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Life Insurance Market Conditions and Products - Part 1
In this section we elaborate on the following:
Term life insurance
Whole life insurance
Universal life insurance
Current assumption whole life insurance
The life insurance industry is one of the largest industries in the world.
Premiums for life, health, and annuity grew by 5.7 percent from $583.6 billion in 2006 to $616.7 billion in 2007 in the United States. This unit concentrates on the life products sold to individuals.
The trend is toward lower life insurance rates for all types of life insurance products. Improvements in mortality rates have accounted for lower expected rates.
The life/health industry’s condition deteriorated during the economic recession beginning in December 2007. These problems are detailed in Case Study 07 - “The Life/Health Industry in the Economic Recession of 2008-2009.”
Case Study 07- The Life/Health Industry in the Economic Recession of 2008-2009.”
Please download and study the case study entitled “The Life/Health Industry in the Economic Recession of 2008-2009”, from the module resources section for this module.
The case study discusses the deterioration of the life/health industry’s condition deteriorated during the economic recession beginning in December 2007.
Term Insurance – Duration
Term life insurance provides protection for a specified period, called the policy’s term (or duration).
When a company issues a one-year term life policy, it promises to pay the face amount of the policy in the event of death during that year.
Short-term life insurance policies involve no investment element. Long-term contracts (e.g., term to age sixty-five), when accompanied by a level premium, can accumulate a small cash value element in the early years, but this is depleted during the latter part of the term because then the cost of mortality exceeds the sum of the level premium and the investment earnings.
Two options are typically available with term insurance sold directly to individuals: renewability and convertibility.
The length of term policies varies; common terms are one, five, ten, fifteen, and twenty years. Term policies are often not renewable beyond age sixty-five or seventy because of adverse selection that increases with age.
Increasingly, however, yearly renewable term policies are renewable to age ninety-five or one hundred, although it would be unusual for a policy to stay in effect at advanced ages because of the amount of the premium. Yearly renewable term policies are subject to high lapse rates (that is, failure to be renewed) and low profitability for the insurer.
Term Insurance – Renewability
If the policyholder wishes to continue the protection for more than one term, the insurer will require a new application and new evidence of insurability.
Each time the policy is renewed, the premium increases because of the insured’s increasing age. Because the least healthy tend to renew and the most healthy tend to discontinue, the renewable feature increases the cost of protection. The renewable feature, however, is valuable in term life insurance.
The risk of being turned down may be handled by purchasing renewable term insurance. The renewability option gives the policyholder the right to renew the life insurance policy for a specified number of additional periods of protection, at a predetermined schedule of premium rates, without new evidence of insurability.
Renewability protects insurability for the period specified. After that period has elapsed, the insured must again submit a new application and prove insurability.
Term Insurance – Convertibility
A term life policy with a convertibility option provides the right to convert the term policy to a whole life or another type of insurance, before a specified time, without proving insurability.
Most life insurance conversions are made at attained age premium rates, meaning that the premium for the new policy is based on the age at the time of the conversion.
The insured or policyowner pays the same rate as anyone else who can qualify for standard rates based on good health and other insurability factors. The option results in no questions about your insurability.
If, for example, at age twenty-eight you buy a term policy renewable to age sixty-five and convertible for twenty years, you may renew each year for several years and then, perhaps at age thirty-six, decide you prefer cash value life insurance.
Your motivation may be that the premium, though higher than that of the term policy at the age of conversion, will remain the same year after year; the policy can be kept in force indefinitely; or you may want to include cash values among your investments. If you become uninsurable or insurable only at higher-than-standard (called substandard) rates, you will find the convertibility feature very valuable.
Term Insurance – Death Benefit Pattern
The death benefit in a term policy remains level, decreases, or increases over time. Each pattern of protection fits specific needs.
Mortgage protection insurance is decreasing term insurance; with each mortgage payment, the face value of the insurance decreases to correspond to the amount of the loan that is outstanding. Otherwise, mortgage protection is like other decreasing term policies.
Credit life insurance is similar to mortgage protection. In credit life insurance, the death benefit changes, up or down, as the balance changes on an installment loan or other type of consumer loan.
For example, a decreasing term policy may be used as collateral for a loan
on which the principal is being reduced by periodic payments. An increasing amount of protection helps maintain purchasing power during inflation. The increasing benefit is likely to be sold as a rider to a level benefit policy.
Term Insurance – Premium Patterns
An insurer’s rates for nonsmokers may be 40 percent or so lower than those for smokers. Rates for women are less than for men. The yearly renewable term contract usually has a table of premiums that increase each year as the insured ages and as time elapses since insurability was established.
Reentry term allows the insured to demonstrate insurability periodically, perhaps every five years, and qualify for a new (lower) select category of rates that are not initially loaded for adverse selection. If the insured cannot qualify for the new rates, usually because of worsening health, he or she can either pay the higher rates of the initial premium table (ultimate rates) or drop the policy and try to find better rates with another insurer.
