Term insurance provides protection for only a specified and limited period, and if the insured dies during while so insured, 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. The length of these policies varies, and can run from one year to 20 years, or to age 65 or above. Basically, these policies insure for the time stated only, or they may give the insured the option of renewing the policy for successive terms without providing evidence of insurability.
Term insurance is carefully underwritten and restrictions can be imposed on the amount of insurance and/or on the minimum age of issue, the length of the renewal period, etc. The principal reason that it is so carefully underwritten is simply that there is considerable exposure for little premium. If, for instance, a person discovers that he has a terminal disease that he believes he can hide from an insurance company, he would apply for term insurance as he feels he would “get more bang for the buck.” There would be little reason for him to apply for a cash value or permanent policy that would demand a higher premium outlay. This does create an underwriting problem by its very nature, as often the insurance company does not receive enough premiums on the policy to enable it to require additional underwriting information.
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. With term insurance, the same situation applies and there is no obligation on the part of the insurer unless the insured dies during the policy term.
Following the conception voiced previously, that term insurance insures only against a contingency. The term premiums is relatively low, even though it carries a high expense loading and allowance for adverse selection—which is possible because term insurance contracts, as a general rule, do not cover the older ages when death is most likely to occur and when the cost of insurance is high.
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 periods of time of one year each. Term policies for longer periods of time—10-20 year term typically—usually are renewable under certain stipulations. Basically, the renewal may occur without evidence of insurability or medical examination if the premium has not lapsed and the insured so notified the home office of the insurer of his intention to renew prior to the expiration of the policy and by the payment of the premium for the new (attained) age. These premiums are usually included in the policy.
The unique feature of this type of term policy is, of course, the right to renew without additional medical information being required. Otherwise, if evidence of insurability were required with renewal, any changes in the health status of the insured would create a non-renewal. These changes that would not be acceptable to the insurer for renewal purposes could be caused not only by ill health, but also by change of occupation or geographical location, or some other reason, and if this would happen, the chances are very slim that the insured would be successful in obtaining like coverage anywhere else. Therefore, it is obvious that the renewal feature of a term policy is designed to protect the insurability of the insured.
With the renewable term policy, the premium increases with each renewal as it is based upon the attained age of the insured, and we all know what happens to mortality at older ages. Interestingly, at age 50, the term insurance premium would be higher than the premium for a whole life contract that was acquired when the insured was 35 or younger. Each term policy renewal renews at the attained age, so they will increase rather substantially at the older ages. The schedule of renewal premiums will be part of the insurance policy and the company cannot change them while the policy is still in force.
The evidence of insurability is usually provided in the form of a certificate or similar form that is to be attached to the insurance policy; however, some insurers may issue a new policy with each renewal.
There are insurance companies that specialize in term insurance—not as many now as there used to be years ago when insurers engaged in a “term war—but life insurers as a whole seem to have mixed feelings about the product. It does fulfill a real need for many persons who otherwise would have no life insurance at all.
The major concern of the insurers is the possibility of selection against the company at time of renewal, and the selection becomes greater the older the insured becomes. It is the “old story” of anti-selection (or adverse selection). Because the premium rises so rapidly at the older ages, those in better health or with fewer infirmities may drop the insurance, while those who are in poor health will pay the premiums, often no matter how high they may be. This leaves a block of business of poorer risks, and since the premiums are based upon the average health of a person at that particular age, this would mean that the premiums are, then, inadequate. Because those of poor health will often (sometime must) renew, while those who in good health will not (generally, they will purchase other coverage at a lower price), the mortality experience among the surviving policyholders will deteriorate faster than expected. The result is that every dollar that is used for protection on a term policy has a tendency to cost middle-aged or older policyholders more than under any other type of policy.
Because of this, companies usually do not allow renewals to be available over a certain specified age—such as 65, 70 or 75—plus limitations on YRT policies are even more stringent as coverage is restricted to 10 or 15 years, or to age 65, whichever is earlier.
As a general rule, renewable term insurance is acceptable to both the insured and the insurer as long as it does not extend into the older ages.
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. Many term policies are both, renewable and convertible.
Convertibility is important to those who want permanent insurance but are unable at the present time to afford the higher premiums for the permanent insurance, still they need immediate protection. There are situations where a policyowner just simply wants to postpone purchasing permanent insurance until a later date, for whatever reason. With some of the interest-sensitive permanent insurance plans available, the individual may want present protection but wants to wait and see what the “market” does, for example. Then, if the policyowner becomes uninsurable for some reason, he still can purchase permanent insurance at a later date (albeit at a higher price which at the younger ages is not particularly significant).
