FAQ
Frequently Asked Questions:
What is Life Insurance?
What are Some Uses of Life Insurance?
What is Term Life Insurance?
What is Whole Life Insurance?
What is Universal Life Insurance?
What is Double Indemnity?
What is an Annuity?
What is Long Term Care Insurance?
What is Health Insurance?
What is Critical Illness Insurance?
What is Disability Insurance?
What is Estate Planning?
What is a Will?
What are Trusts and Estates?
Life insurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a designated beneficiary a sum of money upon the occurrence of the insured individual's death or other event, such as terminal illness or critical illness. In return, the policy owner agrees to pay a stipulated amount (at regular intervals or in lump sums). In the United States, the predominant form simply specifies a lump sum to be paid on the insured's demise.
The value for the policy owner is derived, not from an actual claim event, rather it is the value derived from the 'peace of mind' experienced by the policy owner, due to the negating of adverse financial consequences caused by the death of the Life Insured.
Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; for example claims relating to suicide, fraud, war, riot and civil commotion.
Life-based contracts tend to fall into two major categories:
- Protection policies - designed to provide a benefit in the event of specified event, typically a lump sum payment. A common form of this design is term insurance.
- Investment policies - where the main objective is to facilitate the growth of capital by regular or single premiums. Common forms (in the US anyway) are whole life, universal life and variable life* policies.
Living Benefits of Life Insurance. Many people use a life insurance policy for its living benefits as opposed to the death benefit which is a provided benefit to the beneficiary. These benefits include loans, withdrawals, collateral assignments, funding of buy-sell agreements, split dollar agreements, pension funding, and for estate planning. Insurance, and in particular cash value life insurance, can be used as a source of benefit to the owner.
Uses of Life Insurance include:
- Final Expenses, such as a funeral, burial, and unpaid medical bills
- Income Replacement, to provide for surviving spouses and dependent children
- Debt Coverage, to pay off personal and business debts, such as a home mortgage or business operating loan
- Estate Liquidity, when an estate has an immediate need for cash to settle federal estate taxes, state inheritance taxes, or unpaid income in respect of decedent (IRD) taxes.
- Estate Replacement, when an insured has donated assets to a charity and wants to replace the value with cash death benefits.
- Business Succession & Continuity, for example to fund a cross-purchase or stock redemption buy/sell agreement.
- Key Person Insurance, to protect a company from the economic loss incurred when a key employee or manager dies.
- Executive Bonus, under IRC Sec. 162, where an employer pays the premium on a life insurance policy owned by a key person. The employer deducts the premium as an ordinary business expense, and the employee pays the income tax on the premium.
- Controlled Executive Bonus, just like above, but with an additional contract between an employee and employer that effectively limits the employees access to cash values for a period of time (golden handcuffs).
- Split Dollar Plans, where the death benefits, cash surrender values, and premium payments are split between an employer and employee, or between an individual and a non-natural person (i.e., trust).
- Non-qualified Deferred Compensation, as an informal funding vehicle where a corporation owns the policy, pays the premiums, receives the benefits, and then uses them to pay, in whole or in part, a contractual promise to pay retirement benefits to a key person, or survivor benefits to the deceased key person's beneficiaries.
- A Possible Alternative to Long Term Care Insurance, where new policies have accelerated benefits for Long Term Care.
- Mortgage Acceleration, where an over-funded UL is either surrendered or borrowed against to pay off a home mortgage before the term ends.
- Charitable Gift, where a policy is donated to a qualified charity, or the policy owner names a charity as the beneficiary.
- Charitable Remainder Trust Replacement, where a policy owner wants to replace assets donated to a Charitable Remainder Trust.
- Estate Equalization, where a business owner has more than one child, and at least one child wants to run the business, and at least one other child wants cash.
- Life Insurance Retirement Plan, or Roth IRA Alternative. High income earners who want an additional tax shelter, with potential creditor/predator protection, who have maxed out their IRA, who are not eligible for a Roth IRA, and who have already maxed out their qualified plans.
- Term Life Alternative, for example when a policy owner wants to use interest income from a lump sum of cash to pay a term life premium. An alternative is to use the lump sum to pay premiums into a UL policy on a single premium or limited premium basis, creating tax arbitrage when the costs of insurance are paid from untaxed excess interest credits, which may be crediting at a higher rate than other guaranteed, no risk asset classes (i.e., Certificates of Deposit, US Savings Bonds).
