To purchase insurance, the policyowner must have financial interest in the property being insured

LIFE INSURANCE

Having already examined automobile insurance, homeowners insurance and personal property insurance and the underwriting issues associated with those property and casualty policies, we now turn to a discussion of life insurance. Many individuals will turn to his insurance producer for advice regarding the sensitive subject matter of life insurance. While customers may be hesitant to discuss the purchase of an insurance policy which contemplates their demise, life insurance is one of the most important products which an individual must consider obtaining in order to provide financial security to loved ones.

The Life Insurance Policy

Life insurance is a contract between an individual and an insurance company. In this contract, the insurance company agrees to pay a stated amount of money to a beneficiary, under certain conditions, in exchange for a sum of money called the premium.

It is important that you understand that a life insurance policy, like any other insurance policy, is in fact a legal contract. In other words, it is an agreement between the parties that the insurance company shall perform in exchange for the premium that is paid to the company.

Uses of Life Insurance

Life insurance is primarily used to function in personal and family situations.

As a rule a person�s death creates an immediate need for money. The following is a list of some of the needs that might be created from a person�s death.

�  Expenses created by final illness.

�  Burial and funeral expenses.

�  Debts that are due at time of death.

�  Costs to administer the estate.

�  Federal and state death taxes.

�  Inheritance taxes.

Money may also be needed to provide for the following:

�  Payoff mortgages or purchase a new home.

�  Provide an education for children.

�  Meet unexpected financial needs.

Life insurance can also provide benefits for business situations. Here are a few examples:

�  Loss caused by death of a key employee.

�  Collateral for loans.

�  Buy-out of the business interest of a deceased owner.

�  Fringe benefits for employees.

Life Insurance as a Property

Very few people consider the fact that life insurance is a property. Where else could an individual make a premium payment of $100, and create an immediate estate or property valued at $250,000?  Of course, that is possible with life insurance.

Here are some advantages of life insurance as property:

�  As an asset it is very secure.

�  There is no managerial care required for the property.

�  It can be purchased in any desired amount.

�  It provides a reasonable rate of return.

�  Proceeds are payable immediately upon death of the insured.

�  The insured chooses the method of payment for premiums.

The Life Insurance Application

Three Parties to an Application

A life insurance application contains three parties:

�  The Proposed Insured. This is the person whose life is being insured by the life insurance policy.

�  The Applicant. This is the person that is making application to the insurance company for the life insurance and may or may not be the proposed insured.

�  The Policyowner. This is the person that usually pays the premiums and the person who retains all rights to any values or options contained in the policy.

The great majority of policies are issued on the application of the person to be insured who is also the owner of the policy.

In the typical situation, the policyowner, the applicant, and the insured will be the same person. There are, however, many policies issued where someone other than the insured applies for and owns the policy. The situation in which someone other than the insured is the policyowner is  referred to as �Third party ownership.�  This type of arrangement is often found in family situations where, for example, a wife will insure her husband, or vice versa, or a parent will insure children. Third-party ownership is also often found in business situations, where a business insures the life of a key employee, for example. Another common third-party ownership arrangement is where a creditor owns a policy on the life of a debtor.

Insurable Interest

For a life insurance policy to be issued, an �insurable interest� between the insured and the policyowner must be present. In this regard, it is necessary to examine insurable interest from two standpoints. First, we�ll look at the situation in which a person applies for insurance on the life of another. Then, we�ll look at insurable interest when a person applies for insurance on his or her own life. We will examine the conditions that must be present to satisfy the insurable interest requirements in each of these situations.

Again, to purchase life insurance on the life of another, an insurable interest in the life of the proposed insured must exist. The policyowner must benefit, either emotionally or financially, by the insured continuing to live. Generally, for an insurable interest to exist, the potential emotional loss must arise from love and affection which grows from a close blood relationship, or marriage. And, of course, where one�s own life is concerned, each person has an unlimited insurable interest in his or her own life.

Suppose that a life insurance policy could be sold when no insurable interest requirements existed. If a person could apply for insurance on the life of another without this interest, then the policyowner would stand to gain, and suffer no emotional loss, by the insured�s death. As such, a life insurance policy would constitute a mere wager which would be clearly against public policy, and therefore illegal.

An insurable interest may arise out of a close blood relationship, but being the relative of a potential policyowner does not automatically establish an insurable interest. For example, under most circumstances, a person would probably find it difficult to establish an insurable interest in an aunt, uncle, or cousin unless the policyowner could show that a significant financial or emotional loss would result upon the death of the relative.

There is another important aspect of insurable interest; the relationship between a policyowner and a creditor. This relationship brings about another type of insurable interest.

A creditor can establish an insurable interest with a debtor. For instance, assume a bank loans $5,000 to an individual. Obviously, the bank will suffer financially if the debtor dies before the loan is repaid. This fact establishes the insurable interest between the bank and the debtor. For this reason, the bank can purchase life insurance on the life of the debtor and receive the death benefit of the life insurance policy, but only in an amount which reflects the balance of the unpaid loan, should the debtor die prior to repaying the loan.

Insurance purchased by a creditor on the life of a debtor must be in an amount that approximates the size of the debt. So, if a debtor owes a creditor $1,000, the creditor could not purchase a $10,000 life insurance policy on the life of the debtor.

For this reason, most credit life insurance purchased on the life of a debtor has a reducing death benefit, which keeps pace with the diminishing loan balance. Therefore, if a debtor owes $5,000 to be repaid over a period of five years, the death benefit might begin at $5,000 to match the original amount of the loan. However, this policy would eventually reduce to $0 at the end of five years when the loan has been repaid.

The Application Form

In order for a person to purchase life insurance they must make a request to the insurance company of their choice. The form on which this request is made is the application.

Most companies now require that the proposed insured be physically present in front of the agent while the questions on the application are answered. The application is crucial in that it provides the data that the underwriters and insurance company will use to determine whether to issue a policy.

The application is a life insurance company document containing questions and information, which the company uses in evaluating the insurance risk and in properly preparing the policy if one, is issued. The agent completes the application by asking the applicant the questions.

The information requested on the application generally includes items such as the applicant�s full name and address, age, sex, marital status, occupation, medical and family histories, present physical condition, and a description of the type and the amount of insurance applied for. It also includes the name of the person who is the beneficiary of the insurance along with data on other insurance owned and applied for, as well as whether or not the applicant was ever refused life insurance.

In view of the importance of the application, it is essential that the application be completed fully and accurately. If the application is incomplete, the underwriting process and policy issue will be delayed until the necessary information is obtained. The company depends upon accurate information to make a proper evaluation of the proposed insured.

When the proposed insured signs the application, it constitutes a formal request to the company that a policy be issued on the proposed insured�s life. In addition, the signature on the application indicates that the information is true and correct to the best of the knowledge of the proposed insured.

Minor Applications

In most states a person is not considered an adult until the person is 18 years of age.

As a rule, minors are not permitted to enter into contracts. However, life insurance is the exception in that a person is a minor only until age 15.

In the event that the proposed insured is younger than age 15, one of the following persons must sign the application on behalf of that child:

�  The mother or father.

�  A court appointed guardian of the minor.

�  The child�s grandparent.

Correcting Applications

Should it be necessary to correct a mistake regarding information given on the application, the proposed insured must initial any and all changes on that application. Mistakes on the application can be costly especially when the company is usually paying an outside reporting service to conduct an inspection.

Any changes that are made on a completed application must have the approval of the proposed insured. The normal procedure is to return the incorrect application to the agent who in turn will take it to the insured to have the corrections initialed.

Incorrect or Incomplete Applications

Should an application contain incorrect or incomplete information it should not be taken lightly. In the event that the company has already made a decision on a risk based on these inaccuracies, it could result in a serious loss.

If the error is discovered after the issuance of a policy, the company can cancel or rescind the entire contract from the date of issue.

Of course, this must take place before the incontestability clause of the contract takes effect. The incontestability clause provides a date after which the insurance company cannot contest the information in the application.

Representations and Warranties

All statements on applications are regarded as representations. When a person makes a statement that person believes to be true, the person is in effect making a representation of the truth. While it is possible that a representation may be found to be untrue, a person who makes a representation believes it to be true.

A warranty on the other hand is a statement made with such absolute certainty that it is guaranteed to be true. No statement on an application is considered a warranty.

A false representation can be defined as a misrepresentation.

Fraud

There are three elements necessary to constitute a fraud. They are:

�  A person makes an intentional misrepresentation of what is known to be a material fact.

�  The person has intent to gain advantage from the misrepresentation.

�  A person relies upon that misrepresentation and suffers a loss.

Concealment

Concealment is closely akin to misrepresentation when it comes to information included on a policy application.

While misrepresentation as stated earlier is something known to be untrue, concealment is withholding of facts that the applicant should have given to the insurance carrier at the time of application.

Conditional Receipt

It is best to always collect the first full premium from the applicant at the time of application.

The receipt that is located at the bottom of the application is called a conditional receipt. The word �conditional� is very important because the agent is not guaranteeing that the policy will be issued. Issuance of the policy is subject to the full approval of the insurance carrier.

The conditional receipt serves two functions:

�  It acknowledges the first full premium.

�  It states in very clear terms that the policy acceptance is subject to the approval of the carrier.

In the event the proposed insured dies before the policy is issued, the premium will be returned to the beneficiary.

Policy Effective Date / Backdating

Full protection takes effect as of the policy effective date. The policy effective date is the date on which the contestable period begins. The policy effective date also is the date on which the suicide clause in the life insurance policy begins to run. The suicide clause provides that a beneficiary will not be paid a benefit under the life insurance policy if the insured commits suicide within a certain period of time following the policy effective date.

Policies can be backdated a certain number of months. As a rule, the maximum is to backdate six months. Most companies allow backdating for sales reasons. For example:

�  Often, backdating can save an age by one year for the proposed insured and this can result in a lower premium for the proposed insured.

�  Backdating is useful to assist the policyowner in coordinating dates to fit their income pattern. Perhaps the backdating may change the policy premium due date to closely match payday.

�  Occasionally some policy forms have minimum and maximum age limits and backdating may help to put the applicant�s age within the window of acceptable age limits.

How Much Life Insurance Do I Need?

As an insurance agent, you will undoubtedly be asked the question:  �How much life insurance do I need?�  This is an important question to answer because the majority of families in America are inadequately insured.

As a general rule it is said that a person should carry life insurance equal to five or six times their annual earnings.

Types of Life Insurance

There are many types of life insurance available. We will discuss the following:

�  Term insurance.

�  Whole life insurance.

�  Universal life insurance.

�  Variable life insurance.

�  Adjustable life insurance.

�  Modified life insurance.

�  Family life insurance.

Term Insurance

This is the most basic type of life insurance. Some of its characteristics are as follows:

�  Term Insurance provides only temporary protection from one to twenty years or until the insured reaches a specified age. Should the insured be alive at the end of the term period the protection expires.

�  Term Insurance has no cash value or savings element. It is strictly pure protection.

