Chapter 2: Life Basics

Question 1

Applicant

Answer 1

Person making application for himself/herself or another to be insured under an insurance contract. The applicant may be the insured, the owner, or both.

Question 2

Application

Answer 2

A written formal request by an applicant to an insurer requesting the insurer issue a policy based upon information contained in the application. It is the primary source of information used for underwriting purposes. A copy of the application, if attached to the policy, becomes part of the entire contract.

Question 3

Beneficiary

Answer 3

One or more “parties” named in the policy to receive the policy proceeds, or death benefits, if the insured dies while the contract is in force.

Question 4

Insurable Interest

Answer 4

The relationship that must exist between the applicant and insured, at the time of application, and policy issuance, in order for the contract to be valid.

Insurable interest also exists if a financial or economic loss by the owner results in the event that the insured dies.

Examples: Policy taken out on a family member, business partner, or debtor of the policyowner

Question 5

Policyowner

Answer 5

The individual who has the ownership rights in a policy. The policyowner and insured are usually the same, but not necessarily. Any changes made to a policy must be approved by the policyowner in writing with his/her signature.

Question 6

Third-Party Ownership

Answer 6

A policy owned by a person other than the insured.

Question 7

Issue (Original) Age

Answer 7

Insured’s age on the policy issue date.

Question 8

Attained Age

Answer 8

Insured’s age at any point in time typically used at renewal or conversion.

Question 9

Effective Date

Answer 9

The date when insurance coverage begins.

Question 10

Expiration Date

Answer 10

The date when insurance coverage ends.

Question 11

Advertising

Answer 11

Producers are governed under the rules and regulations, referred to as Unfair Trade Practices, with regard to what they can and cannot use or say when soliciting insurance.

Question 12

Do Not Call Registry

Answer 12

• The Federal Trade Commission (FTC) amended the Telemarketing Sales Rule to give consumers a choice about whether they want to receive most telemarketing calls.
• It is prohibited (under the Telephone Consumer Protection Act - TCPA) for most telemarketers or sellers to call a number on the National Do Not Call Registry.
• Companies, telemarketers, and sellers must update their list at least once every 31 days and drop from their call list the phone numbers of those who have registered.
• Calls to your home before 8 a.m. or after 9 p.m. are prohibited.
• Callers must provide their name, name of the entity, and a telephone number or address where the entity can be contacted.

Question 13

Sales Presentation

Answer 13

Producers are required to provide all prospective buyers a Buyer’s Guide and a Policy Summary
- The NAIC instructs insurers to provide prospective purchasers these materials before accepting a premium payment or deposit, or no later than policy delivery IF the policy has a free look period of at least 10 days. State laws may expand this requirement to include that such documents be provided at the time of application or even at initial solicitation.

Question 14

Buyer’s Guide

Answer 14

A generic brochure developed by the NAIC to assist prospective buyers of life insurance, which consists of descriptions of all basic types of life insurance, as well as comparative costs of each.

Question 15

Policy Summary

Answer 15

Normally, a computer-generate illustration detailing:

• The premiums (current and guaranteed) to be paid along with current and guaranteed interest rates
• Guaranteed and non-guaranteed cash value and projected dividends, if any. The summary is not required to show time value of money
• The surrender values and other guaranteed data pertaining to the policy that is being shown
• The producer’s name and address, along with the address of the insurance company

Question 16

Replacement

Answer 16

Any transaction in which a new life policy or annuity is to be purchased, and the producer knows that existing contract(s) will be:

• Lapsed, forfeited, surrendered, or terminated
• Reduced in value
• Amended with a reduction in benefit or term
• Reissued with a reduced cash value
• Subjected to borrowing

Question 17

Replacing Insurer

Answer 17

The insurer responsible for issuing the new policy

Question 18

Existing Insurer

Answer 18

The insurer who issued the policy to be replaced

Question 19

Conservation

Answer 19

The act of saving or keeping the existing policy and preventing it from being replaced

Question 20

Producer’s Responsibilities Include:

Answer 20

• Completing a Notice Regarding Replacement, which must be signed by the applicant and producer
• Obtain information regarding existing policies, including the names of the existing insurers and policy numbers (this must be provided to the replacing insurer)
• Providing copies of the Notice Regarding Replacement and any sales proposals to the applicant and replacing insurer

Question 21

Replacing Insurer’s Responsibilities Include:

Answer 21

• Upon receiving proper notification with the new application, the replacing insurer must notify the existing insurer of the planned replacement
• Maintaining copies of the information regarding replacement for a specified period of time

**State-specific chapter may have more specific information regarding replacement

Question 22

Field Underwriting

Answer 22

It is the producer’s responsibility to probe beyond the stated questions in the application.

