Understanding Life Insurance
Understanding Life Insurance
Elliot Matloff (President and Broker, The Matloff Company) gives expert video advice on: What should I consider when choosing a beneficiary or contingent beneficiary?; Do I need a medical exam to get life insurance?; In what circumstances can a life insurance policy claim be denied? and more...
What is a "death benefit"?
A "death benefit" is the amount of money that an insurance company is going to pay the day the insured dies. So when the insured passes away, the face page of the policy will indicate that a certain sum of money is going to be paid to the beneficiary. It might be a million dollars, it might be two hundred thousand dollars. Whatever the amount is, that is the amount that's going to be paid. It's called the "death benefit".
What is an "accidental death benefit"?
An accidental death benefit is when you happen to purchase a special rider on your life insurance policy which specifies that should you die from an accident, they will pay double, sometimes triple, the death benefit of the main policy. So if you buy a $500,000 policy and you have accidental death benefit as a rider on your policy, if you die from an accident--let's say you get shot or let's say that you fall off a ladder and die--they'll pay double the face amount. Some companies even pay triple if it's a vehicle of hire. For example if it's an airplane or train or a bus or a taxi. If you die in that type of thing, they might pay triple the benefit. It's a good thing to have for some people who are in risky occupations. Typically, I don't sell it because I think it's an expensive rider and if people are so concerned about having a large amount of coverage, they'd be better off just buying a larger face amount on the main policy.
What is a "rider"?
A rider is a page that rides along a policy that has special provisions which might enhance the benefits of the life insurance policy. So, as a example, one very well known rider for life insurance is called a waiver premium. Should an insured become disabled, this rider guarantees that the insurance company will waive all future preiums. So as an example, husband and wife have life insurance, the husband has a car accident and can't work anymore. He still loves his wife and his kids and still wants the life insurance policy enforced. But because he is not working he cannot afford the premium. The waiver of premium provision says, we understand people sometimes have accidents in their life and their life is messed up and they do not have money to pay their insurance premiums. Because you pay an extra 1. or 112. or 42. extra premium per year in this policy we will waive all future payments for the rest of your life. It is one of the most valuable features you can put in a life insurance policy.
What does "double indemnity" mean?
Double indemnity is the same thing as accidental death benefit. If you die from an accident, the insurance company will pay you double the face amount, typically. Not always. Sometimes they'll pay you up to a certain amount extra because it's an accident. So, if you go skiing and you get impaled by your ski pole because you fall down a cliff and you die, the insurance company might say that your base policy is $500,000. But, because of this accident, we will pay double. So your spouse or beneficiary of your policy will get $1 million dollars instead.
What is a "beneficiary", and how does it differ from a "contingent beneficiary"?
A benficiary is a person who's going to receive the money first if the insured passes away. So let's say the woman has a life insurance policy on her life and the love of her life is her husband and she names him as the beneficiary, usually called the primary beneficiary. He gets all the money if anything happens to her. Now if he and his wife, in this scenario, both die, let's say in a common accident, and the children happen to survive, they will be the contingent beneficiary. They collect if the primary beneficiary is not around to collect.
What should I consider when choosing a beneficiary or contingent beneficiary?
Well, the primary beneficiary in most cases is the spouse; if you are married it's typically your spouse. Occasionally I come across people that have children from a prior marriage and they really want the life insurance for those kids in particular. It depends on your particular needs and you have to express those needs to the insurance agent so that he understands what you're trying to accomplish. One of things that are very important is, let's say that you have a husband and wife, they buy a life insurance policy of themselves and their concern is that in case either one of them dies they want the kids taking care of wealth. So the guardian that they've chosen for their children it's even spell out in their will. The wife's sister, she's a wonderful person. Instead of leaving the beneficiary, the contingent beneficiary the children they decide to leave the money to the sister. Sounds like a logical idea; the problem is if the sister dies the money now belongs to her husband. Her husband could be a great guy and honor the commitment that her sister had to her children but might not do so. In general it's very important when you have children do not only look your beneficiary destination but you know you might go in a hurry to spell exactly what you want because many scenarios, children may not be capable in handling large sums of money. When you have a sophisticated larger estate where people are wealthy and there's lot of money involved, even when there's cases whether not a lot of money is involved. If you want to make sure that money does what you wanted to do, under almost any circumstance you probably is worth spending a thousand dollars or more with an attorney to write up a special type of trust or will for you to specify exactly how the proceeds of the life insurance is paid out.
