Individual Life Insurance,

Group Life Insurance and

annuity

Chapter 19 + Ch21
section 4
Ch19&21 Learning Objectives and
agenda-1
1. Term life insurance
2. Endowment insurance
3. Traditional whole life insurance (non-
participating and participating)
4. Universal life insurance
5. Variable life insurance
6. Variable universal life insurance
Ch19&21 Learning Objectives and
agenda-2
7. Different life insurance policy riders
8. Taxation on life insurance
9. Group life insurance offered by employers
10.Various types of Annuities (Ch21 Section 4)
Ch19 Part I: Agenda
1. Why having life insurance
2. Products overview
3. Review of terminology
4. Term life
5. Endowment
Why need life insurance?
1. Video one uncertainty

2. Video two protection provided by LI

3. be prepared for the rainy day

Life Insurance Product Overview

•
Terminology-1
1. Policyholder (policyowner)
– The owner of the policy

2. Insured
– The person whose life is insured

3. Beneficiary
– who receives the death benefit
 Terminology-2
• Face Amount
– the stated amount of insurance in the policy.
• Death benefit
– amount beneficiaries receive upon insured’s death
• Cash value (accumulation fund)
– amount of savings accumulation

• Net death protection (the net amount at risk)

– (death benefit - cash value)
Exercise
• Assume that the face amount of a non-par
whole life policy equals $100,000 and that
the cash value equals $20,000.
1.What is the death benefit (total amount
paid upon death)?
Answer: $100,000
2. What is the amount of net death
protection?
Answer: $80,000 (=100,000-20,000)
 Terminology-3
• Types of Beneficiaries
1. Primary beneficiary
2. Contingent beneficiary
– E.g.
• “Proceeds to be paid to Christine B. Gill, wife of the insured, if
living; otherwise to Bart Simpson, nephew of the insured.”
– Question?
• In the previous beneficiary designation, who is the primary
beneficiary and who is the contingent beneficiary?
Answer: primary: Christine B. Gill, and contingent: Bart Simpson.
3. Revocable beneficiary
4. Irrevocable beneficiary
Terminology-4
• Surrender/Lapse
– refer to the termination of a policy.
• Cash value
• Surrender charge
• Cash surrender value = cash value – surrender
charge
Term Life Insurance
• Death benefit:
– over a fixed term, For example, one-year (YRT), five-year
term, or up to a given age
– Face amount
• Pure death protection
• No savings feature
• No cash surrender value (some exceptions with Term to 100)
• Premiums increase over time (if renewed), i.e. with
age
• Most are guaranteed renewable: without evidence
of insurability
Endowment Insurance
– face amount paid

• if the insured dies within the term

or
• if the insured survives the policy period

– A small share of market in US

Ch19 Part I: Summary
1. Why having life insurance
2. Important terms:
– policyholder, insured, and beneficiary
– face amount, death benefit, cash value,
and net death protection
– Surrender, surrender charge and cash
surrender value
3. Term life
4. Endowment insurance
Ch19 Part II Agenda
• Traditional Whole life
1. Non-participating policy
2. Participating policy
Whole Life Insurance
– Provide whole life death protection and
saving accumulation (cash value)
– Premiums
1. single premium life:
• single premium
2. Limited-payment life:
• limited number of premium payments
3. continuous premium life (a.k.a., ordinary life,
straight life):
• premiums are paid over the life of the insured.
Exercise
When Kathy buys a single premium
whole life policy:
1. she makes the same premium payment each year of the
policy period.
2. she pays the entire premium in a lump sum when the
policy is issued and is then covered for her whole life
3. she makes the same premium payment each year for a
limited number of years and is covered for her whole life.
4. she makes the same premium payment each year for
her whole life and is covered for her whole life.
Answer: option 2
Whole Life Insurance
– Premiums
• do not increase over time
– probability of dying
• increases over time
==> higher upfront premiums than term life
– P/H “prepays” part of the cost of future death
protection
• cash value (savings accumulation)
• entitled to prepayments if policy is surrendered
Whole Life Insurance
The green curve is the cash value of continuous premium whole life
insurance.
Net

