The “Special” policy discussed here is not the same “special” policy discussed earlier with the “dividends as declared by the Board of Directors” feature. However, this newer “special” is rather controversial also. These “special” policies have a premium rate that is lower than the regular forms, and in recent years, they have been offered in order for insurers to compete in the price-competition world.
These special lower rates can be justified by limiting the death benefit to a minimum amount, or by limiting the issuance of the policy only to preferred risks that have a lower mortality than among regular insured lives because of more rigorous underwriting requirements, or some combination of both. There is controversy about taking the “cream” of the applicants, as those that are left are then “substandard” to some degree.
The minimum amount is used because it reduces the expense rate per $1,000 of insurance. Since the expense of issuing a policy consists of many items with fixed prices, such as medical reports, attending physician’s reports, inspection reports, MIB reports, issue and accounting costs, etc., that remain somewhat constant regardless of the size of the policy. Therefore, if the average size of the policy can be increased, the expense rate per $1,000 of face amount is lower. A class of policies in which the minimum face amount would be, say, $50,000, could be expected to produce an average amount double that of the other classes in which the minimum amount is $10,000. Some companies do not offer their “special” policies in less than $50,000 or $100,000 and up to $1,000,000, so the savings in expenses is quite substantial. Then, since the gross premiums is lower, expenses and commissions and premium taxes are lower also—often the commissions on special policies are lower than on other whole life policies.
The difference in premium between the usual ordinary life policy and a “special” policy can range from $2 to $3 per $1,000.
The reasoning for offering such policies is that if a person takes out a policy that is so large that its expense ratio is lower than the average, why should they not be given some benefit in respect to the savings? The same philosophy applies if the applicant is a better-than-average risk.
There are a variety of arguments against offering such “discounts,” however it makes sense that if the principle of offering a lower rates to superior risks is sound, then what is wrong with extending this principle to other policies—even, the argument goes, to other forms of insurance besides the whole life types?
Perhaps the most telling argument against the practices is that it is contrary to the basic insurance principle of averaging and to get average results, there must be large groups. Such groups would then consist of people with varying prospects of living longer in the same group, therefore some insureds would bear more than their theoretically share of mortality costs while others will contribute less than their fair share.
However, it does make sense when the objection is that by placing larger policies or superior risks in a separate class with a lower premium rate inevitability results in a higher cost of insurance for smaller policies and insureds who cannot qualify as preferred risks.
When it was determined years ago that smoking affected mortality, special rates that were introduced for non-smokers. That meant that the remainder were “smokers” and were substandard risks so they should be charged higher premiums. Insurance companies had difficulty in convincing smokers that they should pay higher premiums, with the inevitable result that the non-smokers received preferred rates, while smokers (it was even advertised) received the “standard” rates. Remember the discussion on anti-selection and adverse selection???
A Modified Lifeinsurance policy is a whole life policy with the early premium (from 1 to 5 years) considerably lower than the typical whole life policy and with higher premiums after the modified period. Some policies charge 50% of the usual premium for a period of 3 or 5 years, and then charge the higher premiums.
There are two types of modified life policies that are highly advertised and considerable premium has been generated with these policies. The principal type is used for “senior” citizens and sold usually in units of $1,000 or $10,000 and are sold primarily to be used for final expenses. These policies may have either no premium for the modified period – 1 to 3 years –or a very low premium. The health questions are very simple and there is little, if any, underwriting, as the premium is loaded for the extra mortality. However, the big difference between these policies and similar modified plans is that if there is a death during the modified period, then the beneficiary will receive only the return of premium. Most states now require that those plans that offered this plan must contain an accidental death benefit of the face amount, or a multiple thereof during the modified period—otherwise these plans could not be considered as “life insurance”.