Question 23

Required Signatures

Answer 23

Both the producer and the applicant/insured must sign the application. The applicant is representing that statements on the application are true.

If the applicant is a minor, a guardian must sign the application.

Question 24

Changes in the Application

Answer 24

Whenever an answer to a question needs to be corrected, the applicant or producer makes the correction and the applicant initials the change, or the producer can complete a new application.

Question 25

Consequences of Incomplete Applications

Answer 25

It is the producer’s responsibility to ensure the application is filled out completely, correctly, and to the best of the applicant’s knowledge. The producer’s primary underwriting role is to make sure the application provides proper information for the insurer. The underwriter will return any incomplete application to the producer for completion by the applicant. If a policy is issued with questions unanswered, it is assumed the information is not material to the issuance and the insurer waives the right to challenge a claim based on the incomplete application.

Question 26

Collecting the Initial Premium and Issuing the Receipt

Answer 26

Producer should attempt to collect the initial premium and submit it, along with the application, to the insurer because the policy will NOT go into effect until the first premium has been paid.

If premium is paid with a check that is not signed (or does not clear), it is not considered paid, and coverage is not effective.

The types of receipts that can be issued when the premium is submitted with the application are:

• Conditional Receipt
• Binding (Unconditional) Receipt
• Acceptance (Approval) Conditional Receipt

Question 27

Conditional Receipt

Answer 27

If premium is paid, coverage will be in effect on the date of the application or completion of the medical exam, whichever is later, as long as the policy would have been issued as applied for.

Question 28

Binding (Unconditional) Receipt

Answer 28

If premium is paid, coverage will begin immediately, for a specific length of time, regardless of whether the applicant is ultimately approved by the insurer. This may also be referred to as a temporary insurance agreement.

Question 29

Acceptance (Approval) Conditional Receipt

Answer 29

The coverage becomes effective once the application is approved. If the company doesn’t approve the application, coverage never goes into effect.

Question 30

Trial Application

Answer 30

One submitted without a premium. The policy does not take effect until the policy is issued by the insurer, delivered by the agent, and the premium is paid.

Question 31

Notice of Information Practices and Disclosure - Fair Credit Reporting Act (FCRA)

Answer 31

Insurance company must meet requirements under the FCRA when gathering information from a third party to use during underwriting. The applicant must be notified and give consent for information to be received by a third party. This information is disclosed as part of the application and the applicant’s signature serves as the notice of information practices. This gives insurance company the right to obtain various investigative, medical, and financial reports needed to complete the underwriting process.

If insurer declines coverage, the applicant will have the right to obtain a copy of all reports from the reporting agency. This is referred to as “post application consumer review.”

Question 32

Disclosure at Point of Sale - Issues Relating to AIDS

Answer 32

Insurers must avoid making or permitting unfair discrimination in underwriting between individuals of the same class for the risks of AIDS. Insurers must also require that strict confidentiality is maintained regarding personal information obtained through testing. They must require informed consent before testing for HIV, for which the HIV Consent Form specifies which individuals may receive the test results.

Insurance companies MAY refuse to issue a policy to individuals based on positive HIV test results. However, applicants must consent to be tested for HIV and be informed that testing for HIV may determine insurability.

Question 33

Errors and Omissions

Answer 33

This type of insurance covers the liability of a PRODUCER or AGENCY, typically written with a deductible to reduce the frequency of claims. Claims are filed due to client reports (complaints) and for a number of other reasons. Two common complaints are:

• Inadequacy
• Negligence

Question 34

Inadequacy

Answer 34

Failing to obtain proper type or amount of coverage on a client

Question 35

Negligence

Answer 35

Quoting inflated information, misrepresenting a plan of coverage, or neglecting to reveal the effect information might have on the client at a later date. The producer may be guilty of negligence whether the mistakes are intentional or unintentional.

