Life Insurance Tutorial

Why is life insurance so important?

Life insurance ensures that, when you die, your beneficiaries will have the financial resources in place to protect their future income and pay for immediate and future financial obligations. Life insurance proceeds are paid quickly to the beneficiary(ies) without the delay of probate and are income tax-free. Without life insurance, your surviving family members could become financially burdened or even devastated at the time of your death. Survivors could possibly lose the house, children may not be able to attend college, a family business could be lost, monthly family bills could go unpaid, the family could be forced to increase their debt burden to pay for things like last illness expenses and burial costs, or any number of other possible issues.

Do you need life insurance?

If your financial obligations at death exceed the assets which will be in place to meet those financial obligations, you need life insurance. With life insurance in place, the family’s standard of living is protected and gives them critical support during a very trying time.

How much life insurance do you need?

Various methods can be used to calculate an individual’s need for life insurance. These methods include: Rules of Thumb (e.g., 10 times your annual salary); The Human Life Value (i.e., present value of the family’s share of the wage earner’s future income); Capital Retention (i.e., preserve assets and have the beneficiary’s income needs supported by income from assets); and The Needs Approach (i.e., considers assets and income at death to pay the for the remaining financial obligations). The needs approach is the most comprehensive in calculating the amount of life insurance needed. It subtracts the total assets from the total financial obligations to determine the amount of life insurance required. A “Life Insurance Needs Analysis” calculator is available to help you assess your needs. Below is a list of some of the financial obligations and assets that should be considered in your insurance needs calculation:

Financial Obligations

Future income for beneficiary(ies)	Child(ren)’s educational expenses
Outstanding debts (e.g., credit cards)	Funeral and Burial expenses
Estate taxes and administrative expenses	Mortgage payment
Business expenses	Last illness expenses

Assets

Investments (stocks, bonds, etc.)	Bank accounts (savings, CD’s)
Current life insurance plans	Annuities with survivor rights
Retirement Funds (IRA, 401(k), Pension, etc.)	Real Estate
Employer’s Survivor Benefit Plan	Social Security

Financial Obligations - Assets = Needed Insurance

What types of life insurance are available for members of the Sea Services (Navy, Marines, Coast Guard, PHS and NOAA)?

There are two basic classifications of life insurance, Term and Permanent.

Term insurance - Provides death benefit coverage for a specified period of time with a premium that is initially low relative to permanent insurance premiums. Premiums are initially low because most contracts do not cover individuals through old age, when death is most likely to occur. The premium is based on the type of term plan you elect, the amount of coverage, risk status (smokers and people in poor health or with dangerous lifestyles pay higher premiums), your current age and the age to which coverage is desired. Term insurance policies which provide a death benefit at older ages will have substantially higher premiums. The death benefit can be level or decreasing. Term insurance does not have cash value. If you terminate a term life insurance policy, none of the money paid in premiums is recoverable, with few exceptions. (More information about Term insurance options )

Permanent insurance - Provides insurance for the insured’s entire life, not just for a limited period, while also providing a savings element known as the plan’s cash value. The cash value is available to the policy owner by taking a loan against the cash value, making a partial withdrawal, or terminating the policy. Premiums for permanent coverage will be higher than term insurance because there is not just a chance that the death benefit will be paid out, but it is sure to be paid out.

The premium is based on the type of permanent plan you elect, the amount of coverage, your current age, risk status (smokers and people in poor health or with dangerous lifestyles pay higher premiums) and the number of years that you wish to take to pay off the plan. You may elect to pay up the plan with a single payment, or over a period of time such as seven or ten or twenty years, or you may elect to make payments for life. Permanent plans can have either level or increasing death benefits. (More information about permanent insurance policies)

A brief explanation of a few types of term and permanent insurance plans are provided along with a graphic illustration of each.

