2. Insurance Planning. 9. Life Insurance Flashcards
Module Introduction
Humans have always sought security. This quest for security was an important motivating force in the earliest formations of families, clans, tribes and other groups. These groups have been the primary source of emotional and physical security and helped their less fortunate members in times of crises.
Today the concept is the same. We continue our quest to achieve security and reduce uncertainty. We still rely on groups for financial stability. Beyond family, today’s groups include employers, the government and insurance companies. We are exposed to many serious perils, including personal losses from incapacity and death. Although, individuals cannot predict or completely prevent such occurrences, they can prepare for their financial effects through life insurance.
The Life Insurance module will introduce you to the various forms of life insurance provided by insurers and the options available with each of them.
The online portion of this module takes the average student approximately four hours to complete.
Upon completion of this module you should be able to:
* Define and classify life insurance,
* Explain the benefits of each type of life insurance,
* Describe the various provisions of the life insurance contract, and
* Outline the fundamentals of life insurance taxation.
Module Overview
When determining a client’s need for life insurance, it is important to approach the subject in the proper order. Selecting the type of life insurance policy should take place only after a thorough analysis of the client’s needs and budget. Too often, clients, and sometimes insurance agents, recommend solutions without first defining the problem. Avoid allowing the product solution to become the emphasis ahead of the need and budgetary constraints of the client. Only then should policy selection take place.
To ensure that you have an understanding of life insurance, the following lessons will be covered in this module:
* Life Insurance
* Types of Life Insurance Policies
* Life Insurance Contract Provisions
* Life Insurance Taxation
* Annuities
Section 1 – Life Insurance Exam Tip:
One of the most unfortunate circumstances to strike any family is the death of a wage earner. Beyond the emotional distress, the need to maintain current lifestyle and meet daily expenses compounds the loss. Such a situation could impoverish a family, create untold hardships, or force dependence on public welfare.
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.
To ensure that you have a solid understanding of life insurance, the following topic will be covered in this lesson:
* Life Insurance Defined
Upon completion of this lesson, you should be able to:
* Define life insurance
* List the classifications of life insurance
* Distinguish between group and individual insurance, and
* Differentiate between industrial, ordinary, and credit insurance.
Exam Tip: Life insurance is a multifaceted test topic, offering several different angles for questions on your CFP exam.
Listen in for the key life insurance knowledge categories that will serve as the cornerstone to building your understanding as you proceed in your studies.
Audio: Expect several questions on life insurance. Can be tested in many different applications:
* Life insurance needs analysis
* Testing on the structure of various contracts
* The living benefits of life insurance
* The income tax ramifications
* Estate planning of life insurance
Start to categorize it out to the main points in each of the sections
Match the term with the correct description.
Death
Retirement
Incapacity
Injury or incurring a disease
* Health insurance, accident insurance, and medical expense insurance.
* Endowments, annuities, and pensions.
* Life insurance or life assurance.
* Disability income insurance or long-term care insurance.
- 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.
Describe Group Life Insurance
Individual consumers purchase individual life insurance on their own accord, whereas 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.
Group Insurance 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.
Practitioner Advice: While many employers offer group life insurance coverage, it is important to understand the differences between group and individually purchased policies. Group policies are sold based on group rates, accounting for volume and a mixed risk assessment. Individual policies, on the other hand, are priced according to the cost of marketing to the individual and based on their specific risk factors. Typically, a healthy non-smoker will find an individual policy to be less costly, though it may require a more extensive application process. On the other hand, a person whose health condition limits his or her ability to purchase life insurance individually may find group coverage to be the only option.
Ordinary insurance includes individual life insurance and health insurance policies whose benefit amounts are smaller than industrial insurance.
* False
* True
False
* Ordinary insurance includes individual life insurance and health insurance policies whose benefit amounts are larger than industrial insurance.
Practitioner Advice:
Describe Credit Insurance as Life Insurance
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.
Credit Insurance in Action Example:
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.
Practitioner Advice: Most experts agree that, dollar for dollar, credit life insurance is much more expensive than traditional life insurance. Unfortunately, credit life is packaged and sold at a time when consumers are making expensive purchases and may feel obligated. Companies selling credit life insurance know this, and are offering a limited product at high cost. Generally, it is best to avoid credit life insurance, and build the amount of protection into your overall life insurance need.
Exam Tip:
Describe Life Insurance Insured, Owner, and Beneficiary
There are three distinct classifications of interest in an insurance policy.
* Insured
* Owner
* Beneficiary
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
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.
