Part I Life Insurance Products, Riders & Benefits 1. Part II The Application, Underwriting & Policy Delivery 27

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1 Table of Contents Life Insurance Fundamentals Contents Page Part I Life Insurance Products, Riders & Benefits 1 Part II The Application, Underwriting & Policy Delivery 27 Part III Standard Policy Provisions & Policy Options 36 Part IV Group Life Insurance 55 Part V Life Insurance and Taxation 63 Part V Glossary of Terms 71 Table of Contents

2 Part I Life Insurance Products, Riders & Benefits Introduction When you are thinking of any insurance product, you are thinking of indemnity. Look at the definition of indemnity: it means to compensate or reimburse. You insure your home, apartment or car against a loss. Should a loss occur, you look to your insurance company for reimbursement or compensation. With life insurance, a named beneficiary is reimbursed or compensated for the loss of income or increased expenses caused by the death of the insured. This is a somewhat liberal example of indemnity. What Does Life Insurance Do? Life insurance creates an immediate estate, and it also provides economic security against two kinds of losses: Losses that occur from physical death, and; Loss of income that can occur at retirement. Life Insurance satisfies two very basic "needs": 1. Personal Needs - Life insurance is used to create a specific sum of money that is payable to a named beneficiary when the insured dies. Living values of life insurance - created through cash accumulations in a policy or policies that can satisfy "living needs" -- i.e.: collateral for a loan, supplement retirement income, pay tuition for college, etc. 2. Business Needs - Life insurance is used in various business entities, sole proprietorships, partnerships, and corporations to satisfy: Funding of Buy-Sell Agreements - An agreement by business principals (sole proprietors, partnerships or corporations) to purchase another business principal's interest in that business upon his/her death, disability or retirement. This agreement is usually funded with life insurance. Key Man Life Insurance - The concept of insuring a key man in a business organization, which if he were to die would cause financial hardship to the business. Various forms of life insurance are used. For example: Whole Life, Term, Universal Life, or Variable Life. Business debt obligation Keeping business intact Deferred Compensation - An "executive incentive" to provide him compensation at some future date, usually at retirement. -1-

3 Tax Treatment of Life Insurance Premiums - Are not tax deductible unless paying for employee benefits such as group insurance. Proceeds - Are the death benefit of a life policy and are not income taxable to the beneficiary. Dividends - Are not taxable, but the interest on the dividends is taxable. Dividends are considered an overcharge of premium and are generally paid by mutual insurance companies. Withdrawals - Are not taxable (usually associated with universal life and annuities). Group Life Insurance - Proceeds are nontaxable like those of an individual life policy. The company, not the employee, may deduct the premiums as a business expense. The premiums paid on behalf of the employee are not considered income to him for tax purposes. Federal Estate Tax - Life insurance proceeds are included in an individual's gross estate and may be subject to tax if the estate exceeds a certain amount. Gifting Life Insurance - The charity (donee) is made the beneficiary and owner. The donor (insured) pays the premium and receives an income tax deduction. The charity is given all rights of ownership in the policy, and for a tax deduction, the donor must not have any control of the policy. A person can gift a policy to someone other than a charity. To avoid a gift tax, the annual values must not exceed $10,000 per donee or a total of $20,000 for him and his spouse. A person may gift a policy which has cash value or can elect to pay the premium up to the above limits to pay for a policy. The gift is received tax free by the donee regardless of the proceeds. The taxation of life insurance will be explored in greater detail later in this text. Types of Life Insurance There are four (4) basic types of life insurance, each having its own characteristics. Each will be discussed in greater detail later in this text. 1. Term Life Insurance Tern life is sometimes referred to as Temporary Insurance. It provides temporary protection for a specified term of years. For Example: one year, five year, thirty years, etc. The policyholder must die during the term of the policy for any benefit to be paid. Mortgage Life is a form of term insurance and it usually provides a reducing death benefit, reducing to "0" at the end of a specified period of time. 2. Whole Life (Ordinary Life Insurance) Also referred to as ordinary or permanent insurance. As implied by its name, affords coverage for life, or up to age 100. At age 100 the policy endows and the insured receives the face amount of the policy in cash. Note: All whole life policies endow at age

