Life Insurance

This article focuses on life insurance. It provides an overview of the U.S. life insurance industry. The main types of life insurance, including term life insurance and permanent life insurance, will be described. The various forms of permanent life insurance, such as whole life, variable life, and universal life, will be summarized. The main components of life insurance, including death benefits, beneficiaries, brokers, riders, premiums, and insurance illustrations, are addressed and the issues related to state-based regulation of the life insurance industry are discussed.

Keywords Insurance Illustrations; Life Insurance; Permanent Life Insurance; Term Life Insurance; Universal Life; Variable Life; Whole Life

Insurance & Risk Management > Life Insurance

Overview

Life insurance is a financial instrument used to help protect assets, accumulate long-term savings, and ensure a secure retirement. Life insurance, which is offered in two main forms including term or permanent, protects individuals, families, and businesses against risks and life-crisis such as premature death of a family member or key employee. The main components of life insurance include policyholders, premiums, brokers or agents, primary beneficiaries, and death benefits. Factors that influence the cost of life insurance include the policyholder's age, health, family medical history, job risk factors, life-style habits, value of the policy, policy riders, and the term or permanent classification of the policy. A common form of policy rider is the accelerated death benefit. The accelerated death benefit, which became common as a tool to finance the costs associated with AIDS care, allows the policyholder to receive the proceeds of his or her life insurance policy prior to their death. Death benefits are tax-deductible while life insurance premiums are not. Factors that influence an individual or business' life insurance choice include the transparency, flexibility, and performance of the life insurance product, the individual or business' needs, and the products available in their geographic region and price bracket (Daily, 1992).

According to the American Council of Life Insurers, the U.S. life insurance industry, which began in the eighteenth century, manages 28 percent of the assets of employer-based retirement plans in America. The life insurance industry, which currently has over $4 trillion invested in the U.S. economy, practices long-term economic investment for its policyholders and shareholders. The life insurance industry is one of the largest corporate sources of investment capital. Projects financed through life insurance companies include the Sears Tower and the Empire State Building. The life insurance industry, as represented by the American Council of Life Insurers, promotes itself as serving a dual function for America: Providing long-term financial protection for families and long-term financial growth for the national economy.

State governments are primarily responsible for overseeing and regulating life insurance companies and agent or broker licensing requirements, market conduct and financial examinations, and product approvals. The state governments' interest in and intense oversight and regulation of the life insurance industry is motivated by two factors. First, state governments function as an agent of consumer protection. Second, state governments regulate life insurance to ensure that Americans will have sufficient retirement income and savings to remain independent of government support and subsidy.

The following section provides an overview of the U.S. life insurance industry. This section will serve as the foundation for later discussion of the main types of life insurance including term life insurance and permanent life insurance. The various forms of permanent life insurance, such as whole, variable, universal, and variable-universal life insurance, will be described. The main components of life insurance, including death benefits, beneficiaries, brokers or agents, riders, premiums, and insurance illustrations, will be summarized. The issues related to state-based regulation of the life insurance industry will be discussed.

The U.S. Life Insurance Industry

The primary professional life insurance association is the American Council of Life Insurers (ACLI). Regulation of the life insurance industry is overseen by the National Association of Insurance Regulator (NAIR). The American Council of Life Insurers, which represents the interests of 373 U.S. life insurance companies, helps shape the tax, retirement, and accounting laws affecting the life insurance industry. According to the American Council of Life Insurers, the main products offered by life insurers include life insurance, annuities, disability income insurance and long-term care insurance, and workplace savings plans such as pensions, 401(k), 403(b), 457 deferred compensation plans, and individual retirement accounts (IRAs). These financial instruments are used for risk protection, financing, and investing.

