Insurance Topics. I. Introduction to Insurance

Transcription

1 I. Introduction to Insurance Everyone has a need for financial security. When tragedies strike, people want to have peace of mind knowing they are financially secure. Tragedies may hit at any time without advance notice. Insurance can provide financial security so the uncertainty surrounding disaster is alleviated. Insurance transfers an individual s uncertainty of loss to the insurance company. Life and Health insurance protects against impairment to a person's greatest asset, their earning power, caused by injury, sickness, retirement and/or death. Insurance contract: A legal agreement made between an insurance company and an individual, where the insurer collects a small amount of money, called a premium, from the insured in exchange for the insurer s promise to pay potential future benefits in the event of covered losses. Two important features must be present for insurance to operate properly: Risk Pooling: Combines similar losses from many people so that the average loss over the entire group is relatively constant. Law of Large Numbers: In order to have a general idea of how many losses will occur in a given year, insurers use the law of large numbers, which states that as the group increases in size, it is easier to predict the number of future losses over a certain period of time. Definitions Mortality is the rate at which people die. Morbidity is the rate at which people get sick, injured or disabled. Risk is defined as the possibility of a loss occurring. Pure risks are the only insurable risks and present a potential for loss such as injury, illness, and death, whereas speculative risks present the chance for loss or gain. Loss is the unintentional decrease in the value of an asset due to a peril. Exposure is the condition of being prone to loss due to a hazard or uncertain event. Peril is the cause of the loss and the event insured against. In life and health insurance, the perils are premature death, dependency during old age, accident, and sickness. Hazard is anything that increases the chance of loss occurring from a particular peril. Hazards are conditions such as icy roads, improperly stored toxic waste and drinking while intoxicated. The 4 types of hazards are physical, moral, morale, and legal. A physical hazard is defined as physical characteristics which raise the loss potential for a particular peril. A moral hazard is defined as the predisposition, character, habits and values of a person which increase the chance of a loss occurring. A morale hazard is an insured s careless attitude, indifference or lack of responsibility which increase the chance of a loss occurring. A legal hazard is the application of laws, regulations, and legal court rulings which increase the chance or amount of loss. Methods of Handling Risk There are 5 ways to handle risk: avoidance, retention, sharing, reduction and transfer. Insurance is risk transfer. Adverse Selection: The term adverse selection is a demand for insurance coverage by people who are worse than average risks, and are therefore more likely to need and use

2 the coverage. For example, an 80-year smoker with lung cancer who has 3 years left to live would receive a huge payout on a life insurance policy purchased at this juncture in his life (because he is almost certain of when he will die). Adverse selection results from an asymmetry of information. The insured knows he is sick already and needs the benefits provided by the insurance coverage, while the insurer may not have this information. Reinsurance spreads risk from one insurer to one or more other insurers. The insurer that accepts the additional risk is termed the reinsurer. The insurer that gives the risk to the reinsurer is termed the ceding company or primary insurer. Insurance Coverage Basic Terms Indemnity means to make whole. Insurance policies agree to provide payment of benefits to restore the insured s economic loss. Limit of Liability: The total amount the insurer will pay for an insured risk. Premium: Set cost of insurance coverage paid by the policyholder to the insurer. Deductible: The amount the insured must pay before the insurer will pay a claim. Coinsurance: A cost-sharing mechanism between the insurer and the insured in a medical insurance transaction, where for a certain range of coverage the insurer agrees to pay a large percentage of the expenses and the insured is responsible for paying the remainder. Claim: The insured s notification to the insurer that a payment is requested for a covered loss. Common Types of Insurance Life insurance is designed to protect against the risk of premature death. Health insurance is designed to protect against the severity of financial loss due to illness, disease, short- or long-term disability, wages lost while ill or disabled, and medical expenses. Annuities protect against the risk or living longer than expected. Annuities provide a guaranteed life income to protect against the risk of depleting retirement funds. Property insurance protects against the risk of damage and destruction to all types of property. Casualty insurance protects against the risk of legal liability for injury, death, disability, damage and destruction to property. Credit insurance protects against the risk that a person in debt, termed debtor, cannot repay the debt to the creditor because of accident, sickness, disability or death. Credit life and credit health insurance cover these risks. Variable insurance is comprised of variable life and variable annuities. Variable insurance products invest premium dollars in securities, which carry more risk due to price fluctuations. One requirement of selling variable products is a securities license and a life insurance producer license. II. Insurance Industry Overview This section will give you a brief overview of the types of insurers in the insurance industry, as well as a look at the various regulations that insurers must abide by when transacting an insurance contract. Types of Insurers

3 Stock Companies are incorporated companies owned by their stockholders, who are paid their share of the company s profit through dividends. Traditionally, stock insurers are called nonparticipating insurers because policyholders do not receive dividends. Transformation of a stock insurer into a mutual insurer is termed mutualization, and the reverse is termed demutualization. Mutual Companies are commercial insurers that are owned by their policyholders. Mutual companies lack capital stock, and profits are paid via dividends to policyholders. Since mutual insurers issue dividends to policyholders, they are referred to as participating insurers. Noncommercial Organizations or Service Providers are not technically insurers and do not sell insurance. They are better described as service organizations that provide prepaid health plans for medical, surgical, and hospital expenses. Service providers sell medical services to members, who are termed subscribers. Admitted versus Nonadmitted Insurers In order to sell insurance in a state, insurers must receive a license from that state s department of insurance. The license, called a certificate of authority, authorizes an insurer to sell insurance for particular lines (i.e. life, health, property, casualty, etc.). Admitted insurers are also referred to as authorized or licensed insurers. Nonadmitted insurers, (non-licensed or unauthorized) do not have licensure because they have not yet applied, have applied and been denied licensure, or are excess and surplus lines insurers. Even though excess and surplus lines insurers are considered unauthorized insurers in a state, they are permitted to transact insurance business in that state. Domestic Insurer: An insurer that conducts business in the state it was incorporated Foreign Insurer: An insurer that conducts business in a state or district in which it wasn t incorporated. Alien Insurer: An insurer that conducts business in a country in which it wasn t incorporated. Independent Rating Services Financial Status Independent rating organizations are credit rating agencies that rate or grade the financial strength and stability of insurers based on claims, reserves, and company profits. The nationally recognized statistical rating organizations that rate insurers are A. M. Best, Moody s Investors Service, Standard and Poor s, Fitch Ratings, Ltd., LACE Financial, and Japan Credit Rating Agency, Ltd. Each rating service has its own rating system, but most use an A to F letter grading scheme. Marketing (Distribution) Systems Distribution systems are the ways insurance products are marketed and sold to the public. Insurance can be purchased through licensed insurance producers, who are either agents or brokers, or through a number of other ways. Agents are appointed to work on behalf of insurance companies. Brokers are not appointed with any insurance company, and can sell insurance for several companies. For insurance transactions, agents represent the insurance company, and brokers represent the purchaser.

