Life Insurance Underwriting [Premiums, Proceeds & Beneficiaries]

Life Insurance Underwriting [Premiums, Proceeds & Beneficiaries]

  1. Basic Principles of Life, Health Insurance and Annuities
  2. Nature of Insurance; Risk, Perils and Hazards
  3. Legal Concepts of the Insurance Contract
  4. Life Insurance Policies, Provisions, Options and Riders
  5. Life Insurance Premiums, Proceeds and Beneficiaries
  6. Life Insurance Underwriting and Policy Issue
  7. Group Life Insurance
  8. Annuities
  9. Social Security
  10. Retirement Plans
  11. Uses of Life Insurance
  12. Health and Accident Insurance
  13. Health Insurance Providers
  14. Disability Income Insurance
  15. Medical Expense Insurance
  16. Private Insurance Plans for Seniors
  17. Health Insurance Policy Provisions
  18. Health Insurance Underwriting
  19. Michigan Laws and Rules Pertinent to Insurance

Life Insurance Premiums, Proceeds and Beneficiaries

When people purchase life insurance, money is being traded for a premium payment, future security, most commonly in the form of Death Benefit. Upon the insured’s death, policy proceeds [Death Benefit] are payable to the beneficiary.We must understand premiums [How they are determined and collected], beneficiaries & various tax consequences related to life insurance premiums & benefits.There are primary factors in premium calculations, policy proceeds & settlement options we must discover.  Tax treatment of proceeds, the types of beneficiary designations & the distribution of death benefits.

 Tax Consequences of Life Insurance.

  • The Application
  • Additional Sources of Underwriting Information
  • Focused On:

    • The Purpose of premiums in life insurance.
    • Factors of Premium Calculations.
    • Mortality factor & mortality rate.
    • Options policy owners have buying a policy.
    • Level, Modified, Flexible & Graded Premium.
    • Earned Premium and Unearned Premium.
    • Costs associated with life insurance contracts.
    • Death Benefit settlement & payment of claims.
    • Types of Beneficiary Designations.
    • Methods to Benefit Distribution.
    • Uniform Simultaneous Death Act & Common Disaster Provision.
    • Tax Consequences of life insurance.
    • Concept of Underwriting & Responsibilities in adverse selection reduction.
    • Importance of Insurable Interest & measures to determine insurable interest.
    • Identifying parties involved in underwriting.
    • Difference between medical & nonmedical applications.
    • Representation, misrepresentation & warranties.
    • Identify situations of material misrepresentation made with fraud.
    • Different types of premiums and how to determine when cover will be in full force.
    • Applicant ratings and insurance receipts

    Reason for Premiums

    The need to establish the payment for the insurance company; it is both an EXCHANGE for insurance protection & a PORTION of the policyowner’s consideration. The consideration is the “Binding Force” in the contract, cementing the agreement between the Insurer & Policyholder.

    Policyholder is expected to remit premiums by the due date.

    • However, as with most bills, insurance companies allow for a “Grace Period” [Time After Due Date] during which payment may be made without a penalty. Nonrepayments case “Policy Lapse”.

    Factors In Premium Calculation

    Life Insurance premiums are calculated per $1000 of coverage.

    There are 3 primary elements utilized to calculate what an insurer will charge for its life insurance product:


    Mortality Factor [Rate]

    Based on the personal characteristics of an interested prospect. This factor is determined from a “Mortality Table” which provides an indication of the “probability of death” of an individual at a particular age (Avg.# of Deaths/year in each age group).The mortality factor originated from the “Commissioners Standard Ordinary Mortality Table” (Insurers use the 1980’s table and others use the newer 2004 CSO table).

    To predict “life expectancy”, Death numbers in a specific age groups are expressed per thousand.

    Interest Factor

    Insurance companies invest premiums they receive in an effort to earn interest. This “interest” is one of the ways an insurance company can lower the premium rates.Premium Calculations are made in the “expectation” that the company will earn an assumed rate of interest. A higher rate will lead to lower premiums. The assumed rate may be higher or lower than the actual interest earned.The “Interest Factor” is a reflection of an insurer’s return on their investments. Insurers invest the premiums they collect in a myriad of investment vehicles. The wiser their investment decisions, the better return.

    Expense Factor

    Also known as the “Loading Charge/Factor”, derived from operating expenses, funds the insurer “pays out”. Expenses include administrative costs (i.e. rent). EACH STATE sets a “Minimum Reserve (Funds)” the insurer must set aside to pay future claims. Additionally, companies need to build in profits, also referred as “SURPLUS”. Companies that are not making a profit will raise premiums, while companies exceeding profits will maintain or even lower the premiums.

    NET premiums Vs GROSS premiums

    Net (single) premium makes a provision for mortality cost (Death Benefit) and Interest. It is influenced by the “Assumed Interest Rate, the proposed insured’s gender, the benefits to be provided & the mortality rate.“Net Level Annual Premium” allows small adjustments to the interest rate [accounting to the fact that most do not pay the policy requirement premium in a single payment, but instead over a period of years].“Gross Premium” is charged by an insurer that is comprised of or influenced by the factors [mortality, interest, expenses]. It is the Actual Premium paid by the policyowner for life insurance coverage. A “Gross Annual Premium” is the gross premium adjusted for over a period of years.

    Net Single Premium = Mortality cost – interest.Gross Premium = Net Premium + Insurer Expenses.

    Mortality Rate = Frequency of DeathsMorbidity Rate = Occurrence of Diseases

    Higher Mortality and Morbidity Rates = Higher Premiums [Additional Premium Factors].

