Life Insurance Premiums, Proceeds, and Beneficiaries

Question 1

What is an Accelerated Benefit (Option) Rider?

Answer 1

The accelerated benefit rider allows the insured to receive a portion of the death benefit prior to death if the insured has a terminal illness and is certified by a physician as expected to die within 1-2 years.

Question 2

What is a Beneficiary?

Answer 2

The beneficiary is the person or entity designated in a life insurance policy to receive the death proceeds.

Question 3

What is Cash Value?

Answer 3

The cash value is the equity or savings element of whole life insurance policies.

Question 4

What is Class Designation?

Answer 4

A class designation is a beneficiary group designation (for example, all of my children), opposed to specifying one or more beneficiaries by name.

Question 5

What is the Common Disaster Provision?

Answer 5

The common disaster provision is a provision of the Uniform Simultaneous Death Act, which ensures a policyowner 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. It also states that the primary beneficiary must outlive the insured by a specified period of time in order to receive the proceeds.

Question 6

What is the Contingent (Secondary) Beneficiary?

Answer 6

The contingent beneficiary is the beneficiary second in line to receive death benefit proceeds if the primary beneficiary dies before the insured.

Question 7

What is Earned Premium?

Answer 7

Earned premium is the amount of premium paid by the policyowner for policy coverage or insurance protection received up to this point.

Question 8

What is the Expense Factor?

Answer 8

The expense factor, also known as the loading charge, is a measure of what it costs an insurance company to operate.

Question 9

What is Excess Interest?

Answer 9

The excess interest provision in life insurance means that the cash value will increase faster than the guaranteed rate if the insurer earns a greater return than the guaranteed rate.

Question 10

What is a Fixed Amount Installment Option?

Answer 10

A fixed amount installment option pays a fixed death benefit in specified installment amounts until the principal and interest are exhausted.

Question 11

What is Fixed/Level Premium?

Answer 11

Fixed or level premium is a concept of averaging what would be the total single premium for a policy over periodic payments. More periodic payments = higher total premium.

Question 12

What is a Fixed Period or Period Certain Option?

Answer 12

A fixed period or period certain settlement option pays the death benefit proceeds in equal installments over a set period of years. The dollar amount of each installment depends upon the total number of installments.

Question 13

What is a Graded Premium?

Answer 13

A graded premium as a premium funding option characterized by a lower premium in the early years of the contract, with premiums increasing annually for an introductory period. After the introductory period, the premium jumps to an amount higher than what the initial level premium would have been. It then remains fixed or constant for the life of the policy.

Question 14

What is Gross (Annual) Premium?

Answer 14

An insurer’s gross premium is the net premium for insurance plus commissions, operating and miscellaneous expenses, and dividends.

Question 15

What is the Interest Factor?

Answer 15

The interest factor is the calculation for determining the amount of interest an insurance company can expect to earn from investing insurance premiums.

Question 16

What is the Interest Only Option?

Answer 16

The interest only option as a death settlement option where 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.

Question 17

What is an Irrevocable Beneficiary?

Answer 17

An irrevocable beneficiary is a beneficiary which may not be changed by the policyowner without the written consent of the beneficiary.

Question 18

What is a Joint and Survivor Option?

Answer 18

The joint and survivor option is a settlement option that guarantees that benefits will be paid on a life-long basis to two or more people. This option may include a period certain, and the amount payable is based on the ages of the beneficiaries.

Question 19

What is a Life Income Option?

Answer 19

The life income option is a death benefit settlement option which provides the beneficiary with an income that they cannot outlive. Installment payments are guaranteed for as long as the recipient lives. The amount of each installment is based on the recipient’s life expectancy and the amount of principal.

Question 20

What is a Life Settlement?

Answer 20

A life settlement is an agreement in which a policyholder sells or transfers ownership in all or part of a life insurance policy to a third party for compensation that is less than the expected death benefit of the policy.

Question 21

What is the Lump Sum Option?

Answer 21

The lump sum option is a death settlement option where the death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. The lump sum option is considered the automatic (or “default”) option for most life insurance contracts.

Question 22

What is a Modified Premium?

Answer 22

Modified premium is a premium funding option characterized by 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.

Question 23

What is the Morbidity Rate?

Answer 23

The morbidity rate demonstrates the incidence and extent of disability that may be expected from a given group of people.

Question 24

What is a Mortality Rate?

Answer 24

A mortality rate is the measure of the number of deaths (in general, or due to a specific cause) in some population, scaled to the size of that population, per unit time.

