Comprehensive General Insurance and Life Insurance Study Guide
General Insurance Principles and Risk Management
Definition of Risk: In insurance terminology, risk is defined as the uncertainty concerning a financial loss. It is the possibility that a loss will occur.
Types of Risk:
Pure Risk: This type of risk involves only the possibility of loss or no loss; there is no possibility of financial gain. Only pure risks are insurable.
Speculative Risk: This risk allows for the possibility of both financial gain and financial loss. Examples include gambling or investing in the stock market. These risks are generally not insurable.
Perils and Hazards:
Peril: The specific cause of a loss (e.g., fire, windstorm, or death).
Hazard: A condition or event that increases the likelihood of a loss occurring. Hazards do not cause the loss themselves but make a loss more probable.
Insurance Company Ownership Models:
Stock Companies: Owned by stockholders who receive dividends if the company is profitable. These companies typically issue nonparticipating policies.
Mutual Companies: Owned by the policyowners. These companies issue participating policies where dividends (which are a return of excess premium) are paid to the policyowners.
Fraternal Benefit Societies: These organizations are typically non-profit and provide life or health insurance benefits exclusively to their members.
Methods of Handling Risk:
Avoidance: Eliminating the risk entirely by not engaging in an activity.
Transfer: Shifting the financial burden of a risk to another party, most commonly by purchasing an insurance policy.
Reduction: Implementing measures to decrease the probability or severity of a loss.
Sharing: Allocating the risk among a group of people or entities.
Insurer Classifications by Location:
Domestic Insurer: An insurance company incorporated or formed under the laws of the state in which it is doing business.
Foreign Insurer: An insurance company incorporated in another state (e.g., a company incorporated in Georgia doing business in Arizona is a foreign insurer in Arizona).
Alien Insurer: An insurance company incorporated outside of the United States.
Authorized vs. Nonadmitted Insurers:
Authorized (Admitted) Insurer: An insurer that has been approved and issued a Certificate of Authority to transact insurance business in a specific state.
Nonadmitted (Unauthorized) Insurer: An insurer that is not approved to conduct business in a state.
Agency and Authority:
Principal: Another name for the insurance company in an agency relationship.
Expressed Authority: Authority specifically granted to an agent in a written contract.
Implied Authority: Authority not explicitly written but necessary for the agent to carry out the duties of the position.
Apparent Authority: Authority that exists when an agent’s actions or deeds lead a third party to reasonably believe the agent has the authority to act on behalf of the insurer.
Fiduciary Responsibility: The producer's legal and ethical obligation to handle funds (premiums) of the insured and the insurer in a position of trust. This includes forwarding premiums promptly and accounting for all monies received; commingling (mixing personal funds with client funds) is strictly prohibited.
Insurance Contract Law and Legal Concepts
Elements of a Legal Contract:
Offer and Acceptance: An agreement reached when one party makes an offer and the other accepts it.
Consideration: The exchange of value between parties. The insured provides the premium and representations, while the insurer providing the promise to pay benefits.
Competent Parties: All parties must have the legal capacity to enter into a contract (e.g., of legal age, mentally competent, and not under the influence).
Legal Purpose: The contract must not violate public policy or law.
Policy Characteristics and Principles:
Indemnity: The principle that insurance should restore an insured to the same financial position held before a loss occurred, without allowing the insured to profit from the loss.
Utmost Good Faith: A principle implying that there will be no fraud, misrepresentation, or concealment between the parties to the contract.
Application Accuracy and Misconduct:
Representations: Statements on an application believed to be true to the best of the applicant's knowledge; they are not guaranteed to be exact.
Warranties: Guaranteed statements of absolute truth in a contract.
Concealment: The intentional failure to disclose a material fact on an application.
Fraud: The intent to deliberately deceive another party for the purpose of financial gain.
Misrepresentation: Untrue statements made by the applicant.
Life Insurance Basics and Personal/Business Uses
Insurable Interest: This must exist at the time of application. It is generally found between spouses, parents and children, or business partners. It does not typically exist between close friends.
Primary Purpose: The primary reason for purchasing individual life insurance is to create an immediate estate for beneficiaries.
