Life insurance Explained

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  1. Difference between Insured & Policy Owner (also known as Policy Holder)

  2. The Beneficiary

  3. Contract terms

  4. Costs, insurability, and underwriting

  5. Death proceeds

  6. Insurance vs. assurance

  7. Types of life insurance

  8. Temporary (Term)

  9. Permanent life insurance

  10. Whole life coverage

  11. Universal life coverage

  12. Equity-Indexed Universal Life Insurance

  13. Limited-pay

  14. Endowments

  15. Accidental death

  16. Related life insurance products

  17. Senior and preneed products

  18. Annuities

  19. Tax and life insurance in the United States


Life insurance or life assurance is a contract between the insurance firm and the policy owner, where the insurance firm agrees to pay an amount of money upon the happening of the insured individual's or individuals' death or other event, such as fatal illness or terminal illness. In exchange, the policy owner agrees to pay up a specified amount known as a premium at fixed intervals or in lump sums. In the U.S.A., the predominant form plainly defines a lump sum to be paid up on the insured's death.

The conditions of a Life Insurance contract delineate the restrictions of the insured events. Particular exceptions are oftentimes written into the contract to bound the financial obligation of the insurance firm; for instance claims relating to suicide, fraudulence, state of war, riot and civil commotion.

Life-based contracts lean to fall into 2 main categories:

* Protection policies - organized to allow for a benefit in the outcome of designated event, generally a complete payment. A typical form of this design is term insurance.
* Investment policies - wherever the main objective is to facilitate the increase of capital by regular or lump sum premiums. Common United States forms are whole life, universal life and variable life policies.

Difference between Insured & Policy Owner (also known as Policy Holder) [Top]

Whenever somebody purchases an insurance policy on his own life he/she is both the insured and the insurance policy holder. But if Roger buys a policy on somebody else (e.g.: his wife) then Roger is the holder and his wife is the insured.
 The insurance policy owner is the guarantee and he or she will be the individual who buys (and pays for) the policy. The insured is a participant in the contract, but not needfully the owner of it.

The Beneficiary  [Top]

The beneficiary receives remuneration upon the insured's death. The beneficiary is not a party of the policy (is not required to pay for it) and it is designated by the owner. The owner can change the beneficiary unless the policy has a clause that forbids it. In this case the beneficiary is said to be irrevocable. With an irrevocable beneficiary, the beneficiary must agree to any beneficiary changes, policy assignments, or cash value borrowing.

In cases wherever the insurance policy owner is not the insured (also pertained to as CQV the cestui qui vit ), insurance firms have attempted to limit policy purchases to those with an "insurable interest" in the CQV. For illustration, close family members and business partners. The "insurable interest" requirement usually demonstrates that the customer will in reality bear some sort of loss if the CQV passes away. Such a prerequisite keeps people from profiting from the purchase of strictly speculative insurances on people they anticipate to die.

With no insurable interest requirement, the chance that a customer would murder the CQV would be high. In at least 1 instance, an insurance firm that sold a policy to a customer with no insurable interest (who afterward murdered the CQV for the payoff), was found liable in courtroom for being contributory to the unlawful death of the victim (Liberty National Life v. Weldon, 267 Ala.171 (1957)).

Contract terms  [Top]

Particular provisions may apply, such as suicide clauses wherein the insurance policy becomes void if the insured commits suicide inside a specified time after the purchase date (commonly two years); some jurisdictions provide a statutory one-year suicide clause. Any deceptions by the insured on the application is also cause for nullification.

Most U.S.A. states delineate that the contestability time period can't be lengthier than 2 years; only if the insured passes away inside this time period may the insurance company hold a legal right to contend the claim on the bases of deception and call for supplemental information before settling or denying the claim.

The declared sum of money on the policy is the initial amount that the policy must pay at the demise of the insured or once the policy matures, even though the actual death benefit can allow for for bigger or lesser than the face amount. The policy matures once the insured passes or reaches a designated age (for instance 100 years old).


Costs, insurability, and underwriting  [Top]

 The price of insurance is ascertained using mortality rate tables measured by statisticians (actuaries). Actuaries are pros who utilize actuarial science, which is founded in calculating chance and statistics. It is possible to deduce life expectancy estimations from these mortality rate assumptions.
The 3 principal variables in a mortality table have been age, gender, and use of tobacco, these, when used in conjunction with the health and family history of the person applying for a policy will provide a baseline for the price of insurance.
The insurance underwriter will (in most cases) look into each nominated insured individual. Group Insurance policies are an exception.

