Life insurance Study Guide

📖 Core Concepts Life Insurance Contract – Insurer promises a benefit to a designated beneficiary when a specified trigger event (usually death) occurs; policyholder pays premiums. Key Parties Policy Owner – pays premiums, holds contractual rights; can change beneficiary unless irrevocable. Insured Person – whose death (or other covered event) triggers the benefit; may differ from owner. Beneficiary – receives proceeds. Insurable Interest – Owner must suffer a genuine loss if the insured dies (e.g., close family, business partner). Contestability & Suicide Clauses – Insurer may contest a claim within the contestability period (typically 2 years). A suicide clause voids benefits if death by suicide occurs within the same period. Policy Types Term (Protection) Policies – Fixed period (10‑30 yr), no cash value. Permanent (Investment) Policies – Lifetime coverage, cash value builds: Whole Life, Universal Life, Variable Life, Endowment, etc. Riders & Add‑ons – Accidental death, premium‑waiver, double/triple indemnity, joint life, etc. Underwriting – Uses mortality tables, medical history, MIB data, and rating categories (preferred best, preferred, standard, tobacco). Tax Treatment (US/UK/SA) – Death benefit generally income‑tax‑free; premiums not deductible (US); cash‑value growth tax‑deferred; special allowances (e.g., UK cumulative allowance). Special Arrangements – Trust‑owned policies (estate planning), STOLI (illegal lack of insurable interest), Pension Term Assurance (tax‑relieved term). --- 📌 Must Remember Face Amount = contractually promised sum at death or maturity. Contestability Period = ≤ 2 years; suicide clause usually the same length. Rating Categories determine premium level (preferred > standard > tobacco). Mortality Rate Approximation – doubles every 10 years (e.g., 0.35/1,000 at 25 y → 2.5/1,000 at 65 y). Tax Highlights US: premiums not deductible; cash value tax‑deferred; Modified Endowment Contract (MEC) loses deferral. UK: policies >10 yr may be exempt from income/capital gains tax; proceeds included in estate unless in trust. SA: benefits not taxable to beneficiaries. Cumulative Allowance (UK) – withdraw up to 5 % of original investment each policy year tax‑free; unused allowance rolls over (max 100 % of premiums). Pension Term Assurance Relief – net premium paid at basic‑rate (22 %); higher‑rate taxpayers claim extra 18 %. STOLI – illegal in many jurisdictions; no insurable interest. --- 🔄 Key Processes Underwriting Workflow Collect application → medical questionnaire / exam → query MIB → assign rating category → calculate premium using mortality table → issue policy (automated or manual). Claim Verification Receive death certificate → verify insured, policy status, contestability period → check for exclusions (suicide, war, etc.) → approve payment → choose lump‑sum or annuity option. Choosing a Policy Type Identify need (temporary protection vs lifelong coverage). Match cash‑value desire → Whole Life/Universal/Variable. Assess flexibility → Universal (adjust premiums/death benefit). Consider investment risk → Variable (sub‑account performance). Using the UK Cumulative Allowance Each policy year: calculate 5 % of original premium → withdraw up to that amount tax‑free → carry forward unused portion. --- 🔍 Key Comparisons Term vs Whole Life – Term: fixed period, no cash value, cheaper premiums. Whole Life: lifetime coverage, cash value accrues, higher premiums. Universal vs Variable Life – Universal: cash value earns a declared interest rate; flexible premiums. Variable: cash value tied to investment sub‑accounts; higher market risk. Group Life vs Individual Term – Group: underwriting based on group size/strength, no individual medical exam. Individual: underwriting per applicant, potentially lower rates for healthy individuals. Revocable vs Irrevocable Beneficiary – Revocable: owner can change at any time. Irrevocable: beneficiary consent required for changes. Trust‑Owned vs Non‑Trust Policy (Estate Planning) – Trust: proceeds excluded from estate → possible inheritance‑tax savings. Non‑Trust: proceeds count as estate assets. --- ⚠️ Common Misunderstandings “Term policies build cash value.” – False; only permanent policies do. All death benefits are tax‑free everywhere. – Generally true for income tax, but may be included in estate tax (UK) or subject to MEC rules (US). Suicide clause never applies. – It applies during the specified period (usually 2 years). Any beneficiary can be changed at any time. – Irrevocable beneficiaries cannot be changed without consent. STOLI is a legitimate investment strategy. – Illegal where insurable interest is required. --- 🧠 Mental Models / Intuition “Two‑Trigger Model” – Think of a policy as a contract that activates on (1) death (or other covered event) or (2) maturity (for endowments). Risk Bucket Analogy – Rating categories = water buckets; the lower the bucket (preferred), the less water (premium) you pay. Cash Value as a Savings Account – In permanent policies, cash value behaves like a tax‑deferred savings account that the insurer invests for you. --- 🚩 Exceptions & Edge Cases Suicide after Contestability Period – Benefit paid (policy not void). Return‑of‑Premium Policies – Refund premiums if insured outlives term; not the same as standard term expiration. Accidental Death Rider – Pays extra only for accidental death; does not replace base benefit. Preferred vs Preferred‑Best – Preferred‑Best may require stricter health criteria; offers the lowest premium. --- 📍 When to Use Which Temporary Coverage Need (e.g., mortgage) → Term (cheapest). Desire for Lifetime Protection + Cash Value → Whole Life (stable premium). Need for Flexible Premiums / Adjustable Death Benefit → Universal Life. Investor wants market exposure → Variable Life (accepts sub‑account risk). High‑risk occupation or want extra accidental protection → Add AD&D rider. Employer wants to cover many employees quickly → Group Life (no individual underwriting). Senior with simplified underwriting → Senior Whole Life / Burial Insurance. Estate liquidity for inheritance tax → Trust‑owned Whole Life. --- 👀 Patterns to Recognize “No cash value” → term policy. “Flexible premium” → universal life. “Performance of sub‑accounts” → variable life. “Two‑year contestability” → look for suicide or exclusion clauses. “Beneficiary can be changed” → revocable beneficiary (unless stated irrevocable). “Tax‑deferred growth” → permanent policy with cash value. --- 🗂️ Exam Traps Choice stating “Term policies accumulate cash value.” – Incorrect; term policies have none. Option claiming “All life‑insurance premiums are tax‑deductible in the US.” – Wrong; only certain business‑related policies may be deductible. Answer that “Suicide is never excluded.” – Misleading; most policies exclude suicide within the contestability period. Distractor suggesting “Beneficiary changes always require consent.” – Only true for irrevocable beneficiaries. Statement that “STOLI is a legal way to invest in life insurance.” – False in jurisdictions that enforce insurable‑interest rules. ---