Uses of Life Insurance

From the 19^th addition of the Florida Life, Health, and Variable Annuity Study Manual FAIFA

The number of uses for family life insurance in meeting personal , family and business needs is really quite impressive. The following list of common uses can be met with term life insurance if the need is temporary (such as providing an additional protection fund while the children are growing up and living at home), with whole life insurance if the need is permanent (such as meeting estate planning objectives and for “living” financial need) or with annuities if the need is for future income (such as retirement income)

In some cases, different products can be mixed to strengthen the protection. For example, a person may use a deferred annuity to plan for retirement, but also use a whole life policy to provide protection before retirement and additional retirement funds, through the policies cash value, at retirement.

Uses of Life Insurance

The obvious use of life insurance is to provide a family with financial protection in the event the breadwinner dies prematurely. It is also often used in business to protect the business from financial loss due to the loss of a key employee or business partner.
Life insurance often has a savings feature that can be used as a means of supplementing retirement, or to save for a child's education.
Two methods used to determine how much insurance is needed. They are the "human life value" approach and the "needs approach". The needs approach is the most widely used method today.
The Human Life Value Approach was developed by Doctor S.S. Heubner in 1924. This approach values a human life and expresses this value in dollars. Essentially it determines the economic value of a person by discounting estimated future net earnings used for family purposes at a reasonable rate of interest.

Family Needs (Life)

There are many family needs that life insurance can provide for and individuals should consider when purchasing insurance:
A final expense fund, also known as a "clean-up" fund includes last illness and funeral costs, outstanding debts, federal and state death taxes, other unpaid taxes, legal fees, court costs and executor's fees, etc.
Housing needs to continue to pay mortgage payments or rent.
Life insurance can provide a family with the funds to pay off the mortgage if so desired.
Life insurance can provide funds for the college education of the children, which are continually rising.
Life insurance can provide a monthly income for the family while the children are young (dependency period) and later for the surviving spouse (blackout period). Although the surviving spouse and children most likely will be eligible for social security benefits, the amount received may not be enough.
Life insurance will provide the difference needed. The Blackout Period begins when the youngest child reaches age 16 and continues until the spouse reaches age 60. During this period, no social security benefits are available to the spouse.
Life insurance can provide an emergency fund for unforeseen expenses such as a new roof or new heating and air conditioning unit and any other miscellaneous expenses.
Cash value life insurance may be used to supplement retirement income.

Business Needs (Life)

Businesses also need protection from financial loss due to the death of a partner, principal, or key employee.
Buy-sell agreements transfer ownership of a business when a business owner dies. These agreements are usually funded by life insurance.
Life insurance is utilized as a form of business interruption insurance.
In order to provide benefits for employees and their dependents, employers use life insurance.

Sole Proprietor

A sole proprietor buy-sell agreement might possibly be an agreement between the owner and an employee who would like to purchase the business. The agreement states the business owner's heirs must sell the business to the employee and the employee must buy the business. The employee may purchase a life insurance policy on the life of the owner. Upon the death of the owner, the proceeds from the policy will be used to purchase the business.
A cash value policy is usually purchased because the proprietor may live and wish to retire. In this case the employee, who is the owner of the policy, may borrow the cash value and use it as a down payment to purchase the business.
The premiums for this policy are not deductible and the benefits are received tax-free.

Partnership

When a partner dies, the law states that the partnership is automatically dissolved. In order for the surviving partner to continue the business, a buy-sell agreement is a definite necessity.
There are two types of partnership insured buy-sell agreements. They are the "cross purchase" plan and the "entity" plan.
In a cross purchase arrangement, each partner will purchase a policy on the life of the other partner. He will be the owner, beneficiary and premium payor of that policy. The estate of a deceased partner must sell the business to the surviving partner and the surviving partner must purchase the business from the estate. The partners are parties to the agreement, not the partnership.
An entity plan is usually used when there are more than three partners. The reason is that too many policies would be required using a cross purchase plan. For example: three partners would require six policies; six partners would require 30 policies.
An entity plan requires one policy on the life of each partner. The partnership is a party to the agreement and the partnership will purchase one policy on the life of each partner. The partnership will own the policies and pay the premiums. The partnership will be the beneficiary and upon the death of a partner will purchase the deceased share of the partnership.
The premiums for this policy are not deductible and the benefits are received tax-free.

