Life Insurance
Is an insurance contract between the policy holder and an insurance provider. Whereas, the nominated policy holder receives a cash lump sum to be given to the named policy holder’s pre-designated beneficiaries (as formally agreed within the life insurance policy document).
The cash payout is subsequent to the policy holder paying an agreed monthly or annual amount of money on and agreed payment schedule to the insurance provider.
Legal Contracts with Terms and Conditions
Life Insurance policies are formal legal contracts with included terms and conditions which must always be met in order to ensure the cover of the nominated insured person.
Death caused by war, suicide, riot or civil commotion are usually not covered in a life insurance policy.
Protection Policies and Investment Policies
Protection policies are provided to benefit named parties or ‘beneficiary’s’ within a formal policy agreement; these are usually paid out via a lump sum.
Irrevocable Beneficiary
The beneficiary’s named within the protection and investment policy can change at any point; however, an ‘irrevocable beneficiary’ will need to grant permission in order for any changes to the policy to be legally binding.
Policy Owner and the Insured
Normally this is one and the same person, however, one example of how this can vary if for example a woman has an insurance policy on her own life; she is then insured as well as the policy holder.
However, in the situation where her husband takes out a life insurance policy for her, then he is the policy holder while she is still the insured party.
Insurable Interest Requirement
Insurance companies are in the process of restricting who can take out a policy on the life of a third party.
In any situation where the insured party differs from the policy owner, an Insurable Interest Requirement is required; this requirement is in order to decrease the odds of a murder being committed by someone with the intention of reaping the insurance payout and means that you will have to establish that the genuine reason for having a policy on another’s life is that you will suffer a genuine financial loss if the insured party should die.
The risk of murder of the insured would be great if there was no Insurable Interest Requirement. An example of this is in 1957, one insurance company sold a life insurance policy to a customer who had no insurable interest in the party insured (who then later murdered the insured for the earnings).
The insurers, Liberty National Life were later found accountable in court for contributing to the victim’s wrongful death, (Liberty National Life v. Weldon, 267 Ala.171).
Contract
In common with most insurance policies, Life Insurance is a contract between the insurer and the insured where a cash payment is given to the named beneficiary’s upon the policy holder’s death, (or an occurrence of an incident covered in the insurance policy documentation).
Life Insurance or Life Assurance
The life insurance policy owner agrees to pay the life insurance company a premium of a stipulated amount in either a lump sum or at regular intervals, to provide financial protection in cases where the person insured becomes terminally ill, or has a critical illness or the insured’s demise.
This is alegal agreement involving the policy owner and the insurer whereby a benefit is rewarded to the designed receiver in an insured occurrence covered by the contracted policy.
Serious Illness
There are often limitations described in the terms of the serious illness contract of this legal document which have special exclusions. Examples of these relate to civil commotion, riot, war, fraud or suicide.
Peace of Mind
The life insurance claim is not an actual value derived from the event; it is usually to give comfort and financial protection against the undesirable financial result caused by the death of the Life Assured, i.e. based upon the lives of the people named in the policy, who will in all likelihood have previously been supported by the policy holder.
Protection and Investment Policies
Life based insurance contracts tend to fall into two categories. In the instance of a specified nominated occurrence, the Protection Insurance’s intention is to provide (typically) a lump sum cash payment to named beneficiaries.
A familiar form of this proposal is Term Insurance. Or, with regular and single premiums, Investment Policies’ purpose is to aid the growth of such.
Participants of a Policy
The person or persons insured is not necessary a party to a contract, but is a participant.
Although often the insured and policy holder are the same, one example of how this can differ is if a wife buys an insurance policy on her husband’s life, she is the insurance policy owner and he is the insured or the participant of a policy.
Beneficiary
The owner of a life insurance policy designates the beneficiary’s which upon the insured’s death will receive a policy payment, the policy beneficiary is not party to the insurance policy, unless there is an ‘irrevocable beneficiary’ (see description of irrevocable beneficiary above); the owner can change the policy beneficiary.
