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Life Insurance Plans and Policies

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Chapter 1 Establishing and Meeting Life Insurance Needs .......................................................................... 1Introduction; Determining How Much Coverage Is Needed; Human Life Value; Needs Approach; The Role of Social Security; Reviewing Life Insurance Needs; Determining the Type of Coverage; Life Insurance Costs; Life Insurance Basics; Life Insurance: A Definition; Purpose of Life Insurance; Transfers at Death; Estate Conservation; Estate Taxes; Business Uses of Life Insurance; Taxation; Modified Endowment Contract (MEC); Section 1035 Exchanges; Summary; Review Questions

Chapter 2 The Life Insurance Contract & Policy Provisions ....................................................................... 23Introduction; The Requirements of a Contract; Offer and Acceptance; Consideration; Parties to the Contract; Different Types of Contracts; Life Insurance Contract Language; The Policy Application; The Underwriting Process; The Element of Financial Risk; Life Insurance Contract Provisions; Entire Contract; Insuring Clause; Ownership Rights; Assignment; Free Look; Misstatement of Age or Sex; Contestable Clause; Suicide Clause; Premium Calculations; Payment Frequency; Cash Value; Nonforfeiture Values; Policy Loans; The Grace Period; Reinstatement; Death Benefits; Beneficiary Designations; Death Benefit Settlement Options; Lost or Missing Policies; Summary; Review Questions

Chapter 3 Term Life Insurance, Whole Life Insurance, & Riders ................................................................ 55Introduction; Term Life Insurance; Home Mortgage Protection; Cost Indexes; Advantages and Disadvantages of Term Life Insurance; Whole Life Insurance; Limited Premium Payment Whole Life; Single Premium Whole Life Insurance; Surrender Charges; Features and Benefits of Whole Life Insurance; Variations of Whole Life Insurance; Whole Life Summary; Advantages and Disadvantages of Whole Life Insurance; Life Insurance Policy Riders; Living Benefit Riders; Riders Summary; Review Questions

Chapter 4 Variable Whole Life, Adjustable Life, Universal Life, & Variable Universal Life Insurance ..... 80Introduction; Variable Whole Life Insurance; The Prospectus; Investment Choices; Dollar Cost Averaging - Investing a Defined Amount Over Time; Fixed Account; Right to Exchange for a Fixed Benefit Policy; Other Types of Variable Whole Life Insurance; Variable Whole Life Summary; Advantages and Disadvantages of Variable Whole Life Insurance; Adjustable Life Insurance; Lengthen or Shorten the Protection Period; Unscheduled Premiums; Adjustable Life Policy Costs; Variable Adjustable Life; Adjustable Life Summary; Adjustable Life Insurance Advantages and Disadvantages; Universal Life Insurance; Features of Universal Life; Universal Life Insurance Policy Riders; Universal Life Summary; Single Premium Universal Life Insurance; Universal Life Insurance Advantages and Disadvantages; Variable Universal Life Insurance; Overloan Protection Rider; Variable Universal Life Summary; Advantages and Disadvantages of Variable Universal Life Insurance; Review Questions

Chapter 5 Joint Life (First-To-Die), Survivorship Life (Second-to-Die), & Group Life Insurance ........... 113Introduction; Joint Life Insurance in the Personal and Business Marketplace; Features, Benefits, and Riders; Other Types of Joint Life Insurance; Underwriting and Taxation; Advantages and Disadvantages of Joint Life Insurance; Survivorship Life Insurance; Survivorship Life Insurance in the Personal and Business Marketplace; Features, Benefits, and Riders; Advantages and Disadvantages of Survivorship Life Insurance; Group Life Insurance; The Workings of Group Life Insurance; Types of Groups Life Insurance; Term Insurance and Permanent Insurance; Features, Benefits, and Riders; Advantages and Disadvantages of Group Life Insurance; Conclusion; Review Questions

Review Questions Answer Key ......................................................................................................................135

Table of Contents

Life Insurance Plans and Policies

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Copyright 2015© A.D. Banker & Company®, L.L.C.

This course, seminar, or publication provides general information regarding the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. The publisher hereby expressly excludes all warranties.

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Chapter 1

Establishing and Meeting Life Insurance Needs

IntroductionMuch like a well-constructed house, a family or business financial plan must be built on a firm foundation; otherwise, it will not stand over time. Nothing provides the brick and mortar of financial security better than life insurance because of the multitude of roles that it can play. Whether amassing permanent life insurance policy cash values to offset a drop in income at retirement or providing for the financial security of loved ones through temporary or permanent coverage, life insurance comes with a secret ingredient: peace of mind.

Coverage can range from tens of thousands to many millions of dollars. Premiums can be fixed or flexible. Returns can be fixed or variable. Immediate, guaranteed, income tax-free benefits at the insured’s death can provide for the basic cash needs, protecting already amassed wealth from erosion due to estate taxes, or creating new wealth for survivors. This is what life insurance is designed to do. It would be hard, if not impossible, to name another financial product that can do all that.

The peace of mind life insurance provides really isn’t a secret. Through the efforts of a dedicated corps of insurance industry professionals, life insurance is owned by many Americans and businesses. When parents think about providing a college education for their children, it is reassuring to know that life insurance can do the job in the event of mom or dad’s premature death. Some are able to retire more comfortably by drawing from the cash in their permanent life insurance policies.

From providing for the large things like paying off the balance of a home mortgage, providing the necessary funds to maintain a partnership, or allowing a business to remain in the family, to providing for the smaller necessities like replacing the washing machine, putting presents under the tree, or buying a new car, life insurance death benefits and cash benefits are in a class by themselves.

As with any important purchase, there are many points to consider before committing hard earned premium dollars to a long-term relationship with life insurance. The following questions are often raised and need to be answered before proceeding with a life insurance purchase:

• What is the need for the life insurance?• How much life insurance protection is needed?• Which type of life insurance is the right choice given the particular situation and circumstances

among the various life insurance policies available?• How much will it cost annually for the life insurance policy selected?• What will the ongoing costs be?• When should life insurance coverages be reviewed?• How will tax law changes affect any of the life insurance contractual values now or in the future?• What changes can be made in the life insurance policy, when can they be made, and what will it cost

to initiate them?

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While the answers will vary among individuals and businesses and the types of life insurance policies under consideration, some items remain constant. Regarding the “why” and “how much” questions: if anyone or business would suffer financially due to the loss of a breadwinner’s income or a key employee’s services or any other form of support, then life insurance should be seriously considered as a way to replace that lost income, services, and support when the time comes. This is known as having an insurable interest in the named insured. If any unpaid debts are left behind, whether of a personal or business nature, life insurance can provide the necessary funds to pay them. If the goal is to ensure that money concerns will not arise for any reason for a surviving family member or business partner, life insurance is the answer for taking care of these responsibilities. It does not matter whether it is to address any immediate cash needs or income replacement needs; having the right amount of life insurance coverage in place when it is needed can be invaluable.

Determining How Much Coverage Is NeededIn general, the following questions should be addressed:

• In the event of death, how much of a lump sum cash payment will be needed to cover current obligations?

• How much continuing income will be needed for living expenses and for how long? • Based on the ages of the children, how much time is there before college and what are their

anticipated college educational expenses going to amount to?• How much Social Security income can be expected until the surviving spouse and children are no

longer eligible? • How are any gaps in income going to be addressed? • How much of the existing financial assets can be committed toward satisfying these needs? • How much will be needed for the survivor’s eventual retirement? • What impact will a pre-mature death have on the current funding of or the eventual values in existing

retirement plans? • What plans are in place to handle any possible disability or long term care needs?

Over the years, various methods of calculating ‘human life value’ have been used, and there are several approaches to the “how much” question. It depends upon the quality of the interaction between the potential policyowner/insured and the insurance professional. It also depends upon the knowledge and skill level of the life insurance professional. In general, each method can be as effective as the others in coming up with a practical answer and more reflective of the true need than merely focusing on how much money is available to pay the premiums.

Often times, merely focusing on premiums leads to under insuring the immediate need, for example, $500 available for annual premiums may buy a 25 year old $50,000 of traditional whole life insurance or $250,000 of 10 year term level life insurance. If the actual immediate need for life insurance is $150,000 then obviously the $50,000 traditional whole life policy would fall short of meeting the need. Focusing on the immediate need first, then considering what types of policies, riders, and premium options would most likely be the best strategy to cost effectively put in place the optimal solution is the best plan.

Some methods advocate in-depth analyses of the present value of future earnings and factoring in other potential sources of income such as Social Security or ongoing pensions. Still, other formulas are based on a multiple of earnings, for example: if Hector earns $75,000 a year, using a 6 times earning formula, he should be covered for 6 times his annual earnings, or $450,000 ($75,000 x 6). If he already has a $50,000 policy and two-times earnings, $150,000 ($75,000 x 2) through his employment, he then needs an additional $250,000 ($450,000 - $50,000 – $150,000) in order to satisfy the need based on this formula. Sounds simple, and it can be. It can also be surprisingly accurate, but many other elements enter into the scenario.

A.D. Banker&Company©

3CHAPTER 1: ESTABLISHING AND MEETING LIFE INSURANCE NEEDS

When the oldest daughter finishes college, Hector’s need may likely decrease, so a portion in term coverage will suffice in his overall life insurance game plan. If his family is a strong proponent for a religious or charitable organization, a separate $25,000 policy with the organization listed as a beneficiary may be a good choice. The group life insurance coverage he has is contingent upon him staying employed at the company. Most companies provide a base amount of coverage at no out of pocket cost to the employee with the option to acquire additional amounts for a stated premium. It may make some sense to explore the possibility of increasing that coverage and evaluate the various options if the group coverage is no longer available due to retirement, layoff, or a company decision to discontinue the plan. Also, group insurance is a great solution for part of the insurance need if health issues are present. Most group plans have open enrollment allowing employees to buy much needed coverage at a reasonable price.

For some individuals, another element is just as important as need: want. Someone whose life insurance needs tops out at $250,000, for example, may want $500,000 coverage. The client may be influenced by devotion to family, fear of inflation, preparing in case things change for them in the years ahead or just for bragging rights with a brother-in-law. Requests for greater coverage are not so unusual. A professional life insurance agent will explain the advantages and disadvantages of such a request to determine if they are insurable for that amount based on their financial situation, explore the various policies available, decide which one life insurance policy or plan design is most suitable, ensuring it is affordable, and then write the application for submission to the home office.

Insurance needs vary with age and family situations. Young singles with no dependents have needs that are different than for a married couple with a mortgage, car loan, and two young children. Young singles are prone to underestimate their need for life insurance in the long-run; after all, while they may currently be without responsibilities or any debt, it is highly probable that they will one day be married, with a mortgage and a car loan, and children, too.

Government-issued student loans are typically discharged at death, but private loans are not, especially if the parents are co-signers. Unless credit insurance is obtained, any outstanding car loan balance could mean repossession by the creditor upon death in satisfaction of the outstanding loan. With life insurance, there could be money available for the survivors to pay off the car note so that a favorite niece or nephew can take possession of the vehicle which would now be free and clear of any debt. Also mom and dad, whose grief should not be clouded with outstanding issues concerning where they are going to come up with the funds for final expenses and any unpaid family loans, can rest assured that financial arrangements are in place for such items. Down the road, when the young single is now 45-years old, they will very likely be glad they have locked in that lower age permanent life premium from 20 years earlier and also have a cash value available to them if and when needed.

Human Life ValueWhile it may not seem possible to place an exact dollar value on a human life, doing just that is the essence of a comprehensive life insurance analysis. The human life value concept was developed by Dr. Solomon S. Huebner, founder of The American College, to determine the economic value a human life had to a surviving family. The concept is also a legal one, invoked in wrongful death lawsuits. It can also be an emotionally volatile topic for life insurance buyers and sellers to discuss. After all, who really wants to be worth more dead than alive?

In determining a person’s human life value, numerous factors come into play, including:

• Current annual after-tax earnings • Current annual consumption expenditures• The projected rate of growth of earnings or an inflation factor• The future working lifetime or years left to retirement



Given these factors, the present value of future earnings can be determined. It may seem cold, but showing the results can emphasize the need for coverage. Simply stated, the amount of insurance should be sufficient to cover a family’s economic needs if the breadwinner were to die tomorrow, and to further emphasize the value of having sufficient coverage in place. Life insurance can be a substantial part of estates left behind. It makes no sense whatsoever to under insure the present risk just as it makes no sense to over insure it as well. Without a methodology to follow that takes into consideration various factors, the amount of coverage purchased can be nothing more than a shot in the dark, or at best a wild guess. At a minimum, this process helps to crystallize the concept of insurance needs, comes up with a number to base the amount on, and gets the discussion going in the right direction.

Needs Approach This approach considers summing the potential cash outlay the survivors may end up being faced with for:

• Final expenses, which includes outstanding medical bills, funeral expenses, and any estate settlement costs that entails court costs and attorney’s fees

• Any outstanding consumer debts and mortgage balances • Any future college costs for children

Then, it adds in a rough estimate of what it will take to replace the lost future income due to the death of the spouse, considering potential increases in pay, and years of earnings prior to death. Taking this a step further, it could also include:

• An inflation factor• How much interest would be earned on funds received up until they had to be spent• Any Social Security benefits anticipated• Existing in force life insurance• Any employer provided benefits• Any savings and investments including retirement plans • Income taxes

So, it can run the gambit of being very straight forward and simple to do or with the use of financial planning software can really dial in on the true dollars needed. It is all based upon how the financial professional positions this part of the process and emphasizing its importance and value. However, the financial professional also needs a willing participant to join them in this effort.

Example: John age 35 is married to Sue, age 30. They have 2 children: Sam, age 8 and Betty, age 5. The following is what a needs analysis might look like:

Sue’s lump sum cash needs at John’s death: Final expenses & emergency fund: $15,000.00 Outstanding consumer debts: + $5,000.00 Outstanding mortgage balance: + $100,000.00 Anticipated public education college costs: + $200,000.00 Total lump sum cash needs: = $320,000.00

Sue’s income replacement needs at John’s death: Annual income to be replaced: $50,000.00 Number of years to provide income: 30 Estimated inflation rate: 3% After-tax net investment yield: 6%



Total amount Sue will need upon John’s death: Present value of income replacement needs: $1,020,053.92 Lump sum cash needs: + $ 320,000.00 Gross need = $1,340,053.92

Less current financial assets: - $ 35,000.00 Less existing life insurance: - $100,000.00 Less present value of Sue’s income: - $380,763.69 John’s additional life insurance need: = $824,290.23

Source: Life Insurance Foundation for Education (LIFE) http://www.lifehappens.org/insurance-needs-calculator-results

What is evident is that the needs approach systematically goes over what is important to the prospect/client. It helps to quantify what it will take in order to provide those things that are important to them. It also allows them to determine for themselves what is or is not realistic. Some goals of theirs may be out of reach and may need to be rethought or adjusted. For example, maybe a community college for the first year or two may make more financial sense than planning for paying the entire four year university bill. Maybe funding 50-75% is more realistic with their children paying for part of the bill from working their way through school, as many have done, or looking into certain other funding options, such as student loans, or work-study programs. Also, there may be ways to earn additional income, or find ways to free up money in their budget. Without going through this or similar exercises, it is really nothing more than leaving for a trip without any pre-planning or maps. More than likely, the clothes packed are not appropriate, things are left behind, and good luck getting to the destination on time, wherever that may be.

The Role of Social SecurityAny method of determining life insurance needs will be a best estimate since circumstances will change and assumptions about earnings, interest rates, inflation, and similar factors will vary. One constant consideration is income replacement, and the role Social Security plays in the planning process. A comprehensive examination of Social Security could fill another book with figures, regulations and fine print, but every life insurance professional should be familiar with a few basics.

Everyone who has ever worked in a Social Security-covered job, which is pretty much any job, and who is 25 or older and not yet a Social Security beneficiary, receives an annual statement of their current status and estimated future benefits.

Social Security statements are also available online at http://www.ssa.gov/mystatement. There it provides:

• Estimates of the retirement and disability benefits to be received• Estimates of benefits families may get when they receive Social Security or die• A list of lifetime earnings according to Social Security’s records• The estimated Social Security and Medicare taxes paid• Information about qualifying and signing up for Medicare• Things to consider for those age 55 and older who are thinking of retiring• General information about Social Security for everyone• The opportunity to apply online for retirement and disability benefits• A printable version of the current Social Security Statement

Source: Social Security Administration



A worker is fully vested after 40 quarters of covered employment, which does take 10 years, but workers are credited with quarters by exceeding a moderate income amount. The entire year’s income will influence benefit amounts, but a year’s four quarters can be earned by January or February.

At full retirement, the age historically has been set at age 65, and soon to be 67 for most working people. Retirees are eligible to receive 100% of their retirement benefit, which is calculated by a formula that takes lifetime earnings into consideration. A reduced benefit is available starting at age 62, and by delaying the start date, the benefit can increase.

Perhaps of more relevance to life insurance analysis, Social Security also provides survivor benefits for spouses and children of deceased workers. There are multiple factors to consider, such as the number of covered quarters, marital status, etc., but in general, benefits are payable to a surviving spouse caring for a child, or step-child of the deceased until the youngest child reaches age 16. Additionally, each child is eligible up to age 18, or 19 if still in high school, or longer if disabled.

In determining a family’s life insurance needs, it is important to note that surviving spouses’ benefits end when the youngest child is age 16, and will not resume until those surviving spouses reach age 60 or age 50 if disabled, at which time they may apply for a benefit based on the deceased spouse’s earnings. This interval of time is referred to as the Social Security blackout period.

In dual-income households, a surviving spouse may be eligible for benefits based on their own earnings as well as on the deceased spouse’s earnings. The actual benefit will be the higher of the two, but in no case will it be both.

Whether or not to include Social Security benefits in the overall analysis and subsequent life insurance planning is a matter of client choice. With it, the overall need for life insurance can be reduced; without it the overall need for life insurance is much higher.

Reviewing Life Insurance NeedsThe frequency of life insurance coverage reviews is a matter for discussion between the client and insurance agent. Some life insurance professionals suggest annual reviews; others say every two years. All parties agree that it should take place, however, and that any significant change in personal circumstances should trigger a re-analysis of their life insurance needs and the policy or policies that are in force. Marriage, divorce, birth of a child, serious illness, death of a family member, job promotion, job loss, job relocation, purchase or sale of a home...the list is virtually endless of life events customers will face and the value of having the right amount of life insurance in place.

Will a quick phone call be sufficient or is a major in person re-evaluation indicated? Only a conscientious follow-up conversation with the client can answer that. Once determined, there needs to be a way to keep track of this, such as using a contact management system, which can also form the basis of a professional insurance producer’s practice management. It is also a good touch to send out birthday or anniversary cards to clients, or just to thank them for their continued business.

Determining the Type of Coverage Which type of life insurance is right for the individual client depends on which individual we’re talking about. That’s not as evasive an answer as it seems, because the “right” type depends upon a myriad of factors. All of the following typically come into play when deciding on the desired type of coverage:

• The amount of coverage as determined by the human life value, needs, gross income factor, or other methodology

• Their ability to pay• Their risk tolerance (conservative-to-aggressive)



• Their overall attitude toward life insurance• Their age, sex, family circumstances, employment status• Just about any other personal characteristic that can be thought of

The following chapters will cover many of the policies available in the insurance marketplace, but not every policy, as it would be impossible and impractical considering all of the variations that life insurance companies can come up with in their effort to meet the ever changing needs of the American consumer and business persons. Not any one particular life insurance policy is suitable for everyone, but everyone should be able to find one or more life insurance policies among the numerous choices available that will suit needs and wants. Today the life insurance marketplace is more competitive than ever.

As for choosing among policies, it should be remembered by both insurance buyers and life insurance producers that since no one policy can do everything, a combination of two or more, or one with appropriate riders, may be more appropriate.

Example: A variable life insurance policy may be a good choice to finance a retirement cruise. A term policy will be appropriate to cover the outstanding balance of the mortgage. A $25,000 whole life insurance policy can provide an emergency fund for a surviving spouse, or term riders on any permanent plan may cover the insurance needs of a working spouse or children.

In addition to providing coverage on working spouses, life insurance should also be a consideration and purchased on stay-at-home spouses. The value of their work is not always fully appreciated or understood from a financial perspective, but hiring someone to do all the things they do day in and day out would be very expensive.

Life Insurance CostsCost is a factor in any purchase. Just as there are choices in automobiles, furniture and restaurants, life insurance policies come in different financial sizes and types to fit different budgets. Permanent plans cost more than term, but many individuals find the future benefits of permanent well worth the added cost down the road. Everyone’s financial situation is different; part of the professional life insurance producer’s job is to find and recommend a plan that will meet the insurance need taking into consideration what the policyowner is able and willing to pay.

Life insurance costs vary with the amount and type of coverage, but they also vary with the age and sex of the insured, as well as with known risks associated with health, such as skin cancer, emphysema, diabetes, obesity, or a dangerous activity, such as parachuting, piloting a private aircraft for newer pilots, and automobile racing. A 40-year-old would pay less than a 50-year-old, for example, and based on their longer life expectancies, women would pay somewhat less than same-age men.

Other higher premium examples include elevated blood pressure or scuba diving as a hobby. Smokers or tobacco users pay significantly higher premiums than do non-smokers or non-tobacco users. Life insurance policies may include an accidental death benefit as part of the policy or as a rider, popularly known as “double indemnity,” which pays the beneficiary twice the policy’s face amount when the insured’s death is from an accidental cause. This and other types of riders, such as waiver of premium, or guaranteed purchase options add additional costs to the base premium of the policy but offer additional benefits and options.



The following chart summarizes this concept:

Factor Higher Premiums Lower Premiums

Age Older YoungerSex Male FemaleHeight/Weight Out of proportion In proportionHealth Not so good GoodTobacco Use Yes NoDriving Record Not so good GoodOccupation/Hobby Hazardous Non-hazardousFace Amount Higher LowerType of Policy Permanent TemporaryRiders Selected Yes No

For higher than standard risks, the insurer can rate-up the policy’s premiums. This means that a higher than standard premium would be required to be paid in order for coverage to be in force. For risks beyond the ones the insurer is willing to handle, they can either not issue the policy or issue the policy with certain exclusions. For example, deaths that are a result of piloting an aircraft or from engaging in off-track automobile racing may be exclusions.

Life Insurance BasicsAs discussed, choosing what amount of life insurance to purchase is a function of what the underlying needs are. Common needs include funding for final expenses, funeral costs, lingering medical bills, legal fees, probate costs, creation of funds sufficient to offset any federal estate and state inheritance taxes, income replacement of the breadwinner, funding college expenses, buying out business interests, and replacing services at the death of a valued employee.

The primary and most commonly recognized purpose of life insurance is to provide financial security for survivors of the insured by replacing future income. When people consider life insurance, they primarily associate life insurance as being protection from financial disaster for surviving spouses, children and other dependents. That is the essence of the social value of life insurance.

Historically, personal or ‘family’ life insurance was considered necessary only for the principal wage earner. Society has progressed beyond this idea of life insurance only for the primary breadwinner. Life insurance is routinely purchased to cover stay-at-home spouses, children whose deaths can leave massive debt from medical bills as well as untold heartbreak, and people not yet established in careers with future high potential incomes. A good life insurance program does more than just replace the loss of income at an insured’s death. It provides peace of mind, the time to take stock of family matters, and most importantly relieves the stress and pressure of immediate financial matters.

Life insurance is also a unique tool for the creation of wealth in the form of liquid capital at the exact time it may be needed. It can also create capital that can last for generations. Considering the varied problems that it is able to alleviate, life insurance provides another very important benefit: peace of mind during the insured’s entire lifetime.



Life Insurance: A DefinitionWhile some life insurance policy’s interworking may be complex, the definition or concept of life insurance is not. Life insurance is a legal contract between a life insurance company known as the insurer and a policyowner wherein the insurer promises to pay a predetermined amount of money, the face amount of the policy, to designated beneficiaries upon the required proof of death of the person named as the insured in the policy while the coverage was in force. This is known as the insuring clause and is found on the front page of almost every life insurance policy. While the policyowner and the insured are most often the same person, that is not always the case. For example, a parent may purchase coverage on a minor age child, and a business partner may buy a policy on another business partner, or a policy on a “key” employee.

The cost of this protection is the ‘premium,’ commonly paid periodically by the policy holder to the company directly or through one of its licensed and appointed agents. This can be done annually, semi-annually, quarterly, or monthly, while certain company plans will deduct the employee’s premium from each of their paychecks. The premium is significantly less than the amount promised at the insured’s death, for example, a $1,000 annual premium could provide for a $350,000 death benefit, and is calculated in such a way as to pay out the benefit, maintain the company’s profitability, and be affordable for the policyowner premium payer all at the same time.

In an overly simplistic example, here is how it is done. Consider ten boys with bicycles and assume that one bike will need a new tire within a year at a cost of $9. None of the boys has the $9, but they each have $1. In exchange for their dollars, $10 (10 x $1) in all, the insurer promises to buy the new tire when needed. So the affected biker gets his $9 replacement tire and the insurer keeps the excess or profit of $1 if only one claim is paid out during the year.

And what did the other nine boys get for their dollars? A year of worry-free biking, which illustrates the true living benefit of life insurance, peace of mind, with the proper amount of coverage in place, knowing that one’s dependents will not suffer financially at one’s death. No other product, no person or entity performs that function as well and as reliably as does life insurance.

Life brings uncertainties. The future holds unknown events: some positive, others negative. Death, of course, is an ever present possibility and many deaths – it’s fair to say most – carry with them the burden of financial strain. Life insurance is designed to lighten that particular burden. An insured’s death exposes a family or a business to financial obligations as immediate as funeral expenses and debt settlement and to long term considerations brought about by diminished family and/or business income.

Life insurance needs differ with every individual. Different types of life insurance policies are suited to individual or business needs. Shopping among insurance companies for the lowest rate is but one factor in selecting policies to consider for purchase, but other factors are equally important. Does policy A provide coverage for enough years to see the twins through college? Will policy B accrue cash values that will supplement pension and Social Security income at retirement? Will insurer C be in business when it comes time to pay the claim? Does company D’s life insurance producers fully understand the policies that they are selling and know how to adjust to changes in financial situations and goals? For example, the 30-year-old middle-management woman with two young children, a mortgage and a stay-at-home husband has different insurance needs from the 55-year-old hedge fund manager who is divorced with three children from two marriages, whose bonus fell from 8 million to 5 million dollars last year.



Purpose of Life Insurance Depending upon the type of life insurance purchased, a policy can provide either a death benefit, or a death benefit and a living benefit.

Paying Death BenefitsThe best understood and most obvious purpose of life insurance is to pay a certain amount of money to named beneficiaries when the insured individual dies. Paying death benefits was the original purpose of life insurance policies and continues to be the predominant reason for purchasing life insurance today. Life insurance paid at the time of death can be used for many purposes, including:

• Ongoing living expenses for survivors, especially those who may have special needs• Paying off a mortgage on the survivors’ home, or providing enough money for future rental costs• Funding all or part of the children’s or grandchildren’s college costs• Paying off any existing personal, co-signed, or business related debts• Paying final expenses, such as final medical bills and funeral costs• Buying out a surviving partner’s interest in a business• Replacing income lost by the death of a key employee• Creating funds to pay any estate taxes or state inheritance taxes• Leaving a legacy to family, charitable, or educational institutions • Providing for the financial and emotional needs of parents or extended family members who are

unable to care for themselves

While life insurance has traditionally been used for purposes such as these, contemporary policies can provide additional benefits while the insured is alive.

Transfers at DeathThrough life insurance proceeds, policy holders can identify precise individuals or organizations that they wish to honor or benefit after the insured’s death. This is accomplished by properly naming the beneficiaries. Some family or business situations may require more analysis than others, for example, consider the situation in which an insured who was into a second marriage and who now has biological and step-children; the listed beneficiary predeceasing the insured, a family with a very large estate, or a family with several business interests. If it can be verbalized, then it can be done. For example, beneficiary designations can allocate 25% to each of the two daughters; 12.5% to each of the two children of a deceased son; 10% each to two former spouses; and 5% to a present spouse who is already wealthy from other sources.

By properly naming the beneficiaries in the life insurance policy, those pre-determined wishes and desires can become a financial reality. After the insured has passed away, it is too late to review and change beneficiary designations. Reviews assure that beneficiary designations are current and up-to-date with the policyowner’s desires as well as the appropriate amount of coverage to meet the pre-determined goals and needs for the life insurance coverage.

Cash AccumulationAs life insurance policies evolved, more emphasis was placed on the cash values that accumulated in some policies over the years. Certain policies feature cash accumulation that may be accessed during the policyowner’s lifetime. For example, a policy might accumulate cash values that would be significant at a particular age or after a certain number of years.



Insurance policies can build both guaranteed and non-guaranteed cash values, depending on the policy type, taxes on any gain are deferred until withdrawal, and they can be withdrawn on a favorable tax basis even then. Cash values, which grow as premiums are paid when due, and from interest or positive investment performance added to the cash values, can be accessed via surrender, partial surrender/withdrawal or loan and converted to any personal use.

Surrendering involves canceling the policy and receiving a check for cash surrender value. Partial surrender/withdrawal is transferring cash values built up over the years from the policy to the policyowner. Partial withdrawals are a feature of universal type policies and will have an impact on both the remaining cash value in the policy and the death benefit. Alternatively, the policyowner can borrow from the policy’s accumulated cash value by taking a loan at competitive interest rates specified in the policy. Both partial withdrawals and loans have short term and long term advantages, and both can reduce the amount of actual insurance protection originally purchased at the time of death.

Example: Don has had a $50,000 cash value life insurance policy for a long time. It now has $20,000 of cash value accumulation. He needs a new car and has chosen a very good used one that costs $12,000, but he does not have that amount of money in the bank. His life insurance agent suggests he take a loan from the insurance company using his policy as collateral. The interest charge is 5% or $600 per year initially ($12,000 x .05). While the loan is outstanding, his death benefit is reduced by the outstanding loan and outstanding loan interest. He can always pay the interest and repay the loan balance at any time. Don now has new transportation at an affordable cost.

Example: John has a $150,000 cash value life insurance policy that he has had for a long time. It now has $50,000 of cash value accumulation. He has another life insurance policy in place with a face amount of $500,000. His total life insurance needs are covered with the $500,000 policy. He wants to take a dream vacation with his wife, Jennifer. John cashes out his policy and uses the money for the trip.

Example: Albert has a $250,000 cash value life insurance policy that he has had for a long time. It now has $100,000 of cash value accumulation. He has another life insurance policy in place with a face amount of $50,000. His total life insurance needs are covered with the $50,000 policy. He wants to increase his cash flow since he is approaching retirement age. Albert uses the $100,000 to provide an income stream which he cannot outlive from the life insurance company by electing a settlement option within the policy.

The potential returns through permanent life insurance can meet living objectives by creating and making available a financial resource. Those objectives can be met through policy loans, dividends from participating policies, settlement options, and full or partial cash surrenders. The funds can be used in case of short-term emergencies, college costs, down payments on homes, or supplemental retirement income, just to name a few examples. In short, life insurance policy’s cash values can provide liquidity when it is needed.

Estate Building Rarely, if ever, has conversation at a funeral been about the deceased having too much life insurance; rather it is more likely that the insured did not have any life insurance or not enough life insurance in place.

Life insurance is an effective financial vehicle for shifting wealth from one generation to another, thus relieving younger survivors from the need to liquidate precious family assets or to endure other unintended financial burdens.



Estate ConservationAt the second death of a married couple, estates over a certain amount are generally subject to federal estate taxation and state inheritance taxation. Leaving the estimated amount of that tax through life insurance proceeds is a win-win proposition. The proceeds are received income tax-free; the heirs receive the estate’s full value, with certain illiquid assets remaining fully intact, and funds to pay the IRS. With an estate sale, the results are either the removal of an item from the family for generations to come or receiving only a fraction of the true or family value. Life insurance can provide the funds in order to pay the estate tax so that no “fire” sale has to take place on treasured family possessions.

Estate TaxesGenerally, life insurance proceeds are received free from federal and most states’ income tax. However, life insurance proceeds are included in the deceased’s gross estate for federal estate tax purposes if received by the estate or if the policy was owned by the deceased at the time of his/her death.

In most cases, if the insured does not own the policy, the proceeds bypass the estate for estate tax purposes. Depending on the size of the estate left behind by the deceased and prevailing tax law, it can be advantageous for someone other than the insured to own a policy on that insured’s life. The proceeds are received income-tax free by a spouse, for instance, and can be used to pay any taxable portion of the estate.

While current tax law and tax professionals should always be consulted, ownership from policy inception, rather than assigned ownership later, is generally recommended, because of the 3-year look back rule. It removes any doubts of intent. If existing policy ownership is transferred within 3 years of the insured’s death, it can be included in the policyowner’s estate. Where adult children own a policy on a parent, the parent may even gift the annual premium amount to them without diluting acceptance of the policy’s ownership provision. Other planning techniques such as the use of trusts and gifts can also reduce the size of a person’s taxable estate.

Life insurance death benefits are generally received by the beneficiary free from federal income tax but the proceeds value can be included in the gross estate of the policyowner for federal estate tax purposes. If an individual does not own the policy on his or her life, the proceeds value would not then be included in the estate, thereby reducing federal estate tax liability.

Charitable Giving Through Life InsuranceAnother valuable use of life insurance is to provide a charitable legacy. Someone of modest means who might want to donate $10,000 to the American Cancer Society, for example, can name the Society as a beneficiary in an affordably priced policy. Another example of a charitable contribution might be a college or university that depends on such posthumous gifts to maintain their programs.

Charitable giving may also include giving the charity a life insurance policy which can ultimately mean a donation of the entire amount of the death benefit proceeds. The donor pays premiums which are a fraction of the eventual gift and the proceeds may bypass the estate for tax purposes. Imagine a person who would like to donate $100,000 to their favorite charity but does not have that amount of money available to do so now but does have surplus cash flow in which to buy a $100,000 life insurance policy death benefit.

When a policy is given, or donated to a charity, or applied for with the charity as owner, the premiums from that point forward can be income-tax deductible. A policy must be given irrevocably, by changing the policy ownership from the existing owner to the charity in order for the donor to receive full tax benefits, and the premium amount may be donated to the charity for remittance to the insurance company. Professional legal and tax advice are needed in order to implement such a strategy so there are no adverse



tax consequences. Insurance companies want to determine if there is a true insurable interest relationship between the donor and the charity before issuing the policy. Insurance companies may also limit the amount of coverage a charity can apply for on a donor.

Example: Chelsea is compassionate about the Leader Dogs for the Blind program. She thinks that teaming up well-trained dogs to act as guides for those who are visually impaired is a win-win situation for both the dog and the recipient of the dog’s services. She has been a volunteer and cash contributor for years. Now that she is in a good financial situation, she would like to do something to have a meaningful impact on the organization so that their good work will continue on after she is no longer around. Her life insurance professional suggests that she buy a $100,000 permanent life insurance policy and once issued donate it to the charity. They will name the organization as beneficiary, and the organization will become the new policyowner. Chelsea can then donate the premium payments to pay for the policy. Upon death the life insurance proceeds will go to the organization to help them fund on-going costs to provide their services. In the event Chelsea is unable to pay all of the premiums, the cash values can be used or other donors may donate funds to keep the policy premiums paid.

Business Uses of Life Insurance Businesses as well as individuals and families have insurance needs. Smooth business continuation after the death of a partner, corporate officer, or key employee is a concern that can be addressed with life insurance. The death of a 45-year-old key employee has been estimated to be fifteen times more likely than a fire, and it is a rare situation to find a manufacturing plant that does not carry fire insurance.

Buy-sell agreements spell out what surviving partners must do in the event of a partner’s death. Commonly, they require the business survivor(s) to purchase the deceased’s share from the heirs. Nothing serves that mandate as well or as cost effectively as life insurance. The heirs inherit their share at its current value, not at the original value plus taxable gain, and the surviving partners receive income tax-free insurance proceeds with which to buy the shares. This allows the business to continue without having to take on new partners who may not have the expertise of the deceased, and without any personnel issues for those situations in which the deceased’s spouse may not get along with the surviving business partners. Imagine if the business were forced to sell assets or take on loans to pay off the deceased’s surviving family. The company may not be able to survive without the valuable assets in place or afford the burden of taking on the debt. The buy-sell agreement properly funded with life insurance can be as clean a separation as can be hoped for by all parties concerned.

In a typical two-partner example, each partner owns a policy insuring the life of the other partner. Ideally, the amount of coverage, face amount, or death benefit, should equal 50% of the business’s value if it is a 50/50 partnership. The buy-sell agreement obligates the surviving partner to purchase the deceased’s half of the business from their beneficiaries or estate at a pre-determined value as determined by objective evaluation. Usually a business valuation study, conducted by a qualified professional, is completed in order to come up with this number. Typically, it is not performed by the life insurance professional. Periodic adjustments in insurance amounts in order to reflect growing values are advised.

A proper buy-sell agreement obligates both parties: the surviving partner to buy out the deceased’s share, and the surviving family members to sell the deceased’s share. Business entities with three or more partners require more complex agreements, but they are equally well-served by life insurance contracts.

Example: Alfred, Beatrice, and Chloe are business partners. Each brings a unique talent to the business, and upon death of any one of them, the business may suffer financially until a replacement can be found and trained. The business has been valued recently at $300,000. Alfred owns 40%, while Beatrice and



Chloe each own 30%. The professional insurance advisor suggests they contact an attorney to draw up a buy-sell agreement. In case any one of them should die, there will be an agreement in place for orderly transition of the deceased interest to the survivor(s). After the agreement is in place, the professional insurance advisor reviews the various ways to fund the agreement. The partners were shown what happens if they should decide to self-insure, take on loans, sell existing business assets, or buy life insurance. After careful consideration and discussion with the partnership’s accountant, it was determined that the most efficient use of the business’ cash flow and existing capital was to purchase life insurance. The professional life insurance agent presented various life insurance options and applications were completed. It was determined that the best way to move forward was to have the partnership own and be named beneficiary of 3 policies, one on each partner, in an amount equal to their ownership interest in the company. Upon death of the partner, the company would have the money to buy out the deceased partner’s interest in the business. The surviving partners would have their respective ownership interest recalculated; and if necessary, their insurance coverage amounts may need to be adjusted. This would also be true if and when they take on a new partner.

This is just one plan design, an entity purchase plan, among many along with just one method of implementing the coverage. For example, the use of a joint-life policy, or first-to-die policy could be appropriate, along with having each partner buy a policy on the other two. Ultimately, it will depend upon the facts and circumstances presented in order to determine the best way to move forward.

Key employee coverage on an executive grants the employer time to carefully recruit and train a replacement without the added strain of a money crunch because of the death benefit that was paid. Key employee life insurance can:

• Cover the expenses of finding, securing and training a new person to take the deceased’s place• Assure creditors that their loans are safe• Assure customers that the business will continue operations• Keep the business running

Key employee plans funded with life insurance can provide a company with the necessary funds to help them weather the storm. The costs involved in terms of time, lost productivity, the search, compensation, ramp-up time, and potential lost earnings are real and can be significant.

Example: Julio is the executive vice-president in charge of sales. Prior to joining the company, sales were averaging $1.5 million per year. Since he started, sales are now at $10 million annually and growing due to his ability to work with existing customers, find new customers, hire good sales managers, as well as help in the development of the sales force overall. His current salary is $100,000. After meeting with their professional insurance agent, it was determined that the company would need approximately $300,000 to buy time to hire a replacement for Julio. The insurance carrier agreed with the rationale provided by the agent. Julio agreed to the process, and the company went forward with an application on Julio’s life and the company was named owner and beneficiary of the policy. Julio was given a 10% bonus by the company in consideration for all that he has done for the company, and the company agreed to pay an additional $25,000 to Julio’s family upon his death from part of the insurance proceeds.

Many compassionate employers also use a portion of the income tax-free death proceeds to bonus the key employee’s family, which is a nice thing to do. Life insurance can play a vital role in helping surviving family members or business partners deal with the financial situation left behind after the death of the insured. There are several methods to determine how much coverage is needed as well as several different ways to put together an insurance portfolio to meet those identified needs.



Business uses of life insurance also include split-dollar plans, nonqualified deferred compensation plans, pure death benefit plans, retiree-benefits funding, and qualified retirement plans which that allow for life insurance.

The uses of life insurance proceeds are many and varied, but they all share a common element: providing liquid assets at the precise time of need. No other financial tool can make that statement.

TaxationAll life insurance policies are subject to the same income tax and estate, gift, and generation-skipping transfer taxation rules. With very few business-related exceptions, death benefit proceeds are free from federal and most states’ income tax, and while the value of the policy, the death benefit, can be included in the estate for estate tax purposes, the proceeds bypass probate, placing capital directly in the hands of the beneficiaries, often when most needed. The exception is if the estate is named the beneficiary, or in situations in which there are no living beneficiaries at the time of death of the insured.

