays more (than the actual cost of insurance) in the early years to help cover the cost of insurance in later years. This allows the premiums to remain level throughout the life of the policy

which of these factors help determine an insured's life insurance premium

avocation (hobby)

The index numbers are designed to give the consumer a means of

comparing the cost of policies of the same generic type The indexes also factor the insured's age and the amount of coverage desired. Each insurer and its producers must use the same computation formulas to arrive at the index numbers, or the purpose would be defeated. Due to the increasing complexity of life insurance policy structures, premium payment methods, benefits, and dividend configurations, the average consumer would not make cost comparisons without these index figures. The NAIC Model Life Insurance Solicitation Regulation requires two interest-adjusted cost indexes for policy illustrations: a surrender cost index and a net payment cost index. These indexes show average annual costs and payments per $1,000 of insurance while also recognizing that $1 payable today is worth more than $1 payable in the future (i.e., the time value of money).

testamentary trusts

created at the insured's death according to a will

comparative interest rate method

determines the rate of return required on an investment account to yield the same return of a life insurance policy that has cash value. - This method is sometimes referred to as the "buy term and invest the rest" strategy. The amount spent on the term insurance plus the hypothetical investment account must be the same as the required premiums for permanent insurance. - The face value of the temporary and permanent insurance products being compared must also be the same. The comparative interest rate is the rate of return required on the investment account, so the value of the investment is equal to the surrender value of the higher premium policy at a specific point (i.e., 30 years, death). - The higher the comparative interest rate (CIR), the less expensive the higher-premium permanent policy is compared to the alternative plan.

What is created after policy proceeds are obtained in a lump sum and then immediately invested?

estate

Purchasing a life insurance policy in order to avoid the forced sale of assets upon death is called

estate conversion

what does the interest only option provide the beneficiary with

flexibility since the proceeds may be left with the insurer, which frees him or her of any investment worry while guaranteeing both principal and a minimum rate of return (i.e., interest).

common disaster provision

further clarifies these complicated situations by adding a survivorship clause. This clause requires that the primary beneficiary not just survive longer but outlive the insured for a specified amount of time, typically 14 or 30 days. The common disaster provision ensures a policy owner that if both the insured and the primary beneficiary die within a short period of time, the death benefits will be paid to the contingent beneficiary. Benefits will only be paid to the primary beneficiary's estate if the primary beneficiary lives past the minimum time period

gross annual premium

gross premium adjusted for the fact that most people do not pay the policy's required premium in a single payment, but instead over a period of years

revocable beneficiary

may be changed or removed by the policyowner at any time without notifying or getting permission from the beneficiary

irrevocable beneficiary

may not be changed without the written consent of the beneficiary. The irrevocable beneficiary has a vested interest in the policy. - Therefore, the policyowner may not exercise certain rights (i.e., assignment, policy loans, surrender, etc.) without the consent of the beneficiary. In addition, an irrevocable beneficiary has the right to receive a copy of the policy if they desire.

net (single) premium formula

mortality cost - interest

when is the net payment cost index useful

if one's primary concern is the amount of death benefits provided in the policy, and is not as concerned with the build-up of cash value. It helps compare future costs, such as in 10 to 20 years, if one continues to pay premiums and does not take the policy's cash value.

What happens to the total amount of premium paid for an insurance policy when the payment frequency increases?

increases

Which type of beneficiary should be named if the insured wants to give explicit directions on how the policy proceeds should be paid?

individual

Which settlement option involves having the proceeds remain with the insurer and earnings paid on a monthly basis to the beneficiary?

interest only

estate conversion

involves purchasing life insurance to avoid the forced sale of assets upon death

problem with the uniform simultaneous death act

it only applies to situations where it cannot be definitively determined if the insured died before the beneficiary. If it can clearly be determined who died first, even if the difference is only a few minutes or hours, the insurance company would follow the normal succession process outlined in the policy

gross premium formula

net premium + insurer expenses

inter Vivos trusts

or living trusts are created during the life of the insured

viator

original policy owner

life insurance decision maker

policy owner

the spendthrift clause is most often used to

prevent a beneficiary from recklessly spending benefits by requiring the benefits to be paid in fixed amounts or installments over a certain period of time.

goal of both the Uniform Simultaneous Death Act and the common disaster provision

protect the contingent beneficiary by not paying the proceeds to the primary beneficiary's estate. Paying the benefits to the beneficiary's estate likely defeats the purpose of the insurance policy. Furthermore, it potentially causes undesired death taxes and probate charges to be assessed, significantly reducing the benefit before the heirs receive what remains. If there is not a contingent beneficiary listed, the benefits will be paid to the insured's estate, just as if the primary beneficiary died before the insured.

