Section 3 - Life Insurance Basics

Insurable Interest

Life insurance is based on this concept
Based on family situation or economics
To buy life insurance on another person you must prove insurable interest to company underwriter at the time of application
1) Prove the family relationship exists
2) Prove you

Third party ownership

Any situation where the insurance owner and the insured are two separate entities
Owner has control of the policy:
1) Can name beneficiary
2) Must pay the premiums
3) Can take a loan or cash surrender of the policy
If third party is an adult, that person'

Insurance regulations

Life insurance is regulated by the state
The McCarran Act states the Fed has the right to regulate insurance only to the extent not regulated by the state

Fixed Insurance Products

Only need insurance license to sell
Includes fixed life and fixed annuities
Guaranteed - you earn a minimum interest on your money
Funded by the insurance company's general account
Regulated by the state
Investment risk is to the insurer

Variable Insurance Products

Money and a portion of the premium are invested directly into the stock market, looking for a higher rate of return to keep pace with inflation
Need an insurance license plus:
1) NASD Securities Series 6 or 7 AND a Series 63 or 66
There are no guarantees

National Association of Securities Dealers (NASD)

NASD regulates its own members
Members are wither Broker Dealers or Registered Representatives

The main purpose of life insurance

To offer protection to your survivors in the event of your death

Personal uses of life insurance

Creation of an estate- life insurance is a creation of an immediate liquid estate upon your death
Cash accumulation
Liquidity
Estate conservation
Viatical settlements

Viatical settlements

You sell your life insurance to an investor
Transfer of ownership to an investor for money
Insured gets less than the death benefit value--the difference is the investor's return on their investment

How to determine the amount of Life Insurance

Human Life Value Approach
Needs Approach

Human Life Value Approach

Valuing someone's life based on their earnings;
Taking earnings and multiplying it by a certain number of years

Needs Approach

More comprehensive than Human Life Value Approach
Takes into consideration other factors, such as:
1) Outstanding debt
2) Survivor
3) Children, if any
4) How old the children are
5) Social Security Blackout Period
6) Where kids want to go to college
7) Ho

Social Security Blackout Period

Social Security allows for survivor benefits until the youngest child reaches 18
After that, benefits stop for both the surviving spouse and children
Spouse will not be eligible for SS benefits until retirement, leaving a "blackout" period

Buy and sell agreements

Life insurance is used to help fund it
Based on legal contracts that set a value on each person's portion of ownership in the business
Another person must purchase the deceased owner's interest in the business (funded through insurance)
Can be used for an

Key Person life insurance

Business owner buys life insurance on a key employee
Business would suffer if key person dies
Death proceeds not taxable; premiums NOT tax deductible

Stock Redemption Plan

A type of buy and sell agreement
If a corporation has an agreement with a shareholder, and that shareholder dies, the corporation will be able to repurchase the outstanding stock the shareholder owned

Executive Bonuses

Some employers use life insurance to fund bonuses (fund deferred compensation plans)
An executive is given a bonus; so the person doesn't have to pay taxes on it, the company uses the bonus to pay premiums on a life insurance policy;
The employee is the o

Group Life Insurance

You go to work for a company,and the company might offer it to you
An Employer provides a group plan for employees
Most inexpensive type of life insurance for company to buy
Sold to employer groups on a payroll deduction plan, which lowers the administrat

Ordinary Life Insurance: Whole Life

Sometimes called Cash Value life
Considered to be permanent
It covers you until you die or until the policy reaches maturity, normally age 100
The policy CANNOT be changed without the client's consent
Never has to be renewed
Premium may be annually or mor

Ordinary Life Insurance: Term

Considered to be temporary
Usually purchased to cover a need, such as a bank loan or a mortgage
Written for a specific period of time
When the term is over, the policy expires
Most term insurance is renewable, but at a higher rate
Grace period of 30 days

Ordinary Life Insurance: Endowment

Similar to whole life, except that endowment policies mature at a predetermined age that is selected by the client upon purchase
Endowments have a cash value that accumulates faster than whole life because it matures earlier, but the premium is more expen

CSO Mortality Table

All ordinary life insurance policies base their premiums and benefits on the 1980 Commissioner's Standard Ordinary Mortality Table, which is based on the Law of Large
Numbers
Table tracks the life spans of 10,000,000 people from newborns through age 100 a

Industrial (Home Service) Life Policies

Also called "Home Service" because producers went to people's homes to collect premiums once a week
Popular in the 1930s and 1940s
Sold by "debit" producers
Grace period 28 days
Small face amounts ($1000 or less)
Used to cover the cost of a funeral
Produc

Nonparticipating Policies

Stock companies issue nonparticipating policies
Company profits may be returned to the stockholders in the form of dividends
Policyholders are not entitled to share in company profits
Dividends are considered to be ordinary income and are taxable

Participating Policies

Mutual insurers issue policies that may participate in dividend distribution
These dividends are a return of premium already paid, so they are NOT taxable
Dividends may never be guaranteed

Gross Annual Premium

The cost of death (mortality) + expenses - interest

Net Single Premium

An initial participating life insurance policy premium minus policy dividends when the insured applies such dividends to pay part of the policy premium

Premium payment mode

How often the premium is paid; monthly, quarterly, semi-annual, annually

Life and Disability Insurance Guaranty Fund

A non-profit entity created to provide insurance coverage to Texas residents when an insurance company fails (found to be insolvent and ordered liquidated). The Texas Guaranty Association keeps the coverage under the insurance policies in force and pays c

Solicitation #1

State law prohibits insurers and producers from engaging in untrue, deceptive or misleading advertising in connection with the solicitation of life insurance