This investigating and ensuing evaluation of the risk is termed underwriting. Health and life-style questions are asked. Certain answers or information received may deserve additional investigating. Life insurance companies in the U.S.A. support the Medical Information Bureau (MIB), which is a Boston established clearinghouse of data on persons that have applied for life insurance with participating firms in the last 7 years. As part of the application, the insurer may obtain selective information from the proposed insured's doctors.

Insurance underwriters will ascertain the purpose of insurance. The most common is to safeguard the owner's family or financial concerns in the consequence of the insurer's death. Additional uses include estate planning or, in the case of cash-value contracts, investment for retirement planning. Bank loans or buy-sell provisions of business agreements are added good purposes.

Life insurance companies are not compelled by law to underwrite or to provide insurance coverage to anyone, with the exclusion of Civil Rights Act compliance requirements. Insurance companies alone ascertain insurability, and some people, for their own health or life-style causes are viewed as uninsurable. The insurance policy can be turned down or rated. Rating increases the premiums to allow for for additional risks.

Several companies use four generic health categories for those assessed for a life insurance policy. These categories are Preferred Best, Preferred, Standard, and Tobacco. Preferred Best is reserved only for the healthiest individuals. This signifies that the proposed insured has no unfavorable medical history, is not under medicament for any precondition, and his family line have no history of early on cancer, diabetes, or additional conditions.

Preferred means that the proposed insured is presently under medicament for a medical condition and has a family history of particular illnesses. Most individuals are in the Standard category.
 Profession, traveling, and life-style factor into whether the person to be insured will be given a policy, and which category the insured falls. For instance, somebody who would otherwise be classified as Preferred Best may be denied a policy if he or she goes to a high risk country. Underwriting practices can vary from insurer to insurer which provide for numerous competitive offers in certain circumstances.

Death proceeds  [Top]

Upon the insured's demise, the insurer demands satisfactory proof of death prior to paying up the claim. The normal minimum proof called for is a death certificate and the insurer's claim form completed, signed (and usually notarised). If the insured's death is suspicious, the insurance firm may choose to enquire farther.

Insurance vs. assurance  [Top]

Outside the U.S.A., the peculiar uses of the terms "insurance" and "assurance" can occasionally be mixed-up. As a whole, in these jurisdictions "insurance" relates to offering cover for an event that could happen (fire, theft, flood, etc.), Whilst "assurance" is the supplying of cover for an event that is sure to happen.

 However, in the U.S.A. both forms of insurance coverage are called "insurance", primarily owing to several companies offering both cases of policy, and rather than refer to themselves utilising both insurance and assurance titles, they rather use just one.

Types of life insurance  [Top]

Life insurance may be separated into two basic classes – temporary and permanent or following subclasses - term, universal, whole life, variable, variable universal and endowment fund life insurance.

Temporary (Term)  [Top]

Term life insurance or 'term assurance' allows for for life insurance coverage for a defined term of years for a stipulated premium. The insurance policy does not gather cash value. Term is by and large considered "pure" insurance, where the insurance premium buys security in the outcome of death and nothing else.

The 3 key factors to be considered in term insurance are:
Face amount (protection or death benefit). The face amount can stay invariable or decline, the term can be for one or numerous years. The face amount is intended to be equivalent to the amount of the mortgage on the policy owner’s residency so the mortgage will be paid if the insured passes away.

Premium to be paid (by the insured). The premium can stay level or increase.
Length of coverage (term). A typical type of term is called annual renewable term. It is a 1 year policy but the insurance company ensures it will issue a policy of equivalent or lesser amount without regard to the insurability of the insured and with a premium set for the insured's age at that time. A different typical type of term insurance is mortgage insurance, which is commonly a level premium, declining face value policy.

Various U.S.A insurance companies sell term insurance with several different combining of these 3 parameters.

A policy holder insures his life for a defined term. If he passes away before that delineated term is up, his estate or appointed beneficiary receive a payout. If he does not pass away before the term is up, he gets nothing. In the past these policies would nearly always omit suicide. However, subsequently to a number of court judgements against the industry, payouts do take place on death by suicide (presumptively except for in the improbable case that it can be demonstrated that the suicide was precisely to profit from the insurance policy).

More often than not, if an insured individual commits suicide inside the first two policy years, the insurance firm will give back the insurance premium paid. However, a death benefit will normally be paid if the suicide takes place after the two year time period.

Permanent life insurance  [Top]

Permanent life insurance is life insurance that remains in force (in-line) till the policy ages (pays out), except when the owner neglects to pay the premium once overdue (the policy runs out or lapses).