spendthrift clause

protects a beneficiary from creditors with regard to life insurance proceeds. When the death benefit is left with the insurer, no creditors can attach a lien of any kind to the proceeds. The spendthrift clause also protects a beneficiary by minimizing or restricting the use of proceeds as long as the insurer holds them. Only after proceeds have been distributed can the beneficiary assign or transfer the benefits to a creditor. Additionally, under the spendthrift clause, a beneficiary cannot take the present value of future payments in a lump sum (commuting) or use future payments as collateral for a loan (encumbering). Outside of preventing distribution directly to the insured's creditors, this clause does not have any effect if the beneficiary receives the proceeds as one lump sum payment. Additionally, once the beneficiary receives the payment, creditors may be able to take steps to collect on money owed.

mortality factor

refers to the frequency of deaths in a defined population at a specific time interval has the greatest effect on premium calculations or rate making in order for a mortality table to be accurate, it must be based upon a large cross section of individuals and time The number of deaths in a group of people is usually expressed as deaths per thousand. Insurance companies use mortality tables to help predict the life expectancy and probability of death for a given group.

premium mode

refers to the policy feature that permits the policyowner to select the timing of premium payments There is usually an additional charge if the policy owner chooses to pay the premium more than once per year (semi-annual, quarterly, monthly, etc.). - This additional charge is because the company cannot earn as much interest and will have additional administrative costs in billing and collecting the premium payments. - Therefore, the higher the frequency of payments, the more the policy will cost the insured in total.

policyowner (other than the insured) list themselves as a beneficiary

require proof of insurable interest

What does a life insurance policy guarantee to the stated beneficiary upon the death of the insured?

specified amount of money

uniform simultaneous death act

states that if the insured and primary beneficiary both die in a common disaster (i.e., plane crash) and it cannot be determined who died first, the insured will be considered to have survived the primary beneficiary (or died last). In other words, the primary beneficiary will be considered to have died before the insured. Therefore, the face amount is paid to the contingent beneficiary.

earned premium

the amount an insurer is entitled to since it provided coverage for a specific period of time

legal reserve

the amount of funds an insurance commissioner (or director/superintendent) requires an insurer to maintain based on the CSO mortality table and assumed rate designated by the state's commissioner or state insurance law. Therefore, the insurance commissioner can specify the two main factors an insurer uses in determining reserves: the CSO mortality table and maximum assumed interest rate.

fixed period

the death benefit proceeds are paid in equal installments over a set period of years. The fixed period option is one of the two options based upon the concept of systematically liquidating principal and interest over a period of years, without references to life contingencies. Under this option, the beneficiary leaves the death proceeds with the insurer. - Interest is paid on the proceeds (i.e., principal) by the insurer. - Monthly income is then paid to the beneficiary for a specified period of time as selected by the beneficiary (i.e., ten years). Part of the installments paid to a beneficiary consists of interest calculated on the proceeds of the policy. This option provides for the payment of proceeds in installments over a definite number of years. - The amount of each installment is determined by the amount of proceeds, the period of time (total number of installments) selected, the guaranteed rate of interest, and the frequency of payments.

insurer's total premium is made up of

the earned and unearned premiums

fixed period primary factors determining the monthly income amount paid to the beneficiary

the face amount and length of time

reserves

the funds (required by law) to be set aside by an insurer to pay current and future claims fixed liability of an insurer - these liabilities represent the amount that is expected to be needed to pay future benefits under a policy

beneficiary of a life insurance policy

the person or entity designated in the policy to receive the death proceeds

the lump sum option is used when

the policy owner wants finds paid in one single disbursement

filing method

the predominant method used and requires that the policyholder notify the insurer in writing of the desired change. The effective date of the change is the date of the request. Some insurers require that a witness sign the request.

gross premium

the premium charged by an insurer that is comprised of or influenced by all factors of mortality, interest and expenses. It is the actual premium paid by the policy owner for life insurance coverage. Gross Premium = Net Premium + insurer expenses.

life settlement

the sale of an existing life insurance policy to a third party for more than its cash surrender value, but less than its net death benefit. In many states, viatical settlements are being replaced by life settlements. Unlike viatical settlements, life settlements do not require the insured to be suffering from a chronic or terminal illness to sell and transfer the policy. With a life settlement, the policyowner may sell the policy to a life settlement firm for any reason. As with viatical settlements, a life settlement broker represents the policy owner and must hold an appropriate life settlement license. Disclosure requirements (e.g., right of rescission, fifteen days) are similar as well.

Life Insurance Surrender Cost Index

uses a calculation formula where the net cost is averaged over the number of years the policy was in force to arrive at the average cost-per-thousand for a policy that is surrendered for its cash value at the end of that period

net payment cost index

uses a similar formula, but it does not assume the policy is surrendered at the end of the period. As such, the cash value element is omitted. The net payment cost index provides the policy owner an estimate of their average annual premium outlay, adjusted for the time value of money.