�  Term Insurance can be renewable and/or convertible. Renewable means that you can continue the coverage for additional periods without proof of insurability. As a rule, the premium increases each time the policy is renewed based on the age of the insured at the time of renewal. Convertible means that the term policy can be exchanged for some type of cash value insurance without proof of insurability.

�  The premium for a term insurance policy is based on a person�s age, health, whether or not he or she smokes and the amount of coverage. Term insurance premium prices are easier to understand than other life insurance policies. One simply pays a specified price for each $1,000 of death benefits.

Term Insurance comes in a variety of policies. These include:

�  Yearly renewable term.

This type of policy is issued for a one-year period and the policyowner has the right to renew coverage for successive one-year periods. If term insurance is not renewable, the company selling the policy can require a medical examination when each period begins.

�  Five, ten, fifteen or twenty year term.

Although a one-year term is the least expensive, term insurance can be purchased for a specific period such as five, ten, fifteen or twenty years, and in some instances even longer periods. The premium remains level during the policy term, and the premium will increase if the policy is renewed at the end of the term.

�  Term to age sixty-five or seventy.

In this instance the term insurance is provided to a stated age. The premium remains level during the policy term and the insurance expires when the stated age is attained. As a general rule, the insured has the right to convert this term insurance to a cash value policy; however the policy must be converted sometime prior to the expiration date.

�  Decreasing term.

With a decreasing term policy, although the premiums remain level during the policy term, the face amount of insurance gradually decreases over time. For example a $100,000 policy issued for a decreasing term of 30 years could decline to $50,000 by the end of the twentieth year and zero by the end of the thirtieth year.

�  Re-entry term.

With this policy the premiums are based on a low-rate schedule. Under the terms of this policy, however, the insured must repeatedly demonstrate evidence of insurability, usually every one to five years.

Whole Life Insurance

Whole life insurance is so named because it lasts for the insured�s whole life. The premium stays the same forever. Critics of whole life state that the policyholder overpays for that protection during the younger years of the insured, which would negate the savings during later years.

Whole life insurance contains the basic elements of term insurance, with an investment element added. The insured pays a premium amount greater than the premium which would be paid for term insurance, and that portion of the payment is invested for accumulation over the life of the insurance policy. The growth on that investment is not taxable to the insured. This favorable treatment of return on investment is unique to life insurance and offers a substantial wealth accumulation vehicle.

Traditional whole life is different from term insurance because it offers both protection and cash value. With a whole life policy, the cash value builds slowly. Life insurance companies stress it as a positive for its value as a savings account. Cash value is money that would be paid to a policyholder when the policy is surrendered. This is sometimes called the surrender value of the policy.

With whole life, part of the premium buys the insurance, and part goes toward the cash value. This interest is tax-deferred and remains tax free if a person never utilizes the cash value before his or her death.

Some examples of whole life insurance include:

�  Ordinary life insurance.

Ordinary life insurance is a form of whole life insurance. Lifetime protection is provided until age 100 and the premiums remain level. In the event the insured is still alive at age 100, the full-face amount will be paid without death having to occur.

�  Limited payment life insurance.

This is another form of whole life insurance. Although the premiums are level, they are only paid for a certain number of years. After that payment period the policy becomes fully paid up. Limited-payment policies can be issued for ten, twenty or thirty years.

A policy that is paid up at age sixty-five or seventy is also available. The premiums for

limited-payment policies are higher than an ordinary life insurance policy but the cash value is also higher.

�  Endowment insurance.

This is the third basic type of whole life insurance. An endowment pays policy proceeds to the named beneficiary if the insured dies within a certain period. If the insured survives to the end of the stated period, the policy proceeds are paid to the policy owner.

Universal Life Insurance

This variation upon whole life insurance became extraordinarily popular after its introduction. Universal life policies are sold as investments that combine insurance protection with savings. Actually, a universal life policy can be defined as a flexible premium deposit fund that is combined with monthly renewable term insurance.

Here�s how it works:

FIRST �

An initial specific premium is paid. Then expenses are deducted from the gross premium and the balance is credited to the policy�s initial cash value.

SECOND �

A monthly mortality charge is deducted from the cash value to pay for the pure insurance protection.

FINALLY �

The remaining cash value is then credited with interest at a specified rate.

Universal Life has the following basic characteristics:

�  Protection, savings, and expense components are separated.

�  There is a stated investment return.

�  The plan offers considerable flexibility to the insured by permitting the insured to increase or decrease the premium and the corresponding death benefit during the life of the policy.

�  Cash withdrawals are permitted.

In some states, universal life is referred to as �flexible-premium adjustable life.� This describes many of its benefits. Universal life can be a useful tool to meet changing needs. It can also be useful if one�s income fluctuates from year to year. A person can vary his or her premium if he or she has a year with lower income. When someone varies his or her premium, the death benefit will fluctuate along with it.

Universal life offers tax advantages to the insured because the investment value grows without current taxation. The tax on the interest is deferred while the policy is in force and until the funds are withdrawn.

Variable Life Insurance

With a variable life insurance policy, the face amount of insurance varies according to the investment experience of a separate account that is maintained by the insurer. This is the perfect solution to the problem of inflation quickly eroding the real purchasing power of life insurance.

Under the variable life insurance policy the premiums are invested in equities or other investments. Should the investment experience be favorable, the face amount of insurance is increased. However, should the experience be unfavorable, the amount of insurance is reduced. In no event, however, can the amount of insurance be reduced below the original face amount.

The variable life insurance policy was designed to maintain the real purchasing power of the death benefit.

Variable life is not just another name for whole life. Variable life combines many features of traditional whole life with the new element of investment choice. That element is for the insurance purchaser who can live with elements of risk.

Along with the freedom of choosing one�s own investments comes the inevitable risk. Variable life insurance can offer higher investment yields than a traditional whole life policy, but one must assume a greater degree of risk. Variable life might be justified if the minimum death benefit guaranteed by the policy satisfies a person�s needs, and he or she can afford to play with the policy in the hopes of achieving a better-than-average return for his or her family.

Adjustable Life Insurance

This variation on the whole life policy permits changes to be made in the following areas:

�  Amount of life insurance.

�  Period of protection.

�  Amount of premium.

�  Duration of premium-paying period.

This type of insurance is frequently called �Life Cycle� insurance because policy changes may be made to conform to different periods in the insured�s life.

Within certain limits, the policyowner can make the following adjustments as the situation warrants:

�  Reduce or increase the amount of insurance.

�  Shorten or lengthen the period of protection.

�  Increase or decrease the premiums paid.

�  Lengthen or shorten the period for paying of premiums.

A cost of living provision can also be attached to the adjustable life policy and this will in fact maintain the real purchasing power of the insurance.

Modified Life Insurance

This is a type of life insurance policy in which the premiums are reduced for an initial period of three to five years and then the premiums increase thereafter:

The initial or reduced premium as paid in the beginning is slightly higher than term insurance rates but substantially lower than the premium paid for an ordinary life policy issued at the same age.

There are different types of modified life insurance:

�  Under one type the term insurance is used for the first three to five years and then automatically converts into an ordinary life policy at a premium that will be higher than what would have been paid for a regular ordinary life policy issued at the same age.

�  Under another type, the approach is to redistribute the premiums by charging lower premiums during the early years of the policy but higher premiums thereafter.

Modified life insurance can be attractive to individuals who expect their incomes to increase in the future.

Family Life Insurance

This is a variation upon the whole life policy designed to insure all family members in one policy. This policy is sold in units that state the amount and types of life insurance on the family members.

One unit for example may consist of the following:

�  $5,000 of ordinary life on the head of the family.

�  $2,000 of term to sixty-five on the spouse.

�  $1,000 of term Insurance on each child up to stated age.

As a rule, term insurance under the family life policy can be converted to some form of permanent insurance. Typically the children�s protection can be converted up to five times the face amount without proof of insurability. There is no additional premium if another child is born, and newborn children are usually automatically covered after a fifteen-day waiting period.

This type of policy is no longer very common.

Types of Insurance Companies

Having examined types of life insurance policies, we now examine the structure of the life insurance companies offering those policies. Life insurance companies can be organized in several ways; however, most are organized either as stock companies or as mutual companies.

Stock Life Insurance Company

A stock life insurance company gets its name from its basic ownership characteristic. The stockholders, people who have bought stock in the company, own a stock company. The stockholders may or may not also be policyowners. The sole function of the stockholders is to elect a board of directors who in turn will guide the operation of the company. If the company is successful financially, the stockholders will receive dividends, which are paid for each share of stock owned. A stock life insurance company is in business to make a profit for the stockholders.

Mutual Insurance Company

A mutual insurance company is also a corporation, and it also derives its name from its basic ownership characteristic. Unlike a stock company, which is owned by its stockholders, a mutual company has no stockholders. Control in a mutual company rests with the policyowners who �mutually� own the company. The policyowners elect a board of directors, and any �profits� are returned as dividends to the policyowners in the form of reduced costs for insurance.

It should be mentioned here that dividends from a mutual company are not profits in the mercantile or commercial sense but rather the return of an �overcharge� of premium.

For example, a mutual life insurance company might sell life insurance at one specific age for $20 per $1,000 of face amount. Once a dividend has been declared, each policyowner might then receive credit on the premium statement in the amount of $2 per $1,000. Thus, the ultimate cost for the insurance is $18 per $1,000 of face amount.

While not true in every case, mutual insurance companies usually issue �participating� life insurance policies. The term �participating� means that if the company realizes a savings in death claims due to a lower mortality rate, or an increase in the interest earned, or if it realizes some efficiency in its operation which reduces expenses, these savings or �profits� are passed along to the policyowner in the form of policy dividends. Thus, the policyowner in a mutual life insurance company �participates� in any savings or �profits� enjoyed by the company.

Insurance agents should not imply to clients that a stock company is better from an organizational standpoint than a mutual company, or vice versa, or that participating policies are better than nonparticipating ones. Both types of companies and both policies are acceptable.

Before any life insurance company can sell insurance in any state, it must be licensed to sell insurance or, as it is called, �admitted� to that state. An insurer that is admitted to a state is authorized to do business in that state. If an insurer is not admitted to a state, it is unauthorized to do business in that state.

Fraternal Benefit Society

Another type of insurer with which you should be familiar is the fraternal benefit society, also known as a �fraternal.�  A fraternal insurer is a social and benevolent organization, which provides, among other services, life insurance benefits for members.

Each state defines and provides for the regulation of fraternal benefit societies in its insurance laws. But, although the exact definition of a fraternal may differ from state to state, an organization usually must have certain characteristics to qualify as a fraternal benefit society. First, the organization generally must exist only for the benefit of its members and of their beneficiaries and be non-profit. Second, it must be organized without capital stock.

A third characteristic is that the society usually must be organized on a lodge system. This means that the organization must have local lodges or chapters, which hold regular meetings to carry on the activities of the society.

Finally, the organization must have a representative form of government. There must be a governing body chosen by the members directly or by delegates, in accordance with the organization�s bylaws or constitution.

Government Insurance Programs

Government Insurance Programs have been established for a variety of reasons throughout history. Social insurance programs have been created to allow the government to make compulsory a program lacking equity in order to cover fundamental risks and to redistribute income. Government insurance programs have been created when private insurers would have been subjected to adverse selection or were incapable of meeting society�s needs.