    Additional Factors that Influence The Premium Cost:

    Age: The older the higher death rates.Sex / Gender: Women tend to live longer.Health: Poor Health and disability.Occupation: Hazardous Jobs.Hobbies: Higher Risk hobbies.Habits: Tobacco use presents higher loss risks.Benefits: The Higher the death benefit amount, the more the policy will cost. Additionally, living benefits (Cash Value in whole life vs Term) will also increase the policy cost.Options and Riders: Adding additional options and riders (waiver of premium or guaranteed insurability) will also increase premium amounts.Premium Mode: Utilized by policyowner, allows the insurer to assess an extra charge if premiums are paid quarterly, semiannually, or monthly (anything other than on an annual basis). These additional modes make it more convenient for a policyowner to pay premiums. Permits the policyowner to select the timing (frequency) of premium payments.Insurance policy rates are based on the “assumption” that the premium will be paid annually at the beginning of the policy year. The insurance company will have the premium to invest (Interest Factor) for a full year.There is usually an additional charge if the policyowner chooses to pay the premium more than once per year (semi-annual, quarterly, monthly).This additional charge is because the company cannot earn as much interest and will have additional administrative cost in billing and collecting the premium payments. Therefore:

    • The Higher the Frequency of payments, the more the policy will cost the insured in total.

    Funding Insurance Premiums

    Policies may be purchased by paying a single premium or by paying periodically. With “Single Premium Funding”,policyowner pays a single premium that “provides protection for the life of the policy”.Single premium funding is generally associated with “single pay Whole Life Insurance. Since a single premium is generally too expensive for the average person, alternative periodic options were developed to be more cost-effective or affordable for the purchaser.

    Fixed/Level Premium Funding

    Averages the “Single Premium” over the policy period. The policyowner “pays more (than the actual cost of insurance) in the early years” to help cover the cost of insurance in later years.This allows the premiums to remain level throughout the life of the the policy.

    Modified Premium Funding

    The initial premium is lower than it should be during an introductory time period (3 to 5 years). After this time, the premium increases to an amount greater than what the initial level premium would have been and then remains level or constant for the life of the policy.

    Graded Premium Funding

    This contract is modified/characterized by a lower premium in its early years. “Premiums increase every year for the initial period”. Then it jumps to an amount higher that the initial level premium would have been, then remains level or constant for the life of the policy.

    Flexible Premium Funding

    This allows policyowners to adjust the premiums throughout the life of the contract.

    Paying Premiums From Policy Values

    Paying a premium with a policy’s cash value and dividends depends on the Type of Policy.  Policyowners can choose to pay down premiums on the existing policy or buy additional coverage in the form of paid-up whole life additions or one year term.While using the policy [Cash] value to pay premiums is an option, this funding method also decreases the value of the policy. The policy will lapse if the policy’s value becomes insufficient and the policyowner does not pay the required premium.

    Minimum Deposit (Financed)

    While sometimes lumped in with “types of life insurance” minimum deposit or financed insurance is not an actual policy type. Minimum deposit financing is a method of financing life insurance best suited for individuals in high marginal tax brackets. It allows the policyowner to use policy loans to pay premiums due each year.

    Policyowner only pays the difference between the premium due and the amount borrowed (plus an interest on the policy loan). For this payment method to work…. the policyowner MUST MAKE TWO OR THREE INITIAL PREMIUM PAYMENTS to build up the cash value. 

    Additionally, under IRS rules, at least four of the initial seven annual premiums must be paid for funds other than policy loans to avoid classification as a MEC.

    Policyowner is allowed each year to borrow, subject to certain tax restrictions, that year’s cash value increase, and use it to pay the premium.

    Premium Collection & Reserves

    Producers generally collect the initial premium from the applicant at the time of application. All future premiums are billed to the insured by the insurer and are remitted by the insured to the company. Insureds who cannot afford premiums may sometimes use premium financing organization that will function similar to an “instalment loan”.

    Earned Vs Unearned Premium

    Earned Premium: amount of premium for which the policyholder has made payment to the insurance company, but coverage has not yet been provided.“Unearned premium typically becomes earned premium as an insurance contract progresses, but also would be the amount returned to an insured by the insurer upon policy cancellation.

    The Earned & Unearned Premium = Insurer’s Total premium


    Funds [Required by Law] to be set aside by an insurer to pay current and future claims. Also Named “Unpaid Claim Reserves“, this is a fixed liability of an insurer. These liabilities represent the amount that is expected to be needed to pay future benefits under policy. An Insurer’s reserve supports its promise to pay as identified in the policy’s insuring provision.Each state has its own “Requirement” with regards to the amount of funds that make up the reserve. Reserves also “demonstrate solvency” of an insurer. Reserves are funded through future premium payments from policyowners, and the interest [Investment Returns] earned on those premiums.A “Legal Reserve” is the amount of funds an insurance commissioner [director/superintendent] requires an insurer to maintain based on the CSO mortality table and assumed rate designated by the state’s commissioner or state insurance law.

    • The insurance commissioner can specific the two main factors an insurer uses in determining reserves:
      1. The CSO mortality table.
      2. The Maximum Assumed Interest Rate.

    Comparing Life Insurance Policy Costs

    Costs of policies could be defend as the difference between what one pays and what one receives back. If one pays a premium for life insurance and receives nothing back, the cost for the death protection is the premium.If one pays a premium and receives something in return, such as a dividend or cash value, your true cost is less than the premiums paid.

    A lower premium DOES NOT automatically mean a lower cost policy.

    “Cost comparative methods” are designed to evaluate the True Cost of the policies against this standard.

    “Interest Adjusted Net Cost” Method

    These are the variables that must be considered in evaluating cost, and they are basis for CASH VALUE. Interest adjusted cost indexes are designed to provide information on these four items:

    • Premiums
    • Death Benefits
    • Cash Value
    •  Dividends

    The index numbers are designed to give the consumer a means of comparing the cost of policies of the same generic type. Also factoring the insured’s age and the amount of coverage desired.

    Each insurer and its producers must use the same computation formulas “to arrive at the index numbers”, or the purpose would be defeated.

