Life Insurance
The Basics
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1/1/2009
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Jan. 1
Life Insurance
The Basics
By [Link]
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Jan. 1
Contents
Section 1
What Is Life Insurance?
Section 2
The Moving Parts
Typical Parts of a Life Insurance Policy
Section 3
The Extras -- Life Insurance Riders
Section 4
Trade-ins? Replacing An Existing Life Insurance Policy
Section 5
Turn Unneeded Life Insurance Policies Into Cash
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What Is Life Insurance?
Life insurance is a contract between the policy owner and the insurer. The
insurer (life insurance company) agrees to pay a sum of money (death
benefit) to a beneficiary when the insured dies or has a terminal or critical
illness. The policy owner agrees to pay a premium, (stipulated amount) at
regular intervals or in lump sums. The policy owner does not have to be
the insured.
Purpose of Life Insurance - To conserve and protect human life value. Human
Life Value is the value of a person's future earnings. That individual's or
family's economic existence can be subject to loss through death, retirement,
disability, or poor health.
Beneficiary - Chosen by the policyholder, the beneficiary receives the death
benefit. There may be more than one beneficiary. There must be an insurable
interest between the insured and the beneficiary. Individuals, businesses,
trusts, estates, and charities can all be beneficiaries. The policy owner has the
right to change the beneficiary at any time for as many times as desired.
Types of Life Insurance
Temporary
Term Insurance - Considered the simplest type of life insurance. It provides
protection for a specified period of time and pays a benefit only if the insured
dies during that period. It is typically the least expensive form of insurance
primarily because it is temporary. The most popular form of term insurance is
level term in which there is a level amount of protection (death benefit) for a
specified time period. There are also increasing term and decreasing term
policies. 10, 20, and 30 year terms are the most common.
Look for a term policy that is guaranteed renewable level term. That means the
premiums remain the same throughout a specified period of time regardless of
the insured's health changes. Often term policies will be convertible. At the end
of a level term period the policy owner can convert the policy to permanent life
insurance without evidence of insurability. The premiums will be based on the
current age of the insured.
Permanent
Whole Life Insurance - Permanent insurance. Death benefit is in force for the
entire lifetime of the insured. Typically, permanent life insurance matures at
age 100 at which time the insured, if still alive, will receive the full value of the
policy. Premiums can be several times higher than premiums you would
initially pay for the same amount of term insurance, but they typically become
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smaller in the insured's later years. Whole life policies develop cash values
which may be available to the policy owner. This cash value can be used as
collateral for a loan or borrowed from the policy. If borrowed, interest is
charged at a specified rate in the policy. Any money owed on a policy loan is
deducted from the benefit at the insured's death. If the policy is surrendered
for cash, the loan is deducted from the cash value.
Universal Life Insurance - Also permanent insurance, but with an investment
component. The policy owner can vary the timing, amount of premiums, and
death benefit. Premium payments must be frequent and large enough to
generate sufficient cash value. The cash value is used to pay the monthly policy
expenses, but if there is not enough the policy terminates. Withdrawals are
permitted from the cash value account. The cash account is considered the
investment component and the funds are invested in stocks, bonds, and money
market mutual funds chosen by the insurance company.
Variable Life Insurance - Permanent insurance with a a riskier investment side
to it. The death benefit and the cash value of the policy fluctuate according to
the investment performance of a separate account fund. The main difference
from universal life insurance is that you may select the types of investment
vehicles as well as determining the investment amount, thus bearing more of
the risk There are two types of variable life insurance - variable whole life and
variable universal life.
With variable whole life the death benefit may increase or decrease depending
on investment performance, but will not fall below the guaranteed minimum if
the required premium is paid.
With variable universal life the policy owner determines the timing and amount
of premiums and death benefit. The owner also directs investment of the cash
value and assumes all the investment risk. Typically there is no guaranteed
minimum death benefit.