Life Insurance

Life insurance refers to insurance that guarantees a specific sum of money to a designated beneficiary upon the death of the insured or to the insured if he or she lives beyond a certain age. Both individuals and businesses purchase life insurance. Individual life insurance has two main functions. First, life insurance protects individuals and families against the financial loss of a premature death of a family wage earner. Second, life insurance is a common financial tool for retirement savings and planning. Individual life insurance benefits have no restrictions on use. Life insurance death benefits may be saved or used, for example, for expenses related to school, home, food, and travel. Life insurance death benefits are intended to help families who have lost a family member maintain their financial independence. Business life insurance is purchased by a firm for the following reasons: To protect against the potential financial losses caused by the death of the business owner and key employee; to provide perquisites for valued employees; to fund business continuity plans; and to fund employee post-retiree health benefits. Businesses tend to select life insurance as one of their main financial instruments due to the tax benefits of life insurance and the ability of life insurance to guarantee a predetermined death benefit payment when the insured dies (Chassen, 1993).

Annuity

Annuities tend to be used and favored by individuals who do not have workplace savings plans. An annuity is a financial contract issued by a life insurance company that offers tax-deferred savings and a choice of payout options to meet an owner's needs in retirement. Annuity pay-out options include income for life, income for a certain period of time, or a lump sum.

Disability Income Insurance & Long-Term Care Insurance

Disability income insurance and long-term care insurance are forms of insurance that provide financial protection for persons who become unable to care for themselves because of chronic illness, disability, or cognitive impairment such as Alzheimer's disease. The American Council of Life Insurers estimates that 45 percent of individuals aged 35 to 65 will experience a period of long-term disability. The insurance industry paid $6.3 billion in disability benefits to plan members in 2001.

Workplace Savings Plans

The life insurance industry is one of the major private sector actors in employer-based retirement and savings plans. Workplace savings plans are a form of financial risk protection. The insurance industry oversees and administers pensions, individual retirement accounts, 457 deferred compensation plans, 401(k) plans, and 403(b) plans. Pensions are programs that provide employees with retirement income after they meet minimum age. Individual retirement accounts (IRAs) are accounts to which an individual can make annual contributions of earnings up to a pre-determined amount. A 457 deferred compensation plan is a supplemental retirement savings program that allows individuals to make contributions on a pre-tax basis. The 401(k) plan is a retirement investment plan that allows an employee to put a percentage of earned wages into a tax-deferred investment account. The 403(b) plan is a retirement investment plan, which is offered by non-profit organizations, that allows an employee to put a percentage of earned wages into a tax-deferred investment account.

The U.S. insurance industry invests policyholder premiums and retirement savings to create the maximum profit and return for both the company shareholders and policyholders. The insurance industry's long-term investment capital is distributed throughout numerous investment areas. Life insurance industry assets are invested in long-terms bonds, private placements, commercial mortgages, secondary mortgages, and infrastructure. The life insurance industry is responding to market and regulatory changes by forming strategic alliances with foreign insurance companies, other domestic insurance companies, commercial banks, technology companies, and medical firms. Life insurance companies follow nine steps to form strategic alliances:

1. Life insurance companies identify their own core competencies and additional competencies required to meet their strategic goals and objectives.
2. Life insurance companies establish strategic alliance objectives such as entering new markets, generating greater revenue, reducing operating costs, gaining new knowledge, or improving information systems.
3. Life insurance companies assess the economic and competitive environment in which the strategic alliance will function
4. Life insurance companies find prospective alliance partners through consulting firms, investment bankers, or their own tactics and searches.
5. Life insurance companies evaluate a prospective alliance partner's compatibility and make a selection.
6. Life insurance companies plan the alliance through addressing requirements, contributions, controls, risk sharing, resource sharing, incentives, and scheduling.
7. Life insurance companies establish appropriate legal structures and financial arrangements that define the parameters of the strategic alliance.
8. Life insurance companies address alliance management issues by creating a committee or board to run the activities that will occur under the strategic alliance.
9. Life insurance companies formulate dissolution provisions in the event that the strategic alliance stops benefiting partners in the alliance.

The benefits of strategic alliances include an increased range of potential business activities; increased resources; and greater efficiency (Gora, 1996).