 The policy can't be invalidated by the insurer for any reason except fraudulence in the application, and that nullification must come about inside a time period delimitated by law (usually two years). Permanent insurance builds a cash value that brings down the amount of money at risk to the insurance firm and thus the insurance disbursement over time.

This signifies that a policy with a million dollars face value can be comparatively unaffordable to a 70 year old. The owner can access the money in the cash value by drawing off money, borrowing the cash value, or giving up the policy and receiving the surrender value.

The three basic types of permanent insurance are whole life, universal life, and endowment.

Whole life coverage  [Top]

Whole life insurance allows for for a level premium, and a cash value table included in the policy bonded by the insurance company. The primary advantages of whole life are assured death benefits, assured cash values, frozen and known yearly insurance premiums, and mortality and expense charges will not bring down the cash value indicated in the policy. The more common drawbacks of whole life are premium rigidity, and the internal rate of comeback in the policy may not be competitory with other savings options.

Riders are available that can allow one to increment the death benefit by paying further premium. The death benefit can also be expanded through the use of policy dividends. Dividends can't be guaranteed and may be greater or lower than historical rates over time. Premiums are much steeper than term insurance in the short-run, but accumulative premiums are approximately equivalent if policies are kept in force until average life expectancy.

Cash value can be got at any time through policy "loans". Because these loans reduce the death benefit if not paid back, payback is nonobligatory. Cash values are not paid to the beneficiary upon the passing away of the insured; the beneficiary receives the death benefit only.

If the dividend option: Paid up additions is elected, dividend cash values will buy more death benefit which will step-up the death benefit of the policy to the nominated beneficiary.

Universal life coverage  [Top]

Universal life insurance (UL) is a comparatively new insurance product meant to allow for unending insurance coverage with more flexibility in premium payment and the potential for a greater internal rate of return. There are numerous kinds of universal life insurance policies which include "interest sensitive" (A.K.A. "traditional fixed universal life insurance"), variable universal life insurance, and equity indexed universal life insurance.

A universal life insurance policy includes a cash account. Premiums increment the cash account. Interest is paid within the policy (credited) on the account at a rate determined by the insurance company. This rate may have a secured minimum (for fixed ULs) or no minimum (for variable ULs). Mortality charges and administrative costs are then charged against the cash account. The giving up (surrender) note value of the policy is the amount of money left over in the cash account less applicative surrender charges, if there are any.

On all life an insurance policies there are in essence two functions that make it work. There's a mortality function and a cash function. The mortality function comprises the classical notion of pooling risk where the premiums paid by everyone else would cover the death benefit for the ones who will decease for a given period of time. The cash function implicit in all life insurance tells that if a person is to reach age 95 to 100 (the age changes depending on state and company), then the policy matures and endows the face value of the policy.

Statistically, it is reasoned out that out of a grouping of 500 people, if even 5 of them live to age 95, then the mortality function by itself will not be capable to cover the cash function. So in order to cover the cash function, a minimal rate of investment return on the premiums will be necessitated in the event that a policy matures.

Universal life insurance deals with the sensed limitation of whole life. Premiums are elastic. Dependant on how interest is accredited, the internal rate of return can be greater, for it moves with prevailing interest rates (interest-sensitive) or the financial markets (Equity Indexed Universal Life and Variable Universal Life); Mortality costs and administrative charges are known. And cash value might be regarded easier to attain since the owner can give up premiums if the cash value permits it. And universal life has a more compromising death benefit as the owner can choose one of two death benefit alternatives, Option A and Option B.

Option A pays the face amount at death as it is designed to have the cash value equivalent to the death benefit at maturity (generally at age 95 or 100). On each premium payment, the policy owner is cutting back the cost of insurance until the cash value arrives at the face amount upon maturity.

Option B pays the face amount plus the cash value, as it is designed to step-up the net death benefit as cash values cumulate.
Option B offers the benefit of a growing death benefit each year that the policy stays active. The drawback to option B is that because the cash value is accrued "on top of" the death benefit, the cost of insurance never diminishes while premium payments are made. Therefore, as the insured becomes older, the insured is faced with an ever growing cost of insurance (it costs more money to offer the same initial face amount of insurance as the policy owner becomes older).

Both death benefit choices (A (level) and B (increasing) are dependent on the same IRS rules and guidelines pertaining premium payments and tax-favored handling of cash values. In order for the policy to maintain its tax favored life insurance condition, it must stay inside a corridor delimitated by Department of State and federal laws that preclude abuses such as attaching a million dollars in cash value to a two dollar insurance policy.