4 Agents are either captive/career agents or independent agents. Captive agents work for only one insurer. Independent agents work for themselves or for several insurers nonexclusively. The primary types of agency systems are: Career Agency System; Personal Producing General Agency System; Independent Agency System; and Managerial System. Mass Marketing Another way to sell insurance is through mass marketing methods. These methods are commonplace today, and include methods such as, direct response and franchise sales. Producers are people who sell, solicit and negotiate insurance. Agents are insurance producers who represent and work on behalf of the insurer. Brokers are insurance producers who represent the insured or purchaser of insurance. Brokers work for several different insurers. Solicitors are licensed salespeople who work for an agent or broker. Agents and Rules of Agency An agent is defined as an individual who works on behalf of another individual or entity, called the principal, in dealing with the contractual agreements of third parties. In the insurance industry, the insurer is the principal. The law of agency states that the acts of an insurance agent are deemed the acts of the insurer. Authority and Powers of Agents Agents are granted authority and power through the agency contract, which is established by the insurer. The powers, duties and authority of agents are the only circumstances under which the insurer is bound by the agent s actions. The three types of agent authority are express, implied and apparent. Express authority is the explicit authority granted to the agent by the principal as written in the agency contract. Implied authority is not specifically expressed by the principal to the agent in the agency contract, but is implicit in the agent s duties and is based on express authority. Implied authority is authority that the agent is presumed to have as part of his ability to transact insurance. Apparent authority is a situation in which the insurer gives the customer reasonable belief that an agent has the power and authority to bind the principal even in cases where the agent does not have such authority. Responsibilities to the Applicant/Insured Insurance agents have a responsibility to act in a professional and ethical way to applicants and insureds. Agents are required to uphold a fiduciary trust with respect to applicants and insureds. This means that agents must handle premiums in a position of financial trust. Agents must not commingle premiums with their personal funds. Market conduct establishes policies and procedures that producers must use as a guide for advertising and selling insurance. A market conduct examination is a non-financial examination conducted by a state's insurance department to investigate an insurer's methods and practices of conducting insurance business. A market conduct examination is used to establish an insurer's authority to transact insurance in a particular state. All books and records of an insurer are investigated to verify that the insurer and its employees are in compliance with state and federal insurance laws and regulations.

5 Industry Oversight and Regulation While insurance is predominantly regulated on a state-by-state basis, the following federal laws affect the insurance industry: Privacy Act of 1974: Establishes a code of fair information practices dictating how information is handled by federal agencies. The Privacy Act mandates federal agencies to provide the public with a notice of their systems of records, or a federal agency s set of records in which individuals information is identified by name or another form of identifier, such as a social security number. The Act forbids disclosure of information from a system of records without the individual s written consent, unless 1 of the 12 exemptions applies. The Privacy Act gives individuals a way of retrieving their records and correcting inaccuracies in these records. Fair Credit Reporting Act: Regulates the way consumer credit reporting agencies collect and use an applicant s personal credit information in order to preserve the confidentiality, accuracy, relevance, and appropriate utilization of the information. Consumer Reports are any written, oral, or other communication of information by a consumer reporting agency about a consumer s credit worthiness, character, general reputation, personal characteristics or mode of living which are used to determine a consumer s eligibility for credit, insurance, employment, or other authorized purposes. Investigative Consumer Reports contain information on a consumer s character, general reputation, personal characteristics, or mode of living but are obtained through personal interviews with neighbors, friends, or associates of the consumer. Investigative consumer reports do not use credit information from creditors, credit records, or credit reporting agencies. Pretext interviews are interviews in which the interviewer assumes a false identity or refuses to disclose his true identity and interviews a person without disclosing the true purpose of the interview. The FCRA requires that applicants receive a notice upon policy application that a credit report may be performed. If an insurer declines to offer coverage or must modify the coverage as a result of the information provided in a consumer or investigative report, the insurer must provide the consumer with the name of the credit reporting agency and address. National Association of Insurance Commissioners (NAIC): Promotes the standardization of insurance laws between states without the use of federal regulations. Fraud and False Statements: Punishes any individual who knowingly and with the intent to deceive, makes any false material statements regarding any financial reports or documents. A person convicted of violation is subject to punishment by a civil fine of up to $50,000 per act or in an amount received or provided in the course of the violation, whichever is greater, or imprisonment for a maximum of 10 years, or both penalties, except that the term of imprisonment will be a maximum of 15 years if the statement or report, or overvaluing of land, property or security jeopardized the safety and soundness of an insurer and was a significant cause of such insurer being placed in conservation, rehabilitation, or liquidation in the appropriate U.S. district court. Guaranty Associations: State life and health guaranty associations provide a safety net for all member life, health and annuities insurers in a particular state. Guaranty associations protect insureds in the event of insurer insolvency, or inability to pay claims.

