Mutualization:
It is harder to raise money being mutual insurance companies. So most companies start as
stock company and then convert to mutual companies when they have enough funds. This
process of converting from share insurance company to Mutual Insurance Company is
called mutualization.
Why Mutualization?
Life Insurance:
A policy where insurance company provides some benefits if insured person dies.
They are of 3 types.
→ Term Insurance:
Pays benefit if insured dies within the covered time period.
No cash value
→ Permanent Insurance:
Provides coverage throughout insured’s lifetime.
Cash value available
→ Endowment Insurance:
Is similar to Term since pays benefit if insured dies while covered or till a stated date.
Has cash value available.
Annuity:
Annuity is a series of periodic payments. If insured’s die then instead of paying a lump some
benefit to the nominees, it can be spaced out in equal installments.
An Annuity can also be a contract under which an insurance company promises to make a series
of periodic payments to a named individual in exchange for a premium or series of premiums.
Health Insurance:
Protection towards sickness, accident and disability.
Types of coverage:
• Medical expense coverage:
o Hospital expense
o Surgery expense
o Physician expense
• Long Term care: like for old people who need constant care and
treatment
• Dental coverage
• Prescription Drug
• Vision care
• Dread disease coverage
Every business must comply with several federal, state and provincial laws so that it operates in a
fair manner.
USA Regulations
According to the McCarran-Ferguson Act (Public Law 15), regulations are made by State
Government until the regulation made is adequate. If not, Congress interferes.
State regulations
Most state regulations are similar in nature since they are based on a model by National
Association Insurance Commissioners (NAIC). NAIC is a non-governmental organization
consists of all state Insurance Commissioners. The NAIC develop model bill, a sample law that
state insurance regulators are encouraged to use as a basis of state laws.
Solvency Regulation
As per this regulation, the SID imposes a minimum limit on the amount of assets, liabilities and
on owners’ equity.
Life and Health Guaranty Association: An organization that operates under the supervision of
the SIC to protect policy owners, beneficiaries and specified others against losses that may occur
in case of insolvency. This association provides funds to guarantee payment for certain policies
up to stated limits.
Market Conduct Laws: This law regulates how insurance companies conduct their business
within the state. As per this law, they perform periodic market conduct examinations of the
insurers.
Policy Forms:
It is a standardized contract forms that shows the terms, conditions, benefits and ownership rights
of a particular insurance product. An insurance company must file these forms and receive the
SID’s approval before launching a new product. SID may ask the company to revisit the form for
reducing jargons so that it could be clearer to the general public.
Federal Regulations
Unlike a US insurance company, a Canadian company may be incorporated under the authority of
either the Fed government or one of the provincial governments.
Federal Regulations
The Insurance Companies Act is the primary Federal law that governs specified insurance
companies operating in Canada.
Every insurance company must file an Annual Return with the OSFI. This gives the financial
statement of the company. OSFI also examine financial conditions of a company on a periodic
basis (usually on every 3 year, but it may be anytime)
SFI may take control or declare a company as insolvent or obtain a court order to liquidate to
company if finds it financially unsound.
Canadian Life and Health Insurance Association (CLHIA): An industry association of life
and health insurance Company operating in Canada.
Provincial Regulations
In most respects, laws to regulate insurance companies operating in different provinces are similar
in all provinces except from Laws of Quebec. This is because the Quebec law is based on a Civil
Law system but other jurisdictions’ laws are based on a common law system.
Solvency Regulation
These laws require the Office of the Superintendent of Insurance to supervise companies that
were incorporated by the province and to examine those companies periodically. Also the
insurance company should obtain a license from the office to start business in a particular
province. Most of the licensing requirements seek to ensure that insurance companies are
financially able to provide the benefits they promise to pay when they issue insurance policies.