4 3. Industrial Life Insurance Policies are written in small death benefits amounts; usually less than $5,000 Usually purchased by low income workers' including their family members Usually no medical examination is required Policies are sold house to house by debit agent (also known as home service agents) The premiums are collected weekly or monthly by the debit or home service agent The grace period is four weeks or 28 days Death benefit settlement is paid in a lump sum Contains Facility of Payment Clause - Permits the company to pay the death benefit to any relative or anyone they deem entitled to the benefits when there is no beneficiary to facilitate funeral arrangements; Contains accidental death & dismemberment coverage Does not have a suicide clause Has a one-year incontestability clause The premiums quoted at age of next birthday Non-forfeiture values are provided in Industrial Life Insurance after premiums have been paid for at least three years. The term non-forfeiture values will be discussed in more detail later. 4. Group Life Insurance This coverage is written on members of a common group, and the group must have been formed for a purpose other than that of obtaining insurance. The coverage can be offered as term or whole life. Characteristics of group life insurance will be discussed in this text. Term Life Characteristics of term life: Temporary protection. (Specified number of years) Face Value paid only at death. Usually, there is no cash value build-up No Permanent Values. Low Premium outlay initially. Options Not all companies provide the following options: (a) Renewability - Right to renew the policy on a renewal date without evidence of insurability. The premium usually is increased on renewal date. (b) Convertibility - Right to convert to a permanent policy without evidence of insurability. Note: To help you remember and understand this life insurance product, think of its name. Term insurance is insuring a life for a defined term of time. Options included in the product are included in the name of the product. Example: Five Year Renewable and Convertible Term. -3-

5 Types of Term Life May be defined by the way the face amount of the policy changes throughout the life of the policy. Level Term - The face amount of the policy remains constant over the life of the policy. Decreasing Term - The face amount decreases throughout the life of the policy. Whole Life Characteristics of whole life: The policy provides permanent protection for the whole life of the insured. Also referred to as permanent life insurance. The policy has cash or loan value, and non-forfeiture values (or simply stated - equity buildup). Policy equity (loan value) must begin after 2 years. The policy will endow at age 100; at maturity (age 100) the Cash Value = Face Amount. The policy provides level premiums and has a 30 day grace period. The policy has a constant face amount of more than $1,000. With any life insurance product, the policyowner pays the premium in advance. Money is paid for future protection. This premium is earned by the insurance company each day the insured lives. Therefore, when a claim occurs, the insurance company keeps that portion of the premium it has earned and refunds the unearned premium to the beneficiary. May be issued as an endowment. This form of life insurance has rapidly building cash value, the amount of which will ultimately equal the death benefit of the policy. Such policies are usually issued with a specific time period in mind year endowment, 20 year endowment, or endowment at age 65. This form of insurance is not as popular in today's environment as it once was. The emphasis of this type of policy is in its cash accumulation more than death benefit and is the most expensive policy that can be purchased. Has a two (2) year incontestability clause and a two (2) year suicide clause. When issued a permanent insurance, all policies shall have non-forfeiture values after premiums have been paid for two (2) years. The non-forfeiture values must be illustrated in the policy annually for no less than twenty (20) years. Death benefit may be paid in a lump sum, or paid under a settlement option other than lump sum to the beneficiary. Whole life insurance products contain equity build up that is called cash value. This equity (cash value) results from the fact that an overcharge of premium is made by the insurer in the early years of the life of -4-

6 the policy. This overcharge is held in an interest bearing reserve that is drawn upon by the insurance company in later years as the insured ages. The billed level premium plus the funds drawn from the reserve, supports the death benefit and maintains the consistent level premium to the maturity age of the insured at age 100. The credited guaranteed rate of interest in the reserve is the cash value or equity in the policy. The policyowner (who is not always the life insured) owns and therefore, has access to the cash value. The cash value can be borrowed for whatever use the policyowner desires. You need to understand and keep in mind that, if a loan exists at the death of the insured, the claim will be paid as follows: Death benefit amount Minus outstanding loan Minus any outstanding interest on loan Equals death benefit payable An additional point to remember and understand is that the insurance company has the right to take up to six months to honor a request for a policy loan from the policy cash value. Also, insurance company can charge interest on a variable loan rate not to exceed 1 ½ % per month (18% APR). Lastly, we referenced a 30-day grace period as one of the characteristics of the policy. The 30-day grace period also applies to term insurance. The importance of the grace period is it is the period of time after the premium due date the policyowner has to pay his/her premium without losing their coverage (policy lapses for non-payment of premium). If the insured dies during the grace period, you must understand two important points: 1. The death claim will be paid, because 2. The coverage is still in force. The death claim will be paid as follows: Death benefit payable Minus the outstanding premium (monthly, quarterly, semi-annual or annual premium) Minus any outstanding loan Minus any outstanding interest on loan Equals death benefit payable If an accidental death benefit (double indemnity benefit) is included on the policy, and the insured dies from an accident during the grace period, the accidental death benefit is included in the calculation of the total death benefit. Note the following example: Death Benefit: $25,000 Accidental Death Benefit: $25,000 Quarterly Premium: $70.00 If the insured dies in an accident during the grace period the total death benefit payable is: Total Death Benefit: $50,000 Minus outstanding premium: Minus outstanding loan: 0 Death Benefit Payable: $49,930-5-