Celui Qui Vit or CQV
Life Insurance companies have sought to limit life insurance policy purchase to those with an insurable interest.
The Celui Qui Vit or CQV is a term used for insurance where the policy owner is not the insured party. CQV’s are insured for ‘insurable interest’, (see discription of ‘insurable interest’ above) usually a close family member or business partner, where in the event of death the policy purchaser will essentially endure a financial loss.
Nullification of Policies
Any falsification or misrepresentation on the application by the insured is grounds for nullification. Provisions are also made by life insurance companies in special cases for enforcing nullification; one example of this is suicide.
If suicide is committed within a specific time, i.e. 2 years after the date the purchased insurance was signed/taken out, the policy will become null.
Policy Matures
Life insurance Policies can mature when the insured reaches a specified age, e.g. 100 years old, or dies.
Face Amount
The life policy’s face amount is the sum that the insurance policy will pay when the policy matures or at the demise of the insured party, although the actual death benefits can present a different amount to the face amount.
Actuaries
The Life Insurance Company calculates the policy prices with the intent to fund claims to be paid and the administrative costs, and to make a profit.
The cost of the insurance is calculated by Actuaries using mortality tables.
Actuaries are specialised individuals who use complex mathematics called actuarial science; principally this is statistics and probability based equation formulae.
Mortality Tables
Statistically based tables, taken from ‘usual’ annual mortality rates. Using these statistical assumptions, it is possible to derive life expectancy estimates; these are important in taxation guidelines.
Variables in a Mortality Table
Gender, Age and Use of Tobacco will vary the policy and provide an insurance cost baseline.
In practice, these mortality tables are used in union with the family history and health of the individual policy submission with the aim to determine insurability and premiums.
The newer tables include separate mortality tables for non-smokers and smokers.
Investment Policy
Is the aid of capital growth via single or regular premiums.
Premium Investing
Premiums paid to the insurance company are pooled to finance business and to pay claims. Contradictory to common belief, the bulk of the companies’ money comes straight from premiums paid.
Even in the most ideal investment market environment money gained through speculation of premiums can never provide enough annually to compensate out insurance claims.
An unfavourable customer selection can have a harmful effect on the insurer’s economic circumstances, hence at the start of any application; the insurer will investigate each individual, (except when it is below a company-established minimum amount).
An exception to this is Group Life Insurance Policies.
Underwriting
The term used in for the investigation and resulting evaluation of the insurance risk.
Health and lifestyle questions are asked and the information or responses received may give cause for additional exploration.
As part of the application, Life Insurance companies ask for consent to permit the insurers to obtain information from the individual’s GP.
The role of the Underwriters
Underwriters will establish the reason for the insurance. Commonly it is to look after the owner’s family or monetary interests in the event of the insured parties death.
Other purposes include bank loans or buy-sell provisions of business agreements or another suitable reason, such as property planning, or in the circumstance of a cash-value agreement, for retirement planning.
Uninsurable
Insurance companies determine insurability, and some individuals for lifestyle or health grounds are considered uninsurable.
With the exclusion to Civil Rights Act, Life Insurance businesses are not dictated by law to provide coverage or underwrite to everyone or anyone.
Rated
The application can be refused (turned down) or rated. Rating increases the premiums to provide for additional risks applicable to the party who has requested life insurance.
Health Categories
Many insurers will evaluate each proposed policy using general health categories . These categories are usually Preferred Best, Preferred, Standard, and the use of tobacco.
Preferred Best
This is reserved only for the healthiest person with no unfavourable health history, not under medication for any condition, and the immediate and extended family have no history of diabetes, early cancer or any other conditions.
Preferred
The proposed insured is presently under medication for a health condition with a family history of illnesses.
Standard category
For the most, this category applies. Factors such as lifestyle, travel and profession will be considered when the proposed insured will be approved a policy and the category the insured will fall into.
A preferred Best Individual may be denied a policy if they travel to high risk locations.