- Whole Life Alternative, where there is any need for permanent death benefits, but little or no need for cash surrender values, then a current assumption UL or Guaranteed UL may be an appropriate alternative, with potentially lower net premiums.
- Annuity Alternative, when a policy owner has a lump sum of cash that they intend to leave to the next generation, a single premium UL policy provides similar benefits during life, but has a stepped up death benefit that is income tax-free.
- Pension Maximization, where permanent death benefits are needed so an employee can elect the highest retirement income option from a defined benefit pension while providing a safety net to the beneficiaries.
- Annuity Maximization, where a large non-qualified annuity with a low cost basis is no longer needed for retirement and the policy owner wants to maximize the value for the next generation. There is potential for arbitrage when the annuity is exchanged for a Single Premium Immediate Annuity (SPIA), and the proceeds of the SPIA are used to fund a permanent death benefit using Universal Life. This arbitrage is magnified at older ages, and when a medical impairment can produce substantially higher payments from a medically underwritten SPIA.
- RMD Maximization, where an IRA owner is facing Required Minimum Distributions (RMD), but has no need for current income, and desires to leave the IRA for heirs. The IRA is used to purchase a qualified SPIA that maximizes the current income from the IRA, and this income is used to purchase a UL policy.
- Creditor/Predator Protection. A person who earns a high income, or who has a high net worth, and who practices a profession that suffers a high risk from predation by litigation, may benefit from using Universal Life Insurance as a warehouse for cash, because in some states the policies enjoy protection from the claims of creditors, including judgments from frivolous lawsuits.
Term life insurance is life insurance which provides coverage at a fixed rate of payments for a limited period of time, the relevant term. After that period expires, coverage at the previous rate of premiums is no longer guaranteed and it becomes an annual renewable term with an increasing premium. The client must either forgo coverage or potentially obtain further coverage with different payments and/or conditions. If the insured dies during the term, the death benefit will be paid to the beneficiary. Term insurance can be the least expensive way to purchase a substantial death benefit amount per premium dollar basis for the initial period.
Term life insurance is the original form of life insurance and can be contrasted to permanent life insurance such as whole life, universal life, and variable universal life,* which guarantee coverage at fixed premiums for the lifetime of the covered individual. Term insurance is not generally used for estate planning needs or charitable giving strategies. Many permanent life insurance products also build a predetermined cash value over the life of the contract, available for later withdrawal by the client under specific conditions. However, on most cash value policies like whole life insurance, there are two ways to receive the cash value of the policy. The beneficiaries receive the face value of the insurance plus accumulated dividends in a participating policy but NEVER the cash value with whole life policies.
Term insurance functions in a manner similar to most other types of insurance in that it satisfies claims against what is insured if the premiums are up to date and the contract has not expired, and does not expect a return of premium dollars if no claims are filed unless you have purchased a Return of Premium Term. As an example, auto insurance will satisfy claims against the insured in the event of an accident and a home owner policy will satisfy claims against the home if it is damaged or destroyed by, for example, a fire.
Because term life insurance is a pure death benefit, its primary use is to provide coverage of financial responsibilities for the insured. Such responsibilities may include, but are not limited to, consumer debt, dependent care, college education for dependents, funeral costs, and mortgages. Term life insurance is generally chosen in favor of permanent life insurance because it is considered to be much less expensive (depending on the length of the term). Many financial advisors or other experts commonly recommend term life insurance as a means to cover potential expenses for a specific period of time.
In general, term life insurance policies can be converted to permanent insurance policies during a stated conversion period without evidence of insurabilty.
Whole Life Insurance is a life insurance policy that remains in force for the insured's entire life and requires (in most cases) premiums to be paid every year into the policy.
All life insurance was originally term insurance. However, because term life insurance only pays a claim upon death within the stated term, a number of term insurance policy holders became upset over the idea that they could be paying premiums for 20 or 30 years and then wind up with nothing to show for it.
In response to market pressures, actuaries conceived of an insurance policy with level premium payments that were higher than traditional term insurance contracts. These contracts would offer a "cash value”, and dividends or paid up additions in a participating policy which was designed to be a cash reserve that would build up against the known claim - the death benefit. These policies would also credit interest to the cash value account and upon maturity of the contract (usually from ages 95 to 131.) The cash value would equal or can exceed the death benefit.