Applications

Term Life Insurance & Permanent Life Insurance

There are two main types of life insurance: Term life insurance or permanent life insurance. Individuals and businesses choose the type of insurance best matched to the policyholder's health, long-term goals, and available resources. Term insurance refer to insurance that covers the insured for a certain period of time. The term insurance policy pays death benefits only if the insured dies during the period of coverage. Term insurance is designed to cover needs that of a set duration such as mortgage or college tuition payments. Term insurance does not accrue savings. Term insurance is the most common form of life insurance offered by employers. Permanent life insurance, also referred to as ordinary life or cash value insurance, is insurance that can stay in force for the life of the insured and accrues cash value. Permanent life insurance, which can be liquidated at any point, maintains a cash value less than the policy amount that will ultimately be paid to the policy beneficiary. Permanent life insurance tends to include riders or provisions which allow the policyholder to add additional insurance coverage without demonstrating good health, to finance long-term illness, and to collect death benefits prior to death in the event the policyholder becomes disabled or terminally ill. There are four main types of permanent life insurance: Whole life, universal life, variable life, and variable-universal life insurance.

1. Whole life insurance, also referred to as ordinary life, is the most popular type of life insurance. Whole life insurance premiums remain constant throughout the life of the policy. Premiums must be paid periodically in the amount specified in the policy. Whole life insurance is a low-risk, cash-value account. Whole life insurance provides safety and predictability but lacks flexibility. For example, the insurer exclusively manages whole life investment decisions. The policyholder cannot choose to invest account assets in separate accounts such as money market, stock, or bond.

• 2. Universal life, also referred to as adjustable life, has fixed minimum and maximum premium payment amounts. Universal life is a type of permanent life insurance that allows the insured, after the initial payment, to pay premiums at various times and in varying amounts, subject to certain minimums and maximums.
• 3. Variable life is a type of permanent insurance providing death benefits and cash values that vary with the performance of a portfolio of investments. The policyholder may allocate or distribute premium payments to different investments offering varying degrees of risk, including stocks and bonds.
• 4. Variable-universal life insurance is a type of permanent insurance that combines the premium flexibility of universal life insurance with a death benefit that varies with the performance of a portfolio of investments.

According to the American Council of Life Insurers, buying life insurance involves three main stages: Researching a life insurance company, choosing a life insurance agent, and choosing a policy beneficiary. Numerous companies, including A.M. Best, Standard & Poor's, Moody's, and Duff & Phelps, rank the financial strength of life insurance companies and publicize their rankings (Daily, 1992). In many private-sector employment situations, individuals do not have the option of choosing a preferred life insurance company. Benefit managers often choose the life insurer for their company's benefit package. In the public sector, federal employees generally cannot choose their employer-sponsored life insurer. Federal employees are generally enrolled in term life insurance through the Federal Employees' Group Life Insurance Program (FEGLI). The Federal Employees' Group Life Insurance Program, established in 1954, provides life insurance to over 4 million Federal employees and retirees and is the largest group life insurance program in the world.

Issues

State-Based Regulation of Life Insurers

Since the eighteenth century, U.S. life insurance companies have been debating with the government whether life insurance should be classified as interstate or state-based commerce. The life insurance industry has maintained that life insurance is interstate commerce and should be regulated as such. In contrast, state governments, which serve a consumer protection function, argue that state-based regulatory control of insurers is necessary and justified. During the 1850s and 1860s, mot states created separate departments of insurance oversight and regulation. The federal government ended the debate between the insurance industry and state-based insurance regulators in 1945 with the passage of the McCarran-Ferguson Act. The McCarran-Ferguson Act (U.S. Code Title 15, Chapter 20) declares insurance to be interstate commerce and empowers the states to regulate the insurance business (Merkel, 1991).

Currently, the U.S. life insurance industry has a state-based system of life insurance regulation. Each state has an office, division, or department of insurance that is responsible for establishing their state rules and regulations by which the life insurance industry must abide; that records and helps resolve consumer complaints; conducts life insurer examinations; collects fees and administers licensing; and reviews life insurance rates and products. The life insurance industry continues to operate and influence state regulations to optimize profits and opportunity. For example, the majority of life insurance companies obtain their state licenses in states with the lowest regulatory stringency, with large populations and workforces, with high levels of home ownership and urbanization, with high ratios of dependents to non-dependents, and with high death rates (Colquitt & Sommer, 2005). Despite federal law, the life insurance industry continues to argue that the state-based system of life insurance regulation harms companies and consumers through high administrative expenses, lack of consistency across states, and slow pace of review and approval of new life insurance products. The life insurance industry is lobbying for reform of the state-based regulator system and an overall more efficient regulatory system for life insurers.