6 Ethical Regulations Unfair Marketing Practices Misrepresentation: Any written or oral statement that does not accurately describe a policy s benefits, conditions, or coverage. Defamation: Any false, maliciously critical, or derogatory communication (written or oral) that injures another s reputation, fame, or character. Rebating: An illegal practice for an agent or broker that involves the return of a portion of the premium or the agent s commission on the premium to the insured or other inducements to place business with a specific insurer. No insurance company, employee, or intermediary may influence another person to buy a policy by offering benefits that are not outlined in the policy. Twisting: The unethical act of persuading a policyowner to drop a policy solely for the purpose of selling another policy without regard to possible disadvantages to the policyowner. Churning: The practice of using misrepresentation to induce a policyholder to replace a policy issued by the insurer the producer represents, rather than the policy of a competitor. False Financial Statements: Deliberately making false financial statements regarding the solvency of an insurer with the intent to deceive others. Unfair Discrimination: Policyholders cannot be charged different premiums or be given different coverage terms unless the difference are based on classifications relating to the nature and degree of the covered risk. Boycott: A form of intimidation in which an individual or group refuses to do business with a company or individual, either to drive them out of business or force them to act in a certain way. Coercion: Manipulating someone through the prospect of something desirable. intimidation: Manipulating someone through the threat of a negative result, i.e. the loss of business or insurance coverage. Unfair Claims Settlement Practices Knowingly misrepresenting to claimants pertinent facts relating to coverages; Failing to acknowledge with reasonable promptness communications regarding claims; Failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements have been completed and filed; Failing to adopt reasonable standards for prompt investigation and settlement of claims; Not attempting in good faith to effect prompt, fair, and equitable settlement of claims; Offering to settle claims for an amount less than the amount otherwise reasonably due or payable. Delaying the investigation or payment of a claim by requiring an insured, claimant, or the physician of either to submit a preliminary claim report and then requiring the subsequent submission of formal proof of loss forms, both of which submissions contain substantially the same information; Threatening a client in order to discourage his effort to recover a loss or reduce the claim by, for instance, mentioning a policy of appealing arbitration awards that are in favor of insureds;

7 Any other practice which constitutes an unreasonable delay in paying or an unreasonable failure to pay or settle in full claims. III. Legal Concepts In this section, we will discuss general contract law including the essential elements of a contract, terms and concepts, and how they apply to the insurance contract. Insurance policies are legal contracts. A contract is a legally binding agreement between two or more parties where a promise of benefits is exchanged for valuable consideration. Every contract must contain the following four elements: The first element is the Agreement made up of the Offer and Acceptance. An offer is made when the applicant submits an application to buy insurance along with the initial premium. The offer is accepted after it has been approved by the insurer s underwriter and issuing a policy. The second element is Consideration. Consideration is an exchange of value between parties of the contract. The insured provides consideration in the statements on the application and payment of the premium. The insurer provides consideration by promising to pay a covered loss. The third element is Competent Parties. All parties must be of legally competence, meaning they must be of legal age, mentally capable of understanding the terms, and not influenced by drugs or alcohol. And the fourth element is Legal Purpose. An insurance contract must be legal and not be against the law. If an insurance contract has insurable interest and the insured has provided written consent, it has legal purpose. Now that you know the elements to an insurance contract, let s discuss a main component of an insurance contract the: Insuring Clause. The insuring clause is the insurer s promise to pay covered losses as long as the insured pays the premiums and abides by the terms and conditions. Insurance contracts have some unique characteristics not found in all contracts: The first is that they are a Contract of Adhesion. They are take it or leave it agreements, where the insured has no say in the contract terms and conditions. The second is that they are Unilateral. Unilateral Contracts are one sided agreements, where only the insurer is legally bound. The third is that they are Conditional Contracts. Insurance contracts are conditional because certain conditions must be met by all parties to the contract when a loss occurs in order for the contract to be legally enforceable.

8 Unique Aspects of Contracts Conditional Unilateral Adhesion Certain conditions must be met by all parties to the contract when a loss occurs in order for the contract to be legally enforceable One- sided agreements; only the insurer is legally bound Take it or leave it contract; the insured has no say in the contract terms or conditions Some Other Characteristics are: Representations: Representations are statements made by the insured, to the best of his knowledge. Misrepresentations: Misrepresentations are intentional misstatements made by the insured. Warranties: Warranties are statements that are guaranteed to be true and are part of the legal contract. Breach of warranty is grounds for voiding an insurance contract. Concealment: Concealment is withholding information material to the risk. Insurers may void policies if the concealment is intentional and material to the risk. Fraud: Fraud is an intentional misrepresentation or concealment of material fact made by one party in order to cheat another party out of something that has economic value. Waiver: Waiver is either intentionally or voluntarily surrendering a known right. Estoppel: Estoppel is the legal process of preventing one party from reclaiming a right that was waived. Rescission: Insurance contracts may be voided if one or more parties to the contract commit a material misrepresentation or concealment. Subrogation: The right of the insurer to assume the rights of the insured and sue the responsible third party for damages inflicted upon the insured. You need to know these definitions. They usually show up on the state exam. Now let s discuss some unfair practices. You can lose your license for violating these so you need to learn them. Rebating: Rebating is an illegal practice for an agent or broker that involves the return of a portion of the premium or the agent's/broker's commission on the premium to the insured or other inducements to place business with a specific insurer. No insurance company, employee or intermediary can influence another person to buy a policy by offering benefits that are not outlined in the policy. The insurance company cannot make agreements not written in the policy. No intermediary, broker or insurer can absorb the premium tax for unauthorized insurance that was purchased.

9 Defamation: Any oral or written communication about a person that is untrue that is harmful to a person's reputation. Unfair Discrimination: Policyholders cannot be charged different premiums or be given different coverage terms unless the differences are based on classifications relating to the nature and degree of the covered risk. Averaging rates amount people covered under a group, blanket or franchise policy is not discrimination. Controlled Business: The amount of insurance issued by a producer in which most states limit the amount that may be written. If he premiums or commissions on controlled business exceed a certain percentage, the producer's license may be suspended, revoked or not renewed. Twisting and Churning: An insurance agent cannot induce or attempt to induce a policyholder to cancel an existing policy to take out another policy that contains close to the same elements by misrepresenting the new policy. An agent cannot attempt to cancel an existing policy and replace it with a new policy because this generates additional commission for the agent and may cost the policyholder more in the future. Advertising: Advertising for health insurance policies must be truthful, not misleading, and avoid using insurance jargon. The words and phrases must be clear and accurately describe the policy features. Illustrations must be accurate and relevant with regards to the policy advertised. Testimonials must be genuine and current. Advertisements may not make unfair, incomplete, or unsubstantiated comparison of other insurers' policies or benefits. IV. Insurance Underwriting In this section we will cover the process involved with applying, issuing, and delivering insurance policies. Underwriting is the process that insurance companies use to select, classify and rate risks. Insurance companies use the underwriting process to prevent adverse selection, which could cause the insurance company to become insolvent. Underwriting is used to classify risks and assign premium rates that accurately reflect the amount of risk undertaken by the insurance company. While the selection, rating, and classifying of risks are part of the underwriting process, the notification of risks is NOT part of the underwriting process.