7 Types of Whole Life (As defined by the methods of premium payment): Continuous Premium Whole Life Policies - Spreads the premium payments over the whole life of the insured (age 100). It is sometime referred to as straight life insurance. Limited Payment Whole Life Policy Another member of the whole life family is the limited payment whole life policy. Again, note the name of the policy. Limited payment (of premiums) with whole life (protection to age 100). Limited payment whole life policies limit the number of premium payments to a specified number of years (10 years, 20 years, or to age 65), but provides coverage (death benefit) for the whole life of the insured (to maturity at age 100). A limited payment life policy will accumulate more cash value more quickly than the lower premium paid continuously to age 100 simply because the limited premium payment is higher. Single Premium Whole Life Policy - This policy provides for the payment of one premium payment covering the entire term of the insurance contract rather than installments. All other facts being equal, this is the least expensive product as far as the total premiums paid is concerned, and therefore is considered to be the most efficient. Endowment Policy An endowment policy is a form of whole life insurance, and is usually purchased to accumulate funds for specified purposes such as retirement, etc. An endowment policy is a savings program with protection against dying before the savings goal is reached. Characteristics of Endowment Policies: Is considered a whole life policy and has an early maturity period Has cash, loan and nonforfeiture values Endows before age 100; i.e. in 10 years, 20 years or at age 65 Specialized Policies There are various policy forms that have evolved from the three basic forms (whole life, term, and endowment) to meet various needs. The following are samples of specialized policies all of which begin with an underlying whole life policy. Combination Policies (Written on Breadwinner) - Family Income Policy: The family income policy combines whole life and decreasing term coverages to provide income protection during child-rearing years. Under the terms of this policy, if the insured dies during the policy period (typically 20 years), a monthly income is provided to the beneficiary for the remaining period of the policy (through the decreasing term coverage). After this time period is completed, the beneficiary receives only the face amount of the policy (from the whole life coverage). For example, the insured purchases a 20- year family income policy with a face amount of $50,000. If the insured died after the policy had been in effect for four years, the insured's beneficiary would receive $100/month for the remaining 16 years. After that time, the beneficiary would receive a lump sum check in the amount of $50,000 (the face amount of the policy). Characteristics of the Family Income Policy include: -6-

8 1. Whole Life Policy 2. Decreasing Term Rider 3. Pays monthly income from date of death until end of term. The income time period begins with the issue date of the policy. 4. Whole life death benefits are usually paid at the end of the term. The Family Policy The family or family protection policy provides coverage on all members of the insured's family from a specified time period after birth (normally 15 days) up to a specified age (18 or 21). Whole life insurance is written on the breadwinner; term insurance is usually written on the spouse and children. Minimal amounts of insurance are written on all members of the family by a rider known as the other insureds rider. The family policy usually provides the following features: 1. Death of the head of the household will result in paid up term coverage on the children 2. Permanent disability of the head of the household will result in a waiver of premium 3. Additional children born to the family insured are covered for no extra premium 4. Most companies require no insurability requirement for newborns; however, some companies will underwrite newborns 5. Dependents may convert their term coverage into permanent insurance without the evidence of insurability Initially, all persons to be insured under the family policy must be insurable. If either husband or wife is not insurable, the policy cannot be issued. Again, as you study the characteristics of these two products, consider their names. The Family Income Policy is designed and sold to provide income to the family if the primary breadwinner dies; thus the name of the product. The Family Policy is designed to insure the family; thus the name. Joint Life Policies These products are normally issued on a whole life basis, and two or more lives are insured under one policy for the same death benefit. Joint First Death This policy insures one or more persons on one policy, and each person insured is insured for the same death benefit. This policy will pay the insured death benefit at the death of the first insured to die. A common policy is issued insuring two lives, however, some companies will issue with more than two lives. Under a two-life joint first death policy, the survivor is usually granted a 90 day conversion privilege permitting him/her to convert to an individual policy at his/her current age without medical evidence. Another feature usually available with this product is the ability to exchange to separate policies. If a joint policy is used in a business situation and the need for coverage is gone, the insureds may exchange to single life policies for the same death benefit issued under the joint life product. The premium is usually adjusted to reflect current ages, and this exchange privilege usually is made without evidence of insurability. Any cash value in the joint life product is refunded, with the new single life policies, to the original policyowner. If benefits such as waiver of premium or accidental death are desired under the joint life product, the benefits applied for must cover all insureds. No insured can be excluded for benefits. -7-