Close Corporation

A Corporation, unlike a partnership never dies. It goes on forever unless dissolved. A close corporation is generally a family business and each stockholder owns shares of stock in the business. Buy-Sell agreements are equally important to this type of corporation as to a partnership.
This buy-sell agreement can be funded either by cross-purchase or an entity type plan. When cross-purchase is used, each stockholder would buy and own a policy on the lives of the other stockholders. The agreement is between the stockholders; the corporation is not a party to this agreement.
Again, too many stockholders would make a cross-purchase plan impractical because of the number of policies that would be required so an entity type plan, in this case it is called a stock-redemption plan, would be used. The corporation would own one policy on the life of each stockholder. The corporation is a party to the contract.
The premiums for this policy are not deductible and the benefits are received tax-free.

Key-Person Insurance

A business could suffer a financial loss due to the death of a key-employee. Having a key-person policy on this employee's life would indemnify the business for this loss if this valuable employee were to die.
The premiums for this policy are not deductible and the benefits are received tax-free.
Other advantages to the business is that if a cash value policy is used, the business would have a reserve fund from which to borrow if need be.
Business creditors and suppliers would have a favorable outlook on this business for protecting it from the financial loss that may occur due to this death.

Employee Benefit Plans

Besides the usual group plans provided by employers, there are other plans that favor certain employees and discrimination is permitted.
One such plan is the split-dollar insurance plan. The employee needs insurance and the employer is going to help pay the premiums for it. The employee and the employer will share the cost of the policy. While there are many variations, the employee will pay the term premium and the employer will pay the increase in cash value each year. If the employee were to die, the employer would receive the cash value and the employee's beneficiary would receive the balance of the death benefit. If this were a participating policy, the 5th dividend option would be used to purchase term insurance on the cash value. Therefore, the employee's beneficiary could receive the full benefit while the employer gets the cash value. This plan is informal and does not require IRS approval. It is considered to be a nonqualified plan.
Deferred compensation plans are also nonqualified and no IRS approval needed. Instead of a raise or bonus, an employee may wish to have the employer set up this plan. The annual raise would fund the life insurance policy or annuity to provide retirement income.
At retirement, the employee would receive the deferred funds. If the employee were to die before reaching retirement, the funds would go to his dependents.
A salary continuation plan is another nonqualified plan that can be offered to certain employees of the employer's choosing. As an example, in order to hold on to a valuable employee, an employer might provide five years of continued salary at retirement if the employee promises to stay with the firm until he retires. The employer might also require some type of consulting services.

BOE Business Overhead Expense

Business Overhead Expense insurance reimburses a business for overhead expenses if a business owner becomes disabled. BOE insurance is sold on an individual basis to professionals in private practice, self-employed business owners, partners and sometimes to close corporations.
Overhead includes such things as: rent or mortgage payments, utilities, telephones, leased equipment, employees' salaries, etc. There is no compensation for the business owner.
The benefit payable is the actual monthly overhead expenses up to the policy maximum. The premium is a tax-deductible business expense; the benefits are taxable.

Key-Person Disability

Key-Person Disability Insurance is akin to key-person life insurance. It indemnifies a business for the loss of services of a key employee, partner or owner, due to a disability.

Disability Buy-Outs

A buy-sell agreement funded by life insurance is fine but it does not provide funds in the event a partner becomes disabled. A fully funded buy-sell agreement is necessary to provide for the buy out in the event of death or disability.
A disability buy-out is characterized by a length elimination period such as two years. This is to enable the disabled partner time to return to the business and not force the buy-out. This plan also allows for either a lump-sum payment or monthly payments.