Question 25

What is a Net Payment Cost Index?

Answer 25

Net payment cost index is a formula used to determine the actual cost of a policy for a policyowner. It helps the consumer compare costs of death protection between policies that will be held for ten or twenty years.

Question 26

What is a Net (Single) Premium?

Answer 26

Net premium is a premium calculation used to calculate an insurer’s policy reserves factoring in interest and mortality.

Question 27

What is PER CAPITA (By The Head)?

Answer 27

Per capita evenly distributes benefits among all named living beneficiaries (i.e., all living children).

Question 28

What is PER STRIPES (By the Bloodline)?

Answer 28

Per stirpes evenly distributes benefits amongst an insured’s according to the family line, branch, or root (i.e., children and grandchildren).

Question 29

What is the Premium Mode?

Answer 29

The premium mode is the frequency in which a policyowner elects to pay premiums.

Question 30

What is the Primary Beneficiary?

Answer 30

The primary beneficiary is the first beneficiary in line to receive benefit proceeds upon the death of an insured.

Question 31

What is Policy Proceeds?

Answer 31

Policy proceeds is the amount actually paid as a death, surrender, or maturity benefit. In the case of a death benefit, it includes the face value plus any earned dividends less any outstanding loans and interest. If surrender benefit, the amount includes any cash value, minus surrender charges, and outstanding loans and interest. If maturity, the benefit amount includes the cash value less any outstanding loans and interest.

Question 32

What are Reserves?

Answer 32

An insurer’s reserve is the money set aside (required by the state’s insurance laws) to pay future claims.

Question 33

What is a Revocable Benficiary?

Answer 33

A revocable beneficiary is a beneficiary that the policy owner may change at any time without notifying or getting permission from the beneficiary.

Question 34

What are Settlement Options?

Answer 34

Settlement options are optional modes of settlement provided by most life insurance policies. Options include lump-sum cash, interest only, fixed-period, fixed-amount, and life income.

Question 35

What is Single Premium Funding?

Answer 35

Single premium funding is a policy funding option where the policyowner pays a single premium that provides protection for life as a paid-up policy.

Question 36

What is the Spendthrift Clause?

Answer 36

The spendthrift clause prevents creditors from obtaining any portion of policy proceeds upon an insured’s death. Additionally, the clause can be selected by the policyowner 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.

Question 37

What is Surrender Cost Index?

Answer 37

The surrender cost index is a cost comparison calculation formula used to determine the average cost-per-thousand for a policy that is surrendered for its cash value. It aids in cost comparisons if the policyowner plans to surrender the policy for its cash value in ten or twenty years.

Question 38

What is the Tertiary Beneficiary?

Answer 38

The tertiary beneficiary is the third beneficiary in line to receive death benefit proceeds. The tertiary beneficiary will only receive the death benefit if both the primary and contingent beneficiaries die before the insured.

Question 39

What is the Underwriting Department?

Answer 39

The underwriting department is the department within an insurance company responsible for reviewing applications, approving or declining applications, and assigning risk classifications.

Question 40

What is Unearned Premium?

Answer 40

Unearned premium includes the premium that has been paid by a policyowner for insurance coverage that has not yet been provided.

Question 41

What is the Uniform Simultaneous Death Act?

Answer 41

The uniform simultaneous death act states that if the insured and the primary beneficiary die at approximately the same time, in a common accident, with no clear evidence as to who died first, the law will assume that the primary died first. Therefore, the death benefit proceeds are paid to the contingent beneficiaries.

Question 42

What is a Viatical Settlement?

Answer 42

A viatical settlement involves someone with a terminal illness selling their existing life insurance policy to a third party for a percentage of the death benefit.

Question 43

Who is the Viatical (Viatee)?

Answer 43

A Viatee or viatical is the new third-party owner in a viatical settlement.

Question 44

Who is the Viator?

Answer 44

The Viator is the original policyowner in a viatical settlement.

Question 45

Purpose of Premiums

Answer 45

Once an insurance company determines that an applicant is insurable, they need to establish the payment (premium) for the insurance policy. 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.

As we previously discussed, the policyowner is expected to remit premiums by the due date. However, as with most bills, insurance companies allow for a grace period, or time after the due date, during which payment may be made without penalty. The effect of nonpayment of premium before the expiration of a grace period will cause a policy lapse.