By its administration of various Federal insurance programs, the U.S. government has become the largest insurer in the world. These various programs include Social Security, Medicare, and the railroad retirement, disability, and unemployment programs.

Reciprocals

Reciprocals are groups of individuals (called �subscribers�) who are insured under an arrangement where each subscriber is both an insured and an insurer. In other words, the other members of the group insure each subscriber. However, the liability of each subscriber is limited.

The administrator of the reciprocal is the �attorney-in-fact.�  He or she is granted this power by the subscribers through a broad power of attorney and receives a percentage of the gross premiums paid by the subscribers. Other than this payment to the attorney-in-fact and administrative expenses, the cost to the reciprocal is limited to the amount of the losses that occur. Any unused premiums are returned to the subscribers.

Lloyd�s of London

Lloyd�s of London is a name familiar to many in the insurance industry. However, perhaps the most interesting fact about Lloyd�s of London is that it is not an insurer nor does it issue policies. Rather, Lloyd�s of London is an association of members who write insurance for their own accounts. The New York Stock Exchange bears the same relationship to stock purchases as Lloyd�s bears to the purchase of insurance.

Like the New York Stock Exchange, Lloyd�s provides quarters for its members as well as procedures for business transactions. Though neither organization engages in trade, each provide facilities and rules that govern how its members will pursue trade. In addition, Lloyd�s maintains worldwide underwriting information and a complete record of losses. It also aids in loss settlements and supervises salvage and repairs throughout the world.

At Lloyd�s, an insurance transaction begins when a proposal is placed before the underwriting members, or their agents, by a licensed broker. The broker prepares the policy and submits it to the Policy Signing Office where the policy is examined. If the policy conforms to agreed-upon rules, it is submitted to the underwriters. Those underwriters who wish to participate in the policy affix their signatures or �underwrite� the risk. American Lloyd�s associations operate under the same principles and methods as Lloyd�s of London.

Insurer�s Financial Status

Changing economic conditions and highly publicized failures of financial institutions (from savings and loan companies to insurance companies) have focused much attention on the financial status of private insurers. Independent rating services provide ratings consumers can use to measure the status of an insurance company and compare it to others.

The two most popular rating services are A.M. Best Company and Standard and Poors. The A.M. Best Company looks at profitability, leverage, and liquidity and assigns ratings from A++ (Superior) to C (Fair) and below. Standard and Poor�s focuses on the claims paying ability of an insurer and offers ratings from AAA (Superior) to D (Insurers placed under an order of liquidation).

In most cases, insurance companies pay a fee to be rated by a rating service. Other rating services include Moody�s Investors Service (measuring financial strength), and Duff and Phelps (measuring claims paying ability and managerial soundness). In addition to private rating services the National Association of Insurance Commissioners measures company performance and prepares analytical reports as part of the Insurance Regulatory Information System (IRIS). Agents have access to IRIS ratios, which serve as indicators of a company�s financial condition in various areas.

Life Insurance � Policy Provisions

It may surprise people that many insurance agents have never read the required policy provisions that are contained in every policy that they sell.

It is important that you realize that policy provisions are in fact contractual provisions and govern what the policyowner can and cannot do with the policy you have sold them.

Here is an overview of the list of provisions and then we will discuss them individually.

�  Ownership clause.

�  Entire contract clause.

�  Incontestable clause.

�  Suicide clause.

�  Grace period.

�  Reinstatement clause.

�  Misstatement of age.

�  Beneficiary designation.

�  Change of plan provision.

Ownership Clause

The owner of a life insurance policy can be the applicant, the insured, or the beneficiary. In most cases, the applicant and insured are the same person.

Under the ownership clause, the policyowner possesses all contractual rights in the policy while the insured is still alive. These rights include the selection of a settlement option, naming and changing the beneficiary designation, election of dividend options, and other rights. These contractual rights typically can be exercised without the beneficiary�s consent.

In addition, the ownership clause provides for a change in ownership. The policyowner can designate a new owner by filling out an appropriate form with the company. The insurer may require that the life insurance policy be endorsed to show the name of the new owner.

Entire Contract Clause

The entire contract clause states that the life insurance policy and attached application constitute the complete contract between the insurer and policyowner.

No statement can be used by the insurer to void the policy unless the statement is a material misrepresentation and is part of the application. In addition, any officer of the company cannot change the terms of the policy unless the policyowner agrees to the change.

Incontestable Clause

Under the incontestable clause, the company cannot contest the policy after the policy has been in force two years during the insured�s lifetime. The insurance company has two years to discover any irregularities in the contract, such as a material misrepresentation or concealment.

If the insured dies after that time, the death claim must be paid. For example, if John conceals a cancer operation when the application is filled out and dies after expiration of the incontestable period, the death claim will be paid.

The purpose of the incontestable clause is to protect the beneficiary if the insurance company tries to deny payment of the death claim years after the policy is issued. Since the insured is dead, allegations by the insurer concerning statements made in connection with the application cannot be easily refuted. After the incontestable period has expired, with few exceptions, the company must pay the death claim.

Suicide Clause

A typical suicide clause states that the face amount of the policy will not be paid if the insured commits suicide within two years after the policy is issued. The only payment is a refund of the premiums.

The purpose of the suicide clause is to reduce adverse selection against the insurer by providing the insurer some protection against an individual who purchases a life insurance policy with the intention of committing suicide.

Grace Period

A grace period is another important contractual provision. A typical grace period gives the policyowner thirty-one days to pay an overdue premium.

The life insurance remains in force during the grace period. If death occurs during the grace period, the overdue premium usually is deducted from the policy proceeds.

Reinstatement Clause

If the premium is not paid during the grace period, a life insurance policy may lapse for nonpayment of premiums.

The reinstatement clause allows the policyowner the right to reinstatement of a lapsed policy under certain conditions:

�  The insured must provide evidence of insurability, a condition that insurers often waive for lapses of less than two months.

�  All overdue premiums plus interest must be paid.

�  A policy loan must be repaid or reinstated.

�  The policy must not have been surrendered for its cash value.

�  The lapsed policy must be reinstated within five years.

If the policyowner wishes to continue the same type of life insurance coverage, it usually is more economical to reinstate a policy than to buy a new one. This is because a new policy is likely to have a higher premium, since it will be issued when the insured is older than at the time of issuance of the first policy.

Misstatement of Age

The insured�s age may be misstated in the application. Under the misstatement clause, the amount paid is the amount of life insurance that the premium would have purchased at the insured�s correct age.

For example, assume that Mary�s correct age is thirty but is incorrectly recorded in the application as age twenty-nine.

Assume that the premium for an ordinary life application at age twenty-nine is $14 per $1,000 and $15 per $1,000 at age thirty. If Jane has $15,000 of ordinary life insurance and dies only 14/15ths of the proceeds will be paid, or $14,000.

Beneficiary Designation

The beneficiary is the person or party named in the policy to receive the policy proceeds.

There are numerous beneficiary designations in life insurance.

They include the following:

�  The primary beneficiary is the first party who is entitled to receive the proceeds at the insured�s death.

�  The contingent beneficiary is the beneficiary entitled to the policy proceeds if the primary beneficiary is not alive.

�  A revocable beneficiary designation means that the policyowner has the right to change the beneficiary designation without the beneficiary�s consent.

�  An irrevocable beneficiary designation means that the policyowner cannot change the beneficiary without the irrevocable beneficiary�s consent.

�  A specific beneficiary designation means that the beneficiary is named and can be identified. For example, Martha Smith may be specifically named to receive the policy proceeds if her husband should die.

�  A class beneficiary designation means that a specific individual is not named but is a member of a group to whom the proceeds are paid. One example of a class beneficiary designation would be �children of the insured.�

Change of Plan Provision

The change of plan provision allows the policyowner to exchange the present policy for a different one.

If the change is to a higher premium plan, such as exchanging an ordinary life policy for an endowment at age sixty-five, the policyowner must pay the difference in cash values between the two contracts plus interest at a stipulated rate.

Since the net amount at risk is reduced, evidence of insurability is not required.

Some insurers also allow the policyowner to change to a lower premium policy, such as exchanging an endowment contract for an ordinary life contract. The insurer refunds the difference in cash values to the policyowner. However, evidence of insurability is required since the net amount at risk is increased.

Exclusions and Restrictions

Life insurance policies contain very few exclusions and restrictions. The more common ones are as follows:

�  Certain activities which are considered dangerous such as flying, hang-gliding, auto racing or skydiving may either be excluded or covered if an additional premium has been paid.

�  The suicide clause described above, which excludes payment of the face amount in the event of suicide within two years of the issue date.

�  An aviation exclusion may be present in the policy and would exclude death coverage from an aviation accident other than as a passenger on a regularly scheduled airline.

�  The war exclusion is designed to control adverse selection during times of war and may be inserted to exclude payment if death occurs as a result of war.

Premiums

There are two basic ways to purchase a life insurance policy.

�  The first is by paying the entire cost in one lump-sum payment. This is the �single premium� method.

�  The second method of purchasing a policy is by the payment of periodic premiums. Rather than making a single payment for the insurance, the policyholder makes annual, semi-annual, or more frequent payments.

A single premium policy is seldom purchased because of the large lump-sum payment that is generally required. The typical policyholder finds the periodic payments much easier to make.

A second reason why single premium policies are seldom purchased concerns the cost of the policy if the insured dies in the early years of the contract. In this situation, the amount paid for the insurance under the periodic method will be less than the single premium amount.

Parts of the Premium

There are three basic factors which affect the premium charged for a life insurance policy.

�  The first factor is mortality. Mortality refers to how many people within a given age group will die each year.

�  The second factor is interest. Interest refers to the earnings the company receives on the premium dollars it invests.

�  The third factor is expenses. Expenses are all of the costs the company incurs in selling, issuing, and servicing its policies.

We said earlier that as one grows older, the cost of insurance increases. The reason for this is that as one grows older, the chance of death increases. Insurance companies use mortality tables and other statistics to determine the number of insureds within each age group, who will die each year. What would happen if more people died in a year than the company had predicted?  The company will pay out more for death claims than was anticipated.

Another factor which influences the cost of insurance is the interest income that the company earns from its investments. Insurance companies receive millions of dollars each month in premium dollars. And, while each company has death claims and other expenses, the costs for these claims and expenses should be less than the total premiums received.

By law, a life insurance company is permitted to invest this extra money to obtain additional revenue in the form of interest. Most life insurance companies invest in stocks, bonds, construction projects, and in a variety of other ventures designed to provide a return on their investment. The principal, as well as the interest earned, on these investments establishes a fund to pay all death claims as they occur and also helps to offset the cost of insurance.

Naturally, the insurance company is not permitted to keep all the money it receives. Expenses, of course, have to be paid. In addition to death claims, expenses include such items as:

�  Agent�s commissions.

�  Salaries.

�  Advertising.

�  Physical examinations.

�  Legal costs.

�  Policy issue costs.