Example: Angie is the insured and owner of a $200,000 life insurance policy which has Bonnie as the primary beneficiary. If Angie dies, $200,000 of life insurance value is included in her estate. $200,000 is paid directly to Bonnie as primary beneficiary income tax free.

Example: Angie is the insured and owner of a $200,000 life insurance policy that names Bonnie as the primary beneficiary. Bonnie dies and Angie fails to name a new beneficiary in her policy. If Angie dies, $200,000 of life insurance value is included in her estate. $200,000 is paid directly to Angie’s estate since there was no one listed as beneficiary who was alive at the time of her death.

Cash value accumulations are free from current income taxation; any income tax owed is deferred while still in the policy. Participating policy dividends are income tax free and so are life insurance policy loans. Withdrawals from and surrenders of life insurance for the cash values are taxed on a cost-recovery, or “first in, first out” (FIFO) basis. That is, withdrawals are not subject to taxation until the funds received exceed the amount paid in from premiums, or cost basis.

Example: Assume a 20-year-old policy with an annual premium of $1,000 and cash value of $28,000. Partial withdrawals up to the $20,000 ($1,000 x 20) paid-in, the cost basis, would be free from income taxation. Withdrawing $21,000 would mean that the $1,000 ‘profit’ would be added to that year’s taxable income. Partial withdrawals are only available on universal life type policies.

Policy loans outstanding are income tax free unless the policy lapses with an outstanding loan greater than the policy’s cost basis.

Example: Assume a 20-year-old policy with an annual premium of $1,000 and cash value of $28,000. The cost basis of the policy is $20,000 ($1,000 x 20), the amount of premium paid-in. The policy loan outstanding is $28,000 due to an outstanding loan and unpaid loan interest which was added to the outstanding policy loan. If the policy lapses, $8,000 ($28,000 - $20,000) would be subject to income taxation.

The opposite is true when considering the taxation of variable or fixed annuity withdrawals, which are taxed on a “last in, first out” (LIFO) basis.

Example: In the previous scenario, $20,000 of premiums was paid in and the policy had $28,000 in cash value. If this policy had been an annuity as opposed to life insurance, the first $8,000 withdrawn would be considered a gain, or profit, and taxed at ordinary income tax rates.

Regardless of the type of policy, the last amounts that are considered to have gone into the policy are the earnings. The first amounts that are considered to have gone in were the premiums. So, the IRS says depending upon the policy, they will take either a FIFO or LIFO approach to taxation for withdrawals. While



FIFO is widely misunderstood, it is nonetheless an attractive feature of cash-building permanent life insurance policies.

Annuity-type distributions that can come into play with life insurance as death benefit settlement options are more complex, with portions of monthly payout amounts taxed according to the total amount and life expectancy which initially can provide a distribution that is partially a tax-free return of premium with the balance treated as earnings that is income taxable. After the entire premium, cost basis, is recovered then all of the distributions would be considered income taxable from then on.

Example: $100,000 is paid out upon death of the insured. The policyowner preselected a lifetime payout to the beneficiary. Payments are expected to last 20 years based on the age and sex of the beneficiary. Monthly income payments are expected to be $600. Using IRS tables and formulas, it is determined that $100 of each payment is earnings and $500 is a recovery of cost basis. Once the entire cost basis is recovered, then any remaining payments are fully taxable as income since the full cost basis has been recovered income tax free.

Modified Endowment Contract (MEC)At one time, certain life insurance products were used to avoid, rather than defer, taxes. Generally life insurance policy withdrawals are taxed on a FIFO basis, whereby withdrawals are not taxed until they exceed the invested amount, or premiums paid. A policyowner could deposit a large sum into a single premium life insurance policy or a universal life insurance type policy; let it grow for a few years, and then withdraw the same amount without taxation, leaving a potentially substantial amount in the policy for tax-free distribution at death. So, there was no out of pocket money at risk in the policy anymore on behalf of the policyowner. The system attracted money launderers as well as tax evaders. Talk about a tax shelter.

A policy’s MEC status is determined through what is referred to as a seven-pay test, which compares the amount paid-in over 7 years with essentially the amount that would have been paid on a seven-pay whole life policy with the same face amount. Thus, a $50,000 variable universal life insurance policy, compared to a $50,000 whole life, which would be paid-up, meaning no further premiums required, after 7 years with $3,000 annual premiums, becomes a MEC if premiums paid-in exceeds $21,000 in 7 years or if premiums exceed the cumulative amount along the way.

For example, if the cumulative premium exceeds $12,000 in the fourth year ($3,000 x 4), the policy becomes a MEC from that point on. Insurance companies monitor this, inform policyowners, and can refund any overpayments which would put the policy in jeopardy of becoming classified as a MEC within 60 days of receipt. Refunding some of the premium after 60 days, paying less the next year, or changing the policy form to a regulation policy has no effect; once a MEC, always a MEC.

The major penalty of having a policy classified as a MEC is a switch from FIFO to LIFO income tax accounting, meaning that any policy withdrawals are first deemed to be gains and are taxable as received. Also, any amounts received prior to age 59½ are subject, with a few exceptions, to a 10% tax penalty. If the policyowner elected to receive a partial surrender (withdrawal), take a policy loan, surrender the policy for its cash values, received a dividend, or collaterally assigned the policy, this will very likely trigger an adverse tax consequence.

Even when the policy is classified as a MEC, the death benefit’s income tax-free status is not affected, so individuals who are certain they will not ever need to access the cash values may still use single-pay or overfund flexible premium products such as universal life to leave substantial amounts to their heirs, providing a transfer of wealth that might otherwise be taxable through other means.

To review: A life insurance policy generally becomes a Modified Endowment Contract (MEC) when the premium exceeds the amount needed to maintain the policy over a person’s lifetime. In other words, the IRS



would like to understand, what the reason is for paying into a financial product whose primary purpose is to pay out a death benefit upon death of the insured to named beneficiaries more than would be required to pay up for life within the first 7 years? The maximum amounts of premiums that can go into a life insurance policy vary with the insured’s age and policy face amount. Most companies will alert premium payers who are approaching the maximums.

The rules are in place to prevent a life insurance policy from becoming a “tax shelter” instead of being what it is supposed to be, that is, life insurance providing a death benefit. The tax deferral of any gains, whether by interest, dividends, capital gains, or appreciation, continues as long as the cash values remain in the policy. Certain changes, referred to as material changes, such as reducing the face amount in adjustable life type policies, like adjustable life, universal life, and variable universal life, can trigger a MEC classification, but most companies have built-in warning signals that notify the policyowner in an attempt to prevent that from happening. Usually the policyowner has 60 days to remove any excess funds from the policy, which can be overpayments in premium or excess cash values. The removal can trigger income taxation. In most cases it is easier, if insurable, to simply increase the death benefit.

Example: Imagine a $250,000 universal life purchased by a 40-year-old with a single premium of $50,000 and a now has a cash value of $100,000. The policy was classified for tax purposes as a MEC but the policyowner forgot. It’s time for that long planned for cruise, and the policyowner withdraws $20,000. Not only is it not considered a FIFO return of his premium, it is taxed at the now 50-year-old’s 30% tax rate plus a 10% penalty tax. The $20,000 withdrawal netted the policyowner $12,000 after tax ($20,000 x [30% + 10%] = $8,000; $20,000 - $8,000 = $12,000) and sounds like a pretty expensive cruise for not considering the MEC tax rules. Perhaps another source of funds would have been a better choice to access.

Another aspect of this rule pertains to withdrawals within the first 15 years if coupled with a reduction in the face amount. The withdrawal is subject to LIFO versus FIFO, and any gains are subject to income tax.

Transfer for ValueWhile life insurance death benefits are generally income-tax free, an exception applies under certain conditions surrounding the sale of an “in force” policy to 3rd parties. The “transfer for value” rule was designed to discourage speculators from reaping income tax-free windfalls. If a policy is sold for a valuable consideration of any kind, the eventual death benefit is taxable to the extent that it exceeds that consideration plus any premiums paid after the transfer.

This can occur in a viatical or life settlement transaction where terminally ill insureds or the elderly, who no longer have a need for their coverage, find a person or entity willing to buy out the current owner for an amount less than the face amount, but greater than the cash values. The new 3rd party owner would be responsible for paying the on-going premium until the insured’s death. Not all life insurance companies permit agents to participate in such transactions, and certain states require special licensing to facilitate such a transaction.

Example: Dora is about to retire from her company. A life insurance policy exists on her life with a face amount of $2,500,000 and a cash value of $150,000 that was used to fund a buy-sell agreement. Her health has declined from the time the policy was initially taken out. Dora does not have the money to pay the premiums due on this policy. She has more than enough coverage from other personal life insurance. She discovers a company that is willing to buy her out of this policy once she is named the new owner upon her retirement. They will ask for her medical records to determine her life expectancy and from that make her an offer. Dora receives an offer of $500,000. All she has to do is sign some paperwork. The entity will become the new owner of the policy and will have to continue the policy in force in order to receive the death benefit. Once Dora dies, the company will receive the



death benefit and will have to report as taxable income the difference between the face amount and any of their costs. Their costs would be the $500,000 lump-sum payment and the on-going premium payments.

For the seller of the policy, there can be ordinary income tax and capital gain tax recognition depending on whether or not the insured is terminally ill, chronically ill, or simply has a reduced life expectancy but is not terminally ill (typically seen in life settlements, life expectancy greater than 2 years). In general, the cash surrender value in excess of the premium paid is considered ordinary income. The amount of the sales price greater than the adjusted basis is treated as a capital gain. The adjusted basis is the sum of the premiums paid, the cost of insurance, and the ordinary income recognized.

Section 1035 Exchanges Much like an employee who had a 401(k) balance prior to retiring from his/her employer and having the opportunity to roll-over the account balance into an IRA to maintain the tax sheltering of the account balance, the same holds true in certain life insurance transactions.

For various reasons, a policyowner of an annuity or a life insurance policy will decide to discontinue the existing policy and move the cash values into a new policy. If the policy has been owned for a while, it may have a fairly large cash value that would be in excess of any premiums paid to date. By surrendering that policy and then using the cash to buy a new policy, it will be treated by the IRS as a taxable event. However, if the IRC 1035 rules are followed and a request is made to the existing insurer to forward the cash values to the new insurer to fund the new policy, then the tax deferral of the cash values will continue much like an IRA rollover.

The following are the various 1035 options:

• A non-qualified annuity into another non-qualified annuity• A life insurance policy into another life insurance policy• A life insurance policy into another non-qualified annuity

The IRS will never allow the 1035 exchange rules to apply to a non-qualified annuity into a life insurance policy.

Note: While the IRS will allow tax deferral to continue, the exchange from one policy to another new life insurance policy from the same or different insurer is likely to require evidence of insurability. Also, the new policy may come from the same or different insurer. 1035s also include life insurance, annuities, or qualified long-term care exchanged into a qualified long-term care policy. The insured on the new policy must be the same as the insured on the old policy. Any outstanding policy loans must be repaid or carried over to the new policy.

Example: Sonja has a life insurance policy that is 30 years old. It has a $50,000 face amount and a $25,000 cash value. Her parents purchased the policy when she was born. When she turned the legal age of 18, she was given ownership of the policy. Premiums paid to this point have been $10,000, the cost basis in the policy. Her tax-deferred earnings are $15,000 ($25,000 - $10,000). She is very insurable and is in need of more coverage. Sonya has discovered through her professional life insurance producer that with the $25,000 available in her existing policy, she can get $250,000 of new universal life insurance coverage for annual premiums of $500 per year guaranteed not to lapse until age 90. Her other option would be to keep her existing policy and pay $2,750 a year for the same plan of life insurance, an amount that is not affordable for her right now. Her life insurance agent helps her fill out the necessary paperwork to apply for the new coverage, request a 1035 from the old insurance company and old policy over to the new insurance policy and new insurance company. The transaction settles, and no income tax is due on the transaction.



Instead of moving forward with the transaction as explained by her insurance agent, Sonja wants to take a week and think it over. During the week, she decides to expedite things so she sends in a request to the old company to surrender her policy outright. Two weeks later, she receives a check for $25,000 from the old insurance company. Next, Sonja contacts her agent and says she is ready to move forward with the purchase of the new policy. The agent arrives and when informed of what transpired since his last visit tells Sonja the good and bad news. The good news is that she is very insurable and has a check in her hand for $25,000. The bad news is that the check received represents a taxable event in the amount of the tax-deferred earnings of $15,000. Given her 20% tax bracket she will owe $3,000 in income taxes ($15,000 x 20%). The 1035 tax free exchange rules were not followed. This leaves $22,000 ($25,000 - $3,000) for her to deposit into her new policy. This new amount deposited into her new $250,000 universal life policy will now only guarantee coverage to age 70 with a $500 per year premium or she can have $225,000 in coverage with a no-lapse to age 90 for the same premium or she can pay $750 annually to have a $250,000 no-lapse policy to age 90. Her life insurance agent helps her fill out the necessary paperwork to apply for the new coverage. The transaction settles, and she pays the income tax due on the original transaction.

If transactions are not conducted properly, adverse consequences may be the result. If the life insurance policy that is being considered for a 1035 exchange is a MEC, then the new policy it is being exchanged into will automatically be classified as a MEC.

Summary Life insurance can provide much needed cash at various times in a person’s life, either due to premature death, or retirement. It can play a role in estate plan funding, charitable giving, business succession, and replacing a deceased’s breadwinner’s income. The IRS has tax rules that must be followed when it comes to premium funding, withdrawing cash from the policy, or exchanging policies.


Chapter 1 Review Questions

1. Jim and his life insurance agent, Paula, were discussing whether Jim would apply for life insurance equal to five times his annual salary or six times. They were calculating Jim’s ____________.a. Life expectancyb. Human life valuec. Annual budgetd. 401(k) plan

2. Tim wanted to have the same life insurance coverage as his older brother Steve, but his life insurance agent explained that the right type of life insurance depends upon individual considerations, which include all the following, EXCEPT:a. Favorite teamb. Employment statusc. Risk toleranced. Ability to pay

3. All of the following are points to consider before committing to a long-term relationship with life insurance, EXCEPT:a. Where to keep the policyb. Why life insurance is neededc. How much insurance is neededd. What are the costs of the life insurance coverage

4. The cash values accumulated within a permanent life insurance policy can be used to fund which ONE of the following? a. An IRA planb. Living objectivesc. Beneficiary immediate cash needsd. Survivor income replacement needs

5. After Stanley died, his widow applied for Social Security benefits based on his income and also on her own income. Which ONE of the following did she end up receiving? a. Both monthly paymentsb. Deferred government compensationc. The higher of the two amountsd. A citation for attempted fraud

6. Social Security retirement benefits go hand-in-hand with permanent life insurance’s projected cash values. Social Security ____________ are important when considering life insurance death benefits.a. Tax increasesb. Waiting periodsc. Survivor benefitsd. Payroll deductions

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7. Life insurance agent Beth’s 22-year old prospect, George, wanted to put off the purchase of a permanent life policy until he says, “I get married and have kids.” Beth pointed out that:a. He might never marry or have childrenb. Premiums increase at every age changec. She only had one policy leftd. He might move out of state

8. Susan, a physician, earns considerably more than Frank, her husband, does. Life insurance can:a. Build cash values to supplement his current incomeb. Give her more time off from her practicec. Replace her income in the event of her deathd. Balance their incomes

9. Life insurance agent Henderson was asked by his client to help them to better understand what life insurance was designed for. Each of the following best addresses the question, EXCEPT: a. It provides liquid assets at the precise time of needb. It can keep lingering debt from adding to heartbreakc. It can provide funds necessary to cover survivor’s ongoing living expenses d. It can help Henderson attain his monthly income goal

10. At a fund-raising rally, the American Red Cross representative pointed out all the following advantages of donating to their organization via life insurance, EXCEPT:a. Premiums can be tax deductibleb. The donation can then be very substantialc. Proceeds can be excluded from the deceased’s estated. Transfusion priority if and when needed

11. Often times merely focusing in on ____________ leads to under insuring the immediate life insurance needs of the prospect. a. Face amountb. Premiumsc. Ridersd. Investment choices

12. Joshua has an annuity which he no longer wants but happens to be in the market for life insurance. So he cashes out his annuity and with the check received from the company goes into Francois’ office and tells him he would like to by some life insurance and arrange for it to be a tax free exchange from the old annuity because he would hate to face the large tax bill that is looming. Francois informs Joshua that this is ____________.a. A clear violation of the 1035 exchange rules b. Not going to be a problem so long as he purchases a hybrid annuity-life insurance policyc. Not a problem and makes it happend. Okay as long as he buys a single premium life insurance policy from a different insurer



13. Ralph bought his elderly neighbor’s $50,000 life policy for $30,000, made himself the policy owner and beneficiary, paid two $1,000 premiums before the neighbor died. What amount of the death benefit was taxable to Ralph?a. $50,000b. $32,000c. $18,000d. None


Chapter 2

The Life Insurance Contract & Policy Provisions

IntroductionLife insurance contracts, or ‘policies,’ contain an array of provisions and clauses that define contractual obligations, rights and duties. The provisions also affect the ‘performance’ of the contract which can occur in several ways. One way a life insurance contract performance is measured, of course, is by the paying of death-benefit proceeds to the named beneficiaries at the insured’s death after a claim has been properly filed. Another indication of performance is releasing any accrued cash values if the policy is surrendered by its owner or a request for a policy loan is made. The final way a policy’s performance is measured is based upon the cash value accumulation within permanent policies.

In most cases, the life insurance contract lapses if premiums are not paid on time and in full. In a sense, the contract ceases to exist although there may be some values which by law cannot be forfeited due to failure to pay the premium. These are known as non-forfeiture values that may provide some benefits despite the policy lapsing.

Individuals considering the purchase of a life insurance contract should be made aware of contractual and legal reasons why policy proceeds can or cannot be paid. Despite some misbehavior by a few individual representatives, the insurance industry has a century-old reputation for fulfilling its contractual obligations. Over the years, there have been some insurance consumers who have tried to obtain money from insurance companies through fraudulent means.

The Requirements of a ContractBefore a life insurance contract becomes effective or is said to be in force, certain requirements must be met:

• The contract must be for a lawful purpose• The contract must have parties to the contract who have the capacity to make a contract• The contract can only come into being after an offer and acceptance• The contract must be for an exchange of value known as consideration

Lawful PurposeThe first two provisions are self-explanatory. An increasingly sophisticated underwriting process discovers unlawful activity. There must be a definable insurable interest in the insured; it cannot be a wager contract. There has to be some person or organization that will suffer a loss upon the death of the insured in which the death benefit will indemnify them for the loss suffered. Spouses and business partners have an insurable interest in each other, and so do creditors in debtors. The insurable interest must be present at the time the policy is effective, not at the time of death.

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Example: Fred and Wilma are married and have two children. Fred wants to buy life insurance on his life and Wilma’s life in order to provide funds for the survivor in case either should die. This is for a lawful purpose. Each has an insurable interest in one another.

Example: Barney wants to buy life insurance on Fred, his neighbor; in case Fred dies, he can make a profit on the premiums he has paid in while the contract is in force. He thinks that this is a better way to go than investing in stocks. This is a wager contract not fulfilling a lawful purpose and will not be issued due to lack of insurable interest. It also may mean that Fred is more likely to meet an early demise.

Capacity to ContractObviously, a minor aged child or an adult without control of their faculties cannot be party to any contract; this is based on contract law because they do not have the requisite mental capacity to do so since they are not likely to know what they are doing. The courts will allow someone who has entered into a contract who does not possess the legal standing to get out of the contract and be put back into the situation they were in prior to signing. This is why parents have to act as co-signers for their children who attempt to finance a car at a young age. If not, then the child could return the car even after wrecking it for a full refund because the contract is voidable. What was missing was one of the required elements to be a legally enforceable contract.

Offer and Acceptance Offer and acceptance refers to the applicant making an offer to buy a life insurance policy that the insurance company may accept, counteroffer, or reject by virtue of submitting a completed application with money. That may appear counterintuitive at first glance, but the life insurance agent is actually soliciting an offer on behalf of the insurance company they represent when the sales presentation is made. Only when the life insurance company accepts the offer can there be a valid insurance contract.

In very limited circumstances can an agent bind an insurance company prior to the actual policy being issued. It is all spelled out in the receipt that the agent provides to the applicant when the application is completed. Money may or may not be provided by the applicant, and it must be indicated on the receipt. If money is not submitted with the application, it is technically the policyowner soliciting an offer from the insurance company. If money is submitted, then the policyowner is making an offer.

Example: George is looking to buy life insurance. He contacts his trusted life insurance advisor and sets up a meeting. The agent, Phil, helps George complete the application. George pays the first premium, and Phil submits it to his insurer. George has made an offer to buy life insurance. The insurance company issues the policy as applied for. The insurer has accepted George’s offer, and a contract is issued. If the insurer decides not to issue the policy but instead refunds the premium to George, the offer George made was not accepted. It is also referred to as George being declined for coverage. Finally, the insurer may decide to accept the risk but not at the premium originally discussed based upon evidence uncovered during the underwriting phase. The insurer says that they will insure George but at 50% more premium. The insurer has made a counter-offer, and it is up to George to accept or decline this offer. If George accepts the counter-offer, then he will have to pay the increased premium if he wants coverage. If he does not, then no coverage was ever in effect.


25CHAPTER 2: THE LIFE INSURANCE CONTRACT & POLICY PROVISIONS

The following chart summarizes offers and acceptances:

Initial action Action Classification Insurance Company Action Result

Agent asks applicant if they are interested in buying life insurance

Agent is soliciting an offer

N/A N/A

Applicant completes an application but does not submit a check

Applicant is soliciting an offer

Rejects the application There is no offer made

Applicant completes an application but does not submit a check

Applicant is soliciting an offer

Issues a policy Offer can be accepted by the applicant by paying the required premium at policy delivery

Applicant completes an application and submits a check

Applicant is making an offer

Rejects the application and returns the premium

There is no acceptance of the offer made



Issues a policy Acceptance of the offer made



Issues a policy at a higher premium

Insurance company counter-offer can be accepted by the applicant by paying the required premium at policy delivery

Consideration Consideration– money – must be exchanged before a life insurance contract takes effect. The exchange usually consists of the policyowner’s first full premium, equal to the full annual amount or an amount based on a semi-annual, quarterly, or monthly payment schedule. This is referred to as adequate consideration. When money is sent with the application, the policy normally becomes effective when the life insurance company receives the pre-paid application, subject to medical requirements. This occurs when the agent provides a conditional receipt.

If the insurance company would have issued the policy as applied for, then if death occurs prior to actual policy issuance, the receipt date is when coverage actually began. Certain discoveries during the underwriting process may cause the company to reject the applicant and return the deposit or move the insurance company to make a counteroffer such as standard issue instead of preferred or a table 4 rating instead of standard. Whether or not a death in the interim is covered is a legal matter. There have been legal decisions in favor of both sides of that question. It is primarily based on the language of the receipt that the agent provided the applicant and whether or not the specified conditions had been satisfied or not.

For example, if the check provided by the applicant to the agent bounces, then there was not adequate consideration so no legally binding contract could have been in existence. If the insured was required to take a complete physical exam but was killed in an automobile accident on the way to the clinic, then there could be no coverage since tests had to be completed prior to death. If the exam was completed and the fatal accident occurred on the way back home, then it depends upon what the underwriting decision is, based on the information provided. If the policy would have been issued as applied for or better, then there would likely be a claim paid. On the other hand, if the information would have led to a declination, then there would be no claim paid (but most likely a lawsuit brought by the beneficiary).



The consideration the insurance company brings to the contract is their promise to pay the death benefit as specified in the insuring clause found on the front cover or front page of the policy. So consideration on both parties’ behalf is what holds the two parties together to bring a contract into existence. Without it, the deal is not sealed.

Parties to the ContractA life insurance policy is a legally enforceable contract issued by the insurer in consideration of the application, and the representations contained therein, and the payment of premiums. There are four “parties” to the life insurance contract:

• The insurer• The insured• The applicant/policyowner• The beneficiary

The first party to a life insurance contract is the insurance company, carrier, or insurer. The insurer is usually a corporate entity, licensed in each state in which it does business.

The second party to the contract is the insured, whose life is being used for a contract of life insurance. It is the age, gender, occupation, and health of the insured that the insurer’s decision to insure and the premium are based on. There are also limits as to how much coverage will be issued on any single life. The insurance company does not want to face the prospect that the insured is truly worth millions more dead than alive. There may be too much of a motive to see that even take place.

The third party is the policyowner who has the ability to exercise each and every right in the contract. Most often, the insured and policyowner are the same individual, but third-party ownership is not uncommon. There are situations where spouses or business partners own each other’s policies, and policies on the lives of minor children are usually owned by a parent or grandparent (known as juvenile or starter policies). Many corporations own policies on key employees. The owner’s rights include the naming of beneficiaries and control over any cash values. In theory, anyone could pay the premium, but timely premium payment is the policyowner’s responsibility.

The fourth party to the contract is the beneficiary. Although the beneficiary does not sign the application and may not even be aware of the policy, they are considered a party to the contract based on a potential direct benefit. In a real sense, at the insured’s death, the beneficiary is the only party to the contract. The beneficiary has no say in the policy except if they are named an irrevocable beneficiary. In this case, they can block the owner’s request to change the beneficiary. Any change in irrevocable beneficiary requires the irrevocable beneficiary’s consent.

Example: Brian takes out a life insurance policy on himself through ABC Life Insurance Company. He names his wife, Lisa, as the person to receive the death proceeds upon his death. Brian is the policy owner. Brian is the insured. ABC Life is the insurer. Lisa is the beneficiary.

Example: Ryan takes out a life insurance policy on his business partner, Carly, through XYZ Life Insurance Company. He will receive the death benefit upon her death. Ryan is the 3rd party owner. Carly is the insured. XYZ Life is the insurer. Ryan is the beneficiary.



Different Types of Contracts Unilateral ContractsLife insurance policies are considered unilateral contracts, meaning that only one party is legally bound by its provisions after issuance. Think about it; every paragraph, every footnote, all the “fine print” in a life policy deals with the life insurance company’s obligations. The company must accept timely premium payment; it must enact whatever nonforfeiture values are listed; it must pay out the proceeds at the insured’s death after a claim is filed. Where does it say the policyowner must pay the premiums or cannot get out of the contract? Don’t bother looking; it doesn’t.

Normally when a contract is entered into by two parties, it requires both parties agreement to get out of the contract or a claim for breach of contract will be filed with a request for damages to be paid due to non-performance. So, it takes two parties to get into a contract, and two parties to agree to get out of the contract. Most contracts are considered bi-lateral.

With life insurance, this is not the case. While it takes two parties to get into the life insurance contract, only one party can take action to get out of it. A beneficiary can sue a life insurance company for failing to pay out a death benefit, not paying it out in full, or not paying it in a timely fashion as they should have based on the contractual language. On the other hand, the policyowner can get out of the contract by not paying any more premiums and letting the policy lapse or surrendering the contract for its cash surrender value. There is nothing the insurance company can do to force the policyowner to pay premiums or to stay with the policy, even if it originally was for their whole life.

The insurance company cannot simply cancel the policy because they feel like it. So long as the policyowner lives up to their commitment by paying the full premium on time, the insurance company is obligated to fulfill the contract based upon its terms.

Example: Adam takes out a life insurance policy for $500,000 through ABC Life Insurance Company on his own life naming his wife, Denise, as primary beneficiary. Five years later Adam finds out that he can get a better deal for the same coverage for less money through PDQ Life Insurance Company, and he decides to make a change by cancelling the ABC policy and buying a PDQ policy. ABC files a claim again Adam for breach of contract stating that the contract was for life and that he had no right to get out of this contract without their consent. ABC’s case is dismissed because this is not a bi-lateral contract, but instead it is a unilateral contract which allows the policy owner to opt out of the contract at any time and for any reason.

Contract of AdhesionThe insurance company alone writes the policy; the insured or owner has no input into the terms or the opportunity to negotiate any of them. This is due to state insurance laws that mandate certain language in insurance policies. A contract between a homeowner and a contractor installing a pool is subject to input from both sides before being signed, and both parties are legally bound by its terms – the contractor to install the pool subject to the negotiated specifications, and the homeowner to pay the agreed upon money at specified times and in specified amounts. In order to be fair, courts rule against the writer of the contract in cases where there is any ambiguity. The writer is “stuck” based on it being considered a contract of adhesion. They must adhere to what they wrote.

Example: Alex’s life insurance policy states that “if the policy owner ever needs money to simply give them a call.” Alex was in need of $500 to repair his car so he gave the company a call. The home office said that he needed to fill out a request for a policy loan and submit it. They would then consider the request, and if approved, the check would arrive in the mail in 6-8 weeks. Alex calls



the State insurance commissioner’s office to complain. The insurance commissioner’s office calls the insurance company’s legal department as part of their investigation. Sure enough the language Alex communicated to them was exactly how the policy read. The insurance commissioner’s office compelled the insurer to forward a check in the amount of $500 immediately as specified in the contract. Since there was ambiguity in the language and Alex had no say in it whatsoever, the insurance company is required to make the loan. The insurance company issued policy amendments to clarify the language and specify procedures for policy owners requesting cash from their policies in the future.

Life insurance contracts are monitored by the states. They can be complex, but they are free from deceit and generally fair to all parties. Their social value is unquestioned.

Aleatory ContractsAleatory contracts are those whose execution or performance depends upon an uncertain or random event and under which the sums paid by the parties to each other are unequal. Casualty insurance policies are aleatory contracts because the insured may collect a large amount after a house fire, for example, or nothing at all in return for premiums paid. Straight life annuities are akin to aleatory contracts because the annuitant might collect well beyond the amount invested, but the company would keep any balance in the event of an early death with a life only option selected. Life insurance premiums are far less than the death benefit payout. The insurance company does not have anything major to do until the death claim is filed. The timing and cause of death are uncertain at the time the policy is issued.

Example: Paul bought a life insurance policy on his wife, Nancy, in the amount of $100,000. The premiums charged by the insurer were $150 per year. Paul could receive a payout far greater than his premiums paid. The difference between the amount paid in overall and the amount paid out by the insurance company depends upon when Nancy dies and if the policy is still in force.

Personal ContractA life insurance policy is a personal contract in that the insured party cannot be assigned. The person identified in the application is the only person whose life the insurance company considered taking the risk on. The policy is priced based on the age, sex, medical history, occupation, family history, driving record, etc. The policyowner cannot substitute the insured of a life insurance policy with some other person unless the policy had some special type of rider that allowed such an event to transpire. The contract between the pool contractor and the homeowner likely can be assigned so long as the new pool contractor lives up to the terms of the original contract. If the pool was made and installed to specifications, it should not matter. The difference between person “A” being the insured and person “B” can be very different indeed. The policyowner can assign the policy to a new owner, but that will not affect the risk the insurance company has taken on the named insured.

Example: Paul buys a life insurance policy on his wife, Nancy, for $100,000. Paul’s mother-in-law, Angela, is in poor health. Paul’s co-worker says that as policyowner, Paul has many rights in the policy, so he can name a new insured anytime he wants to. Paul, having a keen eye for financial opportunity, takes his co-worker’s advice and submits a request to change insureds from Nancy to his mother-in-law. The insurer, upon receiving this request, notifies Paul to inform him that they issued the policy in good faith on the life of his wife, Nancy. Furthermore, they will not insure any other person Paul chooses since the policy is personal in nature, and changing insureds is not one of his rights as owner of the policy.



Conditional ContractThe performance of the life insurance contract is conditioned upon the death of the insured. Until such time, the insurance company is not obligated to pay out the death benefit. Even if the insured dies, there still are conditions that must be satisfied before the actual death benefit is paid. The insurance company has to be assured that:

• The deceased is in fact the person listed as the insured• The death must not be from suicide within the first two years from the policy issue date • There must not be any circumstances that would cause the insurance company to contest the

claim • The policy must be in force at the time of death of the insured

Example: Paul buys a life insurance policy on his wife, Nancy, for $100,000. Paul submits a death claim to the insurer after Nancy dies. The insurer’s death claim department, after verifying that the policy was in force at the time Nancy died, examines the death claim form and notices that it requires a certified copy of Nancy’s death certificate that is missing from the claim submission. The insurance company contacts Paul and informs him of this requirement in order to process the claim. Paul mails in this form, and within a few weeks the claim is paid.

Example: Jeeves buys a life insurance policy on his business partner, Wadsworth, for $1 million. Jeeves submits a death claim to the insurer after Wadsworth supposedly dies. The insurer’s death claim department, after verifying that the policy was in force at the time of Wadsworth’s death, examines the death claim form and notices that there are some discrepancies in the claim submission. They contact Jeeves and inform him that there is some other information required in order to process the claim. Jeeves says he will get back to them. Within a few weeks, it is discovered that Wadsworth is in fact alive and that the two came up with a scheme to defraud the insurance company out of money in order to cover some of Jeeves’ gambling debts. Law enforcement was called in to deal with the situation. The claim was not paid.

Life Insurance Contract LanguageIt is important to understand the contractual terms and clauses that commonly appear in life insurance policies. Some of the elements apply to formalized contracts; some apply to life insurance contracts.

RepresentationsA representation is a statement or assertion that leads someone to take a specific action. The statement or assertion may or may not be spelled out in a contract, and the belief may or may not be accurate, but if a reasonable person is led to a reasonable conclusion, a ‘representation’ may override other factors.

This is one of the reasons for contractual “fine print” and for insurance representatives to be aware of the impact their statements and those of their clients can have. It is not enough, for example, to say that pre-payment establishes coverage during the underwriting process without pointing out that the coverage commences only after any required medical exam is completed (which means they must be alive to have one performed), if one is so required, and that the check must clear the bank (adequate consideration).

On applications for life insurance coverage, in the absence of fraud, all statements are considered representations and not warranties. The representations made by the applicant are to the best of his/her knowledge, as well as accurate and complete. For example, it might be difficult if not impossible to know for certain what exact ailments the applicant’s parents had during their lifetime if the parents did not share their health information with their children. Also, if someone answered “no” to a question about a particular health condition and it turned out later that they had or died from an undiagnosed illness, how



would it be fair to hold them to a standard of diagnostics to that of a highly skilled medical professional, especially if they showed no outward symptoms? These representations are the starting point for an insurance company’s underwriting team to determine what other information is needed to establish the risk class the proposed insured presents.

In another context, representation refers to the relationship between agents and their companies. In ‘exclusive representation,’ an agent is bound to submit applications to a particular company, at least until that company rejects the business. This relationship still exists with certain companies today, especially between new agents and the companies that hire, pay, and train them.

WarrantiesWarranties carry more weight than representations. In general contract law, a warranty is defined as an express or implied term in a contract that assures a statement of fact is true and may be relied on by the other party. An example of this may be a seller’s promise that the item being sold is as promised or represented.

An express warranty is an element of a written contract that promises something. The cruise will sail on a certain date. An implied warranty is one that, while not expressly stated, is implied by the sale. The cruise ship will be seaworthy. The hammer will last 10 years. The muffler will last 1 year.

In the context of insurance, a warranty is an assurance that certain statements are true or that certain conditions will be fulfilled, the breaking of which invalidates the policy.

If statements made on the application were considered warranties and not representations, and someone answered “no” to a question about a particular health condition and it turned out later that they had or died from this undiagnosed illness, then that can be used against the policyowner or beneficiary. This could lead to the policy being cancelled by the insurer, pricing changes, or benefits denied or reduced. The warranty approach is a much higher, or stricter, standard to be held accountable to as compared to representations.

WaiverA waiver occurs when a party voluntarily relinquishes a privilege or right. Examples abound on cable television police dramas when suspects routinely waive their right to counsel. Doing so with full awareness is an express waiver. A relinquishing of a right through continuous action, without actually acknowledging it, can also be recognized as a waiver. An insurer extending the premium-payment grace period and accepting the overdue premium would be an example or waiving an exam, medical records, or financial documents, before issuing a policy.

EstoppelEstoppel often follows waiver. It refers to the concept that previous actions or statements establish precedents that cannot be changed on a whim. A simple example would be an insurance company routinely accepting an insured’s premium payments 65 days past the due date rather than 31 days as stated in the policy. After accepting the ordinarily late premium and then learning that the insured is gravely ill, the company could be prevented or in legal terminology, estopped, from enforcing the 31-day rule claiming the payment was submitted well past the 31 day deadline; therefore, the policy has lapsed. It probably will require proof that the company routinely accepted late payments, but once a waiver is relied upon, it may be too late to enforce the written rule.

Another example would be an insurance company who issues a policy at preferred rates without requiring any medical records, tests, or exams. Three years after issuing the policy, the insurance company cannot



then raise the premium based on a pre-existing condition, since they had the right to gather the necessary information prior to issuance, and waived that right by their inaction. Therefore, they are prevented, or estopped, from being able to reassert that right. If the insured is trying to increase his/her coverage from that point on, the insurance company can require an exam be completed prior to issuance or premium determination for the additional coverage.

MisrepresentationsA misrepresentation is an act of deception by a person that results in, or has the potential to result in, injury or damage to another. Intentional misrepresentation is a form of fraud. Turning back an odometer in a car to make it more saleable would be an example. An insurance agent intentionally misrepresenting an existing policy’s features, benefits, and costs in order to induce a replacement with a new life insurance policy that generates new first year commissions would be another.

A misrepresentation need not be intentional to be unlawful although a party who misrepresents out of ignorance may escape punishment. It should not be necessary to point out that insurance representatives at all levels have an obligation to be well informed about all aspects of their products. Failing to disclose information is known as concealment and is a form of misrepresentation.

Example: Sean is asked by his life insurance agent if he uses tobacco. Sean replies “No” just as he reaches for a lighter for the hand-made cigar he pulls from his inside coat pocket and puffs life into it. Since the insurer has non-tobacco use rates and tobacco use rates, this information is deemed material. If Sean is applying for non-tobacco user rates, he has made a material misrepresentation. If the insurance agent fails to disclose what he saw during the application process, he would have directly participated in the material misrepresentation in violation of the agent agreement with the insurer that could lead to employment termination. The tobacco use is likely to be discovered during lab work if a paramedical exam is ordered by the company.

Example: Richard is asked by his life insurance agent if he had surgery within the past 3 years to which Richard replies “No”. As it turns out, Richard did see a podiatrist to have an ingrown toe-nail removed, which was technically classified as a surgery. His answer, representation, would very likely not be considered material, and would have no impact on the issuance of the policy or subsequent claim payment.

Note: Statements made by an insurance applicant are considered representations, not warranties, but this does not excuse materially false statements or material misrepresentations. If an applicant makes a material misrepresentation – one that influences the issuing of a policy, or the rate at which is charged – the insurance contract can be modified or legally voided typically during the contestable period.

The Policy ApplicationLife insurance companies receive initial information about an individual proposed insured through statements made in the application. The application, which is usually filled out by the insurance agent in the presence of the insured, allows the company to determine whether the applicant is insurable. The insurance agent acts as the “eyes” and “ears” of the insurance company. If the agent sees or hears anything out of the ordinary, he/she is obligated to inform the insurance company as there is a principal-agent contractual relationship. For example, if the proposed insured answers “No”, when asked by the agent if he currently use any tobacco products, while lighting up a cigarette or chewing tobacco, this has to be noted by the agent in the notes section of the application for the home office underwriters to see and consider.



Application information typically requested includes:

• Age, sex, type, and amount of insurance requested• Beneficiary designations • Name of the owner• Information about any other life insurance in force or applied for• Occupation• Information about any medical conditions or treatment• Family medical history• Driving record

Depending upon the company’s guidelines regarding an applicant’s age and the requested insurance amount, an Attending Physician’s Statement (APS) may be requested from each of the applicant’s indicated doctors or medical facilities (with the applicant’s signed Health Insurance Portability and Accountability Act - HIPAA release) regarding any recent or past visits. It is also likely that a paramedical or full medical examination may be required. Adverse health information could result in a premium-rate increase above the standard rate or even outright rejection (declination) of the application (offer).

Signatures of the insured and policyowner are required along with the selling agents’ signature. Any changes made in the application require either that a completely new application is taken out and completed or a line is drawn through the incorrect information with initials of the insured/policy owner proving acceptance of the change. It depends upon the insurer’s procedures as to which one is acceptable. Incomplete applications are either returned, or if the policy is issued, it is with an outstanding requirement to be completed satisfactory to the home office prior to coverage starting. This is normally taken care of prior to or at the time of policy delivery.

Receipts should routinely be given to the policyowner indicating the amount and type of insurance applied for and for any monies that may have been paid at the time of application. The receipt can act like an issued policy in cases where death occurs prior to issuance, as discussed earlier.