Determining Coverage Amount:
Needs Approach: Calculates the required insurance amount by analyzing specific financial needs such as debt, income for survivors, mortgages, and final expenses.
Human Life Value Approach: Centers on calculating the potential future earnings of the insured person.
Social Security Terms:
Blackout Period: The timeframe between when a surviving spouse’s children turn (and social security benefits for the child cease) and when the surviving spouse becomes eligible for retirement benefits.
Business Uses of Life Insurance:
Key Person Insurance: The business owns the policy, pays the premiums, and is the beneficiary. Premiums are generally not tax-deductible, but death benefits are usually received tax-free.
Executive Bonus Plan: A plan where the employee owns the policy and the employer pays the premium as a bonus to the executive.
Buy-Sell Agreement: Used to facilitate the transfer of business interest upon the death of an owner.
Replacement: When replacing an existing policy, the producer must provide a Notice Regarding Replacement of Life Insurance at the time the application is completed.
Underwriting Procedures and Information Sources
Main Sources of Information: The Application is the primary document used by underwriters. Other sources include Medical Exams, Consumer Reports, and the MIB.
Underwriting Factors: Key factors include age, sex, and medical history. Factors like are never considered.
The Medical Information Bureau (MIB): A non-profit association providing medical information to insurers to alert them of adverse medical history and prevent fraud.
Medical Testing: An insurer may only perform a medical test for HIV antibodies if the individual has given written consent.
Premium Receipts:
Conditional Receipt: Provides coverage from the date of the application (or medical exam), provided the applicant is found to be insurable at the end of the underwriting process.
Agent Responsibilities: As a field underwriter, the producer completes the application, obtains signatures, and delivers the policy. The producer does not obtain the MIB report directly; the insurer does.
Policy Delivery: A Statement of Good Health may be required if the initial premium was not collected with the application and is being collected upon delivery.
Risk Classifications:
Standard Risk: Average health and life expectancy.
Substandard Risk: Higher risk than average; these individuals pay higher premiums.
Premium Modes: The frequency of premium payments. Annual payments are the least expensive method.
Life Insurance Policy Types and Characteristics
Term Life Insurance: Temporary protection for a specific period of time. It provides no cash value and expires at the end of the term.
Level Term: Death benefit remains the same.
Decreasing Term: Death benefit decreases over time, often used to cover mortgages or credit debt.
Increasing Term: Death benefit increases; used for certain riders.
Annual Renewable Term (ART): Renews each year without evidence of insurability; the premium increases annually based on attained age.
Whole Life Insurance: Permanent protection designed to mature at age . It features level premiums and a level death benefit.
Cash Value: Usually begins accruing after years.
Limited-Pay: Premiums are paid for a set period (e.g., -pay or paid up at ), but coverage continues until death or age .
Single Premium: The entire premium is paid in one lump sum; cash value is available immediately.
Combination and Flexible Policies:
Universal Life: A combination of annual renewable term insurance and a cash account. It offers flexible premiums and the ability to adjust the death benefit (though evidence of insurability may be required to increase it). The policy expires if the cash account is too small to pay the cost of insurance.
Adjustable Life: Allows the owner to change the death benefit, premium, or coverage period. Increasing the death benefit requires evidence of insurability.
Variable Life/Variable Universal Life: Includes sub-accounts managed by fund managers; acts as a hedge against inflation. These do not have guaranteed cash values and require the producer to have a FINRA license.
Specialized Plans:
Joint Life: Covers two or more insureds and pays the death benefit when the first insured dies.
Survivorship Life (Second-to-Die): Pays the death benefit when the last insured dies. Premiums are generally lower than for two separate policies.
Group Life Insurance:
The sponsor receives a Master Policy (Master Contract), while individual insureds receive a Certificate of Insurance.
Groups cannot be formed solely for insurance purposes.
Conversion: Employees typically have days to convert to an individual policy without proof of insurability if they leave the group.
Life Insurance Policy Provisions and Beneficiaries
Standard Provisions:
Entire Contract Clause: States that the policy and the attached application constitute the whole agreement.
Incontestability Clause: Prevents the insurer from denying a claim due to application statements after the policy has been in force for a specific period (usually years).
Grace Period: A period (typically days for individual policies) after the premium due date during which the policy stays in force to protect against unintentional lapse.
