I. FOUNDATIONAL CONCEPTS
Core Purpose & Mechanics
Life insurance is fundamentally a risk transfer mechanism using:
- Law of Large Numbers: Mortality predictability in groups
- Actuarial Science: Premium calculation via mortality tables (CSO 2017), interest assumptions, expense loading
- Underwriting: Risk assessment via medical/financial/behavioral factors
Key Parties & Structure
- Policyowner: Contract holder with all rights (may differ from insured)
- Insured: Person whose life triggers death benefit
- Beneficiary: Receives proceeds (primary/contingent; revocable/irrevocable)
- Consideration: Premium payment creates legally binding contract
- Insurable Interest: Required at policy inception (owner must suffer financial loss upon insured’s death)
II. POLICY TYPES DEEP DIVE
Term Insurance
- Pure mortality coverage with no cash value
- Renewable vs. Non-renewable: Guaranteed renewal vs. re-underwriting
- Convertible: Right to exchange for permanent coverage (age/time limits)
- Return of Premium (ROP): Higher premiums, refund if outlive term
- Pricing Factors: Age, health, term length, face amount, company mortality experience
- Advantage: Highest immediate death benefit per premium dollar
Permanent Insurance
Whole Life (Participating)
- Fixed premiums, guaranteed cash values, death benefit
- Participating Dividends: Not guaranteed, reflect company’s actual vs expected mortality/expense/investment experience
- Dividend Options: Cash, premium reduction, paid-up additions, term rider purchases, accumulation at interest
- Direct Recognition: Policy loans affect dividends
- Non-direct Recognition: Loans don’t affect dividends (most common)
- Internal Components: Premium = Mortality charge + Expense + Cash value increase
Universal Life (Flexible Premium)
- Unbundled Structure: Clear separation of mortality, expense, and cash value
- Cost of Insurance (COI): Monthly deductions based on current mortality (can increase within guaranteed maximums)
- Crediting Rate: Interest on cash value (often tied to Moody’s Corporate Bond Index minus spread)
- Flexibility: Adjustable premiums/death benefits within limits
- Types:
- Current Assumption: Competitive current rates
- Guaranteed Universal: Higher premiums but stronger guarantees
- Indexed UL (IUL): Interest tied to equity index with caps/floors/participation rates
- Variable UL (VUL): Subaccounts with market risk (SEC-regulated)
Variable Life
- Separate Accounts: Policyowner directs investments (stocks/bonds)
- Market Risk: Cash value and potentially death benefit fluctuate
- Prospectus Required: SEC/FINRA oversight
III. ADVANCED POLICY MECHANICS
Policy Internal Accounting
- General Account: Company-managed, conservative investments (bonds/mortgages)
- Separate Account: Policyowner-directed investments (VUL)
- Cash Value vs. Surrender Value: Cash value minus surrender charges = surrender value
- Corridor of Insurance: Minimum difference between death benefit and cash value (IRC §7702 requirements)
- MEC Testing: 7-pay test to avoid Modified Endowment Contract status (tax disadvantages)
Premium Calculations & Charges
- Mortality Charges: Based on attained age, smoking status, underwriting class
- Expense Charges: Sales loads, policy fees, administrative costs
- Spread: Difference between earned and credited interest (UL)
- Riders: Additional benefits/costs (waiver of premium, accidental death, term riders)
IV. TAXATION COMPLEXITIES
Income Tax Treatment
- Death Benefit: Generally income tax-free to beneficiaries
- Cash Value Growth: Tax-deferred inside policy
- Policy Loans: Tax-free if policy remains in force (interest may/may not be deductible)
- Surrenders: Gain (cash value minus premiums paid) taxable as ordinary income
- MECs: Loans/distributions taxable as ordinary income, 10% penalty if under 59½
- Transfer for Value Rule: Policy transfer for consideration loses income tax-free treatment (exceptions exist)
Estate Tax Implications
- Includibility: Proceeds included in estate if insured owns policy or incidents of ownership
- ILIT Solution: Irrevocable Life Insurance Trust removes from estate (3-year rule for existing policies)
- Crummey Powers: Allow gift tax annual exclusion for premium payments to ILIT
V. ADVANCED APPLICATIONS
Business Uses
- Key Person: Indemnifies business for loss of key employee
- Buy-Sell Agreements: Funds purchase of deceased owner’s interest (entity, cross-purchase, wait-and-see)
- Deferred Compensation: Secures non-qualified benefit promises
- Split-Dollar: Shared premium/benefit arrangements (equity/endorsement)
Estate Planning
- Liquidity: Pays estate taxes without forced asset sales
- Generation-Skipping: Leverages GST exemption inside ILIT
- Second-to-Die: Insures two lives, pays at second death (typically estate tax liquidity)
Advanced Markets
- Charitable Giving: Life insurance in charitable trusts (CRT/CLT)
- Private Placement: Offshore/large face amount, sophisticated investors
- Structured Settlements: Assign policy to settlement company
VI. REGULATORY FRAMEWORK
Key Regulations
- McCarran-Ferguson Act: State primary regulation of insurance
- NAIC Model Laws: States adopt with variations (nonforfeiture, illustrations)
- SEC Regulation: VUL/Variable products as securities
- DOL Fiduciary Rule: Impacts retirement-related recommendations
- ACA/State Rules: Long-term care riders, consumer protections
Illustration Regulation
- Actuarial Guideline 49: Standardized illustration methodology for IUL
- Nonguaranteed Elements: Must be clearly labeled as not guaranteed
- Scenario Testing: Multiple interest/mortality scenarios required
VII. RISK MANAGEMENT & ANALYSIS
Carrier Risk Assessment
- Financial Strength Ratings: AM Best, Moody’s, S&P, Fitch (methodologies differ)
- Asset Quality: Bond ratings, mortgage delinquency rates, real estate holdings
- Interest Rate Risk: Duration matching of assets/liabilities
- Lapse Risk: Persistency experience vs pricing assumptions
Policy Performance Drivers
- Interest Rate Environment: Affects crediting rates on new/old business
- Mortality Experience: Actual vs expected mortality affects dividends/COI
- Expense Management: Company efficiency impacts dividends/charges
- Lapse Rates: High persistency improves policy performance
VIII. MARKET TRENDS & INNOVATIONS
Current Developments
- Living Benefits: Chronic/terminal illness accelerated death benefits
- Underwriting Advances: Simplified issue, accelerated underwriting algorithms
- Blockchain: Policy administration, claims processing
- Parametric Triggers: Automated claims based on verifiable events
Product Evolution
- Hybrid Products: LTC riders, critical illness combinations
- Behavioral Underwriting: Wearable data integration
- Direct-to-Consumer: Simplified products via digital channels
IX. PROFESSIONAL CONSIDERATIONS
Ethical & Fiduciary Duties
- Suitability: Matching client needs/goals/circumstances
- Disclosure: Clearly explaining nonguaranteed elements, risks, alternatives
- Conflict Management: Commission structures, carrier relationships
Due Diligence Framework
- Carrier Selection: Financial strength, product design, service
- Policy Analysis: Internal rate of return, break-even periods, stress testing
- Client Assessment: Risk tolerance, time horizon, objectives
Expert Note: True mastery requires understanding not just how policies work, but why they’re structured as they are—the actuarial, regulatory, tax, and market forces that shape product design. The most sophisticated practitioners combine technical knowledge with strategic insight to solve complex financial problems through insurance structures.
