MODERN
LIFE
INSURANCE
(Review
SUMMARY)
C.E.I.S.
CONTINUING EDUCATION INSURANCE
SCHOOL OF FLORIDA, INC.
www.ceisce.com
12360 US HWY. 19
HUDSON, FL. 34667
1-800-783-9440
ceisce@aol.com
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CHAPTER ONE
BASICS OF LIFE INSURANCE
DEFINITION OF LIFE INSURANCE
Solomon Huebner, the grand old man of the life insurance industry, stated in “Life
Insurance, a Textbook” written in 1914: “Mankind is exposed to may serious hazards
such as fire, disability and premature death, the happening of which, from the
standpoint of the individual, it is impossible to foretell or prevent, but the effect of
which, such as the loss of propert y or earning, it is highl y important to provide
against. If the hazard under consideration is that of premature death, the loss suffered
is indemnified through life insurance.
ACCUMULATING A FUND FOR PAYMENT OF CLAIMS
While all forms of insurance are alike in that they required for their successful
operation a combination of man y risks in a group, they are vitall y different as regards
the nature of the risks covered. In this respect, the chief difference between life and
other forms of insurance is that in the latter the contingency insured against may or
may not happen, and as regards the great majorit y of policies written, does not happen,
while in life insurance the event against which protection is granted, namel y death, is
a “hazard converging into certaint y.”
Since life insurance policies promise a definite sum in the event of death, and in
some instances in the event of survival at a stated time, it is essential that there be an
accurate determination of the liabilit y involved and that an adequate premium be
charged which is just as between ages and t ypes of policies.
Life insurance presents a further problem as regards the accumulation of the fund
necessary to pay policy claims. A workable plan of life insurance required the charge
of a uniform annual premium during the premium-paying period. Simpl y put, a life
insurance policy is composed of a series of one-year renewable term (annual
renewable term) and each year’s premium just covers the cost of the protection.
Under this simple plan, however, as each person ages, the premiums soon become
prohibitive with the result that the healthy members of the group will withdraw rather
than continue to pay the greatl y increased rates.
In order to overcome a problem—the premium must be increased with age—during
the earl y years, the compan y accumulates sufficient funds over and above the cost of
current insurance. This “overcharge” does not belong to the company but is held in
trust with the insurer for the benefit of the insured at an assumed rate of interest for
this purpose.
POOLING OF THE RISK
There are man y other definitions of Life Insurance but the “spreading of risk” and
the “transfer of risk” are the two most common and most accurate in discussing life
insurance in today’s societ y.
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The very basic element of these definitions is the pooling of risks, the sharing of
losses by members of a group. There are various ways to share the risk in Life
Insurance, but principall y it is an arrangement where the members of the group
“insure” each other, or the risk is transferred to an organization that assumes the risk
and pays the losses of the group. For this purpose of this discussion, the very heart,
the “essence,” of life insurance—indeed, all insurance plans—is the pooling of the
risks and losses.
POLICY PROVISIONS
First, it should be understood that a life insurance policy is a legal contract, and as
such, legal terminology is the most correct way to address the subject. The terms of
the contract are drawn up b y the insurer, and the policyholder either accepts the terms
or not.
A t ypical application informs the applicant that the agent cannot alter the wording
or an y provision in the policy. For the applicant, it is a take-it or leave-it proposition.
STANDARD POLICY PROVISIONS
The standard policy provisions laws of the various states require that life insurance
policies include certain provisions but allow the insurance companies to select the
actual wording with the proviso that the wording is approved to the State Department
of Insurance.
REQUIRED PROVISIONS
Grace Period
The grace period clause grants the policyowner an additional period of time to pay
any premium after it was due.
POLICY LOANS
An insurer is required b y law to allow policy loans if the policy provides for cash
values. A loan on the policy simpl y transfers money to the policyowner with the
obligation that it is simpl y an advance to the policyowner from the cash value of the
policy.
Another form of loan is the automatic premium loans that are advances that the
insurer makes to the policyowner from the policy cash value to pay the unpaid
premiums.