Universal Life is a type of permanent life insurance based on a cash value. That is, the policy is established with the insurer where premium payments above the cost of insurance are credited to the cash value. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance (COI) charge, and any other policy charges and fees which are drawn from the cash value if no premium payment is made that month. The interest credited to the account is determined by the insurer; sometimes it is pegged to a financial index such as a bond or other interest rate index.
Universal life is similar in some ways to, and was developed from whole life insurance. The advantage of the universal life policy is its premium flexibility and adjustable death benefits. The death benefit can be increased (subject to insurability), or decreased at the policy owner's request.
Double indemnity is a clause or provision in a life insurance or accident policy whereby the company agrees to pay the stated multiple (i.e. double) of the face amount in the contract in cases of accidental death. An accidental death is a death that is neither intentionally caused by a human being, such as murder or suicide, nor from natural causes, such as cancer or heart disease. This benefit usually ends at age 70.
In 2009, 5.01% of all deaths in the United States were declared accidental. For this reason, double-indemnity clauses are usually relatively cheap and often aggressively marketed, especially to people over 45. Children and people in dangerous jobs, such as heavy construction, are the exceptions.
A life annuity is a financial contract in the form of an insurance product according to which a seller (issuer) — typically a financial institution such as a life insurance company — makes a series of future payments to a buyer (annuitant) in exchange for the immediate payment of a lump sum (single-payment annuity) or a series of regular payments (regular-payment annuity), prior to the onset of the annuity.
The payment stream from the issuer to the annuitant has an unknown duration based principally upon the date of death of the annuitant. At this point the contract will terminate and the remainder of the fund accumulated forfeited unless there are other annuitants or beneficiaries in the contract. Thus a life annuity is a form of longevity insurance, where the uncertainty of an individual's lifespan is transferred from the individual to the insurer, which reduces its own uncertainty by pooling many clients. Annuities can be purchased to provide an income during retirement.
Long-term care insurance (LTC or LTCI), an insurance product sold in the United States and United Kingdom, helps provide for the cost of long-term care beyond a predetermined period. Long-term care insurance covers care generally not covered by health insurance, Medicare, or Medicaid.
Individuals who require long-term care are generally not sick in the traditional sense, but instead, are unable to perform the basic activities of daily living (ADLs) such as dressing, bathing, eating, toileting, continence, transferring (getting in and out of a bed or chair), and walking.
Age is not a determining factor in needing long-term care. About 60 percent of individuals over age 65 will require at least some type of long-term care services during their lifetime. About 40% of those receiving long-term care today are between 18 and 64. Once a change of health occurs, long-term care insurance may not be available. Early onset (before age 65) Alzheimer's and Parkinson's disease are rare but do occur.
Benefits of LTC
Long-term care insurance generally covers home care, assisted living, adult daycare respite care, hospice care nursing home and Alzheimer's facilities. If home care coverage is purchased, long-term care insurance can pay for home care, often from the first day it is needed. It will pay for a visiting or live-in caregiver, companion, housekeeper, therapist or private duty nurse up to 7 days a week, 24 hours a day (up to the policy benefit maximum). Other benefits of long-term care insurance:
- Many individuals may feel uncomfortable relying on their children or family members for support, and find that long-term care insurance could help cover out-of-pocket expenses. Without long-term care insurance, the cost of providing these services may quickly deplete the savings of the individual and/or their family.
- Premiums paid on a long-term care insurance product may be eligible for an income tax deduction. The amount of the deduction depends on the age of the covered person. Benefits paid from a long-term care contract are generally excluded from income.
- Business deductions of premiums are determined by the type of business. Generally corporations paying premiums for an employee are 100% deductible if not included in employee's taxable income
- “Long term care insurance allows the family to supervise the care of a loved one, not manage the care of a loved one.”
Health insurance. A health insurance policy is a contract between an insurance company and an individual or his sponsor (e.g. an employer). The contract can be renewable annually or monthly. The type and amount of health care costs that will be covered by the health insurance company are specified in advance, in the member contract or "Evidence of Coverage" booklet.