What does "cash surrender value" mean?
Cash surrender value is the cash, or equity, that a life insurance policy has. Now, a term policy doesn't have any cash value, or cash surrender value. But a whole life, or universal life policy, has actual money in the policy, like a bank account. That money belongs to the insured. Sometimes the insured decides that he or she does not want the life insurance anymore, and they want to cancel or surrender the policy. If there's $3000, if there's $300,000 in cash in that policy the insurance company will write a check to the named insured or the owner of the policy, and that person will get the cash surrender value. So when you talk about cash surrender you're talking about totally canceling an insurance policy, typically whole life or universal life which has built up equity over many years and that money is paid out to the insured in a lump sum. It's that person's money.
Why do universal and whole life insurance have cash value but term life insurance does not?
Term life insurance isn't meant to have cash value. It's meant strictly to be a death benefit, and it provides a good amount of death benefit for low dollars. It guarantees a premium being level over many years at a very low rate. You're not paying any extra premium during all those years for the true mortality costs that are incurred by the insurance company. When you buy a whole life or a universal life, you're paying more than the pure mortality costs in the early years, and the insurance company takes this extra premium that you've paid. For example, let's say you have a whole life policy where it's a million dollar policy and you're paying fifteen thousand dollars a year for that policy. Maybe only two thousand dollars a year in the early years is a cost of mortality; the chances of you dying. The other thirteen thousand is put into the bank account of cash values of that policy. Now, the purpose of this cash value is many years down the road, when the likelihood of you dying is much greater, that cash value is there to continue the policy in later years. It's kind of like if you rent a house or buy a house. By paying a lot more money in the down payment of a house, in paying mortgage payments instead of rent payments, over time you'll have something that will still be there. However, in a term policy or renting an apartment, at the end of the lease, you're done. They both serve a good purpose. One is going to cost you more but it's going to probably be better for you over a lifetime. The other one is better in the short term.
What is "convertible term insurance"?
Convertible term insurance means that should you decide that you want your term life insurance policy, or you want life insurance to extend beyond the term period of twenty or thirty years. You bought a twenty year term policy; the premiums were level for twenty years; in the eighteenth year of this contract (this policy is a contract) you say, "Gee, you know, I still love my family, I still want the life insurance in force, but I don't have good health. What do I do?" You see that in the twenty-first year under the policy - because there's a page right inside the policy that says in the twenty-first year your premium goes from three hundred dollars to thirteen thousand dollars, and you say, "Oh my goodness! I can't afford that." You call up your agent and he says, you can convert your policy to a universal or whole-life policy where the premiums stay level for the rest of your life. You won't have to have a policy where the premiums go up each year. You can levelize the premiums. Without this feature in a policy, it would leave a lot of people who become uninsurable without insurance. The insurance companies actually can do quite well if you cancel the insurance before they have to pay the claim, but with this conversion ability - the ability to convert insurance to universal or whole-life - you can keep this policy the rest of your life at a reasonable rate.
What is a "dividend"?