Actually, 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.
Some insurers allow conversion on a retroactive basis (Original Age) at any time within a specified number of years after issue. When the conversion is effective, the premium is that which would have been paid had the policyholder taken out the permanent plan originally. Because of this, there usually is strong motivation for a policyowner to convert retroactively. Additionally, there can be better features in a policy that is issued at the original age.
However, it may not be as advantageous as there must be a financial adjustment of a payment by the insured—which can be substantial if the term policy has been in force for several years. After all, an insurance company is not an eleemosynary (charitable) institution. There are a variety of methods used to compute this adjustment, but the most popular method is that the payment will be the greater of (a) the difference in cash surrender values under the exchanged policies, or (b) the difference in the premiums paid on the term policy and those that would have been paid on the permanent plan, plus interest on the difference at some specified rate. These methods are not uniform, and some companies require a payment that is equal to the reserves difference in the two policies, plus a charge (as high as 8%) to compensate for the investment loss on the difference.
These arrangements may seem complicated—and they can be—but the message is that the insurer simply wants to be in the same financial situation that it would have been if it had issued the permanent policy first.
So, what is the advantage to the policyowner to convert retroactively? Actually, very little, as while the insured will pay a smaller premium, they will, in effect, pay it over a longer period of time. On an actuarial basis, the two sets of premiums are equivalent. Do not forget that the insured pays the company the interest it would have earned had the larger premium been paid from the beginning.
Which is the preferred method of conversion? The insured should strongly consider the state of his health. The insured would not be wise to convert retroactively (which entails paying a substantial sum to the insurer) if his health was impaired. The sum that the insured would pay would become part of the reserve under the contract and would not increase the amount of death benefits in case the insured succumbs to an early death. All the additional payment would do is to reduce the effective amount of insurance.
If this seems confusing, it is actually a simple matter of continuing the death benefit at the term premiums (lower than with a permanent plan) and because of health problems, there is a greater chance that the insured will not outlive the term period. So, why pay more for the same death benefit?
Occasionally, the “dream” client may appear—someone who has surplus funds to invest in insurance, in which case the insured would probably be better off if he bought additional insurance, or prepaid premiums on existing policies. This is accomplished by prepaying fixed premiums by the use of premium deposits, or by discounting future premiums. In either case, the funds deposited with the insurer are credited with interest (at some designated rate) and sometimes, the deposited funds are credited with interest earned by the company in excess of the designated rate. When the insured dies, the balance of such deposits is returned to the estate or designated beneficiaries (in addition to the policy’s death benefits). Companies vary as to allowing withdrawals of these funds on the policy anniversary or premium due dates. Some allow withdrawals only in case or surrender or death, and some do not credit interest and may even penalize the insured if the funds are withdrawn—but these companies are in the minority.
A retroactive conversion must take place within a certain number of years after the policy has been issued. If the policy is no more than a 10-year term, for instance, a conversion can usually be accomplished pretty much at the desire of the insured. If the policy term is longer than 10 years, then the policy will usually state when the conversion can take place—always prior to the end of the policy term.
The reason for the time limit is the old bugaboo of adverse selection. There always is some sort of adverse selection in most conversions as those in poor health at the time of conversion are more likely to convert and pay the higher premiums, than would those who are in good health. Therefore, it can be reasonably assumed that since conversion must be made some time before policy expiration, a higher number (percentage) of policyowners will elect to convert as they may not be too sure of their future health. Not surprisingly, statistics indicate that the death rate of those who convert are higher than normal (expected). Therefore, premiums for convertible term insurance are higher than those for term policies that do not allow conversion.
If the term policy is only renewable, the time limitation may be that it must be renewed before age 60 or 65. Sometimes the policy will state that the policy must be converted within a specified period before the latest date that it can be renewed.
It should be noted that conversion might be allowed after the time limit, but only with evidence of insurability.
There are some term policies that automatically convert at the expiration of the term period, to a specified permanent plan. However, there is a question as to whether this effectively reduces adverse selection because those policyholders who are healthy will probably decline to continue the insurance.
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.
A discussion of re-entry term can become complicated, but it is a policy that is subject to two different premium schedules. One, the lowest, rate is based upon mortality tables that apply to those individuals who have recently given evidence that they were in good health (“Select” mortality). These rates are available just as long as the insured can provide new evidence of insurability at renewal dates (and/or other dates as specified by the policy).