Term Insurance Types

Decreasing Term - Provides a death benefit which systematically decreases after a period of time (e.g., 1, 5, 10 yrs) until either the plan is terminated as a result of completing the term or the coverage becomes level at a very low value for the remainder of the insured’s life. Premiums for this policy are generally low and will remain level as the death benefit decreases. (More about Decreasing Term Insurance Policies)
Level Term - The death benefit and the premium will both remain level until the end of a specified term at which point the policy will be terminated. The premiums for these policies are generally more expensive than decreasing term due to the level death benefit. (More about Level Term Insurance Policies)
Renewable Term - This death benefit will remain level while the premium systematically increases after a period of time (1, 5, 10 yrs). In the later years of the policy, the premiums continue to increase and can become cost prohibitive. Renewing your coverage after each term period is guaranteed and does not require additional evidence of medical insurability.

Permanent Life Insurance Types

Whole Life (or Ordinary Life) - Whole Life is the traditional form of permanent life insurance which provides a guaranteed level death benefit for a fixed premium paid throughout the insured’s life (defined as either age 95 or age 100). This plan will have a guaranteed schedule of future cash values and allowable loan amounts.
Interest Sensitive Whole Life - Interest Sensitive Whole Life provides a guaranteed death benefit for a fixed premium which is calculated based on the number of years that you wish to take to pay off the plan (e.g., 7 years, 20 years, etc.). The growth of the plan’s cash value is determined by the company’s crediting rate (interest rate) and cost of insurance charges. As the plan’s cash value grows in the future, the death benefit may also begin to increase. (More about interest-sensitive Whole Life policies)
Universal Life (or Flexible Premium Life) -Universal Life insurance, also known as Flexible Life, has an adjustable death benefit and flexible premiums. The owner can choose between a level death benefit (option A) or an increasing death benefit (option B). Recommended premiums at the inception of the policy are calculated using anticipated investment performance and expenses. If the plan performs as favorably as or more favorably than anticipated, the premium payments will be sufficient to keep the policy in force. However, if performance is less than anticipated, additional premium payments may be required. A policy may make additional premium payments, within guidelines, to increase the savings portion of the policy, or skip a premium at any time. If the premium paid is not large enough, or too many are skipped, the policy could lapse and coverage would end. The amount of insurance can be decreased at any time, and in some cases increased (with evidence of insurability) without having to purchase an additional policy.
Variable Life - Variable Life provides no guarantees of either interest rate or minimum cash value. The death benefit and cash surrender value will vary depending on the investment performance of the plan. A unique feature of this plan is that the owner has the ability to choose among several investments from which to invest the premiums. The investments to choose from will range from high risk to low risk. The important thing to know is that the owner assumes all the investment risk and consequently can benefit directly from favorable results or bear the loss of unfavorable investment performance. Theoretically, if poor investment performance and/or high cost of insurance charges lower the cash value to $0, your policy will be terminated. To inform you of the nature of your prospective investment, a prospectus will be offered for each investment that you may be considering.

What type of life insurance is right for you?

Determining the appropriate type of insurance involves several factors including: the type of need you are protecting, the amount of time you will need the coverage, the amount of money you can afford for premiums, etc.. Conventional wisdom indicates that there are two times when term insurance coverage is appropriate: people with a temporary insurance need for a specific period of time or people who need permanent protection, but who temporarily cannot afford the premiums for permanent insurance.

In the latter case, the insured would maintain a term plan until such a time that his/her financial cash flow would permit a permanent insurance plan to be purchased. With that in mind there are two important features of term insurance that need to be understood and looked for when buying term insurance: Renewability and Convertibility. A renewable policy can be renewed (extended) without proof of insurability. The renewable premium will be higher and based on the renewal age. This is important if the period for your temporary need gets extended.

A convertible policy can be converted to permanent insurance without proof of insurability. This is important for those people who want permanent insurance, but temporarily cannot afford it. There may be an extra premium charged for these two features. Permanent plans are used to cover those expenses that will remain throughout the insured’s lifetime or for an indefinite duration, while providing a saving account that can be used for emergency cash or to supply future income.

Below is a graphic illustration showing some of the needs for insurance and their possible durations (indicated by the length of the line). Various needs for coverage will arise during a person’s lifetime and will range from long term to a comparatively short term. Based on the duration of the need for coverage we have assigned an insurance type that may be most appropriate to meet the obligation.