10 Underwriting Underwriting is the process that insurers use to select, classify and rate risks, so that they accurately reflect the amount of risk undertaken. Factors that impact the selection, classification and rating of life and health risks include the individual s age, gender, build, lifestyle, smoking status, hobbies, hazardous occupations, medical history, and family health history. Insurers cannot base underwriting on national origin, race or sexual orientation. Field Underwriting Field Underwriting is performed by the producer, face-to-face with the applicant. As field underwriters, producers help reduce the chance of adverse selection, assure that the application is filled out completely and correctly, collect the initial premium and deliver the policy. Key Terms Below are a few key terms in underwriting. Applicant is defined as the person applying for the policy who fills out the application to be submitted. Policyowner is the person who has all the ownership rights under the policy, pays the premiums, and accepts the policy when delivered.

11 Insured is the person who is covered under the policy. Beneficiary is the named person(s) who receive the policy benefits. Information Sources The most important source is the application. Another important source is the Medical Information Bureau (MIB). Other sources may include: agent report, attending physician statements, investigative consumer report. Application: The application is one of the primary sources of information used in underwriting an insurance policy. The person who applies for coverage must complete and submit the application. In most cases, the application is attached to, and becomes part of the contract. The application is attached to the policy so that it becomes a legal part of the insurance contract. Therefore, if the insurer discovers intentional misstatements in the application, the application can be used as a legal document. Medical Information Bureau (MIB): The MIB is a nonprofit trade organization which maintains medical information about individuals. Information from the MIB is used by life and health insurers. Member insurers supply the MIB with confidential aversive information about an applicant for insurability purposes. Information collected includes underwriting information such as an individual's hazardous activities and impairments to insurability; however, the MIB does not collect claims information or how much coverage an individual has. Insurers may access MIB information on an applicant only if needed for additional investigation. Insurers cannot refuse to issue policies solely on information supplied by the MIB. Selection Criteria and Unfair Discrimination Insurers are in the business of selecting good risks that will not jeopardize the financial stability of the company. Insurers use discrimination to determine good risks. However, insurers cannot unfairly discriminate against individuals who are part of the same risk class and have the same life expectancy in any policy condition or coverage. Discrimination against the blind, physically or mentally impaired or sexual orientation all qualify as unfair discrimination. Classification of Risks Underwriters use the following rating classification system to categorize the favorability of a given risk: preferred, standard, substandard, and declined. Preferred: Individuals who are above average in terms of physical condition and lifestyle and present a less than average risk to the insurer. Standard: Individuals in average physical condition with average lifestyles and habits. Substandard: Higher risks, due to the applicant s physical condition, disease history, hazardous occupation or dangerous hobbies or habits. Declined: Risks that are uninsurable because the applicant is too risky for an insurer to provide coverage.

12 Premiums Premiums are calculated based on three factors: Mortality: Mortality is the rate at which a specific population dies, (used for life insurance). Insurers compile this information into mortality tables sorted by age, sex, smoking status, etc. Morbidity: In health insurance, morbidity determines the rate at which accident, sickness or disability will occur. Interest Earnings: Premiums are paid in advance before a claim is made, so that they may be invested and earn interest. Higher interest rates allow insurers to charge lower premiums. Expenses: Including acquisition costs, staff salaries, rent, contingency funds, and due claims payments. Expenses are also so called Loading. Premium Concepts for Life Insurance Net Premium includes mortality and interest. Gross Premium is the net premium with loading. Premium=Mortality Risk+Operating Expenses minus interest Premium Payment Mode The premium payment mode is the frequency premium payments are made. Premium Receipts Annual Premium=Least Expensive Mode Monthly Premium=Most Expensive Mode Know the following details with regard to Applications: Producers should make every effort to collect the initial premium with the application. The producer issues the applicant a premium receipt upon collecting the initial premium. Conditional Receipt: The producer issues a conditional receipt to the applicant when the application and premium are collected. The conditional receipt denotes that coverage will be effective once certain conditions are met. If the insurer accepts the coverage as applied for, the coverage will take effect from the date of the application or medical exam, whichever is later. There are two types of conditional receipts: insurability and approval. The difference between the two receipts is when coverage begins. With the insurability receipt coverage begins on the application date or date of medical exam. The insurability receipt provides interim coverage as long as the applicant is insurable as applied for. If not, coverage is not effective. Unlike the insurability receipt, the approval receipt does not provide interim coverage; however, coverage begins when the application is approved by the insurer.

13 Binding Receipt: The binding receipt or the temporary insurance agreement provides coverage from the date of the application regardless of whether the applicant is insurable. Coverage usually lasts for 30 to 60 days, or until the insurer accepts or declines the coverage. Binding receipts are rarely used in life insurance, and are primarily used in auto and homeowners insurance. Backdating is the process of predating the application a certain number of months, up to a maximum of 6 months, in an attempt to achieve a lower premium. Delivery A policy is delivered after the insurer approves the application and issues the policy for delivery. The policy does not take effect until the initial premium has been collected, the application approved, and the policy is issued and delivered. Some insurers require a Statement of Good Health to be signed and collected from the insured, verifying that the insured has not become ill, injured, or disabled during the policy approval process. Explaining Coverage to Client: the applicant must receive a document explaining the coverage purchased and the names of the insurer and agent. In life insurance, this document is called the policy summary. In health insurance, it is called the outline of coverage. Effective Date of Coverage: The effective date of coverage is the date the policy coverage becomes effective and in force. The effective date of coverage is the date of the application as long as the premium accompanies the application, and the policy is approved as applied for. Otherwise, the effective date of coverage is the date the policy is delivered, the statement of good health signed (if required) and the premium collected. Buyer's Guide: The buyer s guide provides information on the different types of insurance coverages available to a policyowner. Many states require the buyer's guide be provided to the applicant upon application. However, the buyer s guide may be provided at the time of policy delivery if a 10-day free look period is provided, which is required in most states. Statement of Good Health: The statement of good health verifies that the insured has not become ill, injured or disabled during the policy approval process (time between submitting application and delivery of the policy). Common Situations for Errors/Omissions (E&O) The producer is prone to creating a situation that misrepresents the proposed coverage while selling the policy to an individual. A producer can protect himself by obtaining Errors and Omissions (professional liability) insurance coverage. USA PATRIOT Act/anti-money laundering The USA PATRIOT Act (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001) gives more leeway to law enforcement agencies in searching the following records: & telephone communications, medical, financial and foreign intelligence garnered within the U.S. The Act provides a means for preventing, detecting and prosecuting international money laundering (money laundering is concealing the origin of money money that has been obtained illegally, such as through crimes, drug trafficking, etc.), especially money