The other, higher, premium schedule is based on rates that apply to insureds that have not produced evidence of insurability for 15 or 20 years after the initial evidence (“Ultimate” mortality). Therefore, if the insured cannot provide evidence of insurability at the renewal date, then they will have to pay the higher premium immediately and into the future, unless, of course, they can show that there has been an improvement in their health.
On the face of it, this seems to be a logical choice—in order to get lower premiums, the insured must be healthy, and in order to get these premiums, the insured should be willing to pay higher premiums if/when his health deteriorates. However, there is always the question as to whether the insured fully understands what can happen if they purchase re-entry term. As anyone with teen-age children knows, young people believe they are immortal so they would never have to pay the higher rates. However, if their health does deteriorate, they will then have to pay the higher (ultimate) rates and (in all probability) they will not be able to buy insurance from another insurer. Looking back at that point, they could see that the single premium schedule term insurance was a real bargain, but by then, it is too late.
Do not feel that re-entry term is a “rip-off” as for those who actually do remain healthy into their retirement years; this can be a very economical way to buy insurance. But, if their health deteriorates at the expected rate, i.e., that of the population in general, insurance can be costly. Statistics indicate that with most person’s health starts to decline around ages 45 to 50 and if they live their normal life expectancy (50% of them will, statistically) they could live 40 or 50 years with impaired health—and they would be paying the higher term rates for more years than they paid the lower rates.
As a general rule, re-entry term initial premiums are about 10% lower than those for a regular renewable term policy (with guaranteed future rates). If, however, the insured suffers an illness or injury and his health deteriorates, the new premium may be as much as twice, what the renewal premium would have been under the traditional renewable term policy. Therefore, they could easily end up paying much more premiums for many more years than they would have if they had just purchased a renewable term.
A professional approach to marketing re-entry term could involve comparison of the high rates of various insurers for similar coverage. Once the insured cannot provide the necessary evidence of insurability, however, the lower premium schedule is meaningless. Comparisons can be made by making pro-forma cash flow simulations of both the high and the low premiums, for each policy under consideration, and at a range of dates that the premiums would increase. Practically, however, this is rarely performed. Those who have absolute faith in their good health extending into the distant future—and there are many of them, nearly all young—look upon re-entry term as a real “bargain” and they are really not too interested in comparisons of anything that suggests that they may not be as healthy as they would wish in the future.
One other important aspect is whether the insurer considers the new policy that is issued if the insured can no longer qualify for the re-entry lower premiums, as a new policy. If they do, there is a possibility that the new policy may have a new contestable period of one or two years. In any event, as any good agent knows and would communicate to his client, -
F if the insured should die while the policy is contestable, the claim will be investigated much more thoroughly; plus it will take longer to settle than for an
incontestable claim.
Most of the discussion of term insurance so far has been generally in the area of short-term policies, or with renewability features. However, there are some very popular term policies that are written for a longer period of time and have distinct features different from those of shorter duration. These policies usually allow the insured to purchase waiver-of-premium and accidental death benefits, similar to that offered with permanent plans.
A term-to-age-65 policy, for instance, provides protection on a level premium basis from the age at issue to attained age 65. The length of the policy is somewhat shorter than the life expectancy of the insured, but the termination date is usually that of the date of retirement; therefore, it covers basically the period of time that the insured is earning a living. Since the term is shorter, the premium is less, than a comparable permanent plan. It is customary (indeed, in many states it is required) for there to be a cash value and surrender values. There may be a conversion privilege offered, to be exercised usually prior to termination date—typically at age 60.
This discussion has centered on level death benefits throughout the term of the policy. However, as anyone who has ever purchased a car or home or borrowed a large sum of money can attest, there are policies with decreasing amounts of insurance. Used in credit life situations, decreasing term policies decrease either uniformly or according to some schedule. “Mortgage Redemption Life Insurance,” for instance, is a form of decreasing term insurance where the face amount decreases periodically to reflect the amount of the mortgage remaining after each mortgage payment. Some specialty policies mirror the decrease in debt exactly, while others simply decrease the policy in approximate amounts to closely reflect the debt decrease.
This type of coverage can be written as a policy, as a rider to a policy or as a combination with another policy.
Increasing term insurance, which is actually a rather-old product, has taken on a new life in recent years, particularly with arrangements such as split-dollar plans that may consider borrowing or encumbering the cash value of the underlying policy. This type of plan can be used to provide a uniform death benefit for the benefit of the beneficiaries by making a provision that there will be an automatic additional amount of term insurance purchased each year in the same (or approximate) amount that the cash value increases.