INCONTESTABLE CLAUSE
The National Association of Insurance Commissioners Standard Policy Provisions
Model Act and the state laws based upon the Model, require that the policy contain an
incontestable clause, a provision that makes the life insurance policy incontestable b y
the insurer after it has been in force for a certain time period.
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REINSTATEMENT
Reinstatement provisions allow a policyowner to reacquire coverage under a policy
that has lapsed. The various state laws and the insurance contracts impose certain
requirements that the policyowner must meet to reinstate the policy. A t ypical
reinstatement statement requires the insurer to reinstate within a specified period
(usuall y three years) and the policy has value and the policyowner applies and
provides evidence of insurabilit y, and pays back premiums and interest, etc.
MISSTATEMENT OF AGE OR SEX
Obviousl y, since life insurance premiums are based upon the age of the insured, and
in man y cases the sex of the insured, if these factors are inaccurate, it would be a
material misrepresentation. The insurer would t ypicall y adjust the premiums and
benefits to reflect the correct age and sex.
Adjustments to the policy’s premiums and/or benefits are usuall y the actions taken
b y the insurer.
NONFORFEITURE PROVISIONS
When insurers developed the concept of level premium insurance policies, the goal
was to make life insurance affordable to elderl y policyholders. Standard Nonforfeiture
laws.
These laws require that after a cash value policy has been in effect for a minimum
number of years—usuall y three—the insurer must use part of the reserved excess
premium to create a guaranteed minimum cash value.
OPTIONAL PROVISIONS
In addition to the required provisions, there are numerous other provisions that are
not required nor are they prohibited.
SUICIDE PROVISION
Typicall y, a death by suicide is not covered for a specified period—usuall y two
years, sometimes one year.
OWNERSHIP PROVISION
Ordinaril y the insured is the applicant and owner of the policy and certain rights
are necessaril y spelled out. Typicall y, the policy states that the owner of the policy is
the insured unless the application states otherwise.
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ASSIGNMENT PROVISION
In keeping with normal rights of property owner, the policyowner may transfer
some or all of his or her rights to another person.
ACCELERATION OF BENEFITS
The AIDS epidemic was the catal yst for this provision, plus public concern about
other terminal illnesses. This provision permits the insured to withdraw death benefits
under certain specific conditions. This also applies to situations where the insured is
terminall y ill whereby the policyowner can withdraw part of the death benefit.
ADDITIONAL COMMON PROVISIONS
Other common policy provisions are those concerning accidental death benefits, the
guaranteed purchase option (also known as the guaranteed insurabilit y option), and the
waiver of premium in the event of the insured's disabilit y.
ACCIDENTAL DEATH BENEFITS
This optional policy provision is added to some insurance contracts in the form of a
rider, or amendment, to the policy and is also known as the double indemnit y provision
because it normall y doubles the standard death benefit if the insured dies accidentall y.
DEFINITION OF ACCIDENTAL DEATH
Because this benefit is payable onl y in the event of the insured's accidental death,
many policies define “accident,” and “accidental death.”
There are two t ypes of accidental death clauses: (1) the accidental result t ype and
(2) the accidental means t ype. The most common t ype of provision in life insurance
policies is the accidental result category. This is more favorable to the consumer,
further, most courts have recognized that the difference between the two clauses is too
difficult for man y consumers to understand and have therefore ceased to recognize a
distinction between the two t ypes of clauses.
The distinction can be explained as follows: under an accidental means clause both
the cause (means) of the death and the result must be unintentional. Under an
accidental result clause, onl y the result must be unintentional.
GUARANTEED PURCHASE OPTION (GPO)
The guaranteed purchase option is quite popular – also known as the guaranteed
purchase option. This is a relativel y new provision. It protects policyowners
against the possibility that they might become uninsurable, right when they need
and want to purchase added coverage. The GPO give the policyowner the right to
acquire additional insurance in specified amounts at specified times or ages—such
as allowing additional purchases every 3 years and after the birth of a child—
provided the events occur before the insured reaches a specified maximum age
(often 45). The right to purchase additional insurance can be very valuable because
the insured does not have to provide evidence of insurabilit y to exercise the option.