In the U.S. health insurance pools may be managed by for-profit companies. It is sometimes used more broadly to include insurance covering disability or long term nursing or custodial care needs. It may be provided through a government-sponsored social insurance program, or from private insurance companies. It may be purchased on a group basis (e.g., by a firm to cover its employees) or purchased by an individual. In each case, the covered groups or individuals pay a fee, premium, or tax---to help protect themselves from unexpected healthcare expenses. Similar benefits paying for medical expenses may also be provided through social welfare programs funded by the government.
By estimating the overall risk of healthcare expenses, a routine finance structure (such as a monthly premium or annual tax) can be developed, ensuring that money is available to pay for the healthcare benefits specified in the insurance agreement. The benefit is administered by a central organization such as a government agency, private business, or not-for-profit entity
How it works
- Premium: The amount the policy-holder or his sponsor (e.g. an employer) pays to the health plan each month to purchase health coverage.
- Deductible: The amount that the insured must pay out-of-pocket before the health insurer pays its share. For example, a policy-holder might have to pay a $500 deductible per year, before any of their health care is covered by the health insurer. It may take several doctor's visits or prescription refills before the insured person reaches the deductible and the insurance company starts to pay for care.
- Co-payment: The amount that the insured person must pay out of pocket before the health insurer pays for a particular visit or service. For example, an insured person might pay a $10 to $45 co-payment for a doctor's visit, or to obtain a prescription. A co-payment must be paid each time a particular service is obtained.
- Coinsurance: Instead of, or in addition to, paying a fixed amount up front (a co-payment), the co-insurance is a percentage of the total cost that insured person may also pay. For example, the member might have to pay 20% of the cost of a surgery over and above a co-payment, while the insurance company pays the other 80%. If there is an upper limit on coinsurance, the policy-holder could end up owing very little, or a great deal, depending on the actual costs of the services they obtain.
- Exclusions: Not all services are covered. The insured person is generally expected to pay the full cost of non-covered services out of their own pocket.
- Coverage limits: Some health insurance policies only pay for health care up to a certain dollar amount. The insured person may be expected to pay any charges in excess of the health plan's maximum payment for a specific service. In addition, some insurance company schemes have annual or lifetime coverage maximums. In these cases, the health plan will stop payment when they reach the benefit maximum, and the policy-holder must pay all remaining costs.
- Out-of-pocket maximums: Similar to coverage limits, except that in this case, the insured person's payment obligation ends when they reach the out-of-pocket maximum, and the health company pays all further covered costs. Out-of-pocket maximums can be limited to a specific benefit category (such as prescription drugs) or can apply to all coverage provided during a specific benefit year.
- In-Network Provider: (U.S. term) A health care provider on a list of providers pre-selected by the insurer. The insurer will offer discounted coinsurance or co-payments, or additional benefits, to a plan member to see an in-network provider. Generally, providers in network are providers who have a contract with the insurer to accept rates further discounted from the "usual and customary" charges the insurer pays to out-of-network providers.
- Explanation of Benefits: A document sent by an insurer to a patient explaining what was covered for a medical service, and how they arrived at the payment amount and patient responsibility amount.
Prescription drug plans are a form of insurance offered through some employer benefit plans in the U.S., where the patient pays a co-payment and the prescription drug insurance part or all of the balance for drugs covered in the Formulary of the plan.
Critical illness insurance is an insurance product wherein the insurer is contracted to typically make a lump sum cash payment if the policy owner is diagnosed with one of the critical illnesses listed in the insurance policy.
The policy may also be structured to pay out regular income and the payout may also be on the policy owner undergoing a surgical procedure, for example, having a heart bypass operation.
The policy may require the policy owner to survive a minimum number of days (the survival period) from when the illness was first diagnosed. The survival period used varies from company to company, however, 28 days and 30 days are the most common survival periods used.
The contract terms contain specific rules that define when a diagnosis of a critical illness is considered valid. It may state that the diagnosis need be made by a physician who specializes in that illness or condition, or it may name specific tests, e.g. EKG changes of a myocardial infarction, that confirm the diagnosis.
In some markets, however, the definition of a claim for many of the diseases and conditions have become standardized, thus all insurers would use the same claims definition. The standardization of the claims definitions may serve many purposes including increased clarity of cover for policy owners and greater comparability of policies.