Here is a very simple formula which indicates how these factors affect premium costs:

Death claims + Other expenses - Investment interest earned = Premium to be charged.

Keep in mind that no company determines the premium to be charged by the simple method we have described above. This simplified approach merely describes the important relationship between these factors.

Net and Gross Premium

The premium that a company charges for a life insurance policy is called the �gross� premium.

When a company is calculating the premium for a policy, it begins by determining the �net� premium. Once the net premium has been computed, the company then adds the expense factor, or �loading,� to this net premium to arrive at the gross premium.

Mortality

An insurance company obviously cannot know when a particular insured will die. However, by using the mathematical concept of probability, the company can predict with a great deal of accuracy the number of insureds who will die each year. This prediction of future mortality is made on the basis of past mortality experience and assumes that future experience will parallel past experience. But, if past mortality is to be a reliable basis for prediction, accurate data must be kept on a large group of representative individuals for a sufficiently long period of time.

Information on past mortality is analyzed and arranged in a table called the �mortality table� which shows probable death or mortality rate at a specific age. Beginning with a given number of individuals at a given age, the mortality table shows the number of people out of the group who probably will die at each age and the number who will survive.

Remember that even if the mortality rates and the mortality table are accurate, a company which wants a reliable estimate of future mortality must apply the rates to a large enough group of individuals for the �law of averages� to operate.

Level Premiums and Reserves

Since few policies are purchased by the single premium method, once the net single premium is computed, the company then converts that premium into a �net level premium�. Let�s now turn to the concept of level premiums.

The early renewable term premium, also called �natural or step-rate� premium, increases each year as the insured ages and the risks of mortality increase. The premium rises rather gradually during the younger ages, but increases sharply for the older ages. As a result, the premiums can become prohibitively expensive for most insureds at the older ages.

To overcome the problem of annually increasing premiums, companies develop the level premium plan. With this plan, the premium remains the same during the premium payment period rather than increasing as the probability of death increases. This level premium is higher than the natural or yearly renewable term premium in the early years of the policy, but it is lower than the natural premium in the later years.

Under the natural premium plan, the net premium charged policyowners each year is just sufficient to pay the expected claims for the year. This is not true for the level premium plan. The net level premium payments made in the early years of the contract are greater than the amount needed to pay the policy claims during those years.

By investing the excess part of the premium in the early years, the company accumulates funds to cover the deficiency which occurs in the latter years. These funds which the company holds to meet future policy obligations constitute the policy reserve or simply the �reserve.�

The reserve is the amount that, together with future premiums and interest earnings, will be sufficient for the company to pay all future policy claims, based on the company�s mortality and interest assumptions. Thus, the reserve is a liability - future obligation to the company.

Because a company�s ability to fulfill its contract obligations depends upon sufficient policy reserves, each state requires a company to maintain certain minimum reserves.

State laws specify the mortality table and the assumed rate of interest to be used in calculation of the legal minimum reserves.

Because of these state regulations, reserves are often called �legal reserves.�

Insurance Age

Premium charged for life insurance depends upon the insured�s age. This is true because the mortality factor is one of the three basic elements of the premium and the mortality factor varies with an insured�s age.

However, the age used to determine the premium is the insured�s insurance age. The insured�s insurance age may, or may not, be the same as his or her actual or chronological age.

A company may use one of two methods of determining an insurance age:

In the first method, an insured�s insurance age is his or her age at the insured�s nearest birthday. If the insured turned age 30 less than 6 months ago, the insured�s age would be 30. However, if the insured�s 30th birthday was more than 6 months ago, the insurance age would be 31 since the next birthday would be nearer than the last.

Although the nearest birthday is the more commonly used method, some companies may use the insured�s last birthday to determine the insurance age. The insurance age under this method is the same as the insured�s actual age, regardless of the number of months since his or her last birthday.

Payment of Premiums

The policyholder of a life insurance contract has a choice regarding how to pay premiums. Premiums generally can be paid annually, semiannually, quarterly, monthly or through monthly bank drafts.

The company usually offers a discount for paying the premiums annually. The most popular method of payment is monthly bank draft.

Settlement Options

When benefits are paid following the death of the insured the payments of benefits is referred to as �settlement of the policy.�

The following is an overview of the settlement options and then we will review them one at a time.

They are:

�  Lump sum settlement.

�  Proceeds and interest.

�  Fixed years installments.

�  Life income.

�  Joint life income.

�  Fixed amount installments.

�  Other mutually agreed methods.

Lump Sum Settlement

This is when the beneficiary receives the policy proceeds in a single payment following the death of the insured.

Proceeds and Interest

Under this option the insurance company will hold the policy proceeds and make interest payments to the beneficiary. The minimum interest rate is spelled out in the policy and the company may pay a higher rate at its discretion.

The beneficiary still has the right to withdraw all or part of the proceeds of the policy at any time.

Fixed Years Installments

With this option the insurance company pays the proceeds in equal monthly payments. The recipient of the proceeds chooses the number of years for which payments will be made.

The amount received monthly depends on three factors:

�  Policy proceeds.

�  Number of years for which payments are to be made.

�  Interest rate paid by the insurance company.

Again, under this settlement option the beneficiary still has the right to withdraw all or part of the proceeds at any time.

Life Income

Under this settlement option the beneficiary will receive equal monthly payments for the life of the beneficiary.

The amount of monthly payments depends on four factors:

�  Policy proceeds.

�  Beneficiary�s sex.

�  Beneficiary�s age at time payments begin.

�  Period certain for which payments are guaranteed.

When payments are guaranteed for a period certain, such as ten years, payments will be made for the specified number of years regardless or whether the beneficiary lives to the end of that period. Should the beneficiary die during the period certain payments will continue to the beneficiary�s designated successor.

For example:

A beneficiary is going to receive $500.00 a month for 10 years certain. This means that should the beneficiary live the entire ten years he will receive $500.00 a month.

After ten years there are no more benefits paid.

However, if the beneficiary dies in the sixth year the remaining four years of $500.00 per month will go to his designated successor.

Joint Life Income

When this option is chosen, equal monthly payments will be made so long as either payee is alive.

This option may be used when an insured contributes to the support of his or her parents. In the event of the insured�s death, the parents, as beneficiaries, would receive monthly income for the rest of their lives.

The amount of the monthly benefits would depend on two factors:

�  The policy proceeds.

�  Parents� ages at time they begin to receive benefits.

However, under this option the beneficiaries typically do not have the right to discontinue the monthly payments and receive the balance in a lump-sum settlement.

Fixed Amount Installments

Using this settlement option, the insurance company makes equal payments per month, or at longer intervals, in an amount chosen by the policyowner or beneficiary.

All proceeds held by the insurance company will earn interest. If the monthly payment is greater than the monthly interest earned, the balance of the proceeds held by the insurance company decreases each month until the total proceeds and interest due are paid out.

Under this option the beneficiary may withdraw the unpaid balance at any time.

If the beneficiary dies before the installment payments are completed, the unpaid balance is paid to the beneficiary�s estate.

Other Mutually Agreed Method

On occasion a life insurance company may allow the policyowner to designate other payment methods. An example of this may be that the proceeds and interest are to be paid to the insured�s spouse for the spouse�s lifetime and, upon the spouse�s death, a lump-sum settlement is to be made to the insured�s children.

Non-Forfeiture Options

Life insurance policies contain non-forfeiture options. They are designed to give the insured ways in which he or she may gain continued value from a policy in the event the insured is unable to continue premium payments.

The five non-forfeiture options are as follows:

�  Cash surrender value.

�  Reduced paid-up insurance.

�  Extended term insurance.

�  Automatic loan provision.

�  Dividend accumulations to avoid lapse.

We will now discuss each of these non-forfeiture options.

Cash Surrender Value

If the policyowner is unable to continue paying premiums, he or she may surrender the policy and request that the company pays the cash surrender value of the policy, if any.

As a rule most policies have no cash value whatsoever for the first two to three years.

The cash surrender value usually consists of the following:

�  The policy cash value.

�  Cash value of paid-up additions.

�  Dividends.

The cash surrender value can be reduced by:

�  Any policy loans that are outstanding.

�  Accrued loan interest on outstanding policy loans.

It is important to know that all coverage ceases when the policy is cash surrendered.

Payment is usually made in one lump sum and in some cases in accordance with one of the other policy settlement options already discussed.

Reduced Paid-Up Insurance

Under this option the policyowner may request that the cash value of the policy be used to keep a reduced amount of paid-up insurance in force under the same policy.

Usually the policy has a table contained in it that shows the amount of reduced insurance in any given year which the cash value would purchase in that year.

Although the policy has had its face reduced, the policy will continue to earn cash value and pay dividends if applicable.

Extended Term Insurance

This option allows the same face amount of the policy to remain in effect for a specified number of years and days. Again, as with reduced paid-up insurance the policy will contain a table showing how long in years and days the original face amount will remain in force during any given surrender year.

The length of time in years and days is calculated by taking the policy�s cash surrender value, the insured�s age and sex at the time premiums were discontinued, and using that cash surrender value to purchase term insurance for a specified amount of years and days.

Under this option the policy does not continue to earn cash value or pay dividends.

Automatic Premium Provision

It is possible for the insured to authorize the insurance company to make an automatic loan from the policy�s cash value to pay any premium not paid by the grace period.

Dividend Accumulations to Avoid Lapse

When the policy pays a dividend, the dividend accumulations may be applied to any premium not paid by the end of the grace period. In the event the amount of accumulated dividends is not enough to pay the entire premium coverage will then be extended in proportion with the amount of premium paid by the accumulated dividends. As a result of this a new grace period will start at the end of extension coverage.

Dividend Options

If a life insurance contract is a participating policy that means that the policyowner is entitled to an annual dividend paid by the insurance company. Participating policies afford the policyowner the opportunity to participate in the earnings of the insurance company through these dividend payments.

The following are ways in which a policyowner may use his or her dividends:

�  Cash payment.

�  Reduction of premium.

�  Accumulation of interest.

�  Paid-up additions.

�  One-year term.

Cash Payment

Under this dividend option the insurance company sends the insured a check equal to the amount of the declared dividend payment.

Reduction of Premium

The premium due on the policy for the upcoming year will be reduced by the amount of the current years declared dividend and the balance becomes the new premium due for the upcoming year.

Accumulation of Interest

The dividend may be held by the insurance company to accumulate interest paid at the rate that is specified in the contract. The insured has the right to withdraw the accumulated dividends at any time.

Should the accumulated interest and dividend be on deposit with the company at the time of the insured�s death, the accumulated interest and dividend will be paid along with the policy proceeds.

Paid-Up Additions

This option enables the insured to receive additional amounts of life insurance by using the dividend to purchase paid-up additions. The additional insurance will be the same kind and subject to the same provisions as the original policy.

Again, on the insured�s death, paid-up additions of insurance will be paid along with the policy proceeds.

One-Year Term

Some policies permit dividends to purchase additional one-year term coverage.

The amount of the one-year term coverage would be added to the face amount of the base policy in the event of the insured�s death.

