Introduction and General Concepts of Life Insurance
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Key Takeaways
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Key Takeaways
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This chapter introduces the general concepts of life insurance policy contracts and the various types of life insurance products available in the marketplace. Determining the best type of life insurance for a person depends on — among several other factors — how long the person wants the policy to last and how much they want to pay. This chapter examines the various types of life insurance policies available, their benefits, and how each policy is funded.
The chapter is divided into the following sections: General Concepts of Life Insurance, Temporary Life Insurance Products, Permanent Life Insurance Products, Alternative Nontraditional Life Insurance Products, Securities and Exchange Commission (SEC) Regulated Life Insurance Policies, Special Use Life Insurance Products, and Other Life Insurance Products.
Chapter Learning Objectives
After completing this chapter, you will be able to
Understand the general concepts used in life insurance contracts, including how a life insurance contract creates an immediate estate.
Identify the different types of term life insurance, including decreasing, increasing, level, renewable, and convertible term.
Identify the advantages and disadvantages of term life insurance.
Understand the general concepts of whole life insurance, including cash value accumulation and maturity at age 100.
Identify the features of straight, limited-pay, and single-premium whole life insurance.
Become familiar with the types of nontraditional whole life insurance policies, including modified, graded premium, indeterminate premium, and current assumption whole life.
Distinguish adjustable life and universal life insurance, including universal life death benefit options and riders.
Identify the SEC-regulated variable life products and the dual licensing required to sell them.
Recognize special use life insurance products, including family plans, joint life, and juvenile insurance.
Understand endowment contracts, modified endowment contracts (MECs), and the seven-pay test.
Keywords
Prior to reading this chapter, please review the following keywords. An understanding of their basic definitions will improve your comprehension of the chapter content.
Accidental Death Benefit (ADB)
A benefit that pays in the event of accidental death, or the accidental loss of sight, speech, or hearing, loss of use of limbs, or loss of a member such as an arm or a leg.
Adjustable Life Insurance
A permanent life policy offering the policy owner flexibility in premium payment amounts and an adjustable death benefit. Unlike universal life, the cash value grows at a guaranteed fixed rate.
Attained Age
The age an insured has reached as of a given date, based on either the nearest or last birthday depending on the insurer's practices. Also referred to as "current age."
Cash Surrender Value
The amount available in cash upon the surrender of a policy by the owner before or after the policy matures.
Convertible Term Life Insurance
Temporary life insurance allowing the policy owner to convert the term policy to a permanent whole life policy offered by the insurer without evidence of insurability.
Decreasing Term Insurance
A type of temporary protection characterized by a reducing face amount each year, often used in conjunction with a debt or loan.
Endowment Contract
A contract that pays a face amount after a fixed period (10, 20 years, or at age 65), or upon the insured's death if it occurs before the end of the period.
Extended Term Insurance
A nonforfeiture option available when a policy is surrendered, continuing the same face amount of the policy in force for a specified period.
Family Income Policy
A policy that combines a whole life policy with a decreasing term rider to provide a death benefit and monthly income payments to the beneficiary.
Joint Life Insurance
A policy that covers the lives of two or more persons, paying a death benefit and ending when the first insured dies.
Universal Life Insurance
The most flexible life insurance policy, with flexible premiums and an adjustable death benefit. The accumulation account is credited with interest, and mortality and expense charges are deducted from it.
Modified Endowment Contract (MEC)
A life insurance policy that fails the IRS seven-pay test because too much premium was paid in too short a period, causing it to lose some of life insurance's favorable tax treatment.
General Concepts of Life Insurance
Life insurance involves the transfer of the risk of death from one party (the policy owner/insured) to another party (the insurer). When a life insurance contract is payable upon the death of the insured, it instantly creates funds for a named beneficiary. In other words, a life insurance contract creates an immediate estate.
Unlike other lines of insurance (e.g., property and casualty), there are no "standard life insurance policies." Today's life insurance policies are typically defined by the benefit options available, the intended length of coverage, and how the policy benefits will be paid for or funded. Broadly speaking, all life insurance policies fall into the following categories:
Permanent (whole life or ordinary) or temporary (term life)
Group or individual
Fixed or variable
Industrial, burial, or debt insurance
A life insurance company may choose to specialize in any of these types, or in just one or two. These basic coverage types are distinguished by customer type, amount of insurance written, underwriting standards, and marketing practices.
Term Life Insurance, Permanent Life Insurance, and the Risk of Dying
Everyone dies, but the age at which we die remains uncertain; therefore, we need life insurance. We do know that, statistically, we are more likely to die when we are older. Insurance companies also know the risk of death in any given time increases each year as we age, and price their policies accordingly. The older we get, the more we pay for life insurance.
Term insurance premiums cover the risk of death for a limited period, which may be as short as one year. Permanent life insurance uses the same concept of an average premium, but the time period covered is a person's entire lifespan, right up to the point where the risk of death is statistically 100%. When the risk of dying gets close to being a certainty, the only way to extend coverage for life is to pay in advance for coverage in those later years — which is exactly how the cash value in a permanent policy is built.
Key Takeaways
A life insurance contract creates an immediate estate for a named beneficiary the moment the insured dies.
There are no standard life insurance policies — policies are defined by benefit options, length of coverage, and funding method.
All life insurance policies can be classified as permanent or temporary, group or individual, fixed or variable, and industrial/burial/debt.
Term insurance spreads the risk of death over a limited period; permanent insurance spreads it over the insured's entire lifetime, requiring prepayment in later years through cash value.