Question 46

Factors in Premium Calculation

Answer 46

Life insurance premiums are calculated per $1,000 of coverage. There are three primary factors or elements utilized to determine what an insurer will charge for its life insurance product. The three factors that influence the gross premiums charged for life insurance are (1) mortality, (2) interest, and (3) expenses.

Question 47

MORTALITY RATE

Answer 47

refers to the frequency of deaths in a defined population at a specific time interval.

Higher morbidity and mortality rates translate to higher insurance premiums.

Question 48

MORBIDITY RATE

Answer 48

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.

Question 49

MORTALITY FACTOR OR MORTALITY RATE

Answer 49

The mortality factor has the greatest effect on premium calculations or rate-making since it can vary greatly based on the personal characteristics of an individual to be insured. The mortality factor is determined from a mortality table which provides an indication of the “probability of death” of an individual at a particular age. In other words, the mortality table provides us with the death rate (i.e., the average number of deaths that will occur each year in each age group). In order for a mortality table to be accurate, it must be based upon a large cross-section of individuals and time. This mortality factor originates from the Commissioners Standard Ordinary Mortality table (some insurers use the 1980 table and others use the newer 2004 CSO table)

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.

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.

Question 50

What is the Interest Factor?

Answer 50

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.

Question 51

What is the Expense Factor?

Answer 51

The expense factor, also known as the loading charge or factor, is derived from operating expenses, or funds the insurer “pays out.” These expenses include but are not limited to death benefits paid; commissions or salaries to producers and other employees; and other administrative costs (i.e., rent). As mentioned previously, 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.

Question 52

ADDITIONAL PREMIUM FACTORS

Answer 52

-Age: The older the person, the higher probability of death and disability.
-Sex / Gender: Women tend to live longer than men, so their premiums are usually lower.
-Health: Poor health increases the probability of death and disability.
-Occupation: Hazardous job increases the risk of loss.
-Hobbies: High-risk hobbies also increase the risk of loss.
-Habits: Tobacco use presents a higher risk than nonsmokers.
-Benefits: Naturally, the higher the death benefit amount, the more the policy will cost. Additionally, living benefits (for example, the cash value in a whole life vs. no cash value in term) will also increase the policy cost.
-Options and Riders: Adding additional options and riders (for example, waiver of premium or guaranteed insurability) will also increase premium amounts.
-Premium Mode: The mode utilized by the policyowner allows the insurer to assess an extra charge if premiums are paid quarterly, semiannually, or monthly (i.e., anything other than on an annual basis). These additional modes available make it more convenient for the policyowner to pay premiums.

Question 53

What is Single Premium Funding?

Answer 53

With single premium funding, the policyowner pays a single premium that provides protection for the life of the policy. Single premium funding is generally associated with “single pay whole life insurance.” Since a single premium is generally too expensive for the average person, alternative periodic options were developed to be more cost-effective or affordable for the purchaser.

Question 54

What is Flexible Premium Funding?

Answer 54

Flexible Premium Funding allows the policyowner to adjust the premiums throughout the life of the contract.

Question 55

Paying Premiums from Policy Values

Answer 55

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.

Question 56

Paying Premiums from Policy Values

Answer 56

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.

Question 57

What is Minimum Deposit (Financed) Insurance?

Answer 57

While sometimes lumped in with “types of life insurance,” minimum deposit or financed insurance is not an actual policy type. Minimum deposit financing is a method of financing life insurance best suited for individuals in high marginal tax brackets. It allows the policyowner to use policy loans to pay premiums due each year.

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.

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 policyowner 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.

Question 58

Premium Collection and Reserves

Answer 58

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.

Question 59

What is Unearned Premium?

Answer 59

is 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.

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).
The earned and unearned premiums make up the insurer’s total premium.

Question 60

What is a Legal Reserve?

Answer 60

is 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.

Question 61

Interest Adjusted Net Cost Method

Answer 61

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.

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.

Question 62

The NAIC Model Life Insurance Solicitation Regulation requires what (2) Interest Adjusted Cost Indexes?

Answer 62

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).

Question 63

What is Life Insurance Surrender Cost Index?

Answer 63

The 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. 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 policyowner plans to surrender the policy for its cash value in ten or twenty years.

Question 64

What is Net Payment Cost Index?

Answer 64

The 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.

The net payment cost index is 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.

Question 65

What is the Comparative Interest Rate Method?

Answer 65

The 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.

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.
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.

Question 66

Which Tax is normally associated with an Individuals death?

Answer 66

Federal Estate Tax