Basic Facts about Life Insurance

A. ECONOMIC VALUE OF A MAN’S LIFE

As we grow older and start to work, we become aware of the importance of income. We know that most men work because they have to earn an income for their families. Money is an essential element in satisfying our basic needs such as food, shelter, clothing, education, and medical care.

Clearly, the life of a man has an economic value, to his family and dependents, which is represented by the support he gives them. While a man is strong and healthy, while he is working and earning an income, he and his family continue to enjoy the necessities and comforts of life. As long as this man can keep working and has this earning power and income, his family’s daily needs are provided for.

  1. Hazards of Life: Threats to the continuity of income
    1. Premature Death

      A death is considered premature when a person dies before he can fully actualize his earning power. For example, if a husband who expects to work until age 65 dies at age of 32, the income he would have earned for 33 years would be denied of his family. The effect of death to one’s family is a total and complete loss of his income.

    2. Disability

      When a person becomes totally disabled, he cannot engage in the material or substantial duties of his or her occupation or profession. He can also be partially disabled when, by reason of sickness or accident, he cannot perform one or more of the important daily duties of his or her occupation. In either instance, a person loses his efficiency to fully carry out his duties. This subsequently affects one’s flow of income by diminishing or stopping it entirely.

    3. Old age

      This is the time when an individual ceases to be economically productive due to a decline or loss of mental and bodily vigor.

      These three threats to the continuity of income can prevent the family from enjoying the basic necessities of life. An alternate source of income must be ready to replace income lost due to premature death, disability, or old age.

  2. The common solutions to provide a future source of income

    The method of saving and investment to provide a future source of income is the program entered into by the more enterprising among us. Roughly, this is done by regularly setting aside some amount from one’s salary or income and investing it in a savings account or a small business, or in stocks or money lending ventures. The person who succeeds in these ventures can, after a considerable time, accumulate funds as a replacement for his current source of income whatever happens in the future.

    There is no guarantee that an individual will live long enough to have that adequate time to accumulate the amount desired. A person may adhere to his savings plan diligently, he can turn out very skillful as an investor, yet when death suddenly claims him, his dependents will immediately be deprived of the future savings he has envisioned for them.

  3. Life Insurance : The Guaranteed Solution

    Life insurance offers people the most efficient and economical method of achieving financial security. Except in life insurance, all other savings and investment plans require time for completion.

    Life insurance or life assurance is a contract between a policy owner and an insurer, where the insurer agrees to pay an insured’s designated beneficiary a benefit upon the occurrence of the insured individual’s death or other event, covered by the policy such as terminal or critical illness occurs. In return, the policy owner agrees to pay a stipulated amount called premium, at regular intervals or in lump sums.

B. THREE GREAT SERVICES OF LIFE INSURANCE

  1. Family Protection

    Life insurance solves the problems that would arise out a man’s early death by providing a definite sum of money to replace his lost income for the benefit of his family.

    The family is then protected from the financial difficulties immediately following the breadwinner’s premature death.

  2. Savings

    Through the help of life insurance, one is able to regularly set aside an amount for the premium which accumulates through the years to build up a fund guaranteed to be completed whether the insured lives or dies. It gives him a secure and profitable method of accumulating funds for illness, injuries or emergencies.

  3. Retirement Income

    Life insurance solves a man’s financial problems that come with old age by enabling him to create a guaranteed source of fund when he grows old.

C. BUSINESS USES OF LIFE INSURANCE

  1. Keyman Insurance.

    Its purpose is to indemnify a business firm from the loss of earnings brought about by the death or disability of a key officer, or employee.

    Life insurance stablilizes the financial position of a firm over the period necessary to secure the services of a person to take the place of a key person. By assuring that the business has a financial cushion in the event of death or disability of key persons, the credit of the business is enhanced.

  2. Life insurance may also be pledged as a collateral.

    The cash value ( savings element ) of a permanent policy may be pledged as a collateral for a loan by assigning the policy to the lender.