Net
Whole Life Insurance
– If insured dies,
• beneficiaries receive face amount
=net death protection + cash value

– CV vs. net DP
• cash value  over time
• Net death protection  over time
Figure 19.4 - Protection and Cash Value
Elements for Single-Premium and Installment
Forms of Cash Value Life Insurance

10
Exercise
Over the life of the policyholder, the face amount of a
whole life policy remains fixed, but the death
protection component ________________ and the
cash value component _______________.
a. increases; decreases
b. increases; increases
c. decreases; decreases
d. decreases; increases

The correct answer is d.

Exercise
• Please show graphically how the death benefit, premium,
cash value, and net death protection change over time for
a continuous premium whole life (nonparticipating) policy
with a face amount of $50,000.

$50,000

Net death protection

Participating Whole life
• Can pay annual dividends
– not guaranteed
– Treated as return of premiums, not taxable

• Why?
– premiums based on conservative assumptions,
hence the premium is higher
– Key assumptions:
• interest rate levels (lower), mortality rate (higher), and
expense (higher)

• Illustrated versus actual dividends

Dividend Options (only for
par policy)
1. Cash
2. Offset premiums
3. Accumulate at interest
4. Purchase paid-up additional insurance
– Typically the default option on a policy
5. Purchase one-year term insurance
Surrender Options

1. Cash
2. Reduced paid-up insurance
3. Extended term insurance (default)
• Question:
– Can reduced paid-up be an option for
dividend distribution?
Answer: No
Policy Loan
• borrow against the CV of the policy
• If the Ed dies prior to repaying the loan
– the loan balance reduces the death benefit

• If the outstanding loan balance is higher than

the CV
– The policy lapses.
• Automatic premium loan provision (prevent
lapse)
Settlement Options

 How death benefits are paid:

1. Cash (lump sum)
2. Interest only
3. Fixed period (annuity certain)
4. Fixed amount (annuity certain)
5. Life Income Options (life annuity with or
without guarantee)
Ch19 Part II Summary
• Traditional Whole life: Non-participating
policy and Participating policy
1. the arrangements for premium payment.
2. Cash value vs. net death protection
3. Surrender options
4. Policy loan
5. Settlement options
• Participating whole life
– Dividends and dividend options
Ch19 Part III: Agenda
1. Universal life
2. Variable life
3. Variable universal life
Universal Life
• Similar to traditional whole life
– permanent death protection + savings accumulation
• Main differences :
– Greater flexibility in premium payments
• Complete flexibility. No fixed premium schedule
• Only needs to maintain a minimum balance (two month MC)
in the accumulated fund (AF) and subject to a allowable
maximum balance.
– Unbundled
• Investment return
• Mortality charge
• Expense charges
 Universal Life
• Main differences (continue):
– AF (Cash value) varies with
• P/H’s premium payments
• expense and mortality charges
• Rate Er uses to credit interest to cash value
– minimum rate usually guaranteed
– rate often linked to short term interest rates
Factors Affecting UL Cash Value
• income items:
1. New premiums paid
2. Guaranteed interest credited
3. Excess interest credited

• Cash outflow items

1. Mortality charge for death protection
2. Administrative and marketing expenses
3. Withdrawals or loans
Factors Affecting UL Cash Value
Cash value at the end of policy year =
the cash value at the beginning of the policy year
+new premiums paid
+interest credited (guaranteed and excess)
- Mortality charge
- Expenses
- Withdrawals or loans
Factors Affecting UL Cash Value
• Mortality charge
– Monthly
– (Mortality rate) * (net death protection)
– Varies among Ers

