LIFE INSURANCE KEY FACTS

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1 GENERAL INSURANCE CONCEPTS LIFE INSURANCE KEY FACTS A condition that could result in a loss is known as an EXPOSURE. An insurer is responsible for all acts of their agents as long as the agent operates within the SCOPE OF THEIR AUTHORITY, which is contained in their agent s contract. Parties to a contract must have legal capacity. A person who is considered to be SANE has the capacity to enter into contracts. A proposal communicated from one party to another is known as an OFFER. The exchange of value is the CONSIDERATION for a contract. SPECULATION is not an element of an insurable risk. Self insurance makes sense if future losses are PREDICTABLE. Individuals or insurers who join together in a syndicate to underwrite risks are known as a LLOYDS ORGANIZATION. When an insurer elects which risks to reinsure and the reinsurer elects which risks to accept, it is know as FACULTATIVE reinsurance. The state insurance department looks at an insurer s legal reserves in an effort to determine SOLVENCY. The SECURITIES AND EXCHANGE COMMISSION (SEC) enforces federal securities laws. The NATIONAL ASSOCIATION OF SECURITIES DEALERS (NASD) regulates their own members to assure they are in compliance with federal securities rules and regulations. Counter-offers that modify the original application must be signed by BOTH the agent and the applicant. Applicants should be aware that a misstatement of a material fact on the application could affect coverage. The insurer s EXPENSES are a factor in determining the premiums charged. 1

2 Under the FAIR CREDIT REPORTING ACT, a customer must be informed of the source of the report if adverse underwriting action results. An agent must give an applicant a CONDITIONAL RECEIPT upon accepting the initial premium payment. REBATING part of the commission to the client is an Unfair Trade Practice. SHARING commissions with agents with like licenses is permitted. A group MAY NOT be formed just to buy insurance. It is NOT a violation to sell insurance to residents of other states if the agent has a nonresident license in those states. Risk is defined as an uncertainty of loss. Misrepresenting a policy provision after a loss is an example of an unfair claims settlement practice. An insurer domiciled outside of the US and selling in the US is an ALIEN insurer. A person adjudged sane CAN enter into a legally binding contract. Reserves are an insurer s future obligations to its policyholders. Insurers purchase reinsurance for a number of reasons but NOT to stabilize profits. An insurer CAN legally pay a commission to a person who is no longer licensed, as long as that person was licensed when they earned the commission (sold the policy). A breach of warranty can void coverage. The law of large numbers states that the more individual risks that an insurer takes on the easier it becomes to predict future losses. However, the insurance company will still be unable to predict who individually will have a loss. An AUTHORIZED insurer is an insurer who is licensed to legally sell within a state. The authority that is granted in an agent s contract is known as EXPRESS authority. The requirement that both parties must bring value toward the contract is CONSIDERATION. It is NOT a violation of the Fraud and False statements regulation to sell insurance in another state as long as the agent holds a non resident license. 2

3 A person who has violated the Fraud and False statements regulation is referred to as a restricted person and can only sell insurance in a state with written approval from the Insurance Commissioner of that state. LIFE INSURANCE Upon cash surrender of a whole life policy, any amount received in excess of the premiums paid is TAXABLE AS ORDINARY INCOME. The SAME RULE also applies to cash surrender of a modified endowment contract. For example, if a client with a $100,000 MEC with a cash value of $50,000 had paid in $25,000 in premiums, upon cash surrender 50% of the cash value would be subject to tax as ordinary income. When taking cash surrender of a 403B tax sheltered annuity under age 59 ½, ALL proceeds received are taxable as ordinary income PLUS are subject to an IRS 10% early withdrawal penalty. Proceeds of a life insurance policy are NOT taxable. Adjusting the premium paid on an ADJUSTABLE WHOLE LIFE policy will affect the face amount, and vice versa. Don t get confused. UNIVERSAL LIFE is actually a type of WHOLE LIFE, so always go with what you know! UNIVERSAL LIFE has many of the same features as whole life, such as: Taking a loan will affect the rate of cash value accumulation, a percentage of the premium paid is allocated to cover the cost of mortality (death), and the company will subtract administrative expenses from the cash value. However, death benefits are not taxable. FIXED ANNUITIES pay a CURRENT INTEREST RATE the first year, which could decline in subsequent years. Life insurance proceeds create an IMMEDIATE ESTATE for the beneficiary. INSURABLE INTEREST must exist at the time of application. For ESTATE CONSERVATION purposes, a beneficiary should select the INTEREST OPTION. A JOINT LIFE policy only pays when the first party dies. On a JOINT LIFE ANNUITY, payments stop when the first annuitant dies. 3