The second type is not as prevalent now as it once was. It is offered to substandard risks, and the original plan would accept any person with no evidence of insurability. There was a premium during the modified period (some offered reduced premiums) and in most respects; the plan was identical to the senior plan discussed in the previous paragraph. If the insured lived past the modified period, any serious health problems would either have been resolved, or the insured would have died, and in which case the beneficiary received the premiums paid (the insurance company kept the interest on the premiums). Eventually, there were a very few health questions asked, such as previous or present episodes of cancer, heart attack, or being hospitalized within the past 6 months (or similar period). Interestingly, prior to these questions being asked, one company’s actuary insisted that the agents could actually accept anyone in a “cancer ward.” While technically and actuarially this may have been correct, the company management elected not to market this product in that fashion.
Most endowment policies mature at ages less than 100, other than that they are identical to whole life policies. Therefore, endowment policies are simply a variation of whole life insurance whereby they provide level death benefits and cash values that increase with duration and the purchaser may specify the maturity date of the policy.
A whole life policy provides a survivorship benefit at age 100 that is equal to the death benefit that would have been payable had the insured not survived that long (As few do). Endowment policies simply do the same thing in respect to providing survivor benefits, but they provide them at younger ages. The maturity date can be quite flexible and they are available in 5- year increments, starting at 10 years and stopping at 40 years. Others may mature at a specific age of the insurance, such as 55, 65, or 70—or even older.
Many years ago, one large life insurer advertised heavily in magazines and newspapers about a “retirement” policy where an individual could purchase a policy today that would pay monthly stipends at age 65. This was, of course, nothing more or less than an endowment policy that matured at age 65. Actually, this is why this plan was devised: to pay a death benefit during the accumulation period that is equal to the “face amount” of the policy. By purchasing such a plan, there was a guarantee that funds would be available whether or not the insured survived the maturity date. The market was basically the mature individuals who wanted earlier cash value accumulations that they could use during their own lifetime.
There was another popular usage of endowment policies—saving for children’s educations. After WWII, many young families used their GI insurance for their life insurance needs, but used a 15 or 20-year endowment policy for funding their children’s education.
During the late 1970s and early 1980s, many persons were losing interest in long-term fixed dollar premium contracts, which included whole life insurance and in particular, endowment contracts. This was during the time when tax-sheltered investment in real estate was extremely popular with the result that the public was looking more to shorter maturity contracts and investments, primarily because of the fear of runaway inflation.
In 1984 the federal income tax law was changed to eliminate the tax-free buildup of flexible premium endowment policies’ cash value. Congress was afraid that life insurance policies, endowment and Universal Life policies in particular, that developed high cash values, were being used by the wealthy as a method of accumulating wealth by using the tax advantages of life insurance (there is little doubt that they were and a lot of insurance was sold because of the tax advantages). This was during the time that Congress was trying to eliminate “tax shelters,” real or perceived.
This concern led to the development of a test for flexible-premium life insurance, the “corridor test,” as determined by Section 101(f) of the Internal Revenue Code. (This will be discussed later in respect to interest-sensitive products). This eliminated the tax preference enjoyed by flexible premium endowment policies, but it did grandfather in those in force prior to 1985. Not being content to leave well-enough alone, Congress then added Section 7702 to the IRS Code which extended the test to all life insurance policies, including fixed-premium endowments purchased after October 1986.
Endowment policies have not been very popular since 1984 and only a few insurers now offer endowment policies. Those that are available now are used for tax-qualified plans and other types of financial planning. However, it is interesting to note that in other countries, especially those with high savings rates, endowment policies are very popular and are used for funding retirement and for children’s education.
As young families looked toward the future, particularly their children’s educational needs, it was apparent that a family’s financial needs varied throughout their lifetime. Life insurers were particularly 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 can be shaped to provide anywhere from short term insurance to single premium whole life insurance, but most importantly, the policyowner has the right to reconfigure the policy at specified times, and to do so without the policyowner having to assume any of the mortality or investment risk.
Adjustable Life policies have the same guarantees as cash value, mortality and expenses as regular whole life, but the premiums, face amount and cash value are subject to change. In most cases, the changes can be made without evidence of insurability, however if the amount at risk increases, evidence may be required, such as a substantial increase in the death benefit or a substantial decrease in premium for the same face amount.