9 Joint Second Death (also known as Survivorship Life) This policy form insures two lives and pays the policy face amount at the second death of the two insureds (a one life deductible type policy). This policy is a very popular policy among the estate planners, and is usually issued on husband/wife combinations. The underwriting is usually liberal in the sense that it is common to find one of the two insureds having a medical problem. In some cases, one of the insured may be totally uninsurable, on traditional individual policy, but insurable under this policy. Usually, no benefits such as waiver of premium or accident death are available for issue under this policy. Most companies issuing this product do not provide for a "split exchange" (issue two single life policies) without complete underwriting including medical evidence on both named insureds. Juvenile Policies As the name suggests, juvenile insurance is written to address the specific needs of "juveniles" (written on children under age 15) for: the funeral expenses of juveniles upon their untimely deaths future education needs. Very often, juvenile insurance takes the form of an endowment policy payable upon the insured juvenile reaching age 18. The amount of the endowment would address projected college expenses at the time the insured reaches college age. As previously noted, endowments provide for accumulating a specific sum of money over a specific period of time with this savings program protected against premature death. A payor benefits rider can be included in insurance on children. It states that in the event of the death or permanent disability of the payor (hence, the name) of the policy (usually a parent, grandparent or some other close relative), future premiums will be waived until the child reaches a specified age (usually age 21 or 25). The payor in question must provide evidence of insurability (e.g., submit to a physical examination) and pay an additional premium for this coverage. Jumping Juvenile insurance is an insurance contract on a juvenile which promises to provide a multiple (usually five times) of the face amount of the policy coverage once the juvenile attains age 21. In this way, the policy "jumps" from the lower original figure to a greater amount. Such contracts provide the advantage of guaranteeing the insurability of a child at age 21 for a given amount of insurance (the initial face amount times the multiple). This contract may also be referred to as the Estate Builder. Modified and Graded Premium Whole Life Modified and graded premium life policies address a market which needs permanent life protection immediately but cannot afford the level premium payments needed to purchase the coverage required. A modified whole life policy is actually a combination of term coverage and whole life; the term policy initiates coverage then automatically converts into whole life after a relatively short amount of time (typically three to five years). With this configuration, the policy offers the advantage of low premium payments for high coverage amounts for the first three to five years. Once the term converts into whole life, the premium payments radically rise from a level lower payment to a level higher payment. -8-

10 As a contrast, a graded premium whole life policy, provides a "graded premium" for the initial period (typically five years) then levels off at the end of that period. The rise from the initial payment to the level premium payment of the sixth year is a gradual one, not a radical jump like a modified whole life policy. In conclusion, the premium payment "profile" of a modified life policy represents "one huge step" from a level lower payment to a level higher payment. In contrast, a graded premium whole life's payment profile represents a series of small steps at the outset of the policy which level off after five years or so. Adjustable Life Adjustable Life is a "flexible premium, adjustable death benefit" type of permanent cash value insurance. Adjustable life, within limits, allows the policyowner to change the premium (lengthen or shorten the premium payment period), and/or the level of death benefit. In general the policyowner may: Increase or decrease the premium Increase or decrease the face amount Lengthen or shorten the protection period Lengthen or shorten the premium payment period Similar to other traditional forms of insurance, various options or riders are available including: Waiver of premium, Guaranteed insurability Accidental death benefit, and Cost-of-living adjustments Although the policyowner has flexibility in selecting the plan of insurance, changes are generally permitted only at specified intervals and with advance notice to the insurer. Between adjustment periods, the policy is a level-premium, level-death-benefit policy. Depending on the particular premium and death benefit levels chosen, the policy can assume the form of almost any traditional term or whole life policy from lowpremium term through ordinary whole life to high-premium limited-pay whole life. Universal Life Although similar in approach, universal life varies dramatically from adjustable life and other traditional whole products by providing a "vehicle" for allowing internal cash values to build at variable current interest rates as opposed to conservative, guaranteed rates. Premiums paid for universal life are divided into two "accounts" (a process also known as "unbundling the cash value"): expense account cash value account The expense account addresses the costs of the agent commission, administrative costs incurred by the company in creating and maintaining the individual policy, etc. -9-

11 The cash value account is the aforementioned "vehicle" which provides the funding for three separate operations: The monthly premium payment for the insurance protection (mortality costs) A small cash value fund which provides a guaranteed, conservative long-term amount of interest (5% or under) A larger cash value fund which reflects the actual investment earnings of the insurer during a given period (e.g., 10%). The extra earnings are commonly known as excess interest. At the inception of the policy, the insured must pay an annual premium to initiate the two accounts and set them in motion. This premium is based on the face amount of the policy desired and the age of the insured. The insured then has the option of choosing a target premium (a premium amount the insured can afford or is willing to pay) and a mode of payment (annual, quarterly, monthly, etc.). These premiums are directed into the expense and cash value accounts as needed. Since premiums are paid directly from the cash value account, the insured may skip a premium payment as long as there are sufficient funds in the cash value account to pay the premium payment. If insureds wish to invest extra money into their cash value accounts, they may do so, subject to certain limits prescribed by the company involved and federal tax law. The death benefit under most universal life policies provides two options: 1. Option A - This option, which is similar to a traditional whole life policy, offers a fixed (level) death benefit. As cash values grow larger, the net amount at risk (or pure insurance) is reduced to keep the total death benefit constant (unless the cash value grows to an amount where the death benefit must be increased to avoid classification as a modified endowment contract). 2. Option B - This option operates in a manner similar to the death benefit one would receive from a traditional whole life policy with a term insurance rider that is equal to the current cash value. Under option B, the death benefit at any time is equal to a specified level of pure insurance plus the policy's cash value at the time of death. Therefore, the death benefit increases as the cash value grows. Unlike traditional whole life policies, universal life policies allow partial withdrawals of money from the cash value account. Traditional whole life policies allow full cash surrenders only (whereby the insured "surrenders" his/her policy in return for any cash value that has accumulated at the time). An annual load may be made against the cash accumulation of a universal life policy. The annual load is generally the difference between the guaranteed rate and current rate of the first $1,000 in accumulated value. For example: 9% current - 4% guaranteed X 1,000 = $50 load. In summary, universal life offers: A fixed conservative return on a small portion of cash values with the possibility of a larger rate of return based on the insurer's investment experience Flexible premium arrangements Flexible, optional death benefits Partial as well as full withdrawals Note of caution: Interest credited to the cash accumulation inside universal life products, variable life products, and traditional whole life products accumulate free of income tax. However, given this "tax -10-