14 which is used to finance terrorism. The Act institutes more stringent record-keeping rules for financial institutions, such as requiring thorough records for transactions processed from parts of the world in which laundering is particularly a concern.

15 I. Life Insurance Basics When a loved one dies, many times the loss of life is not the only loss. The loss of income has dire consequences for the family. Life Insurance provides a way for the insured to leave money to beneficiaries upon death. For life insurance, insurable interest exists when the applicant financially prospers from the continued life of the insured, and the death of the insured would cause financial hardship. Insurable interest must be present when the policy is applied for; however, insurable interest does not need to exist thereafter. In either case, the death benefit will be paid. There are three categories of insurable interest in life insurance: A person s own life The lives of relatives or spouses In business/financial relationships Personal uses of Life Insurance include: Survivor Protection-One of the most common reasons for purchasing life insurance is to provide financial protection for family and dependents if the insured dies. The death of either spouse can strain the financial stability of a family. Life insurance can provide a family with a stream of income to fulfill the family's basic necessities of life and current lifestyle. These needs include: mortgage payments, living expenses, children's education, health insurance, and surviving spouse's retirement income. Estate Creation-Life insurance creates an immediate estate. Estates may be created in other ways, such as through savings and investments, but if such methods are not effective or time does not permit, life insurance can assume the role of estate creation. For example, an investment fund may take years to grow; whereas, a life insurance policy purchased today creates an immediate estate in a minimum amount of at least the initial premium. Cash Accumulation-Life insurance policies that build cash value (whole life policies) may be used as a cash accumulation vehicle for any number of purposes. A life insurance policy that builds cash value is said to have living benefits. Some common purposes for accumulating cash include funding a college education, saving for retirement, or purchasing a home. Business uses of Life Insurance include: Buy-Sell Funding, Key Person Insurance, and Employee Benefit Plans Buy-Sell Funding is life insurance funded agreements used to assure that the ownership of the business is sold to the surviving owners in the event of the insured employee s death or disability. Key Person Insurance is Insurance purchased to prevent the financial loss that may ensue when an owner, officer or manager dies. The company purchases, pays the premiums and is the beneficiary of the life insurance policy on the key person. The amount of coverage needed reflects the expected amount of loss in income and sales

16 caused by the key person s death, and the cost of hiring and training a replacement. The company cannot deduct the premiums from taxes; however, the death benefit is received tax free. Employee Benefit Plans are given to employees as perks or privileges designed to provide incentive to join or remain with the company long-term. A few examples are: Executive Bonus Plans, Deferred Compensations Plans and Split Dollar Plans. Now let s do a general overview of different classes of insurance. Group versus Individual Group Life Insurance provides life insurance to many people under one policy. A master policy is issued to the organization, and individual certificates evidencing coverage are given to each member insured. Individual Life Insurance is issued on the life of one individual, with individual underwriting, rates, and coverage. Permanent versus Term Permanent Life Insurance is whole life insurance that is effective for the entire life of the insured or up to age 100. Whole Life is permanent protection plus the cash value. Term Life Insurance is effective for a temporary period of time, designated by the policy. Term Insurance has no cash value and is temporary. Participating versus Nonparticipating Participating Life Insurance policies are policies that pay dividends to policyholders, who have the option of receiving the dividend in cash, accumulate at interest, purchase more coverage, reduce premium prices, pay up the entire policy, or purchase 1-year term insurance. Mutual Insurance companies are participating. Nonparticipating Life Insurance policies are policies that pay dividends to shareholders, not policyholders. Stock Companies are nonparticipating. Fixed versus Variable Fixed Life Insurance policies earn a constant rate of interest thereby providing a guaranteed minimum of benefits. Variable Life Insurance policies earn a fluctuating rate of interest and do not guarantee a certain cash value. Life Insurance Premiums Life insurance rates, or premiums, are calculated based on three factors: 1. mortality, 2. investment return, and 3. expenses.

17 Other factors that impact the premium amount include: age, sex, health, occupation, hobbies and habits. In life insurance, the risk of death increases with age. Mortality is the most important factor in establishing life insurance premiums. Insurance companies employ people to collect and analyze risk data. These people are mathematicians known to the insurance industry as actuaries. They take statistical data and determine the rate people will die, termed mortality, and the rate people will get sick, termed morbidity. Mortality data is compiled into actuarial tables which are then used to establish premium rates by demographic. Mortality tables require a large number of people over great time periods to be accurate. The 2001 Commissioners Standard Ordinary Tables, or 2001 CSO Tables, portray the number of years a male or female is expected to live at any given age Net single premium = mortality interest Gross single premium = net single premium + expenses Premium Payment Mode The premium payment mode is the frequency that premium payments are made. Most insurers accept premium payments annually, semi-annually, quarterly, and monthly. Home service policies accept weekly premiums. Taxation of Premiums Premiums paid on individual life insurance policies are generally not deductible. Premiums for life insurance used for business purposes are generally not tax-deductible either. Here are the exceptions to these rules: Premiums used for a charity are tax-deductible. Life insurance premiums paid by an ex-spouse as court-ordered alimony are tax-deductible. Employer-paid premiums used to fund group life insurance for the benefit of employees are tax-deductible. II. Life Insurance Policies As you learn about the different types of life insurance, recall that life insurance protects against the risk of premature or untimely death. Keep in mind that your duties as an insurance producer involve helping clients select the appropriate types of coverage to fulfill their needs. Learn the distinguishing features of each policy. Here is a general overview of different classes of insurance: Types of Policies Whole Life Ordinary (Straight) Life Limited-pay Life Single- Premium Life Interest/Market- Term Life Combination Sensitive Plans Universal Life Level Joint Life Variable Whole Life Decreasing Survivorship Life (Second to Die) Variable Universal Life Return of Premium