Survivorship or Second-To-Die Life Insurance - A permanent policy that covers
the lies of two people. The death benefit is payable when the last of the two
insureds dies. Premiums are generally less than two separate policies. Whole
life, universal life, and variable life all offer Survivorship policies. Typical uses
for these are: to pay estate taxes, protect dual incomes, and key person
business insurance.
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The Moving Parts
Typical Parts of a Life Insurance Policy
The more basic provisions in most life insurance policies
Free Look - This is the right to examine the policy and cancel for any reason
within 10 days after you receive it. Any premium paid will be refunded.
Grace Period - There is usually a 30 day grace period for each premium
payment. The policy continues to stay in effect and will pay the death benefit
minus the premium owed if the insured dies.
Incontestable Period - The insurance company usually has 2 years from the
issue date to contest the policy, typically for false or misleading information by
the insured.
Suicide Clause - Typically the policy is nullified if the insured commits suicide
within 2 years from the issue date. Premiums will be refunded minus any loans
or dividends paid.
Misstatement of Age or Sex - If either age or sex were incorrectly stated on
the application, the death benefit will be adjusted to match what the premiums
would have paid for with the correct age and sex.
Reduced Paid-up Option - This is a nonforfeiture option that allows the policy
owner to use the cash surrender value of the policy to purchase a paid-up
policy with a reduced amount of coverage.
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The Extras -- Life Insurance Riders
Some of the options you can buy and add to your policy.
Accelerated Death Benefit - If the insured becomes terminally ill this allows
the policy owner to access a portion of the death benefit to help with medical
care.
Accidental Death Benefit - Payment of an additional death benefit if the
insured dies by accidental means. The policy defines the terms of an accident.
Waiver of Premium - Policy owner no longer has to pay premiums if the
insured becomes disabled for a period of time, usually before age 65. Premiums
must be paid once the insured is no longer disabled.
Guaranteed Insurability - More insurance can be purchased at a later date
without first having to show evidence of insurability.
Double Indemnity - Pays tiwce the amount of the death benefit if insured dies
accidentally.
Other Insureds Rider - Also called a children's or family rider, it allows other
family members to be insured on the same policy.
Cost of Living Adjustment - A COLA provides increases in the amounts of
coverage without evidence of insurability. It is usually tied to increases in the
Consumer Price Index.
Return of Premium - When the insured dies, the an amount equal to the
premiums paid will be paid out to the beneficiary in addition to the death
benefit.
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Trade-ins?
Think Twice Before Replacing An Existing Life
Insurance Policy
Replacing a life insurance policy is not always the best thing to
do. Here's why.
1. A newer policy has most of the expenses being paid for in the first years. If
you replace it with a new one, you'll be paying those expenses all over again.
2. If you use the cash value that accrued, it will not be as large as you expect
because of surrender charges.
3. If your health has changed your premiums will probably be higher.
4. Your premiums will be higher because you are older.
5. Taxes will be owed on any cash value that exceeds the new premiums being
paid. A 1035 exchange does not eliminate taxable income if there is a taxable
gain and an outstanding policy loan at time of surrender.
Consider other options like:
- a Reduced Paid-up rider
- laddering with additional policies.
Whatever you decide, DO NOT terminate your existing policy until
your new policy has been issued.
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No Longer Need Your Life Insurance?
Turn Unneeded Life Insurance Policies Into Cash
In these difficult financial times you may be looking for ways to cut back on
expenses. Letting your life insurance policy lapse or surrendering it for the
cash value may seem like a good idea. But did you know your life insurance
policy is an asset that you can actually sell?
Until recently, the only options for liquidating an underperforming or unneeded
policy was to let it lapse, sell it back to the original insurer for its current net
cash surrender value, or to exercise a non-forfeiture option. In a life settlement,
the sale price is less than the policy's face value, but is higher than the policy's
net cash surrender value. The price can range as low as 3% to as high as 30%
of the face value of the policy (death benefit), but usually averages to about
15% of your policy's face value. The value in the life settlement transaction is
determined by a number of factors including: your age and medical condition,
the type of insurance, the amount of premium payments, and the status of
loans on the policy.