As illustrated above, you will have different coverage needs which may require different insurance types. It is important to understand that if you have multiple liabilities, which you will most likely have, then it may be best to have a combination of insurance plans rather than just one.

After arriving at the general type of the life insurance, you will want to break it down even further to determine the exact type of insurance coverage that would be most appropriate for covering the specific liability. To determine the specific type, you need to be aware of how the liability will perform in the future. In other words, will it decrease (mortgage), increase (income needs) or remain level? After assessing the type of liability, you can then choose from the various types of insurance, illustrated above under “Term Insurance Types” and “Permanent Insurance Types”, that will meet your needs and fit into your budget.

To help you further understand the differences between term life insurance & permanent life insurance, the table below has been developed to help you. Because there are different types of term & permanent insurance we have subdivided the categories to help you understand. A summary of the basic features for each category of insurance has been provided earlier in this tutorial. Please be aware that this is only intended to be a general summary of the various types of plans and may not be directly applicable to the plan you are looking at if the plan has been modified from the traditional type of plan.

	Term Life Insurance		Permanent Life Insurance
	Decreasing	Level	Whole Life	Universal Life	Variable Life
Are the premiums guaranteed to remain level until your plan terminates?	Maybe. Depends on the company and the specific product you purchase.	Maybe. Depends on the company and the specific product you purchase.	Yes	No. If interest rates and/or plan expenses have been unfavorable over time, the planned premiums may need to be changed.	Maybe. Depends on the specific product you purchase.
Can I pay a higher or lower premium whenever I want?	No	No	No	Yes. Generally after the first policy year.	Maybe. Depends on the specific product you purchase.
Can the premiums be paid over a limited period of time?	No	Maybe. Depends on the specific plan you purchase.	No	Maybe. Premiums can be paid over a wide range of payment years.	Maybe. If the company offers a limited pay plan.
Does the policy accumulate cash value?	No	No	Yes. The cash value is determined by a preset schedule.	Yes. The cash value will be determined by the crediting rate and policy expenses.	Yes. The cash value amount will be determined by the performance of the chosen investments and policy expenses.
Can I take policy loans?	No	No	Yes	Yes	Yes
Do I choose where the premiums are invested?	No	No	No	No	Yes. You many chose from a variety of investment vehicles which will range from high to low risk.
Will the death benefit remain level?	No. The death benefit will decrease based on a set schedule.	Yes. It will remain level until the scheduled termination date.	Yes. It remains level for your entire lifetime.	Maybe. If you elect the level benefit option your death benefit will remain level. If an increasing benefit option is elected then the death benefit will increase with the cash value.	No. The death benefit will increase or decrease as a result of the fluctuations in your investments.

*** Because life insurance policies can differ from company to company, please contact your insurance company to find out all the details before purchasing a plan. ****

What kind of insurance riders can be attached to your life insurance plan?

Insurance riders are separate plans, which are purchased with a set premium, that are attached to your primary insurance coverage to provide additional benefits. These riders can provide various forms of additional protection. In order for the benefits of the rider to take effect, several qualifying conditions will have to be met. The qualifying conditions will be explained in the rider explanation form that you will receive at the time of application.

A few types of riders are explained hereafter:

Waiver of Premium - Guarantees that future life insurance premiums will be paid in the event that the insured becomes disabled prior to a specified age.

Accidental Death (or Double Indemnity) - If the insured should die as a result of an accident, an additional amount of death benefit will be paid out to the beneficiary.

Disability - Upon a qualified disability, payments of income can be paid to the disabled owner in the form of an annuity for a set period of time.

Child Coverage - Provides a death benefit in the event of a child’s death prior to a specified age.

Guaranteed Insurability - Allows the insured to purchase a predetermined amount of coverage at certain times in the future without having to be medically insurable.

Cost of Living - Permits the policy owner to purchase an inflation adjusted one-year term insurance equal to the percentage change in the Consumer Price Index with no evidence of insurability.

Long Term Care - In the event an individual should be required to go into a nursing home or receive home care, an annuity can be paid out to the long term care provider to defray some of the nursing care payments.