4 The annuitant and the owner of the annuity are not always the same person. Only the owner of the contract can change the beneficiary. Insurers take the money from annuitants who die too soon and pay it to those who live too long. One purpose of an annuity is to keep customers from outliving their savings. An annuity with no accumulation period that is used to annuitize a lump sum right away is known as an IMMEDIATE ANNUITY. Upon annuitization, an annuity will pay the annuitant a monthly income for life. EQUITY INDEXED ANNUITIES are designed to pay a monthly income for life that keeps up with the performance of the stock market. A deferred annuity can only be surrendered for cash during the accumulation (or pay in) period. Employers may use annuities to fund deferred compensation plans BUT NOT corporate pension plans. An applicant with a dangerous hobby (such as a student pilot) may pay more than the standard rate. A policy that provides for business continuation in the event that a business partner dies is based upon a CROSS PURCHASE BUY/SELL agreement. A corporation may buy a policy on a shareholder to provide for STOCK REDEMPTION in the event of the shareholders death. When life insurance is purchased as an EXECUTIVE BONUS plan for a corporate employee, the policy belongs to the employee. It is the face amount that decreases on a decreasing term policy, NOT the premium. The premium paid for a single premium whole life policy will pay the policy up for the LIFE OF THE POLICY. REPLACEMENT of life insurance is not illegal as long as it is not detrimental to the client. Most group life is written as ANNUAL RENEWABLE TERM insurance. Convertible term is convertible based upon the ATTAINED AGE of the client. 4

5 The REDUCED PAID-UP non-forfeiture option will provide coverage for life. A policy written on the life of a child DOES NOT pay any benefits when a parent dies. When offering GROUP coverage, insurers must accept all eligible employees who apply. On CREDIT LIFE, coverage is limited to the amount of the loan. When an insured dies during the grace period without paying the premium due, the face amount is paid to the beneficiary, less the overdue premium. Interest on a life insurance loan is added to the amount of the loan as it accrues. Under the misstatement of age clause, if the client understates their age, it is the face amount that is reduced. When an insured lists a group of people as beneficiaries, it is known as a CLASS DESIGNATION. WAIVER OF PREMIUM is a rider that will pay the premium after a short waiting period if the insured becomes totally disabled. When adding a CHILDREN S TERM RIDER, all of the insured s children are covered for a single flat premium charge, no matter how many. To avoid withholding taxes when rolling over a qualified plan, participants should utilize a TRUSTEE TO TRUSTEE roll over. 403b Tax Sheltered Annuities (TSAs) are owned by the employee, not the employer. QUALIFED RETIREMENT PLANS offer special tax advantages to both the employer and the employee. The Employee Retirement Income Security Act (ERISA) is administered and enforced by the federal DEPT OF LABOR. On IRAs, the 10% premature distribution penalty is waived upon disability or death, for medical expenses and for first time home buyers, but not for BANKRUPTCY. On term life insurance, the RE-ENTRY option is contingent upon the insured passing a physical exam. Insurance products that have a fixed rate of return are guaranteed by the insurer s GENERAL ACCOUNT. 5