Life Insurance Policy Riders

Most insurance agents are familiar with the term �endorsement.�  However in life and health insurance policies the word �rider� is used in lieu of the word �endorsement.�

The effect is the same in that riders modify the coverage of the basic policy the same as an endorsement would.

The most commonly used riders in life insurance policies are:

�  Waiver of premium.

�  Accidental death and dismemberment.

�  Guaranteed purchase option.

Waiver of Premium

This rider protects the insured in the event he or she becomes totally disabled.

The waiting period is usually six months, and if the insured continues to be disabled after the six-month waiting period, the premium payments on the policy will be waived by the insurance company. Many policies will also refund the premium that was paid by the insured during the six-month waiting period.

The cost for this coverage is a bargain to the insured, and no policy should be sold without this rider.

Accidental Death and Dismemberment

The amount paid in the event of accidental death of the insured is usually twice the policy�s regular face amount. This benefit is often referred to as �double indemnity.�

As a rule the accidental death rider is very carefully worded to define exactly under what circumstances this benefit will be paid.

The most liberal of the definitions is �accidental bodily injury.� The less favorable wording would be that death must occur �by accidental means.�

For example, with the language �by accidental means,� if an insured died from a broken neck after intentionally diving into the shallow end of a swimming pool the policy would not pay the accidental death benefit because the action of diving into this pool wasn�t accidental. However, if the insured accidentally fell into the pool and drowned the benefit would be paid.

On the other hand, under the �accidental bodily injury� definition, even the intentional diving into the pool would have been paid because the broken neck was an accidental injury notwithstanding the intentional dive into the shallow water.

Normally the death caused by the accident must consummate itself within ninety to one hundred eighty days of the incident in order for the double indemnity benefit to be paid under the rider.

While the accidental death benefit is paid to the beneficiary after the death of the insured, the dismemberment portion of the rider provides that the dismemberment benefit will be paid directly to the insured, rather than the beneficiary.

Dismemberment benefits typically are paid for:

�  Loss of sight.

�  Loss of hand or hands.

�  Loss of foot or feet.

Regarding the loss of hand or foot, the loss typically must involve �complete severance through or above the wrist or ankle joint.�

Loss caused by amputation is excluded unless medically necessary and as the result of an accidental injury.

Guaranteed Purchase Option

This rider is used most frequently with whole life insurance rather than term insurance.

Under this option the company guarantees the insured that he or she may purchase additional amounts of coverage without evidence of insurability.

These additional purchases are usually made at specific time intervals or upon events that change the insured�s family status. For example, some policies permit additional purchases of life insurance under the following circumstances:

�  Every fourth policy anniversary year.

�  The insured purchases a new home.

�  The insured gets married.

�  The birth of a new child.

The premium charge for the additional coverage is typically based on the type of insurance purchased and the insured�s age at the time of exercising the option.

Life Insurance Underwriting

The ultimate purpose of life insurance underwriting is to develop a profitable book of business for the insurance company.

In order to accomplish this goal the life insurance underwriter attempts to provide coverage for a diversified group of insureds whose expected death rate is the same or lower than what is expected of the population as a whole.

Underwriting Factors for Individual Coverage

Life insurance is priced on a class basis. Perspective clients of the insurance company are classed on the basis of a number of factors that help to predict expected mortality rates.

The principal rating factors are:

�  Age.

Mortality rates are measured in terms of deaths per one thousand persons, and this of course increases with age.

Thus the older you are the more life insurance costs because you are closer to death than a younger person.

�  Sex.

On average, women in the United States live approximately seven years longer than men. Therefore cost for life insurance on a woman is lower than on a man of the same age.

For example a thirty-year old male may pay the same premium as that of a thirty-three-year old female.

�  Health.

The health of an individual as well as the health history of that individual�s family helps the underwriter to determine if the applicant presents an average or better than average risk to the insurance company.

In evaluating an insured�s health the company will consider whether the applicant or family members have had any of the following illnesses:

�  Cancer.

�  Heart disease.

�  Hypertension.

�  Diabetes.

As a general rule, persons whose health history include the above diseases will likely have a higher than normal mortality rate.

Most insurance companies are now offering discounted rates to non-smokers due to the link between smoking and lung and heart disease.

�  Occupation and avocation.

Since certain occupations and avocations pose hazards, such as flying and scuba-diving, applicants who engage in these hobbies are likely to have a higher than normal mortality rate.

�  Personal habits.

If a life policy is for a large amount of coverage the insurance company will more than likely investigate the personal circumstances of the insured�s life. For example areas such as alcohol or drug use, poor driving record or financial problems may be taken into consideration.

�  Foreign travel or recent immigration.

People who travel or reside outside the United States may be exposed to diseases not commonly found in this country.

Additionally, mortality rates vary from country to country. Therefore if a person is applying for life insurance shortly before leaving the country, special medical tests or a postponement of coverage may take place.

Underwriting Actions

Based on the information that the underwriter receives from the applicant, one of three actions may be taken.

They are as follows:

�  Rate the applicant standard and charge the normal premium.

�  Rate the applicant substandard and charge a higher premium.

�  Decline the coverage.

In addition to the above three actions many insurance companies recognize preferred risks and they will actually reduce premiums for those preferred risks.

Delivering the Policy

Policy Effective Date

The effective date of a life insurance policy is very important since this is the date on which coverage actually begins for the insured. As discussed earlier in these materials, the policy effective date will also have significance with regard to the incontestable and suicide clauses.

To determine the effective date of the policy, we must examine the principle of contract law known as �offer and acceptance.�

If a proposed insured signs the application and submits it with the first premium to the company, an offer to buy insurance has been made by the proposed insured.

If the insurance company issues the policy, as applied for, then offer and acceptance occurs. That is, the proposed insured has made an offer to purchase a life insurance contract, and the insurance company has accepted that offer.

So far, we have assumed that the premium was submitted with the application. However, there are two other possibilities to consider regarding the effective date of the policy.

The first occurs when an application is submitted without the premium. In this case, the applicant has made no offer. The applicant has only extended an invitation to the company to make an offer.

The insurance company makes the offer when it issues a policy as applied for and delivers it to the applicant. Further, the offer is accepted when the applicant pays the premium, assuming any other conditions have been fulfilled. The date of payment of the premium becomes the effective date of the policy.

In situations where the initial premium does not accompany the completed application, most companies state in the application that the proposed insured must be in good health at the time of policy delivery before coverage becomes effective.

So, before accepting the initial premium and leaving the policy with the insured, the agent must obtain a signed statement of the prospective insured�s continued good health. This statement and the initial premium are then transmitted to the company.

The final possibility occurs when the premium is submitted with the application but no receipt is given. If this is the case, then the policy�s effective date is generally the date that the policy is issued and delivered.

Delivery

Delivery of the policy constitutes the company�s acceptance of the applicant�s offer � the application and initial premium.

A policy is considered delivered when one of the following three events occurs:

�  The policy is actually handed over in person.

�  The policy is mailed to the policyholder.

�  The policy is mailed to the agent for unconditional delivery to the policyholder.

Delivery, then, does not usually have to be accomplished by the manual transfer of the policy to the policyholder. Delivery accomplished by means other than a manual transfer is called �constructive delivery.�

If a policy is not, or cannot, be delivered, then the policy is not in effect, as policy delivery has not been accomplished.

Two other situations should be noted:

�  When the applicant wants to examine the policy for a time before paying the initial premium, and the policy is left with the applicant for inspection, he or she should sign a receipt for the policy, referred to as an �inspection receipt.�  This acknowledges that the policy is in the insured�s possession for inspection purposes only and that the initial premium has not been paid and that the insurance is not in effect.

�  An applicant may ask the company to give the policy for which they are applying a date earlier than the application date. The reason for this �backdating� is usually to obtain a lower premium. Premium paid for life insurance depends, among other factors, on the insured�s age. So, in order to obtain a lower insurance age, and, as a result a lower premium, backdating is used.

Agents Responsibilities Regarding Delivery

The agent should deliver the policy to the client as soon as possible after the policy is issued. This is especially important when no premium was submitted with the application, because the coverage will not become effective until the policy is delivered and the first premium paid during the continued good health of the proposed insured.

The agent also has a responsibility to explain the policy�s provisions, riders, and exclusions at the time of delivery of the policy.

Income Tax Benefits of Life Insurance

By building income tax benefits into life insurance, public policy encourages individuals to purchase life insurance and obtain income security in the event of death. Specific income tax benefits of life insurance include the following:

�  Death benefits are income tax-free.

The primary advantage of life insurance is that the policyowner contributes a sum as a premium amount, and when he or she dies the whole death benefit amount is passed on to the insured�s beneficiaries tax-free. This is good for the beneficiaries as well as society since these beneficiaries do not become financially dependent upon society as a result of the death of the insured. The death benefits of life insurance policies have been exempted from income taxation in order to promote this societal benefit.

�  Current earnings and gains not currently taxed.

The second advantage of life insurance is that during the insured�s lifetime, and while the policy is in force, all interest earned, dividends earned and/or capital gains realized on the policy investments are not subject to current income tax. The taxation is deferred until the gains are taken from the policy by the policyowner. All investment life insurance policies enjoy tax-deferral on this buildup and a possibility of total tax-exemption on investment returns within the contract, which occurs when the proceeds are disbursed as death benefits. In other words, if the policyowner never takes the gains from the policy, there will never be tax on the policy�s investment gains and the death benefit will be paid to the beneficiaries tax-free.

�  Policy tax basis includes amounts paid for life insurance and expenses.

The third income tax benefit of life insurance containing investment capital is that the amount of money which the insured recovers tax-free when surrendering a life insurance policy includes all the life insurance costs that the policy has charged during the time the policy has been in force. These costs are paid on a pretax basis even when a policy is surrendered.

�  Tax-free use of untaxed earnings and gains.

The fourth income tax benefit of life insurance depends on whether or not the insured incurs taxation as a result of using the monies accumulated within the life insurance policy while it is still in force.

The insured could use these monies by withdrawing them, borrowing them from the insurance company or pledging the policy as collateral for a loan.

The tax code permits tax-free use of these funds up to certain prescribed levels. Any insured should always obtain competent tax advice before accessing insurance policy funds in order to confirm that the use will be permitted free from tax.

Annuities

Before concluding our discussion of life insurance, we will turn to another product frequently sold by life insurance companies:  Annuities. An annuity is an investment contract between an individual and the insurance company. The individual receives a return on his or her investment that supplements the individual�s contribution. At some point in time, the individual can choose to �annuitize� the investment to provide income for a specified period of time in the person�s lifetime.

The earnings on an annuity can grow without being diminished by taxes. These earnings are not taxable until the individual withdraws them, and they are spread out over a number of years. When an individual begins receiving income from an annuity, only part of the income is taxable because the individual receives both interest and a partial return of the invested principal.

To make the best use of the positive tax advantages of an annuity, individuals also must be aware of potential tax problems. The IRS imposes a penalty on withdrawals unless an individual is over age 59 1/2 when withdrawing money from the annuity or cashing it in. There is a 10 percent penalty on any earnings withdrawn, along with the tax owed on the withdrawal. These charges are in addition to any insurance company fees that might be imposed upon the withdrawal.