Solicitation #2 -
Buyer's Guide

Insurers shall provide to all prospective life insurance purchasers, (except those buying annuities, credit life, group life or variable life) a Buyers Guide and a Policy Summary (proposal) prior to accepting the applicant's initial premium, unless the po

Purpose of the Buyers Guide and Policy Summary

Disclosure documents
They go over everything related to the policy

Illustration

If the purchaser is considering purchasing a policy where cash values, death benefits, dividends or premiums may vary based on events or situations the company does not guarantee (such as interest rates), he may get an illustration from the producer or co

Interest-adjusted Net Cost Method
(Life Insurance Surrender Cost Index)

Purchasers may utilize one of two methods, as explained in the Buyers Guide, to compare the true cost of life insurance
This index is useful if you consider the level of cash values to be of primary importance. It helps you compare the costs of different

Comparative Interest Rate Method
(Life Insurance Net Payment Cost Index)

Purchasers may utilize one of two methods, as explained in the Buyers Guide, to compare the true cost of life insurance
This index is useful if your main concern is the benefits that are to be paid at your death and if the level of cash value accumulated

Rules of index TIP

It is important to remember that a policy with a small index number is generally a better buy than a comparable policy with a larger index number

Entire Contract Clause

The policy, when its issued, plus the application plus whatever's attached is part of the contract and is contestable in court
When you receive your policy the application is always attached

Producer's Report

Part of the application that contains information regarding the producer's personal knowledge of the applicant, such as financial status, habits and character

Notice Regarding Insurance Information Practices
as required by the federal Fair Credit Reporting Act

The insurance underwriter might request a physical exam, run a credit report, or ask for an HIV test
They must notify the applicant and follow all federal guidelines under the Fair Credit Reporting Act

The insurance application must be signed by

Proposed insured, the applicant (if different from the insured) and the producer
Once completed, the producer may not change anything on the application without the written consent of the applicant

The producer is also responsible for

Collecting the premium at the time the application is
signed

Actuaries calculate

The cost of mortality (death) based on the
Law of Large Numbers

Acquisition costs

Commissions, cost of physical exams, underwriters, etc.
Acquisition costs are usually highest the first year

Insurance load

Certain insurance-company expenses such as
acquisition costs, general overhead expense
(rent), and loading for unforeseen contingencies

Conditional Receipt

Makes the coverage effective on the date of application if the company finds the applicant to have been insurable on that date
The conditional receipt will state either there are no conditions to satisfy - I'm covered immediately; or there are conditions

Backdate

Rate is figured based on the applicant's closest birthday
Companies will allow producers to backdate coverage up to six months in order to help the applicant obtain a younger original age

Twisting

Convincing a client to replace coverage to his/her detriment
A violation of the State Insurance Code

Replacement

Applicants must also indicate on the application, whether or not the new application for life insurance will replace a policy the applicant already owns
If yes, with certain exceptions, the producer must also
give the applicant a Notice Regarding Replacem

Binding receipt

Temporary insurance coverage
Always makes coverage effective on the date of application
Limits the maximum amount the company is liable for until the policy is issued (Temporary Term of Coverage)

Free Look

A refund provision
When you buy your life insurance policy, the free look starts from either the date it's delivered (if hand delivered) or the date it's marked, i.e. 10 days, 30 days, etc.
The only time you can return your policy and get a full refund

Collect on Delivery

If the producer submits an application without premium payment for underwriting consideration, the policy may be issued COD There is no coverage yet, since the premium has not been paid
Upon policy delivery,the producer needs two things:
1) premium
2) swo

Statement of Continued Good Health

A sworn statement by the applicant ascertaining that their health has not changed since the original application was completed

Medical Information Bureau (MIB)

A nonprofit association that maintains medical data on applicants for life insurance

MIB Notice

Disclosures contained in a section of the application, usually located just above the signature line.
MIB procedures require:
1. Written Notice: Issued to the applicant that the insurance company may report health findings to the MIB
2. Authorization: Iss

HIV-related tests

No one may require the performance of an HIV-related test without, first, receiving the specific written informed consent of the applicant
No one who obtains confidential HIV-related information, may disclose that information, except to the applicant or t

Fair discrimination

Insurance companies discriminate based on valid statistical data

Unfair discrimination

When discrimination occurs NOT based on statistical data

Unfair Trade Practice

Making any unfair discrimination between individuals of the same class and equal
expectation of life in the rates charged or benefits payable for any contact of life insurance is considered
to be an Unfair Trade Practice

Contributory Group Participation

Insurance companies require that at least 75% of the eligible employees enroll in a group insurance plan where group premiums are shared by the employer and the employee

Noncontributory Group

nsurance companies require that at least 100% of the eligible employees enroll in a group insurance plan where group premiums are paid by the employer

Loss ratio

A loss ratio is determined by dividing losses by total premiums
received by the producer

Underwriters have 4 choices

Issue the policy
Issue with a surcharge
Issue with an exclusion
Reject the application entirely

Standard risk

Average risk with average premium charge
Individual expected to have average life expectancy

Substandard risk

An applicant or insured who has a higher than normal probability of loss, and who may be subject to an increased premium

Rate-up Age

System of rating substandard risks that assumes the insured to be older than he or she really is and charging a correspondingly higher premium 150

Flat Additional Premium

A specific additional premium is added to the standard rate

Tabular Rating

The company actuary determines what the exact surcharge should be for a client with a particular impairment based on claims history of similar clients

Graded Death Benefits

A policy where the full face value will not be paid until graded time has passed, according to policy terms (often 2 to 3 years) due to a substandard risk

Preferred risk

An insurance classification for applicants who have a lower expectation of incurring loss, and who, therefore, are covered at a reduced rate.