1 - 1 introduction to life insurance principal uses estate building and conservation income needs...

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Introduction To Life Insurance

Principal uses Estate building and conservation

Income needs of dependants

Federal and state death taxes

Pay debts

Children's educations

Efficient wealth transfer

Special needs

Charitable intentions

Lifetime annuity

Chapter 1Tools & Techniques of Life

Insurance Planning

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Principal uses (cont'd) Business needs

Funding buy-sell agreement

Funding nonqualified deferred compensation plans

Funding death benefit only (DBO) plans

Financial security from families of employees

Recruit, retain and reward key employees


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Principal uses (cont'd) Advantages

Immediate cash available at death of the insured

Proceeds bypass probate estate

No public record of benefit amount or beneficiary

Creditor protection (amount varies by state)

Cash values provide immediate cash through policy loans

Income tax free death benefit


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Principal uses (cont'd) Advantages (cont'd)

Proceeds often exempt from state inheritance tax

Increase in cash values are income tax deferred

Disadvantages Not available for those in poor health

Products can be complex and difficult to compare

Opportunity cost associated with alternative investments


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Legal Aspects Life insurance is a contract

Between the insurance company and policyowner

Standard provisions Parties to the contract Insurance interest Legal form and contents of the contract Rights of the insured Contestability Grace period Suicide clause Misstatement of age Dividend options


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Legal Aspects (cont'd) Standard provisions (cont'd)

Non-forfeiture options

Settlement 0ptions

Reinstatement provisions

Policy loan definitions

Crediting rates

Policy assignment


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Tax aspects Premiums are not income tax deductible(In general)

Exceptions Group policies Premiums paid by employer as part of a 162 bonus plan Premiums paid for policy subject to an alimony agreement premiums paid for a policy owned by and payable to a charity

Dividends Generally not taxable income to the policy owner

Dividends received in cash taxable once cumulative dividends received exceed policy owners basis

Withdrawals & Loans Withdraws up to basis and then policy loans accessed income tax free

For properly structured policies


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Tax aspects (cont'd) Modified Endowment Contracts (MECS)

Withdrawals & Loans taxed under the interest 1st rule Additional 10% tax if done prior to age 59 & ½

Death benefits still received income tax free

Interest on loans for corporate owned life insurance not tax deductible Exception for corporate owned life insurance on key employee

Interested paid after 10/13/95 Limited to policy loans under $50,000

Loan interest on policies purchased for investment purposes Deductible to extent it does not exceed taxable investment income


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Tax aspects (cont'd) Transfer for value

For policies sold for monetary value

Proceeds in excess of policyowner basis are taxable income

Exceptions (For policies transferred to:) The insured

A partner of the insured

A partnership in which the insured is a partner

A corporation in which the insured is a shareholder or officer


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Tax Aspects (cont'd) Alternative Minimum Tax (AMT)

Corporate owned insurance proceeds payable to the corporation may be subject to the AMT

Incidents of ownership Proceeds will be included in the estate of the insured for federal estate tax purposes if the

insured held any “incidents of ownership” in the policy

Examples Right to designate policy beneficiary

Right to take policy loans

Right to assign policy as collateral


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Tax Aspects (cont'd) Gift taxes

Death Proceeds payable to someone other than owner-insured are not treated as gifts

Premium payments are not generally considered gifts where someone other than the insured or insured estate are named as beneficiary

Economic Aspects Life insurance as an investment

Capital accumulation vehicle with

Death benefit protection and

Savings component


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Premium pricing and cash value calculations Risk shifting and risk sharing

Every insured’s premium contains a small charge to cover the expected deaths claims for the insurance carrier

Insurance carriers can calculate the number of expected deaths per year with great accuracy

Therefore they know how to spread the costs among all insured’s

Premium and costs Common misconception – higher premium means higher costs

All policies are calculated to be actuarially equivalent on a present value or prospective basis


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Premium pricing and cash value calculations (cont'd) Premium and costs (cont'd)

The after tax cost to the insured will vary substantially depending on the policy purchased When death occurs

Interest rates Insurance company assumptions

Interest earned on assets

Mortality experience on pool of insured’s

If reserves earn higher interest, then premiums can be lower

If reserves earn lower interest, then premiums can be lower

Companies will credit a guaranteed minimum interest typically around 4-4&1/2 % for permanent and universal life insurance policies


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Premium Pricing and Cash Value Calculations (cont'd) Mortality, morbidity & the law of large numbers

Mortality Number of deaths in a given period of time

Expressed as proportions to the total population Such as- per 1,000, 10,000 or100,000 lives

Actuaries compute mortality tables based on demographic factors

Morbidity Incidence of disease within a community


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Premium pricing and cash value calculations (cont'd) Law of large numbers

A principle that the larger the number of exposures considered, the more closely will reported losses equal the true probability of loss. This is the basis for the statistical expectation of loss, which determines premium rates.

Adverse selection & moral hazard Adverse selection

The tendency of people who are less that standard risks to seek insurance to a greater extent than others

Stacking against the insurance company

Affects profitability and premium rates

Moral Hazard People with insurance may take greater risks because they know they are protected


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Underwriting process Classify insured’s by their risk characteristics

Age, sex, occupation, smoker/nonsmoker, habits

Classification types Standard, preferred, preferred plus etc Varies by carrier

Expense and risk loading Commissions

Administrative expenses Advertising, salaries, marketing, promotional

Lapse rate expenses

Excess mortality reserves


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Participating and nonparticipating policies Nonparticipating

Premiums, cash values and death benefits are guaranteed

Competitive pressures have made these products unattractive

Participating Policyowner’s participate in the favorable experience of the company through dividends

Dividends considered a return of investment Considered a nontaxable return of overpayment of premium


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Participating and nonparticipating policies (cont'd) Participating policies (cont'd)

Dividends considered a return of investment Considered a nontaxable return of overpayment of premium

Policyowner’s given multiple choices as to dividend options In cash

Purchase Paid-up additions

Reduce premium’s

Accumulate with interest


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Participating and nonparticipating policies (cont'd) Participating policies (cont'd)

Dividends are not guaranteed

Current assumption products More favorable experienced than assumed in credited to the policies cash value

Policyowner can apply favorable experience in different ways Reduce future premium payments

Increase future coverage amounts

Shorten the number of future premium payments


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Participating and nonparticipating policies (cont'd) Variable life insurance policies

Policyowner bears all invest risks and rewards

No minimum guarantee with regard to cash values

Policy owner elects sub-accounts to allocate premium dollars

Two levels of expenses Fund level expenses

Management and operating fees

Policy level expenses Sales loads, cost of insurance, administrative fees etc.


Insurance Planning

1 - 1 introduction to life insurance principal uses estate building and conservation income needs...

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