    Due to the “Increasing Complexity” of life insurance policy “structures”, premium payment methods, benefits, and dividend configurations, the average consumer would not make cost comparisons without these index figures.

    NAIC Model Life Insurance Regulation

    Requires two interest-adjusted cost indexes for policy illustrations: a surrender cost index and a net payment cost index. These indexes show average annual costs and payments per $1,000 of insurance while also recognizing that $1 payable today is worth more than $1 payable in the future [i.e., Time Value of Money].

    Net Payment Cost Index is useful if one’s primary concern is the amount of death benefit provided in the policy, and is not concerned with the build-up of cash value.

    It helps compare future costs, such as in 10 to 20 years, if one continues to pay premiums and does not take the policy’s cash value.

    “Comparative Interest Rate” Method

    This determines the rate of return required on an investment account to yield the same return of a life insurance policy that has cash value. This method is sometimes referred to as the “Buy Term & Invest the Rest” Strategy.

    The amount spent on the term insurance plus the hypothetical investment account must be the same as the required premiums for permanent insurance.

    The Face Value of the temporary and permanent insurance products being compared must also be the same.The comparative interest rate is the rate of return required on the investment account, so the value of the investment is equal to the surrender value of the higher premium policy at a specific point (i.e., 30 years, death). The higher the comparative interest rate (CIR), the less expensive the higher-premium permanent policy is compared to the alternative plan.

    Life Insurance Living Benefits

    A living benefit is an option for policy owner to use some of the future death benefit proceeds before the insured’s death. The policyowner (typically the insured) is the only party that can initiate a living benefit. Beneficiaries do not receive any of the living benefits. In fact, living benefits are typically subtracted from the death benefit or change the benefits together. These are the most common living benefits:

    Cash Value:

    The primary living benefit that a whole life (permanent life) insurance plan possesses during life of the policy is its Cash Value Build-Up. The cash that accumulates may be borrowed against or may be used as collateral. The cash value may also be utilized as supplemental retirement income or withdrawn for emergencies or other situations where cash is needed. Keep in mind, while the cash value is available to the policyowner, depending on the policy, accessing that cash value can result in additional fees, taxes, interest charges, or a reduction to the death benefit. During the early policy years, the cash value of an insurance policy will typically be less than the premiums paid.

    Cash value is different from the insurance company’s reserves.

    Accelerated (death) Benefit:

    The accelerated benefit is sometimes referred to as the terminal illness rider. This benefit allows the policyowner to access a portion of the death benefit if a physician certifies the insured as terminally ill.  To be considered terminally ill, a physician must certify that the person has a condition or illness that will result in death within two years. The amount of benefit received will be subtracted from the death benefit and is received tax-free.

    This option is typically capped at 50% of the face value.

    Policy Dividends:

    Is a refund of part of the premiumunder participating policy or a share of surplus funds. Mutual company insurers derive dividends from savings in mortality and expenses. The policyowner may use dividends for cash payments, to pay the insurance premium, to purchase additional paid up whole life insurance, to purchase a one year term insurance, or as an investment to accumulate interest. Dividends do not reduce the death benefit.

    Viatical Settlement:

    A vertical settlement allows someone with a chronic terminal illness to sell their existing life insurance policy to a third party for a percentage of the face value.The new owner continues to make the premium payments and eventually collects the full death benefit when the viator dies.The original policyowner is called viator, and the new third party owner is called the “Vertical” or the “Viatee”.Due to the nature of the contract, most states require a special license for “Viatical Settlement Providers”, and at a minimum, require a viatical company recommends the client consult a tax adviser as the proceeds could be taxable in certain situations. Tax laws require viators to be chronically or terminally ill to receive payments from viatical settlements tax free.

    Life Settlement

    In many states, viatical settlements are being replaced by life settlements. “A life settlement is the sale of an existing life insurance policy to a 3rd party” for more than its cash surrender value, but LESS than its “Net Death Benefit”.Unlike vertical settlements, life settlements do NOT REQUIRE the insured to be suffering from a chronic or terminal illness to sell and transfer the policy.

    They Policy Owner May Sell the policy to a life settlement firm for any reason.

    As with vertical settlements, a life settlement broker represents the policy owner and must hold an appropriate life settlement license.

    Life Settlement Contracts do not include:

    • Collateral Assignment for a loan
    • The making of a policy loan, or the paying of surrender benefits, or any other benefit, by the issuer of a policy with respect to the policy.
    • A 1035 Revenue Code, exchange of life insurance policy.
    • Agreement where all parties are closely related to the insured by blood or have a lawful substantial economic interest in the continued life, health and bodily safety of the person insured.
    • Legitimate Corporate or Pension Benefit Plan.

    Life Insurance Death Benefits

    Death Benefit Settlement Options & Payment Claims

    Life insurance policies contain a provision that settlement shall be made upon receipt of proof of death (death certificate). Most states require insurers to pay interest on any proceeds not paid within a specific amount of time.

    Death benefits can be paid out in a variety of ways. These methods are known as “settlement options”.The policyowner may select a settlement option at the time of the application and may change the option AT ANY TIME DURING THE LIFE OF THE INSURED.If the policyowner chooses to select a settlement option, it cannot be changed by the beneficiary.In most cases, however, the settlement selection is made by the beneficiary at the time of the insured’s death.Unless the policyowner specifies an irrevocable settlement option, the beneficiary always possesses the right to withdraw proceeds at any time in the future. Under any option selected where the policy proceeds are left “at interest” with the insurer, the beneficiary is protected against the claims of creditors.