Question 36

Individual Underwriting by the Insurer

Answer 36

Underwriting is the process of selection, classification, and rating: determining if someone is insurable, classifying the risk, and determining the rate or premium to be charged. The sources of underwriting include:

• The application
• Medical Exams
• Attending Physician’s Statement (APS)
• The Medical Information Bureau (MIB)
• Inspection Report
• Agent’s Report

Question 37

The Application consists of two parts:

Answer 37

Part I: General questions about the applicant, such as sex/gender, marital status, residence, DOB, occupation, and past and present life insurance

Part II: Questions pertaining to medical background, past and present health, any medical visits, hospitalizations, or surgeries in recent years, and the medical status of immediate family members, including their ages and causes of death.

Question 38

Medical Examinations

Answer 38

Conducted by physicians or nurses who provide the results of an examination and information regarding the applicant’s health. It is usually requested by the insurer after determining if the amount of coverage, age of applicant, or health history warrant the exam. It is more frequently requested due to the higher amounts of insurance applied for, coupled with the high degree of cardiovascular concerns, high cholesterol and enzyme levels, as well as the prevalence of the HIV virus. Medical exams are at the INSURER’S expense.

The Medical Exam is the only report that may be copied and made part of the policy.

Question 39

Attending Physician’s Statement (APS)

Answer 39

Used in cases in which the individual application and/or medical reports reveal conditions of which more information is required. The applicant’s treating physician will complete this as part of the applicant’s medical history. An applicant must sign a written release to enable a release of APS. THe INSURER pays for this.

Question 40

Medical Information Bureau (MIB)

Answer 40

To collect adverse medical information about an applicant’s health, supported by insurance companies, and act as an information exchange.

• Member-owned, Nonprofit in US and Canada
• These services alert underwriters of fraud, errors, omissions, or misrepresentations made on insurance applications. May also help lower cost of life and health insurance for consumers.
• Because MIB information is general, the MIB CANNOT SOLELY be used to deny an applicant for insurance.

Question 41

Inspection Report

Answer 41

General report of the applicant’s finances, character, morals, work, hobbies, and other habits. Sometimes referred to as a Consumer Investigative Report. This can be completed by the insurer or a third-party provider and the applicant MUST be made aware of any information-gathering and has rights provided under the FCRA.

Question 42

Agent’s Report

Answer 42

Personal statement submitted by the producer, to the insurer, regarding the applicant’s financial condition, any personal knowledge of the applicant, etc. This information remains confidential between the producer and the insurer, and it DOES NOT become part of the entire contract.

Question 43

Individual Selection Criteria

Answer 43

The insurer uses information collected by the field underwriter and other sources to determine the insurability of an individual. It is ultimately the HOME OFFICE underwriter’s responsibility to determine if an individual meets the underwriting requirements of the insurer.

Question 44

Nonmedical application

Answer 44

An application used when a requested policy does not require a medical examination for underwriting. Health questions on the application are asked by the producer and are the only medical information required.

Question 45

Rating Applicants

Answer 45

Upon receipt of the information, such as the application, medical exam, blood and urine test results, underwriters analyze the information and determine if the applicant is an acceptable risk. If they are acceptable, underwriters then determine the classification to be used in the calculation of the premium.

Question 46

Classifications include:

Answer 46

• Standard Risks
• Preferred Risks
• Substandard Risks (Higher Risk Exposure)

Question 47

Standard Risks

Answer 47

Individuals who have the same health, habits, sex/gender, and occupational characteristics as those reflected in the mortality table. Individuals in this category have an AVERAGE life expectancy.

Question 48

Preferred Risks

Answer 48

Individuals who meet certain requirements and qualify for lower premiums because of ideal health, height, and weight. Individuals in this category have a LONGER THAN AVERAGE life expectancy.

Question 49

Substandard Risks (Higher Risk Exposure)

Answer 49

Individuals who are not acceptable at standard rates because of poor health, bad habits or occupational hazards. Individuals in this category are issued “rated policies,” known as surcharges, as follows:

• Graded (Lien) Plan
• Rated-up Age
• Flat Rate
• The Tabular Rate

Question 50

Graded (Lien) Plan

Answer 50

Initially, only the premium will be refunded in case of death. The death benefit increases over time with the full face amount eventually becoming payable. This is generally used with Senior Life Insurance plans to provide minimal benefits without a medical examination.