18 Adjustable Life Group versus Individual Interest-sensative Whole Life Equity-indexed Life Annually Renewable Increasing Term Individual Individual issued policy Individual selects plan Individual apply Individual underwriting More expensive More restrictive Group Master policy issued for group Group selects plans to pick from Eligible employees apply Group underwriting Less expensive Less restrictive Group Life Insurance provides life insurance to many people under one policy. A master policy is issued to the organization, and individual certificates evidencing coverage are given to each member insured. Individual Life Insurance is issued on the life of one individual, with individual underwriting, rates, and coverage. Permanent versus Term Permanent Life Insurance is whole life insurance that is effective for the entire life of the insured or up to age 100. Whole Life is permanent protection plus the cash value. Term Life Insurance is effective for a temporary period of time, designated by the policy. Term Insurance has no cash value and is temporary. Participating versus Nonparticipating Participating Life Insurance policies are policies that pay dividends to policyholders, who have the option of receiving the dividend in cash, accumulate at interest, purchase more coverage, reduce premium prices, pay up the entire policy, or purchase 1-year term insurance. Mutual Insurance companies are participating. Nonparticipating Life Insurance policies are policies that pay dividends to shareholders, not policyholders. Stock Companies are nonparticipating. Fixed versus Variable Fixed Life Insurance policies earn a constant rate of interest thereby providing a guaranteed minimum of benefits. Variable Life Insurance policies earn a fluctuating rate of interest and do not guarantee a certain cash value. There are two primary types of life insurance: term and whole Term Life Insurance: It provides a death benefit within a specified time period (pure death protection). Whole Life Insurance: It provides permanent protection: a death benefit and

19 living benefits (cash values) for the entire life of the insured. Term Life Insurance Term life insurance provides pure death protection since it only pays a death benefit if the insured dies during the policy term. Term life insurance does not accrue cash value. Types of Term Insurance Level Term: Level policies provide a level face amount throughout the policy period. Two types: annual renewable term and level premium term. 1. Annual Renewable Term: It has a level face amount and increasing premiums. 2. Level Premium Term: Also called level premium level term, has a level face amount and level premiums. Premiums tend to be higher than annual renewable term because they are level throughout the policy period. Convertible Term: Policies that allow term life policy owners to convert their term insurance into permanent policies without showing proof of insurability. Upon conversion, a convertible term policy will have higher premiums because permanent protection is more expensive than term protection. Original Age-The original age is the insured s age upon conversion. Attained Age- The attained age is the insured s age upon purchase of the term policy. Renewable Term: Policies that allow the policy owner to renew the term policy after the designated term expires without having to prove insurability. Decreasing Term: Policies that provide a face amount that decreases to zero over the policy period. The face amount equals zero on the day the policy expires. The premiums are level. E.g. mortgage reduction insurance. Increasing Term: Insurance that provides an increasing face amount with level premiums. Indeterminate Premium: Policies that have premiums that fluctuate between the current rate and maximum rate, as stated in the policy. Whole Life Insurance Whole Life Insurance provides permanent life insurance protection for the insured s entire life, and living benefits including cash values and policy loans. Cash value in a whole life policy is a nonforfeiture value meaning that the policy owner is guaranteed to it. Policies are issued based on the insured s original, or issue age (age at application). Types of Whole Life Three basic types of whole life are: Straight Life: It is also referred to as ordinary life. This is basic whole life insurance with a level face amount, and level premiums payable over the insured s entire life. Limited Payment (LP) Whole Life Policies: The insured is covered for his entire life, but premiums are paid for a limited time. Face amount and premiums are level.

20 Single Premium Whole Life Policy: It allows the insured to pay the entire premium in one lump-sum, and have coverage for the insured s entire life. Policies have a level face amount. Traditional Whole Life Ordinary (Straight) Life Limited-pay Single-premium Life Adjustable Life Death Benefits Premiums Cash Value Level Face Amount Level premiums payable over the insured s entire life Face amount can be adjusted Level premiums paid for a limited time Premium paid in one lump-sum Premiums can be raised or lowered Cash value is a nonforfeiture value and is guaranteed. Other types of Whole Life Indeterminate Premium: Indeterminate whole life policies provide a lower initial premium that can fluctuate up to a maximum premium as stated in the policy. Joint Life Policies Joint life insurance policies insure the lives of two or more people. Premiums for joint life policies are less expensive than if each life was insured on a separate policy. First-to-die Joint Life: Policy that pays the face amount upon the first insured s death. After the first insured dies, the contract does not provide any further life insurance coverage. Survivorship Life: Policy proceeds are only paid out upon the death of the second insured. Flexible Premium Policies Flexible premium policies not only offer life insurance with flexible premiums, but also provide flexible cash values, face amounts, premium-paying period and period of protection. Adjustable Life: Adjustable Life policies are a mix of whole and term life insurance. Changes that can be made to the policy: raise or lower premium, raise or lower the face amount, change the coverage period, and change the premium-paying period. Universal Life: Universal Life is also referred to as flexible premium adjustable life insurance or unbundled insurance. The primary difference between adjustable life and universal life is that the policy owner can skip premium payments as long as there is enough cash value in the policy to cover the cost of death protection. Policy allows the policy owner to buy term and invest the difference. Two premiums are quoted to the policy owner: the target premium