  3. Business Continuation.

    In a partnership and closed corporation, the problems of business stability and continuation are important to the deceased’s family, and to surviving owners and employees. The partnership form of business is based on the fiduciary relationship between individuals. Thus any change in the membership of the partnership causes its dissolution. Upon the death of the general partner, the partnership is dissolved. The surviving partners are charged with the task of winding up the business and determining the fair share of the deceased’s family. To avoid the problems of liquidating the business and determining the fair share of the deceased’s family, a buy-and-sell agreement financed by life insurance must be drawn up. Under this agreement, the surviving partners are obligated to buy the interest of the partner at a pre-arranged price. This in turn will enable them to reorganize and continue the operation of the business. The life insurance in this is in the lives of the partners, at an amount equal to their interest in the partnership. A similar situation works in the case of a closed corporation.

  4. Mortgage Redemption

    In most instances, the head of the family will acquire a home mortgage loan usually payable in 20 years through amortization or payment of equal monthly installments.
    However, the death of the head of the family may put his widow and other members of the family in an unfortunate situation. Without the needed cash to pay for its amortization, the family is running into the possibility of their home being foreclosed by the lending institution and the family being rendered homeless. Life insurance can be provided to cancel an existing mortgage.

  5. Protection Against Forced Liquidation of Property : Estate conservation

    The proceeds of life insurance will often serve to effect prompt settlement of bills outstanding at the time of death

    Among those claims against the estate, the tax items usually constitute the most serious, particularly in most estates.

    Life insurance serves as the ideal medium which provides liquidity for the estate since the event which produces the need for cash, death, automatically produces the fund. Utilizing life insurance to provide cash for the prompt payment of taxes avoids the necessity of selling a portion of the estate.

  6. Estate Creation

    One of the most significant features of life insurance is immediate estate creation. The full amount of the death estate is always created immediately , that is, (assuming the insured is 30years old by less and healthy ) at the moment the life insurance policy is issued to the policyowner. By way of illustration A death estate of Ps. 1,000,000.00 or more can be created by paying about Ps. 10,000.00 as the first premium. Once created, the death estate is kept in force by the timely payment of future premiums.

D. CLASSIFICATIONS OF LIFE INSURANCE POLICIES

A life insurance policy is designed to meet the specific need(s) of an individual and his family.

Life insurance policies fall under four general classifications:

  1. According to Nature (i.e., policies are differentiated based on the nature of benefits offered. )
    1. Temporary Policies – These policies offer only protection or death benefit over a limited period of time.
    2. Permanent Policies – theses policies offer death and living benefits within the insured’s lifetime. Living benefits may be in the form of dividends, anticipated endowments, universal life policies, and cash values.
  2. According to Coverage – policies are differentiated based on the number of persons enjoying protection under a specific policy.
    1. Individual Policies – A policy which provides insurance protection to one person only
    2. Joint Life – A policy which covers the lives of two or more persons.
      Under this policy the first death which occurs among the lives covered effectively terminates the policy.
    3. Group – a life insurance policy which covers the life of a group of people.
  3. According to Participation in Divisible surplus ( i.e., policies are differentiated based on whether or not such are entitled to receive dividends. )
    1. Participating – a policy which entitles policyowners to receive dividends.
      Dividends are sourced from the surplus earnings of the insurance company which the board of directors could decide to share with policy owners with participating policies.
    2. Non-participating – does not share in the dividends
  4. According to Line of Business ( i.e., policies are differentiated based on the market segments to which a policy caters. )
    1. Ordinary – A policy which caters to the middle and upper income-earners.
      Premiums of this policy are payable on an annual, semi-annual, or quarterly basis.
    2. Industrial – a policy which caters to low income-earners. Premiums of this policy are payable on a monthly, weekly, or daily basis.
    3. Group – A policy which caters to the insurance needs of employee groups, unions, and the like, the premiums of which are generally deducted from the salaries of employees

E. MAJOR TYPES OF LIFE INSURANCE POLICIES

Basically, there are three types of life insurance policies:

  • term,
  • whole life
  • endowment

All three have the same function to create a principal sum or estate.

F. TERM INSURANCE

A term policy is one that pays the face amount only in the event of death within a stated number of years.

Uses of Term Insurance

Term insurance is designed for use in situations where a person needs maximum protection at the lowest premium outlay, particularly where the need is temporary. Term can properly be used to cover permanent needs, but only if the insured understands that is to be done on a temporary basis.

  1. To cover debts, loans, mortgages that will be repaid within a limited period of time.
  2. To provide protection for dependents of a young husband or wife who can’t afford the necessary amount of whole life insurance
  3. To furnish protection and at the same time, insure the insurability of a young person on the way up or whose new business undertaking requires all available capital.