Exam Tip: Listen in for an informative overview of the common exam application of incidents of ownership on life insurance policies.
Audio:
* Incidents of ownership on life insurance policies
* For estate planning purposes, if an insured holds any incidence of ownership at the time of death, then the proceeds from the policy will be includable in the gross estate (something to avoid).
Group insurance 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, usually with greater flexibility or increased optional benefits.
* False
* True
False
* Group insurance 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.
Ownership rights in life insurance policies include the following rights (select all that apply).
* Change ownership of the policy
* Assign the policy as security for a loan
* Name beneficiaries
* Receive dividends
* Take out cash surrender value
Change ownership of the policy
Assign the policy as security for a loan
Name beneficiaries
Receive dividends
Take out cash surrender value
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
Generally, the __ ____??____ __ beneficiary has no rights in the policy while the insured is alive, while a(n) __ ____??____ __ beneficiary has a vested or guaranteed interest in the death benefit.
* revocable; irrevocable
* irrevocable; revocable
* revocable; contingent
* irrevocable; contingent
revocable; irrevocable
* 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.
Each of the following are correct statements regarding a beneficiary EXCEPT:
* A beneficiary receives the life insurance proceeds when the insured dies.
* A person can be both the insured and a beneficiary.
* A person, trust, estate or a business may be a beneficiary of a policy.
* Contingent beneficiaries will only have death benefit rights if the primary beneficiary predeceases the insured.
A person can be both the insured and a beneficiary.
* 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.
* Contingent beneficiaries will only have death benefit rights if the primary beneficiary predeceases the insured.
Section 2 – Types of Life Insurance Policies, Practitioner Advice, Exam
Life insurance policies can be constructed and priced to fit myriad benefits and premium-payment patterns. Generally, however, life insurance policies fit into one or a combination of three types of policy structures. These are term life insurance, endowment insurance, and whole life insurance.
In recent years, insurers have offered hybrid policies that blend a combination of features from the traditional types. Due to this trend, it is not always possible to determine the exact category into which some policies fall at policy issuance. Some policies permit the policy owner flexibility to effectively alter the type of insurance during the policy term. This allows the policy to be classified as a specific form only at a particular point.
To ensure that you have an understanding of the types of life insurance policies, the following topics will be covered in this lesson:
* Term Life Insurance
* Whole Life Insurance
* Universal Life Insurance
* Variable Life Insurance
Upon completion of this lesson, you should be able to:
* Discuss term life insurance,
* List the features of term life insurance,
* Explain endowment insurance,
* Define the mathematical and economic concepts of endowment insurance,
* Discuss whole life insurance,
* Explain whole life cash values,
* Define participating and non-participating whole life, and
* Explain how the contribution principle works.
Practitioner Advice: As there are numerous types of life insurance policies that exist today, it can be difficult to decide which one to purchase. It helps to remember that there are permanent needs and temporary needs for life insurance coverage. Permanent needs are those that the insured wishes to remain in effect for a majority of his or her life expectancy. Temporary needs tend to expire prior to life expectancy. Term insurance was created to cover temporary needs for specific terms of time; whole Life insurance was created to provide more permanent coverage. Keeping this basic concept in mind helps to avoid using the wrong type of policy for the wrong reasons.
Exam Tip: Listen in for helpful tips to organize life insurance-related information that will serve as a foundation to build upon as you learn about the varieties of insurance policies.
Audio:
* If you don’t work with life insurance everyday, it can be confusing and frustrating.
* With the types of life insurance, seek first to understand the general similarities and differences between the 4 types of life insurance - term, whole, universal, variable
* In their differences, what makes that a benefit to the client?
Exam Tip:
Describe Renewability of Term Life 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.
The 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.
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.
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.
Exam Tip: Listen in to build your understanding of the facts on the renewability of level-premium term life insurance policies that will translate to exam points.
Audio:
* Understanding the renewability feature of level-premium term life insurance policy is important
* 10, 20, 30 year terms are most common
* Premium stays the same until that original expiration
* We have to match up that guaranteed period with the client’s time table with the need that they have
* Ex. Young family, with young children and 30 year mortgage - maybe shouldn’t do 10 year term bc their need is much longer than 10 years
* At the end of the 10 years, can renew, but will be at a higher premium
* On the exam, pay attention to timelines given when asked to recommend a particular product
With an annual renewable term insurance policy, the amount of coverage __ ____??____ __ and the premiums __ ____??____ __ as the insured ages.