    Death Benefit settlement options include:

    Lump SUM (Cash Payment):Under this option, the death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. The lump sum option is the most common option used and is considered the automatic (or “default”) option for most life insurance contracts.The lump sum option is used when the policyowner wants funds paid in one single disbursement.Interest OnlyUnder this option, the insurance company holds the death benefit for a period of time and pays only the interest earned to the named beneficiary. A minimum rate of interest is guaranteed, and the interest must be paid at least annually.This option provides the beneficiary with flexibility since the proceeds may be left with the insurer, which frees him or her of any investment worry while guaranteeing both principal and minimum rate of return [i.e., interest].Interest paid by an insurer on policy proceeds is taxable. Even when the policy proceeds are left with the insurer, and the beneficiary selects this option, they continue to possess the right to withdraw the proceeds in the future at their discretion unless the policyowner explicitly listed restrictions.Fixed AmountThe Fixed amount installment option permits the death proceeds to be left “at interest” with the insurer and to pay a fixed death benefit in specified installment amounts until the principal and interest are exhausted. The amount of monthly income selected by the beneficiary, the amount of proceeds, and the interest rate paid by the insurer will all determine the length of time in which the beneficiary receives the monthly income.The larger the installment payment, the shorter the payout period.Under this option, “the amount of income is the primary consideration” rather than the period of time over which the proceeds and interest are to be liquidated.The fixed amount option allows the beneficiary to designate an amount of income to be replaced, such as $1200/month. These payments continue until the principal and interest are exhausted.Fixed PeriodWhen the fixed period or period certain option is chosen, the death benefit proceeds are paid in equal installments over a set period of years. The fixed period option is one of the two options based upon the concept of systematically liquidating principal and interest over a period of years, without references to life contingencies.Under this option, the beneficiary leaves the death proceeds with the insurer.Interest is paid on the proceeds (i.e., principal) by the insurer.Monthly income is then paid to the beneficiary for a specified period of time as selected by the beneficiary (i.e., 10 years).

    “installments paid to a beneficiary consists of interest calculated on the proceeds of the policy.”

    The option provides for the payment of proceeds in installments over a definite number of years. The amount of each installment is determined by the amount of proceeds, the period of time (total number of installments) selected, the guaranteed rate of interest, and the frequency of payments.The fixed option is valuable when the most crucial consideration is to provide income for a definite period of time, for example, until all children graduate high school.

    Life Income

    The Face amount & the Length of time for which payments will be made are primary factors that determine the monthly income amount paid to the beneficiary.This settlement option liquidates policy proceeds (i.e., principal) and interest with regard to life contingencies.Installment payments are guaranteed for as long as the recipient lives. Therefore, “Life Income” option provides the beneficiary with an income that they cannot outlive.The amount of each installment is based on the recipient’s life expectancy and the amount of principal.Using the recipient’s life expectance gives the potential for a greater return, or potential for a greater loss, based on how long the insured lives.

    This is used to ensure the beneficiary receives a payment as long as the are alive.

    Income payments end upon the death of the beneficiary. No refund or any income per $1000 of proceeds. It also possesses the most significant amount of risk since there is “no survivorship”. There are several Life Income options:

    • Single
    • Pure
    • Straight

    Refund Life Income Option

    The refund life income option, also know as the “Joint Life Option”, guarantees the return of an amount equal to the principal less any payments already made. In other words, it provides a minimum guaranteed return. Once the primary beneficiary dies, their survivors may receive the refund on an installment basis or in a lump sum, which is referred to as “cash refund” [Installment Refund].

    Life Income Option with Period Time

    The life income option WITH a “period certain” pays a monthly income for as long as the beneficiary lives. However, if the beneficiary dies before a predetermined number of years elapsed, the insurer will continue monthly payments to a second beneficiary for the remainder of the designated period.

    Joint and Survivor Option

    The Joint & Survivor option guarantees the benefits will be paid on a life-long basis to two or more people. This option may include a “period certain” with a reduction in benefits after the death of the first beneficiary. The amount payable is based on the ages of both beneficiaries.



    The beneficiary of a life insurance policy is the person or entity designated in a policy to receive the death proceeds. The owner of the policy is the ultimate decision-maker and is responsible for handling, naming, or changing a beneficiary.There are a few restrictions on who may be named beneficiary of a life insurance policy. In the underwriting process, the underwriter must consider the issue of insurable interest.When policyowners (other than the insured) lists themselves as the beneficiary, they will require “proof of insurable interest”. This Includes:

    • Individuals: (Name & Relationship)
    • Class Designation: (Group of Individuals)
    • Business: (Business Key Person mitigation)
    • Charities: (Continued Funding “Scholarship”)
    • Trust: (Proceeds Management)
    • Estate: In rare cases the estate is chosen.

    Changing A Beneficiary

    There are two standard methods of changing a beneficiary available if the policyholder wishes to make a change; the “filling/recording method” and the “endorsement method”.- The “Filling method” is the predominant method used and requires that the policyholder notify the insurer in writing of the desired change. The effective date of the change is the date of the request. Some insurers require that a witness sign the request.- The “Endorsement Method” is utilized when the Policy is returned to the insurer so the beneficiary designation can be added to the policy. The effective date of change is the date the new policy is printed.

    A “Revocable Beneficiary” may be changed or removed by the policyowner at any time without notifying or getting permission from the beneficiary.An “Irrevocable Beneficiary” may not be changed without the written consent of the beneficiary. The irrevocable beneficiary has vested interest in the policy.The policyowner may not exercise certain rights (i.e., assignments, policy loans, surrenders, etc.) without the consent of the beneficiary. In addition, an irrevocable beneficiary has THE RIGHT TO RECEIVE A COPY OF THE POLICY if they desire.

    Benefit Distributions

    Distribution by Descent

    • Per Capita: [Head of Person] Evenly distributes benefits among all named living beneficiaries, typically the surviving children.
    • – Per Stripes: [Bloodline] Distributions are made according to the family line, branch, or root.In the event that a beneficiary dies before the insured, and no changes are made to the policy, benefits from that policy will be paid to that beneficiary’s heirs.