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CHAPTER TWO - TERM INSURANCE
BASICS OF TERM INSURANCE
Term insurance provides protection for only a specified and limited period, and if the
insured dies during the period while the insurance is in force the beneficiary will receive the
death benefit amount. If, however, the insured survives to the end of the insured period, the
policy terminates and there is nothing paid to the insured.
Term insurance is, obviously, temporary insurance, and in many ways is comparable to
types of property and casualty insurance. In auto and homeowners insurance, for example,
premiums paid for the protection are considered as fully earned (at the end of the policy year)
whether there is a loss or not, and the policy has no further value once the policy term has
been completed.
Renewing a Term Policy
Many, if not most, term insurance policies have an option to renew for a specified period or
periods of time, which generally are all the same length of time. The YRT policy is renewable
for successive one-year periods. Term policies for longer periods of time—10-20 years
typically—usually are renewable under certain stipulations.
Convertibility
Besides offering renewability, most term policies are also convertible—permitting a
policyowner to exchange the term policy to a permanent type of insurance without evidence of
insurability. Convertibility is more important that renewability as it guarantees access to a
permanent plan, not just to coverage or continuation of temporary protection.
There are two types of convertibility: attained age and original age. With the attained age
conversion, the premiums for the permanent plan would be based upon the age of the
policyowner at which the conversion occurs. The original age conversion (also called
“retroactive conversion”) uses the original date of the term policy and premiums on the
permanent insurance would be based upon the age of the policyowner when he was first
insured under the term policy.
RE-ENTRY TERM
Because the element of adverse selection is so troublesome, insurance companies invented
a term insurance policy that charges higher premiums to those of poor health when they renew
their term insurance, ergo; the degree of adverse selection is reduced.
THE PLACE OF TERM INSURANCE IN TODAY’S MARKET
Even though term insurance may be the oldest form of life insurance, except possibly the
assessment plans, it still has a place in today’s societies. There are those who maintain that all
life insurance should be term insurance as it fills all life insurance needs.
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WHEN TERM INSURANCE SHOULD BE USED
It is obvious that there are two areas where term insurance may be or should be used.
Since term insurance provides temporary protection, then that is one of the areas where it
should be used—to provide temporary protection.
The second area where term insurance is suitable is when the need for insurance may be
permanent, but the insured simply cannot afford permanent insurance to provide the coverage
needed.
OBJECTIONS TO OTHER FORMS OF INSURANCE
The most often used—and the easiest to explain to a prospect—reason not to buy
permanent plans is that it is more expensive. A person buys life insurance so as to leave
money to his beneficiaries in case he dies early or during his income-producing years and that
should be the only purpose of life insurance.
The basic argument is that why should anyone pay in advance for something that they may
not need or live to enjoy? Term insurance, however, is a method of “paying as you go and you
get what you paid for.”
BUY TERM - INVEST THE DIFFERENCE
The “buy term and invest the difference” philosophy as extolled by some, needs further
consideration and discussion as it is based upon the proposition that individuals can invest
their funds as efficiently and profitably as can the insurer, and usually at a higher rate of
return.
Those who preach the “buy-term-and-invest-the-difference” philosophy use this argument, and
therefore they recommend that an individual buy term insurance and the difference in what they would
have paid for level premiums, they can invest in a separate program.
All investments have their place in an individual’s financial and/or estate planning
programs but life insurance is normally the very foundation of such a program or plan, and
rightfully so.
CHAPTER THREE - WHOLE LIFE INSURANCE
PRINCIPAL TYPES OF WHOLE LIFE INSURANCE
Ordinary life insurance is a t ype of whole life insurance that requires premiums for
the entire life of the insured.
Permanent Protection
Basicall y, the term of insurance is always there so that policy does not have to be
renewed or converted. Just as long as the policyholder pays the premium, the
coverage is there for as long as premiums are paid.
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Limited-payment insurance contracts provide benefits that justify the higher
premium rates.