21 and the minimum premium. Paying the target premium will build cash value in the policy, and the policy will resemble whole life. Paying the minimum premium will keep the policy in force by paying the cost of death protection, and the policy will resemble term life. Death Benefits: There are two death benefit options for universal life policy owners: Option A (Option 1): pays a level death benefit. Option B (Option 2): pays an increasing death benefit: face amount and cash value. Variable Insurance Variable insurance provides a way for policyowners to earn higher investment returns on life insurance policy cash values. With traditional whole life insurance, premiums are invested in the insurer s general account, which contains conservative investments carefully selected and insured by the insurance company. Interest rates provided by the general account are fixed and conservative, in the 3% 5% range. With variable life insurance, on the other hand, policyowners have the opportunity to earn higher interest rates. The interest rate is variable because it is linked to the insurer s separate account, which fluctuates according to its investment performance. Since the separate account is not insured by the insurance company, the investment risk is borne upon the policyowner. Variable life insurance products are securities contracts and are regulated by the Securities and Exchange Commission (SEC). Agents selling variable products must have a life insurance and a FINRA representative license. Types of Variable Life The two types are Variable Whole Life and Variable Universal Life. Variable Whole Life: Variable whole life or simply variable life has fixed level premiums and a guaranteed minimum death benefit just like ordinary whole life but differs in that it offers higher interest rates defending the policy owner against the effects of inflation. Only variable life policies allow policy owners to invest premiums in the insurer s separate account. Variable life insurance policies do not guarantee cash value. Any agent selling variable products must have a securities license in addition to a life insurance license. Variable policies have fixed premiums and a guaranteed minimum death benefit. The investments are in a Separate Account. Producers must be registered with FINRA. Variable Universal Life: It is universal life insurance with a separate account. These policies have the flexible features of universal life and the investment choices of variable life. Variable universal life policies are regulated as variable products. Features include:

22 Flexible premiums, Cash value based on investment in separate account, Access to cash values (policy loans and withdrawals), Death protection deducted from cash value, Death benefit option A or B, and Policy owners choose sub-account investments. Interest/ Market Sensitive Universal Life Variable Whole Life Variable Universal Life Interest-sensitive Life Equity-indexed Life Death Benefits Premiums Cash Value Option A: level Any cash value death benefit; OR above the cost of Option B: increasing insurance is death benefit guaranteed Guaranteed minimum death benefit Option A: level death benefit; OR Option B: increasing death benefit Policy face amount can be reduced to offset paying increased premiums. Option A: level death benefit; OR Option B: increasing death benefit Pay the target premium to build cash value; OR Pay the minimum premium to cover the cost of death protection Fixed level premiums that can be invested in insurer s separate account Flexible premiums that can be invested in insurer s separate account Flexible changing premiums based on current interest rates Flexible premiums with interest tied to stock market index. Cash value NOT guaranteed; Higher interest rates defend against inflation Cash value is based on investment and NOT guaranteed Any cash value above the cost of insurance is guaranteed Cash value from a fixed guaranteed interest rate plus the option of a nonguaranteed indexed rate for larger return. III. Life Insurance Policy Provisions, Options and Riders In life insurance, there are no standard policies; however, states have made an effort to standardize provisions recommended by the NAIC. Life insurance provisions, options, and riders make each life insurance policy unique. Provisions are the characteristics, privileges, duties of all parties, and rights of a policy. Options involve how policy funds are utilized. Riders are policy elements that ride on or add to the existing coverage by modifying provisions or coverage. The following chart provides a summary of the various policy provisions, options, and riders.

23 Standard Provisions Policy provisions are conditions or clauses that identify the rights and obligations of the parties in a contract. In other words, policy provisions are the rules which direct how the two parties must plan the game of Life Insurance. Insuring Clause: The insurer s basic promise to pay benefits in the event of a covered loss. Consideration Clause: A policyowner must pay a premium in exchange for the insurer s promise to pay benefits. Execution Clause: The policy is executed when all parties to the contract have met the policy s conditions. Entire Contract: The insurance policy itself (including any riders and endorsements/amendments) and the application, if attached to the policy, comprise the entire contract between all parties. Insurance producers cannot make changes to a policy. Only an authorized officer of the insurer is permitted to make changes to the contract. Payment of Premiums: Stipulates when premium payments are due, how and to whom they must be paid. Grace Period: The stipulated period of time policyowners are allotted to pay an overdue premium during which the policy remains in force. Reinstatement: Permits the policyowner to reinstate a policy that has lapsed, as long as the policyowner can provide proof of insurability.

24 Incontestable Clause: Prevents the insurer from denying a claim or voiding a life insurance policy, except for nonpayment of premiums, after the policy has been in force for a certain number of years, usually 2. Misstatement of Age or Sex: Allows the insurer to adjust the policy benefits if the insured s age or sex is misstated on the policy application. Statements of the Insured: The applicant s statements in the application are considered representations and not warranties, unless fraudulent. Legal Action: Places a limit on the period in which a claimant can file suit against an insurer, usually 60 days since the insurer received proof of loss and within 2 years from the date proof of loss was submitted to the insurer. Payment of Claims: Once the insurer receives notice of the insured s death and receives the death certificate, the insurer must pay the claim within a certain number of days, usually 60. Ownership: The ownership provision stipulates the rights of the policyowner. Changes: Only an authorized executive officer of the insurer can make a change to a policy. Producers cannot make any changes to a policy. Assignment Clause: The right to transfer policy rights to another person or entity. An absolute or complete assignment occurs when the policyowner assigns all rights including cash values to another person or entity. Absolute Assignments: Absolute Assignments are made willingly, so they are also called voluntary assignments. A collateral or partial assignment is the partial and temporary transfer of rights to another person or entity. Collateral assignments are usually intended for securing a loan. Collateral assignments are also called conditional because in order for the assignee to receive the portion of policy proceeds assigned, there must be a balance on the loan at the time of the insured s death. Free Look: The policyowner is permitted a number of days from the date the policy is delivered (usually 10) to look over the policy and return it, if dissatisfied for any reason, for a refund of all premiums paid. Exclusions The policy exclusions section of the contract states what the insurer will not do, including the risks that the insurer will not cover. Policy exclusions are optional, and may be included in life insurance policies at the discretion of the insurer. These provisions exclude or limit coverage and are intended to protect the insurer from adverse selection and misuse of policies. Suicide Clause: The policy will be voided and no death benefit will be paid if the insured commits suicide within a stipulated time period, usually 1 or 2 years from policy issuance. Aviation: The insurer will not pay the claim if the insured dies due to involvement with aviation, such as a military pilot flying a jet aircraft. War or Military Service: The insurer will not pay the claim if the insured dies while in active military service or due to an act of war. Status clause the insurer will not pay the claim if the insured dies while in active military service. Results clause the insurer will not pay the claim if the insured dies due to an act of war. Hazardous Occupation or Hobby: If the insured dies as a result of a hazardous occupation or hobby, the insurer will not pay the claim.