12 shelter" our Government taxing agencies have attempted to close this "tax free / deferred" feature of life insurance. When universal life insurance and other interest sensitive products were first introduced into the market, double digit interest rates began occurring and many field underwriters (agents) sold these products with heavy emphasis on the then current interest rates and tax free cash accumulations in the products. At that point in time, the government recognized the impact of losing the tax dollars they would have received from other forms of investing. Therefore, the Deficit Equity Fiscal Responsibility Act (DEFRA) and the Tax Equity Fiscal Responsibility Act (TEFRA) set forth guidelines establishing the criteria to maintain life insurance as life insurance and retain the continued tax-free accumulation of cash value within a life insurance policy. Violations of the established guidelines will convert the policy into a "modified endowment policy." If this occurs distributions from the policy are adversely taxed. Such distributions are subject to a 10% penalty if they occur before the policyowner attains the age of 59 1/2, dies, or becomes disabled. The guidelines established by DEFRA and TEFRA define to all insurance companies the required cash value levels and the necessary "corridors" of cash value to death benefit to remain a life insurance policy. Whenever either of these areas of concern shows signs of being violated, most insurance companies will notify you as the agent, and your client of the potential problem and how it can be corrected. Further, the illustration process addresses the possible problems whenever large sums of money are "dumped" into an interest sensitive product. Annual Report to Universal Life Policyholders 1. Policyholder receives an annual statement disclosing death benefit and cash value status. Also, all policy transactions are a part of this statement. For example: All expense charges, insurance cost and interest credited. 2. Loads - (front end or rear end loads) - Some universal contracts have gone from a front end load to a rear end load contract. The result is a reduced or replaced front end fixed charge. In a rear end load, there is generally a surrender charge against the cash value for policies surrendered before a fixed period. This period will usually vary from 10 to 20 years from date of issue. Universal Life Waiver of Monthly Deduction - Since premiums on a Universal Life Policy may fluctuate considerably, most companies provide a waiver of premium rider on a Universal Life Policy that will guarantee only the monthly cost of insurance, not the total premium the insured was paying. The policy's cash value will remain intact and continue to earn interest. TEFRA 1982 (Tax Equity and Fiscal Responsibility Act of 1982) - TEFRA allows universal life the same tax treatment as traditional whole life: Interest on cash value accumulates tax free Death proceeds are income tax free, and Cash value withdrawals, up to the amount of premium paid in, are income tax free Variable Whole Life The purpose of variable whole life is to protect the insured from the ravages of inflation. Specifically, traditional whole life policies are written on a fixed dollar value (such as $100,000) which will be paid to the beneficiary upon the death of the insured. The true purchasing power of this amount changes with the inflation rate of the times. In response, variable whole life provides death benefits which "vary" (hence, the name) according to the insured's investment choices which, in turn, vary with inflation. -11-