If a policy replacement is part of the transaction, additional paperwork is required. Briefly this is a state insurance law requirement providing disclosure to the:

• Policy owner• Insurance company being replaced • Replacing agents company

It is in the spirit of protecting the best interests of the policy owner and insured.

Additional disclosures are required to be given to the policy owner/insured. These include:

• A HIPAA notice – allowing medical providers to share information with 3rd parties• A HIV (human immunodeficiency virus) consent form – acknowledging tests will be conducted and a

designated medical professional will be contacted about positive test results • Information about the Fair Credit Reporting Act in cases where the policy is not issued or at a rate

other than standard - to allow the insured the opportunity to challenge or correct any incorrect information stored in 3rd party systems



The Underwriting ProcessUnderwriting is the process of evaluating the risk presented to the insurer from the applicant in order to determine if that risk can be accepted or not by the insurer. Besides the amount of coverage and the type of policy chosen, the premium is determined by certain other characteristics of the proposed insured.

Some of those characteristics, like sex and age, are pre-charted. For example, the base premium for a 40-year-old man is higher than that for a 30-year-old man, all else being equal; and women are generally charged less than same-age men based on their longer life expectancies. Other underwriting factors are judged on an individual basis. Same-age smokers pay more than non-smokers for the same policy; someone on blood-pressure medication might be surcharged, as might a sky-diving hobbyist. Some companies specialize in “sub-standard” risks. Their premiums, while higher than standard, tend to be more competitive because they spread the risk among similarly health-affected people. Based on the information provided to the insurance company’s underwriters, the risk may be accepted as applied for, the insurance company may ask for more premium dollars to accept the risk, or the risk may be unacceptable in which case the offer to buy coverage will be declined and any monies paid at the time of application will be refunded to the policyowner.

So, where does all this information come from? It starts with the representations made on the application. The agent, acting as a field underwriter, also has the opportunity to shed some light on the person applying for coverage based on the visit in the agent report section. The agent can help clarify certain situations and help the applicant present the case based on any information that may not specifically be asked for on the application. For example, the reason for taking a particular type of medication may require an explanation. Certain medications may be for heart issues, but may also be used for other purposes. An insured may have certain test results showing positive results but may not have anything to do with what the initial screening is primarily used for. So, the professional life insurance agent helps to paint the picture for the underwriter to appropriately interpret the information.

The insurance company underwriters can also request copies of medical records and/or an attending physician statement (APS) that the insurance company will pay for. If the face amount of coverage is high enough, an investigative consumer or inspection report can be ordered. Sometimes neighbors of the insured are interviewed by 3rd party companies, or it may simply entail a phone call to the insured by the same company. The insurance industry has also set up the Medical Information Bureau (MIB) to alert its member companies to errors, omissions, misrepresentations or potential fraud in the application process from applicants within the last 7 years. Finally, they can require paramedical or full medical exams, as well as lab tests. It takes time and money to get the job done right. It starts with the field underwriter, the agent, while the final decision rests with the home office underwriters.

Note: The details of any adverse underwriting decisions cannot be shared with the insurance agent of record. The information can be shared only with the insured or the insured’s specified medical professional. The information is treated as personal and confidential.

Life Insurance TablesAll life insurance companies make use of actuary and mortality tables in devising types of policies, riders, and establishing premium rates.

• Actuarial tables are derived from a wide range of statistics used to help calculate insurance risks and premiums. Actuarial analysis is a highly complex procedure.

• Mortality tables are an important component of actuarial computation. The tables show life expectancy and the average probability of death as a function of age, sex, occupation, and other items. For example, a mortality table might show that at age 34, two out of every thousand persons will die, while the life expectancy of those who do not die at age 34 is age 72. Since some



will die at age 35, 36, etc., expectancy to 72 might seem peculiar, but that takes into consideration those who will live to age 92, 93, and beyond or die before age 72. Seventy-two, then, is an average expectancy. One-half of the group is expected to die before that age and one-half is expected to live beyond that age. Companies know approximately how many will die at a given age. Fortunately, they don’t know who.

The Element of Financial RiskPinning down the financial ramifications of someone’s death is not an exact science. Death, of course, is certain; when it will occur is not. Neither is the extent of financial obligations left behind. Without discounting the emotional devastation that comes in the wake of many deaths, it is fair to say that life insurance is the only protection against distressing financial problems that is guaranteed to be there at the precise time it’s needed, provided the proper amount of coverage was purchased and the policy remains in force.

Spreading and Transferring Financial RiskIf every homeowner could accumulate and leave enough money to pay off the mortgage balance in the event of death, then there would be no need for mortgage insurance policies. For those who are unable to accumulate the necessary funds prior to death to pay the mortgage balance, another way to do this is to pay a little over time to insure that the surviving family members will have this obligation taken care of. This is where life insurance comes into play. The law of large numbers allows an individual to insure the outstanding mortgage balance by spreading the risk among the other policy owners. Ultimately, they are trusting that the pool of money representing the premiums and investment earnings given to an insurance company that guarantees to disburse enough to pay the mortgage will be around when the claim comes due. For a price, the premium, the insured is able to transfer the financial risk over to the insurance company. That’s called peace of mind.

Life Insurance Contract ProvisionsLife insurance policies are first and foremost contracts. Occasional legal disputes, which occur in all areas of business life that are not settled in arbitration or through mediation, are traditionally decided by the courts based on contractual language. The personal, subjective expectations of policyowners are secondary to that language. Provable deception or fraud by an insurance company or one of the sales representatives against one of the policyholders is an obvious exception and vice versa.

Some contract provisions are designed to protect the life insurance company from being defrauded. Other provisions protect the policyowner, the insured, and the beneficiary from bad-faith actions by the insurer or one of its representatives.

Entire ContractThe entire contract between the parties is the policy itself and a copy of the application, which normally is attached to the policy. Nothing can be incorporated by reference. Any changes to the policy, any of its riders, ownership, beneficiary designations, etc. must be requested in writing by the policyowner to the insurance company. Only one of their officers or registrars, not the selling agent, has the authority to make any policy changes official. So, what the agent says and any sales illustrations used by the agent are not part of the entire contract.

Example: Sean was asked if he used tobacco products during the application process and he said, “No”. The application was attached to the policy when it was issued. That statement is now part of the entire contract and can be used against Sean and for the company at the time of a claim depending upon when the claim is filed.



Note: While what the agent said and any sales illustrations are not part of the entire contract, they can be used against the insurance company and the agent based on state unfair practice regulations.

Insuring ClauseThe insuring clause is traditionally found on the front page of the life insurance policy. Here the insurance company agrees or promises to pay the death benefit to the beneficiary based upon the terms of the policy when they receive proof of death of the insured as long as the death occurred while the policy was in force and no exclusions apply. Exclusions may address the extraordinary risks for deaths attributable to wartime, aviation (especially for newer private pilots), or hazardous occupations or hobbies.

Ownership Rights While the policyowner is usually the same person, the owner and the insured may be two different parties, and is always the case when a minor child is the insured. A life insurance policy is a piece of property, and the owner of that property is entitled to certain valuable rights. The owner of the policy is the person who applies for and enters into the contract with the insurance company. The owner is also referred to as the applicant and is solely responsible for paying premiums.

The owner has various rights such as selecting the mode of payment, designating or changing beneficiary designations and withdrawing cash values. The owner can also pre-select the settlement option the beneficiary will receive, elect any dividend options available, determine how the net premium will be invested within a variable insurance contract, as well as have the right to assign the policy for a loan or on a permanent basis to some other party. Pre-selection of the death benefit settlement option is useful when the beneficiary is of limited capacity.

AssignmentThe owner can assign or transfer the policy to a third party as a gift, or for valuable consideration (cash or otherwise). An example of assigning the policy would be in the case of providing collateral for a loan. A bank may be willing to extend a loan to a business person, but at the same time will want some assurance of being paid back while the business person is alive, a measure of their creditworthiness, or if they should pass away, as collateral. The bank may require the business owner to collaterally assign, make the bank full or partial owner of the policy, and named beneficiary, only as far as the outstanding loan balance is concerned. Once the loan has been repaid, the assignment is released to the business person in full. The collateral interest the bank had during the time of the assignment was limited to the amount of the outstanding loan. Any excess values would be paid to other named beneficiaries. This is referred to as a collateral assignment which is temporary in nature.

Example: Eric is a business owner in need of additional capital to expand his business. He owns a permanent life insurance policy that he has had for many years. In order to approve the loan, the bank requires some form of collateral to secure the debt. Eric says he has a life insurance policy. The bank agrees that this is an acceptable form of collateral. Before issuing the loan, the bank and the insurance company require a collateral assignment form. This way Eric can name a 3rd party, who has a vested interest in the policy, in case Eric dies prior to paying off the loan in the amount of any outstanding debt. Once the loan is paid off, a release from this assignment will need to be completed. The policy owner has the right to collaterally assign the policy to a third party in situations such as this.

Assigning a policy on a permanent basis is called an absolute assignment and typically takes place in estate planning situations where an existing life insurance policy’s ownership is transferred to an irrevocable life insurance trust (ILIT) in order to keep the value of the death benefit out of the estate of the original policy owner.



Absolute assignments are found in viatical and life settlement transactions. The policyowner irrevocably assigns (exchanges) a life insurance policy in return for an immediate, reduced cash amount, essentially ‘selling’ the policy for somewhat less than the eventual death benefit. So-called viatical or life settlement companies offer discounted cash amounts of, say, $75,000 in return for a policy with a $100,000 or at times $1,000,000 death benefit. The viatical/life settlement company continues to pay the premiums; their potential profit comes when the insured dies.

Viatical settlements most often involve a critically ill insured or owner in need of immediate funds, and the payment depends on that individual’s remaining life expectancy. Such arrangements can be considered ‘assignment-for-value’ and can cancel any historical tax advantages found in life insurance policies. Many insurance companies offer some form of accelerated death benefit which allows partial or total withdrawal of the proceeds prior to death in cases of terminal illness. Life settlements on the other hand offer non-terminally ill seniors and senior business owners a way to obtain cash greater than the policy’s cash values but less than the death benefit for policies that are no longer wanted, needed, or can be afforded.

Absolute assignments can also take place when a policy is donated to a charitable organization, when a parent assigns policyowner rights to their now adult child for a juvenile policy, or in divorce situations.

Example: John and Terri were business partners for 15 years. They purchased life insurance on each other in case either should die the survivor would have the cash necessary to continue the business. John is retiring so the need for coverage no longer exists for business purposes. John wants to maintain coverage because his health has deteriorated, and he does not want to have to go through underwriting now. Terri names John the new owner of the policy that originally insured him as part of the business succession plan so he can maintain coverage and not have to apply for a new policy. John then names Terri the new owner on the policy he had on her. Both assignments are considered exercising an owner’s right and are referred to as absolute assignments.

Free LookThe policyowner has the right to examine the issued policy for 10 days from receipt (delivery), and if not satisfied for any reason may return it to the selling agent or home office of the insurance company for a full refund of any premiums paid up to that point in time. The policy will be considered void from the very beginning. To lock in the starting date of the free look period, many agents have their clients sign a policy delivery receipt that also signifies proof of delivery. So, if the policyowner wrote a check for $500 payable to the insurance company at the time of application, the agent provided a receipt for the check, turned in the check along with the application to the insurer, the insurer issued the policy as applied for, the agent delivers the policy to the policyowner, the policyowner has 10 days from acceptance of the policy (delivery) from the agent to return it for a full refund of the $500 paid at the time of application, no questions asked. Any and all costs, direct or indirect, are absorbed by the agent and the insurance company.

For replacement sales, the free look period may be 20 days in certain states. For sales to the elderly, typically over the age of 64, there may be a 30 day free look in certain states. For variable contracts, the free look period can be 45 days from the application date or 10/20/30 days from policy delivery, whichever time frame is longer, depending on the state, type of sale, and age of the insured.

Misstatement of Age or GenderIf the age or gender of the insured is misstated, the life insurance policy can and will be adjusted to the correct age and gender of the insured. So, if a male insured stated on the application for a $100,000 term life policy that he was age 40 instead of his actual age of 42, then he would have understated his age and paid an insufficient premium. So, for the premium paid, the coverage would be reduced by some formula to essentially what should have been issued based on the correct age and premium. This would also be true in the case if this was discovered at the time of a claim.



Any overpaid premiums as a result of overstating an insured’s age would simply be refunded. Some companies may increase the coverage, but it would then have to deal with underwriting guidelines that would not have been adhered to such as additional underwriting tests or medical records requested and reviewed prior to policy issuance. But then again, it is less likely an applicant would overstate an age as compared to an understatement because there would be no advantage in doing so. Be sure to look at the specific language in the policy in question to see how a particular insurer will handle this.

Contestable ClauseProposed insureds must reveal their complete and accurate health histories on the application, subject themselves to paramedical exams that include an interview, blood, urine, and saliva tests, and in some instances, a medical examination. There’s a contestable period, usually two years from the date of policy issuance, face amount increases, or reinstatement during which the company may invalidate a policy (or a portion of the death claim) upon discovering materially false statements, misrepresentations, that would have precluded issuance, face amount increases, or reinstatement of the policy. In other words, the company has a time limit to contest a claim for benefits based on certain actions or inactions by the applicant.

The contestable clause actually provides peace of mind to the policy owner and beneficiaries that as long as the policy does not lapse the insurer cannot later deny a claim on the basis of any statement made on the application that was attached to the policy beyond the time limit specified. After the time period has run its course, the policy is incontestable. Think of it as a statute of limitations.

Example: Terry forgets that he had athletes foot one year prior to taking out a life insurance application on himself. The policy is issued. He dies 4 years later. The company cannot contest the claim since it was beyond the period of time in which the insurer could contest (challenge) the claim.

Example: Terry fails to disclose that he went to an emergency outpatient clinic for chest pain one year prior to taking out a life insurance application on himself. The clinic told Terry to see a cardiologist immediately once he was back from his vacation. He never did. The policy is issued based upon his representation that he was in good health, has never had chest pain or been seen by any medical professional for chest pain. Terry dies 1 year later. The company can contest the claim since it was within the period of time in which the insurer could contest (challenge) the claim. Had the insurer known of this material information, they may have conducted further underwriting which may have led to a different decision as to the risk. During the claims process, the home office will re-underwrite the policy. If the decision was the same based on the true information, the claim will be paid; if the decision was different, the claim will not be paid.

Suicide ClauseOne provision that protects all parties is the ‘suicide clause,’ which states that the death benefit will not be paid if the insured’s death results from suicide within two years of the policy issue date. This provision protects the company against someone buying a policy in contemplation of suicide, but its original intent was to protect beneficiaries against companies declaring certain types of deaths, such as drownings or single-car crashes, to be suicides and refusing to pay the proceeds. The insurance company will only be liable to refund any premiums paid to the named beneficiary if the insured dies as a result of suicide while sane or insane during the first two years after policy issuance. After two years, the claim will be honored as any other death claim would be. This also applies to any increases in coverage or policy reinstatements.

Example: Anthony buys a life insurance policy on himself. He pays a $10,000 annual premium for a $1.5 million policy and names his wife as beneficiary. One year after the policy is issued, he commits suicide after being fired from his high-paying job, which he was using the monies from to pay off massive gambling debts. The insurance company’s claim paid is equal to any and all premiums paid on the policy.



Example: Charles buys a life insurance policy on himself. He pays a $20,000 annual premium for a $2.5 million policy and names his wife as beneficiary. Four years after the policy is issued he finds himself suffering from depression, about to file for bankruptcy, and his marriage is on the rocks. He drives his brand new Mercedes-Benz off the pier and into the ocean immediately after being fired from his high-paying job, and drowns. The insurance company’s pays out $2.5 million to his wife who was listed as the beneficiary.

Premium CalculationsThere are three primary components in the calculation of base life insurance premiums. Companies consider mortality charges, expenses, and returns on investments.

Mortality charges cover the insurance company’s risk of paying the death benefit. The charges are based on proprietary statistical mortality tables that try to predict the average number of people of a specified sex and age who will die in a given year. The rate of mortality helps life insurance companies determine how unlikely or how probable it is that a death benefit will be paid in the near future. Based on that number, the insurance company is required to have adequate reserves on hand to pay those claims.

If there is low probability, the insurance costs less. The higher the probability, the greater the insurance cost. For example, if the mortality rate for 40-year-old men is 85 deaths per 100,000, jumping to 285 deaths per 100,000 at age 50, that factor will generate a higher premium at age 50 than at age 40. Mortality tables indicate that people are living longer than at any other time in our country’s history. This has implications for insurance planning considering both old and new policies.

The insurance company’s expenses include operational costs: administrative, sales, marketing, taxes, and a myriad of every-day overhead costs. Given the complexities of the insurance business itself, the changes in technology required in order to remain competitive, and the myriad of rules and regulations that must be complied with, such as privacy and anti-money laundering, costs are ever changing and increasing.

The return on investment component refers to companies’ earnings on their own investments held in the general account. Insurance companies, property/casualty as well as life, hold a great deal of money – their “inventory” – which they park short-term and long-term investments. The necessity to hold large reserves dictates conservative investments such as government and highly rated corporate bonds, and certain preferred stocks. 2% of 200 million dollars is still a lot of money. Fluctuating returns have an impact on pricing.

The basic formula is: premium = mortality + expenses – investment returns. For participating policies it goes something like this: premium = mortality + expenses + dividend – investment returns.

An example of the impact of the investment component was seen in the 1980s, when property liability rates rose dramatically after outside interest rates dropped quickly. The 2- and 3-fold increases forced the closure of many entities, including many marginal non-profits. With interest rates at historic lows, companies are having a hard time using this component to keep premiums rates down. With insureds living longer, there has been a slight offset in the life insurance marketplace with the savings from aggressive expense cutting at the home and field offices.

Within the established base premiums, final rates are influenced by individual characteristics. Smokers pay more than non-smokers and sky-divers more than stamp collectors. Those in less than good health pay more than those in good health, but the individual rates all stem from the overall base rates. An underwriter’s job is to place the applicant into the appropriate rate category: preferred, standard, or rated if the risk is an acceptable one or declined if it is not an acceptable risk to take.



Insurance companies offer a wide variety of policies at different premiums. While each company’s expense and investment calculations will vary, the statistically based mortality charges differ very little. The one component over which companies have the most control is the expense factor. Adding a cushion, or “load,” to the expense factor and seeking higher than estimated returns on the investment factor is one of the companies’ main source of profits. No matter how well investments perform or how operationally efficient the home office is, if the underwriters are accepting too many high risks and not charging the proper rate, the losses can be significant.

Payment FrequencyPremiums are generally structured on a cost per-thousand dollars of coverage basis and an annual mode. For example, the annual premium for a $100,000 policy with a stated premium of $8 per thousand would be $800 ($100 x 8) – plus what’s known as a policy fee – so if the policy fee were $50, the final cost would be $850 ($800 + $50).

Other modes of payment are available. Premium payments may be remitted:

• Semi-annually, or twice every 12 months• Quarterly, at 3-month intervals• Monthly, due each month on the policy’s due date

A monthly automatic withdrawal from a checking or savings account has also become a popular mode of premium paying. Automatic premium withdrawals may be lower than the monthly billed premium. Many companies no longer bill monthly; instead, they require monthly payments to be done electronically. The companies encourage this mode of payment which has helped in reducing the number of lapsed policies and saves on costs.

The more frequent than annual modes come at a cost, imposed by the companies to offset the cost of additional administrative processing and lost interest. For example, the semi-annual premium may be $442; quarterly premiums may be $226; and monthly premiums $73.

Example: Mike applies for a $100,000 life insurance policy. Based on his age and underwriting class, the cost per thousand dollars of coverage is $4. If the annual policy fee is $50, the premium for the $100,000 policy at $4 per thousand would be $450 (100 x $4 = $400 + $50 = $450). More frequent premium modes carry relatively higher premiums and overall fees to cover the cost of collecting and processing the premiums. In this example, the quarterly premium may be $108 and the fee $14 for a total yearly premium cost of $488 ($122 x 4).

Generally, companies will allow policyowners to switch from one mode to another on appropriate dates with advance notice. Some policies were designed as single premium policies where one lump sum payment may maintain a policy for many years. IRS regulations that strip “overfunded” policies of some tax advantages have made single premium plans less popular than they once were. Not all policies allow this, and not all companies have an account to hold advanced premium deposits to apply toward future policy premiums.

Policy DateLife insurance policies are in effect from the date of issue or the “policy date.” The policy date is set when premiums are due. Most often these two dates are the same; however, depending upon the timing of the premium payments, or if “backdating” is requested to save age, but for no more than 6 months and paid for, the dates may be different. Some companies base insurance age on the last birthday that has just passed or the age nearest to the birthday (if the insured is closer to age 35 than they are 34, even if they are technically 34 right now, then they are classified as age 35). The policy date establishes the policy’s anniversary date, and it is used to determine future premium due dates and other important dates.



The due date is the date on which all premium payments, after the first payment, become due. Annual premiums for a policy dated May 9 are due every May 9 thereafter; semi-annual premiums are due on May 9 and November 9; quarterly on May 9, August 9, November 9, and February 9; and monthly on May 9, June 9, etc. Premiums are paid in advance.

A policy dated May 9 will mark its anniversary date every May 9 thereafter. This may be unnecessary to point out, except to note that some policy provisions which are tied to the insured’s age take effect on the policy anniversary date following attainment of that age. For example, an automatic increase in coverage at a juvenile’s age 21 would go into effect on the policy anniversary date following the insured’s 21st birthday. Term conversion periods, and rider end dates can be based off this date as well as contestable and suicide clause dates.

Cash ValueCash value is the overall term for the accumulation of financial value within a life insurance policy. Those values accumulate in different ways in different types of policies. In traditional whole life insurance policies, the guaranteed cash value is listed in exact amount year-by-year in the nonforfeiture values under the heading cash surrender values, and thus do not vary over time. All of the numbers are predetermined by set figures and interest rates. In universal life insurance policies, the cash is held within an accumulation account and is credited with a current interest rate the insurance company declares but in no case will it ever be less than the contractual stated guaranteed minimum interest rate. For variable or variable universal life insurance, the amount of cash value is a function of the return on the underlying fixed account and/or investment subaccount investments as selected by the policyowner less any deductions for charges or fees.

Traditional cash value generally does not begin to accrue until the end of the second-to-fourth policy year after which it increases annually in accelerating amounts over time due to additional premium payments and earnings. At any point during the accumulation, the policyowner has access to the cash value through the loan provision or by surrendering the policy. In universal type policies, partial surrenders may also be requested.

Cash values are a result of premiums paid in excess of the actual insurance company “at-risk” costs in the early years as a means to level out the premium over the duration of the contract. As the years progress, this tends to reverse itself so the cash value can actually grow at a faster rate.

Whole life policies mature, or endow, at age 100, at which time the guaranteed cash accumulation equals the death benefit. Up until the 1990s, that generated an automatic payout to the policyowner, which could generate a taxable event. Many companies now allow centenarians to leave the money with the company, at interest, preserving the tax free benefit for the eventual beneficiary. No more premiums can be paid in. Loans can remain outstanding, and essentially the cash value becomes the death benefit payable upon death to the beneficiary.

Nonforfeiture ValuesNonforfeiture provisions protect policyowners from total loss of built-up values in the event of a policy lapse. The first nonforfeiture provision, cash value, assures the owner access to the accumulation even after a policy lapse due to non-payment of premium. After all, the cash values represent an overpayment in premiums in relation to the net risk the company takes in order to provide a level premium in later years when the table turns.

Under the reduced paid-up nonforfeiture option, the available cash value may be applied to the purchase of an amount of insurance that requires no further premium payment, an actuarially equivalent value. So, this single premium reduced benefit is paid up for life. Originally the policy may have had a death benefit of $50,000; now it may only have a benefit of $7,500 if the reduced paid-up option is elected. It depends upon the number of years the policy has been in force, if any loans are outstanding, and how much cash value is available.



The third option is extended term, under which the initial face amount is continued for a given number of years and days. Extended term applies automatically if neither of the other two options is selected after a lapse. It is essentially using the cash values as a one-pay term for a specific period of time, an actuarially equivalent value.

Let’s consider some examples:

After 12 years if a $50,000 life policy has accumulated $6,000 guaranteed cash value, that amount may be withdrawn even after lapse due to non-payment of premium, assuming the automatic premium loan provision is not active. Alternately, the owner could request a lifelong paid-up policy. The $6,000 would buy about $9,000 - $12,000, depending upon the insured’s age. It is based on the table found within the policy itself. Notice how the amount of the paid-up benefit is reduced from the original face amount. If neither option is selected, the original $50,000 remains in force as pure term insurance for a time specified in the policy’s table of nonforfeiture values. This may amount to 7 years and 225 days of coverage. Of course, there would be no cash value remaining. The extended time increases for each year the policy was in force. When settling a claim, the insured may have more than one policy in force now or in the past. The insurance producers should ask about any existing lapsed policies; a lapsed policy still on extended term at the date of death will pay its face amount.

The non-forfeiture table would look something like this (the numbers are purely hypothetical and are for illustration purposes only) for a $50,000 face amount whole life policy:

Policy Year

Cash Surrender Value

Reduced Paid-Up Insurance

Extended Term Insurance Years / Days

10 $5,000 $7,000 5 / 1211 $5,500 $7,985 6 / 10412 $6,000 $9,000 7 / 22513 $6,500 $9,750 8 / 316

Policy LoansAfter a permanent life insurance policy such as a whole life insurance policy has been in force for several years, it builds cash value and is available to the policyowner in the form of an interest-bearing loan. The interest rate, generally lower than outside commercial rates, is stated in the policy. The favorably low interest rate is because the loan is directly from the insurance company and is secured by the cash value of the contract as well as the death benefit. It may seem strange to pay interest on what some policyowners consider their own money, but the company’s bottom line includes earnings on the reserves it holds, either through conservative investments such as U.S. Government securities or via repayment of loan interest. The policyowner need not repay the loan as is true with any installment or other consumer debt, for fear of default, but the interest accrues annually and outstanding loans and loan interest are deducted from the death benefit upon payment of claim, or from the cash values upon surrender. Policy loans are generally not a taxable event even if the loan is for an amount greater than the cumulative premiums paid up to that point in time, unless the policy has been classified as a MEC, or the policy lapses.

The insurer has the contractual right to defer both cash surrender value and loan requests for up to 6 months, just in case there was a run on the insurance company’s general account like there was on the banks during the depression of the 1930’s. The insurance companies have seldom invoked their right to defer a request for policy cash surrender or policy loan. The amount available for policy loans is the largest amount that, with accrued interest, does not exceed the cash value on the next policy-anniversary date. The cash value is its own collateral, in the same way that the value of a house is the collateral for a mortgage loan. In order to borrow $1,000, there must be at least that much cash value unattached in the policy. The insurance company has a collateral interest in the policy up to the amount of loan outstanding and only while the loan is outstanding.



The low interest rate charged for policy loans can be an attractive feature. Fixed rates on older policies range from 4 to 6%. On newer contracts, the rates may be as much as 8%. At one time, money markets were paying over 10% and transferring cash values via policy loans into them was a smart financial move. This was an arbitrage opportunity that essentially allowed the policyowner to earn a risk free return, borrowing at 6% and investing at 10%, thereby earning 4%.

Some contracts offer variable-rate loans with rates tied to financial indicators such as U.S. Treasury bills or some nationally recognized fixed income index. With a variable rate, the insurer adjusts the rate periodically, such as the first day of each calendar quarter. Interest accrues on a daily basis from the date of the loan or, for premium loans, on the premium due date. If unpaid, the interest becomes part of the loan principal. In the same manner as fixed-rate loans, the interest is compounded annually.

For universal life insurance and variable policies, the loaned-out amount still earns interest in the policy. Think of a $6,000 loan from a $12,000 cash value as coming from a separate source, while half of the $12,000 is held as collateral. It’s still there, but it is not accessible anymore since it is now collateral. Since the company is still holding the loan amount, they pay interest on it, but at a rate lower than the un-borrowed amount might earn.

Let’s say the cash value return is 7%. The interest credited to the collateral amount being held may be 4%, while the interest charged for the loan may be 6%. In essence then, the true cost of the loan is 2% (6% - 4%). Paying at least the loan interest every year preserves that ratio. With some companies and in some policies that have been in force for a while, they even offer “wash loan interest rates” where the amount charged for the loan is equal to the interest credited to the cash values.

Under a principle called direct recognition, a policy loan can have a significant impact on dividends paid in participating policies issued by mutual companies. Dividends are essentially a return of unearned or excess-cushion premiums and are based on the companies’ earnings on their reserves. In direct recognition, the company will deduct from the dividend an amount equal to the difference between what the borrower pays in interest and what they could have expected to earn on the cash value if part of it had not been borrowed. The difference reduces the dividend.

For example, a policyowner has an outstanding policy loan of $5,000, for which 5% interest is being charged. Based on the company’s anticipated earnings of 7%, the declared dividend is $500. Since the $5,000 loan is returning to the company, only 5% rather than 7%, the ‘direct recognition’ company will deduct the difference, 2% or $100 ($5,000 x .02), from the dividend. This policy’s dividend will be $400 ($500 - $100) rather than $500, which correlates to an effective rate of 7% on the loan. This preserves the earnings assumption the insurance company made on the reserves which they based their premiums on.

To review, policy loans are at a low interest rate that is stated in the policy and, if outstanding at the insured’s death, decrease the proceeds payable to the named beneficiary. Such amounts are recovered first before any payment is made to the beneficiary. Consider it a secured collateral interest the insurance company has on the policy. The policy loan carries an interest charge that can be paid directly to the company with any future premium or can go unpaid and allowed to accumulate as part of the overall outstanding policy loan. Over time, this may have a negative impact on the policy when there is no further collateral for the insurance company to use to create additional loans sufficient to pay the required premium.

Example: Jared has a $75,000 whole life insurance policy with a $10,000 cash value. He needs $7,000 for an engagement ring for his fiancé. The policy has a 5% loan interest rate. He submits the paperwork for the loan and receives the money. He decides not to pay the $350 ($7,000 x 5%) interest charge for this year. His end of year loan balance is $7,350 ($7,000 + $350). If he decides to cash in his policy, he will receive $2,650 ($10,000 - $7,350). If he dies, the beneficiaries will receive $67,650 ($75,000 - $7,350).



In summary, the consequences of not repaying cash-value loans can include some or all of the following:

• Reduction of the death benefit by the amount of the loan and any outstanding interest• Reduction of the surrender value if the policyowner surrenders the policy for its remaining cash value• Continues to reduce ‘direct recognition’ dividends• Less collateral available for future loans• Potential depletion of values to the point of policy lapse• Policies that lapse with outstanding loans may incur a taxable event if the loan amount includes

values in excess of cost basis (premiums paid)

DividendsMutual insurance companies are not publicly traded; they are owned, in a sense, by their policyholders for their mutual benefit. Company profits, over and above certain retention limits, are distributed to those “owners” in the form of dividends, which are credited to policies in proportion to size and time in force. A 15 year old $100,000 policy would earn a considerably larger dividend than a comparable policy in force for 6 years. Dividends may be used in many ways at the policy owner’s discretion, including withdrawal without current income taxation, since they are essentially a refund of overpaid premiums. Publicly traded, or “stock” insurance companies, do not credit dividends to policies. Dividends, if any, would be paid to stockholders, who may not even be policyowners.

While cash values are guaranteed in traditional whole life insurance policies by both mutual and stock companies, dividends are not. Mutual companies credit dividends based on their profit margins after consideration of their mortality experience, expenses and investment performance. Dividends can be:

• Used to lengthen the protection period• Used to shorten the payment period so the policy becomes paid-up sooner• Accumulated with interest or taken in cash• Applied to reduce the premium• Used to purchase small amounts of paid-up insurance coverage• Used to buy one year term (possibly limited to the policy’s cash values, with any balance

remaining for another option)

For example, if a policy has an original face amount of $100,000, was a participating whole life insurance coverage issued by a mutual company, then dividends may have been used to buy $5,000 of paid-up additional insurance. The proceeds payable at the insured’s death would equal $105,000.

A relatively new premium option is what’s known as “policy improvement,” under which any dividends are added to the guaranteed cash value and lose their separate identity. They can be borrowed out, for example, but not simply withdrawn. This option may also create an increase in the face amount and interior values without any increase in premium amount or frequency.

Example: Pete has a $100,000 participating whole life policy issued by Giant Mutual Company. This year’s dividend was declared and he is going to receive $500 in dividends. He could use this dividend to:

• Help pay up his policy at age 98• Leave it on deposit with the insurance company and earn 5% interest• Offset the $2,100 premium due so he would only have to pay the difference or $1,600

($2,100 - $500)• Buy $5,550 of paid-up additional insurance• Buy $50,000 of one year term life insurance



Note: Participating traditional whole life policies issued by mutual insurance companies may pay policy dividends. Dividends are not guaranteed and must be declared by the insurance company each year if they are going to be paid. Dividends represent an overpayment in premiums which if not needed by the insurance company are refunded in the future. There are several dividend options the policyowner can choose. Dividends are not taxable, but the interest earned by leaving them on deposit is. The receipt of dividends also reduces the cost basis of the policy. Dividends become taxable once payments have exceeded the policy’s cost basis.

Vanishing PremiumThe concept of the vanishing premium depends on the crediting of generous dividends into mutual company participating policies, high interest earnings in universal life policies, or high investment returns in variable universal life policies.

Simply stated, when the cash buildup within a policy reaches a certain level, it may be sufficient to keep the policy in force without any new premium payments. It certainly sounds attractive, but the same decrease in interest rates that precipitated the property and casualty premium increases also created concern among life insurance policy owners who had anticipated vanishing premiums based on consistently high or higher dividends, interest rates, or investment earnings at the time of purchase.

When interest rates continued to fall, the vanishing premium concept also fell. It is important to note that the ‘vanishing premium’ was never contractual. So, selling and buying from sales illustrations without a clear understanding of the internal workings of the policy may lead to negative results, such as unexpected high premium notices, cash values not there when needed, or even policies lapsing even though premiums have always been paid in full on time (just not enough as it turned out). Dividends are not guaranteed, current interest rates can change, and investments can have losses, all of which can negatively impact the original game plan when the policy was first discussed.

Borrowing against a policy’s cash value to pay the premium does not equate to a vanishing premium. Such loans bear interest, and if not repaid, can decrease values to the point where the policy itself vanishes.

The Grace PeriodThere is a grace period, usually lasting 31 days from the premium due date, during which late payments are accepted without any charges, lapse of coverage, or proof of insurability required.

The grace period protects the policyowner and beneficiary against an inadvertent lapse in the policy. It’s an extended period of time, commonly 31 days, from when the premium was due, during which the policy remains in full force despite the fact that the premium has not been paid. All policy provisions remain in effect, and even if the insured dies within that period, the death benefit is payable. The overdue premium would simply be deducted from the settlement payment.

Without this feature, if a payment was even one day late, benefits could be denied, and evidence of insurability could be required to reinstate the coverage. If the premium is not paid during the grace period, the policy terminates or lapses and no further insurance protection exists, except for what would be provided under the policy’s nonforfeiture options. Because lapses are not in the insured’s or the company’s best interest, some companies extend the grace period beyond 31 days to 45 days or even longer. If the policy does in fact lapse, the policy can be reinstated but proof of insurability and the past due premium will have to be received by the insurer in a timely fashion.



Example: Maria has a $150,000 whole life policy in force. Her premium payment is $1,750 per year. While on vacation her premium bill arrives, but she does not return from her extended vacation in time to pay it. Upon returning home, she notices the bill. It is 10 days past the due date. She calls her life insurance agent in a panic and asks what she can do to restore coverage. The agent explains that she actually has 31 days from the premium due date in which to make the premium payment. The insurance industry collects premiums in advance, and the grace period is designed especially for situations in which she has found herself in. Maria sends in the premium payment, and the policy is treated as if the premium were there by the original due date.

For universal life types of contracts, the grace period is not based on a premium due date since the premiums are flexible and the actual mortality cost is deducted from the cash accumulation or investment fund. Here the grace period is 61 days from notice that there are insufficient funds to cover the upcoming mortality cost deduction. Some companies may require 2-3 months of costs to be deposited in order to keep the contract in force.

Automatic Premium LoanThere is also an “automatic premium loan” (APL) provision under which un-remitted premiums are paid automatically, at the end of the grace period, from the insurance company using the cash value as collateral, which keeps the policy in force. The automatic premium loan option or feature is related to a permanent, whole life policy’s cash value. This provision is not automatically included in every cash value life insurance contract, and there must be enough cash value available to cover the premium. Automatic premium loan payments can be a valuable provision, preventing inadvertent lapse. Like any other type of policy loan, interest accrues and repayment is advisable, for no other reason in that it will restore the full benefits within the policy for the policyowner and beneficiaries. The policyowner can turn this feature on or off as they choose.

Reinstatement If the policy lapses due to non-payment of premium, meaning that the grace period has expired, it may be reinstated, within 5 years from the premium due date. Reinstatements require an application, proof of insurability, payment of any and all premium plus interest to bring the policy current, and repayment or reaffirmation of any outstanding policy loans at time of lapse. It may be less expensive to reinstate an old policy rather than buy a new policy. Consider the fact that the original policy may have age 25 rates while the new policy may start out with age 40 rates. The cash value in the original policy may be greater initially than starting over with a new policy because acquisition costs have already been recovered. The loan interest and settlement option rates in the original policy may be more favorable than in the new one. These factors need to be taken into consideration when reinstatement opportunities present themselves.

Example: Consuelo did not elect to have automatic premium loan in effect with her policy. Not only did she fail to pay the premium on time, she lost the notice about paying the premium within the grace period. Her business has been keeping her very busy lately. In the mail, she notices an offer to reinstate her policy by simply bringing the payments current and filling out a questionnaire that asks about her health status. Fortunately, Consuelo stays fit and trim by swimming regularly at the health club, watches her diet, and sees her doctors regularly. She pays any and all back premiums plus one for the upcoming premium cycle, the interest on the overdue premiums, and answers all the questions to the best of her knowledge. A few weeks later she receives a letter from the insurance company stating that her policy is back in force as if nothing had ever happened.

If Consuelo’s health situation had changed from standard or if she was no longer insurable, the story line would not have ended so positively. That is why both the policy owner and agent need to stay on top of premium billings and make sure that they are paid in full and on time.



Death BenefitsThe total amount payable as a death benefit represents the policy proceeds. Typically, the benefit remains level throughout the lifetime of the policy. However, there are instances where that amount may be more or less. It would be less if the policyowner had the option and elected to reduce or increase the amount of protection. This could occur if the policy in question was universal life, adjustable life, or variable universal life.

Life insurance regulations include guidelines regarding the relationship between accumulated cash values and death benefits. In general, there must be a ‘corridor of coverage’ (net amount at risk – the difference between the face amount and the cash values) in order for policies to qualify for certain tax advantages. In variable policies, the death benefit must be increased as the internal cash values grow. For example, 15 years into a policy with a $100,000 face amount and a $60,000 cash value, the ‘corridor’ would have fallen to $40,000 and the actual death benefit would likely have to exceed the initial $100,000 in order to retain its tax advantages based upon the age and sex of the insured.

Some of the most stringent regulations relate to very small-benefit policies sold mainly to older insureds. A $2,500 face amount policy with a $400 premium for a healthy 70-year-old, for example, would not pass the test. Seven years in, the premiums paid would exceed the insurance payable (7 x $400 = $2,800).

Death benefits could also be reduced due to outstanding policy loans and loan interest, or with decreasing benefit policies like decreasing term which typically covers outstanding mortgage balances that decline over time.

Spendthrift Clause Once an insured has died, a contractual arrangement exists between the insurer and the named beneficiary. One of the unique features of life insurance is that the proceeds can be exempt from the beneficiary’s creditors after settlement under what’s known as the ‘spendthrift clause’.

The spendthrift clause is designed to protect the beneficiary from losing the life insurance proceeds to his or her creditors, by assigning the proceeds to them, or by spending large sums recklessly. The spendthrift clause can be included in the policy at issue. It is operative with settlement options other than lump sum, and it shelters only the portion of proceeds not yet paid from the death-benefit settlement amount. If a beneficiary is taking $10,000 a year from a $100,000 death benefit settlement, the balance not yet paid out is secure from the beneficiary’s creditors. After each annual payout, however, the beneficiary’s creditors can legally go after the beneficiary for the money that is owed to them.

Essentially any portion of the death benefit held by the insurance company is exempt from the beneficiary’s creditors’ claims. It is also not assignable by the beneficiary to creditors because it technically is “owned” by the trust who oversees the funds for the beneficiary who is entitled to distributions when requested.