    Distribution by Order of Succession

    • Primary Beneficiary

    The primary beneficiary “is the first or Principal person in line to receive income tax-free policy proceeds.”A policyowner may designate multiple primary beneficiaries and choose different or equal amounts of each beneficiary. Unless specifically requested as part of the contract (per stripes) or “requested by state law”, the estate or heir of deceased beneficiary will not receive any payment.

    • Secondary or Contingent Beneficiary

    The secondary or contingent beneficiary is the second individual in line to receive the death benefit. “They receive the death benefit only if the primary beneficiary has died prior to the insured”. The primary beneficiary must predecease the insured in order for the secondary beneficiary to receive any proceeds.

    • Tertiary Beneficiary

    A tertiary beneficiary is third in line to receive policy proceeds when the insured dies if they survived the primary contingent beneficiaries.

    • Distribution to an Estate

    “The policy proceeds will be paid to the estate of the insured if none of the listed beneficiaries are still alive at the time of the insured’s death.”

    • Distribution to a Minor

    A life insurance company typically will NOT pay policy proceeds directly to a minor beneficiary. While any entity can be named as a beneficiary, many States do not permit proceeds to be paid to a minor since he or she lacks “legal capacity”.For these reasons, a guardian or trustee will typically need to be appointed.In some cases, the insurance company may hold the proceeds, paying interest on them until the beneficiary reaches legal age.

    • Distribution to a Trust

    Trusts may be named as the beneficiary of a life insurance policy and manage the proceeds upon the insured’s death. Naming a trust as beneficiary is the MOST ADVANTAGEOUS DESIGNATION to use when a policy owner wishes to leave policy proceeds to a “minor” child. In this case, a “TRUSTEE” WILL MANAGE THE TRUST for the benefit of the child. This administration fee may reduce policy proceeds.

    • Testamentary Trusts [According to a will]
    • Inter Vivos Trusts [Living Trusts]

    Facility of payment 

    The facility of payment provision permits an insurer to pay a portion (or all) of the policy proceeds to ANY individual who appears to be equitably entitled.Such payment may be provided t a party who paid for the medical or final expenses of the deceased insured.Usually, the facility of payment provision comes into play when a death claim is not filled within two months following the death of the insured.Additionally, this provision may be triggered to assist a guardian when a minor is listed as the beneficiary.

    Special Situations

    Uniform Simultaneous Death Act & Common Disaster Provision

    How a policy responds to common disaster deaths is governed by the Uniform Simultaneous Death Act.This act states that if the insured and primary beneficiary both die in a common disaster (i.e., plane crash) and it cannot be determined who died first, the insured will be considered to have survived the primary beneficiary (or died last).In other words, the primary beneficiary will be considered to have died before the insured. Therefore, the face amount is paid to the contingent beneficiary.The problem with the Uniform Simultaneous Death Act is that it only applies to situations where it cannot be definitively determined if the insured died before the beneficiary.If it can be determined who died first, even if the difference is only a few minutes of hours, the insurance company would follow the normal succession process outlined in the policy:         –  If the primary beneficiary clearly died first, then the insured died, the benefits would be payable directly to the contingent beneficiary.         –  If the insured died first,the death benefit is payable (i.e., due) to the primary beneficiary.If the primary beneficiary then died shortly after that, the face amount will be paid to the estate of the primary beneficiary and not directly to the contingent beneficiary. Death taxes and probate charges may be assessed before the heirs receive what remains.

    The Common Disaster Provision

    This provision further clarifies the mentioned complicated situations by adding a survivorship clause. “This clause requires the primary beneficiary not just survive longer but outlive the insured for a specific amount of time, typically 14 or 30 days”.The common disaster provision ensures a policyowner that if both the insured and the primary beneficiary die within a short period of time, the death benefits will be paid to the contingent beneficiary.Benefits will only be paid to the primary beneficiary’s estate if the primary beneficiary lives past the minimum time period.The goal of both “The Uniform Simultaneous Death Act” and “The Common Disaster Provision” is to PROTECT THE CONTINGENT BENEFICIARY BY NOT PAYING PROCEEDS TO THE PRIMARY BENEFICIARY’S ESTATE.Paying the benefits to beneficiary’s estate likely defeats the purpose of the insurance policy. It potentially causes undesired death taxes and probate charges to be assessed, significantly reducing the benefit before the heirs receive what remains. If there is not a contingent beneficiary listed, the benefits will be paid to the insured’s estate, just as if the primary beneficiary died before the insured.

    Spendthrift Clause

    This provision protects a beneficiary from creditors with regard to life insurance proceeds.When the death benefit is left with the insurer, no creditors can attach a lien of any kind to the proceeds.The SPENDTHRIFT CLAUSE also protects a beneficiary by minimizing or restricting the use of proceeds as long as the insurer holds them.Only after proceeds have been distributed can the beneficiary assign or transfer the benefits to a creditor.Additionally, under the SPENDTHRIFT CLAUSE, a beneficiary cannot take the present value of future payments in a lump sum (commuting) or use future payments as collateral for a loan (encumbering).This clause is most often used “to prevent a beneficiary from recklessly spending benefits” by requiring benefits to be paid in fixed amounts or installments over a certain period of time.Outside of preventing distribution directly to the insured’s creditors, this clause “does not have any effect if the beneficiary receives the proceeds as one lump sum payment”. Once the beneficiary receives the payment, creditors may be able to take steps to collect on money owed.

    Tax Consequences of Life Insurance

    Tax Treatment of Individual Life Insurance

    According to The Internal Revenue Code, “Premiums paid for individual life insurance policies are considered to be a personal expense, and as such, are not tax-deductible.”Just because a premium is used to buy life insurance on a spouse or in a third-party ownership situation does not mean that the premiums will be tax-deductible.Premiums paid on life insurance may be tax-deductible to an employer if the insurance is used as an employee benefit. Premiums may also be tax-deductible if the policy is to provide for charitable contributions. Premiums for an insurance policy to benefit an ex-spouse as court-ordered alimony are tax-deductible.