The intriguing part about this corridor is that for those individuals who can make it to age 95-100, this corridor requisite goes away and your cash value can be equivalent to the face amount of insurance; If this corridor is ever violated, then the universal life policy will be handled as, and in result turn into, a Modified Endowment Contract (or more ordinarily referred to as a MEC).

But universal life has its own drawbacks which originate primarily from this flexibleness. The policy misses the fundamental guarantee that the policy will be in force except when sufficient premiums haven't been paid and cash values are not guaranteed.

Early universal life policies are occasionally mistakenly referred to as self-sustaining policies. In the 1980's, when interest rates were high, the cash value accumulated at a faster rate, and universal life coverage was oftentimes traded by brokers as a policy that could be selfpaying. Several policies did sustain themselves for a drawn-out period, but the combining of lower interest rates and an increasing price of insurance as the insured elds signified that for many policies the cash option was decreased or used up.

Interest-Sensitive Universal Life Insurance
An interest sensitive UL policy was the first attempt at bringing about a flexible premium life insurance policy and was created in the 1980s. Interest-sensitive UL policies guarantee, (to some degree), the death payoff, but not the cash function, hence the flexible insurance premium* and interest returns.

Whenever interest rates are high, the investment returns assist in reducing the called for premiums needful to maintain the policy in effect. Whenever interest rates are low, the policy owner would have to pay supplemental premiums in order to keep the policy good. If interest rates are higher than the lower limit required or minimal guaranteed interest rate, then the policy owner has the flexibleness to pay less as investment returns cover the balance to keep the policy effective.

Equity-Indexed Universal Life Insurance  [Top]

Equity-Indexed Universal Life Insurance or "EIUL" for short, is a fixed universal life insurance policy which was made in the mid 1990's to address worries about market unpredictability and allow for an alternative to the lower interest rates being offered by interest-sensitive UL policies.

EIUL differs from interest-sensitive UL policies in that it credits interest to the policy's own cash values based on the upwardly movement of a specific stock market index, namely the S&P500. The insurance company may then accredit the gains in the stock market accordant to one of many different accrediting methods.

The most common is the "point to point" method.
Once the policy is issued, the insurer -pegs- the stock market's value. At the anniversary of the policy, the insurer checks over the value of the underlying stock index and credits the cash value with the difference equal to a cap that's been before-handedly specified by the insurance company.

Variable Universal Life Insurance (VUL) is another type of universal life insurance. There are generally no guaranties linked with this kind of life insurance policy. The cash account within a VUL is held back in the insurer's separate account - usually in mutual funds, handled by a fund manager -.
The policy owner then picks out the investments he/she wants to invest in. If those investments do well, the insurance company then accredits the policy's cash values accordingly. If the underlying investments do badly, the policy owner will lose their cash value. If the investments do badly enough, it could mean the policy could lapse due to not enough funds to cover the costs of insurance.

Limited pay  [Top]

Another type of permanent insurance is Limited-pay life insurance, in which all the insurance premiums are paid over a designated period after which no further premiums are necessary to keep the policy effective.

Typical limited pay periods include 10-years, 20-years, and paid up at age 65.

Endowments  [Top]

Endowments are policies where the cash value built up inside the policy, equates to the death benefit (face amount) at a certain age. The age this commences is known as the endowment age. Endowments are considerably pricier (in terms of annual premiums) than either whole life or universal life since the premium paying period is abbreviated and the endowment date is earlier.

Endowment Insurance is paid up whether the insured lives or dies, after a specific period (e.g. 15 years) or at a specific age (e.g. 65).

Accidental death  [Top]

Accidental death is a limited life insurance which is organised to cover the insured when they die due to an calamity/accident. Accidents include anything through an accidental injury, but do not usually cover any deceases resultant from health troubles or suicide. Since they only cover accidents, these policies are much cheaper than other life insurances.

It is also very typically offered as "accidental death and dismemberment insurance", also called an AD&D policy. In an AD&D policy, benefits are available not just for accidental death, but also for loss of limbs or bodily functions such as sight and hearing, etc.

Accidental death and AD&D policies seldom pay a benefit if either the cause of death is not covered, or the insurance coverage is not kept up after the accident until death happens. To be well aware of what coverage they have, policy owners should always go over their policy for what it covers and what it does not.

Often, it doesn't cover an insured who positions himself at risk in activities such extreme sports or involvement in warfare. Likewise, a few insurers will leave out death and injury induced by immediate causes imputable (but not limited to) racing on wheels and mountain climbing.

Accidental death benefits can also be added to a standard life insurance policy as a rider. If this rider is bought, the policy will normally pay twice the face amount of money if the insured perishes due to an accident. This used to be referred to as a double indemnity coverage. Some companies may even offer a triple indemnity cover.


