Chapter 6: Life Insurance Premiums Proceeds and Beneficiaries

CHAPTER SUMMARY: LIFE INSURANCE PREMIUMS, PROCEEDS, AND BENEFICIARIES

Life Insurance Premiums

The key points to remember from this chapter include:

▪    The premium is both an exchange for insurance protection and a portion of the policy owner’s consideration.

▪    Factors in premium calculations include:

‒      Mortality factor or mortality rate

‒      Interest factor

‒      Expense factor

▪    The mortality rate refers to the frequency of deaths in a defined population at a specific time interval.

▪    The morbidity rate refers to the occurrence of diseases in a defined population at a specific time interval.

▪    Interest is one of the ways an insurance company can lower the premium rates.

▪    The expense factor—also referred to as the loading charge or factor—is derived from operating expenses or funds that the insurer “pays out.”

▪    Net (single) premium is a premium that makes provisions for mortality (death benefit) losses only while being influenced by the interest rate assumed, gender, the benefit to be provided, and the mortality rate.

▪    Gross (annual) premium is the premium that’s charged by an insurer which is comprised of (or influenced by) the mortality, interest, and expenses.

▪    Additional factors that may influence the premium amount include:

‒      Age

‒      Sex/gender

‒      Health

‒      Occupation

‒      Hobbies

‒      Habits

‒      Benefits

‒      Options and riders

‒      Premium mode

▪    Premium mode refers to the policy feature that permits the policy owner to select the timing (frequency) of premium payments.

▪    With single premium funding, the policy owner pays a single premium that provides protection for the life of the policy.

▪    Fixed/Level premium funding averages the “single premium” over the policy period.

▪    Modified premium funding is characterized by an initial premium that’s lower than it should be during an introductory period (typically the first three to five years).

▪    Graded premium funding is a contract (like modified) that’s characterized by a lower premium in the early years of the contract.

▪    Flexible premium funding allows the policy owner to adjust the premiums throughout the life of the contract.

▪    Earned premium is the amount to which an insurer is entitled since it provided coverage for a specific period. 

▪    Unearned premium is an amount of premium that the policyholder has paid to the insurance company, but coverage has not yet been provided.

▪    As required by law, reserves are the funds that are set aside by an insurer and used to pay current and future claims.

▪    A legal reserve is the amount of funds that an insurance commissioner (or director/superintendent) requires an insurer to maintain based on the mortality table and an assumed rate that’s designated by the state’s commissioner or state insurance law.

Comparing Life Insurance Policy Costs

▪    Surrender Cost Index uses a calculation formula in which the net cost is averaged over the number of years that the policy was in force to arrive at the average cost-per-thousand for a policy that is surrendered for its cash value at the end of that period.

▪    Net Payment Cost Index uses the same formula as the Surrender Cost Index; however, it doesn’t assume that the policy will be surrendered at the end of the period.

▪    During the life of the policy, the primary living benefit that a whole life (permanent life) insurance plan possesses is its cash value build-up.

Viatical Settlements

▪    The accelerated benefit—also referred to as the terminal illness rider—allows the policy owner to access a portion of the death benefit if a physician certifies that the insured is terminally ill.

▪    A viatical settlement allows a person with a chronic or terminal illness to sell his existing life insurance policy to a third party for a percentage of the face value.

‒      The original policy owner is referred to as the viator.

‒      The new third party owner is referred to as the viatical or the viatee.

▪    Chronically ill means a person who needs considerable supervision due to cognitive impairment or a person who cannot perform at least two activities of daily living.

▪    Terminally ill means a person who’s not expected to survive a medical condition for more than 24 months.

Life Insurance Death Benefits

▪    If a policy owner chooses to select a settlement option, it cannot be changed by the beneficiary.

▪    In a lump-sum settlement option, the death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums.

▪    Under the interest only settlement option, the insurance company holds the death benefit for a period and pays only the interest that’s earned to the named beneficiary.

▪    The fixed amount installment option permits the death proceeds to be left “at interest” with the insurer and to pay a fixed death benefit in specified installment amounts until the principal and interest are exhausted.

▪    The fixed period (period certain) option pays the death benefit proceeds in equal installments over a set period of years.

▪    The life income option provides the beneficiary with an income that she cannot outlive.

▪    Under the single, pure or straight life income option (as with a straight life annuity), monthly installments are paid to the beneficiary for as long as she lives.

▪    The refund life income option—also referred to as the joint life option—guarantees the return of an amount which is equal to the principal less any payments already made.

▪    The life income option with a period certain pays a monthly income for as long as the beneficiary lives. However, if the beneficiary dies before a predetermined number of years have elapsed, the insurer will continue monthly payments to a second beneficiary for the remainder of the designated period.

▪    The joint and survivor option guarantees that benefits will be paid on a life-long basis to two or more people.

▪    A revocable beneficiary may be changed or removed by the policy owner at any time without notifying or obtaining the beneficiary’s permission.

▪    An irrevocable beneficiary may not be changed without the beneficiary’s written consent.

Benefit Distribution

▪    Per capita means by the person or by the head.

▪    Per stirpes means by the bloodline.

▪    The primary beneficiary is the individual who receives the death benefit when the insured dies.

▪    The secondary or contingent beneficiary is the second individual(s) in line to receive the death benefit.

▪    A tertiary beneficiary is third in line to receive policy proceeds when the insured dies and this person survived both the primary and contingent beneficiaries.

▪    Testamentary trusts are created at the insured’s death according to a will.

▪    Inter vivos trusts or living trusts are created during the insured’s lifetime.

▪    The Uniform Simultaneous Death Act states that, if the insured and primary beneficiary both die in a common disaster and it cannot be determined who died first, the insured will be considered to have survived the primary beneficiary (or died last).

▪    The spendthrift clause provision protects a beneficiary from creditors with regard to life insurance proceeds.

▪    Dividends that are paid on a whole life policy are tax-exempt since they’re considered a return of overpaid or excess premiums.

▪    A Section 1035 exchange enables the postponement of tax consequences.