Example: Arnold is the beneficiary of a $1 million life insurance policy. The policy owner, knowing Arnold’s spending habits, elected to have the proceeds put into a “spendthrift” trust for his benefit. At the time of the claim, Arnold found himself $250,000 in debt and was forced into bankruptcy. His creditors were trying to get Arnold to assign them the money from the death claim. He filled out the paperwork and submitted it to the insurance company who immediately rejected the request. While Arnold could have requested a $250,000 withdrawal of the money held in trust and paid off his creditors, he could not direct the trust to do so. Payments from the trust could only go to the beneficiary of the trust, Arnold, and no other person(s).



Facility of Payment ClauseOlder “industrial” (debit) policies, usually with face amounts of $2,500 or less, contain a “facility of payment” provision whereby the insurance company can designate a beneficiary if the named beneficiary is deceased or cannot be located within a reasonable time. Not all policies have this provision, but it can also be found in some non-industrial type contracts.

Payment can be made to an executor or to the insured’s estate, to a surviving spouse, a blood (or adopted) relative, or any person determined by the company to be responsible for settling the deceased’s financial matters. This is another reason for inquiring about older policies when settling death claims, especially of older insureds whose spouses have predeceased them. It allows the insurance company to pay out much needed but limited amounts of money to assist in winding up the affairs of the deceased insured. The insurance company is held harmless unless they can be proven to have acted recklessly when dispersing the funds.

Example: Julie was the surviving sister of her brother, Bob, who recently passed away after a long battle with cancer. Julie was left to make the final arrangements and needed $10,000 to cover the costs. Her brother, Bob, named a buddy of his, William, as beneficiary for saving his life during their time together in the military. Unfortunately, William could not be found, and the policy was the only real asset Bob had to his name. Julie writes the insurance company, explains the situation, and requests payment of the proceeds only in the amount of the final expenses of $10,000. Based upon state law and the contract language, the insurance company forwarded $5,000 and explained that at this time it was the best they could do. If William could not be found in a reasonable time, then the balance of the policy would be paid to Bob’s estate and distributed by any will that was in effect or under state succession rules.

Beneficiary Designations The policyowner has the right to name and change the beneficiaries of the life insurance policy. In other words, they are revocable. The first category of beneficiaries is also known as the primary beneficiary. They are first in line to receive the death benefit in cases where they outlive the insured. There can be more than one person listed as a primary beneficiary designation. For example, if two people are named, they do not necessarily split the proceeds 50/50 because the policyowner may indicate 80/20. It is best to indicate how much each will receive in percentage terms since some policies may not pay out the face amount due to outstanding loans or reductions in face amounts. This takes care of situations in which the policyowner may not have made the necessary change in dollar amounts originally listed.

Just in case the insured outlives any and all primary beneficiaries, it is a good idea to list a secondary, also known as contingent beneficiary. They only come into play if they outlive both the insured and primary beneficiary.

Example: Moe is the insured. Larry is the primary beneficiary, while Jerry is the contingent beneficiary. Moe dies, so Larry receives the death benefit.

Example: Moe is the insured. Larry is the primary beneficiary, while Jerry is the contingent beneficiary. Larry dies. A couple of years later Moe dies without having renamed a new primary beneficiary. Jerry receives the death benefit.

If the beneficiary is a minor, the insurance company is unable to pay the money to them directly except for a small amount. The insurance company is concerned that if they do, when the minor age child reaches the age of majority, the adult can then file a new death claim, and it would have to be honored. Therefore, a court appointed guardian would most likely be in charge of receiving and dispersing the money on behalf of the minor age child until he/she reaches adulthood.



Trusts can also be named as beneficiaries. In these situations, the trustee of the trust would file the claim for the death benefit proceeds then would be bound by the terms of the trust document as to how and when the proceeds could be distributed and to whom. Trusts named as beneficiaries are a way to handle situations in which there may be minor aged beneficiaries as a way to bypass the courts and in certain estate planning strategies.

Beneficiary designations can be changed by the policyowner at any time as long as they are not designated as an irrevocable election. Beneficiary designations are presumed to be revocable unless otherwise specified. Irrevocable beneficiary designations can be changed only with the irrevocable beneficiary’s permission, not a very likely occurrence unless they are motivated by some reason to do so.

Death Benefit Settlement Options The payee is the person entitled to receive the proceeds, a designated beneficiary, but sometimes an estate, trust, or other entity may be the payee. More than one person may be listed as a beneficiary. The primary beneficiary may predecease the insured in which case it is prudent to name a contingent or secondary beneficiary.

At the death of an insured, life insurance beneficiaries can elect to receive the policy proceeds, unless the policyowner pre-selected one, in a number of ways, labeled as ‘settlement options’. The most common, especially for relatively small amounts, is the lump sum option. The beneficiary of a $10,000 policy can simply request a check for that amount from the insurance company. The insurance company cuts the check to the named beneficiary and mails it out. The beneficiary can then do as they please with the funds.

Many companies these days mail out a check book to the beneficiary instead of a check so they do not have to go to a bank and open up an account or cash the check. They simply write a check for whatever amount is needed when it is needed. This also allows them to keep the amount of money received private. In a small town, word may spread quickly about who received how much when Joe died. In fact the “checks” may be drafts drawn against the insurance company’s general account or death claim trust account.

For larger amounts, for instance $25,000, or $100,000 or more, the lump sum option may be impractical or ill-advised. Most people who come into sudden possession of such large amounts will ask: “What do I do now?” Also, someone with a lump sum of money may not have the experience to know how to handle money given to them at one time, which is why other options should be considered. Life insurance professionals need to offer clients various solutions.

Those other options may include:

• Allowing the insurance company to act as a banker (Interest Option)• Receiving the money in certain equal payments until the principal is exhausted (Fixed Amount

Option)• Spreading payments over a certain time period (Fixed Period Option)• Spreading it over one’s lifetime (Life Annuity Option)• Spreading it over two lifetimes (Joint Annuity Option)

The Interest OptionWith the interest option, the insurance company holds the money in an internal account in the name of the beneficiary, crediting it with periodic interest in the same manner as a bank. One advantage is the ease with which the account is opened and maintained; it is essentially a paper transaction. Interest rates vary, of course, but insurance company rates are usually competitive with ‘outside’ financial institutions. A potential drawback is the lack of FDIC surety, but all states have Guarantee Associations in place to protect against insurer insolvency of an insurer and its general account assets.



The beneficiary or account holder retains the right of withdrawal; often, these accounts come with pre-printed checks or drafts – again, similar to a bank. The account holder may name a co-owner or beneficiary on the account and may also switch some or all of the money into one of the other options. In recent years, this has become the default option for most of the larger insurance companies.

While life insurance proceeds are received free from federal and most states’ income taxes, the interest earned on proceeds held by the company – or anywhere else – is taxable at ordinary income tax rates. So if the insurance company is crediting 3% interest on a $100,000 balance, the interest income would amount to $3,000.

The Fixed Amount OptionThe fixed amount option allows the beneficiary to select a dollar amount to be disbursed monthly, quarterly, semi-annually, or annually until the proceeds are exhausted, at which point the payments end. Under this option, the beneficiary of a $50,000 policy might elect to receive $500 monthly. According to simple math ($50,000 divided by $500), payments will continue for 100 months. But under this option, the insurer credits the decreasing principal amount it is holding with interest, so even at low rates, there will be somewhat more than 100 payments. The beneficiary or recipient may name another beneficiary to receive the payments in the event of death if a balance remains unpaid.

The beneficiary can also change this option at any time and receive the balance in a lump sum. An example of a fixed amount payout would be as follows:

$100,000 at 3% paying out $6,000 per year will last 22 years and 11 months.

The Fixed Period OptionThe fixed period option is the opposite of fixed amount. In the case of the fixed amount option, the amount is known but the duration is not. In the fixed period option, the length of time over which payments are to be made is specified and the insurer determines the payment amount that fits the duration. Again, the insurance company credits interest to the declining principal amount at a pre-determined rate. Let’s say the beneficiary of $50,000 wants equal payments annually over 20 years. While $50,000 divided by 20 years equals $2,500 per year, the payments would likely be somewhat higher considering the interest on the decreasing principal amount and any anticipated earnings the company can expect from investing that principal. After 20 years, the payments stop. Again, the recipient may name a beneficiary to receive the proceeds in the event of death prior to the 20-year mark. The beneficiary can also call off this option at any time and receive the balance in a lump sum.

An example of a fixed period payout would be as follows:

$100,000 at 3.5% paying out over 20 years will generate approximately $575 per month.

The Life Annuity OptionUnder the life annuity option, the beneficiary or annuitant is guaranteed not to outlive the income stream, which is not the case with fixed amount or fixed period options. Here, the payment amount is based on the annuitant’s life expectancy. Other things being equal, the older a person is when the annuity starts, the higher should be the disbursement. In the $50,000 example, a 50-year-old man with a 25-year life expectancy may receive $175 monthly for life; a 60-year-old man with an 18-year expectancy, $240. In a pure life annuity, payments will continue indefinitely even if the recipient lives well beyond life expectancy, but any balance remaining at an early death is forfeited to the company. Women will generally receive lower payments than same-age men due to longer life expectancies. Life only options provide the largest monthly benefit payments.



Example: Shawn is the beneficiary of a $100,000 death benefit and elects to receive monthly income payments for his life time only. The insurance company calculates the payout based on his age and gender that he will receive $4,000 per year. If Shawn lives only long enough to receive $40,000 in payments and then dies, no other payments are made by the insurance company to anyone else. If Shawn live long enough to receive $160,000 in payments and then dies, no other payments are made by the insurance company to anyone else. Based on the law of large numbers, those who die early help the insurance company create a reserve to pay to those who live longer.

Period Certain It is also possible to lock in any residual values for beneficiaries in case of premature death of the annuitant or beneficiary. This would require the selection of a period certain or a cash refund option. In a period certain, the annuitant would receive guaranteed payments for life. However, if they should die prior to the end of the stated time period certain, the balance of those years would be payable to the named beneficiary. So, if a life with a 10 year period certain is selected and the beneficiary or annuitant dies in year 7, there are still 3 years remaining to the guarantee that the beneficiary will receive.

Example: Shantel is the beneficiary of a $100,000 death benefit and elects to receive monthly income payments for his life with a 15 period certain. The insurance company calculates, based on his age and sex, that he will receive $3,500 per year. If Shantel lived only long enough to receive 10 years of payments and then dies, his named beneficiary will be entitled to collect the remaining 5 years of the period certain. If Shawn lived long enough to receive 18 years of payments and then dies, no other payments are made by the insurance company to anyone else because he has outlived the period certain.

Cash RefundIn a cash refund the insurance company guarantees that the beneficiary or annuitant will be paid for life; but if they should die prior to recovering all of the initial deposit of the proceeds, then any remaining amount is paid out in a lump-sum to the named beneficiary. So, if a life with a cash refund is selected, starting with a $50,000 death benefit, and the annuitant or beneficiary lives long enough to receive $30,000 in payments then suddenly dies, the beneficiary will be paid $20,000. In other words, $20,000 ($50,000 - $30,000) is the difference between what that account was initially funded with and the amount paid out. On the other hand, if the annuitant or beneficiary lives long enough to receive $80,000 in payments then suddenly dies, there is nothing left to refund.

Here are some examples of payouts to demonstrate how each of the options described would work. This assumes a death benefit of $100,000 and a 3.5% interest crediting rate for a 65 year old with payments received monthly:

Male Female

Life Only Life with 10 year certain

Life with cash refund Life Only Life with 10

year certainLife with

cash refund

$613 $588 $559 $543 $532 $512

Notice the difference between the monthly payout in each option. The more the guarantee, the more it costs, therefore, the lower the net payment. Also, there is a difference between the life expectancies of men and women, and it is reflected in the payouts. The longer the anticipated payout, the smaller each payment becomes.



The Joint Life & Survivor Annuity OptionBasically everything previously described with the life annuity/beneficiary option applies to joint life annuity/beneficiary options with limited exceptions. First the payout is over two, not one, lifetimes. Second, the payouts will be lower with joint life versus life only because the anticipated payout time period could be longer. Third, the survivor benefit can be a fraction (2/3 or ½) or the entire amount that was originally coming in. Fourth, since there are two lives involved there is likely going to be a difference between the ages of the two persons which makes the calculations a bit more complex.

Here are some examples of payouts to demonstrate how each of the options described would work. This assumes a death benefit of $100,000 and a 3.5% interest crediting rate for a 65 year old male and 65 year old female with payments received monthly (this is directly from an actual policy):

Joint and 2/3rds

Joint and 50% with male primary and female secondary

Joint and 50% with female primary and male secondary

While both are alive $542 $541 $512

After the first death $361 $270 $256

It is important to review all the options in detail very carefully before making a selection. Once an option is selected that is based on life expectancy, for example--life only or joint and survivor--it is considered irrevocable.

Lost or Missing PoliciesLife insurance policy owners may not inform the parties they list as beneficiaries to policies they purchase. It is possible, therefore, for death benefits to go unclaimed. For a small fee, the Medical Information Bureau (MIB) has a policy locator service that executors or administrators of an estate, or surviving family members can utilize to find lost or missing policies. For more information about this service, visit MIB’s Web site: www.policylocator.com.

The American Council of Life Insurers also recommends checking through any “important” papers, like employee benefit booklets, premium notices, annual reports, dividend payment receipts, insurance papers, business cards, and personal address and phone books. Sometimes clues can come from old envelopes, check books, bank account records, income tax returns, information sent through the mail, or voice messages left on answering machines. States have unclaimed property listings which can be accessed through the National Association of Unclaimed Property Administrators’ website (www.naupa.org) which includes links to each state’s unclaimed property office, and for multi-state searches, www.missingmoney.com combines information from most, but not all, state unclaimed property databases. These are just some of the ideas and sources of information which are worth looking into.

SummaryLife insurance policy provisions give the policy owner many rights that are specified in the contract. By better understanding the provisions and how they work, the insurance professional can help consumers make better informed decisions in life insurance planning. From when the life insurance professional first interacts with a prospect about life insurance to delivery of a death claim to beneficiaries, there are specific contract language that comes into play. The parties to the contract prepare and submit the application with adequate consideration to see if the insurance company through their underwriting process will accept the offer of coverage. The agent must make sure that they not only understand but that the proposed insured and policy owner are aware of the contract provisions that are designed to protect them, their beneficiaries, and the company. Professional agents take the process seriously and carry out their duties in a professional manner.



1. Richard makes certain to pay his life insurance premiums in full and on time in order to keep his policy ____________.a. From lapsingb. Safec. Up to dated. From decreasing

2. A person who wants to work in the rate-establishing department of a life insurance company should become familiar with:a. The gross national productb. The history of insurancec. Actuarial and mortality tablesd. The company president

3. Wealthy homeowners who could leave enough cash to pay off their mortgages after death might still choose to ____________ an insurance company.a. Buy shares inb. Transfer the risk toc. Avoid any contact withd. Open up their own

4. Because life expectancies are longer now than fifty years ago, more beneficiaries are considering the ____________ settlement option.a. Lump sumb. Life annuityc. Fixed amountd. Split dollar

5. Sharon’s annual premium was $801. For years she sent checks in to the life insurance company for $800, which the company accepted. When she died, the company could not deny the claim because the full premium had not been paid. This is an example of:a. Estoppelb. Bad faithc. Generosityd. A lawsuit

6. Life insurance agent Bernard thought it was okay to gloss over important policy details with his customers. In the future, his vague statements about the policy provisions could be legally interpreted as:a. Harmless deceptionsb. Representationsc. Forfeiture valuesd. Estoppels

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7. The time frame during which a company may invalidate a policy upon discovering false statements by the insured is called the ____________.a. Contestable periodb. Grace periodc. Free-look periodd. Study period

8. Martin’s term life insurance policy premium was due May 9th. It is now June 4th. He called his life insurance agent, Gerry, in a panic thinking that his policy had lapsed. Gerry reminded Martin that his policy had a ____________ so that he had nothing to worry about. Martin finally breathed a sigh of relief.a. Non-forfeiture tableb. Waiver of premium riderc. Grace periodd. Contestable period

9. Sixteen-year old Jimmy’s policy includes an automatic increase in coverage at his age 21. During the sales process, the agent explained to Jimmy’s parents that the increase would go into effect ____________.a. On Jimmy’s 21st birthdayb. After 21 premiums were paidc. Gradually over 21 yearsd. On the policy date following Jimmy’s 21st birthday

10. After he signed the application and paid the initial premium, Jim was concerned about what would happen if the company rejected his application. His agent explained that the company would ____________.a. Issue an apologyb. Return his premiumc. Try again in 31 daysd. File his application

11. Working with his life insurance agent, Walter submits his personal information on the application and his check for the initial premium. The company then goes through its procedures in order to decide whether or not to issue a policy. This process is best described as ____________.a. Trial and errorb. Offer and acceptancec. Give and taked. Random selection

12. Robert was concerned that he’d be hauled into court for breach of contract if he didn’t pay his whole life insurance premium. His life insurance agent explained that only the company is legally bound because the policy is a ____________ contract.a. Non-bindingb. Favorablec. Poorly wordedd. Unilateral



13. Realizing that profits were decreasing, the life insurance CEO took steps to reduce his company’s ____________.a. Expense outlayb. Number of deaths per thousandc. Interest earned on its investmentsd. Cafeteria lunch prices

14. ‘Cash value,’ reduced paid-up’ and ‘extended term’ are all ____________.a. Term insurance ridersb. Pre-payment optionsc. Insurance company slogansd. Non-forfeiture values

15. Life insurance clients should be made aware that when a policy loan interest rate is subject to change because it is a ____________ loan.a. High riskb. Variable-ratec. Non-securedd. Long term

16. Under the principal of ____________, a policy loan can have an impact on dividends paid by participating (mutual) policies.a. Non-forfeitureb. Caveat emptorc. Direct recognitiond. Reduced paid-up

17. All of the following are true of policy loans, EXCEPT:a. They may reduce the death benefitb. They need not be repaidc. They are interest-freed. They are limited to the amount of the cash value

18. Rebecca didn’t even know she was her grandfather’s beneficiary. Even so, after his death, she has a ____________ with the insurance company.a. Potential lawsuitb. Memorial servicec. Contractual arrangementd. Job offer


Chapter 3

Term Life Insurance, Whole Life Insurance, & Riders

IntroductionThe two basic forms of life insurance are temporary and permanent, also known as term and permanent. Many variations exist within both categories, but the basic distinction holds true. Term is pure protection without cash values while permanent provides protection and accumulate cash values.

Term Life Insurance Term insurance provides a certain amount of coverage, the face amount, for a certain length of time, the term of the policy. Among the many types of term policies are those written for different lengths of time – as short a term as one year or up to 30 years or more, for example, 30 year term or term to age 70.

Most term policies have fixed level premiums that are unchanging over the term of the contract, but some have premiums that increase at intervals as the insured’s age increases. For example, a $100,000 20 year level premium term life insurance plan for a 30 year old may have premiums of $250 per year, each year, for the 20 year life of the policy.

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An annual renewal term would have premium increases every year. For example, a $100,000 20 year level protection 5 year step-rated premium term life insurance plan for a 30 year old may have premiums of $100 per year for the first 5 years, then an increase for every 5 years thereafter until the policy runs its course or expires.

Example: Term life insurance premium comparison:

End of Policy Year

Level Annual Premium

5-Year Step-Rated Premium

Annual Renewable Premium

1 $1,000 $600 $1502 $1,000 $600 $2753 $1,000 $600 $3504 $1,000 $600 $4755 $1,000 $600 $5956 $1,000 $850 $6507 $1,000 $850 $7008 $1,000 $850 $7509 $1,000 $850 $88510 $1,000 $1,350 $1,09511 $1,000 $1,350 $1,15012 $1,000 $1,350 $1,17513 $1,000 $1,350 $1,29514 $1,000 $1,350 $1,40515 $1,000 $1,600 $1,57516 $1,000 $1,600 $1,69517 $1,000 $1,600 $1,75518 $1,000 $1,600 $1,89519 $1,000 $1,600 $1,97520 $1,000 $1,600 $2,125

While overall term insurance is relatively simple, there are complexities in some of them.

Some term policies are written with a “current” and “maximum” premium payment schedule. With these policies, the company is reserving its right to increase premiums if company costs increase, interest earned on the reserves are not as expected, they experience higher than expected mortality, or regulations change requiring them to maintain higher reserves. Premiums would increase on a class basis, not on selected individuals based on health changes.


57CHAPTER 3: TERM LIFE INSURANCE, WHOLE LIFE INSURANCE, & RIDERS

In some term policies, the amount payable at the insured’s death decreases over time, usually on an annual basis. The premium would remain level during the term of the policy. Think of this type of coverage as intended to pay off a decreasing loan balance as would be the case with a mortgage or auto loan. While it most often can be associated with mortgage or credit insurance, it can also be purchased as an individual policy from some companies.

A principal personal use of term insurance is to provide coverage on the parents while the children are young. The primary business use is to maintain coverage during one’s involvement with the business. In virtually every situation, new term insurance policies provide maximum coverage at a premium cost lower than new permanent policies at most any given age. There is a crossover point, however, in which over time the term premiums could end up being more each year than the level premium permanent ones acquired years earlier.

Renewability and ConvertibilityA term life insurance policy will indicate if it is renewable or convertible.

Renewable means that the policyowner has the right to continue the policy by paying the contractual premiums without having to prove that the insured is still insurable. A policy can be renewable for a period of time, for example, for 10 years; or to a particular age, for example, to age 70.

Example: Susan is age 40 and has a term life insurance policy with a death benefit of $250,000 with level premiums which step-up every 5 years that is renewable to age 65. All Susan must do in order to maintain coverage is to pay the premium on time and in full. There is no need to re-prove insurability along the way, and premiums cannot increase due to a change in her health status.

Convertibility allows a policyowner the right to convert or exchange term life insurance coverage into a permanent life insurance policy with the same insurer without having to prove insurability. Typically, there is a time period in which the policyowner must take advantage of this offer or it is lost. For example, conversion requests must be made within the first 10 years or before age 50. While conversions are completed without having to prove insurability, the premium for the new permanent policy will be higher; however, the rate class will be the same as for the original term policy.

First of all, the new policy is permanent and is no longer term. The policy will build cash values that have to be paid for. Secondly, the insured is now older and the new policy will be priced based on the attained age at conversion. Some companies will allow partial conversions in cases where not all of the original term insurance coverage is needed, in situations where price is a major consideration, or if the policyowner wants and needs to retain some term life insurance protection. Some companies will even offer a term conversion credit whereby all or part of last year’s premium can be applied toward the new policy’s first year premium as an incentive to make the exchange.



Example: Miguel bought a 20 year $500,000 term life insurance policy when he was age 25 at an annual level premium of $500. His policy allows him to renew the coverage through age 70, but after the first 20 years, the premiums increase annually. The conversion privilege is only good through the first 15 years. At age 38, he decides to convert the term insurance policy into a permanent plan with the same insurer. The new permanent plan is whole-life insurance. The new premium for the whole-life policy is $4,250 per year. Miguel is now 13 years older than when he first bought the term life insurance policy, and the new plan provides coverage to age 100, not 70 like the term plan, and builds cash values as well.

Some companies will permit a term conversion as of the original age. If not elected within the first few policy years, however, it is very likely to be cost prohibitive since the difference in premiums will have to be paid up front with interest.

To recap, permanent life insurance is level coverage that will not expire over the lifetime of the insured. Most permanent plans of insurance include some form of cash accumulation within the contract that can be withdrawn or borrowed from the policy or that may increase the total amount payable to the beneficiaries at the insured’s death. Both of these features account for the higher level premium cost of permanent over term. Several different types of permanent policies are covered in more detail later in this chapter.

Death BenefitsIn most term and permanent policies, the death benefit is constant or unchanging (level). A $100,000 policy will pay that amount to the beneficiaries at the insured’s death at any point while the policy is in force. “In force” means that all premiums due have been paid up to the date of death.

Some policies allow for adjustments in death benefit amounts, based on contractual provisions that allow for changing insurance needs. Within certain limitations and restrictions, the policyowner controls these adjustments and may pay a small fee to do so and prove insurability for any increases in coverage. For example, an insured with a $150,000 term life insurance policy that now needs another $50,000 in protection may be able to increase the original amount insured for by requesting an increase or by adding the coverage to the base plan of life insurance with a rider.

In another scenario an insured may have $250,000 worth of coverage and may now only need $200,000. Some companies will allow them to decrease the face amount of the policy. Some term life insurance policies provide for decreasing amounts of coverage, referred to as decreasing term life insurance.

Income ReplacementAs noted, income replacement is a valuable and unique characteristic of life insurance. There are even certain contract riders that provide for payments over and above the stated face amount during periods of specific needs, such as:

• While children are under age 18• The college years• The years preceding retirement for the surviving spouse, to address the Social Security “blackout

period”, or that spouse’s post-retirement income supplement

These have traditionally been referred to as family income riders.

Determining the amount needed to replace lost income can be a relatively simple task by using the following formula: the amount of income times the desired number of years to be replaced or it can be more sophisticated taking into account such things as taxes, inflation, college costs, final expenses, consumer debts, mortgages, business obligations, group benefits, Social Security, financial assets including retirement plans, etc.



While replacing lost income can be thought of as a decreasing need based on the insured living and earning a paycheck into the future, a level amount of coverage is most often recommended in order to account for the impact of inflation in all phases of financial survival. It is not a bad idea to plan for a little bit more than to wind up with a little bit less.

Home Mortgage ProtectionOne of the most common uses of life insurance, in particular for term life insurance, is to cover an outstanding debt such as a home mortgage. A policy in the amount of the mortgage balance due would pay off the remaining loan at the death of the mortgage debtor. Simple enough, but mortgage life coverage can take many forms.

A mortgagee can buy an individual policy or obtain the coverage from a group policy. Most mortgage companies offer mortgage insurance protection as an option at the time of closing the loan and for months or years after that. The premium for coverage would be billed along with the mortgage payment. The mortgage insurance can provide coverage on one or both spouses who are obligated to pay off the loan. Upon death of the insured, the outstanding mortgage balance would be paid by the death benefit provided under the policy. The survivor would then have a home fully paid off and no on-going mortgage payments to worry about. The survivor’s family would then have a place to live that is free from debt.

This coverage is essentially credit-life insurance or decreasing term, with the amount of coverage decreasing as the mortgage principal decreases and coverage ending when the mortgage debt is settled. This is similar to credit life offered with auto loans. Settlement can take place at the time of death, with the mortgage life insurance paying off the outstanding mortgage balance. Mortgage life insurance ends when the loan is paid off. This can occur by making the scheduled monthly mortgage payments until the final payment is made and the debt satisfied, or by refinancing the original mortgage with a new mortgage.

Accepting the mortgage company’s offer for this type of coverage has its advantages. Because it is issued on a group basis where many borrowers are insured through the same mortgage life insurance policy, it is usually available on a limited or non-medical basis, enabling someone with certain health problems to qualify for coverage. The flip side of that is that the premiums tend to be higher than those available to many people on an individual basis. For example, non-smokers may pay the same as smokers, while an ‘outside,’ individually underwritten policy could be priced 40-50% lower than smokers’ rates.

Another advantage is that the insurance amount will always be sufficient to settle the outstanding loan and applying the insurance amount to cancel the loan is automatic and prompt. There are potential drawbacks, however. The insurance is only for the amount of the loan, and it may not be in the best interest of the survivors to pay off the loan at that particular time.

For example, if the original $200,000 mortgage is down to $160,000, so is the insurance coverage. So while the mortgage is paid off, there is no money to cover such things as property taxes, utilities, insurance, or for much needed repairs. Second, a surviving spouse may not want to cancel the mortgage for personal or tax reasons. With enough independent income and/or other insurance, it might be an advantage to carry a low-interest mortgage loan and use the mortgage interest deduction on their taxes. It is also possible that the home may have depreciated in value whereby the mortgage loan balance may be more than the value of the home or the mortgage interest rate is well below current rates so paying it off may not necessarily be a financially smart move. Finally, if the insured needs to maintain coverage once this mortgage is paid off, the coverage is no longer in effect because it only follows that particular loan and cannot be transferred to another one.

These potential negatives can be addressed simply by purchasing individual coverage in the amount of the initial mortgage amount. A level $200,000 policy purchased at the beginning of a mortgage period will remain at that level even while the mortgage balance declines and, further, gives the beneficiary the choice of whether or not to pay off the mortgage. If the mortgage balance was $160,000 at the time the insured died, the



survivors could make a lump sum mortgage payment of $60,000 to pay down the outstanding balance from the $200,000 benefit, possibly refinance if interest rates were favorable which would result in lower payments. This would be true since the new loan would be for only $100,000 and they would still have $140,000 ($200,000 - $60,000) left over for other purposes. So the flexibility going with an individual policy over a group mortgage insurance policy is worth considering before signing on the dotted line.

This technique works with either term or permanent policies, assuming the term runs for a sufficient number of years. While term insurance is lower in cost for the same amount of coverage, permanent life insurance can offer the additional advantage of a cash buildup that can be used to shorten the term of a mortgage. Depending on the type of policy and economic conditions, a permanent policy may even have enough cash value after 22 or 23 years to pay off the entire balance of a 30-year mortgage. It is worth looking into the advantages and disadvantages each type of policy offers the consumer. Having the proper amount of coverage is the key. Life insurance coverage needs offer more benefits than simply covering the outstanding debt.

Return of PremiumSome life insurance companies offer term life insurance policies with an optional rider that will in effect return all of the premiums paid for the base life insurance and the rider if the policy is kept in force until the end of the term. In most cases, the return of premiums paid is without any interest being credited, and if the policy is terminated prior to expiration, then either no premium is refunded or only a fraction of the premium paid is refunded which results in, everything else being equal, expensive term life insurance.

The return of premium rider is designed to encourage a long-term commitment over the length of time a policy holder stays with his or her policy, by offering a cash amount over certain periods of the policy’s life that the policy holder can receive upon surrender, conversion, or replacement of the policy. If the policy is held onto until expiration, then the money paid out can be used for college education costs, a down payment on a new car, or funds to deposit into a new universal life type policy.

Example: A client has the option to buy a twenty year level term life policy for $475 per year or the same policy with the return of premium rider for $1,000 per year. The following is an example of what it could look like:

End of Policy Year

Annual Premium

Cumulative Premium Paid

Percentage of Premiums Paid

Available at Year-end

Cash Available at Year-End

1 $1,000 $1,000 0.0% $- 2 $1,000 $2,000 0.0% $- 3 $1,000 $3,000 0.0% $- 4 $1,000 $4,000 0.0% $- 5 $1,000 $5,000 0.0% $- 6 $1,000 $6,000 5.0% $ 300 7 $1,000 $7,000 10.0% $ 700 8 $1,000 $8,000 15.0% $1,200 9 $1,000 $9,000 20.0% $1,800 10 $1,000 $10,000 30.0% $ 3,000 11 $1,000 $11,000 40.0% $ 4,400 12 $1,000 $12,000 50.0% $ 6,000 13 $1,000 $13,000 60.0% $ 7,800 14 $1,000 $14,000 70.0% $ 9,800 15 $1,000 $15,000 85.0% $12,750 16 $1,000 $16,000 90.0% $14,400



End of Policy Year

Annual Premium

Cumulative Premium Paid

Percentage of Premiums Paid

Available at Year-end

Cash Available at Year-End

17 $1,000 $17,000 92.5% $15,725 18 $1,000 $18,000 95.0% $17,100 19 $1,000 $19,000 97.5% $18,525 20 $1,000 $20,000 100.0% $20,000

In this example, the cost for the twenty year term life insurance policy with a return-of-premium is much higher than if the policy did not have the rider. Typically, there would be no full return-of-premium until the end of the twentieth year, with percentages of the premium paid available to the policy holder if they surrendered or replaced the policy with a new one sometime after the fifth policy year. The return-of-premium values may be used to fund part or the entire first year premium upon conversion into a new permanent life insurance policy.

Cost IndexesComparing the costs of identical consumer products from different sources is easy. If the 12 oz box of a named brand cereal is $3.29 at one store and $2.89 at another, the choice, based on price alone, is clear. Similarly, if a $100,000, 20-year level term policy, with a premium of $300 from one A-rated stock (non-dividend paying) insurance company is being compared to a $100,000, 20-year level term policy, with a premium of $350 from another A-rated stock company; most individuals would purchase the policy from the company with the lower premium. However, at times the policies compared are not exactly identical so basing it on premium per face amount alone does not necessarily tell the whole story. Instead it can become quite complicated and may end up leading to a poor choice.

Example: XYZ insurance company offers a 30 year-old non-tobacco user who is in excellent health a $500,000 20-year renewable and convertible level term life insurance policy for $575 annually. PDQ insurance company has what appears to be an identical policy but prices it at $500 annually. The better value appears to be going with PDQ.

XYZ’s plan allows the following:

• The policyowner can convert to any permanent life insurance plan they have available at the time of conversion any time within the first 20 years from date of issue

• The settlement option tables factor in interest at 3.5%• The policy owner may insure any of their children with a child rider at time of issue or any time

thereafter so long as the policy is in force and the children are insurable• The cost to use the accelerated death benefit rider is $150 up-front plus 5% interest

PDQ’s plan only allows:

• Conversion to take place within the first 10 years and only to a universal life policy with a continuation rider guaranteeing to maintain the policy in force to age 120

• The settlement option tables use a 1.5% interest factor• No child riders are available • The cost to use the accelerated death benefit rider is $500 up-front plus 8% interest

So, while the death benefit is in fact a commodity, and since both companies would pay out the identical amount upon death of the insured while the policy is in force, the policy itself is not a commodity since each may have different features, benefits, provisions, interest credits, riders, and costs that need to be examined carefully.



Comparing actual costs of cash value or dividend-paying policies is not so simple either. It’s not enough to just compare prices, or only how much cash comes back. Accurate computations factor in the timing and frequency of payments, present value of future sums and other factors. When those future sums become available and a variety of other factors are considered, all have an impact on cost-index calculations. Fortunately, experienced actuaries have met the challenge, and life insurance cost indexes are published by nearly all companies. Cost indexes provide a convenient way to compare relative costs of similar policies. Instead of having to wade through complex computations, prospective policy owners and life insurance producers can compare the index numbers provided by the life insurance companies.

There are two major life insurance cost indexes. The surrender cost index is most valuable in projecting cost over a period of time where there are anticipated cash values. It compares costs of cash-value policies upon surrender after 20 years, for instance. And “compares” is the key word. Alone, a surrender cost index has little value, but side-by-side with another similar policy, the index number can be revealing. The more similar the policies are, the more relevant the cost index comparison.

The net payment cost index is useful if the main concern is the benefits that are to be paid at death and if the level of cash values is of secondary importance. It helps to compare costs at some future point in time, such as 10 or 20 years, if the contract owner continues paying premiums on the policy and does not take its cash value.

Another number, the Equivalent Level Annual Dividend, shows the part dividends play in determining the cost index of a participating (dividend-paying) policy. Factoring a policy’s Equivalent Level Annual Dividend into its cost index allows the prospective policy owner and life insurance producer to compare total costs of similar policies. In comparing costs of a participating policy with a non-participating policy, the total cost of the participating policy will be reduced by dividends, but the cost of the non-participating policy will not change. Also, remember that dividends are not guaranteed, and the amounts paid out by companies can and have varied over time.

Generally, a policy with a lower index number is a better buy than a comparable policy with a higher index number. It is also important to remember that cost comparisons should only be made between similar plans of life insurance. Similar plans are those that provide essentially the same basic benefits and require premium payments for approximately the same period of time. The closer policies are to being identical, the more reliable will be the cost comparison. Since no one company offers the lowest cost for all types of insurance at all ages and for all amounts of insurance, it is important to get the indexes for the actual policy, age and face amount under consideration.

Small differences in index numbers could be offset by other policy features, such as differences in the quality of service expected. When the numbers are close, a consumer should consider other factors in making their final decision. Also, life insurance cost indexes apply only to new policies. They should not be used to determine whether a policy holder should replace an existing policy with a new one.

The actual premium charged by the company is based on a couple of key factors, mortality, expenses, investment earnings, and possibly dividends. The type of policy owned and the risk classification of the insured will determine how much premium will be charged. When comparing policies, premium alone doesn’t necessarily tell the consumer the entire story. As with any product under consideration, differences in options and costs should be examined carefully.

Advantages and Disadvantages of Term Life InsuranceTerm life insurance has many points to consider. Many of these are advantages, but there are some disadvantages as well. In devising solutions for clients’ insurance needs, the insurance professional should consider them all.



Advantages• Less expensive than permanent life insurance at inception• Can buy more insurance per premium dollar at young ages when needed most• Is simple to explain to a consumer and easy for a consumer to understand• Can be converted into a permanent plan of insurance if needed without proof of insurability• Can be used to cover specific debt obligations such as a mortgage loan balance

Disadvantages• Over time term becomes more expensive to own than permanent life insurance• Does not build up a cash value• Conversion is at attained age rates• May not be in effect when it is needed most, especially in the later years of life

Whole Life InsuranceWhole life insurance is built on a foundation of guarantees that has helped people protect and prepare for life’s events in one contract for over 100 years. Traditional, ordinary, or straight, whole life premiums are fixed and level from policy inception. Any adjustments from the original premium, such as modified or graded, or decreases that occur when any options riders end, are specified by amount and date within the policy on a page near the front called the data section or appear in the policy schedule. A pure straight whole life policy, with neither riders nor premium duration limits (paid-up), requires premium payment until the earlier of the insured’s death or attainment of age 100.

Paying premiums through age 70 and up to age 100 is properly recognized as impractical. Recognizing this, insurance companies long ago made “limited-pay” or paid-up plans available. For a higher premium, these plans provide for policies to be considered paid-up when certain milestones are reached. That point may be after a period of time – 20 years – or at a particular age; age 65 is common, as it coincides historically with the normal retirement age specified by Social Security and most company pension plans. Thus, the same-age premium for a $100,000 straight-life ‘pay-to-100’ policy would be lower than for a ‘paid-up at 65’ policy. After all the insurance company is still contractually obligated to pay out the death claim to age 100 without any premiums coming in after age 65 so they alter the premium schedule to account for additional premiums being paid in advance.

After premiums are contractually discontinued, at age 65, the death benefit remains in effect. The cash values will grow at a faster rate than if it were not a paid-up policy since more premiums are coming in and will continue to grow, as with all whole life policies, to age 100 when the policy endows. That is, the guaranteed cash value in a $10,000 face amount policy issued to a 40-year-old in 1955 would be $10,000 (the policy’s face amount) in 2015 (1955 + 60); a check for that amount might be a welcome 100th birthday present to the policyowner. In a nod toward increased longevity, most companies now can hold the money at interest as an eventual death benefit. Under certain circumstances, this option has tax advantages to the policyowner and to the beneficiary.

In all cases, the premium schedule an individual agrees to in the beginning is guaranteed for the life of the contract. The insurance company cannot increase the premiums as the policyowner gets older or for health changes. Failure to pay a contractually scheduled premium when due or before the grace period expires would result in a lapsed policy, with certain values available to the policyowner through the nonforfeiture value table options. Assuming timely premium payment, whole life policies never need to be renewed or converted. They are in effect for one’s whole life.



The premium difference between whole life and term is justified by keeping that premium level throughout the life of the policy, by the accrual of guaranteed, tax-deferred (or never taxed) cash values and by a tax-free death benefit that does not expire or decrease. A permanent need for life insurance coverage calls for a permanent plan of life insurance. In the end, consumers get what they pay for.

For many years, whole life insurance was the backbone of the life insurance industry. It was, in a few variations, the only product on the market. Whole life still holds an important place in the ever-expanding range of life insurance products. It’s straight forward and easy to understand in terms of its basic components which include a level death benefit, fixed premiums, and a guaranteed cash value accumulation.

Modified and Graded PremiumsWhole life has also been known as ordinary life, straight life, and the catch-all permanent life, which differentiates it from term life. Some common variations have to do with premium schedules. Modified and graded premiums are contractual elements found listed in the policy itself. The buildup of cash values in modified or graded premium policies is usually delayed or is at least slower to grow while the initial premiums are low. The advantage of a lower outlay may well offset that delay in cash value build up.

Modified Premium Whole LifeModified premium whole life insurance features lower initial premiums that remain at one level from the start, usually for 5 years, and then increase to an ultimate premium and remaining at that level for the duration of the premium-paying life of the policy. The cash values obviously do not grow as fast initially as would be the case with traditional whole life because of the reduction in the initial premium. However, the cash values grow at a much faster rate once the premium payments have reached their ultimate higher level. It is suited to individuals who wish to begin a permanent insurance program and whose incomes are expected to increase. The modification makes it feasible for someone who anticipates higher earnings to purchase permanent life insurance at a younger age, when even the ultimate premium may be lower than if the purchase were to be postponed. Medical interns, young physicians, law school students, and new attorneys are natural markets for modified-premium life insurance along with newly established business owners. The policies may also have business applications, providing a combination of insurance and cash values for business owners, executives and key employees.



