Life Insurance Principles, Products and Annuities
The pricing engine
Premiums reflect three variables: mortality/morbidity (expected claims), interest (earnings on reserves), and expense (commission, administration, taxes). Higher assumed interest or lower expense lowers the premium; a substandard rating raises it. Insurers pool many independent risks (law of large numbers) and defend against adverse selection through underwriting plus insurable interest - the applicant must face a financial loss at the insured's death.
Underwriting classes
Preferred, standard, substandard (table-rated), and declined. Rate-ups are shown as a percentage or table rating; a flat extra covers a temporary hazard.
Life products
Term: level, decreasing, increasing, annually renewable, renewable and convertible (conversion usually allowed without new evidence before a stated age). Whole life: guaranteed death benefit, guaranteed cash value, level premium, non-guaranteed dividends, policy loans. Universal life: flexible premium, interest-credited cash value, monthly cost of insurance; watch no-lapse guarantees. Variable life and VUL: cash value in separate subaccounts - requires a securities license and a prospectus, a favorite trap. Indexed UL: credited by an index subject to a cap, participation rate, and floor. A policy failing the 7-pay test becomes a MEC: distributions are taxed LIFO with a 10% penalty before age 59½.
Annuities
Two phases: accumulation and annuitization. Fixed, variable, or indexed; immediate or deferred; surrender charges and free-withdrawal amounts. Payout options include life only, life with period certain, and joint and survivor. Nonqualified annuities use an exclusion ratio to split basis from taxable gain.
Worked example: $100,000 basis and a $200,000 expected return give an exclusion ratio of 100,000 ÷ 200,000 = 50%, so half of each payment is tax-free until basis is recovered.