Summary - Features of Term Life
In summary, in term life we see the following features:
Death benefits: level or decreasing
Cash value: none
Premiums: increase at each renewal
Policy loans: not allowed
Partial withdrawals: not allowed
Surrender charges: none
Whole Life Insurance
Whole life insurance, as its name suggests, provides for payment of the face value upon death regardless of when the death may occur.
As long as the premiums are paid, the policy stays in force. Thus, whole life insurance is also referred to as permanent insurance. This ability to maintain the policy throughout one’s life, instead of a specific term, is the key characteristic of whole life insurance.
There are three traditional types of whole life insurance. The differences among them is in the arrangements for premium payment.
Ordinary or straight life
Whole Life insurance - Straight Life
The premiums for a straight life policy are paid in equal periodic amounts over the life of the insured.
The level premium policy consists of a protection element and a cash value element. The cash value builds over time, and eventually, when the insured is ninety or one hundred, the cash value will equal the face value of the policy. If the insured is still alive at this advanced age, the insurer will pay the death benefit as if death occurred. By this time, no real insurance element exists.
A basic straight life policy typically has a face amount (death benefit) that remains level over the lifetime. The pattern can change, however, by using dividends to buy additional amounts of insurance or by purchasing a cost-of-living adjustment rider.
The rate is based on the assumption that the insured will live to an advanced age (such as age ninety or 100).
In effect, the insured is buying the policy on an installment basis and the installments are spread over the balance of the lifetime, as explained earlier in our discussion of the level premium concept. This provides the lowest possible level outlay for permanent protection.
Whole Life insurance - Limited-Payment Life
Like straight life, limited-payment life offers lifetime protection but limits premium payments to a specified period of years or to a specified age.
After premiums have been paid during the specified period, the policy remains in force for the balance of the insured’s life without further premium payment. The policy is “paid up.” A twenty-pay life insurance policy becomes paid up after premiums have been paid for twenty years, a life-paid-up-at-sixty-five becomes paid up at age sixty-five, and so on.
The shorter premium payment period appeals to some buyers.
For example, a life-paid-up- at-sixty-five policy ends premiums around the time many people expect to begin living on retirement pay. If the insured dies before the end of the premium-paying period, premium payments stop and the face amount is paid. These policies are mainly sold as business insurance where there is a need to pay fully for a policy by a certain date, such as the time an employee will retire.
Whole Life insurance - Single-Premium Life
Whole life insurance may be bought for a single premium-the ultimate in limited payment.
Mathematically, the single premium is the present value of future benefits, with discounts both for investment earnings and mortality. Cash and loan values are high compared with policies bought on the installment plan, see Figure 19.4, (see Figure 19.4 "Protection and Cash Value Elements for Single-Premium and Installment Forms of Cash Value Life Insurance").
Single-premium life insurance is bought almost exclusively for its investment features; protection is viewed as a secondary benefit of the transaction.
Whole Life insurance - Investment Aspects
The typical buyer of life insurance, however, does not expect to pay income taxes on proceeds from his or her policy. Instead, the expectation is for the policy to mature eventually as a death claim.
Death claims are exempt from income taxes. In practice, most policies terminate by being lapsed or surrendered prior to death as needs for life insurance change.
Life insurers offer participation in portfolios of moderate-yield investments, such as high-grade industrial bonds, mortgages, real estate, and common stock, in which cash values are invested with potentially no income tax on the realized investment returns.
Part of each premium, for all types of cash value life insurance, is used to make payments on the protection element of the contract, but the protection element also has an expected return.
This return is equal to the probability of death multiplied by the amount of protection. Thus, the need to pay for protection in order to gain access to the cash value element of a single-premium or other investment-oriented plan should not be viewed as a consumer disadvantage if there is a need for additional life insurance protection.
The participation (dividend) feature of a policy has a major effect on its cost and worth.
Whole Life insurance - Participation Feature
Mutual life insurers have always sold their term and cash value life products on a participation basis. Stock life companies have also made limited use of participating policies.
Participating whole life contracts pay dividends for the purpose of refunding higher-than-necessary premiums and sharing company profits with policyowners. Thus, as investment returns escalate above previous expectations, or as mortality rates decline, the policyowners share in the success of the insurer.
Participating whole life insurance continues to be a major product line for mutual insurers. Sales illustrations are used by agents in presenting the product to the consumer.
Dividends allow the sharing of current profits from investments, mortality assumptions, expense estimates, and lapse experience with the policyholder. Investment returns usually have more influence on the size of dividends than do the other factors.
The fact that insurer investment portfolios tend to have many medium- and long-term bonds and mortgages that do not turn over quickly creates a substantial lag, however, between the insurer’s realization of higher yields on new investments and the effect of those higher yields on average portfolio returns that affect dividends.
Summary: Features of Whole Life
In summary, in whole life we see the following features:
Death benefits: fixed level
Cash value: guaranteed amounts
Premiums: fixed level
Policy loans: allowed
Partial withdrawals: not allowed
Surrender charges: none
END of Part 1 of UNIT
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