Unlike requirements in the US, however the provinces do not require that all policy forms be filed
before being issued but the insurers are required to file policy forms in only two situations:
1) As a condition of obtaining a license to conduct an insurance business within the province
2) Before marketing a variable life insurance contract in the province
The provinces also regulate many of the marketing activities of the companies to:
1) Prohibit from unfair trade practices, false or misleading advertisement
2) Agent should get the license form the state before marketing in that state. The licensing
requirements are similar to requirements in the United States.
Concept of Risk:
Types of Risk:
a) Speculative risk.
b) Pure risk.
Example: Your purchase shares of stock. This is a speculative risk you are taking.
If the value of the stock raises you gain.
If the value of the stock falls you lose.
If the value of the stock remains the same there is no change.
Example: The possibility of a professional getting physically disabled. If the disability renders the
professional incapable of continuing in his profession, he suffers from a financial loss. If the
professional does not get disabled he will incur no loss from that risk.
Pure risk is insurable. Speculative risk has the possibility of financial gain. The purpose of
insurance is to compensate for financial loss. Hence speculative risk is not insurable.
Risk Management:
Risk management involves identifying and assessing the financial risks we face. In order to
eliminate or reduce our exposure to a specific financial risk we may choose any of at least 4
options: -
a) Avoiding risk:
For example: One can avoid the risk of personal injury that may result from an air crash
by avoiding travel by airplane.
b) Controlling risk:
We can try to control risk by taking steps to prevent or reduce losses.
c) Accepting risk:
When an individual or a business assumes all the financial responsibility for a risk.
Self-insurance
This is a risk management technique by which a person or business accepts the financial
responsibility for financial losses associated with a particular risk.
d) Transferring risk:
When the financial responsibility for an associated risk is transferred from one party to
another (generally in exchange of a fee), it is called transferring of risk.
A most common example is purchasing an insurance coverage.
Policy
A written document that contains the terms of the agreement between the insurance company and
the owner of the policy. This is a legally enforceable contract.
The amount of money that the insurance company agrees to pay – when a specific loss covered by
that policy occurs.
Premium
The fee that the insurance company takes from the owner of the policy in exchange of assuming
the financial responsibility for losses incurred, if the specific risk covered by the policy occurs.
What are the three types of pure risks that are generally covered by insurance companies?
Property damage risk: risk of economic loss to your automobile, home or other personal
belongings due to accident, theft, fire or natural disaster. Property insurance covers a property
damage risk.
Liability risk: risk of economic loss resulting from you being responsible for harming others or
their property. Liability insurance covers a liability risk.
Covers a property risk as well as a liability risk. The insurance company offering such insurance
is called a Property and Casualty insurer or a Property and Liability insurer.
Personal risk:
How an insurance company can afford to be financially responsible for the economic risks of its
insureds?
Insurers use a concept called risk pooling. If the economic losses that actually result from a given
peril, such as disability, can be shared by large numbers of people who are all subject to the risk
of such losses and the probability of loss is relatively small for each person, then the cost to each
person will be relatively small.
1) The loss must occur by chance. (Unexpected event, not intentionally caused by the person
covered)
2) The loss must be definite. (In terms of time and amount)
3) The loss must be significant. (In financial terms)
4) The loss rate must be predictable. (The probable rate of the loss must be predictable)
5) The loss must not be catastrophic to the insurer. (A single or few occurrence of the loss
must not cause or contribute to catastrophic financial damage to the insurer)
Classification of policies:
Depending on the way in which a policy states the amount of the policy benefit, every insurance
policy can be classified as being either of the following:
Contract of indemnity: amount of the policy benefit payable for a covered loss is equal to the
amount of the covered financial loss determined at the time of the loss or a maximum amount
stated in the contract, whichever is less.
Valued Contract: specifies the amount of benefit that will be payable when a covered loss
occurs, regardless of the actual amount of the loss that was incurred.
Example: Most life insurance policies.
Face amount: The amount of the benefit that is listed in the policy.
Claim: The request for payment under the terms of the policy.
Law of large numbers: It states that, typically, the more times we observe a particular event, the
more likely is it that our observed results will approximate the “true” probability that the event
will occur.
