Notes

2 Life Insurance Basics

In this chapter, we will review life insurance policy basics that are generally applicable to both individual and group contracts. Differences between individual and group contracts are discussed later in the course.

Parties to an Insurance Policy

Owner: The person who purchases the contract and is responsible to pay the premium, request changes to the contract and name the beneficiary.

Insured: The insured is the person whose life is covered by the policy.

Insurer: Insurance company who writes the policy.

Beneficiary: Recipient of the death benefit proceeds.


Types of Beneficiaries

Primary: Has the first claim against the proceeds

Contingent: Receives the proceeds if primary is no longer alive.

Revocable: Can be changed by the owner of the policy.

Irrevocable: Cannot be changed without the written permission of the irrevocable beneficiary.

Beneficiaries can be minors, trusts, estates, individuals, businesses and charities. (However: Insurance companies will not pay a death benefit directly to a minor. It must be paid to either a trust or guardian.)

Classes of beneficiaries are allowed such as “All my children”. The insurer will ask for the full names and social security numbers of them, however, to ensure proper distribution of the proceeds upon the insured’s death.

Distribution of policy death proceeds by descent.

Per Stirpes – passed to living children in equal shares

Per Capita – passed to those living but must be specifically named



2;Reasons To Buy Life Insurance

Death Benefit: Proceeds used to help the beneficiary.

Savings Plan: Permanent insurance creates cash savings.

Prepare for retirement: Cash accumulation account with interest applied and tax deferred until withdrawn.

Provide collateral for loans: Banks will accept cash value in policy.

Marketing of Life Insurance

Ordinary Life Insurance: Largest form of insurance, which includes both term and permanent types, including individual and family coverage.

Group Life Insurance: Provides life insurance to a group under a MASTER POLICY. The contract exists between the group sponsor, such as an employer and the insurance company, not between the insured group member and the insurance company. With group policies the insured group members receive a document called a CERTIFICATE, which describes the policy coverage.

Credit Life Insurance: Credit life is term insurance and is used to provide decreasing coverage for credit accounts, auto loans, home mortgage loans, etc.


3;Business Uses of Life Insurance

Sole Proprietor: Insurance is purchased on the life of the business owner to help pay for any expenses at death. The proceeds may also be used to help pay to continue the business, taxes, bills owed, etc.

Key Employee Insurance: The insurance policy is purchased by the company to provide funds in the event a key employee such as a sales manager dies. The funds will be used to conduct a search for a new sales manager or to cover for loss of revenue for the business. The company is always the beneficiary on key employee insurance.

Buy/Sell Agreement: A buy-sell agreement is used to lay out the terms under which ownership interest in a company may be sold if certain events occur. In the event of the death of an owner, partner or major stockholder, the agreement would allow the survivors to buy out the deceased’s interest from the deceased’s estate. The agreement is usually funded with life insurance. However, disability insurance may also be used if disability is one of the events that will trigger a sale of ownership interest.

Split Dollar Insurance: The premiums to purchase the life insurance policy are SPLIT between an executive employee and the employer. Split-dollar arrangements may also include the splitting of cash values, dividends and the death benefit.

Deferred Compensation: This is a non-qualified plan for employees that is funded by reducing their salary, placing the reduction amount into the plan to provide savings for retirement. These plans can be funded with life insurance.


4;roaches in Determining Amounts of Insurance

How much life insurance is enough to properly cover insurance needs while avoiding moral and morale hazards? There are two primary methods used to determine this amount:

Life Value Concept

Take the present value of an individual’s future earnings.

First determine the insureds net income (after taxes).

Deduct the value of maintenance items such as food.

Add an inflation factor to compensate for the reduction in the purchasing power of the dollar.

Needs Approach

Establish final needs at death such as funeral expenses, taxes, etc.

Used to help insure family’s standard of living.

Determine income supplements needed to support children.

Provide for special needs such as college education or retirement.


6;Charitable Uses of Life Insurance

Sometimes called “Bequest Life Insurance”

Allows the insured to designate the proceeds to be used for such institutions such as educational, religious and other charitable types.

Living Death Benefits

Relatively new concept which allows an insured, upon being diagnosed as terminally ill, to receive some of the death benefits prior to death to help ease his/her current financial condition.





7;Premium Payment Factors

There are certain factors that affect the amount of premium required. In addition to age, sex, height, weight and occupation the other factors are as follows:

Mortality The rate at which the pool of insureds is expected to die impacts the cost of insurance, since the insurer’s obligation to pay occurs at death. With people living longer, the costs related to the occurrence of death, using current mortality tables have caused a decrease in life insurance premiums. These tables are based on the theory of probability. The tables establish the cost of insurance for the insurance company. They are used to predict the number of individuals at a particular age that will live or die.

Interest Income: This income results from insurance company investments and could cause the premium to increase or decrease depending on investment results.

Load Factors: Load factors include such things as insurance company rent, telephone costs, secretarial costs and anything else that contributes to non-selling costs. Just like the other two, if expenses go down the premium should decrease. If expenses increase then so should the premiums.

8; Ratings Assigned to Insurance Companies

Measures the claims paying ability of the insurance company.

A.M. Best Company: A++ is the highest rating available.

Standard & Poor and Moody’s: AAA (or Aaa) is the highest rating available.

Substandard Risks

These represent greater risks to the insurance company than a normal healthy individual. A “normal” healthy individual is considered “standard” by an insurer, and charged its normal or standard rates. An individual with high blood pressure, as an example, represents a higher risk in terms of the likelihood of earlier death than , and may be required to pay higher premiums than a healthy individual at the same age. An individual with health factors that causes him or her to be more expensive to the insurer because of an increased likelihood of death is charged substandard (higher) life insurance rates.

Premiums will be adjusted to insure the additional risk.

Permanent extra premiums are charged by the insurance company.

The higher premium is based on a percentage above standard rates.