13 Variable life insurance combines traditional whole life insurance with mutual-fund type investments. Basically, it is a whole life policy where the policyowner may direct the investment of cash values among a variety of different investments. Variable life has a guaranteed minimum face amount and a level premium like traditional life insurance, but it differs in three respects: 1. The policyowner's funds are placed in separate accounts that are distinct and separate from the company's general investment fund. 2. There is no guaranteed minimum cash value. The cash value at any point in time is based on the market value of the assets in the separate account. Variable life policyowners bear all the investment risk associated with the policy. 3. The death benefit is variable. The face value may increase or decrease, but not below the guaranteed minimum. Similar to other traditional forms of insurance, various options or riders are available including waiver of premium, guaranteed purchase or insurability, and accidental death benefits. Insurers that market variable life often offer a number of premium payment plans including single premium, limited pay (for a specified number of years or until a specified age), and lifetime-pay plans. In summary, variable whole life insurance is characterized as follows: The face amount of the policy "varies" with the fortunes of the insured's investment choices This face amount never decreases below an initial specified amount Premium payments are level Investment risks are taken by the insured based upon a prospectus prepared by the insurer Agents need a securities license (NASD) in order to sell variable life Variable Universal Life Variable universal life, which is also called flexible premium variable life, is a combination of universal life and variable life. It offers policyowners the flexibility of universal life with respect to premium payments and death benefits. Specifically, variable universal life owners can: Determine the timing and amount of premium payments (within limits). Skip a premium payment if the cash value is sufficient to cover the mortality and expense charges. Adjust the amount of the death benefit in response to inflation or changing needs (subject, generally, to policy minimums and, with respect to increases, evidence of insurability requirements). Withdraw money without creating a policy loan and without an interest charge if there is sufficient cash value to cover mortality and expense charges. Choose between two death benefit options similar to options A and B for universal life policies. Under option A, the death benefit remains level, similar to a traditional policy. Under option B, the death benefit is equal to a level pure insurance amount plus the cash value. The death benefit of a variable universal life policy is not "variable" in the same sense as the death benefit of a variable life policy. Under option B, the death benefit will vary directly with changes in the cash value. Under option A, the death benefit is level. However, the death benefit of variable universal life policies is flexible or adjustable, within limits and subject to insurability requirements, at the discretion of the insured. -12-

14 Variable universal life policyowners receive periodic reports that explicitly show mortality and expense charges and changes in the investment value of their accounts. Since variable life products are considered securities, prospective purchasers must be given a prospectus. The prospectus contains the identity and nature of the insurer's business, the use to which the insurer will put the premiums, financial information on the insurer, the investment characteristics of the product, expenses, fees, loads, and policyowner rights. In addition, the agent must be properly licensed to sell securities products. Interest-Sensitive Whole Life Similar to continuous pay whole life contracts, interest-sensitive whole life insurance guarantees that the policy's cash values will receive interest over a period of time. The rate of interest varies to reflect the economic conditions of the time; however, it will never fall below a certain rate specified in the contract. Because of the interest-sensitive nature of the policy, the policy's cash values accrue more rapidly than under traditional whole life contracts. Typically, insurers encourage policyowners to assume a relatively high premium payment in conjunction with a provision to utilize cash value buildups toward premium payment with the objective of paying the policy premium in full over a shorter than anticipated period. This process is known as a "vanishing premium" payment. This is another incentive to purchasing interestsensitive whole life insurance. Life insurers typically invest in fixed-income investments for interestsensitive whole life products. Fixed-income investments generally are loans made to large corporations on one of three basis: Short-term - several weeks up to two years Intermediate-term - two to ten years Long-term - 10 years or more Usually, the longer the term, the higher the interest rate received. The investment strategy for interestsensitive whole life usually involves intermediate-term fixed-income investments. Guaranteed interest and any excess interest amounts are applied to the policy's cash values. Policy Riders and Benefits A rider is a form which, when added to an underlying life insurance policy, amends coverage by: Increasing benefits Decreasing benefits Waiving a condition Waiver of Premium Benefit The disability waiver of premium rider provides that the insurance company will "waiver" (voluntarily relinquish) all premiums due on a life insurance policy of an insured who has become totally disabled, usually for a 6 month period and before a certain, specified age (usually 60 or 65). Policy premiums will be waived for the duration of the illness or injury. The insured does not have to "pay back" the insurer for paying the policy premium during a disability. Total disability is usually defined as a disability which will preclude the individual in engaging in any gainful employment. Included within this definition are the loss of both arms, both legs, or the loss of sight as well -13-

15 as other very serious injuries. In practice, the "yardstick" of total disability is used with respect to the insured's present occupation during the first two years of disability; any occupation for which he/she is qualified, thereafter. As a result, if an insured artist could no longer paint pictures for a living as a result of losing a hand, the artist would be considered "totally disabled" even though he/she could still teach art for the first two years of disability, but not thereafter. Permanent disability is usually declared once an insured has been disabled for a period of six consecutive months. The "disability" itself may be caused by an injury or sickness that began after the inception date of the policy. Just about any cause for the disability is covered, but there are typical exclusions for the cause of the injury or sickness such as: War Self-inflicted injuries Violation of the law Guaranteed Insurability Rider Guaranteed insurability is a rider in a policy which permits purchase of additional amounts of insurance at stated intervals without evidence of insurability. Since evidence of insurability is not required, insurability is "guaranteed." Usually, the option of purchasing additional amounts of insurance is limited to a maximum amount of insurance (e.g., $10,000 and $25,000 are typical amounts) and to a maximum specified age (e.g., age 40) at specified intervals (e.g., 3-year intervals). In addition, the insured has a time limit (e.g., 90 days) in which to decide if more insurance is needed through this rider. This rider usually requires an additional premium. It is only available under whole life and endowment contracts. Payor Benefits The payor benefits rider pertains to insurance on children. It states that in the event of the death or permanent disability of the payor (hence the name) of the policy, subsequent premiums will be waived until the child reaches a specified age (usually 21 or 25). The "payor" in question must provide evidence of insurability (e.g., submit to a physical examination) and pay an additional premium for this coverage. As noted, this rider is usually written on juvenile contracts but it may also be used with endowments. Accidental Death Benefit The accidental death rider, as its name suggests, provides that if the death of the insured is caused by an accident, a multiple of the face amount of the policy will be paid to the beneficiary. For years, this rider was referred to as "double indemnity" because it provided for payment of twice the face amount of the policy in the event of the accidental death of the insured. In practice, some companies provide triple or quadruple indemnity as well. In order for this rider to provide its multiple payment, the death itself must: Be purely accidental Occur within 90 days of the accident Occur before age 70 If an insured is hit by a car, and dies at the scene of the accident, he/she obviously would be the victim of an accidental death. If this same auto accident resulted in injuries that caused the insured's death shortly -14-