    Taxation of Proceeds Paid at Death

    Since the premiums paid are not tax-deductible, the proceeds (death benefit) from the life insurance policy “are generally paid income tax-free (tax-exempt) to the named beneficiary”, if taken as a lump sum. The exception to this rule is the transfer for value rule, which applies when a life insurance policy is sold to another party before the insured’s death.Benefits are generally subject to “federal estate tax” if they are included in (paid to) the policyowner’s gross estate.If death benefits are paid in installments, as opposed to a lump sum, the principal is received tax-free, and any interest received is taxable.

    Economic Benefit Doctrine

    The Economic Benefit Doctrine requires that any benefit to an individual that has an economic or financial value be included as compensation for income tax purposes in the year the benefit is granted.The key to avoiding the imposition of the Economic Benefit Doctrine is the existence of a “Substantial risk Forfeiture”.Therefore, individual like insurance avoids this doctrine since premature death can cause a substantial risk to surviving family.

    Taxation of Cash Values

    The interest paid on the cash value as it increases or accumulates is “Tax-Differed”.”The total of the premiums paid into the policy minus total dividends received in cash or used to offset premiums is referred to as the COST BASIS“.According to the cost recovery rule, if the policy is surrendered for its cash value, the portion that exceeds the cost basis, or premiums paid, is considered ordinary income and taxable.As long as the CASH VALUE stays in the policy, taxes will never be imposed on any portion, not even the amount that exceeds the cost basis.

    Taxation of Policy Loans

    With regard to policy loans, if a contract owner borrows against the cash value in the contract, there are no tax consequences in most situations.However, if a policy is MEC, distributions are subject to the interest first rule, which states that “they are taxable as income if the CASH VALUE of the contract, immediately prior to the payment, exceeds the cost basis in the contract”.Borrowing against cash value is sometimes referred to as a PARTIAL SURRENDER. This action on the part of the owner, while not resulting in a taxable event, does lower the owner’s equity in the policy.If a total surrender occurs, the cash value received is not taxable as long as it does not exceed what the owner paid in premiums (cost basis).When a contract owner borrows against the cash value of a Whole Life Policy, the interest paid to the insurer is NOT tax-deductible.

    Example : Assume Mr. Jones is the owner of a $100k Whole life insurance policy on his own life. The cash surrender value is $45k.He paid $35k in premiums ofer 10 years.If Mr. Jones borrows $40k against the policy, he will not be subjected to tax consequences as long as the policy stays active. Mr. Jones will repay the loan from the insurer plus interest. The Interest is not tax-deductible.If Mr. Jones surrenders the policy, he will have a taxable gain of $10k (the difference between 35k in cost basis & 45k in surrender value) that he must report as taxable ordinary income.

    Taxation of Accelerated Death Benefit

    When benefits are paid under a life insurance policy to a terminal il person, the benefits are received tax-free. To be considered terminally ill, a physician must certify that person has a condition or illness that will result in death in two years.

    Taxation of Policy Dividends

    Dividends paid on a whole life policy are TAX-EXEMPT as “they are considered to be a return of overpaid or excess premiums”. While unlikely to happen, any dividends received over the premiums paid are taxable as ordinary income. “If dividends are left with the insurer to accumulate interest, the interest earned will be taxable as ordinary income in the year received.”If the life insurance policy is determined by the IRS to be a Modified Endowment Contract (MEC), dividends will be taxable unless they are used to purchased paid-up additional insurance. In addition, dividends payable under a MEC may be subjected to a 10% penalty tax (applying to premature distribution before age 59 & 1/2).

    1035 Exchange

    When an existing life insurance policy is assigned to another insurer for a new contract, the transaction may be treated for tax purposes as a Section 1035 Exchange.Policy exchanges that qualify as a 1035 Exchange are not taxable.A Section 1035 Exchange enables the postponement of tax consequences.

    The Internal Revenue Code (IRC) enables tax-free Section 1035 Exchange of a life insurance policy to a different policy if it occurs FROM INSURER TO INSURERand the policyowner does not receive any cash.

    Life Insurance Underwriting and Policy Issue

    Purpose of Underwriting

    Underwriting is the process used by an insurance company to determine if applicant is insurable & how much to charge for premiums.

    The underwriter will utilize several different types of information in determining the insurability of the individual. Material facts can affect an applicant being accepted or rejected.

    One of the primary responsibilities of an underwriter is to protect the insurer against adverse selection.

    The underwriter classifies each proposed insured’s risk and selects only those with an acceptable risk per insured’s underwriting guidelines.

    Underwriting Process

    The underwriting process involves reviewing and evaluating the applicant’s information and establishing individual guidelines against the insurer’s standards and guidelines for insurability and premium rates.

    The larger the policy, the more comprehensive and diligent the underwriting process.

    The most common sources of underwriting information include:

    •  The Application: Starting Point & Primary source of information used by the insurance company in the risk selection. Although applicants differ from company to company, they all have the following same components. Insurable interest must exist between the policyowner and insured at the time when application is made.
    • The Medical Report: Used for underwriting policies with higher face amounts. If the medical section’s information warrants further investigation into the applicant’s medical conditions, the underwriter may need an attending physician statement (APS).
    • The Medical Information Bureau : Information from the MIB is used by life and health insurance companies to help avoid adverse selection by applicants. It detects misrepresentations, helps identify fraudulent information, and controls the cost of insurance. Information Bureau about a proposed insured may be released to the proposed insured’s physician. Information received from the MIB about a proposed insured may be released to the proposed insured’s physician. An insurance company will NOT notify the MIB inf an applicant is declined.
    • Special Questionnaires : Are used for applicants involved in particular circumstances, such as aviation, military service, or hazardous occupations or hobbies. The questionnaire provides details on how much of the applicant’s time is spent on these activities.
    • Inspection Reports : This Report provides information about the applicant’s character, Lifestyle, and financial stability. Due to their cost, inspection reports are usually online requested for more extensive coverages. Company rules vary as to the sizes of policies that require a report by an outside agency. When an investigative consumer report is used in connection with an insurance application, the applicant has the right to receive a copy of the report.
    • Credit Reports : Fair Credit Reporting Act of 1970 (FCRA) Regulates how credit information is collected and used to protect consumer’s rights for whom an inspection or credit report has been requested. Information regarding an individual’s credit standing and general reputation is contained in a consumer report. It established procedures for the collection and disclosure of information obtained on consumers through investigation and credit reports. If an insurance company requests a credit report, the consumer must be notified in writing.

