Chapter 12: Life Insurance

12.0 Introduction

Unexpected family death can cause financial burden. Life insurance protects financial security; review coverage.

12.1 Life Insurance: An Introduction

Life insurance is growing and necessary for financial preparation, available via group plans, veterans’ sources, and private companies. Many plans have inflation adjustment and familial growth options; research potential plans to avoid shortfalls.

Components

  1. Joining a risk-sharing group (insurance company) with a policy.

  2. Declaring money to be paid towards beneficiaries at death or maturity.

  3. Paying for coverage periodically with premiums.


Purposes

Life insurance protects those financially impacted by a death, from businesses to families. Purposes include:

  • Paying off debts

  • Providing lump-sum child payments

  • Providing education or income

  • Covering medical or funeral costs

  • Making charitable bequests

  • Providing income

  • Accumulating savings

  • Setting up an estate plan or payments

In short, it provides liquidity during death. Despite this, many are underinsured.


Calculations

Life insurance is calculated by predicting death risks, considering age, gender, and lifestyle. Life expectancy can impact costs and financial planning as life expectancy and lifestyles improve.

12.2 Determining Your Life Insurance Needs

Factor in income, savings, income protection, group life insurance and annuities, net worth, and Social Security benefits to determine life insurance needs.


Considering Needs

Life insurance should be obtained if your death can cause financial stress for your dependents. Consider your household, financial, and life cycle stage for your needs. Ask:

  • How much money you want to leave your dependents

  • If you will require more or less insurance protection with time

  • When you would like to retire

  • What amount of income is needed for retirement

  • How much you are able to pay for insurance


Calculation Methods

Though needs depend on many factors, consider these estimation methods:

  • Multiple of Income: Uses only annual income, ignoring other details.

    • Lower: 5 times current income.

    • Upper: 10 times current income.

  • Easy: Adjusts Multiple of Income for typical families; better for smaller or less indebted ones.

    • Use 70% of 7 years’ current income.

  • Dual Income, No Kids (DINK): For childless couples with similar incomes. Covers half of debt and funeral costs, assuming spouse keeps working.

  • Nonworking Spouse: For spouses needing extra household and family care.

    • Take the amount of years until the youngest child is 18 multiplied by $10,000.

  • Family Need: Estimates needs using your family’s financial situation. Use a financial planner if needed.

Factor in your existing employer and mortgage coverage. Periodically reevaluate plans for rates, situation, inflation, and policy changes.

Online calculators and apps help estimate needs. Use unbiased sources (not insurers) for fair calculations.

12.3 Types of Life Insurance Companies and Policies

Sources

Life insurance comes from:

  • Stock Insurance Companies (85%): Shareholder-owned, selling nonparticipating policies (no dividends or refunds) with lower prices. Best for consistent guaranteed premiums.

  • Mutual Insurance Companies (15%): Policyholder-owned, selling participating policies (higher prices) with annual dividends. Best for trusting company experience, health, and cost management.

  • Determine needs and situations to estimate the best policy. Consider stability, reliability, and provided services.


Types

There are two types of life insurance:

  • Temporary (Term): Protects for a set time, coverage tied to premiums. Best value for younger people, good for decreasing payments with aging children.

    • Renewability: Continuing coverage with adjusted premiums at the end of the term.

    • Multiyear Level: Same payment amount for policy life insurance, good for budgeting.

      • Term to 65: Coverage ends at 65 or upon earlier death.

    • Conversion: Exchanging term insurance for whole life insurance with medical exams and higher premiums.

    • Decreasing Term: Plan with constant premiums but with beneficiaries being paid less over time. Mainly for depreciating assets like mortgage loans; can be replicated with diminishing annual renewal policies.

    • Return of Premium: Refunding premiums if terms are outlived (with a 30-50% higher cost). Reduces insurance selection apathy, but consider investment opportunity costs. Premiums must be maintained to obtain refunds.

    • Reentry: Reduced rates on term insurance for healthy individuals passing examinations.

  • Permanent (Whole): Specified premium for life with a sum in return. An annually increasing cash value if insurance is relinquished aids long-term plans but may reduce overall coverage. Premiums remain constant.

    • Limited Payment: Higher premiums are paid for a period, leading to lifetime coverage.

      • Health Classification: Reduces rates based on medical history (blood pressure, cholesterol, anxiety medication, obesity, acid reflux).

      • Single Premium: One large payment.

    • Modified: Lower initial premiums, higher premiums later.

    • Variable: Value varies with a separate fund; minimum benefit can rise with earnings. This comes with a risk of poor performance; read your policy's prospectus and disclosure statements.

    • Adjustable: Coverage increases or decreases via premium or period adjustments.

    • Universal: Minimum amount with flexible coverage via investments or contributions. Reports provided for insurance charges and rates of return. Premiums controlled, value accessible via loans or withdrawals (unlike whole life). Consider expenses charged for higher rates of return and company policies.


Other Types

  • Group Life: Insures a group without examinations on a fundamental term basis. The cost is split between employers and employees (older employees may pay more), but may be higher than market prices.

  • Endowment: Coverage with guaranteed sum to insured after a period. Beneficiaries receive the sum upon death. Helps save for college at a specified time of contract fulfillment or death.

  • Credit: Repays personal debts after death. May be pricier than decreasing term insurance.

  • Industrial: Plan where premiums are collected periodically by agents; this is decreasing in popularity.

12.4 Important Provisions in a Life Insurance Contract

Understand your insurance provisions to meet your objectives.

Plan Arbitration

Payment plans may be arbitrated:

  • Policy Reinstatement: Reinstates lapsed policy given acceptable risk and an overdue premium repayment within a time limit.