Customers should be advised to approach the purchase of an annuity with the expectation that they will not draw on it until they are older than age 59 1/2. To fully exploit the tax advantages, the individual should plan on holding the annuity for many years so that the earnings can grow without current taxation. No matter what the tax advantages of an annuity are, the individual still must pay close attention to the rate of return on the investment.

Types of Annuities

There are many different types of annuities offered by life insurance companies, including the following:

�  Qualified annuities.

Qualified annuities are purchased with funds generated from qualified retirement plans. Contributions to qualified plans generally are not subject to current taxation when they are contributed to the plan. Examples of qualified retirement plans include Individual Retirement Accounts (IRAs), IRAs that qualify for an income tax deduction are qualified plans as are Simplified Employee Pension Plans (SEPs), 401(k) plans, profit-sharing plans and pension plans.

These qualified plans are unique because in addition to enjoying the deferral on the earnings within the plan which is enjoyed with all annuities, an individual and his or her employer may also make capital investments into these plans without having to pay taxes on the amount of investment in the year of contribution. These qualified plans are usually among the best investment opportunities available.

�  Finite term annuities.

The finite term annuity is sometimes called a certificate of annuity because of its resemblance to a certificate of deposit (CD). An individual may purchase a finite term annuity with a variety of maturity dates and may choose when to pay taxes. The minimum investment is usually $5,000 or $10,000. The yield is usually slightly less than a bank CD. When the maturity date arrives, the individual may withdraw the money and pay taxes on the gain. If the individual does not need the money and does not want to pay the taxes at that point in time, he or she can roll the money over into a new finite term annuity.

This annuity investment is an advantage for someone who is over 59 1/2. It is not ideal for someone younger than that, due to the 10 percent early-withdrawal penalty, along with the tax on the gain. There is also a question of safety. It�s not quite as safe as a bank CD, although choosing an A+ or A rated insurance company can bridge the safety gap.

�  Fixed annuities.

One key appeal of annuities is that they offer the prospect of a guaranteed annual income after retirement, no matter how long one lives. Fixed-rate annuities guarantee a particular interest rate for a specified period of time; for example, ten years. After that period of time, only a minimum yield is guaranteed.

Annuities are often called �life insurance in reverse.�  While life insurance creates an estate immediately upon the insured�s death, an annuity protects against �living too long.�  While many people agree that a long life is a blessing, they also acknowledge that they do not wish to outlast the savings they have accumulated upon retirement. This concern underlies one of the basic attractions of annuities. By assuring continued payments for an unlimited number of years, annuities guarantee that the insured will not deplete his or her source of income.

The payments one makes for an annuity are referred to as premiums. Premiums, like money placed in a deposit account, earn interest, and these amounts increase in value while the insurance company invests them. The annuity contract also specifies the interest rate that the insurance company will pay on the accumulated fund. A specific interest rate may be guaranteed for one or two years and sometimes as long as five or ten years. After the guaranteed-rate period expires, the contract may call for the rate to be reviewed at specified intervals, such as quarterly or annually. At that time, the insurance company adjusts the rate in accordance with changes in the general interest rates.

Many insurance companies use the rate paid on Treasury bills as an index for setting the rate paid on annuities. Sometimes indexes such as consumer prices or cost-of-living calculations are used. Most insurance companies also guarantee that the interest rate paid on annuities will never be lower than a particular rate specified in the contract.

When an insurance company receives premiums on a fixed annuity, it invests them along with other funds it holds. However, not all dollars a contract owner pays are invested, since some are used for sales commissions and fees. These charges may vary between companies and contracts. Some companies charge only surrender fees. However, should the insured die before the cash value stated in the contract equals the amount of premiums paid in, most contracts provide for a payment to the beneficiary of at least the amounts paid in, regardless of sales charges.

�  Immediate annuities.

An immediate annuity provides for payments to commence shortly after the purchase date according to the preference of monthly, quarterly, semiannual or annually under the annuity contract.

�  Deferred annuities.

With a deferred annuity, the contract is arranged for a specific date for annuity payment to begin, also referred to as the maturity date. The time prior to maturity is referred to as the accumulation period. The time following the maturity date during which payments are made to the annuitant (purchaser) is called the liquidation or distribution period. Accordingly, the annuitant will receive payments according to the contract schedule.

Premium Options

Premiums for annuities are usually paid for in one of the following methods:

�  Lump sum premiums.

In this method, the customer pays a single, lump sum premium when the contract is signed initially. Lump sum premiums can be paid for either immediate or deferred annuities.

�  Scheduled premiums.

This method pertains to deferred annuities only. The customer pays premiums on a regular set schedule whether it be annually, semiannually, quarterly or monthly until the date on which benefit payments begin.

�  Flexible premiums.

This method again pertains to deferred annuities only. Flexibility is permitted in the timing and amount of premium payments. This flexible premium annuity may be preferred by annuitants who want a program in which they can vary the amounts they save each year.

Settlement Options

Settlement options refer to the various ways funds will be distributed from an annuity. Terms are agreed upon by the annuitant and the insurance company determining when the owner wishes to begin receiving income from the annuity.

�  Single lump sum.

This settlement may be made in a single lump sum. The lump sum includes both the amount the owner paid in premiums, and the interest those funds have earned.

�  Interest only payments.

The annuitant may wish to receive interest only payments until a later date on which another settlement option may take effect.

�  Designated dollar amount.

The annuitant may elect to have the settlement paid in a specified number or dollar amount payment over a number of years.

�  Life income option.

The life income option is the most common payment associated with annuities. With the life option, the annuitant receives payments until he or she dies. Payments may or may not continue after the annuitant�s death. Three life income options are straight life, period certain and refund.

�  Straight life.

A straight life annuity contract provides for guaranteed periodic payments that terminate upon the death of the annuitant. No remaining balance is paid to a beneficiary or to the annuitant�s estate after the annuitant dies.

�  Period certain and refund options.

Some individuals do not want to use the duration of their lives as the factor that determines whether they will profit, break even, or perhaps even lose money on their investments. Therefore, straight life annuities do not interest them. Period certain and refund options guarantee a minimum amount that the insurance company will pay on an annuity. Both of these options can be regarded as types of death benefits, since they provide for payment to be made to designated beneficiaries upon the annuitant�s death.

Number of Annuitants

An annuity contract may be written to provide for one or more annuitants. If there is only one annuitant named in the contract, the insurance company agrees to provide that person with income beginning on a specific date and to continue for an agreed-upon period, which is normally the duration of the individual�s life.

Some contracts cover more than one person. A popular contract of this type is the joint and survivor annuity. With this arrangement, two people are insured, most commonly the husband and wife. Beginning on the date in the contract, payments are made to the annuitants. The payments are guaranteed to continue to the surviving spouse upon the other spouse�s death. Depending on the contract terms, the continuing payments will either be in the same amount as when both the annuitants were alive or to be reduced.

Two types of joint and survivor annuities are most commonly used. With a joint and two-thirds survivor option, the surviving spouse receives two-thirds of the income paid to the original annuitant. With a joint and one-half option, the surviving spouse receives half of the income.

Surrender Terms

Another set of annuity contract terms which is important to an investor are the surrender charges. The word surrender describes the termination of an insurance contract, such as an annuity, by the owner. When an individual surrenders a contract, he or she turns in to the insurance company the documents stating the contract terms. In return, the company gives the owner a sum of money which is known as the surrender value.

The surrender value is the cash sum that the insurance company agrees to pay the owner in the event the owner surrenders the policy prior to maturity. The surrender value of a policy increases in proportion to the number of premiums paid, but it does not always equal the amount that the contract owner has paid. The surrender value may be lower than the total premium amount, because under some circumstances insurance companies will impose surrender charges. Although these surrender charges vary among insurance companies, most annuities stipulate a period of about seven years during which some penalty is imposed.

Surrender charges are one reason that consumers should not attempt to use annuities as short-term, liquid investments in the same way they might deposit accounts. Some annuity contracts do offer loan privileges where the policy owner may borrow against the contract instead of accepting a distribution of cash. However, this may not be helpful, since the loans carry interest charges that vary according to company regulations. Besides this negative, a policy loan is also considered taxable income.

Determining the Mathematics of Fixed Annuities

The cost of an annuity�s benefit is included in the premium paid for the annuity. Insurance companies use demographic projections as well as complex mathematical calculations to develop and price the annuity products they sell. A company must use projections on average life expectancies when it prices its products, because the number of years people will live directly relates to the amount that the company pays out on its annuities. In turn, statistical projections on the average number of people who will die at different ages influence the amount a policy owner must pay for an annuity.

One important mathematical device insurance companies use for pricing annuities is a mortality table. A mortality table is a mathematical tool used to calculate the frequency of deaths that will occur between successive birthdays. The numbers in a mortality table are calculated through the use of mathematical equations that express the probability or likelihood of the occurrence of a specific event.

Mortality tables are developed by actuaries. Actuaries are insurance specialists who are experts in mathematics. Actuaries calculate risks, premiums, reserves, and other mathematical factors for insurance companies.

The numbers in a mortality table allow an insurance company to project its likely future obligations to annuitants. Similarly, the company uses the mortality table to project how many dollars will be released to it by annuitants who die. This information, together with statistics the company gathers on the interest it can earn on its holdings, is then used to calculate the premiums to be charged for annuities as well as their other products.

Investor Considerations � Fixed Annuities

The promise of a guaranteed lifetime income during retirement may be attractive to many investors. However, a guaranteed income is only one factor that should be considered when considering annuities. Among the other issues that should be examined carefully are risk, liquidity, earnings, and taxes.

�  Risk.

Annuities are relatively safe investments. While they are not covered by federal deposit insurance, the principal and interest an individual invests in a fixed annuity contract are provided by the rigid state and federal regulations that govern insurance companies� operations. However, these regulations do not protect an investor from all potential problems.

If the insurance company that sold an annuity to an individual experiences severe business problems and becomes insolvent, other insurance companies doing business in the same state will be required to help meet that company�s remaining obligations. However, the annuitant may face extra paperwork and delays in attempting to obtain funds.

Additionally, it is a good idea to research the soundness of the insurance company before purchasing an annuity from it.

�  Liquidity.

Annuities are relatively liquid investments because they provide ways for individuals to surrender their contracts and withdraw their funds during the accumulation period. They are not completely liquid, however, since investors may not receive the full amount that they have paid in premiums if they decide to withdraw from their annuities. The amount that an individual would lose depends on the surrender fees and penalties assessed by the insurance company. These charges are described in the annuity contract.

�  Earnings.

Interest earnings on annuities have attracted many current investors. Guarantee periods vary with different insurance companies. Some will pay an initial rate for one or two years followed by subsequent annual guarantees. Others will peg their rates to formulas based on Treasury bill or consumer price indexes.

A desirable feature that a careful buyer will seek in an annuity is the bailout provision. With this provision, the contract owner may bail out without paying any surrender charge if the rate falls below a certain designated percentage from the original rate, even if the initial guarantee period has expired.