Situations that can trigger adjustments to the policy include increased children’s educations costs (private school or college), losing employment, starting a new business (or having a business fail), a career change, or retirement. The largest number of adjustments would involve lowering the premium so as to lower the cash flow during a period of time when income has been reduced, expenses have been increased, or both. Once the children are grown, oftentimes the policyholder will direct that the premium be increased so as to have more funds for retirement.
Adjustable life was first introduced in the mid 1970s, prior to the introduction of Universal Life in the 1980s. Since that time, Universal Life is a recognized superior product to Adjustable Life, particularly because of the investment feature during a period of increased interest earnings. Adjustable Life has basically disappeared from the scene and the name has become synonymous with Universal 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 also called “indeterminate-premium whole life” by others. The CAWL provides non-par whole life insurance under a more modern “transparent” format. Generally, 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. While more traditional whole life policies use dividends as a means of passing to the policyowner any changes in assumptions used in the pricing of the original policy, CAWL uses changes in the cash value and premiums to reflect the changes in the company expense and interest criteria from that guaranteed inside the contract.
Because CAWL policies are “unbundled,” much like Universal Life, there is a stated allocation of premium payments and interest earnings to the mortality charges, expenses and cash values. Contract this with the traditional whole life policy, where the policyowner has no idea as to how these funds are allocated.
To be specific, the premiums paid are charged for expense charges, and the remainder is a (net) addition to the policy fund. This 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 mortality charge is made, 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.
The CAWL can be either a low-premium plan, or a high-premium plan.
The initial indeterminate premium is lower than that of a traditional ordinary life policy and the policy has a provision that allows the company to “redetermine the premium using either the same or other (new) assumptions for future mortality and/or interest, within the guaranteed assumptions in the policy.” When the premium is redetermined, it, combined with the existing account value, will be sufficient to maintain a level death benefit for the life of the policy (if the new assumptions are proven correct). If these new assumptions are higher or lower than those used at the time of issue, the premiums will be either higher or lower – if they are the same, the premium will remain the same.
If the new premiums are lower than the previous premium, there are three options available to the policyowner:
If the premium is higher than the previous premium:
The high premium plan is, as the name implies, relatively high, however, there is a guarantee that the premium will not exceed a stated amount. Some of the policies offer a vanishing premium concept which states that the “vanish” will continue as long as it is greater than the minimum cash value. Policyowners have been known to confuse the “may vanish” in this option, with a paid-up life policy where the policy has no more premiums to be paid.
There are many variations of this policy, some of short-lived duration. The principal difference between the CAWL and Universal Life is that the CAWL has a required premium, making it easier for companies to administer, and the company has a greater control over the cash value buildup. One of the principal advantages in the mind of many is that it “forces” the payment of an established premium amount. One of the well-established advantages of life insurance as a savings or investment vehicle is that many people do not consider themselves (and probably rightfully so) as having the personal discipline to pay flexible premiums.
In the CAWL policy, current interest rates are used to enhance the accumulation account; however, the CAWL does not have the flexibility of premium of Universal Life policies. The insured/policyowner assumes some of the investment risk and a small amount of the mortality risk. Moreover, as indicated above, if the experience does not turn out as well as expected, the policy can be periodically downgraded on each redetermination date. Conversely, if the experience is positive, the policyowner then participates in the positive effect (one might say that it was earned because the policyowner assumed these risks, or a part thereof, so it is only fair that he is rewarded). If the experience is favorable, costs can be much less in the long run, than the original projections.
Dating back to England in the 17th century, debit insurance was the major type of life insurance sold in the U.S. until the beginning of the 20th century. Also called Industrial insurance, it was sold in small amounts, usually no more than $2,000, and was sold door-to-door by “debit” agents who had their own territory – called a “debit” because the insurance agent would accept the payment (usually weekly, then later monthly) and then “debit” the insured’s record for the premium payment. In today’s market, debit insurance usually applies to any type of insurance sold through home marketing.