Reinstatement: Allows a lapsed policy to be reactivated within a set period if the owner provides proof of insurability and pays back premiums plus interest.
Misstatement of Age: If an age is understated, the insurer will pay a reduced death benefit based on what the premium would have purchased at the correct age.
Assignment: The transfer of ownership rights. Absolute Assignment transfers all rights; Collateral Assignment transfers partial rights to a creditor to secure a loan.
Free Look: A mandatory period (usually days) starting from policy delivery during which the owner can return the policy for a full refund.
Beneficiaries:
Primary Beneficiary: First in line to receive death proceeds.
Contingent Beneficiary: Receives proceeds only if the primary beneficiary dies before the insured.
Irrevocable Beneficiary: A beneficiary designation that cannot be changed by the policyowner without the beneficiary's written consent.
Common Disaster Clause: If the insured and sole beneficiary die in a common disaster, it is assumed the beneficiary died first; proceeds are paid to the insured’s estate.
Exclusions: Common exclusions include war, military service, and hazardous hobbies (e.g., skydiving). Commercial aviation (fare-paying passenger) is generally not excluded.
Policy Loans: Funds borrowed from the cash value. If not repaid, the loan amount plus interest is deducted from the death benefit.
Life Insurance Policy Riders
Disability Riders:
Waiver of Premium: Waives premiums if the insured is totally disabled. Cash values continue to grow during the waiver period. There is typically a waiting period (e.g., months).
Disability Income Rider: Pays a monthly income to the insured (based on a percentage of the face amount) and waives premiums in the event of disability.
Payor Benefit: Primarily for juvenile policies; waives premiums if the person paying them dies or becomes disabled.
Benefit Riders:
Accelerated (Living) Benefit: Allows an insured with a terminal illness to receive a portion of the death benefit early. This reduces the final death benefit paid to beneficiaries.
Accidental Death Benefit (Double Indemnity): Pays a multiple of the face amount if death occurs due to an accident. If the death was caused by an illness (e.g., a heart attack that caused a car crash), the standard death benefit is paid, but the rider benefit is not.
Guaranteed Insurability: Allows the purchase of additional insurance at specified future dates or life events (e.g., marriage, birth of a child) without proof of insurability. Costs for the new coverage are based on attained age.
Cost of Living: Adjusts the death benefit based on an inflation index (like the CPI) to protect purchasing power.
Return of Premium: A rider (increasing term) that pays the beneficiary the death benefit plus a sum equal to all premiums paid if the insured dies within a certain timeframe.
Family Riders:
Family Term Rider: Provides level term insurance for a spouse and children under the primary insured’s policy.
Life Insurance Policy Options: Nonforfeiture, Dividends, and Settlement
Nonforfeiture Options (Required for policies with cash value):
Cash Surrender Value: The owner receives the cash value and coverage ends.
Reduced Paid-up Insurance: Uses the cash value to purchase a smaller face amount of the same type of permanent insurance (coverage lasts until age ).
Extended Term: Uses the cash value to purchase term insurance with the same face amount as the original policy for a specified period of time. This is the automatic option selected by many insurers if the owner makes no choice.
Dividend Options (For participating policies):
Cash: Paying the dividend directly to the owner.
Reduction of Premium: Using the dividend to lower the next year’s premium.
Accumulate at Interest: Insurer holds the dividend in an account to earn interest. While the dividend itself is not taxable, the interest earned is taxable.
Paid-up Additions: Using dividends to buy additional permanent whole life insurance; this increases the total death benefit.
One-Year Term: Using the dividend to purchase a one-year term policy.
Settlement Options (Methods of paying death proceeds):
Interest Only: The insurer holds the proceeds and pays only the interest to the beneficiary. This is considered a temporary option.
Fixed Period: Pays equal installments for a specified length of time.
Fixed Amount: Pays a specified income amount until the proceeds are exhausted.
Life Income: Guarantees payments for the life of the recipient. This option typically pays the highest monthly benefit because it carries the risk that the recipient may die soon.
Annuities: Characteristics, Types, and Settlements
Phases of an Annuity:
Accumulation Period: The "pay-in" phase where interest grows tax-deferred.
