Pearson Vue - Types of Life Insurance Policies

CHAPTER SUMMARY: LIFE INSURANCE POLICY TYPES

Key points to remember from this chapter include:

General Concepts of Life Insurance

• Life insurance involves the transfer of the risk of premature death from one party to another party.

• Life insurance contracts create an immediate estate.

• Unlike other lines of insurance (e.g., property and casualty), there are no “standard life insurance policies.”

Temporary Life Insurance Products

• Term lifeinsurance provides pure or temporary protection and is the simplest form of life insurance coverage

  • It provides the maximum amount of life insurance at the lowest initial premium.

  • Temporary or limited protection

  • No cash value / no equity

  • Protects the insured against the financial loss that an early death may cause.

  • Level term life insurance provides a level amount of protection for a specified period, after which the policy expires.

  • Increasing term life insurance provides a death benefit that increases at periodic intervals over the policy’s term.

  • Decreasing term life insurance provides a death benefit amount that decreases gradually over the term of protection.

    • Mortgage redemption insurance is a type of decreasing term life insurance policy.

    • Credit life insurance is a limited benefit (term) policy that’s designed to cover the life of a debtor and pay the amount due on a loan if the debtor dies before the loan is repaid. The maximum benefit for a credit life insurance policy, regardless of individual or group, is the value of the loan.

    • The option to convertgives the insured the ability to convert or exchange the term policy for a whole-life or permanent policy without evidence of insurability.

      • The cost of insurance is the most important factor to consider when determining whether to convert term life insurance at the insured’s original age or the insured’s attained age

      • Interim term life insurance is a type of convertible term insurance that’s written on a person who wants protection immediately, but who’s not able to afford permanent protection immediately. The premium for the temporary protection is based on the original application age. The premium for permanent protection is based on the age when permanent protection begins (the attained age).

      • The option to renewallows the policy owner to renew the term policy before its expiration date without being required to provide evidence of insurability.

        • Step-up premium is a steady increase in premium.

        • Annually renewable term (ART) or yearly renewable term (YRT) life insurance provides coverage for one year and allows the policy owner to renew coverage each year, without evidence of insurability.

        • Advantages of term life insurance policies include:

          • Term life insurance is less expensive than permanent insurance.

          • Term life insurance may protect the insured’s insurability if the policy is renewable and or convertible.

          • Term life insurance may be used in conjunction with debts, mortgages, or as a supplement to whole life insurance.

          • Term life insurance provides the most substantial amount of protection for the lowest cost.

          • Disadvantages of term life insurance include:

            • The protection provided by term life insurance policies terminates when the policy terminates. No protection is in effect once the term protection ends.

            • If the term life insurance policy is renewable or convertible, premium rates rise as the insured ages, which often leads to policy cancellation prior to the policy terminating.

            • Due to the temporary nature of term insurance, few death claims are actually paid under term life insurance policies.

            • Term life insurance policies don’t contain any cash savings or equity elements (i.e., cash value). Since it has no cash value, it doesn’t mature as does a whole life policy.

Permanent Life Insurance Products

• Whole lifeinsurance provides for the payment of a death benefit or face amount of coverage upon the death of the insured, regardless of when the death occurs.

  • It’s a form of permanent insurance.

  • Level, fixed, or predetermined death benefit

  • Level, fixed, or predetermined premium

    • The shorter the payment period, the higher the premium.

• Tax-deferred cash value (i.e., equity or savings)

• Whole life insurance is designed to mature (cash value = face value) at the age of 100.

• Ordinary Whole Life / Straight Life / Continuous Premium Lifeis the most basic form of whole life insurance.

  • Premiums are payable as long as the insured is alive.

  • Limited Payment Whole Life

    • Predetermined premium for a limited payment period

    • A single premiumwhole life policy is the most expensive whole life policy initially.

      • An immediate non-forfeiture value (cash value) is created.

      • A large part of the premium is used to set up the policy’s reserve.

      • The advantage offered by a single premium policy is that the policy owner will pay less for the policy than if the premiums were stretched over several years.

      • Modified whole life insurance is a type of whole life insurance policy that’s characterized by an initial premium that’s lower than straight whole life insurance for an introductory period (e.g., five years). After the introductory period, the premium jumps to a rate higher than a straight life policy would have cost if it were taken out originally.

      • A graded premium whole life plan is a contract that’s characterized, like modified life, by a lower premium than straight whole life in the early years of the contract. However, premiums increase annually or every year for the initial period. Thereafter, it jumps to an amount that’s higher than the whole life premium and remains fixed for life.

      • Enhanced Whole Life Insurance, also referred to as economatic life or extraordinary life, is a low premium based participating permanent insurance policy.

      • Indexed Whole Life Insurance offers a face amount (death benefit) that increases in line with rises in the Consumer Price Index (CPI) without requiring evidence of insurability.