Only certain types of life insurance companies issue dividends. They're usually issued by what's called "mutual" life insurance companies. When life insurance companies started many years ago, they were usually "mutual" companies. That meant that the policyholder owned a piece of that life insurance company. It might be a very small piece, but it was relative to their policy size. Because these companies made a lot of money, and because the policyholders are really cared for, the board of directors would say, "We made an extra $27 million. We're going to give it back to the policyholders in the form of a dividend." In a life insurance contract, a dividend is non-taxable. It's not even required to be declared on your income tax return. A dividend is a return of premium. If an insurance company is making lots of money and they want to stay competitive in the industry, they will say, "We have made so much money, let's give it back to the insureds. They will be more loyal to us. They'll buy more insurance from us. They will refer us more business." A dividend is basically a return of premium. It's not guaranteed. Some companies have been historically paying dividends every year for 15 years, and then, all of a sudden, they get hit with major losses. Then they say, "This next five years, we will not be able to pay any dividends." But it doesn't mean that they won't start again at a later date. In general, life insurance rates have come down, and insurance companies typically have been so profitable. They're profitable because, when they issued insurance 40 years ago, the average insurance age, the average death benefit age, was something like 65. I can remember saying my father, when I was a young boy, "How long are you going to live?" and he said he'd be happy if he lived to 60 or 65. He lived to 90. Today, people are living longer and longer. If an insurance company does not have to pay a death claim for an extra 30 years, that is profitable. They're able to keep the money in their own coffers, so to speak. If it's a mutual company, and they care about their policyholders, they will pay that surplus, that return of premium, to the policyholder. That's what a dividend is.
What happens if I don't make my premium payments?
If you don't make your insurance premium payments, the insurance company will send you a notice and you have thirty-one days to pay your premium. At that point if you still haven't paid the premium, the policy will lapse.
Do I need a medical exam to get life insurance?
With most life insurance companies, if you apply for life insurance you have to take an exam. The exam is not a major physical exam, it's generally a very mini exam. A person comes to your home or your office, does blood and urine tests and sends them to an insurance company. They ask you several medical questions about your health: what kind of doctors you go to, if you're taking any type of medications, and that physical exam is then sent to the insurance company underwriters. They look at your health history, they look at the results of your blood and urine chemistry, and then they decide if you're a good risk or not a good risk.
In what circumstances can a life insurance policy claim be denied?
It rarely ever happens that a life insurance policy claim is denied. However, if that does happen, you should obviously contact your insurance broker and discuss the situation with him or her. You will sometimes have to contact an insurance commissioner. The only reason why an insurance company would ever not pay a claim is if they thought there was some foul play involved, or, if there was a significant fraudulent statement made on the application. One of the nice things about life insurance policies is that, after two years, the policies are completely incontestable. Even if a person was fraudulent on the application, on life insurance, the insurance company has to pay and even on a suicide, the insurance company has to pay the claim. Within two years, however, if there is fraud, the insurance company could deny benefits. For example, let's say that you were in Mexico and you had a heart attack and you had treatment in Mexico City. You came back to the United States, bought an American Life Insurance Policy, and did not tell the agent or the insurance company that you had anything wrong with your heart, and they issued the policy because they didn't know about your doctors in Mexico. If you died in the next two years, the insurance company could use that information and deny the entire claim and they would pay your beneficiary the premium that you have paid in plus interest which is completely normal and completely ethical for an insurance company considering you've defrauded them. On the other hand, if you've kept the policy for two years or longer, and they happen to find out this information of fraud, they would still have to pay the claim. The reason why they do this also, is that many times you could forget to mention something. For example, let's say you had childhood asthma and you forgot to mention that during your physical exam. You could wonder for the rest of your life whether or not the insurance company going to use this against you and not pay the claim. To sell insurance, to market it to the community and make sure people are not worried about that, they say two years is all we can do. We can deny the claim the first two years, thereafter, we can't do anything. Another thing that could happen is, you and your spouse have an argument and you say "I could kill myself for ever marrying you". You go into a car and you get into a car accident. If your best friend overheard you say you could kill yourself for ever getting married then you wouldn't want an insurance company to use that comment, that you meant in jest, as a reason for you to be denied a claim. So the insurance companies again say, after two years, there's nothing they can do to not have to pay that claim.
Does suicide nullify a life insurance policy?
If you kill yourself within two years of the issuance of that policy, yes, they will not pay the claim. But, after two years, if you read the suicide clause of every life insurance policy it states specifically that there is nothing that we can use against you to not pay this claim even with fraud or misinformation on the application. We have to pay the claim.