  • Grace Period: The time a premium payment is allowed without a policy lapse.

  • Automatic Premium: Plan where premiums are paid from your policy cash value to prevent a lapse from nonpayment.

  • Guaranteed Insurability: Added coverage without proof of insurability. Helpful to increase insurance, especially for those in poor health.


Classes

Classes may be included:

  • Nonforfeiture: Prevents benefit forfeiture if policies are dropped. Cash values remain accessible if payments stop.

  • Incontestability: Secures policy validity for the insured's lifetime without disputes, protecting beneficiary benefits.

  • Suicide: Death benefits equal premium paid upon suicide until two years or a specified period elapses.


Payment Modification

Payments could also be modified:

  • Beneficiaries: You may name who receives policy benefits (one person or multiple people), including contingent beneficiaries.

  • Misstatement of Age: Benefits are paid based on one’s true age, not a  misstated age.

  • Policy Loan: Borrowing from a policy's cash value, reducing benefits if unpaid.

  • Joint Life: Insurance for two people.

    • First-to-die: Pays benefits upon death of the first person.

    • Second-to-die (Survivorship): Pays benefits upon death of both persons.


Riders

Riders may modify policies with specialized conditions.

  • Waiver of Premium Disability Benefit: Waives premiums upon permanent disability before a certain age. Consider affordability impact; most companies include this through age 55.

  • Accidental Death: Pays twice the amount if a death is accidental (double indemnity). Death must occur within a certain time after injury and before a certain age. This option is generally more expensive and restrictive.

  • Cost-of-Living: Adjusts benefit value to inflation.

  • Accelerated Benefits: Option where benefits are paid to the terminally ill before death (25-95% of benefits), reducing beneficiary payouts. Used for long-term care.

12.5 Buying Life Insurance

Guidelines

Buy from financially strong companies with qualified representatives (you are entering a long-term relationship). Some sources include:

  • Insurance companies

  • Financial institutions

  • Employers

  • Labor unions

  • Professional or fraternal organizations

Despite rising life expectancies and price cuts, rates are increasing with stricter guidelines and restrictions.

Reputable insurers provide excellent, reasonably priced coverage. Find information from others or satisfaction ratings.


Choosing an Agent

Insurance agents aid selections; note their payment differences and products sold. Captive agents (salaried or commissioned) sell one company's plans. Independent agents offer more choices with commissions. Choose an agent based on online info and personal connections, considering:

  • Availability: For immediate action

  • Financial Planning: For overall protection

  • Pressure: For freedom of choice

  • Knowledge of Changes: For up-to-date coverage

  • Question Answerability: For transparency

  • Professional Group Membership: For experience

    • Chartered Life Underwriter (CLU): Passed insurance exams

    • Chartered Property and Casualty Underwriter (CPCU): Passed property and casualty insurance exams

Talk freely to agents without obligation.

Policy Features

Consider each policy's features. Costs depend on:

  • Cost of business

  • Return on investments

  • Mortality rate

  • Policy features

  • Company competition

Other Details

Underwriting uses attributes to determine premiums (risk levels). Note company competitiveness in prices.

Interest-Adjusted Indexing: Evaluates costs by considering the time value of money. Lower index numbers equate to lower costs. Look for an agent providing these to combine your annual premium, the time value of money, and ending cash value.

Price Quote Services: Compare premium costs with your personal and occupational information. Use unbiased services or ask for the most common rate.

Apply with personal information and medical history (usually not for group policies). Insurability and premium costs are calculated via the application.

Scrutinize policy documents point-by-point with your agent as legal documents. If needed, use the "free-look period" to change your mind and receive a premium refund. Provide your beneficiaries and lawyer with a policy copy and its location to claim any proceeds.

12.6 Life Insurance Proceeds

Well-planned programs provide benefits to dependents or funds to the insured in their lifetime.

Death Benefits

Death benefits cover immediate expenses and income loss. Multiple settlement options are offered:

  • Lump-Sum: Face amount paid in one installment.

  • Proceeds with Company: Proceeds are left with the company at interest to beneficiaries.

  • Limited Installment: Proceeds are paid for a specified number of years.

    • Fixed Period: Equal payments for a specified time.

    • Fixed Amount: Paid out at the same amount until all benefits are exhausted.

  • Life Income: Payments are made to beneficiaries for life based on annuities (immediate or deferred) based on beneficiary information.


Policy Expenses

Life insurance can cover beneficiary expenses.

  • Whole Life Policies: Cash value balance with loan or surrendering options (decreasing beneficiary benefits if unpaid).

  • Variable Life Policies: Investment products supplementing retirement income via withdrawals as market-dependent annuities. May offer extra death benefits, guaranteed minimum income benefits, or long-term care insurance as an extra charge that can reduce account or investment values.

    • Surrender: Charges on withdrawn amounts within a period as a commission to agents, declining gradually over several years.

    • Mortality and Expense: Charges as a percent of account value for risks assumed under annuity contracts, used for costs of business and commissions.

    • Administrative: Charges as a flat fee or percentage for administrative expenses.

    • Underlying Fund: Fees for mutual funds included in variable life policies.

    • Other Features: Fees for added features or actions. Ask your agent about these, guarding against sales pitches and considering options without pressure.

Hold and don’t swap insurance policies for ease of collection. Ensure insurability before relinquishing protection and consider newer costs and provisions with age.


Purchasing Guidelines

Insurance is regulated by state insurance commissioners. Guidelines:

  • Understand life insurance needs before purchase

  • Buy from licensed companies

  • Select competent agents

  • Compare costs and coverage

  • Ask about lower nonsmoker premiums

  • Read your policy

  • Inform beneficiaries about coverage

  • Keep policy safe

  • Check coverage periodically or with life changes