1. 1 - 1 Introduction To Life Insurance  Principal uses  Estate building and conservation  Income needs of dependants  Federal and state death taxes  Pay debts  Children's educations  Efficient wealth transfer  Special needs  Charitable intentions  Lifetime annuity Chapter 1 Tools & Techniques of Life Insurance Planning

2. 1 - 2 Introduction To Life Insurance  Principal uses (cont'd)  Business needs  Funding buy-sell agreement  Funding nonqualified deferred compensation plans  Funding death benefit only (DBO) plans  Financial security from families of employees  Recruit, retain and reward key employees Chapter 1 Tools & Techniques of Life Insurance Planning

3. 1 - 3 Introduction To Life Insurance  Principal uses (cont'd)  Advantages  Immediate cash available at death of the insured  Proceeds bypass probate estate  No public record of benefit amount or beneficiary  Creditor protection (amount varies by state)  Cash values provide immediate cash through policy loans  Income tax free death benefit Chapter 1 Tools & Techniques of Life Insurance Planning

4. 1 - 4 Introduction To Life Insurance  Principal uses (cont'd)  Advantages (cont'd)  Proceeds often exempt from state inheritance tax  Increase in cash values are income tax deferred  Disadvantages  Not available for those in poor health  Products can be complex and difficult to compare  Opportunity cost associated with alternative investments Chapter 1 Tools & Techniques of Life Insurance Planning

5. 1 - 5 Introduction To Life Insurance  Legal Aspects  Life insurance is a contract  Between the insurance company and policyowner  Standard provisions  Parties to the contract  Insurance interest  Legal form and contents of the contract  Rights of the insured  Contestability  Grace period  Suicide clause  Misstatement of age  Dividend options Chapter 1 Tools & Techniques of Life Insurance Planning

6. 1 - 6 Introduction To Life Insurance  Legal Aspects (cont'd)  Standard provisions (cont'd)  Non-forfeiture options  Settlement 0ptions  Reinstatement provisions  Policy loan definitions  Crediting rates  Policy assignment Chapter 1 Tools & Techniques of Life Insurance Planning

7. 1 - 7 Introduction To Life Insurance  Tax aspects  Premiums are not income tax deductible(In general)  Exceptions  Group policies  Premiums paid by employer as part of a 162 bonus plan  Premiums paid for policy subject to an alimony agreement  premiums paid for a policy owned by and payable to a charity  Dividends  Generally not taxable income to the policy owner  Dividends received in cash taxable once cumulative dividends received exceed policy owners basis  Withdrawals & Loans  Withdraws up to basis and then policy loans accessed income tax free  For properly structured policies Chapter 1 Tools & Techniques of Life Insurance Planning

8. 1 - 8 Introduction To Life Insurance  Tax aspects (cont'd)  Modified Endowment Contracts (MECS)  Withdrawals & Loans taxed under the interest 1st rule  Additional 10% tax if done prior to age 59 & ½  Death benefits still received income tax free  Interest on loans for corporate owned life insurance not tax deductible  Exception for corporate owned life insurance on key employee  Interested paid after 10/13/95  Limited to policy loans under $50,000  Loan interest on policies purchased for investment purposes  Deductible to extent it does not exceed taxable investment income Chapter 1 Tools & Techniques of Life Insurance Planning

9. 1 - 9 Introduction To Life Insurance  Tax aspects (cont'd)  Transfer for value  For policies sold for monetary value  Proceeds in excess of policyowner basis are taxable income  Exceptions (For policies transferred to:)  The insured  A partner of the insured  A partnership in which the insured is a partner  A corporation in which the insured is a shareholder or officer Chapter 1 Tools & Techniques of Life Insurance Planning

10. 1 - 10 Introduction To Life Insurance  Tax Aspects (cont'd)  Alternative Minimum Tax (AMT)  Corporate owned insurance proceeds payable to the corporation may be subject to the AMT  Incidents of ownership  Proceeds will be included in the estate of the insured for federal estate tax purposes if the insured held any “incidents of ownership” in the policy  Examples  Right to designate policy beneficiary  Right to take policy loans  Right to assign policy as collateral Chapter 1 Tools & Techniques of Life Insurance Planning

11. 1 - 11 Introduction To Life Insurance  Tax Aspects (cont'd)  Gift taxes  Death Proceeds payable to someone other than owner-insured are not treated as gifts  Premium payments are not generally considered gifts where someone other than the insured or insured estate are named as beneficiary  Economic Aspects  Life insurance as an investment  Capital accumulation vehicle with  Death benefit protection and  Savings component Chapter 1 Tools & Techniques of Life Insurance Planning