Question 51

Rated-up Age

Answer 51

Rates an insured at older than their actual age

Question 52

Flat Rate

Answer 52

A constant dollar amount added to the standard rate per $1,000 of coverage.

Ex. If the standard premium is $25 annually for $1,000 of insurance, with a flat rate of $5/$1,000 added to the standard premium the new total premium per $1,000 is now $30. A student pilot or someone who has a hazardous hobby would be flat rated.

Question 53

Tabular Rate

Answer 53

A surcharge calculated using a table showing past claims history of individuals with similar impairments.

Question 54

Declined

Answer 54

This is NOT a rating classification, but a decision that the risk is one for which the insurer refuses to issue insurance. In this case the applicant is deemed uninsurable. The applicant must seek insurance from another insurer or a state guaranty association.

Question 55

Assumptions and Calculations

Answer 55

When calculating premium rates, life insurers assume that all:

• Premiums are paid in advance of the period of coverage
• Premiums will be invested and earn interest
• Claims will be paid by the end of the year

Question 56

Factors in Premium Determination for Life Insurance

Answer 56

Premiums are based on expected mortality, interest, and expenses, and these factors are used by all insurers to determine premiums.

Mortality - Interest + Expenses = Total Premium paid to the insurer

Question 57

Mortality

Answer 57

Mortality Tables are used to give the company a basic estimate of how much money it will need to pay for death claims each year. By using this, a life insurer can determine the average life expectancy for each age group, based on the year of birth. The mortality rate is taken from the Mortality Table, which shows life expectancy and the death rate per 1,000 people living in the United States.

This table allows the insurer to rate policies using the law of large numbers, so accurate mortality predictions are extremely important. The higher the age group, the higher the mortality rate will be - translating to a higher premium. The Mortality Table also shows that males have a higher mortality rate than females. Based on this statistic, males will pay a higher rate than females.

Question 58

Interest

Answer 58

Interest earnings are also used in calculating premium. Insurance premiums are paid in advance, and insurance companies invest these premiums and assume a certain rate of interest will be earned. The earned interest reduces the amount of premium paid.

Question 59

Expense

Answer 59

The amount charged to cover each policy’s share of expenses of operation (salaries, commission, and cost of doing business) is called expense loading. This can vary from company to company based on its operations and efficiency.

Question 60

Net Premium

Answer 60

Takes into account interest and mortality factors ONLY

Mortality - Interest = Net Premium

Question 61

Gross Premium

Answer 61

Additional charges (expenses) are added to the new premium rate to enable an insurer to meet all costs under the contract.

Net Premium (Mortality - Interest) + Expenses = Gross Premium

Question 62

Reclassifications

Answer 62

When reviewing an application, the underwriter may find it necessary to reclassify the risk. This could either increase or decrease the premium.

Question 63

Policy Reserves

Answer 63

The net premiums paid plus interest earned; the policy reserves must also reflect possible contract obligations. A reserve is an amount, representing actual or potential liabilities, kept by an insurer to cover debts to policyholders. A reserve is usually treated as a liability.

Question 64

Premium Payment Mode

Answer 64

Mode reflects the frequency of payment. Payments are made either monthly, quarterly, semiannually, or annually. Additional charges are included in modes other than annual to offset the lost interest earnings and increased administration costs.

For this reason, the annual mode results in the LOWEST premium outlay. The more frequently the premiums are paid the more expensive the mode of payment.

Question 65

Policy Delivery

Answer 65

When the insurer determines that an applicant is an acceptable risk, the insurer will send the policy to the producer for delivery to the insured. It is the PRODUCER’S responsibility to delver the policy and collect any premiums that were not paid at the time of application. The producer should explain the policy to ensure the policyowner/insured understands the benefits, including any ratings, endorsements, exclusions, and riders.

Question 66

Constructive or Legal Delivery

Answer 66

Occurs only if premium was paid at the time of application. Once the insurer issues the policy, a legal contract has been formed because the policy becomes the acceptance. Once the insurer mails the policy to the producer, it is considered constructively or legally delivered by the insurer. It is still the producer’s responsibility to obtain delivery signatures and explain policy benefits to the policyowner/insured.