      • Equity Indexed Whole Life Insurance includes contracts where the policyholder can share in a percentage of the growth of an indexed investment (e.g., a Mutual Fund tied to the Standard & Poor’s Index). The minimum interest and death benefit are guaranteed. These products are not considered securities.

Alternative Non-Traditional Life Insurance Products

• Adjustable while life insurance policies, also referred to as blended or combination policies, are distinguished by their flexibility from combining term and permanent insurance into a single plan.

  • Permanent insurance in which the face amount and premium may change

  • Looks to the future (i.e., prospective)

  • Flexible / adjustable death benefit based on changing needs

  • Universal Life (UL)insurance is essentially a term policy with cash value (savings), flexible premiums, and an adjustable death benefit.

    • Tax-deferred cash value (money market rates) has a guarantee (i.e., interest rate).

    • Universal Life Insurance is considered permanent insurance. Coverage remains in place for the life of the insured as long as the cost of insurance can be paid by the cash value or increasing premium payments.

    • The policy owner may surrender the universal life policy for its entire cash value at any time.

    • Target premium is a suggested premium that’s used in universal life policies.

    • Universal life insurance offers two death benefit options:

      • Option A: the death benefit equals the cash values plus the remaining pure insurance (decreasing term plus increasing cash values).

      • Option B: the death benefit equals the face amount (pure insurance) plus the cash values (level term plus increasing cash values).

      • Equity Index Universal Life Insurance combines most of the features, benefits, and security of traditional life insurance with the potential of earned interest based on the upward movement of an equity index.

Securities and Exchange Commission (SEC) Regulated Life Insurance Policies

• Variable Life (VL)

  • Guaranteed minimum death benefit

  • The death benefit and cash value will vary based on investment performance

  • Tax-deferred cash value is deposited in a separate account and then invested in securities

  • Permanent insurance in which the owner has control over the investment portion

  • Fixed premium

  • Universal Variable Whole Life (or Variable Universal Life)

    • Hybrid of UL and VWL

    • Flexible premiums and death benefit with control over investment aspect

    • Combines an investment feature and a flexible premium

Special Use Life Insurance Products

• The family plan policyis designed to insure all family members under one policy.

  • A family maintenance policy consists of both whole life and level term insurance, which provides income for a specific period beginning on the date of death of the insured.

  • A joint life policycovers two or more people and pays a benefit upon the first death of a covered person.

    • The last to die (survivor) policy covers two or more people and pays a benefit upon the death of the last covered person.

    • A juvenile life insurance policy is any type of ordinary life insurance policy that insures the life of a minor.

    • An endowment policyis characterized by cash values that grow at a rapid pace so that the policy matures or endows at a specified date (i.e., before the age of 100).

      • Higher premiums than WL.

      • Quickest or accelerated cash value build-up.

      • Pays if the insured dies or if the insured survives the endowment (i.e., specified) period (e.g., 10-year; 20-year; 30-year, endowment at the age of 65).

      • A modified endowment contract is (according to IRS tables) considered to be a policy that’s overfunded. As such, MECs don’t technically meet the IRS definition of a life insurance policy. “Failed the 7-pay test;” Premiums paid in the first 7 years exceed the total amount of premiums required for the same insurance policy to be paid up in seven years.

      • Industrial life insuranceis characterized by comparatively small issue amounts, such as $1,000, with premiums collected on a weekly or monthly basis.

        • Monthly debit ordinary life insurance is a combination of industrial life insurance and ordinary life insurance.

Other Life Insurance Policy Concepts

• A face amount plus cash value policy is a contract that promises to pay the policy’s face amount plus the policy’s cash value upon the death of the insured.

• Stranger-Owned Life Insurance (STOLI) is when a person purchases life insurance only to sell to a third-party with no insurable interest, who would, therefore, be unable to legally purchase the original policy.

• Non-medical life insurance typically doesn’t require a medical exam and tends to be more expensive than medically underwritten policies.

• A participating life insurance policy is a policy that has dividend payments from the life insurance company.

• A non-participating policy does not have the right to share in excess earnings and consequently doesn’t receive dividend payments.

Please take a look at the tables below to gain a better understanding of the various types of life insurance products:

CHAPTER SUMMARY: ANNUITIES

Key points to remember from this chapter include:

• The primary use of an annuity is to provide income for retirement.

• An annuity is NOT a life insurance contract.

• The following four entities are involved in an annuity:

  • The insurance company (insurer) invests the annuity contributions and also makes certain guarantees to the contract owner that are stipulated in the annuity contract.

  • The policy/contract owner invests in the annuity and has the power to terminate the annuity, withdraw all or part of the money, name the annuitant, name/change the beneficiary, and possibly change the investments.

  • The annuitant is the person whose life determines the annuity payouts

  • The Beneficiary of an annuity is the person who will benefit or prosper from the annuity upon the death of the annuitant.

• Regardless of the entity that’s providing the annuity for sale—banker, financial planner, brokerage firm, or any individual or business that’s licensed to sell annuities—the annuity agreement is always between the contract owner and the insurance company.