6 If the insured/owner of a life policy does not designate a settlement option prior to death, the beneficiary may choose whichever option they want. When a corporation sets up a qualified retirement plan to contribute a portion of their net income for the benefit of employees, it is known as a PROFIT SHARING plan. When a client exchanges his life insurance policy for another life insurance policy written by the same or a different company in order to defer taxes, it is known as a 1035 EXCHANGE. A trustee to trustee roll over will eliminate any withholding tax and defer current taxation on accumulated funds. Example: Jill leaves her company and has the trustee of her current pension plan cut a check to the trustee of her new retirement account (not Jill). Had the check been made out to Jill then there would have been a 20% withholding. However, since it was made out to the trustee of her new account it is considered a direct or trustee to trustee rollover and no tax is due. The owner of the annuity is responsible for paying the premium. Decreasing term is the type of life insurance policy provided in mortgage redemption insurance. The type of policy best suited to cover a 30 year mortgage is a 30 year decreasing term policy. If a person purchases a whole life policy and adds a return of premium rider they will receive a level (whole life) and increasing (the return of premium rider is a type of increasing term) amount of insurance. Industrial life policies have low limit face amounts. Whole life insurance will pay the face amount to the insured if they live to age 100. Equity Indexed Annuities have low purchasing power risk (inflation risk) since their rate of return is based in part on an equity index (such as the S&P 500). Annuities have many uses such as lottery payouts and structured settlements. A corporation CANNOT use an annuity to built tax deferred growth on corporate assets. A stock redemption plan is an agreement whereby a corporation agrees to buy back stock of a deceased shareholder. A viatical settlement is an agreement where a terminally ill insured sells their life insurance policy to an investor to pay for medical expenses. In a viatical settlement the insured will receive LESS than the policy limit from the investor. 6

7 When an insured is terminally ill they can apply to receive a portion of the death benefit from the insurer prior to death. This is known as accelerated benefits. The waiver of premium rider does NOT pay a cash benefit to the insured. If the insured becomes disabled for a certain period of time this rider will waive the insured s premium. Life insurance covers death due to sickness or accident. If an individual takes distributions from an IRA prior to age 59 ½ they will have to pay ordinary income tax in addition to a 10% penalty. There is NO dollar limit on the amount that can be rolled over in a qualified plan. If an individual exchanges on annuity for another annuity there is no current tax due. This is an acceptable 1035 exchange. Keogh plans are qualified plans for the self employed and partners. Pension and Profit Sharing plans have tax advantage to both the employer and employee. The contributions are not included in the employees gross income and the growth in the account is tax deferred (both are of benefit to the employee). An employee covered in a group life insurance policy will receive a certificate of insurance as their proof of coverage. If an outstanding policy loan plus interest exceeds the cash value of the policy the policy will lapse. In relation to modified endowment contracts a material change is defined as any INCREASE in the DEATH BENEFIT under the contract. An individual who is age 65 and is ready to retire may want to purchase an immediate annuity. Policy dividends can NEVER be guaranteed. If the insured selects the interest dividend option the interest the insurer pays the insured is taxable as ordinary income. If the beneficiary takes the policy proceeds in a LUMP SUM the spendthrift clause WILL NOT apply. The contingent beneficiary will receive policy proceeds if the primary beneficiary predeceases the insured. 7

8 An absolute assignment is a permanent transfer of all ownership rights. If an annuitant selects a payout option that will continue payments to their beneficiary for a set period of time should they die they have selected a period certain annuity. If an annuitant selects a payout option that does not include a beneficiary they have selected the straight or pure life income annuity. A juvenile life policy is a life insurance policy written on the life of a minor. The total cost of premiums the insured pays over a 12 month period is known as the Gross Annual Premium. The insurer must provide to all prospective life insurance purchasers both a Buyer s Guide and Policy Summary. A life insurance applicant must sign a HIV consent form prior to being tested for HIV. The HIV consent form must also state that the results of the test will only be shared with certain individuals (such as the underwriter). The insurance agent is sometimes referred to as a front line underwriter since they get to meet the applicant in person. The agent aids the underwriter in classifying the applicant. However, it is the underwriter who determines the applicant s rate, not the agent. In life insurance the incontestability clause last for a period of two years. An irrevocable beneficiary cannot be changed without consent of both the owner of the policy and the irrevocable beneficiary. Surrender penalties levied by the insurance company will reduce the amount the owner receives upon cash surrender. A parent of a minor does NOT need the minors consent in order to purchase life insurance on them. Decreasing term is the type of policy used in group credit life insurance. If an annuitant selects a pay out option that will pay them $500 per month for an unspecified period of time they have selected the fixed amount pay out option. If an annuitant selects a pay out option that will pay them for a certain period of years they have selected the fixed period pay out option. 8

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