16 after the accident (but within 90 days), this death would be considered accidental. The 90 day "expiration" period is imposed upon the accidental death definition to provide some necessary parameters to the definition. Realizing that everyone must die some day and most people become involved in accidents, one could argue a case of accidental death for every living human eventually without this 90 day maximum. Finally, an age limit of 70 is further imposed on this rider because of the frequency of deaths in the post-70 age group. To further underscore the required accidental, unplanned, unforeseen nature of death, this rider usually excludes death by: Any disease or illness of any kind, physical or mental infirmity or medical/surgical treatment of these Suicide, while sane or insane War or military conflict Committing a felony Drugs, unless prescribed by a physician Poisonous gas (except from an occupational accident) Acting in any capacity, other than as a passenger, on an aircraft Cost-of-Living Rider With the cost of living rider, the policyowner has the option to increase the death benefit of his or her policy to match any increase in the cost-of-living index (usually the CPI-U the Consumer Price Index - All Urban). Any increase in the death benefit, of course, will mean an increase in premium. Any subsequent decrease in the index will not result in lowering the policy's death benefit. Waiver of Monthly Deduction (Universal Life) Since premiums on a universal life policy may fluctuate considerably, most companies provide a waiver of premium rider on a Universal Life Policy that will guarantee only the monthly cost of insurance, not the total premium the insured was paying. The policy's cash value will remain intact and continue to earn interest. Accelerated (Living) Benefit Rider Many insurers make living benefit riders available which, when attached to a life insurance policy, pay benefits during the lifetime of an insured who is seriously or terminally ill. Accelerated benefits are benefits payable under a policy that meets all of the following criteria: The benefits are payable to the policyholder or certificate holder during the lifetime of the insured upon the occurrence of a "qualifying event." The benefits are payable in amounts that are fixed at the time of the acceleration of benefits. The benefits reduce the death benefit otherwise payable under the policy. A qualifying event is the occurrence of any of the following: A medical condition that drastically reduces the potential life span of the insured to a period of time that is within the period of time specified in the policy. -15-

17 A medical condition that requires the use of extensive or extraordinary medical care or treatment, including major organ transplant or the continuous use of artificial life support systems, without which the insured would likely die. A condition that normally results in continuous confinement in an eligible institution, as defined in the policy, if the insured is expected to remain in the institution for the remainder of his or her life. A medical condition that, in the absence of extensive or extraordinary medical care or treatment, would drastically reduce the potential life span of the insured. Other Insured Rider Individuals other than the named insured can be insured under most insurance policies through the use of specific riders such as: Spouse and children insurance rider Second insured rider As its name suggests, the spouse and children rider is designed to be added to a whole life insurance contract to provide coverage on the insured's spouse and children. The coverage provided by this rider is term insurance and is usually subject to certain specified maximums. The term coverage on the spouse usually is written for a much greater amount (e.g., a multiple of five) than the amount written on the children. Furthermore, the amount of insurance written on the children is a stated, flat amount that does not change with the addition or deletion of any one child. Once a child reaches a certain specified age, he/she is eliminated from coverage. A spouse and children insurance rider typically provides: A conversion privilege, allowing a child reaching the "stated age" to contract for permanent insurance without evidence of insurability. Paid-up term riders on the spouse and children if the named insured dies The second insured rider is a rider that adds a second insured to a life insurance policy, but usually for an amount different from the amount written on the "first" or named insured. A single mother or single father wishing to insure a child under his/her coverage would be an ideal market for a second insured rider. Miscellaneous Life Insurance Concepts Keyman Life Insurance - Businesses often insure persons who vitally contribute to the success of the business. The death benefit indemnifies (insures) the business against losses that could occur if the key person were to die. Funds received by the business would help solidify the continuity of the business and provide funds to seek a capable replacement. These funds would also help the business with any interruption in business due to the loss of the key employee. Buy-Sell Agreement - is a formal written arrangement specifying the terms and conditions for the retirement of, or passing of, a business interest. Characteristics of a buy-sell agreement include: -16-