Policy Loans
Policyowners have cash values at their disposal for all level premium life insurance
policies such as whole life, universal life, adjustable life, variable life, variable
universal life, and current assumption whole life—all have provisions for policy loans.
Policy loans simpl y provide a cash value access to the policyholder without having to
terminate the policy.
When the loan and/or accrued interest are not paid to the insurer in cash, the
insurer can withhold such funds from the death benefits if the insured dies or from the
cash surrender value if the policy is terminated.
It must be kept in mind that a policy loan, per se, is simpl y an advance against the
death benefit, therefore the death benefit is adjusted to reflect the previous
disbursement. When the insured dies, the death benefit is reduced by the full amount
of outstanding policy loans and accrued interest under most t ypes of policies.
Nonforfeiture or Surrender Options.
One of the most important contract provisions with whole life is the nonforfeiture
options—also known as surrender options. Basicall y there are three surrender
options—cash, reduced amount of paid-up whole life insurance, or paid-up term
insurance.
Cash Value.
Standard wording states that the policy may be surrendered at any time for its cash
value, then the protection terminates and the company has no further obligation under
the policy.
Reduced Amount of Paid-Up Whole Life.
The amount of the policy is the amount that could be purchased at the attained age
of the insured which would be the net cash value—cash value less any policy
indebtedness (such as policy loans and interest) plus any dividend accumulation as the
original policy.
Paid-Up Term.
A no t he r ( t h e t h i r d ) o p t i o n p r o v i d e s p a i d - up t e r m i ns u r a nc e i n a n a m o u nt e q ua l t o t he
o r i g i na l f a c e a m o u n t o f t h e p o l i c y , p l u s d i v i d e n d a d d i t i o n s o r d e p o s i t s a n d r e d u c e d b y a n y
p o l i c y i nd e b t e d n e s s . T h e l e n g t h o f t he c o nt r a c t w o ul d b e w ha t c a n b e p ur c ha s e d a t t he
i ns ur e d ' s a t t a i n e d a g e w i t h t h e n e t c a s h v a l ue a p p l i e d a s a ne t s i ng l e p r e m i um .
Limited-Payment Life Insurance
The policyholder pays a premium for a predetermined number of years and he keeps
his policy for the rest of his life.
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The Face Amount
This policy has a death benefit that is guaranteed to stay level for as long as the
policyowner owns it, even up to age 100. The face amount is usuall y paid out income
tax free to the beneficiary. It can be paid in one lump sum or in the form of a monthl y
income.
ADJUSTABLE LIFE INSURANCE
As young families looked toward the future, particularl y their children’s
educational needs, it was apparent that a famil y’s financial needs varied throughout
their lifetime. Life insurers were particularl y sensitive to this need—after all,
providing funds for the future is what they do—and they introduced whole life
insurance that can be adjusted when needed during the life of the policy, hence, the
Adjustable Life Insurance policy was born.
Adjustable Life policies have the same guarantees as cash value, mortalit y and
expenses as regular whole life, but the premiums, face amount and cash value are
subject to change.
CURRENT ASSUMPTION WHOLE LIFE INSURANCE
A current assumption whole life (CAWL) provides a “bridge” between traditional
insurance and interest sensitive “new generation” products. In effect, a CAWL is
called “interest sensitive whole life” by some, and called “indeterminate-premium
whole life” b y others. The policy will use interest rates that reflect the new-money
rates and will also use the current mortality charges in determining the cash value.
Because CAW L policies are “unbundled,” much like Universal Life, there is a
stated allocation of premium payments and interest earnings to the mortalit y charges,
expenses and cash values. To be specific, the premiums paid are designated expense
charges, and the remainder is a (net) addition to the policy fund that is added to the
previous policy fund balance and any interest (at the current rate) that has
accumulated on the fund. From this fund total, a mortalit y charge is levied, and the
remaining amount is the year-end fund balance. This balance, less any stipulated
surrender charges, would be the net surrender value if the policy were to be
surrendered.