    Privacy Notice

    The Health Insurance Portability and Accountability Act is a privacy rule that provides federal protections for an individual’s health information.

    HIPAA gives patients an array of rights concerning individually identifiable health information. When an agent submits an application that reveals personal information regarding the applicant, the agent is responsible for providing the insurance applicant with notices.

    Producers must also secure an HIV consent form from the applicant in applicable situations and communicate that blood tests may be required. Even tough the insurer requires a blood test as part of its regular underwriting activity, it must still secure a signed consent form which indicates to the applicant that any blood taken will be screened for HIV and that he or she is providing permission for such testing to be completed.

    Applicant Ratings : once all the information about a given applicant has been reviewed, the underwriter seeks to classify the applicant’s risk to the insurer. This evaluation is known as risk classification.

    Classifications of Risk

    Once all the information about a given applicant has been reviewed, the underwriter will utilize several different types of information in determining the insurability of the individual and the risk that the applicant poses to the insurer. This evaluation is known as risk classification. The following rating classification system is used to categorize the favorability of a given risk:

    • Preferred – Low Risk – Lower Premiums:
    • Applicant does not smoke or drink
    • Good Personal/Family health history
    • Standard – Average Risk – No Extra Ratings or Restrictions. Standard Terms & Rates.
    • Standard – High Risk – Rated Up – Higher Premiums due to chronic conditions, insulin diabetes, or heart disease.
    • Declined – Not Insurable – Potential of Loss to Insurance Company is Too High. Terminal illness, too many chronic conditions.

    Field Underwriting Procedures

    Field underwriting is completed by the agent. Unlike the Insurer, the agent has a face-to-face contact with the applicant, which can aid the insurer in risk selection. As field underwriters, agents help reduce the chance of adverse selection, assure that the applicant is filled out completely and correctly, collect the initial premium, and deliver the policy.

    Other Duties Include:

    • Forwarding the application to the insurer in a timely manner
    • Seeking additional information about the applicant’s medical history if requested
    • Notifying the insurer of any suspected misstatements in the application
    • Assuring the application is filled out completely and correctly
    • Collect the initial premium
    • Agents have the responsibility and duty to solicit only profitable business. An agent’s solicitation and prospecting efforts should focus on cases that fall within the insurer’s underwriting guidelines and represent profitable business to the insurer.
    • Upon policy delivery, agents must deliver the life insurance buyer’s guide and policy summary to the applicant. A life insurance producer may also be required to obtain a signature on a good health statement at the time of policy delivery.

    Applicant Errors

    If an agent realizes that an applicant has made an error on an application, the agent must correct the information and have the applicant initial the changes. 

    An incomplete application will be returned to the agent.

    The agent can NEVER change the application without the customer present to initial changes.

    • Buyer’s Guide : Provides general information about types of life insurance policies available in simple language that can be understood by the average person.
    • Policy Summary : Provides Specific Information about the policy purchased, such as the premium and benefits. For example, your grandmother calls you excited because she bought a new health insurance but can’t tell you what it is. The summary allows you to quickly see what “health insurance” specifically, she bought: Medicare Supplement, Major Medical, Critical Illness, Long-term Care, etc.
    • Suitability Form : Ensures that the customer is best suited for the policy they are purchasing. For example, a 75-year-old customer living off of Social Security would not be suited for a single premium deferred annuity because they would be giving up a large sum of cash that they could live on and possibly not live long enough to collect on the annuity,
    • Signatures : The agent and the applicant are required to sign the application. If the applicant is someone other than the proposed insured, except for a minor child, the proposed insured must also sign the application. Having a policy owner (applicant) that is different from the insured (parent and minor child) is considered third party ownership in most states. Once a minor reaches the age of 15, he is eligible to contract for an insurance policy.

    If an agent fails to deliver a fully completed and accurate application, the insurance company will return the agent’s application.

    When an applicant makes a mistake in the information given to an agent in completing the application, the applicant can have the agent correct the information, but the applicant must initial the correction.

    However, if the company discovers the mistake before the applicant, it usually returns the agent’s application. The agent then corrects the mistake with the applicant and has the applicant initial the change.

    • An Incomplete Application will be returned to the producer, and a new one will have to be filled out.

    Premiums and Receipts

    Agents should make every effort to collect the initial premium with the application. If the premium is not collected with the application, the POLICY WILL NOT BECOME VALID until the initial premium is collected.

    The agent issues the applicant a premium receipt upon collecting the initial premium.

    The only time a customer will receive a receipt is if they pay their initial premium at the time of application. No receipt will be given at any other time.

    There are two types of premium receipts that determine when coverage will begin. These are conditional receipts and binding receipts.

    • Conditional Receipt : The producer issues a conditional receipt to the applicant when the application and premium are collected. The conditional receipt denotes that coverage will be effective once certain conditions are met. If the insurer accepts the coverage as applied for, the coverage will take effect from the application or medical exam date, whichever is later.
    • Binding Receipt : The binding receipt, or the temporary insurance agreement, provides coverage from the date of the application regardless of whether the applicant is insurable. Coverage usually lasts for 30 to 60 days, or until the insurer accepts or declines the coverage. Binding receipts are rarely used in life insurance and are primarily used in auto and homeowner’s insurance. Under a binding receipt, coverage is guaranteed until the insurer formally rejects the application. This may also be described as the insurer is bound to coverage until the application is formally rejected. Even if the proposed insured is ultimately found to be uninsurable, coverage is still guaranteed until rejection of the application.