In some circumstances, insurance underwriting practices can offer competitive payment rates that can differ from insurer to insurer.
Death Proceeds
Upon the demise of the insured, proof of death is required before a claim can be considered. This is usually a death certificate plus a signed and completed insurer’s claim form.
If there are any suspicious circumstances surrounding the insured’s death, especially if the payout is of a vast quantity, before any obligation to pay the insurer may investigate the circumstances surrounding it.
Earnings can be paid as an annuity, paid over time in regular payments for either the beneficiary’s life span or during a specified time, or as a lump sum.
Assurance V’s Insurance
These terms are often muddled. Commonly in these jurisdictions “assurance” is the stipulated cover for an incident that will happen.
“Insurance” refers to the provision of cover for an occurrence that could or might happen (flood, theft, fire, etc.), “Insurance” is the generally accepted term, never-the-less, people using this description are likely to be corrected.
In the United States both types of coverage are referred to as “insurance”, primarily owing to nearly all companies offering both types of policy, so they use just one word.
Types of Life Insurance
These can be divided into two fundamental groups or classes, permanent insurance or temporary insurance. Alternatively, they can be arranged into the following Subclasses, Endowment Life, Universal, Term or Whole Life Insurance.
Permanent Life Insurance
Life Insurance continues in force until policy pay out/matures. The insurance holder is contracted to pay the contracted premiums, failure to pay means the policy is null and void.
However, the policy cannot be cancelled by the insurer for any other reason apart from deceit in the claim, and that annulment must occur within a set time defined by law (typically 2 years).
Permanent insurance builds a cash value that reduces the amount at risk to the insurance company and thus the insurance expense over time.
A policy with a one million pound face value can be somewhat excessive to a 75 year old.
The owner can access the cash value funds by surrendering the policy, borrowing the cash value, or withdrawing money or receiving the surrender value.
Temporary Term Insurance
Provides Life Insurance coverage with a specified premium for a specified time, without accumulating cash value. This term is largely thought as “pure” insurance, where the cover is in the incident of death only.
Three key factors to be considered in Term Insurance
One: Length of coverage (term).
Two: Face amount (death benefit or protection).
Three: Premiums to be paid (cost to the insured).
Insurance companies offer term insurance combining variations of any of these three categories. This can be implemented for one or more years. The face amount can decline or remain stable. The premium can increase or stay level.
Annual Renewable
A single year agreement, with a premium set for the insured’s age at that time, where the Insurance Company guarantees it will issue a policy of equal or lesser amount without regard to the insurability of the insured at that time.
Mortgage Insurance
Another common type of term insurance is typically a level premium, declining face value. The intention is a face amount is to equal the sum of the mortgage on the policy owner’s dwellings, which will be paid if the insured dies.
Specific Term Policy Holder
For a specified term, a policy holder insures his life to guarantee his named beneficiary or estate receives a payout if he dies before the expiry of the allotted term, conversely no payout will be received if he does not die before the policy ends.
Previously, these policies would normally disallow suicide. But, since the industry has had a number of court judgments made against them, payouts can take place on death by suicide, unless, (presumably) it can be shown it was to benefit from the policy.
A death benefit will usually be paid if the suicide occurs after the two year period, however, commonly, if an insured individual committed suicide within the policy’s first 2 years, the insurer will reimburse the premiums paid.
Types of Permanent Insurance
Universal Life, Endowment, Whole Life and Limited Pay, all detailed below.
Universal Life (UL) Coverage Types
There are many different kinds of UL policies; equity indexed Universal Life Insurance, variable Universal Life Insurance and “Interest Sensitive” (or “Traditional Fixed Universal Life Insurance”).
Universal Life Policies
A relatively new product in the permanent insurance range. This is the option for flexible with premium payment, with the potential for a higher internal rate of return.
This policy includes a cash account which the premiums increase the cash account. Interest is paid on the account and credited within the policy at a rate individual to the company.
There are two crucial functions that make this work, mortality function and cash function.