The U.S. life insurance industry, lead by the American Council of Life Insurers and the National Association of Insurance Commissioners (NAIC), is working to reform state insurance regulation. The Interstate Insurance Product Regulation Compact, established in 2006, is an interstate compact formed to develop national standards for life insurance, disability insurance, long term care insurance, and annuity products in participating states. Interstate compacts are a form of agreement, described in the U.S. Constitution, which refer to a contract between states that allows states to cooperate on multi-state or national issues while retaining state control. The life insurance industry argues that the Interstate Insurance Product Regulation Compact will benefit consumers by centralizing information about available life insurance products and will increase speed and efficiency of the insurance approval process. Insurers are hoping a quicker approval process will help them compete more effectively with banks, securities brokers and mutual funds (Postal, 2006). The Interstate Insurance Product Regulation Compact includes 30 member states and represents over half of the life insurance premiums in the United States. According to the Interstate Insurance Product Regulation Commission, the potential benefits for Compact member states include the following: Increased and cost-effective insurance choices in support of a competitive and modern financial marketplace; strong consumer protections; and the freedom of state insurance departments to re-allocate resources originally used for product review towards other regulatory operations.

While the final effects of the Interstate Insurance Product Regulation Compact are not yet known, the Interstate Insurance Product Regulation Compact will likely reduce some of the administrative costs and redundancy for state governments. In addition, the new Compact may result in better and more life insurance products for Americans. That said, stringent state regulation of life insurers remains important due to the potential for unethical brokers and the complex nature of life insurance policies. For example, one of the most common tools of insurance brokers, the insurance illustration, is extremely complex and potentially misleading to consumers. Life insurers provide potential policyholders with insurance illustrations. Potential policyholders often believe that these insurance illustrations are the facts, terms, and conditions of their policy. In practice, insurance illustrations are hypothetical representations that reflect critical assumptions about future market behavior. The illustrations describe a guaranteed value and a non-guaranteed value. Life insurance companies may use extremely speculative insurance illustrations to attract clients. In addition, life insurance policies are often illustrated with a premium that rises dramatically in ten years (Daily, 1992).

In addition, the life insurance industry requires continued stringent regulation and oversight due to the potential unethical and illegal race-biased premiums common at various times in the history of the life insurance industry. Beginning in the 1930s, many African Americans were sold substandard life insurance policies based on skewed mortality tables. In 2002, MetLife, Prudential, Liberty Life, and more than 20 other life insurance were under investigation by the National Association of Insurance Commissioners for race-biased policies and premium pricing (Jackson, 2002). Continued state regulation of the insurance industry and insurance brokers is necessary to ensure ethical behavior of brokers and full disclosure of policy information. Ultimately, the life insurance industry may become doubly strong and pro-consumer with the Interstate Insurance Product Regulation Compact and continued state-based industry oversight, licensing, and regulation (Cooper, 2003).

Conclusion

In the final analysis, life insurance serves three main purposes or functions for individuals and businesses: Protection, financing, and investing. The main components of life insurance include death benefits, beneficiaries, brokers, riders, premiums, and insurance illustrations. Life insurance can be divided into two main categories: Term or permanent. Factors that affect the choice of life insurance products include the flexibility, transparency, and performance of the product. In addition, individuals and companies choose their policy type based on their own objectives and the life insurance products available to them (Daily, 1992).

Terms & Concepts

Annuity: A financial contract issued by a life insurance company that offers tax-deferred savings and a choice of payout options to meet an owner's needs in retirement.

Benefits: The amount payable by the insurance company to a claimant, assignee, or beneficiary when the insured suffers a loss covered by the policy.

Beneficiary: The person or financial entity named in a life insurance policy or annuity contract as the recipient of policy proceeds in the event of the policyholder's death.

Disability Income Insurance: Insurance that provides financial protection for persons who become unable to care for themselves because of chronic illness, disability, or cognitive impairment.

Insurance Illustrations: Hypothetical representations of the value of an insurance policy that reflect critical assumptions about future market behavior.

