Life Insurance Basics, Underwriting and Beneficiaries
Life Insurance Basics
Why people buy life insurance
Personal uses include income replacement, debt and mortgage payoff, education funding, final expenses, and estate liquidity. Business uses include key person coverage, buy-sell funding, and executive benefits. Two analytical approaches appear on exams: human life value (present value of the insured's future earnings) and the needs approach (income replacement plus specific obligations minus existing resources). Needs analysis usually produces the amount sold.
What drives the premium
Three factors: mortality (expected deaths for the age/sex/health class), interest (assumed earnings on reserves - higher assumed interest lowers premium), and expense (commissions, administration, taxes). The net premium covers mortality and interest; the gross premium adds expenses. Level premium whole life works because early premiums overpay the true cost, building cash value reserves that offset rising mortality costs later.
Policy types and ownership
Ordinary (individual), group, and industrial/credit are the traditional categories. Term is pure death protection; whole life is permanent with guaranteed cash value; universal life is flexible with adjustable premiums and a current interest rate; variable life shifts investment risk to the owner. The owner holds all rights - naming beneficiaries, borrowing, surrendering, assigning, and choosing dividend and settlement options - and may differ from the insured.
Delivery and the free look
Coverage usually begins when the policy is delivered and the first premium paid, unless a conditional receipt applies (coverage if the proposed insured was insurable under the insurer's rules). The free-look period (typically 10–30 days) allows a full refund.
Trap and rule of thumb
Dividends are a return of premium, not guaranteed and not taxable until they exceed premiums paid. Rule of thumb: higher assumed interest and lower expenses mean a lower premium.
Underwriting and Beneficiaries
The application and information sources
The application has Part I (general data) and Part II (medical history), plus the producer/agent report. The producer acts as a field underwriter: record answers exactly, never answer for the applicant, and never leave a question blank - write none if applicable. Insurers may use the MIB, paramedical exams, attending physician statements, inspection reports, prescription databases, and credit-based insurance scores. The Fair Credit Reporting Act requires notice and gives the applicant the right to know the nature and source of adverse information.
Representations and defenses
Applicants make representations (believed true) rather than warranties (guaranteed true). A material misrepresentation on the application allows rescission during the contestable period; concealment is intentional silence about a material fact. A misstatement of age or sex does not void the policy - benefits are adjusted to the correct amount.
Classifications
Preferred, standard, substandard (table ratings or flat extra premiums), and declined. The incontestability clause (typically two years) limits the insurer's right to rescind for misrepresentation; the suicide clause limits payout for suicide within two years.
Beneficiaries
Know primary versus contingent, and revocable (owner may change without consent) versus irrevocable (consent required to change, borrow, or surrender). Designations may be specific, class-based (children of the insured), or estate. Per stirpes divides a deceased beneficiary's share among that beneficiary's heirs; per capita divides only among survivors. Minors cannot receive proceeds directly - use a guardian, trust, or UTMA. Common disaster and simultaneous death provisions decide who is presumed to have survived.
Trap and rule of thumb
If the primary beneficiary dies first and no contingent exists, proceeds go to the insured's estate and may be subject to probate and creditors. Rule of thumb: always name a contingent.