Mortality tables: Charts that indicate to a great degree of accuracy the number of people in a
given group (of 100,000 or more) who are likely to die at each age.
Morbidity tables: Charts that indicate to a great degree of accuracy the incidence of sickness and
accidents, by age, occurring among a given group of people.
Retention limit: The maximum amount of insurance that the insurer is willing to carry at its own
risk on any one life without transferring some of the risk to a reinsurer.
Retrocession: When a reinsurer cedes risks to another reinsurer then that transaction is called a
retrocession. The reinsurer to which the risk has been ceded is called a retrocessionaire.
People who are involved in the creation and operation of an insurance policy
Policy owner: The person or business that owns the insurance policy.
Insured: The person whose life or health is insured under the policy.
Third-party policy: When one person purchases insurance on the life of another person.
Beneficiary: The person or party the policy owner named to receive the policy benefit.
Underwriting: This is the process of identifying and classifying the degree of risk represented by
a proposed insured. There are 2 primary stages in this process:
Underwriter: The employee of the insurance company who is responsible for underwriting.
Identifying risks
Insurers cannot predict when a specific individual will die, become injured, or suffer from illness.
But there are a number of factors that can increase or decrease the likelihood that an individual
will suffer a loss.
The most important of these factors are the following:
Physical hazard: Physical characteristic that may increase the likelihood of a loss.
Example: A person with a history of heart attacks possesses a physical hazard that will increase
the likelihood that the person will die sooner than a person of the same age group and sex without
such a physical hazard.
Moral hazard: The likelihood that a person may act dishonestly in the insurance transaction.
Example: An individual with a confirmed record of illegal behavior is more likely to defraud an
insurer than is a person with no such records.
Classifying risks
The purpose of classifying a proposed insured into an appropriate risk category is to enable the
insurer to determine the equitable premium rate to charge for the requested coverage.
Laws in all states and provinces require that when an insurance policy is issued the policy owner
must have an insurable interest in the risk that is insured- the policy owner must be likely to suffer
a genuine loss or detriment should the event insured against occurs.
For health insurance an insurable interest exists if the applicant can demonstrate a genuine risk
of economic loss should the proposed insured require medical care or become disabled.
An insurable interest exists when the policy owner is likely to benefit if the insured continues to
live and is likely to suffer some loss or detriment if the insured dies.
The figure below shows the family tree of a certain insured. The circles in the bold outline depict
the relationships that create an insurable interest in the life of the insured.
Grandfathe Grandmother
r
Father Mother
Aunt Uncle
Cousin
Siste
Sister-in- Brothe Insured Spouse r
law r
Principles of Insurance: Life, Health & Annuities Page 13 of 113
Dated: 26th Feb, 2003
Nephe
Niece Child’s
w Child Grandchild
spouse
Principles of Insurance: Life, Health & Annuities Page 14 of 113
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CHAPTER 4: MEETING NEEDS FOR LIFE INSURANCE
Points to remember:
1) Insurance Agent / Sales Agent are an authorized person by an insurance Co. to represent
the Co. in its dealings with applicants for insurance.
2) Insurance meets
(a) Individual / Personal needs
I. Funds to cover final expenses
II. Dependents’ support
III. Education costs
IV. Retirement income
V. Others
(b) Business needs
Estate: All things of value, called “Assets”. Assets include cash, bank &
investment A/Cs, real estate, and ownership interests in business.
Estate Plans: A plan to settle one’s Estate as per one’s wishes. The Estate Plan
considers the amount of assets and debts that one is likely to have when
one dies and how best one can preserve those assets so that that can be
passed to one’s heirs.
Note: Settling an estate means identifying & collecting the deceased’s property,
filing any required tax forms, collecting all debts owed to the deceased,
and paying all outstanding debts owed by the deceased.
To provide funds to support the family members, if the financially supporting member
dies, until they obtain new methods of support or until they adjust to a lower
income.
In addition, LIP (Life Insurance Policy) can be used to supplement the family’s expense,
which is tax-free as well.