Popular Life Insurance Riders

Guaranteed Insurability Rider

The Guaranteed Insurability Rider allows the insured to purchase additional insurance up to the face amount of the original policy at various ages stated in the policy; typically, every three years beginning at age 25 and ending at age 40. (Age 25,28,31,34,37,40) There are several features of the Guaranteed Insurability Rider, including: the insured does not have to prove to be insurable; the new policy must be purchased within 90 days of the option date; if desired, the new policy will include all riders that are attached to the original policy; and the premium is based on the age of the insured at the time of each new purchase.

Waiver of Premium Rider

The purpose of the Waiver of Premium Rider is to prevent the policy from lapsing due to nonpayment of premium during a disability.
If disabled, the insured is relieved of the premium payments during the period of disability. The waiting period is 90 days or 6 months. The insured pays the premium during the waiting period. The company will then return the premiums paid during the waiting period and they will continue to waive the premiums until the end of the disability. This is not a loan.
All features and benefits of the policy continue just as if the insured was paying the premium. Cash values continue to grow and are available to the policyowners. The policyowner retains all rights of policy ownership.
The insured will have to satisfy the definition of "total disability" as defined in the policy. Typical definitions are:
The insured's inability to engage in any work for which he/she is reasonably fitted by education, training experience. This definition is very restrictive.
The insured's inability to work at his/her own occupation for a stated period (i.e. 2 years) then any occupation thereafter. This is a liberal definition.
The rider drops off at age 60 or 65 and the premium reduces accordingly. If the insured is disabled before the expiration of the rider, the premiums will be waived until the insured is no longer disabled, even for life.

Payor Rider or Payor Provision Rider

This is waiver of premium on the premium payor, not on the insured. All rules of Waiver of Premium apply. This rider costs extra.
Found primarily in juvenile Insurance, this rider waives the premium if the payor of the policy becomes disabled. The payor must be insurable. If the payor becomes disabled and satisfies the definition of total disability as well as the waiting period, the premium will be waived until the child reaches age 21 or 25. Also known as a "Death and Disability Payor Benefit". This rider drops off at age 21 or 25 depending on the policy.

Automatic Premium Loan Rider

The Automatic Premium Loan Rider may be a standard feature in some policies. If not, it can be elected by the policyowner as a rider at the time of application or may be added later, depending on the company.
There is no charge for this rider. The premium is paid out of the cash value if not paid by end of the Grace Period. (30 days) This is treated as a loan and interest will be charged.
The purpose of this rider is to prevent the policy from lapsing due to nonpayment of the premium as long as there is sufficient cash value in the policy.

Accidental Death Benefit Rider

This rider provides for an additional death benefit in the event the insured's cause of death was accidental. Twice the face amount would be known as "double indemnity". Three times the amount would be known as "triple indemnity".
This rider is very strict in its definition. Death must occur within 90 days and must be purely accidental and not related to any medical condition of the insured. Not usually offered after age 55 or 60. The rider expires at age 60 or 65. At that time, no further premiums are charged for the rider.

Return of Premium Rider

This Rider Simply will return the premium paid in, back to the owner of the policy at the end of the insurance term or to the beneficiary upon death of the insured.
Example A: If the Insured does not die within the 10 year term of an insurance policy and over 10 years $10,000 was paid into the policy, the owner of the policy gets the $10,000 returned.
Example B: Assume the policy death benefit (face amount) is $100,000. The amount of the premiums paid up to the death of the insured totaled $10,000. The total benefit the beneficiary might receive is $110,000.

Cost of Living Rider

The Cost of Living Rider (COL) or Cost of Living Adjustment Rider (COLA) allows the policyowner to increase the amount of the policy to provide for increases in the cost of living.
No evidence of insurability is required. It is tied to increases in Consumer Price Index (CPI). A maximum of 5% increased is allowed in any one year. This rider uses increasing term insurance. When increased, the policyowner is billed for the additional premium. This rider can be used with Whole Life and Term.

Other Insureds Rider

The Other Insureds rider allows for additional insureds on the same policy. A spouse rider adds the spouse. A child's rider adds the children. All persons being insured must prove insurability.

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