18 It is a contractual agreement and not a life insurance policy. Life insurance is used for the purpose of "funding" a written agreement and providing funds for the retirement of the business interest caused by death. The agreement establishes a price for the business interest removing the need to negotiate with heirs. The agreement binds all parties mandating that, due to a death, the survivor(s) must buy and the decedent's estate (executor/administrator) must sell the business interest for the price stipulated in the agreement. A properly written buy-sell agreement will not only address the issue of death, but will also define how, when and the term under which a business interest will be retired due to a total and permanent disability or the retirement of a partner or stockholder. Parties to a buy-sell agreement may be a partner or partners, stockholder or stockholders, a trust or a corporation. There are two types of buy-sell agreements: 1. Cross Purchase The parties to a cross purchase agreement are the owners of the business and the insurance funding this agreement is owned by the business owners. 2. Entity Purchase With this agreement, the business is the entity agreeing to retire the owner s interest in the business. Any insurance funding in this agreement is owned by the business (the entity). Split-Dollar Plan - is an arrangement where a designated employee and his/her employer split the cost of a life insurance purchase for the benefit of the employee. Under such an arrangement, a policy is purchased on the life of the designated employee and the employer pays a portion of the premium each year so that at any time the total employer contributions to date do not exceed the sum of the policy cash value at the end of the current policy year. Each year, the employee pays the remaining portion of the premium. Such an arrangement is usually used as a reward to a valued employee without risk or cost to the employer. This arrangement enables the designated employee to purchase life insurance for much less than he otherwise would pay for such protection. If the employee dies while the split-dollar plan is in effect, the employer receives from the proceeds an amount equal to the cash value of the policy or his premium payments and the employee's beneficiary receives the balance of the proceeds. In a much broader sense a "split-dollar life insurance plan" has come to mean any plan of life insurance under which the right to benefits and/or the obligation to pay premiums is split between two individuals or entities, one of whom has a need for life insurance protection, and the other a reason to assist financially in providing such protection. -17-

19 I. Whole Life A. Types of Policies Summary Types of Policies 1. Continuous Premium (Straight Life) 2. Limited Pay 3. Single Premium 4. Endowment B. Characteristics 1. Builds Cash Value 2. Endows (matures) at age Level Premiums 4. Permanent Protection 5. Mode - monthly; quarterly; semi-annually; annually 6. Loans - Yes, generally at a guaranteed interest rate stated in policy 7. Partial Surrender - No. Only a full policy surrender 8. Non-forfeiture Values a. Loan or cash surrender value b. Reduced paid-up c. Extended term 9. Dividends a. Participating policies only b. Cannot be guaranteed c. Return of over-charge of premium d. Non-taxable; interest is taxable II. Term A. Types of Policies 1. Level Term 2. Decreasing Term 3. Increasing Term B. Characteristics 1. No cash value 2. Temporary - must die within term of policy for death benefits to be paid 3. Mode monthly; quarterly; semi-annually; annually 4. Term varies from 1 year to 30 years 5. Premium - lower cost per $1,000 because there is not CV buildup -18-

20 a. Can be level for the term. b. Can be step-rate; ranging from 1 year to every 5 years; 10 years, etc. 6. Renewable a. May be written in policy provisions or by rider b. Allows insured to renew policy without evidence of insurability c. Premium usually increases at renewal 7. Convertible a. May be written in policy provisions or by rider b. Allows insured to convert without evidence of insurability. Conversion is to a permanent policy which builds cash value c. Conversion date varies by company d. Conversion either at original age: 1. Must pay difference between lower cost term and higher cost WL, plus interest, in lump sum 2. Advantage - builds some CV immediately 3. Disadvantage - must pay lump sum e. Conversion at attained age (present or current age at conversion) 8. Uses a. Can fill the need where greatest amount of protection for lowest cost is appropriate b. Decreasing term - protect mortgage, installment loan, business loan, time period children in college III. Specialized Policies A. Family Income 1. Combination of WL and decreasing term policies 2. Provides monthly income from date of death for remaining years of term. Counting of term years begins at issue date of policy. 3. Term usually varies from 10 years to 20 years 4. Most companies pay the WL benefits after final term payments 5. No monthly income if insured out lives term Example: Insured is age 30 when policy is purchased with 20 year term. Dies 5 years into term. Company pays income for remaining 15 years of term. If insured lives beyond age 50, no income paid - only WL benefits B. Family Policy 1. Combo of level term and WL 2. No monthly income 3. Permanent insurance on breadwinner; term on spouse and children 4. Term insurance provided for each child born or adopted after policy issued at no additional premium -19-