Chapter 3. Life Insurance Basics

life insurance

an insured pays a premium to an insurance company, which, in turn, the insurance company assumes the risk of that person dying prematurely

family dependency period

when the insured dies early and the spouse has kids to support. biggest need for income during this time

preretirement period

kids are grown, but spouse isn’t old enough for social security (before age 60). income needs drop, but no social security yet

retirement period

spouse stops working and gets social security. still needs income to maintain lifestyle

debt cancellation

insurance may be used to pay off debts of the insured

emergency reserve funds

insurance proceeds may be used to pay for sudden expenses following the death of the insured

education funds

insured is used to pay for children’s education or for survivors that need to receive education to re-enter the job market

retirement fund

insurance is used as a source for retirement income

bequests

at the time of death, an insured may wish to leave their funds to their children, family, etc.

liquidity

how easily and quickly an asset can be converted into cash without significantly impacting its market price

human life value approach

gives the insured an estimate of what would be lost to the family in the event of a premature death for them

buy-sell agreement

legal contract that determines what will be done with a business in the event that an owner dies or becomes disabled

• aka business continuation agreement

cross purchase

each partner buys a policy on the other

entity purchase

the partnership buys policies on the partners

stock purchase

each stockholder in a private corporation buys a policy on the others

stock redemption

the corporation buys one policy on each shareholder

business overhead expense (BOE)

pays a disabled business owner’s overhead costs, like bills, rent, salaries, utilities, but doesn’t replace their personal income

executive bonus

employer pays extra money (bonus) to cover the employee’s life insurance premium. employee owns the policy. premium is tax-deductible for employer and taxable income for employee

business continuation

a plan for business owners to buy a disabled or deceased owner’s share so the business can keep running smoothly

limit of liability

the maximum amount the insurer will pay (policy face value or death benefit), minus any loans or interest owed on the policy

solicitation of insurance

an attempt to persuade a person to buy an insurance policy (could be done orally or in writing)

every applicant for a life insurance policy must be given…

a written disclosure statement that provides basic information about the cost and coverage of the insurance being solicited

illustration

a presentation showing non-guaranteed parts of a life policy

• must show

  • guaranteed vs projected amounts

  • say it’s not part of the contract

  • point out non-guaranteed values

life insurance illustration must include

• insurer and agent info

• insured’s name, age, sex

• underwriting class

• policy name/number

• initial death benefit

• dividend options (if any)

• date of illustration

• label: “life insurance illustration”

what can’t you do with a life insurance illustration?

• misrepresent it as something else

• mislead about nonguaranteed parts

• show unrealistic performance

• leave out info

• say no premiums will be needed if not true

• use “vanish” or “vanishing premium” improperly

• use an unsustainable (non-self-supporting) illustration

buyer’s guide

basic, generic information about life insurance. helps buyers compare and choose policies. must be given before accepting payment

policy summary

a written statement with key details about the policy: agent/insurer info, policy/rider names, premium, cash value, dividends, surrender value, and death benefit

traditional net cost method

• compares cash value if you surrender the policy (10-20 years)

• ignores interest you could earn elsewhere

• easy but can be misleading

interest-adjusted net cost

• includes interest you could earn

• more accurate comparison

• has two types: surrender cost index and net payment cost index

underwriting

• process of picking which risks the insurer will accept

• goal: avoid adverse selection

• looks at: health, job, lifestyle, habits

application

starting point for underwriting which includes basic info about the applicant to decide if they’re insurable

general information

name, age, address, job, existing policies, coverage details, beneficiary info

medical information

health history, recent visits, family health, cause of relatives’ deaths

agent’s responsibility for application

• make sure app is complete, correct, and honest

• help applicant answer all questions

• report misrepresentation

attachment of application to policy

if app is taken with payment, it becomes a part of the contract and must be attached to the policy

agent’s (producer’s) report

agent’s personal observations about the applicant

signature

= info is true

incomplete applications

• all questions must be answered

• insurer returns incomplete apps

• if issued anyway, insurer waives right to missing info

premium receipt

shows when coverage starts

conditional receipt

coverage starts on app date or medical exam date

binding (unconditional) receipt

rare in life insurance. gives coverage immediately for a set time even if found uninsurable

approval conditional receipt

coverage only begins after insurer approves the application

temporary insurance agreement

gives short-term coverage while underwriting

pre-selection

agent collects all needed info to see if the applicant is insurable

post-selection

underwriters review app, decide risk level: standard, substandard, uninsurable

investigative consumer report

report from outside firm on finances, character, hobbies

fair credit reporting act

law to keep consumer reports confidential, accurate, and fair

consumer reports

info on credit, character, habits from employment records, credit reports, public sources

investigative consumer reports (details)

• include interviews with friends/neighbors

• applicant must be told within 3 days of request

• consumer can ask for details within 5 days

single premium

one lump-sum payment to fully pay policy. gives immediate cash value

limited pay

level annual premiums paid for set time (like 20 years or to age 65), then fully paid up

modified pay

low premium at first (3-5 years), then higher level premium for rest of life

level premium

stays the same throughout the policy

fixed vs flexible premium

fixed = same amount each time

flexible = can pay more or less than planned

Life Settlement Disclosures – What must be told to the owner?

• Alternatives (like accelerated benefits)

• Proceeds may be taxed/claimed by creditors

• May affect public assistance eligibility

• Payment timing (within 3 business days)

• Possible policy changes (conversion, waiver loss)

• Total amount paid & net amount to owner

• When/how funds are paid

• Provider’s info (name, address, phone)

• Consumer info booklet

Right to Rescind (Cancel) Life Settlement

• Owner can cancel within 30 days after signing or 15 days after getting proceeds, whichever is sooner.

• If insured dies during rescission period, contract is void and provider returns everything.

What is Stranger-Originated Life Insurance (STOLI)?

• When someone with no relationship to insured buys policy to sell it.

• Done purely for profit.

Why is STOLI a problem?

• Violates insurable interest rule.

• Insurance is for protecting against loss from death, not betting on it.

Are STOLIs legal?

• No—illegal in many states, including California.

• Buyer must have insurable interest in insured at policy start.