Disability Insurance, often called DI or disability income insurance, is a form of insurance that insures the replacement of the beneficiary's earned income to a limit not to exceed 66 2/3 % against the risk that disability will make working (and therefore earning) impossible. It includes paid sick leave, short-term disability benefits, and long-term disability benefits. Statistics show in the US a disabling accident occurs every second.
Estate planning is the process of anticipating and arranging for the disposal of an estate. Estate planning typically attempts to eliminate uncertainties over the administration of a probate and maximize the value of the estate by reducing taxes and other expenses. Guardians are often designated for minor children and beneficiaries in incapacity.
Estate planning devices
Estate planning involves the will, trusts, Beneficiary designations, powers of appointment, property ownership (joint tenancy with rights of survivorship, tenancy in common, tenancy by the entirety), gift, and powers of attorney, specifically the durable financial power of attorney and the durable medical power of attorney. After widespread litigation and media coverage surrounding the Terri Schiavo case, virtually all estate planning attorneys now advise clients to also create a living will. Specific final arrangements, such as whether to be buried or cremated, are also often part of the documents.
Many people confuse a living will with a durable medical power of attorney. A living will sets out directives concerning end of life decisions, whereas a durable power of attorney gives all medical decision making authority to an appointed individual upon incapacity, including end of life decisions. Some people have both a living will and a health care power of attorney. Some, who wish to give complete discretion to a loved one, including end of life decision, have only a health care power of attorney.
A will or testament is a legal declaration by which a person, the testator, names one or more persons to manage his/her estate and provides for the transfer of his/her property at death. A will also is used to name a guardian for minor children.
In the strictest sense, a "will" has historically been limited to real property while "testament" applies only to dispositions of personal property (thus giving rise to the popular title of the document as "Last Will and Testament"), though this distinction is seldom observed today. A will may also create a testamentary trust that is effective only after the death of the testator.
The law of trusts and estates is generally considered the body of law which governs the management of personal affairs and the disposition of property of an individual in anticipation of the event of such person's incapacity or death, also known as the law of successions in civil law. Its techniques are also used to fulfill the wishes of philanthropic bequests or gifts through the creation, maintenance and supervision of charitable trusts.
In some jurisdictions, such as the United States, it can overlap with the area that has come to be known as elder law that deals not only with estate planning but other issues that face the elderly, such as home care, long term care insurance or social security or disability benefits. There may also be overlap with areas of the law touching on End-of-life issues, not solely for the elderly, but also persons with terminal conditions.
At common law, an estate consisted of the tangible assets of real and personal property which belong to a natural person. More recently, the concept of an estate has been expanded to encompass any thing of value to which the deceased person was or might have been entitled to claim during his or her lifetime. The property of the estate must either be bequeathed through a will or transferred through the laws of intestacy if there is no will. A will is the most commonly used legal instrument for the distribution of the property of a deceased person. Before property can be disposed of pursuant to the terms of a will, the will must be submitted to a probate court having jurisdiction of the estate of the deceased. Probate is often considered a relatively lengthy and expensive process, albeit one which may provide greater safeguards with regard to the rights of a deceased person's beneficiaries, though probate often is contested by creditors or disgruntled members of the family of the deceased who feel they have not received their fair share of the deceased's property.
Uses of trusts
In order to expedite the process of transferring assets to intended beneficiaries, some people choose to arrange their property so that it can bypass the probate process upon their deaths. For example, placing property into a trust before death (as opposed to a testamentary trust) will often allow the accomplishment of the objectives of property distribution without coming under the jurisdiction of a court and the possible redistribution after a lengthy contested probate process and trial. Similarly, jointly held property (in common law systems), life insurance, annuities, 401(k) Retirement Plans or Individual will also avoid probate as these devices allow property to transfer to beneficiaries outside the probate process.
Special needs trusts are created to ensure that beneficiaries who are developmentally disabled or mentally ill can receive inheritances without losing access to essential government benefits. Use of estates and trusts
Another major factor in trusts and estates law may be to minimize one's tax exposure. After an applicable exempt amount, the United States federal estate tax very quickly approaches 55% of one's taxable estate. The proper use of trusts may reduce one's tax burden. The applicable exempt amount is currently three and one half million dollars in 2009, after which the estate tax is temporarily repealed for one year in 2010. The year after, 2011, the estate tax is scheduled to be reinstated, with the previous exemption of, thought to be, one million dollars.