Graded Premium Whole Life Graded premium policies begin with more deeply reduced premiums than modified policies; their premiums increase annually rather than moving up to the next level in one big jump and level off after as few as 5 and up to 10 years for the duration of the policy. It is similar to a one-year renewable term life insurance premium schedule at the outset. Just like the cash with the modified premium plan, the cash values do not grow as fast initially as would be the case with traditional whole life because of the reduction in the initial premium. However, the cash values grow at a much faster rate once the premium payments have reached their ultimate higher level. The market place for this type of premium structure can be similar to that of the modified premium plan.

Limited Premium Payment Whole Life Other versions of whole life insurance are the limited-pay plans, which become “paid-up” before age 100. A popular example is life paid-up at 65. The premium for the $10,000 policy may be 25% higher in order for the company to collect enough in the shorter pay-in period to fund the death benefit to age 100, but the trade-off is that premiums would cease at the insured’s age 65, when the policy owner is likely to be retired and face a reduction of income making it harder to pay on-going premium payments. The death benefit would remain intact, the cash values would continue to accrue but at a faster rate than the traditional whole life while the premiums were being paid because they were higher, and the policy would still endow at age 100. Some companies offer 20-year and even 10-year limited pay policies, whose premiums would, of course, be even higher. The trade-off for the increase is that the policyowner does not have to pay premiums at age 75, 80, or even 90!



Example: Life paid up at age 65:

Single Premium Whole Life InsuranceSome whole life policies can be “paid up” with one initial payment, known as single premium whole life insurance. The concept is straightforward: based on an insured’s sex, age and health, a one-time premium will provide a pre-paid death benefit. Naturally, the larger the initial contribution, the greater the death benefit will be. Younger insureds, with more living years over which the company can earn a profit, will get more for their money. For example, a 60-year-old might use a $50,000 single premium to provide a $100,000 death benefit to her beneficiaries, while a 45-year-old’s $50,000 single premium may yield a $175,000 death benefit.

In this type of policy there are two ways to go about it. First is how much money does the policyowner want to commit to the plan, and from this the insurance company determines how much coverage can be issued. Second given how much coverage the policyowner is looking to obtain, the insurance company will determine how much premium is needed to put the plan into effect.

The difference between the purchase amount and the face amount, known as the corridor of coverage, is essential to the retention of the tax free death benefit, which remains in effect as long as the policy remains in force.

Single Premium Whole Life (SPWL) was considered by some to be a viable investment vehicle. Years ago when overall interest rates were high, a plan such as this may have been offered in the marketplace with a cash value interest rate of 8-10%. Imagine being in a financial position to move money from a bank account earning roughly the same or lower interest and depositing it into the single premium whole life insurance



plan. First, the cash value growth was tax deferred as opposed to being taxed yearly as ordinary income. Second, the policyowner at that time could withdraw the entire initial premium in a couple of years’ time without much or any charge and income tax free. They then could take this money and put it to use in perhaps another policy. Meanwhile, the single premium whole life insurance policy had only the interest earnings that is compounding income tax free and upon death pays it out in an essentially level death benefit income tax free to named family members. It sounded and acted too much like an unintended use of the existing tax code for life insurance to be a tax shelter.

In 1988, the IRS established the Modified Endowment Contract (MEC) rules, which applies to single premium life insurance as well as other life insurance contracts and diluted some of the tax advantages originally associated with life insurance. Withdrawals described previously would now be subject to adverse income tax consequences which effectively put an end to those types of arbitrage strategies being used. The sale of single premium life fell dramatically after passage of the new tax rules which provided some credence to the IRS’s position on the entire subject matter. Single premium life had been used for tax evasion and money laundering schemes. Federal, local, and IRS regulations, including MEC rules, must be carefully examined before buying or proposing a single premium life insurance policy.

At the purchase of a single premium whole life policy, the net premium (initial sum minus expense and mortality fees) becomes the immediate cash value, which then grows by interest and with declared dividends if issued by a participating company. The interest rate is either fixed at policy inception, or variable with a minimum guarantee. Some companies allow the policyowner to choose between the interest options. Mutual company dividends can be withdrawn in cash, left on deposit with interest, or applied toward increasing the death benefit via “paid-up additions.”

Most single premium whole life plans operate on a “current assumption” interest rate basis, with a minimum interest rate guaranteed. Current assumption contracts resemble mutual contracts in that the company’s investment return has a direct bearing on policy values. Rather than declaring dividends, however, the company will increase the interest rate. The earned-interest (or dividend) portion can be withdrawn, and as much as 90% of the cash value can be borrowed from the policy, which will reduce the death benefit and the internal growth. However, cash value withdrawals or loans will likely trigger a MEC tax treatment and possible penalties depending upon the age of the withdrawal.

Surrender ChargesMost single premium policies impose a “back-end” fee or surrender charge (similar to annuities) if the policy is surrendered within the first 5 to 10 years. Typically, the charge starts at 7% to 10% of the initial lump-sum premium in the first year and declines by 1% or so annually thereafter. For example, for a $10,000 single premium, the charge might be 10%, or $1,000, in year one, 9%, or $900 in year two, and down to zero by year ten and thereafter. Some companies use total cash value rather than purchase premium in determining surrender fees. In the previous example, if the $10,000 had grown to $11,000, the first-year 10% fee would be $1,100, and so on, re-calculated annually on the total cash value. As stated, any cash withdrawal may be subjected to the MEC tax rules.

Features and Benefits of Whole Life InsuranceVarious features and benefits make whole life an attractive life insurance purchase option. Among those features are guaranteed mortality charges, premiums, and death benefits. Depending on whether the policy is purchased from a mutual company or a stock company, a policyowner may also receive an annual non-guaranteed “refund” of part of the premium in the form of a dividend, which is determined each year by the company.



Guaranteed PremiumsWith the few exceptions noted, whole life premiums remain the same throughout the life of the insured, until the policy is surrendered, or it endows. Premiums are higher than for term insurance, a difference that narrows with age, and the eventual cash value buildup compensates for the added premium outlay. Plus, when purchased at a young age, a $100,000 whole life premium would be comparable to a new term policy after 20 or 25 years – and stay level as term premiums continue to increase and as an added benefit cash values accumulate.

Simply stated, whole life insurance is a contractual arrangement wherein an insurer agrees to pay the face amount to a beneficiary at the death of the insured or to pay the same amount to the insured when they reach age 100. So, regardless of the contractually stated premium duration, and assuming payment of those premiums, a whole life policy remains in force until the sooner of the insured either dying or reaching age 100.

Guaranteed Death BenefitFixed benefit whole life insurance guarantees a death benefit will be paid to a named beneficiary upon filing a claim and providing the necessary proof of the insured’s death. Its payout is not based on potential returns from underlying investments or interest rates that are subject to change. With whole life insurance, families and businesses can depend on the benefit being there at the precise time it’s needed to pay last expenses and upcoming obligations. The social value of life insurance cannot be overstated. Also, regardless of the amount, monies paid to a named beneficiary at an insured’s death are free from federal and states income taxes.

Guaranteed Cash ValuesMost U.S. life insurance companies invest whole life policy cash value holdings in what is known as a “general account,” comprised largely of conservative holdings in U.S. Government bonds and highly rated corporate bonds, mortgages, and preferred stocks. These conservative fixed income investments earn the prevailing interest rate at the time of purchase, and the preferred stocks can earn dividends. The returns are projected to support the cash value that is specified and guaranteed throughout the life of the whole life contract and the death benefit.

To offset the costs of issuing a policy, which includes sales commissions, underwriting, medical exams, etc., companies impose a “front load” by not crediting any cash values for the first few years. As the policy remains in force, however, the policy will see ever-increasing cash values. From years 8 to 9, for example, a policy’s cash value may increase by $300. From year 12 to 13, the same policy’s cash value may increase by $400. This is partly a function of accumulated earnings, but is also a reward for longevity.

If a whole life policy lapses within two years of issue, it may be due to insufficient understanding of the products features and benefits. Proper and complete explanations by insurance professionals will result in twin benefits: high customer satisfaction and low lapse rates.

Whole life insurance is well suited to needs that do not diminish over time, such as paying estate settlement costs, final expenses, and taxes. Whole life policies cash values are guaranteed and listed in exact amount, year by year, in a policy’s table of nonforfeiture values. The guaranteed cash value is not taxed as it accrues in the policy, nor is it taxed upon surrender, unless and until it exceeds the total amount of premiums paid. Also, policy loans are received income tax free while the policy remains in force. Some whole life policies, issued by mutual companies, are also eligible for dividends that can enhance the overall cash available to the policyowner.



Variations of Whole Life InsuranceInterest-Sensitive Whole LifeInterest-sensitive whole life can be called a hybrid of traditional cash-value whole life insurance and universal life insurance. As in traditional whole life, the premium and the death benefit are fixed at issue, but rather than accruing in pre-determined increments, the cash value is dependent upon prevailing interest rates. If interest rates are favorable, the cash value can actually increase at a faster rate.

Interest-sensitive whole life is suited to those who want the fixed-premium, “forced-savings” feature of traditional whole life and the potential for higher interest rates than those guaranteed in traditional whole life insurance policies. The policy has a guaranteed minimum interest that it pays into the cash value accumulation account, for example, at 3.5%. Additional interest credits can also be applied as determined by the company.

At issue, interest sensitive premiums are determined in the same way as other whole life insurance policies. With enough cash value in the accumulation account, future premium payments may even be skipped in part or in whole. Also, with enough growth in the cash value, the total death benefit can actually increase over time. This is due to the MEC rules and has to do with the net amount at risk within the policy to the insurer.

Most interest-sensitive policies have low initial charges or front-end fees, and some cash value is credited in the first year. A gross cash value represents the overall growth, and a net value, the amount available for loan, withdrawal, or at policy surrender. That gap narrows over the years until the amounts merge, rewarding policyholder longevity. Interest sensitive life led to the development of current-assumption whole life.

Current-Assumption Whole Life Current assumption whole life insurance is a type of permanent, cash value life insurance that is a variation of whole life with some similarities to universal life insurance policies. This type of policy provides premiums that are fixed for specified periods and recalculated on predetermined anniversary dates based upon the insurance company’s actual mortality experience, overall investment earnings, and expense management. This will ultimately have an impact on the premium and cash value of the policy. With some policies, the death benefit is also recast.

Current assumption whole life mimics universal life in the manner in which interest is credited and expenses are identified and charged. Most policies contain a minimum interest rate guarantee and a maximum mortality charge. Some policies will tie the premium to the interest being earned, applying interest over a target amount, if any, to reduce the premium. The downside risk is that the premium may increase, subject to a specified maximum, if the target is not reached. The same holds true based on mortality experience. The better mortality the company experiences, the more benefit to the policyowner reflected in lower premiums or higher cash values. The opposite is also true. The worse the company’s mortality experience, the less benefit to the policyowner reflected in higher premiums or lower cash values.

Current assumption policies are considered to be “unbundled,” allowing policyowners to see how the policies operate internally. The annual (sometimes quarterly) policy statements are in spreadsheet form. So, with current-assumption whole life policies, the policyowner bears the risk that the interest credited and mortality experience of the company will be less favorable than originally assumed. The insurance company can recalculate, on an annual basis, the premium and policy benefits based on the overall company performance. This can lead to the policy owner being able to:



• Withdraw some cash values• Reduce or increase future premium payments• Increase or decrease the face amount• Shorten or lengthen the premium payment period• Shorten the coverage period

Current assumption whole life (and individual insurance companies’ variations) are sometimes referred to as interest-sensitive whole life, indeterminate premium whole life, or fixed premium universal life. The most widely available interest-sensitive permanent life insurance policy is universal life. Current-assumption is only one form of interest sensitive whole life. Others include policies that allow for adjustments in premium, face amount and the length of protection. Some of these changes can be accomplished on a contractual basis, others with minimal underwriting. A practical application of that benefit might be a 65-year-old who becomes widowed and wishes to reduce a substantial amount of coverage in the policy to a more modest coverage amount. That change would lower the premium and, in many cases, release some cash value as well.

Second-to-Die, Survivorship Whole Life InsuranceSecond-to-die whole life insurance insures two people, typically a husband and wife. It pays the death benefit to the beneficiary at the death of the second insured. Evolving estate-tax regulations have put a dent in the market for second-to-die, but at one time, when marital estates could be hard hit at the second death, they served an important function. There are still some uses: when a substantial pension plan ceases at the second death, or when a couple wishes to leave a significant contribution to a charity after they’ve both passed on. An advantage of a second-to-die contract is that its dual coverage costs less than purchasing two separate policies. These plans can be either traditional whole life or one of its derivatives, such as universal life. This type of policy also has more liberal underwriting especially if one of the potential insureds has health issues since the payout is after the second insured’s death. Given the state of the U.S. economy and tax law changes, there may be a resurgence in this type of policy for estate planning, especially when it comes to providing the necessary liquidity to cover estate taxes.

Whole Life Summary The plans discussed are all potential solutions for some clients’ financial situations. Whole life can provide solutions to a wide variety of insurance needs: plans for young adults to begin building an estate, protection for growing families, last-expense plans for seniors, cash-building coverage for children, financial protection for businesses, charitable bequests and more.

The list is endless, which brings us back to social value. Accumulating enough liquid assets to replace ongoing income after death is beyond the means of most people and families. Charities are stretched to the limit, and Social Security, while a valuable program, is only a basic safety net. In one form or another, life insurance is affordable for most people, especially for the peace of mind it provides.

Advantages and Disadvantages of Whole Life InsuranceWhole life insurance offers many advantages, but also has a few disadvantages as well. When reviewing options with clients, it’s important the insurance producer examine all options to meet his client’s specific needs.

Advantages• Guaranteed level death benefit• Guaranteed cash values not subject to market risk or interest rate changes, in most cases



• Regular savings encouraged through mandated premium payment• Liquidity through access to cash values• Ability to use the policy as collateral or security for personal or business loans• Insurance protection for the “whole of life”

Disadvantages• The premium may be unaffordable for persons with limited financial resources• Interest paid on policy loans is generally nondeductible• Life time distributions of cash values are taxable to the extent attributable to gain in the policy• Surrender of the policy within the first 5-10 years may result in loss, since early surrender values

reflect the company’s recovery of its initial policy expenses• Pre-established cash values may not keep pace with inflation• The overall rate of return on guaranteed cash values may not be competitive in comparison with

alternative investments

Buy Term and Invest the DifferenceSome believe that the idea of whole life insurance policies sound better than term life insurance policies. The argument is that owning is better than renting. With owning there is a chance of building equity; with renting all that can be counted on at the end of the rental period is the payment receipts. So, why rent, some say, when ownership is available.

Let us compare two options. Option 1 is to buy traditional whole-life insurance and Option 2 is to buy term life insurance over a 10 year period of time. Assume that age, gender, face amount, and underwriting classifications are all the same.

Option 1 Option 2

End of Year Whole Life Insurance Premium

Term Life Insurance Premium

1 $600 $200 2 $600 $200 3 $600 $200 4 $600 $200 5 $600 $200 6 $600 $200 7 $600 $200 8 $600 $200 9 $600 $200 10 $600 $200

Total Premium Paid $6,000 $2,000 Total Cash Value $6,000 $0

Difference $0 $2,000



Given the numbers in the chart, the whole life story is to compare the total amount of premium paid to the cash value in the policy. The term life story is to see how much out of pocket premiums were actually paid. From this analysis, it appears that the whole life insurance protection is basically acquired at no cost; and the term policy is acquired at full cost

Premium Paid In Cash Value Paid Out Cost for ProtectionWhole Life $6,000 $6,000 0Term Life $2,000 0 $2,000

What if the difference of $400 ($600 - $200) per year was invested at 5%? Assuming a tax rate of 20%, the net return each year would be 4% (5% x 20% = 1%; 5% - 1% = 4%). Over 10 years, the account would have grown to $4,802. Therefore, the total out of pocket for the term and invest the difference option would have been $6,000 consisting of both the premium and the investment ($200 x 10 = $2,000; $400 x 10 = $4,000; $2,000 + $4,000 = $6,000). The “total cash value” worked out to be $4,802 so the difference would be $1,198, which is greater than $0. So upon further review, maybe buying term life insurance is the way to go.

So, does this prove that buying term and investing the difference is superior to buying traditional whole life insurance? Does this take into account what happens to the term life premiums after 10 years is up? If the whole life policy was invested, were potential dividends taken into account? Were investment results actually greater than or less than the 5% gross and 4% net shown? Were tax free or tax deferred accounts taken into consideration? The answer to all of these questions is absolutely NO!

The point of the exercise is to show that there is more to a proper analysis than merely looking at short term time horizons, limited data, and taking only certain facts and scenarios into account. After all, it is possible that outside investment results could have in fact been negative. For example, buying stock at $10 per share today and selling it down the road for $3 per share is a negative 70% return ($10 - $3 = $7: $7/$10=70%). The need for truly temporary coverage may mean that permanent coverage plans make less sense and that truly longer term coverage needs may not be well suited for term.

In a low “outside” interest rate environment, whole life insurance policy returns on net investment (premium less cost of insurance coverage) may actually outperform conservative savings and investments. In higher interest rate environments, the reverse may likely turn out to be true.

The decision as to which type of policy, term or permanent, is a highly personal one, and at times a very emotionally charged one. One’s risk tolerance, financial knowledge, and general market conditions, as well as the primary reason for buying insurance in the first place all need to be evaluated. Even then, there can be unforeseen circumstances.

Using $1,000 a year for 10 years as an example, someone who pays for $100 term insurance and deposits $900 into a generic common stock fund from 1992 to 2001 may have scored well. Over the next 10 years, 2002-2011 may have been a different story. In those years, a permanent insurance plan with a $1,000 annual premium and a guaranteed cash value would likely have come out ahead, tax-deferred and risk-free. Employees lose jobs, insured’s health changes, families grow, college costs increase, mortgage balances and interest rates rise, retirement sneaks up quicker than most realized, and income tax rates change. Life events need to be considered just like market returns, because seldom are they linear.

Income tax on the gain in permanent policies is deferred until withdrawn or surrendered, and taxable only then to the extent the amount exceeds the total paid-in premiums. Any outside mutual fund dividend and capital gain distributions are subject to income tax in the year distributed. Gain in share price is deferred until sold, and then likely taxable at capital gains rates.



Whole life policies typically are not profitable if cancelled in the first 7 to 10 years if comparing the gross premium paid to the cash value in the policy. The cash accumulation grows slowly until the company recovers the majority of its issuing costs, which can translate into surrender penalties or back-end loads, early termination fees, and other administration charges in the early years. The early loads and charges vary from company to company; it behooves the consumer to shop wisely. A company’s profitability may be derived more from high charges and lapse ratios than based on other more traditional performance measures. Comparative ratings and performance histories may be available on-line or can be provided from the insurer or one of its representatives.

In the end it may not be a matter of buying one or the other, term life insurance or permanent life insurance. The better overall strategy may be to buy some of each as they both have their advantages. So, a 5-year term life insurance plan may be ideal for a father and mother who want to guarantee a college-age daughter’s tuition, even if either one or both the parents were to die before or during the college years. The same couple may also have one or more permanent life insurance plans in place in order to provide financially for the surviving spouse whenever death occurs, even well into the future, to cover final expenses such as last illness medical bills, burial and funeral expenses, any court costs and legal fees, as well as taxes.

Life Insurance Policy RidersRiders are benefit options that a policyowner can elect most often at the time of application, but some are available after issue for a premium that will add additional benefits to the policy. They are said to ride along with the base plan, and most can be cancelled at any time.

Cost of Living ProvisionFor an additional premium, the cost of living provision rider will drive the death benefit up each year equal to the rate of inflation or some other identifiable index. So, a policy issued with a $100,000 face amount will have a $102,000 face amount one year later if inflation runs at 2%. The insurance company may adjust the cost of the rider every year to reflect the increased amount of risk they are now exposed to without the insured having to prove insurability.

Example: Jorge has a 30 year $100,000 term life insurance policy with an inflation rider. At the end of 12 years, inflation has averaged 6%. Jorge’s policy’s death benefit will then be around $200,000.

Disability RidersEmployees typically have short-term and long-term disability income coverage provided through an employer group plan. Some have taken the additional step to purchase individual disability income insurance to make sure that they have enough coverage in case they become disabled. The likelihood of becoming disabled prior to age 65 is far greater than dying prior to age 65. In order to make sure that life insurance protection remains in force during times of policy owner disability, the life insurance industry has riders to address such a situation.

Waiver of PremiumWaiver of Premium (WP) is a rider that can be added to most fixed level premium policies that provides for the scheduled premium to be waived by the company in the event of the insured’s (or owner’s) disability as defined in the rider occurring before a specified age. Companies charge an extra premium for this rider, while some may factor the cost into the stated premium.

The disability must be verified and re-established at certain intervals, but the waiver stays in effect during the disability and the policy’s benefits and values continue to grow as if the premium were being paid by



the policy owner. If the insured recovers from the disability, the insured starts paying the premium from that point on. The insured does not have to repay the insurance company for the premiums that were waived because it was not a loan; it was an insured benefit.

Example: Jose has a $100,000 whole life insurance policy with a waiver of premium rider. The premium for the entire plan is $950 per year, with $900 going towards the base plan and $50 earmarked for the rider. To qualify for the waiver of premium, Jose must be medically unable to engage in any gainful employment for which he is suited by education or training. The disability must last at least 6 months prior to filing a claim during which time he must continue to pay the policy’s premium. Once Jose files a claim, the company will refund any premiums paid during the 6 month waiting period; and the policy will be in effect as if he were paying the premiums. In fact, the company will have waived its right to collect premiums during his disability.

Disability Income BenefitThis rider pays out a modest monthly income to the policyowner in case of a qualified disability while the policy is in force. Typically, it is a multiple of the policy’s face amount, or it can also be a specified dollar amount.

Example: The disability income benefit on Marla’s policy will pay out 10% of the face amount as an income benefit if she suffers from a qualifying disability. Her $100,000 policy would pay out a maximum of $10,000 per year ($100,000 x 10%) or $833.33 per month.

Payor Benefit (Juvenile Life Insurance)This rider waives the premium during the policy owner’s disability or upon death until the minor aged insured reaches the age of majority. At the age of majority, the insured will then be able to take over the juvenile insurance policy as his own, which was originally issued at or near his time of birth. At that point in time, the newly minted adult takes over as official owner and takes on the premium paying obligations in order to continue the policy in force.

Guaranteed Insurability/Option to PurchaseGuaranteed insurability, also known as option to purchase additional insurance rider (OPAI), allows for the availability of periodic increases in coverage in order to help keep pace with increasing needs. The rider pre-approves the purchase of additional coverage, commonly at 3-year intervals, in the same underwriting class as the original policy. Attained-age premiums may also be approved without evidence of insurability in amounts equal or less than the original face amount of the policy. Normally this rider is available to permanent life insurance policies like whole-life.

The additional coverage is either added to the original policy as a rider, or as is normally the case, issued as a separate policy. The OPAI rider itself carries a modest premium; the amount of increase in life insurance coverage available is specified in the rider; and there is no obligation to exercise the option. Obviously, the rider is most valuable to insureds whose income is likely to increase over time and they see the needs for insurance increasing as well. Those who are most likely to exercise this option are those whose health becomes questionable or who have switched from stamp collecting to sky diving, similar to converting from employer group life to an individual policy if separation of employment occurs.

Depending on one’s cash flow, protection needs, and personal and business goals and philosophy, life insurance needs can change. Limited protection for a single individual starting a career may be sufficient. Flash forward 10 years to that person now with a spouse, two kids and a mortgage, and the picture changes. With all changes, however, the rider offers a way to obtain additional insurance coverage with no questions asked. By completing the request form, and paying the additional premium, increased coverage will apply.



Example: Andre purchased a $20,000 whole life policy with a guaranteed insurability rider when he was 23 years old. The rider allows him to elect to buy more insurance without having to prove insurability starting at age 25 and every 3 years thereafter until age 40. If he is the father of a newborn or gets married, he will be granted an additional option which will offset any of the other options but can be elected in between the set option dates. So, in total, Andre has 6 options to buy additional $20,000 policies. If he elects to exercise each option, then he would have a total of $140,000 worth of coverage in place when all is said and done ($20,000 x 6 = $120,000 + $20,000 = $140,000). Andre would be paying premiums on 7 policies, each with a different premium reflecting the age at which the policy was acquired.

Living Benefit Riders Accelerated Death Benefit/Terminal Illness BenefitIn an effort to show compassion, the life insurance companies now offer riders on the newer issued policies, without initial cost, to allow for a payout of a portion of the face amount of the policy in cases where the insured is facing a terminal illness, life expectancy of less than 6 months to 2 years typically. Once the claim is filed and accepted, the insurance companies will typically pay out 50-80% of the death benefit up to a specified dollar amount such as $250,000 - $500,000. In some cases, this may be income tax free with an administrative fee and/or a percentage of the payout 5-8% which represents a loan interest charge. In essence, this is an advance on the death benefit or an acceleration of the death benefit to provide necessary funds to take care of expenses or fund a trip around the world. In fact, it is similar to a policy loan as the insurance company has a lien on the policy for which interest is charged. Upon death, the beneficiaries receive any remaining death benefit and in many cases never less than $10-15,000.

Long-Term CareIf an insured is in need of long-term care, some insurance companies offer riders that will pay out long-term care like benefits due to confinement to a qualified nursing home. It could be a pool of money from which monies can be advanced starting with the policies death benefit through a stated daily or maximum monthly amount. The death benefit once again can be accelerated to cover these costs. The cash values can also be drained from the policy. Not all companies or policies offer this rider. With the increased costs of long-term care insurance and long-term care costs overall, this rider is becoming more popular with consumers. This rider is most often found on universal life type policies.

Additional Insureds (Spouse, Other, Children, Family)Policyowners can elect, by rider, to cover more than just the insured under one policy. The other insureds must have some relationship to the primary insured, such as business partner, spouse, or child. The idea with this type of rider is to have one policy cover more than one insured, possibly saving additional policy fees. Most often this coverage is in the form of term life insurance. Each insured must qualify, and current age rates are applied. If the policy owner or primary insured dies, then the riders may be able to be converted into individual policies or will terminate along with the base policy. Normally the conversion is at attained age rates, same underwriting class, without having to prove insurability but the converted policy is not necessarily term insurance so cost may be a factor going into a permanent plan.

Most whole life and term life plans of insurance can be tailored to individual needs through the addition of policy riders. Riders can provide additional coverage to cover limited needs for a limited time.

Example: A mother with an 18-year-old college-bound son may want a 5-year $100,000 term life insurance rider (10 year and other riders are available also) included in her policy to defray tuition costs if she doesn’t live to see him graduate. The rider is pure term insurance, which does not increase the base policy’s cash values, but which is less costly than the same amount of permanent



whole life insurance. The rider premium is tacked on to the base premium, but it comes off when the rider coverage ends.

Other riders can cover additional insureds. The prevalence of dual income families has made separate spousal policies the norm, but one may still add a spousal rider to a base policy.

Example: A working spouse with a $100,000 whole life policy may add a rider for up to the same amount on the stay-at-home spouse while the children are young. Again, the premium is added, but it will be significantly less than another $100,000 whole life policy.

Example: Children’s riders are also available, from day 15 of life up to typically age 15 or 19 and for small amounts of coverage, $1,000 – $10,000 typically, which covers all children. The premium is on a per-unit basis, for example, $5 or $8. A $5,000 child rider may then cost $25 – $40 per year.

Another common term rider is geared to a mortgage loan. A 15-year decreasing term rider in the amount of one’s mortgage would provide funds to pay off that mortgage in the event of the homeowner’s death. Some companies offer a husband-and-wife rider that would pay the outstanding mortgage amount at the first death. The added-on premium is generally lower than the premium for the optional “credit life” offered directly in a mortgage loan.

Accidental DeathThis rider pays out a benefit in addition to the base policy death benefit, typically in an equal amount, if the insured’s death is due to an accidental bodily injury that causes death independently of all other causes within a specified time period from when the accident took place, such as 90 days. Traditionally, this rider has been called double indemnity because with the rider a policy with a $100,000 face amount will actually pay out $200,000. The additional $100,000 would come from the rider.

Critics argue that if the insured has a need for $200,000 worth of coverage, then he should buy $200,000 and not rely on accident policies or accidental death benefit riders. The reasoning for this is that while in the hospital after the accident occurs if death is caused by catching the latest non-treatable infection, then the additional benefit is not paid. If cost is a factor, then consider different types of coverages or riders to achieve the proper level of insurance at an affordable premium.

Riders SummaryRiders with different costs and benefits allow the policyowner to customize the policy to meet current and anticipated future insurance needs. Professional life insurance producers must be aware of company riders, how they work, costs, which policies can be added to, when they can come into play, and most importantly need to be discussed and offered to clients on a regular basis. After the client suffers a disability or his insurability changes, is too late to have this discussion.



1. Tom travels frequently on business. He’s a nervous flyer. His life insurance agent suggests adding ____________ to his life insurance policy.a. An accidental death riderb. His co-workersc. An extra beneficiaryd. His stay-at-home spouse

2. Tom and Cindy have just become parents of triplets. They are aware of the need for additional life insurance, but their finances are understandably strained. Which ONE of the following will provide them with the best solution under the current circumstances?a. Apply for whole life policiesb. Apply for term policiesc. Apply for financial aidd. Move in with Cindy’s parents

3. Larry was undecided between two companies’ very similar whole life policies. To help him decide which one was the better buy, he checked out ____________.a. The agents’ reputationsb. His disposable incomec. The non-forfeiture valuesd. The policies’ cost indexes

4. Betsy plans on opening a medical clinic when she graduates from medical school in 3 years. Her agent urges her to include the ____________ rider in her life insurance policy.a. Option to purchase additional insurance (OPAI)b. Juvenile insuredc. Modified endowment contract (MEC)d. Child

5. Following a serious accident at work, Sandy, the client has been in traction, unable to work for more than 6 months. It’s time that he should apply for his policy’s ____________.a. Face amount of insuranceb. Non-forfeiture valuesc. Waiver of premium benefitd. Incontestable clause

6. Xavier has been invited to address a graduating law school class on some of the characteristics of permanent life insurance. For that particular audience, he wants to be sure to stress the benefits of ____________.a. Modified and graded premiumsb. Guaranteed cash valuesc. Waiver of premium ridersd. Spousal term riders

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7. In traditional whole life insurance policies, the premium schedule an individual is faced with in the beginning is ____________.a. Subject to periodic increasesb. Guaranteed for the life of the contractc. Reduced as cash values accumulated. Waived at age 65

8. Ethel wants a fixed premium life insurance policy to force her to put some money away for the future, but she also wants a chance for a higher return on her cash values than a standard whole life policy would provide. Which ONE of the following would best meet her need? a. Two separate life insurance policiesb. A Roth IRA annuityc. A current assumption life insurance policyd. A government bond rider

9. All of the following statements about modified premium policies are true, EXCEPT:a. Initial premiums are reduced for several yearsb. The premium increases every 3 years to age 65c. The ultimate premium remains leveld. It is suited to individuals whose incomes are expected to rise

10. Most whole life insurance plan can be tailored to meet the individual life insurance needs of a prospect through the addition of ____________.a. Policy ridersb. Non-forfeiture valuesc. Unilateral clausesd. Co-beneficiaries

11. A high school senior hopes to attend medical school after earning her undergraduate degree. It would be advisable for her parents to include ____________ in their existing whole life insurance policies.a. The waiver of premium provisionb. Ten-year term ridersc. The daughter as beneficiaryd. A incontestable clause

12. Zelda tells her life insurance agent that she “Hates payment plans, always pays cash for cars, and even paid cash for the house.” She obviously is not likely to be interested in hearing about ongoing life insurance premium payments; therefore, she is likely a good prospect for a ____________.a. Gold bullion mutual fundb. Million dollar life annuityc. Single premium whole life insurance policyd. New car and a bigger house

13. At the purchase of a single premium whole life policy, the net premium, the initial sum minus expense and mortality fees, becomes the ____________.a. Immediate cash valueb. Additional term coveragec. Modified premium excessd. Death benefit settlement account



14. Before someone decides to surrender a 3-year old single premium life insurance policy, they should be made aware of the ____________.a. Surrender charge or “back end load”b. Impact on their credit ratingc. Mandatory 31-day waiting periodd. Non-renewal penalty

15. A life insurance prospect is interested in coverage on his wife and on their young son, but he dislikes writing so many premium checks for so many different policies. What can be recommended to address his concern?a. Pay in cashb. Use a spouse and child rider for his own policyc. Let them pay for their own policiesd. Pay for the additional coverage with the automatic premium loan provision


Chapter 4

Variable Whole Life, Adjustable Life, Universal Life, & Variable Universal Life Insurance

IntroductionNow it is time to look at the evolution of permanent life insurance into its present day variations:

• Ones that tie cash value and death benefits to investment markets • Those that allow for flexibility in premium payments• Adjustments to be made to death benefits after issue

Variable Whole Life InsuranceVariable life (VL) is a form of whole life insurance that combines lifetime protection with investment opportunities. It actually is a form of insurance that transfers risk back to the policy owner. For those who are willing to take on investment risk with a life insurance policy in order to potentially achieve a greater cash value accumulation and overall total death benefit, then this policy needs to be considered.

RegulationBecause variable contracts subject the policyowner to market risks and the policy contains investment options similar to the operations of mutual funds, it is considered a security. As a securities contract, variable life insurance is regulated by the SEC (Securities & Exchange Commission) under federal securities laws, such as the Securities Exchange Act of 1934, the Securities Act of 1933, the Investment Company Act of 1940, and the Investment Advisors Act of 1940. It is also regulated at the state level as both a securities and insurance product. Advisors or agents who market variable life must be properly authorized. This requires obtaining a FINRA (Financial Industry Regulatory Authority) series 6 or 7 registered representative registration, a state series 63 or 66 registration, and a state insurance license to sell life insurance and/or variable contracts. Also, because variable products are considered a new issue security, it must be sold with a prospectus which provides details about the product as well as all fees, charges, expenses, and risks.

The ProspectusWithout the prospectus, any variable contract sale would be prohibited. The prospectus is the most important and complete source of information about a variable contract’s inner workings, including fees and charges, goals, government requirements, and, of course, investment options. Salespeople must offer a prospectus prior to or concurrent with any sale, and the prospect should read it before investing any premium dollars. Granted, a detailed reading of a prospectus by a prospect or client is rare, but even scanning it can guide one toward the right investment choices, including consideration of:

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81CHAPTER 4: VARIABLE WHOLE LIFE, ADJUSTABLE LIFE, UNIVERSAL LIFE, & VARIABLE UNIVERSAL LIFE

• The various subaccounts’ investment objectives and policies• Management fees and other expenses charged• The risks and volatility of the accounts

In short, the prospectus is a valuable tool for both parties to a variable contract sales presentation.

PremiumThe policy has regularly scheduled premium payments like traditional whole life. The fixed premium is what drives the guaranteed minimum death benefit. Net premiums can be directed into one or more mutual fund like investment sub-accounts, which offer potentially high returns at varying degrees of risk.

Virtually every state taxes life insurance premiums, commonly at 2%. In traditional policies, the company takes this tax into account when determining premiums. In variable policies, however, the premium tax is usually charged against every premium as it’s paid.

Cash Values With variable contracts the term “variable” refers to the fact that the policy owner can allocate premium dollars and cash values to a variety of investment funds within an insurance company’s separate account. Such investment general category options typically include the three basic asset classes:

• Equity funds• Bond funds• Money market funds

The “funds” available in variable products’ portfolios function in much the same way as mutual funds, but they are properly and officially called “separate or segregated accounts.” Companies generally provide 20-50 investment fund options that can include:

• Large, mid, and small cap• International, foreign• Emerging market, growth, blend, and value styles• Common stock funds• U.S. Government, high-grade and high-yield• Long-term, intermediate, or short-term bonds funds• Indexed stock and bond funds• Specialized funds, for example, utilities, real estate, and commodity common stock funds • U.S. Government or corporate money market funds

Insurance companies can also make available one or more fixed accounts of various holding periods, such as 1, 3, 5, 7, or 10 years. The funds held inside the fixed accounts are backed by the insurance companies’ general account and are therefore considered guaranteed. Some companies place restrictions on the ability to move funds out of this account, for example, no more than 25% of the account balance can be transferred out in any one year. The insurance companies do not want this to act like or be considered as a money market account for trading in and out of. Fixed accounts typically credit 3%-4% annual interest depending on the holding period.



Investment Choices Net premiums can be directed by the policyowner into one or more mutual fund like investment sub-accounts. Policyholders can select from these accounts and can make changes in the investment choices without incurring any tax liability. Transfers among the investment account choices may incur an administrative fee, and there may be limits as to how many transfers can take place during a calendar year. Other than the values residing in the fixed account, the cash values are subject to full market risk and are, therefore, not guaranteed.

Nearly all companies allow multiple-choice allocations, subject to minimum dollar amounts or percentages. Someone with a $100 monthly premium may allocate 25% each to a small cap stock fund, a utility fund, a corporate bond fund, and a foreign stock fund. Inclusion of the fixed-interest option provides a hedge against steep market losses whereas stock funds possibly provide a hedge against inflation. A foreign stock or bond fund possibly provides a currency hedge of sorts.

The investment-account funds are held and managed separately from the insurance company’s general accounts, and policy values reflect the actual experience of the selected fund’s investments after fees and expenses are deducted. The actual investment managers may be from the insurance company’s investment department or from a 3rd party money manager, most likely from a name brand mutual fund organization.

Asset AllocationAsset allocation is a process where an investor spreads the risk not just through diversification, but by allotting investments in pre-selected percentages. This process is related to diversification, because it involves spreading investments among different sectors of the economy as well as among different companies and investment styles.

Asset allocation starts with an investment questionnaire in an attempt to gauge an investor’s risk tolerance. From there a model portfolio is recommended that is made up of different asset classes and sub-classes. Think of it as a type of team a franchise would like to put together with the actual players consisting of the various separate account funds of different types who are put on the field to achieve success. Success is measured not by wins and losses but by how well the stated investment goals have been achieved.

Asset allocation tries to achieve the highest possible returns for the least possible risk for any given allocation. This is known as the efficient frontier which Harry Markowitz won a Nobel Memorial Prize for his work in developing modern portfolio theory. Examples of portfolio asset class mixes would include a 90% equity and 10% fixed income portfolio for an aggressive investor, a 60/40 portfolio for a moderate or balanced investor, and a 20/80 portfolio for a conservative investor.

Portfolio RebalancingWhen the front-end of a car gets out of alignment or the wheels get out of balance, it is best to have them checked by a qualified mechanic and have them put back in alignment and balance for optimal driving pleasure, fuel efficiency, and safety. Similarly, a portfolio should be re-examined from time to time to see if it needs to be put back into alignment or as they say, rebalanced.

If the original allocation was 50/50 based on the results of the investment questionnaire indicating the investor’s risk tolerance and now the portfolio stands at 60/40 due to a bullish stock market, the question becomes what course of action, if any, needs to take place? One course of action is to do nothing and see what happens going forward. Will the stock market continue to go up, remain the same, or will it go down? Will the investor be able to handle the greater risk exposure to stocks as compared to bonds? To put the portfolio back to its original allocation, some of the equity portion of the portfolio would have to be pared back and invested into the fixed income fund.



This can be accomplished with a letter or a phone call requesting the desired action take place. It can also occur automatically. Insurance companies provide automatic portfolio rebalancing on a periodic basis. Most often it is done annually, but it can be done more or less frequently.

Example: Assume an initial, one-time purchase payment of $100,000, allocated in the following proportion: 50% in a stock subaccount; 40% in a bond subaccount; and 10% in a money market account paying 2% interest. The chart shows how the account performed during year 1.

Stock Bond Money Market TotalBeginning Allocation 50% 40% 10% 100%Starting Value $50,000 $40,000 $10,000 $100,000+/- +20% -10% +2%Growth/Earnings +$10,000 -$4,000 +$200 +$6,200Ending Value $60,000 $36,000 $10,200 $106,200Ending Allocation 56% 34% 10% 100%

The chart shows how the account performed over the second year by “letting it ride”.

Stock Bond Money Market TotalBeginning Allocation 56% 34% 10% 100%Starting Value $60,000 $36,000 $10,200 $106,200+/- -10% +10% +2%Growth/Earnings -$6,000 +$3,600 +$204 -$2,196Ending Value $54,000 $39,600 $10,404 $104,004Ending Allocation 52% 38% 10% 100%

The chart shows how the account would have performed over the second year if the account had been rebalanced at the end of year 1, instead of “letting it ride”. Rebalancing would have moved some of the stock fund value over to the bond and money market fund at the end of year 1.