    Effective Date of Coverage

    As explained under conditional receipt, coverage is not effective without the collection of the initial premium, approval of the application, and policy issuance and delivery. If the initial premium does not accompany the application, the premium must be collected by the agent. In some cases, the insurer requires the agent to collect a good health statement from the insured at the delivery time. If the initial premium is not submitted with the application, the policy effective date is established by the insurer. In this case, it could be the date the policy is issued. Generally, for a policy to be in effect:

    • The Insurer Must Issue The Policy
    • Insured must submit the initial premiums; and if applicable, must sign a statement of continued good health.
    • EFFECTIVE DATE : This is important for two reasons, it identifies when the coverage is effective and establishes the date by which future annual premiums must be paid.
    • Backdating : Is the process of predating the application a certain number of months to achieve a lower premium. A younger age at the time of application results in a lower premium. A backdated application results in a backdated policy effective date, if approved by the insurer. Applications usually can only be backdated for up to 6 months. This is also known as “Saving Age”. Policyowners are required to pay all back-due premiums, and the next premium is due at the backdated anniversary date.

    Policy Issue

    Policy issue happens when the insurer “Approves” the application; they are “issuing the policy”. The insurance issued contract is sent to the sales agent for delivery to the applicant. The policy usually is not sent to the policyowner because the sales agent should explain it to the policyowner.

    A Policy could be ISSUED and not delivered for days or weeks later.

    • Constructive Delivery : May be accomplished without physically delivering the policy into the policyowner’s possession. Constructive Policy occurs if the insurance company intentionally relinquishes all control over the policy and turns it over to someone acting for the policyowner, including the company’s owner agent. Mailing the policy to the agent for unconditional delivery to the policyowner also constitutes constructive delivery, even if the agent never personally delivers the policy. If the company instructs the agent not to deliver the policy unless the applicant is in good health, there is no constructive delivery.
    • Statement of Good Health : Verifies that the insured has not become ill, injured, or disabled during the policy approval process (time between submitting application and delivery of the policy), or did not submit the initial premium with the application. It is used when the applicant did not submit the initial premium with the application in such cases.

    Common company practices requires that, before the policy the agent must collect the premium and obtain from the insured a signed statement attesting to the insured’s continued good health. Statements of good health are also used when reinstating a policy.

    Personal Delivery Of The Policy is a good practice as it allows the producer to explain the coverage to the insured (such as the riders, provisions, and options). Personal delivery also builds trust and reinforces the need for the coverage. All of the following acts can be considered means of delivery : mailing policy to the agent, mailing the policy to the applicant, and the agent personally delivering policy.

    * 1868 Paul v. Virginia : This case, which the U.S. Supreme Court decided, involved one state’s attempt to regulate an insurance company domiciled in another state.* 1944 U. States v. SEUA : In the Southeastern Underwriters Association case, the Supreme Court ruled that the insurance industry is subject to a series of Federal Laws, many of which conflicted with existing state laws. As such, insurance is a form of interstate commerce to be regulated by the federal government.* 1945 McCarran-Ferguson Act : This law made it clear that the states continued regulation of insurance was in the publics best interest. However, it also made possible the application of federal antitrust laws to the extent that [The insurance business] is not regulated by state law.* 1958 Intervention by the FTC : In 1958 the Supreme Court held that the McCarran Ferguson Act disallowed such supervision by the FTC, a federal agency. Additional attempts have been made by the FTC to force further Federal Control, but none have been successful.* 1959 Intervention by the SEC : The Supreme Court ruled that Federal securities laws applied to insurers that issued variable annuities and, thus, required these insurers to conform to both SEC and state regulations. The SEC regulated variable life insurance.* 1970 Fair Credit Reporting Act : Requires fair and accurate reporting of information about consumers, including applications for insurance. Insurers must inform applicants about Any Investigations that are being made upon completion of the application.* 1994 U. States Code (USC) Section 1033 & 1034.According to 18 U.S.C. 1033 & 1034 : It is a criminal offense for an individual who has been convicted of a felony involving dishonesty or breach of trust to willfully engage or participate (in any capacity) in the business of insurance without first obtaining a “Letter of Written Consent to Engage in the Business of Insurance” from the regulating insurance department of the individual’s state of resistance.* 1999 Financial Services Modernization Act. :  In 1999 Congress passed the Financial Services Modernization Act, which repealed the Glass Steagall Act. Under this new legislation, commercial banks, investment banks, retail brokerages and insurance companies can now enter each other’s lines of business.* 2001 Uniting & Strengthening America by Providing Appropriate Tools Required to Intercept & Obstruct Terrorism Act. : The Patriot Act, which amends the Bank Secrecy Act (BSA), was adopted in response to the September 11, 2001, terrorist attacks. The Patriot Act is intended to strengthen U.S. measures to prevent, detect, and deter terrorists and their funding. The act also aims to prosecute international money laundering and the financing of terrorism. These efforts include anti-money laundering (AML) tools that impact the banking, financial, and investment communities.* 2003 Do Not Call Implementation Act. : The Do Not Call Registry allows consumers to include their phone numbers on the list to which telemarketers cannot make solicitation calls.* 2010 Patient Protection & Affordable Care Act (PPACA) : Often shortened to the Affordable Care Act (ACA), it represents one of the most significant regulatory overhauls and expansions of health insurance coverage in U.S. history.

    All notes come from an In-depth study into: The Michigan Pre-licensing Education – Life, Accident and Health Insurance course has been approved by the Michigan Department of Financial Services as meeting the mandatory 20-hour requirement for Life and 20-hour Requirement for Health | XCEL Solutions LLC. Provider ID#: 0950 Course ID#: 60731/60732

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