Individual Retirement Account: An account to which a person can make annual contributions of earnings up to a specified dollar limit.

Life Insurance: Insurance that guarantees a specific sum of money to a designated beneficiary upon the death of the insured or to the insured if he or she lives beyond a certain age.

Pensions: Programs to provide employees with retirement income after they meet minimum age and service requirements.

Permanent Life Insurance: Insurance that can stay in force for the life of the insured and accrues cash value.

Term Insurance: Insurance that covers the insured for a certain period of time.

Universal Life: A type of permanent life insurance that allows the insured, after the initial payment, to pay premiums at various times and in varying amounts, subject to certain minimums and maximums.

Variable Life: A type of permanent insurance providing death benefits and cash values that vary with the performance of a portfolio of investments.

Variable-Universal Life Insurance: A type of permanent insurance that combines the premium flexibility of universal life insurance with a death benefit that varies as in variable life insurance.

Whole Life: A life insurance plan in which the premiums remain constant throughout the life of the policy.

Bibliography

About ACLI. (2007).The American Council of Life Insurers. Retrieved July 9, 2007, from http://www.acli.com/ACLI/About+ACLI/Default.htm

Chassen, A. (1993). Choosing life insurance. Management Accounting, 74, 10-22.

Colquitt, L., Sommer, D., & Godwin, N. (2005). An empirical analysis of life insurer state licensing choices. Journal of Insurance Regulation, 24, 93-111. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=20024609&site=ehost-live

Cooper, R., Frank, G., & Williams, A. (2003). The life insurance industry's ethical environment: Has it improved in the new millennium? Journal of Financial Service Professionals, 57, 38-50. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=11233524&site=ehost-live

Cordell, D., Finke, M., & Lemoine, C. (2007). The death of life? Journal of Financial Planning, 20, 42-44. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=23722770&site=ehost-live

Cymbal, K.M. (2013). Choosing a family member as trustee of an irrevocable life insurance trust. Journal of Financial Service Professionals, 67, 41-52. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89934873&site=ehost-live

Daily, G. (1992). Life insurance sense and nonsense. The CPA Journal, 62, 58-65.

Frequently Asked Questions About the Interstate Insurance Product Regulation Commission. (2006). Interstate Insurance Product Regulation Commission. Retrieved July 9, 2007, from http://www.insurancecompact.org/compact%5ffaq.htm

Gandolfi, A., & Miners, L. (1996). Gender-based differences in life insurance ownership. Journal of Risk & Insurance, 63, 683-693. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9701241957&site=ehost-live

Gora, J. The basics of life insurance industry strategic alliances. (1996). The Journal of the American Society of CLU & ChFC, 50, 38-42.

Hezzelwood, W.L. (2013). Managing life insurance policies: An analytical approach built on standard actuarial techniques. Journal of Financial Planning, 26, 60-66. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90536792&site=ehost-live

Jackson, L. (2002). Race-biased premiums. Black Enterprise, 32, 282. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=6700678&site=ehost-live

Love, T., & Miller, W.C. (2013). Repercussions of a sustained low-interest-rate environment on life insurance products. Journal of Financial Service Professionals, 67, 44-52. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85802247&site=ehost-live

Merkel, P. (1991). Going national: The life insurance industry's campaign for federal regulation After the Civil War. Business History Review, 65, 528-554.

Postal, A. (2006). Interstate compact comes to life. National Underwriter, 110, 6-7.

Suggested Reading

Corbett, R., & Nelson, J. (1992). A comparison of term insurance rates to protection-related charges in universal life insurance. Journal of Risk & Insurance, 59, 470-475. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9701231498&site=ehost-live

Hwang, T., & Greenford, B. (2005). A cross-section analysis of the determinants of life insurance consumption in mainland China, Hong Kong, and Taiwan. Risk Management & Insurance Review, 8, 103-125. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=16792879&site=ehost-live

Polborn, M., Hoy, M., & Sadanand, A. (2006). Advantageous effects of regulatory adverse selection in the life insurance Market. Economic Journal, 116, 327-354. Retrieved July 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19476935&site=ehost-live