Stock Bond Money Market Total

Beginning Allocation 56% 34% 10% 100%Starting Value $60,000 $36,000 $10,200 $106,200Original Allocation 50% 40% 10% 100%Rebalanced Account Values $53,100 $42,480 $10,620 $106,200

+/- -10% +10% +2%Growth/Earnings -$5,310 +$4,248 +$212.40 -$849.60Ending Value $47,790 $46,728 $10,832.40 $105,350.40Ending Allocation 46% 44% 10% 100%

Rebalancing at the end of year 1 would have resulted in a $1,346.40 difference ($105,350.40 - $104,004).



Dollar Cost Averaging - Investing a Defined Amount Over TimeVariable contracts offer a unique way to invest a lump sum and implement dollar cost averaging. A policy owner can make a lump sum purchase, let’s say $50,000, into the money market subaccount or fixed account and authorize periodic purchase of a common stock subaccount from the money market fund or fixed account. The interest credited to the account overall from the money market fund or fixed account will make additional funds available to invest. A monthly $1,000 investment could result in a difference between average cost per unit and average price paid per unit over several months. Dollar cost averaging is a technique typically used for buying mutual fund shares that can be used with equal effectiveness in variable contracts in which investments of the same amounts are made on a regular basis.

Over many months, the difference between average cost and average price can be significant. Dollar cost averaging does not protect against loss. Dollar cost averaging is a long-term, disciplined strategy, requiring continuous investing during declining market periods. There is no guarantee of positive investment results. A consideration before committing to dollar cost averaging is whether or not the policy owner’s financial situation and the account balance will continue to allow the purchases. Only the individual investor can determine that.

Example: Following is a simplified example of an investor putting $500 to work per month over a 5 month period of time to demonstrate the concept described.

Month Investment Price per Unit Units Purchased

1 $500 $25 202 $500 $20 253 $500 $10 504 $500 $14 35.715 $500 $17 29.41

Totals $2,500 $90 160.12

Average price paid per unit $18 = $90/5

Average cost per unit $15.61 = $2,500/160.12

Due to the math, no matter what price per unit sequence is used and regardless of how many time periods are taken into consideration, the average cost per unit will always be lower than the average of the prices paid per unit. To repeat, this strategy does not guarantee an investor will make a profit.

Fixed Account The fixed account, with rate guarantees, is a better choice for the ultra-conservative investor. Most variable policies offer a fixed account, invested primarily in conservative, high-grade corporate and government bonds. There may be several fixed accounts, offering different durations with different guaranteed rates. Fixed account yields are predictable and without volatility. The principal and interest are guaranteed by the insurance company based upon creditworthiness and claims paying ability. The fixed account is supported by the insurance company’s general account. If the only place the policy owner wants to keep cash values is in a fixed account, other than for temporary purposes, then the choice of a variable policy may not have been appropriate in the first place.



Unlike accounts that are subject to fluctuating market conditions, fixed accounts pay a certain fixed rate of interest that are guaranteed for a stated period of time, after which the insurance company may reset the interest rate. Usually, a minimum rate is guaranteed in the contract from the start. Most are for one year, but not too many years ago insurance companies offered fixed accounts with varying maturities and interest rates. The longer the time period in the fixed account, the higher the rate; and the shorter the time period, the lower the rate. This mirrored the primary underlying investments made by the insurance company to support these accounts, U.S. Government and high-grade corporate notes and bonds. Back then there was an interest rate spread to work with. Insurance companies could take in premiums and invest them at an average rate of let’s say 6% and credit 4-4.5%. Today the spreads have narrowed simply because virtually all rates are at historic lows. Long dated bonds now have rates that have historically been associated with 2-5 year treasury notes. T-bills pay next to nothing.

Death BenefitThe policy is first and foremost life insurance that has investment choices for the net premiums and cash value available. The fixed premium is what drives the guaranteed minimum death benefit. The death benefit could actually increase if the investments perform especially well. This is not only a side-effect of high-earning investment funds; it also keeps the corridor of coverage, the gap between the cash value and death benefit at any given age, at a level which preserves the policy’s tax treatment as insurance rather than as an investment, like an annuity. Those advantages include tax-deferred growth, tax favorable withdrawals and tax-free death benefits. If the underlying subaccount investments do not perform well, any previous increases above and beyond the guaranteed minimum death benefit may be recaptured. Going forward any “losses” would first have to be made up before the total death benefit could ever again exceed the guaranteed minimum. The guarantee is based on the claims paying ability of the insurance company.

Example: In this example, focus on the concept—not on how the internal death benefit was actually calculated. This is for illustrative purposes only to show the difference between the guaranteed minimum death benefit and the internal death benefit which is directly related to the investment performance of the investment funds.

End of Year

Actual Investment Performance

Assumed Interest Rate*

Guaranteed Minimum

Death Benefit

Internal Death Benefit

Actual Death Benefit

0 0% 0% $100,000 $100,000 $100,000 1 10% 4% $100,000 $106,000 $106,000 2 0% 4% $100,000 $102,000 $102,000 3 -20% 4% $100,000 $86,000 $100,000 4 5% 4% $100,000 $90,000 $100,000 5 2% 4% $100,000 $88,000 $100,000 6 4% 4% $100,000 $88,000 $100,000 7 12% 4% $100,000 $99,000 $100,000 8 31% 4% $100,000 $130,000 $130,000 9 10% 4% $100,000 $140,000 $140,000 10 -50% 4% $100,000 $80,000 $100,000

*The assumed interest rate is what the insurer used to base the policy’s premium on for the guaranteed minimum death benefit. If investment performance is below that, the insurance company assumes that risk and must still provide a guaranteed minimum death benefit so long as premiums have been paid.



Provided the scheduled premium is paid on time and in full, the variable whole life’s initial death benefit is guaranteed to remain in force. For the actual death benefit paid out to be greater than the initial death benefit, the actual investment performance of the separate account must clear a hurdle rate, also known as the assumed investment or interest rate (AIR). It works something like this:

• If the actual investment returns are greater than AIR, the internal death benefit will be larger than the previous year.

• If the actual investment returns are the same as AIR, the internal death benefit will be the same as the previous year.

• If the actual investment returns are less than AIR, the internal death benefit will be less than the previous year.

The actual death benefit paid out in any one year will be the greater of the internal death benefit or the minimum guaranteed death benefit. Notice how the internal death benefit fluctuates with the actual investment performance of the investment account and how prior year’s underperformance has to be made up before it can exceed the guaranteed minimum. Depending upon the year of death, there may or may not be a payout greater than the guaranteed minimum. So keeping track of the investments and the death benefit on a regular basis are required to make sure the most benefit is obtained from the policy for the premiums paid.

Right to Exchange for a Fixed Benefit PolicyThe variable whole life insurance policy owner has the right to exchange the policy for a traditional whole life insurance policy where the benefits do not vary with the investment performance of the underlying investment accounts. This opportunity is only available if the investment funds change its investment adviser or if there is a material change in the investment policies or objectives of the investment fund. From insurer notification, the policy owner has 60 days to make the exchange. The new policy will be issued on the same insured, and with the same policy date, issue age, and with coverage at least as much as the initial guaranteed minimum death benefit.

Other Types of Variable Whole Life Insurance Variable life insurance is available in several forms such as second-to-die and single premium. Our discussion to this point has centered on variable whole life, which features a level fixed premium and a guaranteed minimum death benefit as well as the investment choices that identify the policy as “variable.” Few companies offer variable whole life insurance anymore. Instead, they are more likely to offer variable universal life policies.

Survivorship (Second to Die) Variable Whole Life InsuranceSecond to die variable whole life insurance policies insure two lives in the same contract. As the name implies, the death benefit is payable at the death of the second of the two insureds. The policies are medically underwritten, but the poor health of one party can be offset to a degree by the good health of the other, who is usually a spouse. The level of premiums will reflect any underwriting problems. A common use of these policies is to fund a trust for children at the death of the second parent, to provide liquidity for estate taxes, or to leave a legacy.

Single Premium Variable Whole Life InsuranceSingle premium variable whole life insurance policies are those purchased with one lump sum payment rather than periodic premium payments. They do allow access to the funds, but the IRS considers all single premium policies, including variable ones, as modified endowment contracts, which do not include all of the tax benefits of non-MEC life insurance policies. Single premium policies are highly specialized contracts with a limited appropriate clientele.



Variable Whole Life Summary It is important to read and understand the prospectus to assure proper knowledge about this type of product in order to properly meet the needs of the life insurance buying public. Most prospects and current policy owners have not and will not read this entire document. Variable whole life is a relatively complex insurance contract, but one that offers a family the security of life insurance and the potential for significant cash accumulation through various investment fund options.

Advantages and Disadvantages of Variable Whole Life Insurance

Advantages• The potential for market-driven increases in cash accumulation and the possibility of increased

death benefits as the funds grow in value. • Insurance companies tend to assume low rates in calculating minimum premiums, so a period of

investment growth may provide some protection against the erosion of value due to inflation. • The availability of switches or transfers among internal investment accounts on a tax-free basis as

compared to “outside” mutual fund transfers which are subject to taxation as sale-and-purchase transactions.

• As long as the scheduled premium is paid in full and on time, there is a guaranteed minimum death benefit.

• Guaranteed fixed premiums.• Variable life policyholders can invest their net premiums into various subaccounts.

Disadvantages• Variable whole life insurance is sold by prospectus which may not be read or fully understood by

the consumer. • While there is a guaranteed minimum death benefit, it requires the policy owner to continue to

make scheduled premium payments regardless of market conditions. • Having too many investment choices tends to be confusing and overwhelming. • The time it takes to keep track of and up to date with how the policy is performing in relation to

the underlying investment choices selected can be burdensome. • Not all consumers have the discipline to stay with the investments during volatile markets nor do

all consumers have the ability or desire to deal with the investment risks. • Tends to be expensive as compared to other forms of life insurance. These additional fees and

charges reduce the amount of premium actually invested and can be a drag against the investment returns. These ‘disadvantages’ do not preclude the possibility of higher returns on the net investment, but may make them more difficult to achieve.

• The death benefit is tied to the performance of the policy’s underlying investments. Anticipated death benefit increases may not develop, and any previous increases may be reversed during down or prolonged bear markets.

• The principal caution when considering any variable contract or investment is to be aware of the assumption of risk.

• The potential for gain or risk of loss is all on the contract owner. • A downturn in market conditions can have a negative effect on both cash values and the death

benefit.



Adjustable Life InsuranceIntroduction With traditional whole-life insurance, premiums are fixed and inflexible, death benefits were fixed and non-adjustable, cash value returns were set at the issuance of the policy, and the length of time the policy was set to be in force was predetermined. When consumers face inflation, unemployment, or an uncertain future, they look for life insurance policies to adjust to the changing times and circumstances and better adapt to their needs.

Adjustable Life InsuranceAdjustable life is a type of life insurance that gives policyholders the option to change the characteristics of the policies as insurance needs change over time. They may lengthen or shorten the protection period, increase or decrease the face amount, and raise or lower the premium amount and its pay-in period. These are permanent, not term policies, with potential internal cash value buildup. Sometimes known as “flexible premium adjustable whole life,” they differ from other life insurance products in that it is not necessary to buy new or cancel old coverage as insurance needs change over time.

Adjustable life policies are most appropriate for individuals who want the security, protection, and cash value benefits of whole life insurance and the added feature of policy adjustability. Policyholders can customize their coverage as incomes and family responsibilities evolve over the years. Adjustable life is sometimes confused with universal life, but despite some similarities, the two are different types of insurance. Adjustable life is a whole life product with structural flexibility, and was the insurance industry’s first attempt at providing a more flexible type of policy.

It may sound contradictory, but adjustable life is actually a level-premium, level-death benefit whole life contract with options that enable policyowners to change it into other contracts that are also level, but in new configurations. Some changes may be contractually guaranteed: frequency and amount of premium subject to minimums and maximums would be one. Others, such as increases in face amount, would require approval from the company based on evidence of insurability. It is even possible, based on the changes permitted, for it to act just like a term life insurance policy.

The initial type of policy that adjustable life could be is term, endowment, whole life, or a limited premium payment whole life. Depending upon the plan selected, the insurer will base premiums on the face amount, age, sex, and underwriting classification of the insured. Cash value, age, and contractual provisions will dictate what changes are permitted down the road, for example, after age 70 the ability to have the policy act as term insurance may have expired. Think of it this way, based upon a specific request by the policyowner, the insurance company would then calculate what is possible.

Example: A 30-year-old policy owner would like the plan to initially start out as a $500,000, 30-year term insurance plan. The company will calculate what premium will need to be paid by the policyowner to make that a reality. If the policyowner requests,10 years later, that the plan now becomes whole life and they can afford $5,000 annually, the insurance company will calculate how much coverage the plan will have to provide in order to generate a guaranteed death benefit to age 100, along with cash value. Finally, the policyowner may indicate how much coverage he would like and the premium he can afford, and the company will then inform the policy holder of his plan options.

Once the policyowner has “set” an adjustable life policy into a given plan, premiums must be paid as scheduled until additional adjustments may be requested, typically on the policy anniversary. Note that if the death benefit is reduced, it could force the insurance company to send a check to the policy owner for some of the cash value in order for the policy to remain classified as life insurance under the IRC 7702.



Lengthen or Shorten the Protection PeriodSimilar to traditional permanent policies, the pure protection and the savings components are not segregated. For a given premium payment plan, the cash value schedule is set and withdrawals (as opposed to loans) are not generally permitted without a complete or partial surrender of the policy.

Example: If the policyowner, Cecile, originally applied for and was issued an adjustable whole life policy at age 30, with a $200,000 face amount, and a scheduled premium of $3,000, the policy will probably look and act like a traditional whole life policy. At age 35, Cecile has been promoted and makes more money. Now that she is the mother of twins, she needs more coverage. She applies for an additional $200,000 in protection and requests that the premium payments not increase. The insurance company adjusts the policy accordingly and now Cecile’s policy is going to look and act likes a $400,000 35-year level term life insurance policy. At age 55, after a stellar rise in her field, she is at the top of her game, making the most money she has ever made. Now, she would like to focus on cash accumulation and not have to worry about paying premiums when she has planned on retiring at age 67. She requests the change to the insurance company’s home office, Cecile is health qualified for the change, and they adjust the policy so that the coverage remains at $400,000, the premium paying period ends at age 67, and her new premium is $9,000 a year. Cecile’s policy is now going to be a whole-life paid-up at age 67 plan.

Unscheduled PremiumsAdjustable life allows a policyowner to make “unscheduled” payments directly to the cash value. At times this is to take advantage of favorable interest crediting. Such payments can end up lengthening the term of coverage, or shortening the premium-paying period, depending on the plan of insurance in place. A large enough payment may extend a 10-year term to 15 years, or turn a life paid-up at 75 to a life paid-up at 65. Some insurance companies restrict the availability of this feature during the first few policy years.

Adjustable Life Policy CostsInsurance company costs associated with adjustable life tend to be higher than for most of the other traditional life insurance products. Pre-sale expenses—marketing, underwriting, clerical, etc.—are similar to the rest of the life insurance portfolio, as would be agency sales force commissions. Post-issue, however, is a different story.

Adjustable policies are subject to being “re-opened” for revised underwriting, maintaining records, and service. The home office needs to be ready to determine how any requested change will affect the policy that is already in force. It’s no surprise, therefore, that adjustable policies have somewhat higher charges built into the premiums. It takes at least 3 in-force years to recoup the costs of issuing and maintaining the average life insurance policy, which explains the companies’ emphasis on retention.

Variable Adjustable LifeVariable adjustable life (VAL) adds investment choices to the other characteristics of adjustable life. Policyowners can select and diversify from a full range of investment sub-accounts that have the potential to earn a higher rate of return on the cash values than traditional policies. The cash value of a variable adjustable life policy will vary depending upon the performance of the underlying sub-accounts and may be worth more or less than the original amount invested in the policy. The sub-accounts mentioned here are the same as found in variable whole life or variable universal life policies.



Adjustable Life Summary With adjustable life insurance, all of the adjustments requested by Cecile over her lifetime were able to be met with one life insurance policy. This is something that could not be accomplished with an individual term life insurance policy or a traditional whole life insurance policy, in particular with “unscheduled” premium payments. Adjustable life lets the policy owner decide: How much insurance is needed, how much premium can be afforded, and if protection is needed to a certain age or for a lifetime. Depending on the cash flow, protection needs, and personal and business goals and philosophy, adjustable life insurance changes as needs change. So with this flexibility, adjustable life insurance may be well suited for anyone from young married couples to professionals and business owners. The acceptance of adjustable life led to the creation of flexible premium adjustable life, better known as, universal life.

Adjustable Life Insurance Advantages and DisadvantagesAdvantages

• Gives policyowner control over a life insurance program because it can change as the need for protection changes – without adding a new policy or dropping an old one.

• Eliminates the need to choose between whole life and term. With adjustable life, the type of plan is determined by the need for protection and the amount of premium paid. The policy can change from term to whole life – and back again – as conditions dictate.

• Allows tax-deferred growth, which can be accelerated by paying additional money to the policy beyond the regular premiums – short of it becoming a MEC, that is.

• Gives a policyowner a competitive return on cash value. Adjustable life insurance invests cash value at market rates.

• The policyowner has only one policy to deal with -- one premium notice, one set of cash values, one beneficiary designation, one agent, and one company.

Disadvantages• Surrender of the policy within the first 5 to 10 years may result in considerable loss since cash

surrender values reflect the insurance company’s recovery of sales commissions and initial policy expenses.

• There may be restrictive withdrawal rules.• Increased premium payments and reduced death benefits could trigger MEC, with adverse tax

consequences. Most companies are vigilant in this regard.• Costs can be higher than for traditional whole life insurance policies.• Not paying attention to what changes have taken place can lead to customer dissatisfaction.• It offers only the traditional level total death benefit, unless the variable version is in force.

Universal Life InsuranceIntroductionUniversal life insurance (UL) is a form of permanent life insurance that combines flexible premiums, adjustable death benefits, and cash values that can earn interest credits based on the current money market rates. The technical name for universal life is flexible premium adjustable life insurance.



How it WorksIn simplest terms, universal life is a combination of one year term insurance and a savings account. Assuming monthly premiums, deposited into the cash value accumulation account, picture the costs being deducted from the cash values while the balance is credited with interest. In a significant departure from traditional plans, however, universal life provides for the automatic monthly payment of the mortality costs from the accumulated cash value even if the planned premium is not paid. As long as there is enough cash value in the account, the policy does not lapse. Think of this as the first life insurance product that unbundles all of the interworking of a life insurance policy and discloses to the policyowner where all the money goes via an annual report showing the policy’s current status.

Rather than pre-determined cash value as in traditional whole life, universal life’s cash value is based on premium deposits, expense deductions, and an interest credit all taking place within the cash value accumulation account. After the net premiums are deposited into the account, deductions are taken for the mortality charge and company expenses. The monthly mortality charge is based upon the age, sex, and rating of the insured at the time of policy issue. The balance is credited with a current interest rate set by the company, subject to adjustments based on the company’s underlying earnings, but all universal life contracts specify a guaranteed minimum rate.

In another difference from traditional plans, the policy owner has the option with universal life to pay more than the established premium. For example, the planned premium is $100 monthly, with hypothetically speaking, $50 applied to fixed costs and $50 being added to the interest-bearing cash value account, a $125 payment will leave $75 for deposit at interest, which can help to ensure that there will be enough of a balance to prevent lapse. This “overfunding” technique is a potential hedge against lowered interest rates as well as a method of building up accessible cash values for eventual living benefits down the road. So, the policy has a flexible premium feature unlike traditional whole life insurance policies.

The line between the protection, expense, and investment elements is made clear in universal life’s annual statements. While the mortality charge increases with the insured’s age, a policy owner can keep pace by adding to the planned premium. The mortality charge has a maximum rate beyond which the company cannot charge, but most companies charge what is known as the current rate. So, given that there are two interest rates, a guaranteed minimum and a current rate, and that there are two mortality charges, a guaranteed maximum and a current rate, a universal life policy must be closely monitored to be certain that it is adequately funded.

It is possible for either or both rates to change, but that does not necessarily mean both will wind up going to the maximums. If an illustration, upon which the policyowner bought life insurance, rates showed current interest being credited at 8% and current mortality charges, the policy will not perform as illustrated down the road if interest credits are reduced to 5% and the new current mortality charges are higher than at the time of issue. Nor will that be the case if planned premiums were not paid in full or on time.

Generally, the interest rate is declared monthly and applied to each month’s deposit for one year. Because economic conditions tend to change gradually, rates are pretty constant month-to-month, but there can be 12 separate balances, with each one rolling over every year into that new month’s prevailing rate. How this might have been managed before the advent of computers is a subject for another course!

A very simplistic way to explain the principal difference between universal and variable insurance is to think of universal life as a policy with an attached bank account at declared interest rates while variable life has an attached brokerage account that’s subject to market fluctuation.



Features of Universal LifeUniversal life insurance is also known as flexible premium adjustable life insurance. It divides the death benefit feature from the cash value feature and offers premium flexibility along with the ability to adjust the death benefit if and when needed. The premium flexibility allows someone whose income fluctuates to fund a policy with maximum convenience. That feature enables the policy owner to increase the premium amount when interest rates are high to take advantage of the opportunity to earn high rates on a tax deferred basis and decrease or skip premiums when their budget requires or when interest credits are not as attractive. It may also be the case that if the policy is properly funded, then there may not be the incentive to add more money when interest rates are at the lowest. Loans against the cash value and partial surrenders are also available. Partial surrenders are a unique feature to the universal life insurance type of policy.

Premium FlexibilityUniversal life affords policyholders wide latitude in the amount and frequency of premium payment a degree of flexibility not available in most other policy forms. As long as the policy owner stays within the company’s and policy’s stated minimums and maximums, for example, the insurer may not be willing to accept $.01 or $10,000,000, but are free to add virtually any amount at any time. A policy owner may increase or decrease the premium amount, make payments on any given day or date, and even contribute lump sums well in excess of stated or planned/scheduled premiums. The minimum premium deposit is usually $50; maximum premiums and drop-ins vary with face amount and are subject to contractual and IRS maximums.

Scheduled premiums can be skipped. If the cash value account is sufficient to pay ongoing internal monthly charges, as well as fees and expenses, premiums can be discontinued. Conversely, contributing too little may reduce the cash value below the sustaining level, especially as mortality charges increase with the insured’s age. Policyholders who contribute the bare minimum while interest rates are relatively high may be required to make mandatory contributions when rates fall in order to continue the policy. This may take the policy owner by surprise so proper counseling at the time of purchase and periodically thereafter is highly recommended.

Imagine a policyowner buying from the sales illustration 10 years ago showing that if he paid $150 per month each and every month the policy would be “paid-up” for life or would contain a certain amount of cash value at a stated point in time. The policyowner never missed paying the planned premium on time and in full only to receive a notice from the insurance company that the policy is not “paid-up”, does not have any cash value, and unless $5,000 is sent to the insurance company immediately, the policy will lapse without any value whatsoever. How could this have possibly happened?

Interest rates fell to or near the minimum guaranteed rate. While the insurance company did not impose the maximum mortality charge, it raised the initial current rate to a higher current rate. If the policyowner had originally funded the policy assuming that both the interest rate and mortality rate were at the guarantees, lowest possible interest credit, and highest possible mortality charge, then he would have had to pay a higher premium.

The premium funding strategies can be summarized as follows:

• Minimum funding, or paying just enough to cover expenses - not a viable choice in early years as it may have an impact on any policy guarantees and the policy would act similar to term life insurance

• Adequate funding - just enough to maintain the policy with minimum cash values• Investment funding, or over-funding to increase cash values for future use• Maximum funding, or paying the company’s stated maximum to achieve all of the benefits the

policy has to offer and providing the utmost flexibility in the years ahead



Cash Value In the early years, universal life guarantees were 4% or even higher, with the then current rates higher still. Since the mid-1990s, a 3% guarantee would be considered generous. Rates paid on the net-invested premium tend to be slightly higher than commercial “outside” rates; however, policy owners typically have a motivation to keep the policy in force and not “trade” them like growth stocks.

Universal life takes the cash value concept several steps further. It breaks out the mortality and other charges and offers the policyholder the opportunity to earn more than what may be guaranteed from a traditional whole life insurance plan. That is, if the internal charges remain constant, increases in premium payment are deposited into the cash value accumulation account which can benefit from interest credits that exceed the guaranteed minimum rate.

The cash value is deposited into a fixed account with two stated interest rates, a current rate and a minimum guaranteed rate. The current rate is generally higher than the guarantee, but in a very low interest rate economy, that may not be the case. They may actually be the same rate. Years ago, the difference between the minimum and maximum rates was quite large. For example, current rates of 10-12% with a guaranteed minimum of 4-6%. Today, the difference is minimal or non-existent, for example, current rates of 3-4% with guaranteed minimums of 3-4%.

While the scheduled premium will maintain the policy initially, higher premiums may be required later when the mortality charge (adjusted for the insured’s age) increases or interest rates fall. Overfunding from the start by adding to the scheduled premium is a hedge against getting requests for additional premium funding. The extra dollars will increase the cash values and possibly the death benefit.

Grace Period Like other life policies, universal life is a “unilateral” contract, which means that only one party to the contract is legally obligated to perform any of its provisions. Think about it. The company must credit interest into the cash value; it must adhere to the stated minimum interest rates; it cannot impose higher than the guaranteed maximum mortality charges; most important, it must pay the death benefit at the insured’s death. The other party to the contract, the policyowner, isn’t legally bound to do anything, including pay the premium. The catch is that non-payment of the premium or insufficient cash values to continue funding the internal costs may release the company from its legal obligations, for example, if the policy lapses.

Recognizing the importance of keeping policies in force, a premium-paying grace period has been universally adopted. Most life insurance premiums will be accepted up to 31 days after the premium due date, without incurring any lapse in coverage. Some companies have an informal practice of allowing an additional 15 days to keep the policy going without having to go through the reinstatement process which includes proving insurability.

For example, on September 9th a life insurance premium is due but is not paid; the insured dies on October 8th. The claim will be paid (minus one month’s premium) since the policy is within the grace period. Remember, premiums are paid in advance. If a life premium is not received by the end of the grace period, a traditional life policy lapses for non-payment. Coverage may continue via nonforfeiture options, but other policy provisions and riders, such as accidental death, may not. Most term coverage ends if not paid during the grace period.

The grace period protects against inadvertent failure to pay a premium. Further guards against inadvertent lapse include overdue notices that are usually sent early in the grace period and a provision offered to older policyowners to have someone else notified if a premium isn’t paid on time. In a recent example in New Jersey, the daughter of a 77-year-old woman received a copy of the overdue notice. She paid the premium just before the end of the grace period. Her mother died a few days later. The claim was paid.



Since universal life has a premium that can be flexible as opposed to a fixed premium with traditional whole life insurance, the grace period works a little differently. With universal life insurance policies the grace period is not based on the actual premium due date, instead it is based on whether the cash value account has sufficient funds to cover the upcoming monthly deduction for mortality charges and expenses. The grace period in this instance is 61 days from the notice sent by the insurance company to the policy owner. Companies may require 2-3 months’ worth of anticipated deduction amounts to avoid the policy from lapsing.

Annually, the insurance company will send the policyowner a projection of how long the coverage can stay in force assuming guaranteed rates are in play (worst case scenario) and current rates are in play (best case scenario) provided no further premium payments are made. Reality may actually lie somewhere in between the two.

Continuous premium payment on a timely basis is recommended in order to keep the cash value growing, but the automatic deduction of internal mortality charges from the available funds to keep the policy alive and well is a positive element of universal life. It might be fair to summarize universal life as a cross between whole life and term insurance. The flexible net premium first pays the mortality charge at term rates, and the excess is invested in a fixed-interest account accessible only by the policy owner. With thoughtful management of the premium dollars, universal life can be the ideal insurance product.

Death Benefit OptionsThere are two types of death benefits available for universal life policies, commonly labeled option A and option B (although some companies refer to them as I and II). Option A provides a level face amount and death benefit regardless of the amount of cash value built up in the policy, while option B adds all or a portion of the cash value to the proceeds.

Example: Assuming a $100,000 policy with $10,000 cash value at the time of death, the option A insurance proceeds would be $100,000; option B would be equal or close to $110,000.



It would seem that option B would be the best choice. Why opt for just the face amount if there was $10,000 more available at the time of death from having the cash values paid out on top of the death benefit? While some policyholder’s select option B, there are some factors in favor of option A.

For one, option A will have higher cash values overall in the later years. In option A, the corridor of insurance narrows as the cash value increases through premium payments, interest credits, or both. The net amount the insurance company is actually at risk for is the amount between the cash value and face amount. Since that corridor represents pure insurance, the company’s ‘amount at risk’ decreases as the cash value increases. As that ratio progresses, a smaller percent of the premium is devoted to mortality charges. So, as the insured ages and the mortality rate increases to reflect this overall, less of the account value will be tapped than with option B to fund it. All things being equal over time (interest rates, administrative charges, etc.), this would result in a higher cash buildup in option A than in option B.

Even this may have limited appeal, but younger parents, for instance, whose need for the insurance coverage will cease when their twin daughters finish college, may want the higher cash value to finance the celebration of the girls’ graduation with a cruise around the world.

The IRS requires a certain coverage corridor be maintained in order for the contract to keep its identity and tax advantages as insurance rather than an investment. If that limit is approached, either the death benefit must be increased or some of the cash value must be withdrawn.

The insurance company closely monitors the corridor and provides the policyowner with the policy’s status. Another appeal of option A lies in building up the cash value sooner in order to discontinue premium payments and let the internal policy costs be deducted monthly from the accumulation. This will decrease the cash value over time, but it will not affect the death benefit, which was set from the start anyway. Of course, there must be enough in the account to sustain the charges; very low interest rates challenge the viability of this approach. If the cash values are minimal, then the policy basically will act like term insurance. If this is done by design, think of the possibility of having permanent term insurance.

Option B has the effect of increasing the tax-free death benefit. Assuming no withdrawals, the face amount is augmented by the cash value and the entire amount is received by beneficiaries free from federal income tax. Under long-prevailing law, this holds even if the policy had been overfunded into a MEC. The policy funding of option B must be closely monitored since the net amount at risk (corridor) remains constant throughout the life of the policy. As the insured gets older and the internal charges increase, the actual amount deducted from the policy account value will rise dramatically causing both the cash values and overall death benefit to begin to decline.



Regardless of which death benefit option is chosen at policy inception, some insurers allow a limited amount of switching between the two while the policy is in effect. Such changes may require a greater or smaller premium commitment, based on the company’s increased or decreased risk, but it affords the policyowner a certain measure of control. Someone with a limited life expectancy, for example, could shelter funds from eventual taxation by dumping them into an option B universal life insurance policy. Some companies may impose a minimal charge to make the switch and moving from A to B may require providing proof of insurability.

Adjustable Death BenefitThe death benefit is adjustable which means it can be increased (subject to insurability) or decreased at the policy owner’s request. This allows for the policy to potentially meet the changing insurance protection needs of the policy owner without having to buy another policy or replace the existing plan.

Example: Melissa takes out a $175,000 face amount universal life insurance policy when she is 28 years old. While still insurable and now age 32, Melissa determines she now needs more coverage and applies for an adjustment in the coverage from $175,000 to $250,000. The insurance company reviews and approves the application after conducting a quick medical history and medical background check and sends her a policy amendment indicating that the coverage in force is now $250,000. Internally, the policy will now have a greater amount deducted for mortality costs since she is older and a greater amount of coverage is in place. At age 55, she decides that her coverage needs are now $100,000, so Melissa again sends in a request to the insurance company to adjust the face amount to $100,000. The insurance company mails her an amendment indicating the requested change has taken place. Internally, the policy will have a lower amount deducted for mortality costs as compared to previously which means the cash value may grow faster.

Other Tax IssuesThe IRC provides all the formulas to make sure that it will qualify as life insurance for tax purposes. The primary goals are to prevent the policy from having too much cash value within it as compared to the death benefit (a corridor must be maintained) and from “over-funding” the policy beyond what it needs to provide permanent lifetime coverage. The insurance company keeps track of this and will return any excess funds when and if necessary as specified in the contract. It is also possible to prevent the policy from failing these two tests if the death benefit can be increased.

Cash Value Accumulation TestThe IRC requires that the death benefit be sufficient to prevent the account values from exceeding the net single premium required to fund the future benefits in the life insurance policy. The amount takes into consideration the age, sex, and underwriting classification of the insured.

Guideline Premium TestThe IRC specifies the maximum amount of premium that can be paid into the policy in relation to the death benefit and also a minimum amount of death benefit in percentage terms that must be maintained in relation to the policy’s account value at any particular age of the insured. Excess premiums will be returned to the policy owner in order to retain the favorable life insurance tax status. Effectively this test limits the amount of premium that can be paid into the policy.



Accessing the Cash Values For a period of time, the cash value available will be less than the cash value accumulation. The gap between the two is due to the surrender charge that will be imposed for withdrawals during the first 10-15 years. The surrender charge is a declining charge based on a percentage of premium paid or on the entire cash value. The charge eventually disappears and the cash value is then fully accessible.

The surrender charge table will resemble ones used with annuities. The year-by-year declining withdrawal or surrender charges are represented by the difference between a policy’s accumulation account balance and its current cash surrender value. Accumulation is the total amount accrued to the policy owner’s credit in the policy. The cash surrender value is the amount accessible by loan, through withdrawal or at surrender. Eventually, because the percentage charge declines to zero, the amounts merge. The terms “accumulation” and “cash surrender value” are often used interchangeably from the start, and after a period of time they are identical.

The interest rate credited to universal life cash values may fluctuate, but it will not fall below the contractual minimum guarantee. The values grow on a tax-deferred, annually compounded basis and can be accessed on a tax-favored FIFO basis for emergency expenses, college funding or that cruise around the world. Universal life is permanent life insurance with cash value accumulation that’s more easily accessible than traditional whole life plans.

In short, as long as the cash value is sufficient to pay the internal monthly fees and mortality charges with or without continued premium payment, a universal life policy will stay in force with its death benefit intact. It behooves the universal life policyholder to maintain the premium payment or even overfund in the early years to build up enough cash to cover mortality charges that increase with the age of the insured.

To re-state an important factor: Overfunding beyond certain maximums can cause a policy to become a modified endowment contract, or MEC, thereby losing some significant tax advantages, upon taking cash from or against the policy. Recognizing that insurance companies will not become aware that premium amounts have exceeded the MEC limits until already invested, the IRS provides a 60-day window for the company to return the excess as if it had never been paid in. So, the company is responsible for making the calculation and providing the information to the policyowner.

Universal life’s cash buildup accumulates free from current taxation. It is technically tax deferred and is taxed at withdrawal on the favorable FIFO basis only after withdrawals exceed cumulative deposits. In other words, withdrawals to basis are not taxed, only the funds representing the excess will be.

Policy LoansUniversal life includes the option to borrow from accumulated cash values. Loans are generally limited to a percentage of the accumulation, 90% is common, and an interest rate is charged. While in a sense the internal cash buildup already belongs to the policyowner, the interest is justified because the company is no longer able to use the loaned-out sum for its own investment purposes.

The cash value of a universal life insurance policy may be used as collateral for a policy loan. That is, loans are based on cash value balances, but are actually extended from the insurance company, while a like amount is “frozen” in the policy as collateral. As such, it continues to earn at least the minimum guarantee, making the net interest rate paid on the outstanding loan that much less. So a 6% loan interest rate offset by a 3.5% guaranteed minimum interest credit means the net loan cost is 2.5%.

Repayment of the loan is not required with an installment loan or mortgage, but if the interest is not paid, it is added to the outstanding loan balance, which removes an additional amount from the available cash



value. If that remaining balance is not sufficient to cover the internal deductions and interest, the policy will lapse. Any outstanding loans will be deducted from the payout in the event of the insured’s death.

The insurance company keeps tabs on outstanding loans and provides the necessary information to the policyowner in a timely fashion. One advantage to policy loans as opposed to ‘outside’ commercial loans is that policy loans are not reported to any credit agency. Payment or non-payment of the loan will have no effect on one’s credit rating. Also, as long as the policy has not become a MEC, loans are considered to be a non-taxable event.

Loans will have a long-term effect on the policy, reducing the policy’s reserves, lowering the cash value, requiring continuing interest payments and possibly resulting in a need for higher premium payments as remaining cash values may not be sufficient to cover higher mortality charges that increase with the age of the insured. As with nearly all personal loans except home mortgages (currently), the interest paid is not tax-deductible. Policies that lapse with an outstanding loan balance greater than the policy’s cost basis will trigger a taxable event.

WithdrawalsMost universal life policies include the option to withdraw rather than borrow cash values, which reduces the remaining cash value and the death benefit. The policy remains in force, and there is no interest charge. In contrast, the owner of a traditional whole life insurance policy can withdraw cash value only by canceling (surrendering) the policy. Think of this as a partial surrender.

Imagine for a moment that a policy owner could essentially take a $150,000 face amount universal life insurance policy with $15,000 of cash value and split it into two entirely separate contracts, one for $145,000 of death benefit with a $10,000 cash value, and the second a $5,000 death benefit with a $5,000 cash value. When a life insurance policy’s cash value equals its death benefit, the policy is said to endow. The death benefit ends and the equivalent amount is paid out in cash to the policy owner.

This is not a loan so no interest is charged; however, the remaining policy has a reduced death benefit and cash value. While this is an oversimplification of what transpires, it demonstrates the difference between a traditional whole life policy and a universal life policy. There is another way to obtain cash from a universal life insurance policy that is not available from a traditional whole life insurance policy. Partial withdrawals, once taken, can never be repaid like policy loans can.

Universal life withdrawals are applied against premiums first and then gains and are non-taxed until they exceed the premiums, assuming not a MEC, and withdrawals can affect a contract’s long-term viability in the same way as can loans.

Some companies impose a small administrative withdrawal fee or charge against withdrawals, in much the same way as annuities, with a year-by-year declining surrender charge assessed against the amount if taken within the first 10-15 years or so. Like annuities, some companies may allow up to 10% of the cash to be withdrawn without incurring that charge. Some companies will “carry over” that privilege; if no withdrawals are taken in a year, up to 20% will be charge-free the following year. Both of these limits relate mostly to single pay universal life because cash buildup is slower to develop in conventional policies. MECs tends to discourage withdrawals from any single pay policies prior to age 59½.

Surrendering Surrendering a policy for its cash value is one of universal life’s options. An owner can turn in a policy and receive a check for its cash surrender value, minus any outstanding loans. The total amount received at surrender is taxable only to the extent that it exceeds the cumulative paid-in premiums. If the policy is a



MEC, the total earnings may be taxable and possibly surtaxed as well. Conversely, if the amount received is less than the cumulative premiums, the difference is not a tax-loss deduction as an outside investment loss might be. Universal life policies have surrender charges that are similar to most annuity contracts. A difference exists between the cash value and the cash surrender value. The cash surrender value is simply the cash value less any applicable surrender charge.

Example: Mike has a $250,000 universal life policy. It has been in force for 7 years. The policy has a 15 year surrender charge. This year Mike has to surrender his policy to the insurance company. The policy has a cash value of $7,500. The surrender charge in year 7 is $500. Mike will receive $7,000 ($7,500 - $500) from the insurance company once they receive his written request along with the policy.

Front-End and Back-End LoadingA front-loaded policy is one in which most of the expense charges are assessed against the first premiums on a percentage basis, for example, 5-7%. Whole life and early universal life, with zero cash values credited in the first year or two, are examples. In a more modern back-loaded universal life policy, most expense charges are spread more evenly over time, with cash values showing up sooner but being subject to surrender penalties (“back-end” charges) if accessed in the early years. With universal life being a long-term commitment, the latter option seems more attractive to policyholders. Even with limited or surcharged access, the cash values are earning interest while they sit untouched. While not actually paid out, assuming no early withdrawals, the load is “paid” by the amount of time the company has had full use of the funds for its own investment purposes.

The charges referred to are the substantial costs of underwriting and issuing the policy. They include sales commissions, which can approach the first-year’s scheduled premium; medical services, including exams, blood work and, for high face amounts, a battery of other tests; and general clerical and administrative costs. Some ongoing costs are assessed against premiums. This would include any premium taxes, which vary by state. Since universal life is an “unbundled” product, the breakdown of charges and investment values is shown in regularly issued statements.

Universal Life Insurance Policy RidersWaiver of Monthly DeductionA waiver is available for universal life policies in cases of disability similar to those found in other traditional policies. However, with universal life insurance policies, only that portion of the premium that supports the actual insurance – not the premium amounts – is waived. In other words, it waives the monthly deduction of the mortality charges and not the planned premium in its entirety. There may be some companies who offer to waive the entire planned premium so that the policy continues to build cash value. That type of rider would, of course, cost more in premium.