Increasing term insurance can be provided on a year-to-year basis through the fifth dividend option. This dividend option makes available the use of the dividend to purchase one-year term insurance. There are a couple of forms of this, one of which applies the dividend as a net single premium to purchase as much one year term insurance protection that the dividend can buy. Another form purchases one-year term insurance in an amount equal to the policy’s cash value with the excess dividend portion applied tone of the other dividend option—often used with split-dollar insurance plans . The purpose is to assure the beneficiary payment of an amount equal to the policy’s face amount if the insured dies, even though the cash value may be totally pledged—hence the use of increasing term insurance.
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. This theory gained some traction in the marketplace 20-30 years ago when it became fashionable to market yearly renewable term with the slogan of “buy term and invest the difference.” This led to several insurers entering the additional field of “investment” by either forming their own mutual funds or contract with various mutual funds. At that period in time, the typical cash value of whole life policies were only credited with 3% growth each year, while other investments were producing investment returns of around 10%—sometimes even higher. This required that life insurance agents become dually licensed—securities and insurance licenses—and this also meant dual regulation with the SEC concerned with the securities and the Insurance Departments concerned with the life insurance. This dual regulation will be discussed in more detail when the Variable Life Insurance plans are explored later in this text.
To this day, there are agents who will encourage a whole life policyholder to cash in their policies and replace them with term insurance. Insurance companies discourage this type of indiscriminate use of term insurance which /has led to an impression by the general public that life insurance companies want to sell only permanent insurance so that they can receive more premiums, thereby increasing their assets and income. Regardless of public perception, there are certainly valuable uses for this product.
From the previous discussion, 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 that is needed. As an example, if an insured wants insurance to pay off a large debt in case of his untimely passing, it might be nice to have permanent insurance as then when the debt is paid off, he will still have life insurance regardless of his state of health at that time. However, often the insured can only afford the term insurance premiums. As a corollary, consider that driving to work every day behind the wheel of the large Lexus, many people can only afford a Corolla that will get them to work just as well as a Lexus or any luxury car. There are times when one cannot afford what they would like or even what would be best for them, so they have to find another way that they can afford.
It is certainly advisable, if term insurance is purchased, to purchase term insurance that is convertible. This can be the best of both worlds as the insured may later be able to convert the term insurance to a permanent plan when they can better afford to do so. The basic premium between convertible term and non-convertible term is so slight that rarely will an applicant refuse this feature.
The policy should be renewable as well, as the financial status of the insured may remain the same in the future. Renewability and convertibility features serve different functions, but they work together well and should be used in all term policies.
It was mentioned above that a person might only need temporary protection, particularly when insurance is needed to “hedge” a loan. A term policy in the amount of an obligation serves a dual purpose: (1) it protects the lender or lending institution against the possible loss of the principal, thereby making the loan easier to obtain and often on better terms if the loan is protected against loss by premature death of the debtor; (2) it protects the estate of the insured against having to repay a loan if the insured should die before the obligation has been fulfilled.
There is actually a plethora of situations where temporary protection is not only desirable, but also needed. While most people are familiar with mortgage redemption insurance where the mortgage is paid off if the mortgagee dies while there still is a mortgage, other uses can include corporations purchasing a form of key-man insurance when they are engaged in experimental products that would provide funds; so that the corporation can be reimbursed for any losses they may suffer if there is a death in those most heavily involved in the experiments. Movie studios will cover their principal actors—and sometimes their directors or producers—for the period of time that the movie is in production.
A perhaps more mundane type of temporary protection is needed by parents who need the protection while the children are still dependent, but not so much when they are “all grown-up.” This, by the way, can be accomplished by term insurance on the parents or a larger amount on the breadwinner during the child-rearing years, or sometimes it is better accomplished by the use of decreasing term being superimposed on a permanent insurance plan.
Younger persons who fully expect their financial situation to improve in the future often use term. While young professionals are getting established, it is often wise for them to purchase insurance that will provide funds to cover their debts and other expenses, in addition to family needs (particularly if there are children), at the lowest premium available, with the ability to convert at a later time to more permanent type of insurance. Term insurance can be used in the same manner for young persons who are entering the business world, especially if they have executive possibilities and ability.