Terminal Illness - Allows terminally ill insured with a life expectancy of usually under one year to receive all or part of the death benefit.

What should you do when comparing life insurance policies?

When you have established the amount, duration, and type of life insurance policy(s) that you feel will best meet your need(s), your next step is to shop for the best coverage. Here are several considerations when shopping for the best coverage:

- Always compare similar policies (apples to apples).
- Shop around and get quotes from different insurers.
- Compare premiums and ask if they can change in the future.
- Be aware of any commissions, surrender fees, or loads.
- Understand the guaranteed features, if any, of the policy.
- Ask for the crediting rate and crediting rate history (if applicable).
- For new permanent plans, ask for and compare net payment & surrender cost indices.
- Compare cash surrender values and future death benefits using a realistic crediting rate.
- Ask about the financial security of the company.

Term insurance is easier to compare and understand than the more complicated permanent plans and confusion can easily arise. Therefore, it is always in your best interest to have an unbiased insurance counselor or financial planner review your different plans with you if you are having a hard time with the comparison process.

Should you cancel or replace your current policy?

When thinking about the possibility of replacing your coverage, you should consider several things before taking action.

1) Are you going to be medically insurable? Never terminate your current plan before knowing that you have been approved for the replacement coverage.

2) Premiums for your new plan may be higher than your current plan. If this is the case, you should determine whether the new plan will provide you with a guaranteed death benefit or some other favorable feature which the current plan does not offer. Note: when comparing permanent plans, always assume that you are transferring the cash value of your current policy as a lump sum to the new policy. This will insure a more accurate comparison by lowering your monthly premium.

3) If you have not completed about 15 years with the current plan, you will usually incur a surrender charge on the policy which will lower your cash surrender value below the total premiums paid. You must weigh the advantages of the reduced cash value return with the newly acquired benefits of the proposed plan.

Whenever comparing policies, it is always important for you to ask for a break down of premiums, cost of insurance, death benefits, reasonable interest rates, as well as the various features of the two insurance plans. If a replacement policy is determined to be in your best interest, request to have the policy transferred through a 1035 exchange. The 1035 Exchange will allow the cash value and tax basis of your current plan to be transferred over to your new plan tax-deferred and possibly save you a lot of money in the future.

When should I review my needs for life insurance?

It is beneficial for you to review your insurance needs every few years or when a major life change occurs (marriage, children, house, new job, etc.). In addition, it is always important that you have your life insurance papers and other valuable papers in a safe location that can by reached by a family member or trustee in the event of your death. If they can’t get to it or do not know that the policies even exist, then you might as well not even have the coverage.

Will my beneficiary receive the death benefit in on payment or as a series of payments?

Insurance companies may offer a variety of payment options. The owner of the plan may designate the option(s) prior to the death of the insured. If no option is designated, the beneficiary(ies) of the life insurance plan may choose to receive the death benefit under the options shown below. Always remember to keep your beneficiary designation up to date.

Lump Sum Payment: Death benefit proceeds will be received as a single payment.

Fixed Period: The death benefit can be received over a fixed period of 1 to 30 years. If the annuitant should die during the fixed period, the remaining principal will be paid in full or payments will continue for the remainder of the fixed period to a beneficiary(ies).

Fixed Amount: The death benefit will be paid in equal amounts every month until the entire amount of proceeds has been paid. If the annuitant should die during the fixed amount payment period, the remaining principal will be paid in full or payments will continue to a beneficiary(ies) until the full amount is paid.

Interest Only: Interest payments are paid by the life insurance company on the amount of the proceeds retained. The death benefit remains available for full or partial withdrawals at any time or may be converted to an annuity payout option. Interest payments continue until the option is surrendered or converted to another option.

Life Income: The death benefit will be paid for life of the annuitant. The annuitant may elect an option, know as a guaranteed period certain, with the life income annuity which will ensure that payments will be paid to a beneficiary if death of the annuitant should occur within a certain number of years after the purchase of the annuity. The years which may be elected under the guaranteed period certain option are typically 5, 10, 15, or 20 years. Should the annuitant die during the guaranteed period certain, payments will continue to the new designated beneficiary for the remainder of the period certain.