Question 67

Policy Delivery will be accomplished by:

Answer 67

• Personal delivery, with signed receipt of delivery

- Registered or certified mail with a signed receipt of delivery

Question 68

Statement of Good Health

Answer 68

When initial premium is not paid with the application, the producer must collect the premium before coverage can begin. The producer must also get a signed Statement of Good Health from the applicant/insured at the time of policy delivery that verifies that the insured has not suffered injury or illness, had any surgeries, or been admitted to the hospital since the application date.

If applicant is NOT in good health, the policy should be returned to the insurer for further underwriting.

Question 69

Survivor Protection

Answer 69

Providing funds for surviving spouses and dependents

Question 70

Estate Creation

Answer 70

Life insurance proceeds paid in a lump sum provide financial assets to create an immediate estate the insured can pass on to survivors.

Question 71

Estate Conservation

Answer 71

Provides money to pay any estate or loans which must be satisfied upon the death of the estate owner (the insured), preserving the insured’s estate

Question 72

Cash Accumulation

Answer 72

An amount of cash accessible to the policyowner from within permanent life insurance policies

Question 73

Liquidity

Answer 73

Immediate funds available upon death to pay creditors, taxes, and final expenses, as well as cash values available for policy loans, withdrawals, and full surrenders

Question 74

Pre-need Plan

Answer 74

A type of coverage with a small face amount, typically purchased to pay the burial expenses of the insured.

Question 75

Charities

Answer 75

To help fund favorite charitable organizations upon the insured’s death

Question 76

Security

Answer 76

Peace of mind knowing that future insurability is not an issue, and benefits will be in place as long as the required premiums are paid.

Question 77

Exemption from creditor claims/probate

Answer 77

The policy’s values are normally exempt from any creditor claims, unless the policy was assigned as collateral for a loan that still exists at the time of the insured’s death.

Question 78

Viatical Settlement

Answer 78

A terminally ill insured/owner selling their policy to a third party for less than the death benefit but more than the cash values in order to obtain funds when no other sources are readily available.

Question 79

Personal Uses of Life Insurance

Answer 79

There are many personal uses and advantages to purchasing life insurance. Ultimately, life insurance reduces uncertainty, giving greater peace of mind by replacing the possibility of a larger loss (income) with a known smaller loss (premium). Life insurance does not eliminate risk; it reduces the loss by transferring the larger risk from the policyowner/insured to the insurance company.

Question 80

Stranger Originated Life Insurance (STOLI)/Investor Originated Life Insurance (IOLI)

Answer 80

These terms describe investors, producers, or brokers with absolutely no personal or business connection with a person, who induce a purchase of a life insurance policy with the sole intent of selling that policy to investors for an amount less than the death benefit but greater than the policy’s cash value, essentially “selling” their mortality.

These practices have resulted in fraudulent abuses causing many states to outlaw these policies because of the lack of insurable interest.

Question 81

Determining Amount of Personal Life Insurance Needed

Answer 81

Two of the approaches used to determine the need and amount of life insurance are human life value and needs analysis.

Question 82

Human Life Value

Answer 82

A measure of the projected FUTURE earnings of a person at risk in the event of their premature death. The objective is to provide the proper amount of coverage as determined by the value of the individual to their dependents, using the rate of inflation and the individual’s:

• Age and gender
• Occupation
• Annual wage and employment benefits
• Planned retirement age

This method takes inflation into consideration when determining the amount of coverage needed.

Question 83

Needs Analysis

Answer 83

Determines a need for coverage upon the premature death of an individual. It always assumes the death of the individual to be immediate and factors the following items into arriving at the proper amount of coverage needed:

• Calculate all financial needs cause by an immediate death, including debts, medical bills, and final expenses
• Provide lifetime income to the spouse
• Pay off a mortgage or other debt
• Provide funds for children’s education
• An Emergency Reserve Fund or lump-sum needs may be part of the calculation to provide for unexpected emergencies the family might encounter immediately after the death of the insured
• Subtracts any assets available to fund financial needs after death

Question 84

Income Objective

Answer 84

To analyze the insurance needs in either approach, the producer must also take into consideration the income objective of the proposed insured. There are two methods of income objectives that can be used to arrive at the amount of insurance needed to fill the human life value or needs analysis requirements:

• Capital Liquidation
• Capital Retention/Conservation

Question 85

Capital Liquidation

Answer 85

Assumes both principal (capital) and interest are liquidated over the relevant time period to provide the required income for the dependents. When income is paid out under this method the account balance will decrease as each payment is distributed.