Many employees that are covered by group life insurance as part of an employee benefit plan are hesitant to purchase individual life insurance. In many cases, the employee that has a good benefit program has the attitude that the employer is “taking care of him” whether he is injured or becomes ill, or unable to work, and will provide adequate life insurance for the protection of his family. Unfortunately, in most cases, the group life insurance is only for $50,000 or less, and while that seems like a lot of money for many young working persons, an individual could not even leave a mortgage-free house to his family if he should die early.
Employees should be aware of how much of the group life insurance they can convert after an involuntary termination of employment—strike, lay-offs, plant closing, work reduction, etc. They should purchase term insurance in at least the amount of their group life insurance plan while they are still employed.
Anyone who has been in the life insurance field for any period of time has heard some of the objections to whole life and other forms of permanent insurance—some may have used these arguments in attempts to sell permanent 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. That is what term insurance covers and why should anyone pay more so that the life insurance company can invest his funds along with a jillion other insured’s premiums, when the prospect can invest it himself and get a better return without having to pay an intermediary? Plus, if he needs the money for a good reason, he will not have to invest the savings in the premium—it can be spent for whatever he wishes.
The argument is basically 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.”
OK, there is a lot to the argument that the insureds would be better off with term insurance, if they are sure that they are going to die within a short period of time. But what if they get “lucky” and they live to a ripe old age? As they get older, the health deteriorates, and they will probably not be able to get life insurance after the end of the term life period, and they can use funds for estate purposes, future debt settlement in case of death, even burial costs. The possibility of living so long that the premiums paid in exceed the total premiums paid under a level premium plan is relatively high.
The factual argument is that with a level premium plan, the insured is protected against living too long and having to pay extravagant premiums. Since, in reality no one knows when they are going to die, the level premium plan shifts some of the premium burdens of living too long to those who die early and who have a very large return on their premium outlay.
The old story, worth repeating, is where an agent attempting to sell life insurance, was asked by his prospect, “Exactly how much life insurance should I buy?” The agent replied, “I can tell you exactly what you need, and I only need to know two things — your date of birth and your date of death.”
Perhaps the most intellectual (?) argument against permanent insurance is that policyowners are overcharged because the reserve under permanent plans of insurance is “forfeited” to the insurance company when the insured dies. Therefore, it is contended, the death benefit should be increased by the amount of this reserve.
If, as suggested, the reserve is to be paid in the event of death, in addition to the death benefit, this destroys the level premium concept, the heart of which is the reduction in the net amount at risk as the reserve increases. If the reserves were to be paid in addition to the death benefit, premiums will obviously be inadequate as they are calculated on the assumption that the death risk is a decreasing risk.
OK, you may know of a policy that will return the reserves in addition to the death benefit, however check the premium—it will be increased accordingly. Remember,
F Life insurance companies are not eleemosynary institutions.
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. There are some arguments for this as an individual can “play the market” and if he is knowledgeable (and lucky), he can probably “beat” the investment return for the insurer as the insurer is restricted as to where it can invest its assets. Their restrictions are regulated tightly by insurance regulations and they are rather conservative for the protection of the policyholder. The Departments of Insurance do not want to see insurance companies go into receivership or bankruptcy because of risky investments. Therefore, there is some truth to the assertion that an individual may do better than insurers in their return on investments.
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. Some recommend that all such investments be in government bonds, some recommend investing in investment trusts or mutual funds, or even in common stocks.
It may be necessary to determine what kind of investment program best serves those that ascribe to the term-and-investment philosophy. Textbooks (quoting experts) maintain that any investment program should have safety of principal, yield and liquidity. Each of these should be discussed separately.
This is, so to speak, a ballgame in the insurer’s ballpark! Throughout the years the life insurance business has a solvency record that is better than any other type of business organization. True, there have been insolvencies but in every case, the Insurance Departments have been able to either find a buyer for the company or its business, or have assigned blocks of businesses to other companies. Even when the Baldwin United Life Insurance Company was taken over by the Department of Insurance many years ago, leaving thousands of annuity owners fearing for their own investments in annuities, the worse that any annuity owners suffered was that there was no increase in annuity assets for a year or so, and then the annuities were taken over by other companies and the annuity owners lost no more investment income. Few, if any, industries could perform as well.
The insurers are required to concentrate on quality investments and government bonds (federal, state and local), high-grade corporate bonds and real estate mortgages, and there must be diversification by regulation. Investments are diversified as to type of industry, distribution, maturity, etc. The individual policyowner’s reserve is commingled with all of the other policyowner reserves; therefore, each policyowner has a pro-rata share of each investment unit in the insurer’s portfolio. This affords the maximum of security of investments and they are collectively beyond the reach of any individual investor. The only way that an individual investor could match the safety of principal of the insurance companies, would be if they could invest in federal and state government bonds, which would sacrifice yield in deference to safety, and few investors would want to do that, even if they could.
