Life Insurance Basics
Why people buy life insurance
Two analytical frameworks appear on exams. The human life value approach capitalizes future earnings; the needs approach adds up specific obligations (income replacement, mortgage, education, final expenses) and subtracts existing resources. Personal uses include survivor protection, estate creation and liquidity, and cash-value accumulation; business uses include key person coverage, buy-sell funding, deferred compensation, and executive bonus plans. A viatical or life settlement sells an existing policy to a third party, which requires insurable interest at settlement in most states and carries tax and disclosure rules.
Underwriting and classification
Field underwriting begins with the producer, who must record accurate answers and forward any known adverse information. The home office classifies risk as preferred, standard, substandard (rated by table or flat extra), or declined. A conditional receipt provides coverage from the date of application or medical exam only if the applicant proves insurable under the insurer's rules; a binding receipt would provide immediate coverage regardless.
Policy delivery, ownership, and beneficiaries
Coverage generally begins when the policy is delivered and the first premium is paid while the insured is still healthy. The owner holds all rights: naming beneficiaries, surrendering, assigning, borrowing. Beneficiaries may be primary, contingent, revocable, or irrevocable; a per stirpes designation passes a deceased child's share to that child's heirs, while per capita divides only among survivors. Death benefits are generally income-tax-free; cash-value growth is tax-deferred. A modified endowment contract (MEC) fails the 7-pay test and loses favorable loan and distribution treatment.
Worked example
Client needs $60,000 of annual income for 20 years and has $200,000 of existing assets. Rough need: $1.2 million minus $200,000, plus mortgage and education costs - a needs-approach illustration, not a human-life-value one.