Annuity (Annuitization) Period: The "pay-out" phase where the account is liquidated to provide income.
Classification of Annuities:
Immediate Annuity: Payments begin within one year (usually within month) of purchase; it is funded with a single premium.
Deferred Annuity: Income starts at a future date (after one year); can be funded with single, level, or flexible premiums.
Investment Types:
Fixed Annuity: Guaranteed minimum interest rate; the insurer bears the investment risk. Payments are level.
Variable Annuity: Premiums are invested in a Separate Account. Interest rates and payments are not guaranteed. Served as a hedge against inflation. Requires a securities license and an insurance license.
Equity Indexed Annuity: Interest rate is tied to an external index like the S&P 500.
Settlement Options:
Straight Life (Pure Life): Payments stop when the annuitant dies; provides the highest monthly income.
Refund Life: If the annuitant dies before receiving the full principal, the remainder is paid to a beneficiary in a lump sum or installments.
Life with Period Certain: Guarantees payments for life, but also for a minimum specified period (e.g., years) regardless of whether the annuitant is alive.
Joint and Survivor: Guarantees income for as long as either of two people is alive.
Annuity Features:
Surrender Charge: A fee levied against the cash value for early withdrawal to discourage termination. It typically decreases over time.
Death Benefit during Accumulation: If the owner dies before annuitization, the beneficiary receives the cash value or total premiums paid, whichever is greater.
Federal Tax Considerations for Life Insurance and Annuities
Life Insurance Taxation:
Death Benefits: Generally received income tax-free if paid in a lump sum.
Installments/Settlement Options: The principal is tax-free, but the interest portion is taxable as ordinary income.
Cash Value Surrender: Only the amount that exceeds the total premiums paid (the cost basis) is taxable.
Dividends: Generally considered a return of overpaid premium and are tax-free, unless they accumulate at interest (interest is taxable).
Annuity Taxation:
Exclusion Ratio: Used to determine what portion of an annuity payment is a non-taxable return of principal versus taxable interest.
Early Withdrawal Penalty: A penalty applies to withdrawals/surrenders of interest before age .
Modified Endowment Contracts (MECs):
A policy that fails the -pay test (too much premium paid in the first years).
Once a MEC, always a MEC. Distributions (loans, withdrawals) are taxed on a LIFO (Last-In, First-Out) basis, and death benefits remain tax-free to the beneficiary.
Estate Taxes: The death benefit is included in the insured’s taxable estate if the insured named the estate as beneficiary, owned the policy at death, or transferred ownership within years of death.
Arizona Insurance Laws and Regulations
The Director of Insurance: Appointed to regulate insurers, producers, and advisers. The Director can conduct hearings and investigations but cannot change insurance laws/statutes (this is a legislative duty). The Director must examine domestic insurers at least once every years.
Licensing Requirements:
Temporary License: May be issued for up to days in cases of death, disability, or military service of a producer, for the next of kin or an administrator.
Continuing Education (CE): Life insurance producers must complete hours of CE every years.
Annuity Training: Arizona producers have a hour one-time training requirement to sell annuities.
Change of Address: Producers must notify the Director within days of a change in name or address (residential, business, or email).
Unfair Trade Practices:
Rebating: Offering something of value (like a portion of the premium) to an applicant to induce a sale; this is illegal.
Twisting: Making a misleading comparison of policies to induce a policyowner to drop an existing policy and buy a new one.
Defamation: Publishing false or malicious statements about an insurer’s financial condition with the intent to injure.
Misrepresentation: Issuing false illustrations or misleading sales materials.
Unfair Discrimination: Discriminating based on race, origin, or gender. Note that discriminating based on poor risk is legal underwriting.
Federal Regulations:
Fair Credit Reporting Act: Protects consumer privacy. Willful violations resulting in a general business practice are subject to a penalty of up to .
Telemarketing Sales Rules: Calls are prohibited after . Organizations must consult the National Do Not Call Registry every days.
Gramm-Leach-Bliley Act: Protects consumer financial privacy; requires annual privacy notices and the right to opt-out of data sharing.
Record Keeping: Producer and broker records must be kept for years. Continuing education providers must maintain records for years.
Penalties: Violating a cease and desist order can result in license suspension/revocation and a fine of up to per violation.