Life Insurance

Life insurance is a contract between the policy holder and the insurer, where the insurer promises to pay a designated beneficiary a sum of money (the "benefits") upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger payment. In return, the policy holder agrees to pay a stipulated amount (the "premium") at regular intervals or in lump sums. In some countries, death expenses such as funerals are included in the premium; however, 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 the 'peace of mind' in knowing that the death of the insured person will not result in financial hardship.

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; common examples are 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) are whole life, universal life and variable life policies.

Overview

Parties to contract

There is a difference between the insured and the policy owner (policy holder), although the owner and the insured are often the same person. For example, if Joe buys a policy on his own life, he is both the owner and the insured. But if Jane, his wife, buys a policy on Joe's life, she is the owner and he is the insured. The policy owner is the guarantee and he or she will be the person who will pay for the policy. The insured is a participant in the contract, but not necessarily a party to it. However, "insurable interest" is required to limit an unrelated party from taking life insurance on, for example, Jane or Joe. Also, most companies allow the Payer and Owner to be different, e. g., a grand parent paying premiums for a policy on a child, owned by a grandchild [or vice versa].

The beneficiary receives policy proceeds upon the insured's death. The owner designates the beneficiary, but the beneficiary is not a party to the policy. The owner can change the beneficiary unless the policy has an irrevocable beneficiary designation. With an irrevocable beneficiary, that beneficiary must agree to any beneficiary changes, policy assignments, or cash value borrowing.

In cases where the policy owner is not the insured (also referred to as the celui qui vit or CQV), insurance companies have sought to limit policy purchases to those with an "insurable interest" in the CQV. For life insurance policies, close family members and business partners will usually be found to have an insurable interest. The "insurable interest" requirement usually demonstrates that the purchaser will actually suffer some kind of loss if the CQV dies. Such a requirement prevents people from benefiting from the purchase of purely speculative policies on people they expect to die. With no insurable interest requirement, the risk that a purchaser would murder the CQV for insurance proceeds would be great. In at least one case, an insurance company which sold a policy to a purchaser with no insurable interest (who later murdered the CQV for the proceeds), was found liable in court for contributing to the wrongful death of the victim (Liberty National Life v. Weldon, 267 Ala.171 (1957)).

Contract terms

Special provisions may apply, such as suicide clauses wherein the policy becomes null if the insured commits suicide within a specified time (usually two years after the purchase date; some states provide a statutory one-year suicide clause). Any misrepresentations by the insured on the application is also grounds for nullification. Most US states specify that the contestability period cannot be longer than two years; only if the insured dies within this period will the insurer have a legal right to contest the claim on the basis of misrepresentation and request additional information before deciding to pay or deny the claim.

The face amount on the policy is the initial amount that the policy will pay at the death of the insured or when the policy matures, although the actual death benefit can provide for greater or lesser than the face amount. The policy matures when the insured dies or reaches a specified age (such as 100 years old).

Costs, insurability, and underwriting

The insurer (the life insurance company) calculates the policy prices with intent to fund claims to be paid and administrative costs, and to make a profit. The cost of insurance is determined using mortality tables calculated by actuaries. Actuaries are professionals who employ actuarial science, which is based in mathematics (primarily probability and statistics). Mortality tables are statistically-based tables showing expected annual mortality rates. It is possible to derive life expectancy estimates from these mortality assumptions. Such estimates can be important in taxation regulation.

The three main variables in a mortality table have been age, gender, and use of tobacco. More recently in the US, preferred class specific tables were introduced. The mortality tables provide a baseline for the cost of insurance. In practice, these mortality tables are used in conjunction with the health and family history of the individual applying for a policy in order to determine premiums and insurability. Mortality tables currently in use by life insurance companies in the United States are individually modified by each company using pooled industry experience studies as a starting point. In the 1980s and 90's the SOA 1975–80 Basic Select & Ultimate tables were the typical reference points, while the 2001 VBT and 2001 CSO tables were published more recently. The newer tables include separate mortality tables for smokers and non-smokers and the CSO tables include separate tables for preferred classes.

Recent US select mortality tables predict that roughly 0.35 in 1,000 non-smoking males aged 25 will die during the first year of coverage after underwriting.[5] Mortality approximately doubles for every extra ten years of age so that the mortality rate in the first year for underwritten non-smoking men is about 2.5 in 1,000 people at age 65.[6] Compare this with the US population male mortality rates of 1.3 per 1,000 at age 25 and 19.3 at age 65 (without regard to health or smoking status).