• Expense charges
– Implicit: through margins
– Explicit:
• Front-end expenses
• Surrender expenses
 Exercise
• Other things being equal, explain how each of the following
would be likely to affect the growth of a universal life policy’s
cash value.
1. The policyholder reduces the annual premium payment by 50
percent after five years.
Answer: The cash value would grow more slowly or decline.
2. Market interest rates are stable for five years and then
decline sharply and remain at the lower level.
Answer: The cash value would grow more slowly.
3. Researchers discover a cure for cancer five years after the
policy is issued, and the improved mortality is considered.
Answer: The cash value would grow more rapidly since mortality
charges decline.
 Death Benefit Options with UL
Option B: Death benefit varies
Option A: Level death
with cash value (keep constant
benefit (as with WL)
net death protection
Universal life
• Other features
– Allow partial withdrawal
– Allow increasing (requires satisfactory
evidence of insurability) or decreasing face
amount
Variable Life
• Similar to traditional whole life
– permanent death protection + savings
accumulation
– Fixed premium schedule
Variable Life
• Main differences:
– Investment:
• Separate investment account
• Investment decision: P/H chooses the accounts to invest
• Risk: borne by P/H
– Cash value
• does not follow a fixed schedule
• varies with return earned on portfolio of mutual funds chosen
by P/H
– Death benefit
• Fluctuates with investment performance
• Subject to guaranteed minimum (face amount)
Figure 19.7 - Hypothetical Values for a
Variable Life Insurance Contract
Variable Universal Life Insurance
• Variable + universal life
• a.k.a., flexible premium variable life insurance.
1.The premium flexibility of universal life
2.The death benefit flexibility of universal life
3. investment flexibility of variable life
4.The disclosure of universal and variable life
5.The ability to withdraw cash values as policy loans
without any tax penalties
6.higher investment risk than universal life.
Table 19.1 - Characteristics of Major
Types of Life Insurance Policies
Table 19.1 - Characteristics of
Major Types of Life Insurance
Policies
Ch19 Part III: Summary-1
1.Universal life and its unique features:
– unbundled policy
– flexible premium
– cash value not following a fixed schedule
– unique death benefit options
– partial withdrawal
– flexibility in changing the face amount of death
benefit
Ch19 Part III: Summary-2
2. Variable life and its unique features:
– investment and its risk,
– fluctuating death benefit

3.Variable universal life

– combination of variable life and universal life,
and has features from both of them.
CH19 Part IV: Agenda
1. Life Insurance Riders
2. Taxation on life insurance policy
3. The use of life insurance products
4. Group insurance
5. Annuities (Ch21 section 4)
Life Insurance Riders-1
1. Waiver of premium rider
– Waive premium after insured’s total disability

2. Disability income rider

– provides disability income benefit of $10 per month
per $1,000 of initial face amount of life insurance
– for as long as total disability continues and after the
first six months of such disability
– provided it commences before age 55 or 60.
Life Insurance Riders-2
3. Accidental death benefit (or double
indemnity) rider
– double the DB if the cause of insured’s death is an
accident
– usually in effect until age 70
4. Guaranteed insurability option rider
– gives the P/H the right to buy additional amounts of
insurance
– usually at 3-year intervals up to a specified age, without
new proof of insurability.
– The usual age of the last option is 40.
– amount of each additional purchase <= the face amount
of the original policy.
Life Insurance Riders-3
5. Accelerated death benefits rider
– Part of DB paid prior to death if diagnosed of
either a catastrophic illness or a terminal illness
– A.k.a., living benefits,
– the face amount of the basic policy is reduced
– Catastrophic illness coverage rider
• If diagnosed of specified illnesses
• The specified illnesses differ among insurers
– terminal illness coverage rider
• if diagnosed of a terminal illness (insured has six months
or less to live)
Tax Treatment of Life Insurance
• Premium on individual life insurance:
– Not tax deductible
• Death benefits
– Income Tax free
• Increase in cash value while the policy is in
force
– Not Taxed
• Tax at surrender is charged on
Cash surrender value + sum of all policyholder
dividends - sum of all premiums paid
Implications of Tax Treatment
• returns on saving accumulation
– If insured dies:
• Escape income tax
– If the policy is surrendered
• Tax deferred
• Partially taxed: Amount that is taxed is less than
implicit return, because part of premiums is cost
of death protection, but the total premium is
deducted.
The use of life insurance
products
Term vs. whole life
• Your needs
• Risk appetite
• Your ability to pay premium
• Your alternative investments
Exercise
• Jane is divorced with two young children.
Her salary is $40,000 per year, and she
has no group life insurance.
1.Should Jane buy any life insurance?
yes
2. If so, should she buy term or whole life?