Question 86

Capital Retention/Conservation

Answer 86

Assumes the desired income will be generated by interest only, thus retaining or conserving the principal

Question 87

Group

Answer 87

An insurance plan normally owned by an employer, creditor, or association, under which coverage is provided for employees, debtors, or members. Group insurance generally provides protection for an employee’s named beneficiary, typically their spouse if married. Coverage may be changed only in the Master Policy.

• Written on a renewable term basis
• NO cash value or living benefits
• Coverage can be limited to a fixed dollar amount OT a multiple of earnings (such as 2 times annual salary)
• Upon retirement, group coverage can be converted to an individual permanent life plan without having to prove insurability

Question 88

Individual

Answer 88

The greatest difference between group and individual life insurance is the full latitude of ownership. Unlike group policies, individual policies may be of any classification or type of insurance. Individual policies may also build or preserve a living benefit for the terminally ill. Unlike group insurance, which can end upon separation of service or the employer choosing to discontinue the plan, individually owned policy leave the decision of keeping the policy to the policyowner.

Question 89

Ordinary Life Insurance

Answer 89

• NOT group, industrial or government insurance
• A large number of people are insured with an ordinary life policy, making this the largest portion of the life insurance in force today.

Question 90

Industrial (Home Service) Insurance

Answer 90

Synonymous with debit life insurance, it makes u only about .03% of the life insurance today. These small policies, normally $250 to $1,000, were originally sold to pay funeral expenses.

Question 91

Permanent Life Insurance

Answer 91

A life insurance policy that remains in force to age 100 or beyond. Premium is always higher than that on a term policy at issuance, when the amount of coverage and underwriting factors are equal. This policy provides living benefits for the policyowner or insured by way of its cash values. It also has many options available to the policyowner.

Question 92

Term Life Insurance

Answer 92

Has the LOWEST INITIAL PREMIUM OUTLAY and designed for someone with a large insurance need, but with limited cash flow. This coverage is often referred to as temporary, as it is usually written to cover a short time period. This policy DOES NOT build cash values and the benefit will either remain level, increase, or decrease depending on the type of policy. It is typically used to cover mortgages, short term obligations, or for younger couples with one or more children.

Question 93

Participating

Answer 93

A class of policy marketed by a mutually-owned company. The word “participating” means a dividend may be paid to the policyowner when they are declared by the Board of Directors. The company is not required to issue only participating policies, but only participating policies will be eligible for dividends. Participating policy dividends are treated as a refund of premium for tax purposes initially. However, once all premiums have been recovered, any further dividends are taxable.

Question 94

Nonparticipating

Answer 94

A policy marketed by a stock insurer, who is a company under the control of the stockholders who would receive a share of any profits in the form of a corporate dividend, as opposed to a policy dividend. Stock dividends are treated as ordinary income for tax purposes. A policyholder does not have to be a stockholder.

Question 95

Fixed

Answer 95

The policy has a FIXED amount of coverage, benefits and premium. Without riders, further inflationary trends will cause the purchasing power of the policy’s benefits to be reduced.

Question 96

Flexible

Answer 96

Universal and Variable Universal Life policies have given the policyowner more flexibility in terms of premiums, investment objectives, and other policy benefits. These policies assist the insured during inflationary periods with the changing needs of the policyowner and insured.

Question 97

Variable

Answer 97

• Introduced in the 1970s
• Uses separate account(s) for the cash value accumulation. Separate accounts are similar in nature to mutual funds.
• Securities (FINRA) and life license required to sell this policy
• Policyowner takes on investment risk
• The policy’s overall death benefit can increase, along with the cash values, with positive investment performance coming from the separate accounts selected; however, there is NO guarantee of return and down markets can cause significant loss of policy value.