For example, assume the initial guaranteed rate is 8 percent for a period of one year. The contract promises a 1 1/2 percent bailout provision. The contract also says that a surrender charge is made upon a premature withdrawal anytime within seven years from the purchase date.

After the initial one-year period of the contract, the company announces the next year�s interest rate will be 6 1/2 percent. Since this rate dropped 1 1/2 percent from the initial rate, the customer is entitled to avoid any surrender charges if the contract is cashed in.

�  Income Tax.

One of the main appeals of deferred annuities is the income tax advantage that is offered investors. Investors pay no taxes on the earnings during the accumulation period; taxes are deferred until the liquidation period. Once payouts to the annuitant begin, only a portion of each payment is taxed as income. The remaining portion, which is not subject to income taxes, is considered as a return of the money that the investor paid into the annuity during the accumulation period.

The portion of an annuitant�s income that is subject to taxes is determined through a calculation required by the U.S. Department of the Treasury. This complex calculation is based on the projection of the amount the annuitant will receive in annuity income if he or she lives to life expectancy. This total income is referred to as the expected return. Once an expected return is determined, the next step is to calculate the percentage of the amount that was invested in the contract. Once the percentage is calculated, it is used each year to determine how much of the annual annuity income should be considered return of capital and how much should be regarded as taxable income.

There are certain income tax penalties related to annuities. In particular, there is a 10 percent penalty which applies to lump sum withdrawals from annuities before age 59 1/2. This penalty applies whether the amount is taken as a loan or an outright withdrawal. (There is an exemption to this 10 percent penalty if the amount of withdrawals before age 59 1/2 is part of a series of approximately equal periodic payments over a lifetime. Also, exempt are such payments in the event of death or disability.)

An important exception exists in the case of business-owned annuities. If a business entity, such as a corporation, partnership, or trust, owns an annuity on an employee�s life, any interest earnings or annual gains in the contract are subject to current income taxes. Annuities that are part of qualified plans, such as pensions and similar employee benefit programs, are exempt from the ruling. Immediate annuities are also exempt. (In addition to employer pension plans, the exclusion of taxable earnings on annuities applies to IRAs and other tax-sheltered annuities sponsored by certain nonprofit corporate employers.)

Variable Annuities

Like the fixed annuity, the variable annuity is a contract between an individual and a life insurance company. With both types, the owner contributes premiums that, along with their earnings, are accumulated within the policy contract. At an agreed-upon time, the insurance company begins making payments to the annuitant. Payments are made over the individual�s lifetime or for some other stipulated period.

The basic difference between fixed annuities and variable annuities is the way in which accumulated funds are invested and the resulting payout. With fixed annuities, the accumulated funds are combined with the insurance company�s general investments. These investments help form the basis for the guaranteed cash values of life insurance and conventional annuity contracts. In general, insurance companies invest funds for their fixed products in long-term bonds and other non-speculative issues.

The premium payments made on a variable annuity are not combined with the insurance company�s general investments. They are placed in stocks, government securities and other types of fluctuating investments. These investments have a better growth potential than those that underlie investments, but also are subject to a greater degree of risk. The investments make up a portfolio that is managed in much the same way as a typical mutual fund. When the annuitant is ready to receive payment, he or she can choose the best payout option.

For many years, marketers of annuity products as well as savings institutions emphasized the advantages of conservative and secure investments. During the 1930s, when the U.S. economy was experiencing only moderate inflation rates, many people purchased annuities for retirement in the belief that they insured a comfortable, guaranteed income for life. A successful insurance company advertisement of the late 1930s enthusiastically proclaimed, �Retire for life on 300 dollars a month!�

Then rising inflation rates began to affect the average person�s standard of living. Beginning in the 1960s, people became aware that they had to plan for more retirement dollars just to keep pace with anticipated increases in living costs. Savers sought financial instruments that could more readily keep up with inflation. Individuals of even average means were turning to the stock market for an increasing portion of their investments. Like savings institutions, insurance companies looked for ways to improve their traditional products. In an attempt to combine traditional annuity guarantees with the growth potential of a securities investment, the variable annuity was developed.

Variable annuities generally are divided into two basic types. The difference between them lies in who has control over investing the money deposited into the annuity. With the first type, the company-managed variable annuity, the insurance company determines how the annuity funds are invested. With the second type, which could be referred to as a self-directed variable annuity, the annuity owner has substantial control over the investment of funds.

�  Company-managed variable annuity.

The original variable annuities which were introduced in the 1950s were company-managed types. In this type of annuity, premiums paid in by contract owners are pooled and placed in a separate account designated by the insurance company. This method serves to distinguish these investments from the company�s other invested funds. (One advantage of a variable annuity is if the insurance company runs into financial problems, the funds in the separate account are beyond the reach of the company�s creditors. This is also true for the portfolios in self-directed plans.)  The account is organized like a mutual fund in that it is made up of various investments � usually stocks, bonds and government securities. The insurance companies� investment managers buy and sell these investments on a continuing basis.

Like mutual fund managers, the insurance company tries to invest the money wisely and profitably so that it will generate a competitive return for its investors. In addition, the insurance company must meet both state and federal regulations regarding investment practices for these products. (Variable annuities are subject to regulation by the Securities and Exchange Commission, Internal Revenue Service, and state regulatory bodies.)

One of the better known company-managed annuities is the College Retirement and Equities Fund, or CREF. Designed by the Teachers Annuity and Insurance Association, it was the first variable annuity, appearing on the market in 1952. Because of CREF�s relatively long history, it has been the subject of many detailed studies.

�  Self-directed variable annuity.

With the self-directed annuity, the contract owner can choose from several investments, each with different objectives. The selection of investments may be made during both the accumulation and distribution periods. In effect, the contract owner may construct a personal investment portfolio within the annuity. The owner selects investments based on his or her investment objectives in much the same way that a mutual fund investor does.

The annuity application form lists the selection of investments that the insurance company offers. For an example of a hypothetical self-directed variable annuity, consider there are five selections available. These include four mutual funds with differing objectives, plus a fixed account. The fixed account offers guaranteed safety of principal and specifies a fixed interest rate. (Interest rates on the fixed account may be guaranteed for periods ranging from one calendar quarter to one or two years or even longer.)  Customers choose from among these options according to their investment objectives.

On the annuity application the customer indicates, usually in percentage units, how each premium is to be allocated among the selected accounts. Most contracts allow an unlimited number of percentage combinations. The applicant can even allocate the entire premium to a single investment choice.

One distinguishing characteristic of self-directed annuities is the owner�s ability to change the composition of the annuity portfolio.

Three major factors that affect how individuals invest their assets are their investment objectives and philosophies, their financial standing and economic conditions. Since each of these factors may change over time, it is advantageous to the investor to be able to change the way in which his or her money is invested.

As an individual progresses through life his or her investment philosophy and objectives often change. Many people who previously might have been inclined to take investment risks may become more cautious as they grow older. For the owner of a variable annuity, a change to more conservative investments may mean moving money from stock funds to funds composed of government securities or even a fixed fund. The typical self-directed variable annuity offers the contract owner the opportunity to redirect the investment of funds as his or her investment objectives change.

Changes in one�s financial standing may also alter an individual�s willingness to accept risks. For example, some individuals may invest in more aggressive and risky funds only after they have accumulated what they consider an adequate nest egg. Similarly, some individuals move their variable annuity funds into conservative options if they experience losses in their other investments.

Economic conditions and forecasts may also lead an individual to take advantage of a variable annuity�s flexibility. When stock prices are expected to fall, some individuals direct their money out of stock funds and into other types of funds. When yields on other investments are falling, investors often move their money into bond funds because these generally are considered good investments during such period. Thus, variable annuities allow the investor to react in the face of changing market conditions.

Choosing an Annuity Type

Determining which type of variable annuity is suitable for an investor depends mainly on two factors. One is the potential purchaser�s investment sophistication. The other is the extent to which the person wishes to become involved in investment decisions.

�  The first consideration applies to the inexperienced investor with limited knowledge of the stock market. In this case, a company-managed variable annuity is probably the better choice, since the insurance company will make all the investment choices and manage the portfolio.

�  The second factor concerns whether the contract owner wishes to continually monitor changing economic conditions and be responsible for changing the direction of investments in the annuity portfolio. With the self-directed type of variable annuity, the investor decides on the mix of investments in the portfolio. It is the contract owner�s responsibility to periodically review these investments to see whether their performances are still in tune with his or her investment objectives and adjust the portfolio accordingly. The self-directed plan is probably more suited to an investor who is accustomed to making these types of decisions.

The investor should also be aware of the various charges that the insurance company�s fund managers impose. Each annuity contract has its own schedule of fees and other charges, and the investor should carefully assess these before making a purchase.

One charge that is commonly imposed is a surrender charge. This is similar to the surrender charge for fixed annuities.

Typically, the surrender charge limits the amount of money that may be withdrawn during the early years of the contract. Some policies have a declining charge. For example, the charge might be 6 percent for the policy�s total value in the first year and decrease by a percentage point each year thereafter. Thus, no surrender charge would be imposed on withdrawals made after the sixth year.

For funds invested in company managed accounts, companies usually impose management charges. Funds held in a fixed account usually escape the investment management fees. The insurance company typically justifies these fees by providing for a guaranteed death benefit and covering the administrative expenses involved in providing a life income.

Accumulation Units

During the years in which premiums are paid into the annuity contract, the annuity owner acquires accumulation units. Accumulation units have a designated initial price at the time of the annuity purchase but fluctuate in value thereafter. In the case of company-managed products, the changing values will correspond to the performance of the pool of investments. This is similar to the way mutual fund values are expressed. With a mutual fund share, each accumulation unit of a variable annuity has a designated value on a given day. In the case of self-directed annuities, the values of the fund or combination of funds the policy owner has chosen are totaled. The value of each accumulation unit is then calculated from this total.

Under both company-managed and self-directed plans, each premium payment purchases a certain number of accumulation units. The number of units varies according to the unit�s current market values. The number of units continues to increase, as additional purchases are made, although each unit�s value will vary over the life of the contract according to its worth in the marketplace. This, too, is similar to the manner in which mutual fund share values are calculated.

Annuity Units

In order for the insurance company to begin paying out income from the annuity, accumulation units are converted into annuity units. An annuity unit is a measure of value that an insurance company uses when it calculates the amount of income to be paid to an annuitant. At retirement, the annuitant is credited with a designated number of annuity units.

The exact number of annuity units to be credited depends on four basic factors.

�  The first factor is the annuitant�s age. The insurance company calculates from its mortality tables all charges in order to provide a designated amount of lifetime income at a specified age.

�  The second factor is the number of guaranteed payments. If the annuitant chooses a period certain life income option, the extra charge for that benefit will be reflected in the calculation of the annuity unit.

�  The third factor is the interest rate that the insurance company projects. If the company predicts a fairly high interest rate, the annuity unit will have a greater value than it would with a lower rate. Interest rates typically are projected annually to determine the projected investment return.

�  Finally, there are administrative expenses to be incorporated into the unit cost calculation.