G. WHOLE LIFE INSURANCE

  1. In contrast with term insurance, whole life will pay the face value whenever death occurs. It gives the most permanent coverage over the insured’s entire lifetime for the least amount of premium.
  2. Kinds of Whole Life Insurance

    From the standpoint of premium payment characteristics, there are two kinds of whole life:

    (1) ordinary or straight life;
    (2) limited payment life

H. ORDINARY LIFE

  1. Premiums are payable for life
  2. Most flexible type of life insurance, can most easily be adapted to changes in the insured’s financial situation or family responsibilities
  3. Offers the most permanent protection
  4. Preferred choice if the need for family protection outweighs the need for higher cash values or the need for a fully paid-up policy at an early date.

I. LIMITED PAYMENT LIFE

  1. Premiums payable for a specified number of years only
  2. After the premium – paying period, the policy becomes paid up for its full face amount. However, it does not mature for the face amount until age 100
  3. Suited for situations where the insured
    • desires to pay premium during his productive years despite the premiums being higher than ordinary life
    • when an individual’s remaining best years are expected to be few ( for example; middle-aged persons, professional athletes, entertainers )
    • for juvenile insurance situations where a parent wants to start a child’s policy that will be paid up at an early age

J. ENDOWMENT INSURANCE

  1. Whereas term and whole life are primarily designed to be payable on death, endowment policies are designed to provide funds for the insured at the end of a specified period.
  2. An endowment policy is written for a definite number of years ( not for life ) and guarantees to pay the face amount:
    1. to the insured if he survives past the maturity date and,
    2. to the beneficiary if the insured dies before reaching the maturity date.
  3. Kinds of Endowment Insurance

    Endowment plans are written in two ways:

    1. to mature within a stated number of years, such as 10,20,30, etc., or
    2. to mature at a stated age, such as 60,65,70,etc.
  4. Typical Uses for Endowment Insurance
    1. Long range semicompulsory savings-investment plan

      It is difficult for many people, even those with good incomes, to accumulate a substantial amount of money over a long period. They lack the will power and good judgment required for success in saving money.

    2. Accumulate money for a specific purpose

      The endowment contract is a convenient way to amass funds for definite objectives, such as a child’s education, gifts to individuals, colleges, churches, hospitals, charities, or for retirement, travel t\etc. The death benefit eliminates the financial hazard that the insured may die before he necessary amount has been accumulated

    3. Self-completing savings plan

      The endowment policy’s death benefit makes it an ideal hedge against the possibility that the savings period may be disrupted by the saver’s premature death. And when a disability waiver of premium benefit is added to an endowment, the plan also becomes self-completing in the event of the insured’s permanent disability.

K. GROUP LIFE INSURANCE

Group Life insurance – insurance on the lives of a number of persons, insured as a group under one master policy. Instead of individual policies, the members of the group receive certificates, which describe the essential details of their coverage. The largest amount of group life insurance is in force on employee groups, but a great deal is also issued to corporate creditors such as banks, and finance companies, to ensure the lives of their debtors.

L. VARIABLE UNIVERSAL LIFE INSURANCE

  1. A type of life insurance wherein the cash value built up can be invested in a wide variety of separate accounts, the choice of which to use is entirely up to the contract owner.
  2. The ‘variable’ component in the name refers to this ability to invest in separate accounts whose values vary—they vary because they are invested in stock and/or bond markets.
  3. The ‘universal’ component in the name refers to the flexibility the owner has in making premium payments. This flexibility is in contrast to whole life insurance that has fixed premium payments that typically cannot be missed without lapsing the policy.
  4. Variable universal life is a type of permanent life insurance, because the death benefit will be paid if the insured dies any time as long as there is sufficient cash value to pay the costs of insurance in the policy.
  5. With most if not all VULs, unlike whole life, there is no maturity age (which for whole life is typically 100). This is yet another key advantage of VUL over Whole Life. With a typical whole life policy, the death benefit is limited to the face amount specified in the policy, and at maturity age, the face amount is all that is paid out. Thus with either death or maturity, life insurance company keeps any cash value built up over the years. With a VUL policy, the death benefit is the face amount plus the build up of any cash value that occurs (beyond any amount being used to fund the current cost of insurance.)

References:

  • Training Manuals of a number of Life insurance companies
  • Wikipedia
  • Business World of June 21, 2005