GROUP LIFE INSURANCE
Group life insurance is an important part of the life insurance industry, accounting
for about 40% of all life insurance in force by amount with an average certificate of
$32,000.
GROUP INSURANCE REQUIREMENTS
While groups eligible for insurance coverage can cover a wide variet y of
professions, industries, etc., there are, at times, questions as whether loosel y joined
groups of people qualify as a “group” for insurance purposes.
It is “etched in stone” that a group cannot be qualified for group insurance if
the group was been formed for the purpose of obtaining insurance.
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Participants
Generall y, onl y active, full-time employees are eligible for group coverage.
Probationary Period
Emplo yees usuall y have a probationary period, usuall y one to six months, during
which they are not eligible for coverage.
Coverage Period
The coverage period is usuall y the length of time that the employee remains with
the emplo yer (assuming the plan stays in force with the employer and the employee
pays their share of the premium, if any).
Benefit Amount
Typicall y, the employee does not specify the benefit amount and the amount is
usuall y (1) a set amount for all employees, (2) a percentage of the employee’s income
with the emplo yer, (3) an amount that is designated for the position the employee
holds (job title), or (4) a function of the employees length of service. .
Type of Insurance
Group life insurance is basicall y yearly renewable term insurance.
Employee Contributions
For contributory plans, employee contributions are usuall y at a set rate per $1,000
of coverage at all ages. In most states, employers are required to pay at least a
portion of the premium.
CHAPTER FOUR - VARIABLE INSURANCE POLICIES
VARIABLE LIFE INSURANCE
A predecessor to Universal Life Insurance is Variable Life Insurance, introduced in
1976, which shifts the investment risk to the policyholders.
A variable life insurance policy provides no guarantees of either interest rate or
minimum cash value. Theoreticall y, the cash value can go down to zero, and if so, the
policy will terminate.
SEC Objections to Variable Life
There were two main obstacles in gaining SEC approval of variable life products.
The first one was the maximum compensation to agents for the sale of this product as
the SEC wanted the sales load not to exceed 8 percent of the sale price. Another
problem was whether insurance companies would be permitted to allow flexiblepremium payments under these policies.
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In the beginning, variable life insurance policies gave the purchaser (insured) three
investment options into which the funds could be directed—whether all or a
distribution in whatever portions desired among the options. Typicall y, there was a
minimum requirement of at least 5 or 10 percent of incoming funds had to be allocated
to any investment option the policyowner selected. The minimum requirement was
supposed to eliminate the chance that administrative costs would exceed the amount of
money being directed into a particular option.
The options were usuall y a stock fund, a bond fund, and either a treasury fund or a
money market fund.
VOLATILITY OF VARIABLE PRODUCTS
Those who are experienced in equit y investments may be comfortable with the
variable life insurance policy. For those without such experience, the dail y portfolio
fluctuations can provoke great anxiet y in individuals who are not used to or
comfortable with such market value fluctuations.
Increased Number of Investment Fund Options
It should not be surprising that variable life insurance policy designs have not been
static since their introduction with the result that life insurance companies are now
offering man y more investment fund options made available in the earl y stages of this
product's development. Some insurance companies have more than 4 dozen funds to
choose from in their current product offering, consisting of a wide variet y of stock
funds, including growth stock funds, income stock funds, balanced stock funds, and
international stock funds.
Man y insurance companies offer a managed fund as one of the portfolio choices.
The policyowner can put all of the policy funds in a managed portfolio fund and have
the investment allocation decisions made by a professional money manager working
for the insurance compan y.
THE PROSPECTUS
Variable life insurance policies cannot be sold without providing a prospectus
similar to that required b y stock issues. The prospectus is a full disclosure of all of
the provisions of the contract including expenses, investment options, benefit
provisions, the policyowner rights under the contract. Purchasers should take the time
to read the entire document even if it is rather lengthy and they should be aware that it
contains information that they could not receive elsewhere.