The calculated number of annuity units remains constant over the payment period. The annuitant has the option of choosing a fixed or a variable payment, or, as is often the case, a combination of both. With the variable payment, the annuity unit�s value may fluctuate just as it does during the accumulation period. The value will continue to vary according to the performance of the underlying investment portfolio and the general administrative costs that the company incurs. Obviously, the amount of periodic income also will fluctuate.

There are two important reasons for the continued fluctuation in variable annuities after the retirement income period begins:

�  The first is that the portfolio�s value constantly changes to reflect current market conditions.

�  The second is that the investments funding the annuity contract also change continually, just as they do during the accumulation period. The various stocks, bonds and other financial instruments that make up the portfolio continue to change based on the decisions of the fund managers who supervise this process. In a self-directed plan, the contract owner may frequently change the contents of the portfolio.

Risk Considerations for Variable Annuities

The variable annuity, with its combination of traditional guarantees and investment flexibility, offers great promise as a financial planning tool. It has the potential to be more responsive to economic trends than the conventional savings account or even the traditional fixed annuity. However, the savings customer who has basically considered only fixed investments should be aware of the special risk concerns connected with the purchase of a variable annuity.

There are two important points to keep in mind regarding the risks of variable annuities. One concerns the insurance company that issues the annuity and the second concerns the investment�s fluctuating nature.

Regarding the first point, it is essential to note that, while both fixed and variable annuities may be marketed by savings institutions, neither product is covered by the federal insuring agencies. The investment is backed only by the guarantee made by the insurance company that sells the annuity contract.

The second area of risk is the fluctuating nature of the variable annuity. Investors should recognize that whenever they place money in variable annuities, the dollar value of their investments is subject to both upward and downward changes. An investor should assess his or her tolerance for risk when selecting a variable annuity and composing the annuity portfolio.

Particular caution is needed during the retirement period when the contract owner may be contemplating changing investment strategies. Many owners like a more conservative investment position at the time when they were making deposits and accumulating funds. While it is possible to increase income payments by making the right investment choices, it is also possible to make the wrong decisions. Unlike during the accumulation period, when there is sufficient time to make up for a temporary loss, once retirement begins, it is difficult to recoup any losses resulting from investment mistakes.

Life Insurance Terms and Definitions

Having reviewed the background, provisions, underwriting and tax benefits of life insurance policies and annuities, we now provide an alphabetic listing of many of the important terms and definitions which you will encounter with respect to life insurance. Many of these terms have been used during our discussion of life insurance, while some of these are additional terms which may be helpful to supplement your understanding of life insurance.

AGE CHANGE � The point in the 12 months between natural birthdays at which the individual is considered to be of the next higher age for the purpose of insurance rates. Most life insurers consider that point as halfway between birthdays. Health insurers frequently use the age at last birthday until the next birthday is actually reached.

AGE LIMITS � The ages below or above which an insurer will not issue a given policy.

AGENT � An individual appointed by an insurer to solicit, negotiate, effect or countersign insurance contracts on its behalf.

ALIEN COMPANY OR INSURER � An insurer organized and domiciled in a country other than the United States.

APPLICANT � The party submitting an application to an insurer for an insurance policy.

ATTAINED AGE � The age an insured has reached on a given date.

BENEFICIARY � A person, who may become eligible to receive, or is receiving, benefits under an insurance plan, other than as an insured.

BENEFICIARY CHANGE � A change in the policy which alters the previous beneficiary designation. Must be made by formal application to the insurer. Compare to Beneficiary, Irrevocable.

CANCELLATION � Termination of the insurance contract by voluntary act of the insurer or insured, effected in accordance with provisions in the contract or by mutual agreement.

CARRIER � The insurance company that �carries� the insurance. Generally, the term �insurer� is preferred.

CASH SURRENDER VALUE � In life insurance, the value in a policy that is the legal property of the policyowner, and which the policyowner may receive if the policy is surrendered for cash. Synonymous with cash value.

CLAIM � The demand of an insured or his or her representative or beneficiary for benefits as provided by an insurance policy.

COMMISSION � The portion of the premium stipulated in the agency contract to be retained by the agent as compensation for sales, service, and distribution of insurance policies.

CONCEALMENT � The withholding, by an applicant for insurance, of facts that materially affect an insurance risk or loss.

CONDITIONAL RECEIPT � Provides that if the premium accompanies the application, the coverage is in force from the date of the application (whether the policy has yet been issued or not) provided the insurer would have issued the coverage on the basis of facts as revealed by the application and other usual sources of underwriting information.

CONTINGENT BENEFICIARY � Person or persons named to receive benefits if the primary beneficiary is not alive at the time the insured dies.

DEATH BENEFIT � The policy proceeds to be paid upon the death of the insured.

DEATH CLAIM � A formal request for payment of policy benefits occasioned by the death of the insured. Should be made through the agent, but may be made directly to the home office. Requires a copy of the death certificate as proof of death and is made by the beneficiary.

DECLARATION PAGE � The portion of an insurance policy containing the information regarding the risk.

DECREASING TERM INSURANCE � Term insurance for which the initial amount gradually decreases until the expiration date of the policy, at which time it reaches zero.

DOMESTIC COMPANY � An insurer formed under the laws of the state in which the insurance is written.

DOUBLE INDEMNITY � Payment of twice the basic benefit in event of loss resulting from specified causes or under specified circumstances.

EFFECTIVE DATE � The date on which an insurance policy goes into effect.

ENDORSEMENT � Technically, a change made directly on the policy form by writing, printing, stamping or typewriting and approved by an executive officer of the insurer. In general use, also may refer to a change made by means of a form attached to the policy.

ESTATE � Assets of an individual comprising total worth.

EXCLUSIONS � Stated exceptions to prior provisions in a policy. Common exclusions in health policies include pre-existing conditions, suicide, self-inflicted injuries, and many others. In life policies, common exclusions are death through flying in a private airplane, riot, or act of war.

EXPIRATION � The date upon which a policy�s coverage ceases.

FACE AMOUNT � The amount indicated on the face of a life policy that will be paid at death or when the policy matures.

FAMILY PLAN POLICY � An all-family plan, usually with permanent insurance on the father�s life, with mother and children automatically covered for a lesser amount.

FOREIGN COMPANY � An insurer organized under the laws of a state other than the one where the insurance is written.

FRAUD � An intentional misrepresentation made by a person with the intent to gain an advantage and relied upon by a second party which suffers a loss as a result.

GRACE PERIOD � A period of time after the premium due date during which a policy remains in force without penalty even though the premium due has not been paid. This period is commonly 30 or 31 days in life insurance policies.

HOME OFFICE � The place where an insurance company maintains its chief executives and general supervisory departments.

INSURABILITY � The condition of the proposed insured as to age, occupation, physical condition, medical history, moral fitness, financial condition and other factors that makes the individual an acceptable risk to an insurance company.

INSURABLE INTEREST � In life and health insurance, the interest of one party in the possible death or disability of an insured that would result in a significant emotional or financial loss. Such an interest must exist in order for the party to purchase insurance on the life or health of another.

INSURANCE DEPARTMENT � A governmental bureau in each state or territory charged with administration of the insurance laws, including licensing, examination, and regulation of agents and insurers. In some jurisdictions, the department is a division of some other state department or bureau.

INSURED � The party to an insurance contract to whom, or on behalf of whom, the insurer agrees to indemnify for losses, provide benefits, or render service.

INSURER � The party to an insurance contract that undertakes to indemnify for losses provides other pecuniary benefits, or renders service. Also called insurance company and sometimes-insurance carrier.

IRREVOCABLE BENEFICIARY � A named beneficiary whose status as beneficiary cannot be changed without his or her permission.

LAPSED POLICY � A policy for which the policyholder has failed to make the premium payment during the grace period, causing the coverage to be terminated.

LIFE EXPECTANCY � Average number of years of life remaining for persons at any given age.

LIFE INSURANCE � Insurance that pays a specified amount upon the death of the insured to the insured�s estate or to a beneficiary.

LOAN VALUE � The amount of cash value in a policy which may be borrowed by the insured.

MISREPRESENTATION � Falsely representing the terms, benefits, or privileges of a policy on the part of an insurer or its agent. Falsely representing the health or other condition of the proposed insured on the part of an applicant.

MORTALITY RATE � The average number of people in a particular class who die each year.

NON-FORFEITURE OPTION � A legal provision whereby the life insurance policyowner may take the accumulated values in a policy as (1) paid-up insurance for a lesser amount (2) extended term insurance; or (3) lump-sum payment of cash value, less any unpaid premiums, or outstanding loans.

NON-PARTICIPATING POLICY � A policy that does not provide for the policyowner to share in dividends. Also called a nonpar policy.

NON-RESIDENT AGENT � An agent licensed in a state in which he or she is not a resident.

PAID-UP INSURANCE � A non-forfeiture option in life insurance policies under which insurance exists and no further premium payments are required.

PARTICIPATING POLICY � A policy in which the policyowner receives a share of policy dividends. Also called par policy.

PERMANENT INSURANCE � Life insurance with some type of cash value accumulation.

POLICY LOAN � A loan to the policyholder from the insurer using the insurance cash value as collateral.

PRE-AUTHORIZED CHECK PLAN � An arrangement under which the policyowner authorizes the insurer to draft his or her bank accounts for the (usually monthly) premium.

PRIMARY BENEFICIARY � The beneficiary named first to receive proceeds or benefits of a policy that provides death benefits.

PROOF OF DEATH � A usual requirement before paying a death claim is that a formal proof of death form of some type be submitted to the insurer.

REINSTATEMENT � Putting a lapsed policy back in force, sometimes requiring the payment of back premiums and evidence of insurability. Provision is usually made for a method of reinstating the policy to its original amount.

RIDER � An amendment attached to a policy that modifies the conditions of the policy by expanding or decreasing its benefits or excluding certain conditions from coverage.

SETTLEMENT OPTION � A method of receiving life insurance proceeds other than a lump sum.

STANDARD RISK � A risk that meets the same conditions of health, physical condition and morals as the risks on which the rate is based without extra rating or special restrictions.

SUICIDE CLAUSE � In a life insurance policy, states that if the insured commits suicide within a specified period of time, the policy will be voided. Paid premiums are usually refunded. The time limit is generally one or two years.

TERM INSURANCE � Life insurance that normally does not have cash accumulations and is issued to remain in force for a specified period of time, following which it is subject to renewal or termination.

WAIVER OF PREMIUM PROVISION � When included, provides that premiums are waived and the policy remains in force if the insured becomes totally and permanently disabled.

WHOLE LIFE � Permanent life insurance on which premiums are paid for the entire life of the insured.

Conclusion

Any insurance agent selling life insurance policies to customers must maintain solid knowledge of the types of life insurance policies and the provisions of each policy in order to answer any questions and offer competent service to customers. By demonstrating command of the subject matter, the insurance agent will benefit from additional referrals and recommendations from satisfied, happy clients. The customer may also inquire regarding the life insurance company�s annuities, and working knowledge of these products should accompany the agent�s understanding of life insurance.

At what time must a policyowner have insurable interest on the insured?

When must a person have interest in a property insured?

When must an insurable interest exist for a property and liability insurance policy?

Who must have insurable interest in the insured?