Life Insurance: Basics Flashcards
Life Insurance Contract:
2-Party Contract vs. 3-Party Contract
2-Party Contract
(Applicant and Insured are the same person)
* The Insurer
* The Insured/Owner/Applicant
3-Party Contract
(Applicant and Insured are not the same person)
* The Insurer
* The Insured
* The Owner/Applicant
What must be present for a 3-Party Contract to be issued?
Life Insurance Contract
There must be “Insurable Interest”
* The person applying for the policy must be at risk of suffering a significant loss if the insured dies
* Required at the time of application
* Not Required at time of loss/claim
Examples of Emotional “Insurable Interest”
(Personal Insurance)
3 Parts
Life Insurance Contract
Relationships based on Love and Affection
1. Spouses/Domestic Partners
2. Parents and Children
3. Close Family Members
Examples of Economic “Insurable Interest”
(Business Insurance)
4 Parts
Life Insurance Contract
Relationships based on Financial Dependency
1. Business Partners
2. Corporations and their Officers/Directors
3. Businesses and their Key Employees
4. Lenders/Creditors and their Borrowers/Debtors
What are some “Personal Uses” of Life Insurance?
6 Parts
- Survivor Protection
- Mortgage Payoff
(Mortgage Life Insurance Policy) - Estate Creation
- Estate Conservation
- Liquidity
- Cash Accumulation
What are the methods used to determine
how much Life Insurance is needed?
2 Methods
Personal Uses of Life Insurance
1. Human Life Value
* Straightline Calculation
2. Needs Approach
* More Detailed and More Accurate
Human Life Value:
Formula for Life Insurance Coverage
Straightforward Calculation
Personal Uses of Life Insurance
The Individuals Annual Income
X
The # of years until they retire
The Needs Approach:
What are the 2 “Financial Needs” categories?
Personal Uses of Life Insurance
- Cash Needs
- Income Needs
The Needs Approach:
What are examples of “Cash Needs”?
4 Parts
Personal Uses of Life Insurance
1. Final Expenses
(Funeral/Burial Costs and Medical Bills)
2. Debt Payoff
(Home Mortgage, Credit Cards, Car Loans, etc.)
3. Children’s Education
(A fund to pay the future cost of college/trade school)
4. Emergency Fund
(Unexpected Expenses)
The Needs Approach:
What are the “Income Needs” Periods?
3 Parts
Personal Uses of Life Insurance
1. Family Dependency
(Children are too young to support themselves and depend on the surviving parent)
2. Pre-Retirement
(The children have become self-supporting, but the surviving spouse has
not yet reached retirement age)
3. Retirement
(The surviving spouse is no longer earning an income)
The Needs Approach:
What is the “Blackout Period”?
3 Parts
Personal Uses of Life Insurance
The timeframe between when the youngest child turns 16 and when the surviving spouse turns 60
(The Social Security Administration provides benefits for surviving spouses with children under age 16)
What are some “Business Uses” of Life Insurance?
4 Parts
- Buy-Sell Agreements
- Key Person Coverage
- Executive Bonus Plans
- Deferred Compensation Plans
Definition:
Buy-Sell Agreements
Business Uses of Life Insurance
Provide for the sale of a business interest at the death/disability of an owner
(a.k.a. Business Continuation Plans)
What are the 2 Types of “Buy-Sell Agreements” that are used most?
2 Parts
Business Uses of Life Insurance
- Entity Plan
- Cross-Purchase Plan
Definition:
Entity Plan
Buy-Sell Agreement
Business Uses of Life Insurance
The business/entity owns the policy on the life of each business owner
(If the business is a corporation, it is called a “Stock Redemption Plan”)
Definition:
Cross-Purchase Plan
Buy-Sell Agreement
Business Uses of Life Insurance
Each partner/shareholder owns a policy on the lives of the other partners
Definition:
Key Person Coverage
Business Uses of Life Insurance
The business owns, pays for, and is the beneficiary of the policy
(Insurance proceeds are used to offset the financial aspect of losing a “Key Person”)
Examples:
* Drop in sales
* Cost of finding and training a replacement
Definition:
Executive Bonus Plans
Business Uses of Life Insurance
Employer pays the premiums - Employee owns the policy
During Employees Lifetime:
* The employee has full access to the policy’s living benefits
After Employee Passes:
* The proceeds are paid to the beneficiary (named by the employee)
(a.k.a. Section 162 Bonus Plan)
Tax Features:
Executive Bonus Plans
(Employer; Employee; Beneficiary)
2 Parts for Each
Business Uses of Life Insurance
Employer:
* Pays bonus to employee
* Bonus is tax-deductible for employer
Employee:
* Uses bonus to pay premiums
* Bonus is included in the employee’s gross income
Beneficiary:
* Receives the proceeds once employee dies
* Death Benefit received income tax-free
Definition:
Deferred Compensation Plans
Business Uses of Life Insurance
The employer agrees to pay the employee a set amount of income (starting at retirement)
The employee agrees to stay with the employer until a specified future date (typically at retirement)
Employee:
* The Insured
Employer:
* Owns the Policy
* Pays the Premiums
* Named as the Beneficiary
What are the Classes of Life Insurance Policies?
10 Parts
- Individual
- Group
- Term
- Permanent
- Participating
- Non-Participating
- Fixed
- Variable
- Industrial
- Home service
What are the Differences?:
Individual vs. Group
3 Parts Each
Classes of Life Insurance Policies
Individual
* Cost is based on individual insured
* Policy issued to the individual
* Policyowner chooses amount of insurance
Group
* Cost is based on the group
* Policy issued to employer/group sponsor
* Employer chooses amount of insurance
What are the Differences?:
Term vs. Permanent
4 Parts Each
Classes of Life Insurance Policies
Term
* Death Benefit (only)
* Increasing Premiums
* Temporary Coverage (Expires after Term)
* Cannot be Renewed/Extended (after a certain age)
Permanent
* Living and Death Benefits
* Level Premiums
* Lifetime Coverage (No Expiration)
* Protection (through advanced ages)
What are the Differences?:
Participating vs. Non-Participating
3 Parts Each
Classes of Life Insurance Policies
Participating
* May pay dividends (to policyowner)
* Higher Premium
* Issued by Mutual or Stock Insurers
Non-Participating
* Does not pay dividends
* Lower Premium
* Issued by Stock Insurers (only)