POLICYOWNER ASSUMED RISKS
As stated earlier, fixed premium variable life insurance contracts are very similar
to whole life insurance contracts – the principal difference is the policyowner assumes
reinvestment risk and therefore can participate in favorable investment returns. This
provision does not allow the policyowner to increase or decrease the death benefits b y
negotiated adjustment – if results are favorable, it is automaticall y translated into
increased death benefits amounts.
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The policy does guarantee a minimum death benefit level that is equal to the
original face amount of the contract, regardless of the investment performance.
UNIVERSAL LIFE INSURANCE
Universal Life insurance was introduced in the 1970s and had been sold in Europe.
Companies in the United States were desperate to have such a plan. The big problem
was with the problem of non-forfeiture laws that are regulated so as to eliminate such
a plan unless it is sold as a noninsurance product that would then bring the SEC into
the marketing and accounting of life insurance.
In the late 70’s three well-known and respected actuaries met at an
insurance/reinsurance forum in Monaco and were able to discover an acceptable
solution—hence Universal Life was born. It was the first variation of whole life
insurance that could offer trul y flexible premiums and also include adjustment
provisions similar those contained in Adjustable Life.
FLEXIBLE PREMIUMS
The trul y unusual feature of Universal Life was the completely flexible premiums
after the first policy year—the onl y time a minimum level of premium payments for
Universal Life insurance policy is required. Therefore, the first year’s premium can
be arraigned on a monthl y, quarterl y, semiannual or annual basis.
FUNDING CHOICES
With the introduction of Universal Life insurance, the investment risk to the
policyowner was shifted to the policyowner and as such they had to make
determination of the amount, if an y, of pre-funding. One choice is to pay maximum
premiums and maintain a very high cash value, or, on the other hand, the policyo wner
can pay minimum premiums, which just barel y will cover mortalit y and expense
charges because there is so little up front or no pre-funding.
Even though insurance companies must predict with some amount of accuracy
future interest rates investment returns, their very future depends upon policies’ cash
values if they are going to return part of the premium to policyholders. If they are
not, the insurer then may need to keep all the investment returns, and might still have
difficult y meeting the problems in the contract. Therefore, it just makes good sense to
have more premium money collected upfront, further delaying the collection of funds,
in the hope that economic conditions will be better in the future.
POLICY LOANS
There is a differential crediting rate on the cash value of Universal Life policy,
which depends on whether or not there are policy loans outstanding. If the
policyowner borrows funds from the cash value, then the insurer credits a lower
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interest rate or earnings rate to the portion of the cash value associated with the policy
loan. This is another effort to curb disintermediation.
An y outstanding policy loans when the insured dies reduces the death benefit b y
the amount of the loan plus an y unpaid interest of the loan—the same for Universal
Life policies and for an y life insurance policy that has policy loans.
LIFETIME FLEXIBILITY
Probabl y the most attractive feature of Universal Life policies, when you come
down to it, is not necessaril y the fact that the policyowner now has the abilit y to share
in excessive interest earnings but primarily the flexibilit y of premiums that have to be
paid under the policies. Life insurance policies now can keep pace with the needs of
the policyowners without "programming" various assumptions. The policy can be
funded heavil y when premium dollars are available and conversel y, they can be
suspended when the budget gets tight or new expenses arise (such as tuition).
INDEXED UNIVERSAL LIFE
The indexed product first started with fixed annuities—called Equit y Indexed
Annuit y— then spread to the Universal Life insurance policy, and they are now
holding hands as they tried to make inroads to a whole life policy. The indexed
Universal Life policies have basicall y all the features of a non–indexed Universal Life
policy but it also has a minimum interest crediting rate guarantee, therefore they are
classified as fixed rather than variable life insurance contracts by the SEC and
therefore, are not subject to securities regulation by the federal government.
The indexed feature adds the possibility of enhanced crediting rates linked to
the performance of a specific stock index such as Standard & Poor's 500.
Insurance companies usuall y provide a lower guaranteed interest rate under the
index universal policy than their standard Universal Life policies, and the reduction
can range from 50 to 150 basis points. Therefore the indexed feature must overcome
this reduction before the policyholder receives a positive net benefit from the contract.