The mortality of underwritten persons rises much more quickly than the general population. At the end of 10 years the mortality of that 25 year-old, non-smoking male is 0.66/1000/year. Consequently, in a group of one thousand 25 year old males with a $100,000 policy, all of average health, a life insurance company would have to collect approximately $50 a year from each of a large group to cover the relatively few expected claims. (0.35 to 0.66 expected deaths in each year x $100,000 payout per death = $35 per policy). Administrative and sales commissions need to be accounted for in order for this to make business sense. A 10 year policy for a 25 year old non-smoking male person with preferred medical history may get offers as low as $90 per year for a $100,000 policy in the competitive US life insurance market.

The insurance company receives the premiums from the policy owner and invests them to create a pool of money from which it can pay claims and finance the insurance company's operations. The majority of the money that insurance companies make comes directly from premiums paid, as money gained through investment of premiums can never, in even the most ideal market conditions, vest enough money per year to pay out claims.[citation needed] Rates charged for life insurance increase with the insurer's age because, statistically, people are more likely to die as they get older.

Given that adverse selection can have a negative impact on the insurer's financial situation, the insurer investigates each proposed insured individual unless the policy is below a company-established minimum amount, beginning with the application process. Group Insurance policies are an exception.

This investigation and resulting evaluation of the risk is termed underwriting. Health and lifestyle questions are asked. Certain responses or information received may merit further investigation. Life insurance companies in the United States support the Medical Information Bureau (MIB),[7] which is a clearinghouse of information on persons who have applied for life insurance with participating companies in the last seven years. As part of the application, the insurer receives permission to obtain information from the proposed insured's physicians.

Underwriters will determine the purpose of insurance. The most common is to protect the owner's family or financial interests in the event of the insured's demise. Other purposes include estate planning or, in the case of cash-value contracts, investment for retirement planning. Bank loans or buy-sell provisions of business agreements are another acceptable purpose.

Life insurance companies are never required by law to underwrite or to provide coverage to anyone, with the exception of Civil Rights Act compliance requirements. Insurance companies alone determine insurability, and some people, for their own health or lifestyle reasons, are deemed uninsurable. The policy can be declined (turned down) or rated.[citation needed] Rating increases the premiums to provide for additional risks relative to the particular insured.[citation needed]

Many companies use four general health categories for those evaluated for a life insurance policy. These categories are Preferred Best, Preferred, Standard, and Tobacco.[citation needed] Preferred Best is reserved only for the healthiest individuals in the general population. This means, for instance, that the proposed insured has no adverse medical history, is not under medication for any condition, and his family (immediate and extended) have no history of early cancer, diabetes, or other conditions.[2] Preferred means that the proposed insured is currently under medication for a medical condition and has a family history of particular illnesses.[citation needed] Most people are in the Standard category.[citation needed] Profession, travel, and lifestyle factor into whether the proposed insured will be granted a policy, and which category the insured falls. For example, a person who would otherwise be classified as Preferred Best may be denied a policy if he or she travels to a high risk country.[citation needed] Underwriting practices can vary from insurer to insurer which provide for more competitive offers in certain circumstances.

Death proceeds

Upon the insured's death, the insurer requires acceptable proof of death before it pays the claim. The normal minimum proof required is a death certificate and the insurer's claim form completed, signed (and typically notarized).[citation needed] If the insured's death is suspicious and the policy amount is large, the insurer may investigate the circumstances surrounding the death before deciding whether it has an obligation to pay the claim.

Proceeds from the policy may be paid as a lump sum or as an annuity, which is paid over time in regular recurring payments for either a specified period or for a beneficiary's lifetime.[citation needed]

Insurance vs Assurance

The specific uses of the terms "insurance" and "assurance" are sometimes confused. In general, in these jurisdictions[clarification needed] "insurance" refers to providing cover for an event that might happen (fire, theft, flood, etc.), while "assurance" is the provision of cover for an event that is certain to happen. In the United States both forms of coverage are called "insurance", principally due to many companies offering both types of policy, and rather than refer to themselves using both insurance and assurance titles, they instead use just one.