Mortality Function and Cash Function
Charges are made against the cash account. The amount remaining in the account is less the applicable surrender charges if any.
The mortality function is a pooling of everyone’s paid premiums to cover the benefits paid on the death of the one or two who will die during a given time period.
In all Life Insurances, the cash function inherent pays the face value upon maturity of the policy, usually a pre-stated age at 95 or 100 years old.
The mortality function alone will not cover the cash function required, e.g. even if 10 people within a group of 1,000 live to the age of 95.
In the occasion that a policy matures the least rate investment return on the premiums will be needed to cover the cash function.
The perceived drawbacks of Whole Life are addressed with Universal Life Insurance
One benefit is the premiums have more options and are subject to financial markets and interest rates and dependent on how the interest that is credited, the internal rate of return can be chargeable, and can gain from a higher rate of return.
If the cash value allows it, the owner can discontinue premiums. There are also two death options available on Universal Life. Administrative charges and mortality costs can apply.
Option A
Designed to have the cash value equal the death benefit at maturity, i.e. 95 years old, and pays face value at death. As the insurance matures, each premium amount is reduced.
Option B
Designed to escalate the net death benefit as cash values accumulates in addition to paying the face value. Whilst in force this gains an increasing death benefit with each additional year.
The disadvantage is that unlike Option A the premiums never decrease, since the cash value is accrued in addition to the death benefits.
Whole Life Coverage
A cash value table is provided and guaranteed by the company, with a level premium. Whole Life Insurance will guarantee death benefits, fixed and known annual premiums, guaranteed cash values, and expenses and mortality charges, which will not reduce the cash value shown in the policy.
However, the inflexible with premiums internal rate of return will neglect competitiveness. Another downside is, if the insured dies, the cash riders is kept by the insurance company with only the death benefit going to the beneficiaries.
The options of paying additional premiums riders are available, and policy dividends are possible too to increase the death benefit. Dividends can however, be higher or lower than historical rates over time, so are not guaranteed.
If the policy is kept in force with accumulating premiums maintained until average life expectancy, the costs will roughly equally out, but in the short term it is more expensive.
Limited-Pay
A permanent insurance where over a specified period of time, usually 10 or 20 years, the premiums are paid and once the period is achieved, the policy is kept in force, and there are no more premiums required.
Endowments
A policy where the cash value of premium built up inside the policy will equal the death benefit at a certain age. This is known as the Endowment Age.
This insurance is considered more expensive than Whole Life or Universal Life in terms of the annual premiums.
The expense is due to the endowment date being earlier, and paid whether the insured dies or not, and the shorter premium paying period.
Accidental Death
A cover provided for accidental death through injury, but less likely for suicide or health related problems. This type of insurance is typically less expensive.
AD & D
‘Accidental Death & Dismemberment’ Insurance. Covers the loss of bodily functions and limbs including, but not isolated to, sight and hearing.
This rarely pays out a benefit, either the premiums are not continued post-accident until the insured’s demised, or the cause of death is not within the specification of the policy.
The insurance policy does not include risks in activity, i.e. flying aircraft, parachuting, involvement in a war (whether in the military or not), mountaineering, racing on wheels injuries or death.
Double Indemnity Cover
This is an optional rider that can be added to a standard Life Insurance policy. This rider means if an accident occurs the insurer will pay out double the face amount.
Triple indemnity’s can also be available.
Additional Products Related to Insurance Policies
Joint life, Survivorship Life, Single Premium Whole Life, Modified Whole Life, Group Insurances, Senior and Preneed Investments Policies and Bonds, Annuities, Taxation and Pensions are such examples.
Joint Life
This policy Insures two lives or more, with either a permanent or term insurance policy. This policy is payable on the death of either the first or second insured life.
Survivorship Life
This is a Whole Life Insurance between two people’s lives, and the proceeds are payable on the latter’s death.
Single Life Whole Life
A Whole Life Insurance where a life is insured with a single premium at the time the policy is issued.