To insure the education of the children, even after the death of the parents.
2. B. Business needs
Liquidation is the process of selling off for cash a business’ assets of the
deceased, such as its building, inventory, etc, and using that cash to pay the
business’s debts. Any funds remaining are then distributed among the owners of
the business.
Buy-Sell Agreement is an agreement in which (1) one party agrees to purchase the
financial interest that the 2nd party holds in the business following the 2 nd party’s
death and (2) the 2nd party agrees to direct his estate to sell his interest in the
business to the purchasing party.
The BSAs vary based upon the form of the business organization as
follows:
Buy-Sell Agreements
1) Sole Proprietorship BSA: Here the 1st party is the owner and the 2nd party is
an employee having the ability & the drive to take over the business after the
owner’s death. The 1st party will identify the 2nd party. The 2nd party, however,
may not have sufficient assets to fund the purchase of the business. In that
case, individual LIP is the common way to fund for him.
2) Partnership BSA: Here the 1st party is one partner & the 2nd party is the other
partner(s).
Here Employers pay for all or part of the employee benefits as part of the total
package under which the Co. compensate its employees. Employers may even
offer individual benefit plans to certain employees along with the one that all
other employees receive.
There are two types of individual life insurance benefit plans – (I) Split-Dollar
LIP and (II) Deferred Compensation Plan.
Types of Contracts:
Should be in written form and the Document Can be Written or Oral. In Canada however
should have some form Seal to be legally provincial laws require Insurance contracts to
enforceable be in writing.
a) The written contract puts to rest any sort of confusion over the terms of agreement.
Without it legal problems might arise.
E.g.:- Construction of house where owner E.g.:- Life insurance policy in which the
pays the contractor a promised sum when the insurer pays the insured certain sum only if
house is completed. the insured dies.
* The (I) indicates that insurance contract fall under this category.
• The parties to the contract must manifest their mutual assent to terms of contract.
In case of life/health insurance policies the parties reach this mutual assent through a
process of “Offer” and “Acceptance” in which one party makes an offer and another
accepts it.
The insurance company must have the legal capacity to issue policy. They should be
licensed or authorized by proper regulatory authority to do business.
As far as the individual is concerned he/she shouldn’t be a minor or lack mental
capacity.
A minor is a person who has not attained the age of majority (18 in Canada and in most
states in the US). If a minor takes an insurance policy then the beneficiary must be a
member of the minor’s immediate family. In case an insurer issues a policy to a minor,
then the company has to provide the promised insurance protection. The minor, however
avoid the policy and the company would have to return the paid premiums.
These requirements must be met when life/health insurance policies are formed.
Property: A bundle of rights a person has with respect to something. It is of two types.
Ownership of Property: is the sum of all the legal rights that exist in that property. The legal
rights an owner has in property include the right to use and enjoy the property and the right to
dispose of the property.
In order for an insurer to have enough money available to pay policy benefits when they become
due, the insurer determines the premium the company must charge for the specific insurance
coverage. In this chapter we shall discuss the methods evolved over the years for determining life
insurance premiums
Mutual Benefit Method: - Here the money is collected after the death of the person who was
insured. This method was also known as post death assessment method. Each member of a mutual
benefit society agreed to pay an equal amount of money when any other member died. This method
had three main drawbacks---- 1) Collection of money. 2) Recruitment of new members. 3) As the
members grew older, the number of deaths increased in each year.
Assessment Method: - Under this method the insurance company estimated their cost for certain
period of time, usually for one year. The organization then divided this amount among the
participants. This method also faced the same drawbacks as the above method.
Legal Reserve System: - This is the modern pricing system and is based on proper calculation and
collection of premiums for the death benefit of the insured. The premium is directly related to the
amount of risk covered. This system is based on laws requiring that insurance company should
maintain Policy Reserves.