Long-Term Care RiderThe life insurance industry has recognized the need for long term care and has developed innovative ways to provide such benefits in conjunction with universal life insurance policies. Typically, they are associated with single premium universal life policies because of the immediate leverage the lump-sum can provide. Periodic premium plans can also provide this benefit but not in as dramatic a fashion. Long-term care benefits may be activated when an individual is unable to perform 2 of the 6 activities of daily living.



Most are designed to address four situations:

1. If the insured lives to a certain age and does not need the long-term care benefits – the cash values are always accessible

2. If the insured lives to a certain age and does need the long-term care benefits – it comes from the death benefit and cash values first, then the rider benefits for a limited amount and period of time

3. If the insured wants to cancel the policy – the cash surrender values are there and likely without any surrender charges

4. If the insured dies – there is the tax free death benefit which can be the original face amount, the original face amount less any long-term care benefits paid out, or the minimum guaranteed death benefit, which can be a percentage of the original face amount or a specified minimum amount, $10,000 - $15,000

While this may appear to be less expensive than a standalone long-term policy, it does not provide the same amount of benefit as long-term care insurance does. If the benefits are not used, it can turn out to be a very costly policy in the long-run.

The long-term care rider taps into the life insurance policy’s death benefit to pay for qualifying nursing home care or home health care expenses. Any amount used for approved long-term care expenses will reduce the policy’s death benefit and cash values. Initially, the long-term care benefits are simply an acceleration of the death benefit. The rider provides monthly benefits for nursing home care or home health care of the person whose life is covered by the policy. The benefit is paid whenever qualifying conditions and a 90-day waiting period, known as the elimination period, are met. After that is exhausted, then the long-term care rider takes over. The rider is a multiple of the premium deposit or the initial death benefit.

Example: Francesca, age 65, pays a single $100,000 premium for a universal life insurance policy that has a long-term care rider that can provide up to 4 years of long-term care benefits. If she needs long-term care, she can receive up to $80,000 per year for 4 years to reimburse her for her long-term care costs. If she never uses the long-term care benefits, her beneficiaries will receive $160,000 after she dies. If she uses only some of her death benefit for long-term care, the remaining benefit passes on to her beneficiaries. If she changes her mind, she can get the original $100,000 premium back.

No-Lapse RiderRiders are available to assure that the policy will not lapse if certain premium levels are maintained. This can apply to the policy up to a certain time period or age.

Example: John buys a universal life insurance policy that guarantees that if he pays a specified premium the policy will not lapse during its first 5 years of being in force. Gary has a universal life insurance policy that charges him for a rider that if paid for and if he pays a specified premium on time and in full, will guarantee that the policy will not lapse prior to age 80. Brad has a universal life insurance policy with a rider that will keep his policy into effect until age 120.

All of these riders have one thing in common. As long as the specified premium is paid in full and on time, regardless of the amount of money in the policy’s accumulation account, the policy owner will not have to worry about the policy lapsing.



ClienteleThe ideal universal life policyholder is an individual with a need for insurance who also favors a conservative savings plan. While there is no investment choice, as in variable life insurance plans, the cash values are not subject to market risk, and have a guaranteed minimum interest rate. The policyholder should be looking for premium flexibility and adjustable death benefits to provide options for their changing circumstances. Universal life is unlike any other life insurance policy.

Universal Life SummaryUniversal life policies provide:

• Permanent life insurance protection• The ability to accumulate cash value inside the policy on a tax deferred basis• Access to that cash value via withdrawal or through loans at a low net rate• Flexibility to increase, decrease, skip or, in some cases, even discontinue premium payments• Adjustability of the face amount• Two death benefit options to choose from

In universal life, the mortality charge is deducted each month as it increases, which is another advantage to overfunding from the start, when a greater percentage of premium dollars is allocated to cash values as a cushion is built up for later use.

Along the way, the cash value will be available if necessary to pay internal charges or to be borrowed against for any reason. As noted, loan interest is charged, and any outstanding loan plus any outstanding interest will be deducted from the death benefit and cash values.

It takes a while for significant cash to appear in a universal life policy because the insurance company amortizes its expenses in the first couple of years like it does with any other permanent policy. The death benefit is in place from the very start. Over the life of the policy, there is a steady increase in the amount of cash value that earns interest on a compounded basis.

Universal life provides some of the benefits of whole life—permanent coverage, cash values, loan provisions, etc.—but can beat generally lower premiums. The trade-off is that unlike whole life, the actual amount of cash value is not guaranteed on a year by year basis because of the future unknowns of the amount and timing of the premium, the actual mortality charges year by year or the actual interest rate credited above the guaranteed minimum rate. With whole life, the company assumes 100% of the investment risk; with universal life, some of the risk. The changing interest rate that is or would be credited to the cash values is in the policyholder’s hands.

Single Premium Universal Life InsuranceLike traditional whole life policies, universal life insurance may be purchased with a single premium paid at the policy’s inception. There would be a substantial cash value in the early years. Mortality charges would be deducted. Guaranteed minimum interest rates and guaranteed maximum mortality charges would be stated within the contract. Both current interest rates and mortality charges are subject to change and can impact the performance of the policy. Paying a single premium is very likely to cause the policy to be treated as a MEC for tax purposes. There’s little difference between universal and interest-sensitive “current assumption” policies. Both credit interest to the cash value based on rates that are subject to change. The benefits of paying a single large premium are also the same as those for whole life, and maintaining the corridor of coverage is a common element as well. Because universal life is often intended to provide living benefits, the MEC factor may come into play when cash withdrawals are taken from the policy.



Policy BailoutMany current-assumption and single premium universal life insurance policies include a bailout provision similar to the one found in certain annuity contracts. The provision allows the policyholder to withdraw the initial premium without a withdrawal fee if the interest rate falls below a specified level. The bailout applies only to a company’s surrender charges, not to any income taxes or penalties that may be payable on amounts received upon surrender.

Equity Indexed Universal Life Imagine the underlying components of an equity indexed annuity coupled with a universal life insurance policy. The twist here is that the interest credit is not determined by the insurance company rather it is based upon the performance of a stock index such as the infamous S & P 500. If it does well, the interest credited to the policy will be greater than any stated guaranteed minimum. If it does not do well, then the interest credit can be zero with some policies or the stated guaranteed minimum such as 2% credited at some designated time in the future. The minimum guaranteed rate may not be paid until the end of the year or at the end of several years, such as at the end of the 5th policy year or the end of the term of the policy.

As with equity indexed annuities, there will be limits to how much of the gain in the index is creditable to the policy’s cash values from such devices as participation rates and caps. Participation rates limit the amount of gain that can be used to credit interest to the policy.

Example: If the participation rate is 70% and the index gain is 10%, then only 7% (70% of the 10%) is available for interest crediting purposes. A cap rate would be specified in the contract as well. For instance, if it was stated as 6%, then in no case will the interest credit exceed 6%. So, if the policy had both a participation rate limit of 70% and a cap rate of 6%, and if the index advanced 10%, then the actual interest credit to the policy would be 6% (70% of the 10% = 7%, however with the cap set at 6%, the most the policyowner would receive is 6%). The time frame for measuring the index gains can be from month to month or annually based on the policy anniversary date or from policy inception until the end of the term of the policy (most likely when the surrender charge period is over, in 10-20 years).

Unlike with variable contracts, there can never be a negative return. Basically, it is positive or nothing or next to nothing. The policyowner can also choose to put all or some of the premium and/or cash value into a traditional fixed account or allocate all or a part of the premium and/or cash value into an account whose interest credit is tied to the index’s performance.

How the insurance company is able to do this is quite simple. They purchase call options on the index. If the index goes up in value, the call options become worth more. They sell the option at a gain and that money is available for interest crediting. If the index falls in value, the option becomes worthless; therefore, no money is available for interest crediting.

Universal Life Insurance Advantages and DisadvantagesAdvantages

• The policy is “transparent.” Policy illustrations and annual reports break out and report each of the policy elements separately. This unbundling allows the policyowner to identify and track premiums, death benefits, interest credits, mortality charges, expenses and cash values, and compare projections against actual performance over time.

• Universal life insurance policies have over time paid a higher effective rate of interest than traditional whole life insurance policies.



• The policyowner has a wide choice or flexibility in the premium amount. As long as internal monthly fees and mortality charges are covered, the policyowner may even skip premium payments.

• Universal life insurance policies offer a choice of two death benefit options, labeled options A and B which amount to a level and increasing payout.

• The policyowner may adjust the level of death benefits. Decreases in the death benefit are permitted at virtually any time. Increases in the face amount, if permitted, are subject to evidence of insurability.

• Policy cash values can be borrowed at a low net cost.• Partial withdrawals are permitted as an alternative to surrender or loans.• Riders are available for a cost to prevent the policy from lapsing.

Disadvantages• Under certain conditions, abuse of the premium-payment flexibility can result in a policy

becoming a MEC and losing some of its tax benefits.• Reducing the face amount can trigger the policy becoming a MEC.• Mortality and expense charges are guaranteed not to go beyond a certain level but can be

dramatically higher than when the policy was first taken out.• Universal life policyowners bear more of the risk of lowering interest rates even though the

company guarantees a minimum interest rate.• If the policy is not watched by the policy owner and/or the insurance producer, unexpected results

may occur such as lapse notices even when premium payments have been made.• Policy surrender within the first 5 to 10 years may result in considerable loss since surrender

values reflect the insurance company’s recovery of deferred sales commissions and initial policy expenses.

Variable Universal Life InsuranceIntroduction Variable universal life insurance (VUL) combines the features of universal life and variable whole life into one policy. Some say that variable universal life combines the best features of universal and variable whole life, and variable universal life’s popularity in the life insurance marketplace would tend to bear that out. Universal life, with its conservative guarantees, is still a major player, but plain variable whole life has taken a back seat to variable universal life primarily because of the premium flexibility.

How it worksWith universal life insurance, the amounts and timing of premium payments can vary, but policyholders have no control over the investment portion of the net premiums. It’s all deposited into a fixed, interest-bearing account with a guaranteed minimum interest credit or a current interest credit. With variable life insurance, policyowners can select among a variety of investment options, but the premium amounts and due-dates are fixed. With variable universal life, policyowners pay whatever amount they want, subject to contractual and company minimums and maximums, whenever they want.

If a policyowner operates a landscaping business in the Midwest, then they can double-up the premiums from April to September. A professional Santa Claus can pay one large amount every December 26th. There are also tax regulations that must be adhered to so down the road when cash withdrawals are made no negative income tax consequences occur. Assuming the policy has a cash value balance sufficient to pay the monthly mortality and expense charges, premiums may even be reduced or skipped.



Investment OptionsAlong with this premium flexibility, the policyholder has discretion over the investments. Most variable universal life policies offer a wide range of options, similar to those found in variable whole life insurance policies. The portfolios can be established and managed by the insurance company or a third party money manager, most likely a name brand mutual fund. The 3rd party money manager would create a portfolio based on the collective policyowner’s assets that would not be readily available to the public but might mirror an already existing retail mutual fund. Due to the timing of cash inflows, how long the assets are left in the accounts, and the charges against the portfolio, it is often difficult if not impossible to compare the performance of the two accounts although they may have similar objectives and management.

To complement the variable universal life investment options, the policies routinely offer:

• Auto Rebalancing – Will restore the desired proportion among a number of funds automatically for the policyowner on a quarterly, semi-annual, or annual basis. This is a very valuable risk management tool that is also accomplished free of any income tax considerations since the cash values are growing tax deferred.

• Dollar Cost Averaging – Some companies and policies have what are referred to as dollar cost averaging “specials”. Here an insurance company is encouraging the new policyowner to deposit a lump-sum premium in order to get the policy started. Within a variable universal life, this may be accomplished by directing that $10,000 lump-sum premium into the fixed account which may be crediting a couple of points of interest above the guaranteed minimum on the deposit which has not yet been invested into one or more separate accounts. The “deal” is that the policyowner may have 6-24 months to fully invest the lump-sum deposit. The company would divide equally the money in the fixed account. For example, $12,000 invested in a 12 month dollar cost averaging program would mean that $1,000 would be automatically moved from the fixed account over into the selected investment accounts for 12 months. Over each of the 12 months, there is a decreasing balance in the fixed account until all the money is invested. It may provide some extra funds to invest overall from the interest credits to the fixed account, and it may also alleviate some investor angst if they are unsure about what the near term market outlook is.

Investment TimingThe timing of the returns can play a major role in the overall performance of the variable universal life insurance policy. Let’s take a look at three scenarios with an original $10,000 single investment.

Original Investment Original

Investment Original Investment

Year Returns $10,000 Returns $10,000 Returns $10,000 1 20% $12,000 -10% $9,000 4% $10,4002 10% $13,200 -5% $8,550 4% $10,8163 5% $13,860 5% $8,977.50 4% $11,248.644 -5% $13,167 10% $9,875.25 4% $11,698.595 -10% $11,850.30 20% $11,850.30 4% $12,166.53

Avg. Return 4% Avg. Return 4% Avg. Return 4%

Even though each of the three investments averaged the same return over the time period studied (by summing the returns and dividing by the number of years observed), the year by year results were anything but the same. The internal charges against the investment account occur monthly and without sufficient funds in the account, the policy could lapse.



The impact on the cash values and/or the death benefit could be dramatically different, especially when taking into account annual premiums as opposed to a lump-sum. Here are three scenarios considering annual premiums.

Year Annual Premium Returns Acct. Value Returns Acct. Value Returns Acct. Value

1 $1,000 20% $1,200 -10% $900 4% $1,0402 $1,000 10% $2,420 -5% $1,805 4% $2,121.603 $1,000 5% $3,591 5% $2,945.25 4% $3,246.464 $1,000 -5% $4,361.45 10% $4,339.78 4% $4,416.325 $1,000 -10% $4,825.31 20% $6,407.73 4% $5,632.98 Avg. Return 4% Avg. Return 4% Avg. Return 4%

Depending upon how the market performs at the beginning or at the end will determine if the policy owner has an above average or a below average experience. The policy will outperform or underperform accordingly. That is why it is important to stay actively involved in what is going on with the policy through periodic reviews.

Among the elements that influence the performance of U. S. financial markets are economic conditions abroad, the impact of natural disasters, hostilities between nations and the threat or outright occurrence of terrorism. Wide fluctuations in values have become the norm; portfolios that underlie variable life contracts are not immune to relatively sudden plunges in value. Tumbling values can cause even well designed variable life policies to become underfunded and require additional premiums or resumption in premiums that were supposed to have terminated.

Death BenefitVariable universal life insurance (VUL) is issued under various companies’ nicknames in various forms. But “life insurance” is the key term. It is technically known as flexible premium adjustable variable life, which pretty much tells the policyowner what the policy can do.

The death benefit of the policy may be subject to fluctuation depending upon the performance of the underlying accounts and on the death benefit option selected. As with straight universal life, option A provides for a fixed, level, face amount death benefit that does not include cash values, while the option B death benefit would be the face amount plus the inside cash value build-up. Both options are subject to tweaking by the insurance company home office in order to maintain favorable tax treatment of the policy’s benefits.

No-lapseVariable universal life can also be issued with a no-lapse guarantee. This can range from a period of years, for example, the first 5-10 years from issue date or to a specified age such as 70, 90, or 120. There will be an added charge for the insurer to provide for this guaranteed minimum death benefit regardless of investment results. It will depend upon the timely payment of sufficient premiums to make all of this happen.

With some policies, the death benefit is:

• Not guaranteed and can fluctuate daily with the investment performance of the underlying investment funds

• Guaranteed for a limited period of time, such as 3-5 years, with a monthly cost associated with the guarantee (no lapse premium)

• Guaranteed to be equal to a percentage of the cash value ranging from 100-250% (in order to comply with IRS tax regulations)



Additional premiums paid in may actually extend the period of time the no-lapse protection is in place while any policy withdrawals will decrease the duration of this protection. Note that some no-lapse protection benefits can place restrictions on investments into certain investment funds or place a limit, on a percentage basis, as to amounts which can be placed into those funds. Typically, its aim is to keep the policy from being overly aggressive in the investment selections that would pose additional risks to the insurer. Some companies even have a defined portfolio(s) which must be used when electing this feature or rider.

RegulationVariable universal life is also subject to oversight by federal and state insurance and security regulators. Agents and managers must be properly licensed and registered. A prospectus must accompany sales presentations. After all, the word variable means the product is a security, and investment risk is what the policyowner faces.

It is in the best interest of not just the policyowner but the registered representative as well to make sure that the variable universal life policy is a suitable product to put in effect. On-going meetings are important to have either in person, over the phone, or through email communication to make sure that the policy is performing the way it was intended. The touch-base meetings also allow for the professional insurance producer to see what changes, if any, have occurred since they last visited.

Tax Treatment of Investment Fund TransfersAn important tax benefit is the ability to transfer account assets among the various subaccounts within the policy without incurring a tax liability. Transferring a $5,000 gain from an aggressive stock fund to a conservative bond fund in the “outside” financial world, for example, is a sale-and-purchase event. The gain would likely be considered a taxable event. The same transaction within a variable universal life or variable whole life policy is not. This makes asset allocation and portfolio rebalancing tax-efficient.

LiquidityVariable universal life insurance offers access to accumulated policy values via full surrender, partial withdrawals, or policy loans. Depending upon when a full surrender is requested will determine what percentage of the cash value will be paid to the policyowner. Similar to universal life insurance, there is a surrender charge schedule that is applied to the account values during the first 10-20 years, depending on the company and policy, which decline over the years to zero. Surrender charges may decrease annually from the start (10% in year 1; 9% in year 2; etc.) or may hold steady for a while and then decrease (10% first 3 years; 9% year 4; 8% year 5; etc.).

Partial withdrawals may be subject to minimum amounts such as $500 and administrative fees such as $25 - $100. Partial withdrawals are identical in concept to universal life ones. Once taken, partial withdrawals can never be repaid like policy loans can.

Using the policy’s values as collateral for a loan from the insurance company requires that the policyowner incur an interest charge.

Net loan interest rates are very competitive. For example, if the policyowner borrows $3,000, the $3,000 loan is from the insurance company’s general account funds, against the $3,000 in the account value, which is held as collateral. But the company still credits it with interest, say 3%, while the rate on the loan might be 5%. The collateralized cash values are no longer considered invested. The values are transferred from the investment subaccount over to the fixed account. One year later, the interest owed is $150 (5% of $3,000), but the $3,000 collateral has earned $90 (3% of $3,000). The net cost then is $60, or 2% ($60/$3,000). This is a distinct advantage over loans from any other source.



Overloan Protection RiderThere is typically a one-time charge, for example, 5% of the current investment fund value and can prevent a policy from lapsing when a loan is outstanding thus triggering a taxable event. With this rider, the policy will not lapse when the outstanding policy debt plus any outstanding policy loan interest is greater than the investment fund values from which monthly deductions are taken. If this goes into effect, certain other policy benefits and features will be impacted. The policy will typically become a reduced paid-up policy, and no more premiums can be added.

Free LookBecause variable universal life is a security, the free look period is the later of 10 days from delivery or 45 days from signing the application to return the policy and request a full refund of any and all premiums paid up to the point in time.

Grace PeriodThe grace period is the same as found in universal life insurance policies, 61 days from when the insurance company sends notice that there is insufficient premium to maintain the policy in force.

Policy ExchangeVariable universal life insurance policies may be exchanged for a non-variable life insurance policy at any time typically within 12 months after policy issuance. The new policy will be issued with the same policy date, issue age, and initial death benefit of the variable universal life insurance policy.

Variable Universal Life Summary A widespread market and interest exists for variable universal life. Issue ages are as low as newborns, with ownership vested in a parent, grandparent or guardian, and as high as 80. By combining the investment components of variable whole life with the premium flexibility, death benefit options, and adjustable death benefits found in universal life, variable universal life offers unmatched competitiveness for consumer’s premium dollars.

Advantages and Disadvantages of Variable Universal Life Insurance

Advantages• Opportunity to utilize “dollar cost averaging” without having to time the financial markets.• Ability to change or re-balance investment choices without taxation.• Ability to choose from various investment subaccounts to offset the effects of inflation,

accumulate more cash value, and increase the death benefit payable to beneficiaries.• Flexible premium payments• Two death benefit options• Adjustable face amount• With a no-lapse feature, a variable universal life policy provides death benefit assurances

that the policy will continue in force for the guaranteed period no matter what the investment performance of the sub-accounts may be, if the required premiums are paid.



Disadvantages• A certain amount of attention must be directed to manage the investment accounts.• Cash values must be sufficiently high to cover internal insurance costs.• To increase coverage, a policyowner may need to produce satisfactory evidence of insurability

and will need to meet any other applicable underwriting requirements. • Transfers among separate accounts may be subject to some restrictions such as limits to the

number of transfers allowed in a year and possible imposition of fees. • Depending upon the performance of the underlying investment options, the cash value available

for loans and withdrawals may be worth more or less than the original amount invested in the policy.

• The policy’s long-term success is contingent upon the nature of the selected investments and the level of premium payment.

• Companies may impose limits and/or fees on loans and withdrawals.• The policyowner assumes 100% of the investment risk.• Policy may lose tax benefits if classified as a MEC.• Poor investment performance may jeopardize the policy’s death benefit.



1. The cash value of a variable life insurance contract will fluctuate primarily based upon which ONE of the following?a. The company’s mortality expensesb. The performance of the underlying investmentsc. When the premiums were paidd. The size of the policy’s face amount

2. The local hardware store owner, Jean, plans to bonus his key employee, Sally, with a life insurance policy in an amount equal to twice her current salary. They both want to avoid having to replace the policy every time she gets a raise. Their life insurance agent, Stan, suggests an adjustable life insurance policy with a ____________.a. Salary-increase riderb. Double indemnity clausec. Managerial step-up riderd. Flexible term rider

3. All of the following are considered advantages of adjustable life, EXCEPT:a. It can change from whole life to term and back againb. Its cash value earns market interest ratesc. Increases and decreases in the death benefit are permittedd. Interest paid on policy loans is tax-deductible

4. Before Ulysses goes on a 3-year world tour with his music group, he wants to purchase a life insurance policy with one lump sum payment. He’s worried about being stuck with the very low prevailing cash value returns. The better way to go would be to ____________.a. Wait for rates to increaseb. Buy a single premium universal life insurance policyc. Initiate a dollar-cost-averaging pland. Accompanying him on the tour

5. A potential single-premium life insurance client, Ted, wants to direct his policy’s cash values into investments. Even though this sounds attractive Ted needs to be advised, that with a single-premium variable universal life insurance policy ____________.a. He should name financially responsible beneficiariesb. He should only invest when bank CD rates are at all-time lowsc. The death benefit could become taxable as a MECd. The cash values could fall below the level necessary to keep the policy in force

6. Single-premium and universal life insurance clients must be made aware of the consequences of over-funding their policies. Their most significant penalty will be a switch from ____________ on loans and withdrawals, which will result in less favorable income taxation treatment.a. FIFO to LIFOb. High to low interestc. Permanent to termd. LIFO to FIFO

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7. Othello’s client, a landscaper, needs more life insurance. The landscaper leaves the following message on Othello’s voice mail, “My income is high from spring to early fall, but I may not be able to afford the monthly premium in the winter.” One solution to this life insurance-related cash-flow problem would be a(n) ____________.a. Part-time Christmas season jobb. Annually adjusting life insurance policyc. Dividend-paying mutual fundd. Universal life insurance policy

8. Alvin is a client with a $100,000 universal life insurance policy which has accumulated $18,000 in cash value. His brother, Bert, told him the death benefit was only $100,000. Alvin’s life insurance agent explains that it would be $118,000 because his policy includes a(n) ____________.a. Double indemnity death benefitb. Income tax free death benefitc. Option B death benefitd. Stepped-up death benefit

9. A young, healthy fellow who is more interested in high cash values than more life insurance coverage might opt for ____________ in his universal life insurance policy.a. Option B death benefitb. The return of premium riderc. Option A death benefitd. A spendthrift clause

10. As long as the cash value is sufficient to pay the monthly expense and mortality charges, a universal life insurance policy will stay in force with its death benefit intact with or without ____________.a. The first-to-die riderb. Continued premium paymentc. A named insuredd. A buy-sell agreement

11. Policy withdrawals and loans from single-premium universal life insurance policies are taxed differently from continuous-premium policies, but the ____________ is still tax-free.a. Loan interestb. Back-end chargec. Excess premiumd. Death benefit

12. Nancy’s life insurance prospect, David, tells her, “I’m willing to assume the investment risk, but I want a guaranteed death benefit.” From this statement she figures that he is a potential prospect for ____________.a. Dollar cost averaging life insuranceb. Term life insurancec. Variable whole life insuranced. Universal life insurance



13. While a variable universal life insurance policy’s cash value could be wiped out due to poor investment markets, it could still provide the policy owner with ____________.a. The possibility of high returnsb. Individualized company servicec. A consistent cash flow from portfolio interest, dividends, and capital gain distributionsd. An income tax write-off

14. Variable whole life insurance policies offer a choice between fixed and variable death benefit options. Under the variable death benefit option, the death benefit is subject to increase or decrease in relation to the ____________.a. Rates set by the board of directorsb. Consumer price indexc. Dow Jones industrial averaged. Policy’s investment fund’s performance

15. All of the following are characteristics of variable whole life insurance policies, EXCEPT:a. Fixed accounts are not an available optionb. Policyholders select from the investment accounts available c. The variable death benefit is income tax freed. Term life insurance and other riders are available

16. Mr. Bolton likes the idea of a variable universal life insurance policy, but he’s concerned that poor investment results might reduce his cash values to a point that the policy will lapse even though he never missed a scheduled premium payment. The professional life insurance agent should recommend which ONE of the following to address Mr. Bolton’s concern? a. Purchase a no-lapse riderb. Add on a waiver of premiumc. Only invest net premiums and cash values into the money market fundd. Exercise the policy exchange option

17. Ronald’s life insurance clients Alpha and Omega have different money-management theories. Alpha is an aggressive investor, while Omega has a lower tolerance for risk. Variable universal life insurance policies might suit both of their insurance and retirement-savings objectives because of the policy’s ____________.a. Decreasing surrender chargeb. Premium flexibilityc. Preferred underwritingd. Varied investment options

18. Cheryl wants three sub-accounts in her variable universal life insurance policy to be funded in equal amounts. Over the past year, their different investment performances have changed that proportion. She can restore it by adding ____________ to her policy.a. Automatic rebalancingb. Different fundsc. Beneficiariesd. Premiums



19. All of the following are income tax advantages of variable universal life insurance policies, EXCEPT:a. Tax-free death benefitb. Tax-free internal exchangesc. Tax deductible premiumsd. Eventual FIFO taxation if not classified as a MEC

20. Norman is a life insurance client who wants to minimize the average cost-per-unit in his variable universal life insurance policy’s common stock sub-account with a one-time $25,000 premium payment. It is best for him to select the money market fund or fixed account and authorize equal monthly transfers into the stock account over a period of time. This is an example of ____________.a. Dollar cost averagingb. Market timingc. Rebalancingd. Asset allocation

21. Mr. Carson wants a life insurance policy which replaces his income upon death and also pays out any cash value accumulation on top of the face amount income tax free to his beneficiaries. The best option to choose from those listed below to accomplish his objective is ____________.a. To buy three separate life insurance policiesb. Incorporate a split-dollar life insurance planc. To diversify his investments d. To acquire a variable universal life insurance policy with death benefit option B

22. Ms. Rayburn wants to know what she could do if the investments in her variable whole life insurance policy ever fall to near zero. Like all variable contract policyholders she ____________.a. Can file a class action lawsuitb. Assumes 100% of the investment riskc. Can always change the beneficiaryd. Should always asset allocate and rebalance


Chapter 5

Joint Life (First-To-Die), Survivorship Life (Second-to-Die), & Group Life Insurance

Introduction As the names indicate, joint life and survivorship life insurance policies cover more than one person, most commonly two, in one policy, and pays out the face amount at the death of the first or after the second of the named insureds.

Multiple and ongoing changes in estate taxation have diminished the prevalence of second-to-die policies in recent years. Another factor in their declining popularity has been the availability of term policies with low premiums and extended terms of coverage, as well as a couple of companies offering joint life and survivorship term life insurance policies. First-to-die and more importantly second-to-die policies are still offered in the marketplace. They can provide unique ways to meet estate preservation and liquidity needs within the tax structure, as well as being used in other personal and business insurance needs situations.

Joint Life Insurance in the Personal and Business MarketplaceA first-to-die or joint life insurance policy covers at least two lives and pays out the face amount upon the first death. First-to-die life is most often a permanent or whole life insurance policy. Depending upon the ages of the insureds, premiums tend to be 20% to 25% lower than they would be for individual policies on each life. There is only one premium to pay and one contract to manage. First-to-die coverage fits some spousal situations, where a substantial trust fund will be distributed at the second death, and there is a need for funds prior to or as a way to cover outstanding debts such as a mortgage if either should die.

The joint life policy can be an effective tool in preventing financial hardship on a surviving spouse, especially in dual income families, in a cost-effective way. First-to-die can include different insurance amounts, “top heavy” coverage on the greater wage earner or on principal business owners. Another element of the policy is the survivor’s option to purchase an individual plan of insurance – and, via the death benefit, the ability to pay for it.

First-to-die coverage can also fit into a pension maximization plan. Some pension plans offer two income options: life-only or life-with-survivor options. Life-only will result in a higher monthly pension benefit, but a surviving spouse will receive no payments after the death of the pension recipient. A first-to-die policy can provide for the surviving spouse if the pensioner dies first, and can often be paid for by the higher life-only pension payment. It is always recommended to obtain all the facts about any pension payout options and analyze them thoroughly before making any recommendations. The spouse will have to sign-off on any life-only pension payout option under ERISA and company rules.

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In the business market, it could be used to cover a business loan that is outstanding. It might make some sense to have it paid off if either partner dies leaving the surviving partner debt free. An innovative and cost effective use of first-to-die is the funding of buy-sell agreements. A typical two-partner buy-sell binds the surviving partner to purchase the deceased partner’s share of the business from the heirs. Traditionally, each partner would own a policy on the other’s life: two policies, two premiums to pay; two policies to update or replace as business values increase.

Several factors favor one first-to-die rather than two separate policies. For one, the premium will be lower, and can be split down the middle rather than a younger partner paying more to insure an older partner. Recent versions of first-to-die life insurance allow partners to insure more than 2 lives under one policy, with some insurers accepting up to 8 lives in one contract. In a 3-way partnership, any two surviving partners could be 50/50 beneficiaries. The tax ramifications depend upon the policy and premium-paying provisions and should be discussed with legal counsel. In short, the first-to-die policy can be a valuable option when it best fits the situation.

Features, Benefits, and RidersNew versions of the first-to-die product, as well as the special riders associated with it, are designed to fill specific existing and emerging needs in the marketplace. Besides the premium savings, first-to-die offers other features and benefits, as well as riders to consider. Several riders associated with first-to-die policies include various term riders (both first-to-die and single-life): waiver-of-premium, policy-split option, survivor purchase-option, and exchange option.

First-to-Die Term RidersFirst-to-die term riders can be added to a base policy. Assuming the base is a permanent plan of insurance, a term rider is a cost-effective way to ramp up the coverage for a temporary period of time. The single-life rider can provide for varying amounts of insurance on each insured life – a particularly attractive feature in the business market where company ownership or stock holdings are in unequal shares. A more complex application of first-to-die coverage is as a rider on a second-to-die policy. The first-to-die rider face amount, usually lower than the last-survivor face amount, would provide living expenses of a surviving spouse, while the last-survivor policy funds estate needs.

Financial planning with a first-to-die policy requires determining that there is sufficient flexibility for changing needs. Riders that allow a split into two separate policies or allow a surviving insured to purchase individual life coverage, either option without evidence of insurability, are important features to consider.

Waiver of Premium (WP) Rider Some first-to-die waiver riders waive the entire premium if either insured is disabled; others only the premium associated with the disabled life, or the policyowner if a natural person. Some companies even allow the waiver to be placed on only one insured.

Policy Split Option (PSO) RiderThe Policy-Split Option Rider allows the policy to split into single-life policies upon divorce or dissolution of the partnership. Policy-equity split is determined at the time of split and evidence of insurability may be required before the two new policies are issued especially if a coverage increase is requested and allowed. The split is not necessarily 50/50. It will depend upon several factors.


115CHAPTER 5: JOINT LIFE (FIRST-TO-DIE), SURVIVORSHIP LIFE (SECOND-TO-DIE), & GROUP LIFE INSURANCE

Survivor Purchase Option (SPO) RiderThe Survivor-Purchase-Option (SPO) Rider allows the survivor(s) to purchase an individual policy at the attained-age rate without evidence of insurability after the first death. The option must be elected within a specified time after the first death and can be subject to restrictions as to plan of insurance and face amount available.

Exchange Option Rider The Exchange Option Rider allows any of the insureds to convert their first-to-die coverage to an individual policy at attained age premiums without having to prove insurability.

Survivor Insurance BenefitThe Survivor Insurance Benefit extends no-cost coverage for the survivor for a stated period of time, usually 30-to-90 days. During this time, the policy owner would be able to explore current insurance needs and available options.

Simultaneous Death BenefitThe Simultaneous Death Benefit, included in most first-to-die policies, provides for payment of double the face amount to a contingent beneficiary in the event of simultaneous deaths – in a common accident, for example. Many policies extend the “simultaneous” concept for a second death for up to 30 days. In policies covering three or more individuals, the benefit is capped at two. As with all life insurance, naming a contingent beneficiary should be an imperative to prevent inadvertent payment of death proceeds to the estate.

Different Amounts of CoverageSpouses can be insured for differing amounts of coverage as needs dictate; one spouse may have substantial coverage elsewhere, for example. Businesses partners who do not own equal portions can also purchase differing amounts of coverage.

Substitute InsuredsSome companies offer an option to substitute insureds. This allows the substitution of a new insured for a present one during the life of the policy. New partner X, replacing departing partner A, can replace A in the policy as well as in the board room. Evidence of insurability is generally required, but it allows the policy to continue as opposed to starting all over. This can save the other partner’s original insurance age. This will also very likely trigger a taxable event.

Other Types of Joint Life Insurance Low-Load Some companies offer low-load, first-to-die policies on two or more lives. These policies by-pass traditional marketing methods and offer reduced premiums. Individual service on low-load is provided directly from the home offices of the insurer through a fee-based financial planner, or life insurance counselor. Lower loads may mean higher cash value build up especially in the early policy years or perhaps a slightly lower premium.

Graded-Premium These plans are attractive where resources are initially low but expected to increase over time. A graded-premium plan is written with lower initial premiums that increase over time to an ultimate, higher level premium.



Underwriting and TaxationUnderwritingBoth or all lives are underwritten for first-to-die coverage, with the emphasis on the most questionable risk. This is the opposite theory in second-to-die underwriting. In any situation – one impaired risk, age and/or gender difference – one policy will cost less than two or more separate ones.

As in all life insurance, first-to-die is underwritten based on each proposed insured’s age and amount. Impaired risks are generally excluded for coverage because they represent possible early claims. This is the opposite situation in a second-to-die policy where impaired risks can be accepted under the same assumption – that they will pre-decease the healthier risk and therefore postpone the ultimate claim.

TaxationFirst-to-die life insurance is taxed in a similar manner as other life insurance policies for income tax purposes. Death benefits are generally received income-tax free. Cash values build without current taxation as long as the policy is not overfunded to the point in which the policy is considered a modified endowment contract (MEC). Withdrawals and distributions are generally received on a “cost recovery” basis (FIFO) treated as recovery of basis until the basis has been fully recovered and only then as a taxable gain.

Ownership provisions of multi-insured policies can be complex. In personal situations, adding a first-to-die rider to a policy individually owned by one of the insureds is one way to proceed. Ownership provisions in business applications should be subjected to professional review.

Advantages and Disadvantages of Joint Life Insurance Advantages

• A major advantage of first-to-die insurance over multiple single-life policies is the lower premium cost. Premiums are typically 15 to 20% lower than the sum of the single life premiums, because only one policy and one cash value is funded.

• Only one policy to deal with.• Many first-to-die policies will pay an additional death benefit if a second life dies within up to 90

days of the first death.• For businesses, the first-to-die policy eliminates redundant coverage when the need is simply to

insure the first death among several lives.• Riders can allow a split into two separate policies or allow a surviving insured to purchase

individual life coverage, either option without evidence of insurability, are important features to consider.

Disadvantages• There are some important ownership issues and tax traps for the unwary. Failure to adhere to

certain guidelines may have adverse tax consequences.• All coverage ceases at the first death unless the policy is coupled with appropriate riders.• Underwriting may not be as liberal as with survivorship policies.



Survivorship Life InsuranceIntroductionSurvivorship life (SL), also known as “joint and survivor life” or “second-to-die” life insurance, covers two people in one policy and pays the death benefit only at the second death. The principal use of survivorship life is to provide funds to pay estate taxes at the death of a second spouse. Current estate tax law provides an unlimited marital deduction between spouses, meaning that an estate of any size may pass from a deceased spouse to a surviving spouse without the imposition of an estate tax. Upon the second death, however, an estate whose value exceeds a certain amount is subject to taxation. The tax is due in nine months and the proceeds from the life insurance policy can be there to help pay all or part of the tax bill.

While estate tax limits, credits, deductions, exemptions, tax rates and other specifics are important considerations in survivorship life policies, those numbers are subject to change through legislation. Individuals marketing or considering the purchase of survivorship life should familiarize themselves with those specifics and how they apply to their particular circumstances as well as staying current with legislation and tax laws pertaining to estates. Other than assuming that the unlimited marital deduction, instituted in 1981, is here to stay, we’ll confine our discussion here to the general concepts and applications of survivorship life insurance.

Survivorship Life Insurance in the Personal and Business MarketplaceThrough the use of sophisticated estate planning strategies, wealthy people can protect their estates from maximum federal estate and state inheritance taxation. By placing policy ownership in a third party, such as an irrevocable life insurance trust (ILIT), the value of the life insurance proceeds are not included in the estate of the policyowner/insured nor are they added to the estate at the second death. Survivorship life insurance can create the funds necessary to pay any estate taxes upon the second death.

Example: A husband and wife have a combined estate of $8 million, some of the assets within the estate are jointly owned, some are in his name, and some are in hers. At the husband’s death, his “share” passes to his wife with virtually no tax levy regardless of the amount, via the unlimited marital deduction. At the wife’s subsequent death, 5 years later, the estate, which has grown, passes to the couple’s adult children. Let’s say that $4 million becomes the taxable amount. If the tax rate was at 35% the tax bill would be $1.4 million and at the tax rate of 55% it would come out to be $2.2 million. Where is the money going to come from to pay this tax bill within 9 months?

Back up twenty years and imagine the couple applying for and becoming insured under a $2.5 million second-to-die life insurance policy owned from inception by their adult daughters (or an ILIT) with an annual premium of $18,000. Every year, the parents gift $9,000 each to the daughters, who then pay the premium with their own personal checks ($9,000 x 2 = $18,000). Total premiums over 20 years: $360,000 ($18,000 x 20). This generates a totally income tax-free payout at the second death: $2.5 million, with which the beneficiaries would have available in order to pay the estate tax bill of $1.4 - $2.2 million). Net cost to the heirs? Zero, unless you count the $360,000 paid in premiums, but even then they come out way ahead. Even at 30 years it is a cost-effective solution ($18,000 x 30 = $540,000).

A typical alternative might have been to sell assets from the estate, as opposed to taking out loans, to help raise the cash in order to pay the tax bill. Estate sales typically do not capture the full value of family property, some of which is very personal. Instead many times assets are sold for a fraction of what their true worth is due to the motivation the estate has to sell the property in order to meet the looming time deadline the IRS has established. While this example may not have considered all the estate planning techniques available, it was to



provide a simple illustration as to how a second-to-die policy can fit in an overall estate plan and meet a very large and pressing need. Remember the old adage, there are only two things certain in life, one being death, and the other being taxes.

Under certain circumstances, the value of survivorship life insurance proceeds can become estate taxable themselves if a death occurs within 3 years of policy ownership transfers. Professional planning, including third-party ownership from policy inception, such as in an irrevocable life insurance trust (ILIT) can avert application of the “Three Year Rule”, which applies in situations where the policy ownership is changed within 3 years prior to death. When new policies are not able to be procured at financial reasonable prices, or at all, then transferring existing policies over to an ILIT is a sensible alternative. By not making the transfer of ownership, the life insurance policy owned by the deceased, will be included in their estate. By transferring it and living more than 3 years, the policy is effectively removed from their estate saving a lot of money in taxes. The 3 year time window is the gamble some people are willing to take or have no choice in taking.

Other uses for second-to-die coverage include providing funds for the continued care of a child with special needs after the death of both parents and leaving a substantial sum to a favorite charity. In these cases, trusts are often established to serve as directed beneficiaries.