Life insurers measure their investment yield by a percentage of their mean ledger assets—the net investment income without capital gains or losses, and after deducting investment expenses but prior to deducting federal income taxes—and they earned over 9% during the past 10 years, reaching 9.87% in 1985. However, these rates have been declining since 1985 as general investment returns have dropped for all sectors of the economy. So, it is possible for an individual investor to do as well as an insurance company by investing in common stocks or other equity investments, particularly if unrealized capital appreciation is considered—and many investors have done as well. Still, it is rather unlikely that the typical life insurance policyowner can do as well as insurance companies over a long period of time. Plus, a very important factor,
F annual increases in cash values are not subject to federal income taxes as they accrue, while the earnings from a separate investment account would be taxed to the owner as ordinary income.
This is where the life insurance policy “shines.” Simply, the policyowner’s investment can be withdrawn at any time without losing any of the principal through surrender for cash or through a policy loan. This means that the insured never has to worry about liquidating assets during a market downturn—and the policy loans cannot be “called” because there is inadequate collateral.
True, there are some types of investments that are quite liquid, but no market-value investment can come close to the liquidity of the obligations of the life insurance contract.
One more, but important, point. As anyone who knows anything about life insurance can attest, one of the most important reasons to buy life insurance is the “forced savings.” This is what many, many have discovered when they bought term and “invested” the difference—the difference just did not get invested. For life insurance, when the savings feature is combined with the protection feature, there is a considerable incentive for the insured to save.
Contrast the situations where if an individual purchased, say, bonds for investment on a regular basis, they may skip a month, or two, or three, if they either feel that they need the money to buy something else or some other disposition of money is more important at that time. Conversely, if they set aside a predetermined amount each month to a savings account that if not paid, could mean that they would lose valuable protection that might be irreplaceable (particularly if there are health problems)—they are much more likely to put the amount into the “savings account” each month, like clockwork. With forced savings, if the insured did not save, they would have no other way to preserve their protection.
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.
STUDY QUESTIONS
1. If the insured dies while insured under a term policy
A. the beneficiary will receive the death benefit amount.
B. the beneficiary will receive the difference between the reserve and net amount at risk.
C. the death benefit is always a pro-rata share of the face amount decreased by a factor involving the number of years that the policy has been in force.
D. the beneficiary will receive the face amount plus any cash value.
2. The renewability of a term policy is designed
A. to keep premiums down.
B. to provide continuing commissions.
C. to protect the insurability of the insured.
D. to provide nonforfeiture values.
3. In a term policy, there are two types of convertibility;
A. attained age and original age.
B. issue age and mortality age.
C. permanent and temporary.
D. cash value and non-cash value.
4. A retroactive conversion must take place within a certain number of years after the issue date, which date
A. must fall within 3 years of issue date.
B. will always be at the date of policy expiration.
C. will always be prior to the end of the policy term.
D. will be designated in 5-year increments.
5. A term policy that is subject to two different premium schedules would be
A. a re-entry term policy.
B. a limited term policy.
C. a yearly renewable term policy.
D. an adjustable term policy.
6. In many states, a long-term term insurance policy
A. is outlawed.
B. can be required to have cash values and surrender values.
C. must be of a duration in excess of 25 years.
D. must only be a decreasing term policy.
7. “Mortgage Redemption Life Insurance” is a form of
A. decreasing term.
B. increasing term.
C. level term.
D. adjustable term.
8. Increasing term is often provided on a year-to-year basis through
A. mortgage redemption life insurance.
B. estate planning trusts.
C. the fifth dividend option-use of dividends to purchase one-year term insurance.
D. group insurance.
9. In the study life insurance, it is important to remember that life insurance companies
A. are always mutual companies.
B. are not eleemosynary institutions.
C. are regulated entirely by the federal government.
D. receive all of their profit from investment income.
10. Earnings to an individual from a separate investment account is taxed to the owner as ordinary income; annual increases in cash values are
A. taxed at capital gains rates.
B. not subject to federal income taxes.
C. are subject to federal income taxes.
D. taxed as ordinary income every five years only.
ANSWERS TO STUDY QUESTIONS
1A 2C 3A 4C 5A 6B 7A 8C 9B 10B