• A life annuity guarantees that an annuitant cannot outlive the payments.

• The death of an annuity contract owner will generally trigger a payout to the beneficiary.

• There are two distinct time periods involved with an annuity:

  • Accumulation (pay-in) period, and

    • Annuity (pay-out) period

• The accumulation period is that time during which funds are being paid into the annuity.

• The annuity or pay-out period refers to the point at which the annuity ceases to be an accumulation vehicle and begins to generate regular benefit payments.

• Benefits are paid out monthly, quarterly, semiannually, or annually.

• Surrender charges apply for the first five to eight years of the contract.

• A bailout provision allows the annuity owner to surrender the annuity without surrender charges if interest rates fall below a stated level within a specified period.

• Annuity principal is funded in one of two ways:

  • Immediately with a single premium, or

    • Over time with a series of periodic premiums

• There are two types of annuity investment options:

  • Fixed annuities

    • Variable annuities

• Fixed annuities provide a guaranteed rate of return

• Equity indexed annuities (EIA) are a type of fixed annuity that offer the potential for higher credited rates of return than their traditional counterparts, but also guarantee the owner’s principal.

• A market value adjusted (MVA) annuity’s interest rate is fixed and guaranteed if the contract is held for the period specified in the policy.

• Variable annuities shift the investment risk from the insurer to the contract owner.

• A sales representative who wants to sell variable annuity contracts must be registered with the Financial Industry Regulatory Authority (FINRA) as well as hold a state insurance license.

• An immediate annuity is designed to make its first benefit payment to the annuitant one payment interval after the date of purchase.

• Deferred annuities accumulate interest earnings on a tax-deferred basis and provide income payments at some specified future date.

• The annuity period is the income phase.

• There are several annuity income options available:

  • Straight life income

    • Cash refund

    • Installment refund

    • Life with period certain

    • Joint and survivor

    • Fixed amount, and

    • Period certain

• Under the fixed amount option, the annuitant receives a fixed payment until the contract value is exhausted.

• A straight life income annuity option pays the annuitant a guaranteed income for the annuitant’s lifetime.

• The period certain income option is not based on life contingency.

• The life with period certain option payout approach is designed to pay the annuitant an income for life but guarantees a definite minimum period of payments.

• The cash refund option provides a guaranteed income to the annuitant for life.

• The installment refund option guarantees that the total annuity fund will be paid to the annuitant or the annuitant’s beneficiary.

• Under a temporary annuity certain, the payments are guaranteed to be made for a specified number of years.

• The joint and full survivor option provides for payment of the annuity to two people.

• An annuity contract cannot be exchanged tax-free for a life insurance contract.

• In a joint and two-thirds survivor, the survivor’s income is reduced to two- thirds of the original joint income.

• In joint and one-half survivor, the survivor’s income is reduced to one-half of the original joint income.

• Annuity benefit payments are a combination of principal and interest.

• Corporate-owned life insurance is generally treated as a deductible business expense.

• A qualified plan is a tax-deferred arrangement that’s established by an employer to provide retirement benefits for employees.

• A tax-sheltered annuity (TSA) is a particular type of annuity plan that’s reserved for non-profit organizations and their employees, as well as school system (educational) employees.

CHAPTER SUMMARY: USES OF LIFE INSURANCE

Key points to remember from this chapter include:

▪    The Human Life Value Approach calculates the amount of money that a person is expected to earn over her lifetime to determine the face amount of life insurance she needs.

▪    The Needs Approach is used to determine the amount of life insurance an individual needs based on his (or his family’s) financial goals and objectives.

▪    When a sole proprietor dies, the business also dies.

▪    Third-party ownership of a life insurance policy is widely used in business insurance and estate-planning situations.

▪    Buy-Sell Agreements are also referred to as business continuation agreements.

▪    There is a two-step business continuation plan to keep the business running after the proprietor’s death:

1. Buy-Sell Plan

2. Insurance Policy

▪    There are two types of buy-sell agreements for partnerships:

1. Cross-purchase plans and

2. Entity plans

▪    In a cross-purchase plan, each partner purchases, pays the premiums for (and is the beneficiary of) a life insurance policy on each of the other partners.

▪    In an entity plan, the partnership itself agrees to buy the deceased partner’s share of the business.

▪    A closely held corporation is legally separate from its owners.

▪    For closely held corporations, an entity plan is referred to as a stock redemption plan.

▪    The purpose of key person insurance is to prevent the financial loss that may ensue when an owner, officer, or manager dies.

▪    Corporate-owned life insurance is generally treated as a deductible business expense.

▪    Deferred compensation is an executive benefit that an employer may use to pay a highly paid employee at a later date.

▪    In a Salary Continuation Plan is a corporate sponsored benefit that’s generally designed to replace an executive's income in the event of her death, retirement, or disability.

▪    An executive bonus plan is a non-qualified employee benefit arrangement in which an employer pays a compensation bonus to a selected employee who uses the bonus payment to pay the premiums on a life insurance policy that covers her life.