Debit insurance has lost its appeal as $2,000 does not go far today and the premiums are relatively high compared to other permanent insurance. Debit insurers have received bad publicity because their premiums are so high; however, the principle reason that premiums are high is that the persistency is not good, as the lapse rate is very high. Many debit customers drop the insurance for a month or so if finances become tight, and then start again when they have a few dollars available. Today most of the companies are called home service life insurance companies, which is an appropriate name, and most of their “debit” insurance is monthly debit ordinary which are ordinary life policies written for amounts of $5,000 to $25,000, usually with premiums collected monthly at the policyowners home, although some policyowners make monthly payments regularly at the local insurance office, or they mail the premiums monthly.
It is fully expected that debit insurance will continue to decrease as group insurance has replaced much of the debit insurance. There has also been considerable legislation restricting the marketing and provisions of debit insurance, with the result that much of the profit of this business has disappeared.
A Family policy is a policy or a rider on a contract that provides for whole life insurance for the father or mother and with term insurance for the other family members. The coverage on the spouse and children can be a specified amount of insurance, or it can vary by age. The amount of life insurance is often measured by a “unit”, typically $1,000 of coverage per unit for spouse and children, and $5,000 per unit for the principal insured.
The premium for a family policy typically will remain level, regardless if there are additional children, and is based upon an average number of children. This could prove inexpensive coverage if there are several children or expensive if there is only 1 child.
Typically, Juvenile Insuranceis a whole life policy issued on the application of the parent or other responsible person, on the life of a juvenile. Most juvenile policies are written on children who are at least one month old and the applicant controls the policy until the child reaches the age of 18 (usually) or upon the death of the applicant, whichever comes first.
The purposes of juvenile insurance are many, but principally it is used for guaranteeing a college fund if the applicant should die prior to the child entering college, or at least there will be a cash value that can be used for college purposes. It is also frequently used to guarantee that there will be some life insurance for the child even if the child becomes uninsurable later.
Many agents and financial planners insist that it is better to use the funds that would go to pay the premiums on a child, for the purchase of additional coverage on the “breadwinner” under the theory that there is little “financial” loss that will occur in the death of the child, and only the death of the breadwinner will cause a financial hardship.
Burial insurance is also called “Pre-need Funeral Insurance” by some of those in the business, as it is felt that “burial” is a small part of the final expense of the insured (undoubtedly true). This policy provides that a fund will be made available for final expenses, and in most cases, it is used to fund a prearranged funeral. The funeral provider (usually a funeral home) agrees to furnish certain services and articles for the funeral, including casket and in many cases, even a burial plat, for the amount of the policy.
These policies are usually sold to persons between ages 65 and 70, and provide $2,500 to $10,000 of coverage – frequently a single premium whole life policy.
There were considerable concerns about these policies as some consumer advocates believe that the funeral companies were taking advantage of older persons because they were easily confused and did not understand that they were dealing with a life insurance agent. The NAIC has since changed its advertising and disclosure model regulations to include funeral insurance, with the result that complaints have diminished significantly.
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.
While the minimum size of a group was typically 50 lives a few years ago, it is now usual for states to require a minimum of 10 lives required by state law and by insurance companies. The larger the group, the less expense per person is incurred.
Generally, only active, full-time employees are eligible for group coverage, usually specified by occupation classification of those that must be included in the group, such as “salaried employees” or “all hourly employees.” The employee must be actively at work for a normal number of hours per week (usually 30 hours) at the employee’s regular job at the date the employee becomes eligible for coverage.
Employees usually have a probationary period, usually one to six months, during which they are not eligible for coverage. After this period, under a contributory plan (the employee pays part of the premium) the employee has an eligibility period in which they must apply for insurance without submitting evidence of insurability. This period is usually for 30, 31 or 45 days. If the plan is noncontributory, then there is no eligibility period as all employees automatically go on the plan when they have completed the probationary period.
The coverage period is usually the length of time that the employee remains with the employer (assuming the plan stays in force with the employer and the employee pays their share of the premium, if any). The employer has the right to continue coverage for an employee temporarily off the job and upon termination; coverage is usually afforded for 31 days.