Modified Whole Life
An insurance policy where the premiums are smaller for a specific period and then increase for the remainder of the contract.
Group Life Insurance
Typically this is for members of a Union or employees in a company are covered as a group, with the provision that a member exiting the group has the right to buy individual insurance coverage.
The underwriter will consider the size of the group, financial strength, and staff turnover. Individual verification of insurability is not normally regarded in the underwriting.
Riders
Modifications added to a policy at the time of purchase. A common rider is a premium waiver; if the insured become disabled, the premium waiver waves the policy.
Senior or Final Expense Insurance
Due to the increase of the aging population, a niche market has arisen to provide affordable insurance. Typically a low to moderate face value, and often presented as (but not required), end of life expenses insurance.
Preneed or Prepared
Is not strictly age related, but largely offered to the older applicant. This insurance is specifically designed for funeral expenses at point of death.
Often the applicant’s funeral arrangements are prefunded and signed for by the insured with any excess proceeds given to the policy holder’s estate or beneficiary.
Investment Policy
Some investment policies are non-profit policies and have no privileges to partake in the insurance company’s profit. However With-Profit policies a capital growth is achieved, through a form of collective investment.
With Without-Profit polices, a guaranteed return is offered but is not depend on the underlying investment performance of the company; these are often confused with Without-profit, which is incorrect.
Investment Bonds Pensions
This is a form of Life Insurance, however, whilst Permanent Health insurance, Basic Life Insurance, Non-Pension Annuity Business will include a degree of morbidity risk or mortality, but for an insurance company there is a possibility of longevity for pensions.
Investment Bonds Pension Fund
Built up throughout an insurable working life. At the point of retirement the pension matures and is then payable.
An annuity contract will need to be purchased during the policy and this will guarantee a monthly pay-out on a specific date until death.
Annuities
This is a contract between the insured and the insurance company. At any given predetermined intervals, a sum is paid out subsequent to the purchaser’s initial premium/s into an account which is tax-deferred.
Life Insurance Taxation In the UK
Policies that were issued pre March 14, 1984 still benefit from 15% Life Insurance Premium Relief, and as the policy holder will be accountable for the net premium.
Premiums issued post March 1984 are not subject to corporation or income tax.
Non-Investment Policy
If a policy has an investment component, e.g. Investment Bond, Whole Life Policy or an Endowment Policy, then the qualifying status determines the tax treatment.
Qualifying Status
The qualifying status is defined by the stipulated criteria of the policy, e.g. principally a 10 year (or more) policy are long term contracts and inclined to be a qualifying policy.
The proceeds are exempt from capital gains tax and income tax. Short term polices tend to be single premium contracts and depending on the marginal rate of that year is subject to income tax.
All insurers in the United Kingdom have to pay a special rate corporation tax on the profits from their life book; this is stated as the lower rate liability (20% in 2005-6) for holders of this policy.
Top-Slicing
Holders of the higher rate policy that meet the higher rate of taxpayers (40% in 2005-6), (or become one through transactions), will pay on the gains at the difference between the two rates.
A calculation is then applied based on the length of time the policy has been held.
5% Cumulative Allowance
Particularly favours investments bonds, and allows 5% of the original invested sum to be drawn each year, which avoids any taxation, and can roll over to subsequent years if unused, (but, this is subject to a maximum tax deferred withdrawal of 100 per cent).
Life Insurance and Inheritance Tax
In the UK, Life Insurance proceeds will be included in the estate for inheritance tax, with the exception of policies written in trust may fall outside the trust.
Taxation and trust law of trust can be complex; professional advice is advisable from a solicitor or an Independent Financial Adviser.
Pension Term Assurance
Often adopting the name ‘Life Insurance with tax relief’, from April 2006, Pension Term Assurance became common.
However, in December 2006 this ceased to be available, however, those who have existing policies are to enjoy this normal term life assurance with tax relief.
All premiums would pay a net of basic rate tax at 22% and tax payers of the higher rate gained via their tax return with an extra 18% tax relief.