25 Policy Loan and Withdrawal Provisions Insurance Topics Policies that permit cash value have policy loan and withdrawal provisions. These policies must begin to build cash value after a certain number of years. In most states, this is 3 years. The policyowner has the right to the policy s cash value. Policy loans are not taxable. Cash Loan: Policyowners can make a policy loan in an amount up to the current cash value, less any existing indebtedness (prior loans with interest). Automatic Premium Loans: Allows the insurer to automatically use the policy cash value to pay an overdue premium. Withdrawals or Partial Surrenders: Withdrawals or partial surrenders of policy cash value can be made from universal life policies. Modifications: Policy changes must be made by an authorized officer of the insurer and attached to the policy. Only the policyowner has the right to request changes. Medical Examination and Autopsy: Require the proposed insured to undergo a medical examination prior to issuing coverage at the insurer s expense if necessary, such as for large amounts of coverage. Provision grants right of autopsy to insurer, at the insurer s expense. Excess interest provision: When a life insurance policy s interest rate becomes greater than the assumed interest rate, the policy will build excess cash value. Rights of Ownership Ownership rights include naming beneficiaries, choosing the settlement option (how the policy proceeds will be paid), the right of assignment, the right to policy cash value, if any, choice of premium payment mode, dividend options, if any, and the right of conversion if the policy is a convertible term policy. Third-party ownership: In third-party ownership the three parties to the contract are the policyowner, insured and insurer. The policyowner must have an insurable interest in the life of the insured. Beneficiaries The named individuals or entities designated by the policyowner to receive the policy proceeds upon the insured s death. Individuals, classes, estates, minors, and trusts may be designated as beneficiaries. Succession: The policyowner may name up to three levels of prioritized beneficiaries: primary, contingent and tertiary. The beneficiaries at lower levels of priority (contingent and tertiary) do not receive policy proceeds unless the higher level(s) beneficiaries predecease the insured. Revocable vs. Irrevocable: The policyowner can change revocable beneficiaries without their consent. However, with irrevocable beneficiaries, the policyowner must receive their written consent to exercise any ownership rights except for the right to pay premiums. Uniform Simultaneous Death Act: It solves the problem of determining who receives the policy proceeds if the insured and the primary beneficiary are killed at the same time in a common accident. In most policies, the primary beneficiary

26 must die within a certain number of days of the insured, such as 30, 45 or 60, in order for the primary beneficiary to be considered to have died first. If there is evidence that the insured died first, then the primary beneficiary or his estate would receive the policy proceeds. Common Disaster Clause: It protects contingent beneficiaries rights by stipulating a certain number of days the primary beneficiary must outlive the insured after a common accident causing near-simultaneous death in order for the primary beneficiary to receive the policy proceeds; otherwise, the contingent beneficiaries receive the policy proceeds. If the primary beneficiary dies before the insured, then the policy proceeds are paid to the contingent beneficiaries, or if none, to the insured s estate. If the insured dies before the primary beneficiary, then the policy proceeds are paid to the primary beneficiary only if he outlives the insured by the specified number of days. The stipulated period is usually 15 or 30 days. Short Term Survivorship: It requires that the insured and primary beneficiary s deaths are from unrelated causes. Spendthrift Clause: It is used to prevent creditors from seizing life insurance policy proceeds provided there is at least one named beneficiary, excluding the insured s estate Facility of Payment Provision: It allows the insurer to choose a beneficiary if the insurer cannot get in contact with the named beneficiaries after a certain amount of time. Policy Options Policy options allow the policyowner choices regarding financial decisions about the policy. In other words, the policyowner has a way to customize the contract without any additional costs. Policy options include Settlement options, Nonforfeiture options, and Dividend options. Settlement Options Because the purpose of life insurance is for the benefit of the living, it is crucial that the policyowner pay attention to how the policy death benefit will be paid to the beneficiary. Settlement options are the ways that life insurance policy proceeds are paid out to beneficiaries upon the insured s death or when the policy endows. Settlement options allow the policy proceeds to be retained by the insurer and paid out gradually. Lump-Sum: One cash payment. Interest Only: The insurer retains the policy proceeds, which become the principal, and pays out only the growth on the principal to the beneficiary on a scheduled basis. Fixed-period or Period Certain: Installment option that uses an annuity to pay the policy proceeds to the beneficiary for a certain number of years. Fixed-amount Installment Option: Uses an annuity to pay the policy proceeds, but the payment amount is specified instead of period of time. Life Income: Option that uses an annuity to pay the policy proceeds. The beneficiary is provided with income that cannot be outlived: income is guaranteed for the beneficiary s entire life. Straight Life or Single Life: Pays the beneficiary periodic income for his entire life. Once the beneficiary dies, the payments stop, and any balance of principal is

27 forfeited to the insurer. Refund Life Option: Pays the beneficiary periodic income for his entire life. If the beneficiary dies before the policy proceeds have been paid out entirely, then a second beneficiary receives the payments until the principal reaches zero. The refund life option provides a guarantee that the minimum benefit will be paid out. Life Income Certain Option: Pays periodic payments to a beneficiary for his entire life. If the beneficiary dies before a specified period in the policy has passed (such as 10 or 15 years), then a second beneficiary will receive payments until that period ends. The life income certain option provides the beneficiary with a guarantee that benefits will be paid for a minimum number of years. Joint and Survivor Option: Allows two or more individuals to receive income payments for their entire lives. Nonforfeiture Options