Related life insurance products  [Top]

Riders are alterations to the insurance policy added at the same time the policy is issued. These riders alter the basic policy to allow for some feature wanted by the policy owner. A common rider is accidental death, which used to be generally referred to as 'double indemnity', which pays up twice the sum of money of the policy par value if death results from chance causes, as if both a Comprehensive policy and an accidental death policy were in effect on the insured. Another common rider is premium waiver, which waives subsequent premiums if the insured becomes invalided.

Joint life insurance is either a term or permanent policy insuring 2 or more lives with the proceeds payable on the 1st death.

Survivorship life or second-to-die life is a whole life policy insuring two lives with the proceeds payable on the 2nd (later) death.

Single premium whole life is a policy with just 1 premium that is payable at the time the policy is issued.

Modified whole life is a whole life policy that charges cheaper premiums for a defined time period after which the premiums increase for the remainder of the policy.

Group life insurance is term insurance covering a group of people, usually employees of a firm or members of a union or association. Individual proof of insurability is generally not a condition in the underwriting. Instead, the underwriter looks at the size and turnover of the group, and the financial strength of the group. Contract provisions will endeavor to exclude the chance of unfavorable selection. Group life insurance often has a provision that a member leaving the group has the right to buy separate insurance coverage.

Senior and preneed products  [Top]

Insurance companies have recently developed products to offer to niche markets, most notably aiming at the senior market to address needs of a population that's growing older. Many insurers offer policies customised to the necessities of senior applicants. These are often low to moderate face value whole life insurance policies, to give a senior citizen buying insurance at an older age an opportunity to buy affordable insurance. This may also be commercialised as final expense insurance, and an agent or insurer may suggest (but not expect) that the policy payoffs could be used for end of life expenditures.

Preneed (or prepaid) insurance policies are whole life policies that, even though available at any age, are usually offered to aged applicants as well. This kind of insurance is designed explicitly to cover funeral expenditures when the insured person passes away. In some cases, the applicant signs a pre-funded funeral arrangement with a funeral services provider at the time of applying for the policy. The death proceeds are then warranted to be sent first to the funeral home for payment of services provided. Most contracts order that any excess proceeds will go either to the insured person's estate or a specified beneficiary.

These products are some of the times set apart into a trust at the time of effect, or soon after. The policies are irrevocably assigned to the trust, and the trust becomes the owner. Since a whole life policy has a cash value element, and a loan provision, it may be regarded as an asset; assigning the policy to a trust means that it can no more be regarded as an asset for that person. This can affect a person's ability to qualify for Medicare or Medicaid.

Annuities  [Top]

An annuity is a contract with an insurance firm through which the purchaser pays for an initial premium or premiums into a tax-deferred account, which pays out a sum of money at pre determined time intervals. There are 2 periods: the accumulation - when payments are paid into the account - and the annuitization - when the insurance company pays out -.

For instance, a policy holder may pay $10,000, and in return receive $150 each month until he dies; or $1,000 for each of 15 years or death benefits if he dies before the full term of the annuity has elapsed. Tax penalties and insurance company giving up charges may apply to early withdrawals.

Tax and life insurance in the United States  [Top]

Premiums paid by the policy owner are normally not deductible for federal or state income tax purposes.

Proceeds paid by the insurance company upon death of the insured are not included in gross income for federal and state income tax purposes; nevertheless, if the proceeds are included in the "estate" of the deceased, it is likely they will be subject to federal and state estate and inheritance tax.

Cash value growths within the policy are not subject to income taxes except when certain events occur. Because of this, insurance policies may be a lawful tax shelter wherein savings can increase without taxation till the owner cashes in the money out of the policy. On flexible premium policies, big deposits of premium could cause the contract to be seen as a 'Modified Endowment Contract' by the Internal Revenue Service (IRS), which nullifies several of the tax advantages connected with life insurance. The insurance firm should explain to the policy owner about this risk before applying their premium.

Tax deferred profit from a life insurance policy may be counterbalanced by its low return in some cases. This depends on the insuring insurance company, kind of policy and other variables such as mortality, market return, etc etc. Likewise, other income tax sparing means (i.e. Individual Retirement Account (IRA), 401K and Roth IRA) might be more beneficial alternatives for value accruement. This will depend upon case-by-case and their particular circumstances.

The tax ramifications of life insurance are tangled. The policy owner should be well advised to carefully review them. As ever, the U.S. Congress or the state legislatures could change taxation laws at any time.

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