There are many reasons you may no longer need or desire a life insurance
policy:
- loss of a loved one
-need to pay for long term care or medical costs
-premiums have become unaffordable
- divorce
- beneficiaries no longer need the death benefit
- financial hardship
- your estate got smaller
- a key executive retired
- sale of a business
- loan repayment
- policy underperforming your expectations
- your level term life's conversion period is expiring
- estate tax law revisions mean your heirs no longer face a hefty tax bill at your
death
Who can qualify?
A potential candidate for a life settlement is typically aged 65 or older; has a life
insurance policy with a face amount of at least $250,000, and has a life
expectancy greater than 2 years.
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What type of insurance policy can be sold?
Most types of life insurance policies can qualify as long as they've been in
existence for more than 2 years. However the most common are Universal Life,
Whole Life, Variable Life, Survivorship Life, and convertible Term Life.
What happens to my policy?
A life settlement transfers ownership of your policy to a third party investor
that only has a financial rather than an insurable interest in your life. In other
words, the death benefit will eventually be paid to the new owner. Once you sell
your policy you give up all rights and obligation to the investor in exchange for
the sale price. The buyers are usually institutional investors such as pension
funds, charitable endowments, universities, and hedge funds.
What can the money be used for?
You can spend the money on whatever you like. Some people use it to fund
other investments, make charitable donations, fund a relative's education, or
even purchase replacement life insurance.
Actual Cases
From LISA, Life Insurance Settlement Association
Case 1: Policy seller: 70 Male
Policy type: 20 year term policy
Policy value: $1,000,000
Net Settlement paid to seller: $156,000 (15.60% of death benefit)
Case 2: Policy seller: 69 Male
Policy type: Universal Life policy
Policy value: $500,000
Cash surrender value (CSV): $10,335 ( 4.01% of death benefit)
Net Settlement paid to seller: $210,000 (42% of death benefit)
Settlement vs. CSV ratio yield: 1047.6%
Case 3: Policy seller: 80 Female
Policy value: $2,000,000.00
Cash surrender value (CSV): $9,897.65 (0.49% death benefit)
Net Settlement paid to seller: $330,000.00 (16.50% of death benefit)
Settlement vs. CSV ratio yield: 3334.12%
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What are the fees?
Be aware that the commissions on life settlements can be as high as 33%.
These commissions are negotiated between the advisor and the purchasing
company, but are not always disclosed to the client. Make sure your advisor
clearly states their cut. Most commissions hover around 8% of the net death
benefit or 30% of the offer price, whichever is less.
Other than commission there is no other fee. You can put your policy out for
bids and decide whether or not you will accept a bid or turn it down. The whole
process takes about 4 months.
Do I have to take a bid if I don't like it?
Never! There is absolutely never any obligation or fees if you don't want to
accept the bids for your policy. It is free to put your life insurance policy out for
bid just to see what it's worth in the life settlement market.
What are the tax implications?
A life settlement is generally a taxable event.
- The portion of the policy owner's investment (premiums paid) will be received
tax-free.
- The difference between the premiums paid and the net cash surrender value
will be taxed as ordinary income.
- The portion exceeding the net cash surrender value will be a gain, in most
circumstances a capital gain.
Since every situation is different it is important that you consult with your tax
advisor when contemplating selling your life insurance. Life settlement brokers
are not tax consultants.
Important Considerations
Life settlements can be a wonderful source of funds. But they are not for
everyone. You must consider whether you still have a need for continued
coverage. If your premiums are too expensive you may be able to lower your
amount of coverage and keep your current policy by exercising a non-forfeiture
option. If after the life settlement, you plan to replace your existing policy with
another policy there may not be any other availability or comparable coverage
for less cost. You must assess your circumstances, including financial need,
investment objectives, tax consequences, and other relevant implications of
selling a policy.
If you have a specific question about your situation or would like more
information call W. Goldband at 443-756-9281 or email at
wgoldband@[Link].
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