Insurance is an important component of both financial and estate planning. Care must be taken to ensure that insurance products achieve the protection desired, and that they will be available when needed.For this reason, resources should always be consulted when making insurance decisions.See www.insure.com to get online ratings from Standard & Poor's as well as comprehensive reports on individual insurers (evenonline premium quotes).
Life insurance is used to provide a death benefit: a stipulated sum (the face amount of the policy) is paid to a beneficiary upon the demise of the policyholder (who has paid the premiums).Remember: a beneficiary who receives life insurance payments due to the death of the insured pays no income tax on the amount received.
Because policies are taken out without the insurance company knowing when payment of the policy will be required, companies may issue: • participating policies, in which the company shares the costs of coverage with policyholders; if premiums exceed costs, a policy dividend is issued • nonparticipating policies, in which the company does not share profit (or loss) with the policyholders; the premiums for these companies tend to be lower
There are 2 types of insurance companies: • stock companies are owned by the company stockholders and usually sell nonparticipating policies (example: MetLife Insurance Co.) • mutual companies are run by the company policyholders and usually sell only participating policies (example: Massachusetts Mutual Life Insurance Co.)
Life insurance policies account for about 25% (by premiums paid) of the insurance sold in the US, nearly $165 million in 2006; by comparison, annuities accounted for 50% of insurance premiums, or about $310 million. Type of InsuranceNet Premiums WrittenPercent of Total Ordinary Life (individual) $129,241,600 20.9% Group Life $35,255,000 5.7% Annuities (individual) $193,432,600 31.2% Annuities (group) $117,152,700 18.9% Accident and health (individual) $57,169,300 9.2% Accident and health (group) $84,235,700 13.6% Other Types $3,226,000 0.5% Total $619,712,900 100.0%
There are 2 types of life insurance sold: term and permanent. Life insurance is typically used to secure business loans, for partnership buy-sell agreements, and as security for families. • Term policies provide coverage for a period of years, typically 1 or 5 (but this is changing) • policies provide insurance only • premium costs increase with age • coverage is not offered after age 65 to 70
There are 2 types of term policies: • Yearly renewable term has premiums that are initially low; however, the premiums increase substantially as the insured gets older. These policies have diminished in popularity due to the introduction of level premium term life insurance. • Level premium term has premiums which remain unchanged over a specified period of time. Coverage is purchased for a period of 5, 10, 15, 20, 25, or even 30 years. After the initial level period expires, the annual premium will increase for the next level (but there is usually a guaranteed maximum increase).
Yearly renewable term insurance premiums increase rapidly with age, whereas level term insurance premiums only change over a period of years (e.g., every 10 or 20 years). Over the 20 years, level term premium costs are about one third those of yearly renewable term.
The newest product in term life insurance is called the “return of premium” (ROP) policy.A level term policy is purchased, usually for 20 or 30 years, and if the policyholder makes it through the 2 or 3 decades, the insurer pays back the premium payments (tax free). So the premium cost is zero. However, the premiums are 30% to 40% higher than with regular level term policies (the 30 year policies have the least increase in cost).And the insured has to “stay the course” for the time period involved.
Permanentinsurance policies provide coverage “for a person’s whole life”, hence also the name “whole life”; policies provide both insurance coverage and investment return.The policy premium does not change substantially over time, even though payments can be made for many decades.Also, the policy accumulates cash value that can be borrowed (usually at a set interest rate). So at the death of the insured, both the policy face amount and the cash value are paid to the beneficiary.
There are 3 types of “whole life” coverage: • ordinary life—premium payments continue for the policyholder’s whole life; there is usually a modest guaranteed investment return for the cash value • limited payment life—premium payments continue to a certain age or for a stated number of years; premiums are higher but cash value accumulates faster because of the reduced years • variable life—offers a minimum death benefit, fixed premiums, and investments in stocks, bonds, mutual funds, or money market funds; the value of the policy at death is primarily based on the return on the investments
Universal life insurance provides flexible insurance coverage and investment return, and both can be changed over time as the policyholder wishes.The investment return is usually greater than with ordinary and limited payment life policies; the policyholder may make tax-free withdrawals (up to the amount contributed) or the annual return can be used to pay for coverage, making it self-funding; there is a maintenance fee, but annual statements are provided to explain costs.This is the preferred type of “whole life” policy because of it’s flexibility.
Comparison of premium costs for a $500,000 life insurance policy (nonsmoker): • 20 year term policy 20 year cash value -30-year-old male $600 is zero; total cost is -30-year-old female $400 $12,000/$8,000 • 20 year ROP term policy 20 year ROP is -30 year-old-male $800 $16,000/$11,000; total -30-year-old female $550 cost is zero • Whole life policy 20 year cash value -30-year-old male $1,600 is about $25,000; total -30-year-old female $1,300 cost is $7,000/$5,500 • Universal life policy 20 year cash value -30-year-old male $2,400 is about $40,000; total -30-year-old female $2,000 cost is $8,000/$6,000
Life insurance coverage may vary from individual to individual, but the usual progression is: • begin with term • add universal life (can be used to pay for college expenses) • the coverage amount should be sufficient to allow the family to adapt after death (typically 5 to 7 years’ equivalent of income) To obtain a comparison of premium costs for different types of insurance, go online to www.accuquote.com
Life insurance coverage can be supplemented by the use of riders: • guaranteed insurability—guarantees periodic increases in coverage • accidental death—pays double or triple the face amount (“double indemnity”) • disability—pays premiums of a disabled policyholder
There are several payment options; it is left to the policyholder to decide which one to use: • lump sum—the total value of the policy is paid to the beneficiary • fixed period—payments are made over a set period of years • fixed income—payments are made in equal installments • interest income—only interest is paid to a (usually) minor beneficiary until a certain age • life income (annuity)—payments are made for the life of the policyholder
Life insurance can be converted into an annuity. An annuity pays a certain amount each month to the policyholder (“annuitant”) until the policyholder dies; thus it provides a “life benefit”.For example, a policyholder may purchase a single premium immediate annuity (payments begin immediately) or single premium deferred annuity (payments begin in years) for the cash value of the policy.
Annuities can provide payments for the policyholder’s life (“straight life” annuity) or for a minimum number of years (“life with period certain”); in the latter case, if the policyholder dies before the minimum period, the beneficiary receives the annuity proceeds for the remainder of the period. “Joint and survivor” annuities pay benefits for the life of the policyholder and spouse.Only part of the annuity proceeds are taxable (because after tax dollars were used to pay for the insurance premiums).
Annuities can also be used strictly as retirement funds [403(b) plans]. These annuities are plans into which income is paid (usually with matching funds from the employer), invested, and allowed to grow on a tax-deferred basis. Withdrawal without penalty may begin after 59 ½ years and before 70 ½ years. Fixed annuities pay a fixed interest rate, usually with a guaranteed minimum return. Variable annuities allow the investor to select the investment fund and thereby determine the return. The designated beneficiary receives the fund at the death of the policyholder.
Annuity ExampleA 65-year-old woman who is retiring decides to convert her life insurance into an annuity. The cash value of her life insurance policy is $165,000 and is used to buy a Single Premium Immediate Annuity offering a lifetime income and an “installment refund”.The monthly income, for as long as she lives, is $1,524 (equaling $18,293 yearly). Approximately 79% of this income will be received tax-free for approximately 9 years (after which 100% of the income will be taxable).The “installment refund” guarantees that if she dies prior to receiving the full $165,000 she paid as the premium, the annuity will continue the payments to the beneficiary until this full amount has been received.
“Richard, Mr. Iduvudu, the insurance man, is here to determine your life expectancy.”