Joint life is permanent insurance; traditional whole life and, more recently, universal life, and variable universal life are the common policy forms. Since the coverage need is generally large, some companies will not write less than a million dollar face amount. For some business uses, it is possible to insure three or more people on one policy and the insurance benefit is paid at the last death, providing funds for the eventual beneficiary to buy out the business.

Married couples or business partners considering second-to-die life insurance should be sure that insurance won’t be needed at the first death, or that there are separate policies to cover needs at the first death such as lingering medical bills and burial expenses.

A survivorship policy is less costly than having two separate policies. Since the death benefit is not paid until the last death, the premium is based on a compromise life span and can even be lower than one individual premium on the older of two insureds. Also because of the delayed payout, underwriting is generally more lenient. Someone who might be rated or even declined on an individual basis for health or other considerations might be insurable (or includable) in a second-to-die policy, since the chance of payout in the early years due to the death of both the named insureds is very low.

Although first-to-die is usually more appropriate in the funding of partnership arrangements, second-to-die has applications as well. Some partnerships have continuation provisions that postpone buy-outs until the second or last partner’s death.

Other uses include estate equalization in situations where business or real estate assets are hard to divide. For example, one of the children, Angelo, has worked long and hard in the family business while the other, Tomas, traveled the world. To be fair to each, Angelo can inherit the family business while Tomas can be paid out a fair amount from the death benefit. In the leave a legacy category, charities or schools can benefit from the payout of a second-to-die policy, or the family can receive the funds as a replacement for an asset donated to the charity or school.



Features, Benefits, and RidersDeath BenefitA traditional whole life permanent policy guarantees the death benefit, and while a universal or variable universal policy may or may not, the initial face amount can be kept in force with continuous sufficient premium payment or with optional no-lapse coverage riders.

Enhanced Death BenefitSome survivorship life companies offer an increased-coverage rider to cover additional estate taxes if both deaths occur within 3 years of any policy ownership changes (the “Three Year Rule”). This can also be referred to as an estate preservation rider.

Policy Split/Exchange OptionMany companies provide an option to split or exchange a survivorship life policy for two individual policies typically within 6 months of a specific change in circumstance such as divorce or estate tax law changes. This serves the best interests of the policy owner should there be major estate tax law changes such as if future legislation revokes the marital deduction and imposes an estate tax at the first spouse’s death or a divorce or if tax rates suddenly are reduced or disappear entirely.

Because the death benefit may not be paid for many years and estate tax laws are subject to tweaking if not outright revision, the option could end up being an important estate-planning tool. Let’s just say an option to separate insurances might come in real handy in cases where the couple has decided to split as well. Some companies include the “Policy Split/Exchange” option for a nominal additional premium; others include it at no charge.

Premium StructureSome of the same premium variations available in “regular” whole life, and universal type policies, are also available in survivorship life. Typically, the policy is issued with fixed level premiums. Survivorship life can also be funded with a single premium that would be advised only in cases where there is certainty that the policy’s cash values will most likely never be accessed at least prior to age 59½. Allowing second-to-die to become a MEC distorts the whole purpose of the policy and can have negative consequences if the cash values were ever needed.

Since estate taxes are relatively insignificant until the second spouse dies, the survivorship policy is typically part of an estate plan whose goal it is to be an effective tax-minimization tool. While generally purchased after an estate has been amassed – ages between 50 and 60 are the largest block – some companies will consider applicants as young as 20 and up to age 90. At older ages, universal life, with its premium flexibility, is the preferred form.

Level term ridersTerm riders can provide death benefits upon the death of the first insured in cases where funds may be needed. It can be issued in the form of a first-to-die rider.

Tax ImplicationsSurvivorship life insurance has the same tax considerations and advantages as other types of insurance. Death benefits are received by beneficiaries free from federal and most states’ income tax, loans are available and, assuming non-MEC status; withdrawals are taxed on the cost recovery (FIFO) basis.



While virtually all life insurance death benefits are received free from income tax, the proceeds can be added to the deceased’s estate for estate taxation if the policy is owned improperly. This would, of course, seriously dilute the very intent of a survivorship life policy. To avoid that situation, policy ownership should be vested in a third party from policy inception. Transferring ownership after issue could have some adverse gift and/or estate tax implications if death occurs within 3 years of the transfer as previously discussed.

The primary benefit of this policy is to the survivors of the estate owner and spouse. In sufficient amount, it will leave the beneficiaries the full value of the assets willed to them at death, rather than splitting those assets. The eventual beneficiaries, then, are the obvious and appropriate purchasers and owners of such a policy either directly or through a life insurance trust or a family limited partnership. Again, legal help is mandatory to make sure anything being put in place does not have any unintended adverse tax consequences. Frequently, the insureds pay the premium indirectly, by gifting the money. This is common within families, but the adult children beneficiaries could pay the premium from their own personal accounts. While there are annual limits on tax-free gifting, it would be rare that a premium would exceed those liberal limits. If it does, the adult children can pay the difference with their own money.

The ownership provision can be complex. Competent legal input is advisable – for all joint life insurance arrangements. Potential buyers of survivorship life should be advised that since policy ownership is almost always third-party, the insureds will have little or no control over policy provisions. Only policyowners can access the cash values.

Advantages and Disadvantages of Survivorship Life Insurance Advantages

• Lower premiums than equivalent coverage in separate permanent life insurance policies.• Since only one benefit will be paid, and since there is a good chance that the healthier or younger

insured will survive the other by years, underwriting is more lenient. In survivorship life, marginally insurable individuals are often deemed acceptable co-insureds.

• Can help to fund estate taxes.• Have applications in businesses, to leave a legacy, or estate equalization situations.

Disadvantages• No benefit is payable at the first death.• Policyowners/insureds generally give up control of the policy to third-party owners, such as

trusts.• Survivorship life/second-to-die/joint and survivor life policies are not offered by all mainstream

insurers. It may require shopping around for an accepting – and acceptable – company.• Improper ownership or early deaths may have unintended adverse tax consequences.



Group Life InsuranceIntroductionGroup insurance refers to a variety of insurance products available to people who collectively belong to a definable group. Group insurance can include life, disability, and health coverages; we will focus on group life plans. Group insurance is most often provided in a business setting with an existing employer-employee relationship. Group life insurance is almost always issued as one year renewable term life insurance, although other forms of insurance are possible. This means that the coverage expires at the end of each year but can be renewed automatically without any other underwriting. The premium rate per $1,000 of protection is subject to annual increases as insureds age, and death benefits are paid upon a group member’s death generally from any cause.

Defining Group Life InsuranceGroup life insurance provides insurance for a group under a master contract between the insurer and an employer. In most jurisdictions, groups of 19 or fewer are “small groups” for rating and underwriting purposes. Twenty to 49 participants constitutes a “large group,” and 50 or more is a “true group” – or just a group. Technically, the insured individuals are not party to the contracts. It is believed that nearly 40% of all life insurance in force in this country is on a group basis. In most states, a group plan can be started with as little as 5-10 employees.

Because group life insurance has long been recognized as a basic workforce benefit, many employers offer it to their employees on a partially or fully subsidized basis. Those employers pay some or all of the premiums, so that employees are covered at little or no out-of-pocket cost to themselves. The group life concept grew out of the hundred-year-old tradition of industrial employers paying last expenses from their own pocket. In a very real sense, group life is a transfer of that risk from employers to insurance companies and, considering the higher face amounts, at a manageable cost.

Types of Groups Because group life plans impact both employers and employees, there are various laws to regulate what will constitute an eligible group plan. We’ll consider basic group life plans and then look at some specific types of coverage.

Organized Union GroupsOrganized labor unions were among the originators of group life plans. Can you imagine contracts for United Auto Workers or the Communication Workers of America not including life insurance coverage? The coverage was for union members who were employed at various companies.

Employer-Employee GroupsEmployer/employee groups are probably the most familiar type of group insurance. Simply put, the employer arranges for life insurance to be made available to the employees. Coverage is most likely based upon a multiple of the employee’s earnings, such as, 1x or 2x salary, with the employee given the option to buy more coverage up to certain maximum amounts. The premium is collected through the employer payroll system for the optional additional coverage applied for by the employee.



Creditor-Debtor GroupsCreditor-debtor groups exist when a lending institution provides a loan to one of its customers. It can also offer life insurance from 3rd party insurers to its borrowers in the amount of their loans. This coverage (credit life insurance) protects both the institution against defaults at the death of a customer, and the borrower’s heirs, or family, from having to continue payments on the deceased’s loan, thereby retaining the asset debt-free as opposed to having the asset such as a car be repossessed. This is considered to be eligible group life because it is available to people who share a common relationship as debtors to the same creditor. The creditor is usually the beneficiary; the loan is paid-off by insurance proceeds in the event of the covered debtor’s death.

Multiple Employer-Employee GroupsMultiple employer-employee groups, also known as ‘multiple employer trusts’ (METs), allow small employer-employee groups to join together for the sole purpose of availing themselves of the same group insurance offerings as larger employers. In this way, companies that fall short of minimum participation levels can qualify for lower rates and other group considerations by being or becoming part of the group.

State Groups Many states offer their own state group life insurance to employees of any state-affiliated institutions or agencies. State colleges and motor vehicle agencies would generally qualify as would direct employees of the state. Elective amounts of coverage range from 1 to 5 times salary, and the coverage is portable among the eligible groups. A motor vehicle agency employee who leaves for a security job in the state capitol building would remain covered. Plan details vary by state, but generally the coverage is fully paid by the state and is convertible at attained-age rates without evidence of insurability upon termination of eligible employment or at retirement.

Association Groups Members of groups such as alumni associations can also provide group life coverage for their members. As with any other group, the primary purpose of the members coming together must be for reasons other than to buy life insurance.

Master ContractWith group life insurance, only one policy is issued. It is referred to as the master contract. It is usually held by the employer. The master contract details the coverage just as any other life insurance policy, and instead of individual policies, employees/insureds receive certificates of insurance as proof of their coverage. The certificate provides essential information such as who is covered, when and for how long the coverage is in effect (duration of employment is common), and the amount of insurance provided. The certificates usually accompany booklets that include other information, such as claims procedures.

The employer is considered the owner of the master policy and is responsible for remitting premiums to the insurance company, either from its own account or combined with employee payroll deductions. The master contract provides for annual renewal and reserves the insurer’s right to increase premiums on a class basis applicable to all similar master contracts in specified industries or areas. The insurance company may also reserve the right to non-renew the contract if the number of employees falls below a specified number. Insurance companies can also price themselves out of the contract by increasing premiums based on past or future expected claims.



Other important clauses in the master contract include:

• Grace Period – This period is generally 31 days after the premium due date.• Timely Payment of Claims – A death benefit claim must be made within a specified time from

the date of the last premium paid for a deceased employee, usually one year.• Adjustment in Premiums Clause – If an employee’s age is overstated, the employer will

receive a refund. If it is understated, the employer will be required to make up the difference in premiums. Age discrepancies discovered during claims on individual life policies result in an adjustment of face amount to how much insurance the premium would have bought at the accurate age.

• Incontestable Clause – The policy is incontestable except for fraud.

Eligible EmployeesEmployee eligibility can vary among groups as long as the rules are neither discriminatory nor unfair to the employee. Typically, employers require employees to be continuously employed for a certain length of time before they become eligible. In some cases, only employees who are paid a specified minimum salary are eligible. Very commonly, only full-time employees are eligible while part-time and seasonal employees are not. This could be established based on the number of hours worked each week, generally 35 hours.

Contributory and Noncontributory PlansWhen the employer pays the entire premiums with no contribution from the employee, the plan is non¬contributory and 100% of eligible employees must be included in the plan to prevent discrimination considered unlawful in all jurisdictions.

Plans that require any premium payment from employees are called contributory and employees may opt out. However, insurance companies usually require at least 75% participation in order to maintain profitability and avoid adverse selection.

Conversion PrivilegeSome group life plans permit conversion of the group term coverage to an individual cash value life insurance policy upon an employee’s separation from the group. This conversion privilege is usually available for 30 days from separation and is limited to certain policies in the insurer’s portfolio. Premiums will be at the insured’s attained age and evidence of insurability is usually not required. By not having to prove insurability when a person has an illness or infirmity that requires leaving the job, the conversion privilege can be a valuable feature of group life plans for the employee. The rates are typically set to a standard smoker. It is likely that the uninsurable or potentially highly rated applicants will opt for conversion while those in a much better insurability situation will shop for the best value on a newly issued policy.

BeneficiaryCovered employees may name any beneficiary they wish, although some states prohibit the naming of the employer as a beneficiary. The employee may also change the beneficiary as often as they want.

If the named beneficiary does not survive the insured, and there is no secondary beneficiary named, the death benefit will be paid to the estate of the covered employee or to one or more of the following survivors: spouse, parents, children, siblings, the estate’s executor or, through the “facility of payment” clause, to a person who has incurred funeral or last illness expenses for the covered employee. It is always prudent to name a contingent beneficiary and to review the designations from time to time to make sure that they are current.



The Workings of Group Life InsuranceQualifying Factors for Group Life InsuranceThe Employee Retirement Income Security Act (ERISA) includes regulations and requirements for group life insurance plans. One such requirement is that the plan must be established in writing. Also, the plan document must provide a procedure for amending the plan should the occasion arise; and plan documents must provide one or more “named fiduciaries” who administer the plan.

The plan documents must specify the basis on which payments are to be made to and from the plan; and a claims review procedure must be included.

• The master policy must be carried directly or indirectly by the individual’s employer.• The plan’s benefits must be offered to a group of employees as compensation for their services.• The amount of insurance provided to each employee must be computed under a certain formula

rather than on an individual basis.• The plan must provide a specific death benefit that meets the definition of the life insurance

contract.

Considering Experience RatingExperience rating refers to the practice of establishing premiums based on the mortality and expense costs of a particular plan rather than on the experience of a larger pool of employers’ plans. Usually, experience ratings are based on claims and expense experience of groups of 200 or more employees. Premiums of smaller employers will typically be based on the experience of a large pool of employers covered by similar master contracts.

In a “pooled rate” situation a uniform rate is applied to all the groups in the pool. Competition for group sales may have some effect on both experience and pooled ratings, and group term premiums are recalculated annually with consideration of the average age of the group and its aggregate experience. Insurance companies renew group term life annually and may adjust premiums up or down at that time. Two or three-year guaranteed rates are common.

Tax ImplicationsEmployer-paid premiums for group life insurance are tax deductible by the employer as an ordinary and necessary business expense and tax-free for the employee to the extent that the coverage is considered “incidental” or not exceeding certain prescribed maximums. The first $50,000 of life insurance coverage provided by the group plan is a nontaxable benefit to the employee. However, the employee must report and pay income tax on the economic benefit of the coverage in excess of $50,000.

Example: Julia is an office manager and is insured in her employer’s non-contributory group plan for two-times salary, $140,000. The economic value of the first $50,000 is non-taxable to her, but the value of the remaining $90,000 will be. That value, calculated to be $200, for instance, will be noted on her W-2 as a taxable amount. The actual calculation will be from an IRS table provided for that purpose.

Source: IRC Section 79

Another IRS provision, Section 162, regulates the uses of insurance within executive compensation and bonus plans. Both sections 79 and 162 are complex and subject to change. Careful examinations of all facts and figures should precede any discussion or sales presentation.



Types of Groups Life InsuranceBasic Group Term LifeBasic Term Life is generally an employer-paid benefit that provides employees with life insurance typically equal to a specified dollar amount such as $50,000 or equal to or twice an employee’s pay.

Supplemental/Optional Life Insurance CoverageEmployees who are enrolled in their company’s basic group life plans may be eligible to purchase additional optional coverage over and above the regular group amount. The coverage amount is subject to certain limits: two times the basic life insurance amount is common. This coverage is paid in full by the employee, without an employer matching contribution, and the premium is subject to age-related increases generally at 5-year intervals. During open enrollment periods, or within a certain period after establishing eligibility, commonly 14 or 31 days, evidence of insurability is not required. Outside those windows of time, evidence may be required.

This coverage may feature prompt-response centralized processing, a variety of coverage schedules, and a disability waiver of premium. An accelerated benefit option may also be included, providing terminally ill individuals with access to a portion of their life insurance benefits prior to death.

Subject to the length of their active participation in the optional life insurance plan, retirees may be eligible to continue some or all of their coverage. The retiree pays the full cost of the coverage, which begins to diminish in increments all the way down to zero from age 65.

Dependent Group Term LifeDependent group term life extends voluntary life insurance protection to the employee’s spouse and/ or eligible children up to specified limits. Some companies may also extend this coverage opportunity to civil union or domestic partners. Many dependent plans also include a conversion option with limited or no evidence of insurability. The amount of coverage available is much less than what can be obtained by the employee. Spouses may be limited to a specific dollar amount, $50,000, or a percentage of the coverage that the employee has in place, 25-50%. Children typically are able to obtain $5,000 – $20,000 of coverage.

Group Survivor Income Benefit InsuranceGroup survivor income insurance provides a continuing monthly income stream to qualified survivors, usually spouses and/or children, at the death of a covered employee. Most benefits are based on a percentage of earnings. Some plans pay out a flat amount applicable to all insureds; others may vary the amount by job classification. Group survivor plans are often supplements to group term life and payments made to a surviving spouse may end at a specified age, at remarriage or upon reaching Social Security eligibility. Payments made to unmarried surviving children usually end at a specified age, commonly age 19.

Group Universal Life InsuranceGroup universal life is a group life insurance product that allows eligible employees/members and their covered spouses the option of contributing to a cash value fund over and above their group term coverage.

Group universal life is essentially a combination of group term life with a universal life interest-bearing account feature. As such, it combines economy of scale and other advantages of group life coverage with flexibility and the potential for cash accumulation.



Since the policy is divided into pure life insurance protection and cash-value accumulation, part of each premium pays the mortality costs while the balance of the covered employee’s contribution is dedicated to the cash value portion.

Each insured selects a contribution amount and can increase or decrease the premium, increase or decrease the benefits, or borrow against the cash value. As in individual universal life policies, an employee’s premium payments can be reduced or skipped and coverage will continue as long as the cash value is high enough to meet the insurer’s mortality and expense charges.

The insurance protection in group universal life is at low term rates, which makes it affordable. The cash values have a minimum guaranteed rate but can be credited at a higher current rate. The typical group universal life contract insures groups of 1,000 or more employees. The employer installs and administers the plan, but the covered employees pay the entire premium.

As with individual cash-accumulating policies, the potential buildup in group universal life insurance accrues on a tax-deferred basis. Cash-value withdrawals are taxed on the favorable FIFO basis, and the death benefit including any cash accumulation is income tax free to the beneficiary.

Group universal life can be a stand-alone employee benefit or be combined with separate group term life coverage. A terminated or retiring covered employee may continue his or her policy or surrender it for its cash value. Under certain nonforfeiture options, the insurance can continue in the form of a “reduced paid-up” policy. Assuming a substantial cash buildup over years of contributing, a retiring employee may opt for an annuity-type payout.

Employee Adjustable Life InsuranceAdjustable life is one of the many insurance products that can be offered on a group basis to employees of businesses that are willing to collect and remit premiums through payroll deduction. The advantages to the employee include competitive group discounts, simplified underwriting (sub-standard risks may be accepted as part of the group) and automatic premium payment.

Employers generally do not contribute to the plan, but facilitating premium payment through payroll deduction is a benefit that employees value. The upside for the insurance company is the number of potential customers and the surety that premiums will be paid.

Through payroll deduction, an insurance company is able to offer competitive rates on this potentially cash-value building policy. A short, simple application is usually all that’s needed. Physical exams are usually not necessary. Individual employees own their own policies, which can be tailored to meet their own needs. Since ownership is vested in each insured, an employee who leaves the employer for any reason can continue their policy without any change in premiums or benefits.

Group Variable Universal Life Group variable universal life combines the life insurance protection employees are seeking along with tax-deferred investment options found in variable contracts. The investment account is segregated from the insurance company’s general account and offers varying investment objectives with different degrees of risk. The employee can custom design a portfolio to attempt to achieve account value returns in excess of what could be achieved in a universal or adjustable life insurance policy. A fixed account that offers guarantees is also generally available. The premiums are flexible and the death benefit is adjustable. All of the features and benefits available with an individual policy are also available on a group basis through the employer.



Term Insurance and Permanent Insurance Group plans may be offering both term and permanent life insurance to their employee so it is important for them to fully understand and appreciate the differences. Term life insurance is designed for low cost protection and when the protection need is temporary. It does not build cash values. It may be portable, or it may have to be converted upon separation of service to a permanent plan.

Permanent life insurance is designed for a lifetime of coverage and the potential cash value build up. It is more expensive than term life insurance. It is more likely to be portable. Universal policies offer premium flexibility and adjustable death benefits. Variable policies offer investment choices. An appropriate choice will depend upon the need, finances, sophistication, and risk tolerance of the employee.

Features, Benefits, and Riders The primary features of group life insurance include reasonable premium rates and availability to everyone within the group. It’s the law of large numbers at work. The expectation is that a great many men and women of differing ages and health conditions will pass through the group over time, and further augmenting the ‘large number’ concept, many groups may be underwritten by the same carrier. Some older members will leave the group before they die, thus terminating their group term coverage before any claim is paid, and new, often younger members will join the group, generating additional low-risk life insurance premiums for the coverage selected.

Waiver of PremiumGroup term life contracts usually contain provisions for the protection of disabled employees. One of these provisions is “waiver of premium”. The waiver of premium provision relieves the employer of the requirement to pay premiums for any covered employee who becomes totally and continuously disabled prior to a specified age in the policy contract. This age varies but is commonly set at 60.

There is also a waiver of premium rider available to employees who opt for the optional supplement coverage on their life or that of their dependents which exempts qualifying, disabled employees from paying life insurance premiums on their coverages.

InsurabilityUsually only members of the very smallest groups are required to prove their individual insurability while members of larger groups are often covered automatically when they become eligible. This is typical, but there are exceptions so it is important to know exactly how a particular insurer writes group life coverage and accepts new insureds. Typically, within a certain time window from initial hire, 60-90 days in many cases, employees may sign up for group life insurance without having to prove insurability. The insurance company probably assumes that if a person was hired they have at least some semblance of insurability otherwise they would not have had a job interview, had an offer extended to them, or accepted that offer and made it to work on-time.

Benefit ScheduleA benefit schedule is a predetermined formula under which benefits will be provided. These benefit schedules generally base coverage amounts on one or more factors, including:

Duration of ServiceIncreasing coverage based on years of service may help to bind valued employees to the company. The longer an employee is with the company, the greater amount of life insurance coverage will be in place.



Occupational ClassificationsA manufacturing company may assign one level of group life coverage to assembly line workers, a higher level to supervisors and a further step up to executives. One advantage here is the ease of administration. Also, the coverage levels are often related to the employee’s survivors’ needs, to the employee’s ability to pay in the case of a contributory plan, and to the recognition by all concerned of the employee’s value to the business.

EarningsPerhaps the most common formula will base the amount of insurance on a multiple of the employee’s earnings. Most insurers require a minimum of $5,000-to-$10,000 on each covered employee and some may require a minimum coverage for the entire group, for example, $250,000 in aggregate. There’s also a per-life maximum, which can be as high as $500,000 - $2,000,000 depending on the number of enrollees and the aggregate amount. Such high amounts will likely be medically underwritten, and reinsurance (selling off some of the risk to another company) is not uncommon.

Proponents of an earnings-based schedule point out that this benefits survivors by providing an amount commensurate with what the deceased would have provided through their earnings, at least for a time. Two-times earnings, for example, equals two years’ income to survivors. Assuming salary increases, the insurance amount will keep pace with inflation. Also, the more productive, higher paid employees are rewarded commensurately.

A Flat BenefitProviding a flat benefit amount for all participants is the simplest formula to administer. This type is often the choice of large multiple-employer groups providing coverage under collective bargaining agreements. For example, all union members of a multi-store grocery chain could be covered for $10,000 each.

Other Features Commonly Found in Group Life Insurance PlansAccelerated Benefit Option – Allows terminally ill employees to receive part of their insurance benefit while still living.

Conversion Option – Permits employees to convert coverage to an individual insurance policy when no longer employed without having to prove insurability. Typically this option is good for 30 days from separation of service.

Portability Option – Enables eligible employees to continue a certain level of their group coverage when they are no longer employed with their current employer, essentially allowing them to take their policy with them.

Accidental Death and Dismemberment (AD&D) – Pays for a covered accident which results in loss of life, speech, hearing or sight, or in paralysis.

Overall, group life insurance is a socially valuable benefit. In the event of employee’s deaths, the impact upon their families without the proceeds from their group life coverage can only be imagined.



Advantages and Disadvantages of Group Life Insurance AdvantagesFor the Employer:

• Premiums paid are considered ordinary and necessary business expenses and therefore, are eligible for federal income-tax deductibility

• Meeting employee’s expectations that employers will provide this and consider this a desirable fringe benefit

• It may help in reducing employee turnover, ultimately saving money in hiring and training process

• It may contribute towards employee’s feeling more secure, being more loyal, and having a higher morale

For the Employee:

• Life insurance coverage provided and/or available at a low group rates• No proof of insurability required at open enrollment or for new hires• Convertibility upon separation of service with no medical questions asked• Coverage options for dependents• First $50,000 provided at no cost and income tax free• Option to buy more coverage through payroll deduction• Different types of life insurance can be made available• Convenience• It is the only life insurance some employees carry

DisadvantagesFor the Employer:

• Group life insurance coverage must be provided on a non-discriminatory basis, disallowing the employer to “pick and choose” who will be covered and on what terms. Employers must be made aware of this.

• The employer’s out-of-pocket cost can increase as employee’s age, especially if no new, younger employees enter the plan.

• Group life insurance is subject to certain ERISA limitations and requirements, necessitating administrating and reporting obligations.

• A group term life plan cannot cover non-employee shareholders.

For the Employee:

• By design and formula, group life insurance protection ceases or is reduced at retirement.• Group term life insurance is temporary coverage.• May not be able to buy all the coverage that is needed.• The premiums to employees who convert from the group plan into a permanent plan will likely

see premiums rate rise dramatically from what they are used to, based on type of coverage, attained age, and premium rating class.

• Over $50,000 provided is taxable as income.• Employees have no guarantee that group coverage will be continued by the employer since a

group policy is a contract solely between the employer and the insurer and may therefore be discontinued or changed without employees’ approval.



Conclusion The insurance professionals’ obligation is to meet insurance consumer’s needs for coverage. There are many methods by which to engage a potential customer in this important discussion as well as several methodologies to ultimately answer the question, “How much coverage is needed?”

Life insurance policies have state mandated contractual language along with policy provisions to clearly establish protections for the insurer, policy owner, insured, and beneficiaries. Understanding of the language and provisions policies contain and being able to effectively communicate them to the policy owner is critical to customer satisfaction.

Policies can be temporary or permanent, fixed or variable, or issued on an individual or group basis. Riders allow for customization of benefits and providing additional protections not found in the base life insurance policy. Policies can be paid for in various manners, can cover more than one person, and can allow for the risk to be borne entirely by the insurer or can be shared by the policy owner.

Today the life insurance marketplace is more advanced than ever before offering policies, features, benefits, and riders never thought of or ever heard of years ago. It takes commitment on behalf of the life insurance professional to stay on top of what their company offers as well as their competitors. In this rapidly ever-changing industry, the commitment to continuing education was never more important than it is today.



1. A middle-aged couple with two incomes, high fixed expenses, and no dependents are looking for a way to replace lost income if one of them dies. They have determined that the surviving spouse would be unable to live on just their one income and maintain their current standard of living. That couple should consider which ONE of the following solutions? a. Moving into a smaller houseb. Getting along with just one carc. Buying a first-to-die policyd. Investing in high-yield bonds

2. Two business partners were interested in funding their buy-sell agreement with a first-to-die policy, but they were concerned that if they died in a common occurrence, it might be impossible to determine who died first. Their fears were allayed when they learned about the policy’s ____________.a. Double indemnity riderb. Simultaneous death benefitc. Dual beneficiary optiond. Tax-free death benefit

3. A married couple is sold on the idea of a first-to-die policy to replace either of their income at the first death, but she earns considerably more than he does. How can this problem be solved? a. Have them buy separate policiesb. Include a single-life riderc. Have him get a second jobd. Re-financing their home

4. When they sold their business, the partners both wanted to keep the coverage in their first-to-die policy. Their problem was solved when they learned about the ____________.a. Extended term provision riderb. Increasing term riderc. Waiver of premium provisiond. Policy-split-option rider

5. All of the following are advantages of first-to-die policies, EXCEPT:a. Premiums are lower than buying two separate policiesb. Eliminates the need for redundant coveragec. Liberal underwriting d. Coverage is extended on the survivor for up to 90 days

6. In a joint life insurance policy, it would be advisable to buy the ____________ benefit to make sure that the policy is continued in the event of the premium payer’s disability.a. Extended term insuranceb. Automatic premium loanc. Option to purchase additionald. Waiver of premium

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7. A life insurance agent’s cousin wants to start a group life insurance plan for him and his buddies who gather every Sunday to watch football on cable television. However, they don’t qualify as a __________ for insurance purposes.a. Definable groupb. Significant groupc. Representative groupd. Congenial group

8. Two brothers own a couple of auto body shops across town from each other. Each is too small to qualify for low group life rates. They could look into forming or joining a ____________ to obtain the life insurance benefits they seek. a. Large shopb. A family partnershipc. A multiple employer-employee groupd. A non-competing pact

9. Jim doesn’t want to leave his wife with the payments on his new domestic luxury car in the event of his death. Fortunately, the car dealer offers ____________ which will allow him to achieve his objective.a. A mortality buy-back planb. A payment forgiveness planc. A 1.9% loan interest special d. Creditor-debtor insurance

10. The group survivor income insurance benefit provides ____________ to qualified survivors at the death of a covered employee.a. Replacement job opportunitiesb. A continuing income streamc. An emergency fundd. Bereavement counseling

11. The re-negotiated union contract mandated a voluntary permanent cash-value life insurance option. The company’s financial team installed a group ____________.a. Mutual fund planb. 401(k) planc. Non-contributory creditor-debtor pland. Universal life insurance plan

12. In an effort to limit employee turnover, the CFO installed a group life insurance plan that based the coverage amount on the employee’s:a. Salary levelb. Age, height, and weightc. Years of serviced. Premium contribution

13. The ‘unlimited marital deduction,’ instituted in 1981, provides for an estate of any size to pass from a deceased spouse to a surviving spouse ____________.a. Without any documentationb. Regardless of a will to the contraryc. Without an estate taxd. Only if it’s a first marriage for both



14. Mr. and Mrs. Gordon are concerned that after they have both died, their disabled daughter might not receive the care necessary for her comfort and survival. They rest easy after establishing a trust that will eventually be funded by ____________.a. Contributions from family and friendsb. Nationally recognized charitiesc. The sale of their homed. A second-to-die life insurance policy

15. Bert and Michelle want to make sure their survivorship life insurance proceeds don’t add to the value of their gross estate causing a higher estate tax bill. They can avoid this pitfall by ____________.a. Having their daughter own the policyb. Adding a term rider to the policyc. Not naming the estate as beneficiaryd. Avoiding the policy from becoming a modified endowment contract

16. The attorney and CPA advised that the adult son and daughter own their parents’ survivorship (second-to-die) life insurance policy and pay the premium as well. The insured parents paid the premium indirectly by ____________.a. Gifting the premium amount to the son and daughterb. Using an offshore accountc. Placing the policy on automatic premium loand. Paying in the insurance agent in cash

17. A client wants substantial life insurance coverage for estate equalization purposes. They also are on a budget and want to minimize their total premium outlay. Which ONE of the following is most likely the best option for them to choose?a. Buy two smaller policiesb. Consider buying decreasing term life insurance coverage as a rider on some permanent life insurancec. Buy a survivorship life insurance policy d. Acquire a single premium MEC

18. Conscientious insurance representatives should make a special point of informing prospects for survivorship second-to-die policies that they will probably end up giving all control of their policy to ____________ if they want to keep the policy out of their estate for planning purposes.a. The IRSb. The insurance companyc. The insurance agentd. Third-party owners


Chapter 11. B Multiples of earnings is a commonly invoked guide in estimating ‘human life value.’2. A While Tim and Steve’s favorite teams are important to them, it is not a factor in choosing life

insurance coverage.3. A Where to keep the policy may be of some importance later, but hardly compares to the other answer

choices provided.4. B Permanent life insurance cash values can serve an individual’s living objectives.5. C Someone eligible for more than one Social Security benefit will receive the highest amount.6. C Social Security survivor benefits are an important part of life insurance needs calculations.7. B His premium will be higher at age 23, 24, etc.8. C Income replacement is one of the major uses of life insurance.9. D The agent’s income is not part of the definition of insurance.10. D Depending upon how it is all arranged, premiums can be tax deductible as a charitable donation,

death benefits can be large, and the value of the policy along with its proceeds can by-pass the donor’s estate.

11 B Often times merely focusing in on premiums leads to under insuring the immediate life insurance need. Focusing in on the immediate insurance need first then considering what types of policies, riders, and premium options, would most likely be the best strategy to cost effectively put in place the optimal solution.

12. A A 1035 exchange is not permitted from an annuity into a life insurance policy. It is also not going to work here because the money must go from the old insurer directly to the new insurer.

13. C Under the Transfer for Value rule, the death benefit becomes taxable to the extent it exceeds the consideration ($30,000) plus any ensuing premiums ($2,000), $50,000 - $32,000 = $18,000.

Chapter 21. A Only ‘in force’ policies pay benefits at an insured’s death. Paying premiums on time and in full keeps

it from lapsing.2. C Insurance rates are based on actuarial and mortality tables.3. B Insurance in the amount of a mortgage transfers the risk to the company.4. B The life annuity option provides income as long as a person lives.5. A Estoppel refers to the concept that previous actions or statements establish binding precedents.6. B His half-truths could be considered his representations.7. A The contestable period protects the company against fraud by insureds.8. C Premiums are accepted during a grace period, usually 31 days from premium due dates, without a

lapsing the coverage.9. D Most contractual changes occur on a policy’s anniversary date. This is one example.10. B Upon declining an applicant, the initial premium is returned.11 B Walter has made an offer that the company will decide whether or not to accept.12. D A unilateral contract binds only one of the parties legally. Robert is free to surrender the policy, stop

paying premiums on the policy, or transfer ownership in the policy to a third party.13. A The expense factor (payroll, utilities, etc.) is the only factor over which a company has major control.14. D The three terms are the non-forfeiture options found in permanent life policies.

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Review Questions Answer Key

15. B Variable-rate loans, issued by some companies, are subject to interest-rate adjustments.16. C Dividends may be reduced under the principle of direct recognition.17. C Policy loans are generally low-interest, but are not interest-free.18. C A contractual arrangement exists between beneficiaries and insurers after the insured has died.

Chapter 31. A An accidental death rider might give Tom extra peace of mind.2. B Term insurance can be a low cost solution for young parents.3. D Cost indexes are a way to compare the cost of very similar cash value policies.4. A The OPAI rider guarantees eligibility for additional coverage regardless of health.5. C The waiver of premium benefit provides for the premium to be waived to the insured and paid by the

company in the event of a serious and continued disability.6. A Modified and graded premiums are best suited for individuals who can expect their incomes to

increase in the foreseeable future.7. B Traditional whole life insurance premium schedules are guaranteed for the life of the contract.8. C Current assumption whole life insurance uses current interest rates that can augment the guaranteed

cash value.9. B Modified premiums are reduced to start and increase once to an ultimate premium that remains

constant for the balance of the policy years.10. A Term life insurance riders for temporary extra coverage on the primary or additional insureds can be

added to fill individual life insurance needs.11 B Additional coverage in a 10-year rider would offset education costs in the event of a parent’s death.12. C Single premium whole life insurance (SPWLI) is a type of life insurance which is entirely paid up

from the beginning of the policy. The owner/insured pays one lump-sum premium and never makes any more premium payments.

13. A The net premium becomes the immediate cash value, which then grows by interest and with declared dividends if issued by a participating company.

14. A Most single premium life insurance policies impose a surrender charge, decreasing over 5-to-10 years.

15. B Individuals other than the primary insured, typically spouses and/or children, may be covered by Additional Insured Term Riders. This way only one policy has to be issued but more than one person is covered.

Chapter 41. B Variable policy cash values fluctuate with the investment results of underlying accounts.2. A The salary-increase rider can trigger an increase in the face amount to keep pace with any salary

increases.3. D There is no tax deduction for interest paid on policy loans on any life insurance policy.4. B Single premium universal policies credit interest to the cash value at rates which are subject to

change. If interest rates increase, so will the return on the cash accumulations. The opposite is also true, but when prevailing rates are very low, increases might be on their way soon.

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5. D Internal investment values could fall below a policy sustainable level. MEC status eliminates some tax advantages upon withdrawals, but the death benefit remains free from federal income tax.

6. A A switch from first-in-first-out (FIFO) to last-in-first-out (LIFO) means that withdrawals will be considered profits to the extent they exceed the policy’s cost basis, and will be taxable first, and subject to possible additional tax penalties if taken prior to age 59½.

7. D A universal life insurance policyholder can gear the timing and amount of their premiums to their own particular financial schedules due to the flexible premium nature of the policy.

8. C Option B provides for the accumulated cash values to be added to the insurance’s face amount at death.

9. C Option A provides for a fixed death benefit and faster buildup of universal policy cash values than is the case for Option B.

10. B The mortality and expense charges are deducted from the policy’s cash value monthly whether or not premiums are paid.

11 D A single-premium policy retains the tax-free death benefit even if it has lost other tax advantages by becoming a modified endowment contract (MEC).

12. C Variable whole life insurance policyholders assume the investment risk of the investment funds, but a minimum death benefit is guaranteed, assuming continuous premium payments are made on time and in full.

13. A The trade-off for assuming the investment risk of low or negative returns is the possibility of high returns over the long-run.

14. D The variable death benefit option allows the death benefit to fluctuate according to the investment performance of the policy’s sub-accounts.

15. A With any variable life insurance policy, a fixed account is available for selection by the policy owner for diversification purposes.

16. A The no-lapse rider will guarantee that the original face amount will continue in force regardless of adverse investment results so long as specified premiums have been paid.

17. D Variable universal life insurance investment options range from very conservative accounts to relatively high-risk funds.

18. A Auto rebalancing restores the desired account proportion through internal sales and purchases of the investment funds at selected intervals, usually on an annual basis.

19. C Personal variable universal life insurance policy premiums are not tax-deductible. The other three choices are real income tax advantages.

20. A The suggested technique is an example of dollar cost averaging.21. D Death benefit option B can convert potentially taxable cash values into a tax free death benefit. The

cash accumulation is paid out in addition to the face amount of coverage.22. B Variable contract policyholders should always be made aware that they assume 100% of the risk of

the sub-accounts’ investment performance.

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Chapter 51. C A first-to-die policy could replace the income of the deceased spouse.2. B The simultaneous death benefit provides for payment of double the face amount to a contingent

beneficiary in the event of simultaneous deaths in a common accident, for example.3. B The single-life rider can provide for varying amounts of coverage on each insured life in a first-to-die

policy.4. D The policy-split rider allows the policy to split into single life policies upon dissolution of a

partnership. Evidence of insurability may be required.5. C Underwriting is based on the joint insured’s insurability. If one of the insureds is high risk or

uninsurable, the policy may become unaffordable or it will not be issued.6. D The waiver of premium rider will in effect pay the premium during the qualified person’s disability

which will keep the policy and all of its benefits in force.7. A Group insurance refers to a variety of insurance products which are made available to people who

collectively belong to a definable group, formed for the purpose other than to buy insurance.8. C Small employers can band together by forming or joining a multiple employer-employee group for

the purpose of availing themselves of group life insurance offerings.9. D Creditor-debtor group life insurance pays off any remaining loan balances at the death of the debtor.10. B The survivor income benefit provides an income stream to deceased group members’ survivors,

usually spouses and children.11 D A group universal life insurance plan allows for contributions toward a cash-value fund as well as

providing for a portable death benefit.12. C Basing coverage increases on longevity of service can help bind valued employees to a company.13. C The estate of a deceased spouse passes to a surviving spouse free from estate tax.14. D Providing ongoing care is one of the uses of survivorship (second-to-die) life insurance.15. A Third-party ownership is a way to keep proceeds from becoming taxable as an additional part of the

estate itself.16. A Gifting the money is a legitimate and effective way to pay the premium indirectly.17. C Survivorship life insurance policies are ideally suited for estate equalization purposes. It is less

expensive than buying two separate policies and pays out at the second death.18. D Policy owners have total control over access to cash values and beneficiary provisions. To keep the

value of a life insurance policy out of the estate requires 3rd party ownership and is routinely done for estate planning purposes.

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