12. 1 - 12 Introduction To Life Insurance  Premium pricing and cash value calculations  Risk shifting and risk sharing  Every insured’s premium contains a small charge to cover the expected deaths claims for the insurance carrier  Insurance carriers can calculate the number of expected deaths per year with great accuracy  Therefore they know how to spread the costs among all insured’s  Premium and costs  Common misconception – higher premium means higher costs  All policies are calculated to be actuarially equivalent on a present value or prospective basis Chapter 1 Tools & Techniques of Life Insurance Planning

13. 1 - 13 Introduction To Life Insurance  Premium pricing and cash value calculations (cont'd)  Premium and costs (cont'd)  The after tax cost to the insured will vary substantially  depending on the policy purchased  When death occurs  Interest rates  Insurance company assumptions  Interest earned on assets  Mortality experience on pool of insured’s  If reserves earn higher interest, then premiums can be lower  If reserves earn lower interest, then premiums can be lower  Companies will credit a guaranteed minimum interest typically around 4-4&1/2 % for permanent and universal life insurance policies Chapter 1 Tools & Techniques of Life Insurance Planning

14. 1 - 14 Introduction To Life Insurance  Premium Pricing and Cash Value Calculations (cont'd)  Mortality, morbidity & the law of large numbers  Mortality  Number of deaths in a given period of time  Expressed as proportions to the total population  Such as- per 1,000, 10,000 or100,000 lives  Actuaries compute mortality tables based on demographic factors  Morbidity  Incidence of disease within a community Chapter 1 Tools & Techniques of Life Insurance Planning

15. 1 - 15 Introduction To Life Insurance  Premium pricing and cash value calculations (cont'd)  Law of large numbers  A principle that the larger the number of exposures considered, the more closely will reported losses equal the true probability of loss. This is the basis for the statistical expectation of loss, which determines premium rates.  Adverse selection & moral hazard  Adverse selection  The tendency of people who are less that standard risks to seek insurance to a greater extent than others  Stacking against the insurance company  Affects profitability and premium rates  Moral Hazard  People with insurance may take greater risks because they know they are protected Chapter 1 Tools & Techniques of Life Insurance Planning

16. 1 - 16 Introduction To Life Insurance  Underwriting process  Classify insured’s by their risk characteristics  Age, sex, occupation, smoker/nonsmoker, habits  Classification types  Standard, preferred, preferred plus etc  Varies by carrier  Expense and risk loading  Commissions  Administrative expenses  Advertising, salaries, marketing, promotional  Lapse rate expenses  Excess mortality reserves Chapter 1 Tools & Techniques of Life Insurance Planning

17. 1 - 17 Introduction To Life Insurance  Participating and nonparticipating policies  Nonparticipating  Premiums, cash values and death benefits are guaranteed  Competitive pressures have made these products unattractive  Participating  Policyowner’s participate in the favorable experience of the company through dividends  Dividends considered a return of investment  Considered a nontaxable return of overpayment of premium Chapter 1 Tools & Techniques of Life Insurance Planning

18. 1 - 18 Introduction To Life Insurance  Participating and nonparticipating policies (cont'd)  Participating policies (cont'd)  Dividends considered a return of investment  Considered a nontaxable return of overpayment of premium  Policyowner’s given multiple choices as to dividend options  In cash  Purchase Paid-up additions  Reduce premium’s  Accumulate with interest Chapter 1 Tools & Techniques of Life Insurance Planning

19. 1 - 19 Introduction To Life Insurance  Participating and nonparticipating policies (cont'd)  Participating policies (cont'd)  Dividends are not guaranteed  Current assumption products  More favorable experienced than assumed in credited to the policies cash value  Policyowner can apply favorable experience in different ways  Reduce future premium payments  Increase future coverage amounts  Shorten the number of future premium payments Chapter 1 Tools & Techniques of Life Insurance Planning

20. 1 - 20 Introduction To Life Insurance  Participating and nonparticipating policies (cont'd)  Variable life insurance policies  Policyowner bears all invest risks and rewards  No minimum guarantee with regard to cash values  Policy owner elects sub-accounts to allocate premium dollars  Two levels of expenses  Fund level expenses  Management and operating fees  Policy level expenses  Sales loads, cost of insurance, administrative fees etc. Chapter 1 Tools & Techniques of Life Insurance Planning