Typically, the employee does not specify the benefit amount and the amount is usually (1) a set amount for all employees, (2) a percentage of the employee’s income with the employer, (3) an amount that is designated for the position the employee holds (job title), or (4) a function of the employees length of service. Insurers do not usually write insurance for less than $2,000 on an employee, most companies require $5,000 or $10,000, or more. Most companies allow for additional insurance over the normal maximum with evidence of insurability.
Employees usually have the option to convert their group life policy into an individual cash value policy within 31 days after termination of employment or after the employee ceases to be a member of an eligible position. The death benefit is paid under the group policy within 31 days after the insured has withdrawn from the eligible group.
A typical waiver of premium is used with group life insurance plans, and the premium will be waived as long as the insured can prove disability periodically.
Group life insurance is basically yearly renewable terminsurance. Group premiums are paid monthly, except with some small groups when premiums may be paid quarterly. Premiums are usually guaranteed for one year only, but often for competitive purposes, the premiums are guaranteed for a longer period of time.
For contributory plans, employee contributions are usually 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, and some states restrict the amounts that can be paid by any one employee, commonly 60 cents per month per $1,000 of coverage, or 75% of the total premium for that employee.
Supplemental life insurance may be provided to employees, normally contributory and the amounts of insurance available are banded. Generally, the maximum is a multiple of the employee’s salary.
A common form of group insurance is Credit Life insurance, which provides a benefit that is equal to the unpaid amount owed to the institution by the consumer. The creditor, which is usually a bank or a finance company, is both the policyowner and beneficiary of the policy. The debtor usually pays premiums, but if there are dividends, they are paid to the creditor. Needless to say, group credit life can be very profitable to the lender and there has been considerable abuse. States have reacted, most states now have maximum rates that can be charged, and most, if not all, states do not allow the purchase of credit life insurance to be a prerequisite for obtaining a loan.
Group life insurance often includes an accelerated death benefit, which pays a portion of the face amount of the policy in case of the terminal illness of the employee.
Under U.S. law, the value of the first $50,000 of employer-provided group term life insurance is non-taxable as income to the employee, but amounts over $50,000 may be taxable. If the employee contributes towards the plan, then the amount of the contributions are allocated to the excess coverage. The formula for determining the taxable amount to an employee is as follows:
When a group has less than 10 lives, IRS Regulation 1.70-1(c) requires that all full-time employees who provide adequate evidence of insurability, must be included unless they “opt” out.
Under the U.S. Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the $50,000 tax exemption is not available to key employees if the plans discriminates in their favor, either in eligibility or type and amount of the benefit; but are not discriminatory if all benefits to the key employees are also available to all group members. Plans will not be discriminatory if they have a uniform relationship to the total compensation of the group members, or the basic rate of compensation of each employee.
For those retired employees, they may be provided group life insurance coverage if the plan continues a portion of the term life insurance, or cash-value life insurance is provided, or a retired lives reserve is established.
Group cash-value life insurance is the simplest method of providing coverage for retirees, and is usually expressed as either a flat amount or a percentage of the previous group coverage.
Group paid-up insurance has been popular and is a combination of accumulating “units” of single-premium whole life and decreasing units of group term life. Usually this is on a contributory plan and the employees contributions go toward units of single premium whole life insurance. The employer’s contributions provides an amount of decreasing term insurance, when added with the amount the employee pays for, equals the total amount for which the employee is eligible. Then at retirement, the term insurance portion is discontinued and the paid-up insurance remains in force on the employee for the remainder of his/her life.
Group ordinary insurancecan be any traditional plan (except group paid-up) that provides the cash value life insurance to employees, where the employer pays the cost of the term portion, and the employee (which the employee may refuse to accept) pays the cash value portion.
Group Universal Lifehas the typical guaranteed interest rate, a fixed death benefit and loan option, plus the flexibility and added returns of the newer life insurance products. Group Universal Life (UL) is the same as individual UL, except that Group UL is generally issued (up to a certain amount) without evidence of insurability and is usually high enough to meet the needs of most employees. Group UL products usually pay low, or no, commission, plus administrative charges is lower than individual plans. Generally, these plans are 100% contributory; therefore, the plans are very portable.