During periods of poor stock market performance, the indexed Universal Life
policy will most likely underperform the standard Universal Life policy.
Marketing promotions for the indexed products emphasize interest guarantee plus
potential enhancement of the crediting rate from stock index increases. This may
seem to be, and is often stated, the best of both worlds as there is a guaranteed
minimum performance but still the chance to participate when the stock market goes
up.
VARIABLE UNIVERSAL LIFE INSURANCE
This is one of the most recentl y developed t ypes of whole life policies as it
incorporates all of the flexibilit y and policy adjustment features of Universal Life
with the policyowner directing the investments of variable life insurance. Fixed
premium features of the variable life insurance contract are not present in this policy.
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Variable Universal Life offers policyholder a choice among a particular group of
mutual funds management of separate accounts, usuall y created and maintained b y the
insurance compan y. Some insurance companies have made arrangements with other
investment companies to use separate account portfolios that have been created and
maintained b y these investment management firms. Basicall y, many of the separate
funds are simpl y copies of popular mutual funds available to other investors.
FLEXIBILITY
Variable Universal Life offers the maximum in both flexibility with the
policyholder and the amount of the risk has been shifted to the policyowner.
Variable Universal Life contracts are not designed for or should be even desirable
for policyowners who do not want to assume the risk of investments under the
contract. The policyowner who says they want to assume the investment risk would
become very anxious over an y short-term fall in the value in the particular investment
portfolio they have selected, and they would be wise to exercise caution.
COMPARING LIFE INSURANCE POLICY COSTS
NET COST
There are a wide variet y of methods used to compare life insurance policies and
usuall y, the net cost method is the most understood and used. The way that works is
rather simple, eas y-to-understand and actuall y even eas y to calculate. The steps are to
determine a starting point that is a specification of the duration of coverage to be
evaluated–usuall y 10 or 20 years of coverage. Then the actual mechanics of this
process involves taking all the net premiums paid under the policy, adding them
altogether, subtracting the cash surrender value for the time-frame being considered,
and all dividends paid over that period. One of the reasons this method is so easy to
understand is that it does not take into account the time value of money, e.g., it
ignores interest.
THE COMPARATIVE INTEREST RATE METHOD
There are other comparison methods that utilize and assume a cost of coverage. Creating an interest
rate for comparison purposes will also illustrate the problems of comparing any life insurance policy
because there are degrees of freedom in the parameters involved. The comparative method looks for the
interest rate that would make the buy-term-and-invest-the-difference comparison exactly equivalent in
the provided death benefits. The only way that can be accomplished would be for the premiums and
side funds to be exactly equal to the death benefit. The problem with this method is that it requires a
large amount of data input and a sophisticated computer program in order to accurately determine the
interest rate needed.
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CHAPTER FIVE - POLICY PROVISIONS & RELATION TO
DEATH BENEFITS.
POLICY PROVISIONS OF VARIABLE CONTRACTS
Certain mandatory provisions are part of a variable contract. Some of the t ypical
provisions that appl y to both variable and traditional insurance have been discussed,
but there are other important variable provisions that need to be understood.
Guaranteed Minimum Death Benefit
Variable life policies provide that the death benefit must be equal to the initial face
amount as a minimum.
Separate Accounts
This states that the cash value of the policy will be determined by the separate
account(s) activit y of the funds that are held in one or more separate accounts.
Redetermination of the Death Benefit
The policy’s face amount—death benefit—must be calculated annuall y and the
method of recalculation is provided (paid-up additions/surrenders, or the cash value
increase/decrease method).
Revaluation of the Cash Value
The separate accounts change dail y according to the investment value increase or
decrease, however the cash values supporting the policy are onl y determined
(revalued) on a monthl y basis.
Free Look Provision
Except for short-term nonrenewable policies, such as temporary policies and travel
insurance, life insurance policies have a provision that allows the policyowner to
examine the policy and provides for a full refund of premiums if the policy is returned
to the insurer, usually within 10 days after delivery or within 45 days after the
application was completed.
Incontestability
Variable life has the same two-year contestabilit y period as traditional life
insurance.