* remains constant; decrease
* decreases; remains constant
* remains constant; increase
* decreases; increase
remains constant; increase
* With an annual renewable term insurance policy, the amount of coverage remains constant and the premiums increase as the insured ages.
* This reflects the rising cost of insuring actual risk at a specific risk.
Practitioner Advice:
Describe 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.
Practitioner Advice: Most Term policies sold these days come with a Level Premium that is guaranteed for a set number of years. For example, Joe can buy a 20-year Level Term policy to cover the college education costs for his 5-year-old daughter. David can buy a 30-year Level Term policy to cover his new 30-year mortgage debt.
Practitioner Advice:
Describe 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.
Practitioner Advice: One of the major advantages of any cash value type of life insurance contract is that the cash value grows on a tax-deferred basis. The funds in the savings part of the contract grow every year, and there is no income tax due unless the owner takes out more money than has been paid in.
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.
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.
Practitioner Advice: Many consumers misunderstand the concept of cash value. It is important to remember that this is not equal to the amount paid into the policy by the insured.
Thus, cash values are typically non-existent in the first year of a policy and grow slowly over time to equal the face amount of the policy by age 100. Remember, premiums are not deposits; insurance is not an investment.
Julia 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.
* False
* True
False
* 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.
Practitioner Advice:
Describe the 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.
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.
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.
Practitioner Advice: It is essential for clients to understand that dividends are simply projections, and not guaranteed. While insurance companies do a better job of highlighting the possibility of change, the planner or agent also needs to discuss this with the client.
Practitioner Advice:
Describe Dividends Actually Paid
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.
Practitioner Advice: Having a loan against your cash value life insurance policy will probably have an impact on the dividends you receive. Most insurers that pay dividends use a direct recognition scale so that those with loans get lower dividends than those who have no loans from their cash value.
Practitioner Advice:
Describe the 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.
Contribution Principle 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.
Practitioner Advice: The dividend received by the policyholder is actually a credit for an overpaid premium and is considered by the IRS to be a “return of premium.” The dividend received is not taxable income to the insured unless it exceeds the cost basis. For example, if the policyholder’s cost basis is $1,000, any amount received of $1,000 or less is a return of basis and there are no tax consequences. However, if the dividend is $1,025, $1,000 is return of premium/basis and $25 is taxed as ordinary income.
Practitioner Advice & Exam Tip:
Describe 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.”
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.
Practitioner Advice: Universal Life Insurance has more flexibility than Whole Life Insurance. It also carries surrender penalties that insureds would not encounter in Whole Life policies. Make sure that the agent explains all of the advantages and disadvantages of this product.
Exam Tip: Listen in to learn about distinguishing characteristics associated with Universal Life Insurance Option A & Option B.
Audio:
* In original universal life policy structure, there was an Option A death benefit and Option B death benefit
* Option A - face amount remains level. If started at $200k, always remained $200k.
* Option B - death benefit is the sum of both original face amount and the cash value in the policy at the time of death. $200k face value + $50k cash value = $250k death benefit
Match with correct description:
Features
Premiums
Monthly Cost
* Subtracted from the fund value.
* Premium, cash value, and death benefit can be adjusted as the insured’s needs change.
* 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.
- Features - Premium, cash value, and death benefit can be adjusted as the insured’s needs change.
- 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.
- Monthly Cost - Subtracted from the fund value.
Exam Tip:
Describe 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.
Exam Tip: Listen in for an overview of need-to-know exam-related information on variable life insurance separate accounts for cash value.
Audio:
* Variable Life Insurance has separate accounts for the cash value.
* Separate accounts look and perform like mutual funds, but called sub-accounts in an insurance product.
* These funds are not part of a insurance company’s general account.
* Fixed income life insurance and annuities, term life, whole life insurance - all supported from the general account of the insured.
* In the event of failure of insurance company, the general assets would be subject to creditors, but the funds in sub-accounts are not subject to the creditors.
Practitioner Advice:
Describe 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.
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.
Practitioner Advice: Endowment policies are no longer sold in the U.S. In 1984, Congress passed legislation that included definitions of life insurance. Because endowment policies have premiums that are much higher than required for the death benefit, these policies no longer qualify as life insurance, and as a result, lose the benefit of tax sheltered growth of the cash value.
Section 2 – Types of Life Insurance Policies Summary Exam Tip
The four major types of life insurance are term life insurance, whole life insurance, universal life, and variable insurance. Each of them is enhanced by a variety of features, some of which are optional.
In this lesson we have covered the following:
* Term Life Insurance is a policy that covers a set time period and promises to pay benefits only if the insured dies during the policy term, with nothing paid if the insured survives the term.