term life
Group Life Insurance
• E.g., group yearly renewable term life
• death benefit amounts
– % of employee’s annual salary
– Additional amounts: available on a
supplemental basis.
• Underwriting:
– Usually don’t require evidence of insurability
• Low expense and commission
• May require min participation rate
Annuity Contracts
– Large and growing part of life insurance
business
– Suitable for funding retirement benefits
– Risk management perspective
• Protection against outliving resources
– Savings perspective
• Tax advantaged method of saving
– Investment incomes are tax deferred
How do you fund an annuity?
• Premium Payments may be made:
– All at once (single premium)
– Over time
• Fixed payments OR
• Flexible Payments

• contract periods
– Accumulation period
– Payout period

• Type of annuity based on the commencement benefits

(contract periods)
– immediate annuity
– deferred annuity
 Payout Period of Annuities
(settlement options)
1. Straight life annuity
 benefit payments are guaranteed for life
2. Annuity Certain
 guarantees annuity payments over a specific period
no matter the annuitant is alive or dead
3. Life annuity with period certain
 a combination of a fixed period annuity and a life
annuity.
4. Joint and last survivor annuity
 End at the second death.
 Payment may be reduced after the first death
exercise
Jerry, age 40, purchase an annuity for himself. He
pays annuity premium for next 20 years, and from age
60 he will be able to receive the annuity benefits for
the rest of his life. The annuity he purchased is: ?
1) Deferred annuity
2) Immediate annuity
3) Straight life annuity
4) Annuity certain
Answer: deferred annuity and straight life annuity
 In the example, what is the accumulation period?
40-60
 And what is the payout period? Age 60 and after
Saving Features
1. Fixed annuity
– Guaranteed interest rate
– Guaranteed fixed annuity payments
2. Variable annuity
– Non-guaranteed interest rates
– Interest credited and annuity payment vary with
return on mutual funds chosen by policyholder
3. Equity-index annuity
– With a minimum guarantee interest rate
– Interest credited and annuity payment based upon
external index, e.g., S&P 500.
– Not a variable annuity
Exercise
• Please explain why death rates of life
insurance buyers generally are higher
than those of people who buy annuities.

• Answer: because
– People who expect to die early are more likely
to buy life insurance, and
– people who expect to live longer than the
average people tend to buy annuities.
Summary of Annuity Contracts
CH19 Part IV: Summary-1
1. Life Insurance Riders
– Waiver of premium rider
– Disability income rider
– Accidental death benefit (or double
indemnity) rider
– Guaranteed insurability option rider
– Accelerated death benefits rider
• Catastrophic illness coverage rider
• Terminal illness coverage rider
CH19 Part IV: Summary-2
2. Taxation on life insurance policy:
– Premium
– death benefit
– cash value
3. The use of life insurance products
4. Features of group insurance
5. Various types of Annuities
Chapter summary
1. Term life insurance
2. Endowment insurance
3. Various types of whole life insurance: non-
participating, participating, Universal, Variable,
and Variable universal
4. life insurance riders
5. Taxation on life insurance
6. Group insurance
7. Various types of Annuities
Reminder

• Please complete Ch19 and Ch21 quiz

before the due date.