Retired life reserves (RLR) is a group reserve accumulated before retirement in order to pay premiums on term insurance after retirement. The employer can make tax-deductible contributions to this reserve on behalf of the employees, and these contributions are not taxed as income to the employees. RLRs can be administered through a trust or by a life insurance company and as long as there are employees participating in the plan, the reserve cannot be recaptured by the employer. If an employee dies (or resigns) prior to retirement, the individual’s reserve value is used to fund the RLR for others in the plan. The plan must be nondiscriminatory and limits the amounts to $50,000.
Either supplemental coverages are generally available, through the insurer of the group, or by another insurer, that offers supplemental benefits, such as accidental death,or accidental death & dismemberment.
Some plans also offer Survivor Income Benefitswhere proceeds are payable in monthly income benefits only. Beneficiaries are not named but are covered by specified beneficiaries in the policy, and benefits usually continue as long as there is a surviving beneficiary and sometimes are discontinued if the survivor remarries.
Dependent Life insurance may be offered whereby the spouse and/or unmarried dependent children are insured for usually a small amount of life insurance.
STUDY QUESTIONS
1. “Special policies” are “special” inasmuch as
A. they are guaranteed issue.
B. they pay no commissions.
C. they have a lower premium than regular forms.
D. they are cash value term insurance policies
2. A whole life insurance policy with early premiums considerably lower than normal in the early years, and increased premiums in the later years, is
A. a special policy.
B. a modified life insurance policy.
C. an early endowment policy.
D. a decreasing term insurance policy.
3. The principal difference between a whole life policy and an endowment is
A. the whole life policy can mature at ages less than 100.
B. the whole life has cash values, the endowment does not.
C. the endowment can mature at ages less than 99-100.
D. that no commissions are paid on endowment policies.
4. A policy that can be shaped to provide anywhere from short term insurance to single premium insurance, and the policyowner has the right to reconfigure the policy without having to assume any of the mortality or investment risk, is
A. an adjustable life insurance policy.
B. a Variable life insurance policy.
C. a Variable endowment policy.
D. a current assumption whole life policy.
5. The life insurance policy that provides non-par whole life insurance and uses interest rates that reflect the new money rates, plus using the current mortality charges, is called
A. an adjustable life insurance policy.
B. a modified life insurance policy.
C. a Variable annuity.
D. a current assumption life insurance policy.
6. With group life insurance, a typical plan will have eligibility requirements, which include limiting insurance to
A. executives of a company only.
B. active, full-time employees.
C. any employees, regardless of status.
D. only those employees who can pass a stringent physical examination.
7. Another eligibility requirement typically used for group life insurance is
A. the employee must be male.
B. the employee must not be of child-bearing age or physical condition.
C. the employee must pay for 90% of the premium.
D. the employee must have worked full-time for a period, usually 6 months,
before they are eligible to join the group.
8. Employers may offer life insurance for some amount, for example $10,000, but if an employee wants more coverage
A. the employer must pay 100% of the additional premium.
B. the employee cannot, for any reason, be insured for more than $25,000.
C. usually they can obtain it with evidence of insurability.
D. an employee may obtain as much as $100,000 with no further action.
9. Under the law, employer-provided life insurance is non-taxable as income to the employee,
A. up to a maximum of $50,000, unless the employee contributes to the premium, and then taxes are determined by a formula.
B. up to a maximum of $10,000 coverage per employee.
C. with a maximum premium for each certificate holder of not more than 25% of the employee’s annual income.
D. but the employer must not pay for any of the premium.
10. When a group plan sets aside a reserve that accumulates prior to retirement, for the purpose of paying premiums on term life insurance after retirement, this is called
A. retired life reserves.
B. group retirement endowment.
C. term life to age 100.
D. parlaying.
ANSWERS TO STUDY QUESTIONS
1C 2B 3C 4A 5D 6B 7D 8C 9A 10A