* Two important features of term life insurance are as follows:
* Renewability: Permits the policy owner to renew the policy for a certain number of additional periods without reference to the insured’s insurability status.
* Convertibility: Permits the policy owner to exchange the term policy for a cash-value insurance contract without evidence of insurability.
Exam Tip: Extend your understanding of the life insurance policy types by reviewing CFP® Board’s Contextual Variables and identifying the life phases, special circumstances, and financial situations in which application of a specific type of life insurance serve as a ‘best-fit’ risk management strategy.
Audio:
* Piece produced by the CFP board - wheel of 8 general topic areas and respective percentages on exam.
* On the right side are the domains - equate to steps in financial planning process
* On the bottom - Contextual Variables - means the demographics (ex. young family, widow, small biz owner)
* Good to look at the wheel and Contextual Variables - think how the products would change based on the Contextual Variables (scenario, demographics)
* Ex. Life insurance with young children, buying a house - As opposed to a widow’s need for life insurance
* Opposed to a wealthy family - what role would life insurance have for them - maybe pay estate taxes in order to preserve more of the estate & put it in an insurance trust.
- Whole Life Insurance is a policy that provides coverage for the whole of the insured’s life.
- Whole Life Cash Values are provided by insurers and are available to the policy owner at any time by surrendering the policy. The policy owner can also borrow the cash value while keeping the policy in force.
- Participating Whole Life policy owners have the right to share in surplus funds accumulated by the insurers, and the surplus is paid out as dividends.
- Non-participating Whole Life policy elements are fixed and make no allowance for future values to differ.
Concepts relevant to participating whole life policies include:
* Dividend Illustration is provided by insurers to prospective purchasers of participating policies.
* Dividends Actually Paid may not equal the dividend illustration.
* Dividend History is the schedule of dividends actually paid.
* Contribution Principle ensures that policy owners receive the surplus in proportion to their contribution.
* Universal Life Policy combines the low cost nature of term and the cash value features of whole life.
* Variable Life Policy offers an increased the opportunity for the cash value fund to grow, but with greater investment risk to the insured
* Some specialized contracts intended to meet the needs of insureds in particular situations were also reviewed in this section.
James Gordon asked his insurance agent whether he would receive the full-face amount of his insurance policy next year when it reaches the end of its term. The agent’s reply was negative.
Which type of insurance policy does James Gordon have?
* Whole Life Insurance
* Term Life Insurance
* Endowment Insurance
* Tenure Life Insurance
Term Life Insurance
* Term life insurance terminates with no maturity value and therefore nothing is paid to the insured at the end of the term.
Match the elements with the correct definition.
Dividend Illustration
Dividend History
Contribution Principle
* Surplus received in proportion to contribution.
* Provided by insurers to prospective purchasers.
* Schedule of dividends actually paid.
- Dividend Illustration - Provided by insurers to prospective purchasers.
- Dividend History - Schedule of dividends actually paid.
- Contribution Principle - Surplus received in proportion to contribution.
Which feature(s) of term life insurance do not require evidence of insurability?
* Renewability
* Endowment
* Convertibility
* Re-Entry
Renewability
Convertibility
* Renewability and convertibility are two features provided in term life insurance without reference to the insured’s insurability status.
* The re-entry option is available only if the insured can demonstrate that they meet certain insurability criteria.
* Endowment is not a feature of term life insurance; it is another type of insurance.
Section 3 – Life Insurance Contract Provisions
A life insurance contract is in many ways more difficult to analyze and describe than a homeowner’s or a personal auto insurance policy. No standardized life insurance policies exist, although most life insurance companies sell policies that have comparable provisions required by state law.
New York’s insurance law states:
All life insurance policies, except as otherwise stated herein, delivered or issued for delivery in this state, shall contain in substance the following provisions, or provisions which the superintendent deems to be more favorable to policyholders.
As New York insurance law serves as a model for most other states’ insurance regulation, we use it as a guide throughout this chapter. The other states have laws with similar, if not identical, requirements. Thus, the discussion to follow has relevance everywhere in the United States.
When a life insurance policy is purchased, three distinct classifications of interest are created:
* The insured is the person whose death causes the insurer to pay the claim.
* The owner is the person who may exercise the rights created by the contract.
* The beneficiary is the person receiving the proceeds when the insured dies.
