Chapter 13

LIFE INSURANCE POLICIES

Life insurance is a contract. The contract stipulates that, for a financial payment (the premium), a specified party, the insurer, will pay another party, the insured, or his beneficiary, a defined amount of money upon the occurrence of death or some other specified event such as disability.

We often hear the joke that life insurance is actually "death insurance," but that is not really true. Life insurance insures one's LIFE, not their death. It would be more accurate to say that this type of policy insures one's life against death.

Life insurance policies fall into two categories:

(1) those on your own life and

(2) those on someone else's life.

As long as a beneficiary is listed, the policy will by-pass probate proceedings in most cases. The asset will, however, still need to be listed. The face value of those policies on your own life can be taken out of the estate tax by transferring the policies to the beneficiaries. Policies that you own on someone else's life should probably not go to that person in the event of your death. If they do, the cash value will be taxed on your death, and the face value will be taxed on the death of the person insured. Your will should probably direct that these policies go to the beneficiaries of the insured or to a trust for their benefit. It is important to note that tax laws change regularly. Therefore, a tax consultant should always be sought out for the most current advice.

It would probably be impossible to establish and manage an estate effectively without including life insurance in some form. Life insurance is an important estate planning tool used by nearly every estate planner. It can be used to provide cash for the payment of estate and inheritance taxes (where inheritance taxes apply), debts, administrative costs and other estate expenses.

There are, of course, varying types of life insurance. While most agents have personal preferences, nearly every type of life insurance works well in some specific situation. In other words, each type of life insurance has its proper place. The experienced agent makes the best use of each type of life product rather than attempting to use only one type for every case. In fact, an agent who attempts to use only one type of product either (a) has few products to choose from, or (b) has not been well enough informed regarding the various products available and their financial uses.

Term Insurance

Term life insurance does not build cash reserves. Term life is often combined with other products, such as annuities or mutual funds.

Under term insurance:

1. The insured must die before the term expires (the period of time under which the policy is effective).
2. At the expiration of the term the insurance ends. A new term may be started, however, depending upon the terms of the policy.
3. The cash outlay (premium) can be relatively low, especially at the lower ages. The opposite may be true at older ages, however.

Even within the types of insurances, there can be sub-categories. Term insurance has basically four categories although there can be variations of each category. The four types are:

1. Annual renewable term insurance which is renewable each year regardless of the insured's health. The premium will be higher each year.
2. Convertible term, which allows the insured to exchange the policy without evidence of insurability. The exchange often means converting to a whole life policy or an endowment type of policy.
3. Decreasing term, which is often called Mortgage Insurance. The death benefit decreases over a specified period of time although the premium usually remains level.
4. Level term insurance generally has both a level death benefit and premium cost for the entire term of the policy.

Whole Life Insurance

Whole life insurance is also called Permanent Insurance. Whole life or permanent insurance has several characteristics:

1. The premium remains level throughout the policy's lifetime.
2. The contract builds up cash reserves in the early years which allows the company to maintain level premiums even though the insured becomes older which would normally trigger higher premiums. These reserves also bring about a "cash value" which may be borrowed by the policyholder or may be taken as surrender proceeds if the policy is canceled.
3. A whole life contract, by definition, can be kept at the same premium level for the lifetime of the insured.

There are both "straight life" and "limited payment life" whole life policies. Under a limited payment life policy, premiums are payable over a shorter period of time. Because premiums are paid over a shorter period of time, they are higher. In effect, one might say the cost is the same; the policyowner is just paying off the contract sooner.

There are also modified whole life policies and preferred risk whole life policies. A modified life insurance policy typically provides a given amount of insurance at unusually low prices for an initial time period after issue and then the premium is higher for the remainder of the premium period. Modified plans usually have a lower initial cash value than a corresponding face amount of typical straight life policy would have.

Preferred risk, as the name implies, usually requires that the insured be in better than average health at the time of application. Preferred risk policies are often sold to professionals or others in low risk occupations. Also, these policies are sometimes sold only in higher face amounts. The premiums may be slightly less that standard policies.

Endowment Insurance Policies

Endowment insurance is not used widely anymore. The primary characteristic of endowment insurance is that the contract pays the face amount at the sooner of either the time of "endowment," which is the maturity of the contract, or at the insured's death, if prior to the endowment date. Endowment life insurance policies are typically considered a type of "forced savings." In fact, the protection aspect of the policy is relatively low. Various types of endowment policies are often found in pension plans since the aim of pension plan is to provide cash during life. Since the cash values in endowment plans build up tax free, they are well utilized by individuals in high income tax brackets.

Universal Life Insurance Policies

Many consumers are aware of the term "universal life," but have only a vague idea of what it actually is. A universal life insurance policy is a life insurance policy in which the investment, expense and mortality elements are separately and specifically defined. The policyowner selects a specified death benefit which typically remains level. The death benefit may, however, be one that increases over time, coinciding with the increased cash value of the policy (death benefit Option II), or, alternatively, the death benefit can remain level regardless of the underlying value changes (death benefit Option I). A "load" is deducted by the insurance company from the premium paid by the policyholder for defined insurer expenses. The premium remaining is credited towards the contract owner's policy cash values. Then mortality charges are deducted. Interest earned on the remaining cash is credited at whatever percentage current rates happen to be. Since specific policy details do vary from company to company, variations will occur. Increased expenses or "loads" and/or increased mortality rates will also result in lower cash values. Just like annuities, there is usually a minimum contractual guarantee on the interest rate earned; typically around 4 or 4.5 percent. Mortality costs also generally have a guaranteed maximum premium charge for the pure cost of the death benefit. Most insurance companies do not charge that maximum rate, however. Typically, the rate charged is lower.