Grace Period
The same 31-day grace period as with traditional life insurance is used with variable
insurance. Note, however, that Variable Universal Life has a different t ype of
grace period. Since the VUL is an “unbundled” policy, there reall y is no connection
between the payment of the premium and the continuation of the coverage, but
whether the policy continues is a function of the cash value. If the cash value is
insufficient to maintain the cost of insurance, the policyowner will be so notified
that a premium must be paid. From that date–date of notification–the required
premium to keep the policy in force must be paid within 61 days or the policy will
lapse. Full coverage remains in force during the 61 days.
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TAXATION AND REGULATION
 The separate accounts within a VUL policy builds cash value within a life
insurance policy, therefore a VUL receives the same favorable tax treatment as
other cash value life insurance policies.
Even though it is regulated as a Securit y, it still retains its originalit y as a life
insurance policy for taxation purposes.
Death benefit proceeds are tax-free, and lump-sum benefits paid to a beneficiary
are excluded from the beneficiary’s gross income for tax purposes.
In order for a VUL policy to meet the definition of an insurance contract and obtain
the favorable tax treatment, three tests must be met:
1. Cash Value Accumulation Test
When the cash value of a permanent life insurance policy exceeds the single
premium that would pay for all future benefits, at that point the policy no longer
meets the IRS definition of life insurance. If a policy does not meet this cash value
accumulation test, the policy is “disqualified,” with the disqualification retroactive
to the policy issue date. All income credited to that policy becomes taxable to the
policyowner.
2. The Corridor Test
All VUL contracts contain a provision that defines the minimum of pure insurance
protection in comparison to the cash value amount. This minimum amount,
technicall y referred to as the guideline minimum sum insured, is the amount that
is necessary to prevent the policy from violating the IRS Corridor rules.
3. The Seven-pay Test
Another test! However, if a policy fails the 7-pay test, it still remains as a life insurance
policy, even though it loses the tax advantages of policy loans and withdrawals.
NASD CONDUCT RULES
An outline of the NASD Conduct Rules was indicated earlier. At this point, it would
be advantageous to discuss some of those rules in a little more detail as they are
very important to the marketing of Variable Universal Life.
ILLUSTRATIONS
Because the variable products are rather complex and the outcomes are not readily
and accuratel y forecast without considerable explanation and assumptions, it is rather
difficult to describe to the average consumer exactl y how a VUL functions. The life
insurance industry has a checkered past in using illustrations as a sales tool, so the
insurer’s representative or agent must be extremel y careful and must always tell the
prospect that all illustrations are h ypothetical and based on assumptions, and are
certainl y not a guarantee of cash value accumulations.
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All illustrations must show that separate account returns are what determines the
cash values as well as the death benefits, and they must show maximum mortality and
expense charges.
It is NOT appropriate to compare one policy to another based on hypothetical
performances. Further, a h ypothetical illustration can onl y show the relationship
between the cash value and the death benefit value, not whether it is “better” than
another policy.
SPECIAL NASD VARIABLE CONTRACT RULES
Variable contracts have special rules as part of the NASD rules and they appl y
mostl y to the construction of the policy and not specificall y to agent’s conduct.
Obviousl y, when the values of a contract can change dail y, it is necessary that the
value must be determined at a specific time, in this case when the payments have been
received—they are considered to have been received when the application has been
received. This further emphasizes that all applications and premiums must be
submitted to the insurance compan y’s home office promptl y.
Sales charges may not be excessive and the NASD Rules set forth what is
considered as “excessive.”
When a sales charge has multiple payments, they cannot exceed 8.5% of the total
payments due in the first 12 years of the contract or for total length if the contract
length is less than 12 years.
Section 2300 of the Conduct Rules addresses “suitabilit y” which is the
recommending of products for customers onl y when the product suits the customer’s
needs.
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CONTINUING EDUCATION INSURANCE
SCHOOL OF FLORIDA, INC.
www.ceisce.com
12360 US HWY. 19
HUDSON, FL. 34667
1-800-783-9440
ceisce@aol.com
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