To ensure that you have an understanding of life insurance contract provisions, the following topics will be covered in this lesson:
* Life Insurance Policy Provisions
* Insured Options
Upon completion of this lesson, you should be able to:
* Define grace period and lapsed policy,
* Explain reinstatement provisions,
* Describe the clauses in an insurance contract,
* List and discuss the insured options,
* Identify five different ways a beneficiary may take death proceeds, and
* Explain policy illustrations.
Exam Tip:
Describe Life Insurance’s Grace Period
The insurer will send the insured a notice of when the premium is due before the due date. If the insured neglects to pay a premium when it is due, the policy does not end immediately.
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.
If there is enough cash value in the policy, the premium will be paid, reducing the cash value. If there is not enough cash value to pay the premium, the policy will lapse. The policyholder must pay the premium before the end of the 31 days provided by the grace period to avoid having the policy lapse.
However, if the policyholder dies during the grace period, the insurer will pay the proceeds to the beneficiary, minus the overdue premium.
Grace Period Example:
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.
Exam Tip: Listen in for a quick discussion on the common exam application of the grace period on life insurance policies.
* Make note of key numbers (ex. days to do this or that)
* Grace period provision in a life insurance policy - 31 days to make the premium payment or the policy will lapse.
Practitioner Advice:
Describe Reinstatement Provisions for Life Insurance
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.
New York has a limit of three years from the date of default in which the owner may reinstate the policy. Furthermore, the insured must not have withdrawn the cash surrender value, but must have chosen a non-forfeiture option that allows the policy to continue.
Practitioner Advice: As previously noted, some states have different regulations that can impact the insured’s rights.
For example, the Commonwealth of 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. Unfortunately, by taking away the consumer’s right to make that decision, the state has created a situation where some people who have become uninsurable cannot buy a new policy. For this reason, it is important that policy owners and professional advisors fully understand existing policy features and options before making any changes.
Each of the following conditions must be met to reinstate a life insurance policy EXCEPT:
* Evidence of insurability.
* Payment of all defaulted premiums without interest.
* Repayment of any loans secured by the policy.
* No engagement in dangerous occupations or hobbies.
Payment of all defaulted premiums without interest.
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.
Exam Tip:
Describe the Incontestable Clause
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.
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.
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.
Exam Tip: Listen in for a quick discussion on the common exam application of the incontestable clause on life insurance policies.
Audio:
* Incontestable Clause - highly testable feature of a contract
* Means after policy has been in force for 2 years, if insurance company discovers fraud, the insurance company cannot contest or void the contract.
Select the way(s) in which a life insurance policy may be terminated or contested.
I. Non-payment of premiums by the insured.
II. Fraudulent claims are suspected.
* I only
* II only
* Both I and II
* Neither I nor II
Both I and II
* A life insurance policy may be terminated or contested due to premium non-payment and/or submission of fraudulent claims by the insured.
Exam Tip:
Describe the Misstatement-of-Age Provision
As the applicant’s age is a key factor in underwriting and pricing the insurance, a misstatement of age, either intentionally or by mistake, causes rating errors.
The 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.
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.
Misstatement-of-Age Provision Example:
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.
Exam Tip: Listen in for a quick discussion on the common exam application of the misstatement-of-age provision on life insurance policies.
If the applicant (intentionally or unintentionally) mis-states their age on the application, the insurance company may adjust the death benefit accordingly to what would’ve been purchased at the time of application, based on the correct age. They won’t void the contract. But allowed to adjust the death benefit to the proper age.
Practitioner Advice:
Describe the 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.
Note: Many insurance companies have a one-year restriction that is more favorable to the policyholder and permissible under law.
The policy will pay for death caused by other illnesses, including mental illness. 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. Therefore, after the two-year restriction, the company will pay for suicide deaths because the suicide presumably has been caused by mental illness that occurred after the policy’s inception. Where there is no history of mental illness and the applicant is contemplating suicide, it is improbable that a suicidal person could wait two years to complete the act.
Insurers often have a difficult time establishing that the insured’s death resulted from suicide. In one case, within two years of the policy’s effective date, an insured took between 30 and 40 sleeping pills, pulled the phone out of the wall and subsequently died. The autopsy and death certificates each listed suicide as the cause of death. Moreover, this was the second occasion within three months in which the insured had taken an overdose of sleeping pills. Nevertheless, the jury was instructed that the presumption is against suicide in all cases, and that suicide may be assumed only when no other conclusion could reasonably be drawn. As the jury thought it was possible the insured’s death may have been caused by the motive of “self-indulgence,” the insurer had to pay the claim.
Practitioner Advice: If the policyholder commits suicide within the two years of issuance, the insurance company will pay the policyholder’s estate all premiums paid without interest.