Many consumers assume there is a "standard" universal life insurance policy that is somewhat uniform from company to company. Actually, there is no such thing as a "standard" universal life policy. The level of premium paid, the amount of death benefit, and the length of time over which premiums are paid are all variable. While the first policy year may have a stated minimum premium due, following that first year, the contract owner may usually vary all factors: the premium paid, the payment date, and the frequency of the payments. These features are what make this type of policy favored by consumers. These features are sometimes called "Stop-And-Go features" or options. The ability to discontinue payments and then resume them at a later date does not require reinstatement of the policy. As long as there is enough cash values within the policy to pay the required expenses and mortality rates, the policy will remain in force. The policy will terminate if the cash values are not adequate, although there is usually a grace period allowed of up to 60 days.

Variable Life Insurance Policies

A variable life insurance policy is, in relation to other types of insurance, a relatively new product. The sale of a variable life insurance product usually must be accompanied by or preceded by a prospectus approved by the Securities and Exchange Commission.

A variable life insurance policy resembles the traditional whole life policy, but does have two major differences: both the death benefit payable upon death and the surrender value payable during life are not guaranteed. They can both increase or decrease depending upon the investment performance of the assets upon which the policy relies. The death benefit generally cannot decrease below the initial face amount, however, assuming all the premiums have been paid. With this type of policy, the consumer trades the cash surrender value guarantee for the potential of investment growth.

The policyowner may direct the premium (after certain deductions are made) to a specific sub-account held by the insurer. What those sub-accounts are will vary and may include a money market account, a growth stock account, a bond account, or some other type of investment vehicle. Some companies may allow changes among the accounts more than once per year while other companies may have limitations on the number of times that funds may be moved among the various investments. Usually, the death benefit is adjusted once per year while the cash value is adjusted on a daily basis. Premiums tend to be fixed so that they remain the same. The product gets its name, variable life, because both the surrender value and the death benefit can vary.

Before any of the contract's funds may be diverted into a sub-account by the policyowner, charges must first be paid. These charges would include administrative and sales expenses, any state premium taxes, and of course, mortality costs.

For those policyholders who desire to take an active role in their finances, a variable life policy is an attractive mode of life insurance. The policyholder may direct where their premium dollars are placed.

Variable life insurance policies enjoy the same income tax treatment as other types of insurance policies. Earnings from the investments are currently income tax-deferred, which, of course, is always a benefit to the consumer. There is no tax on the internal build-up of cash values. If the policy is surrendered (cashed in), and if the cash proceeds are more than the policyowner's cost basis, then the proceeds may experience some taxability. Death benefits, regardless of growth, pass income tax free in most cases.

Most variable life policies allow the policyowner to borrow a designated percentage of the cash value without surrendering the policy. Normally, the insurance company will charge interest on the loan, but often the rate is typically lower than the rate that would be charged from a bank or lending institution.

Like other insurance policies, one may see riders and/or waivers added to the basic policy. These might include such things as accidental death riders or waiver of premium if disability occurs.

Survivorship Life Insurance

Survivorship life insurance is also called Joint-And-Survivor-Life insurance. Survivorship life insurance is used to insure two or more people under the same policy. There are variations offered for this type of policy including some universal life products.

The death benefit is not paid under a survivorship policy until the last of the two or more insured individuals dies. At that time, the full death benefit goes to the named beneficiaries. Since there are so many variations to a survivorship policy, the agent involved must pay special attention to the provisions listed.

Most of the survivorship life policies use whole life products, although other types are also available. They provide for an increase in cash values upon the first death of one of the insured individuals. If the policy is a participating policy, which pays dividends, the dividends would then also increase. Depending upon the terms of the contract or policy, the premiums may continue until the survivor's subsequent death. It is possible that, through a special option, the policy is paid up at the first death so that no further premiums would be required.

As with other types of policies, there must be an insurable interest on the individuals insured in the survivorship life policy. This type of policy is typically used between spouses, parents and children, or related business owners. This type of policy is effective in easing federal estate taxes on those who would be subject to such taxes and have elected to take maximum advantage of the marital deduction, which would have tax due upon the survivor's death.

It should be noted that there is no requirement that all those insured must also be policyowners. The policy may be owned by any party that could own any other type of insurance policy.

Single Premium Whole Life Policies

Unlike traditional life insurance policies, the Single Premium Whole Life policy has only one premium payment (thus, the name). The initial premium is paid up front with no further premiums required.

Single Premium life offers many of the traditional tax advantages offered by whole life policies:

1. The money contributed to the policy builds up tax free through policy cash values.
2. The policyowner can borrow those cash values tax free.
3. The proceeds from the policy (the face value which is different than the cash surrender value) at the death of the insured would go to the beneficiaries income tax free and without going through the procedures of probate.

The immediate cash value of the policy is, of course, one of the main reasons for selecting a Single Premium Whole Life policy. The cash value may be accessed through policy loans or by surrendering the policy. Since the insurance company imposes penalties for early surrender, loans make the most sense in the early years of the policy. Although the insurer will charge interest on any loans taken out, in many cases, the insurer will also credit the policy with an interest earning. As a result, the policyholder may pay only a percentage or two. If the two percentage rates paid are identical, they will cross each other out entirely which gives a zero net loan cost.