Insurance Company employs specialist, known as actuaries, who are responsible for calculating
the premium rates the company will charge for its products. Premium rates must be adequate for
the company to have enough money to pay policy benefits. Premium rates must be equitable so
that each policy owner is charged premiums that reflect the degree of the risk covered. The
following factors govern the premium calculations: -
• Rate of mortality.
• Investment earnings.
• Expenses.
Rate of Mortality.
1. Block of policies.
2. Mortality Tables.
a) Expected mortality.
b) Mortality experience.
Mortality Tables, therefore, are charts that show the death rates an insurer may reasonably
anticipate among a particular group of insured lives at certain ages-that is, how many people in
each age group may be expected to die in a particular year. Although the rates that actually occur
may fluctuate from group to group, the fluctuations will tend to offset one another, being higher in
Investment Earnings.
Premium dollars are the primary source of funds used to pay life insurance claims. Because most
policies are in force for some time before they become payable, insurance companies have
premium dollars to invest. The earnings from these investments provide the company to charge
fewer premiums. Any investment earning can be expressed as rate of return.
Expenses.
A policies net premium is the amount that the insurer should pay in order to provide the benefits.
The net premium depends on 3 factors: -
• Mortality rate.
• Investment Earnings.
• Lapse rate. (The rate at which the policies are dropped due to non-payment
of premiums.)
To this net premium the Insurance Company adds their operating costs, known as loading. This
total amount is known as gross premium.
The level premium system allows the purchaser to pay the same amount of premium amount each
year the policy is in force. It is used to price whole life insurance, term insurance that provides
coverage for than one year, and endowment insurance. In this system higher premium rates are
charged, than what required, during the early years of the policy. The extra money charged is
invested and the return is used to meet greater risks during the later stage of the policy.
In our discussion, however, we have assumed that once each pricing element is assigned a value
and the premium is set for a particular policy, the pricing process is finished. That is not always
the case. For several type of policy the price can change even after it has been issued
The first method is by paying policy dividends.
The second method is by changing pricing elements as the policy is in force.
Policy Dividends.
Insurance policies.
Principles of Insurance: Life, Health & Annuities Page 23 of 113
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Participating Non participating
policies. policies.
Participating policies are the one where the policy owners share the company’s divisible surplus.
Surplus is the amount by which company’s assets exceed company’s liabilities. The share of the
divisible surplus that the policy owner receives is known as policy dividend. By issuing
participating policies, insurance companies can return money to the policy owner when the
condition is favorable, yet establish premium rates that will be sufficient to meet unfavorable
conditions. A participating policy contains a policy dividend provision that gives the policy owner
several choices in the way policy dividends can be used. These choices are known as dividend
options. Laws in the United States and Canada do not require insurance companies to declare
regular policy dividends; the only thing that they need to indicate is when they will declare policy
dividends.
Non-participating policies are the one where the policy owners do not share the divisible surplus.
Generally the premium paid for non-participating policies is less than the premium paid for
participating policies of the same type.
Certain policies mention all the cost elements and their minimum and maximum value. Based on
these such a policy may declare a minimum or maximum rate of return. When the insurer gives a
high rate of return the cost of the policy is reduced. The cost also depends on mortality rate. If the
experienced mortality rate is less than expected mortality rate then the price of the policy is
effectively reduced.
With reference to Chp-1 Stock Companies can issue both participating and non-participating
policies. In the past Mutual Fund Companies issued only participating policies. Today Mutual
Companies issues non-participating policies (with changing pricing factors) but in order to do so it
demutualizes a part of it as a subsidiary Stock Company.
Contingency
Policy Reserves. Reserves.
Policy Reserves represents the amount an insurer estimates it will need to policy benefits.
Insurance companies must acquire assets that will exceed policy reserve so that they have funds to
Contingency Reserves: - An insurance company must be able to pay death claims even when the
conditions are not favorable. As for example during an epidemic the mortality rate will increase
rapidly and the policy reserve may not be sufficient to pay the death claims. In order to cope up with
this kind of situations, a part of the loading added to net premium is kept as a reserve. This is known
as Contingency Reserve.
The type of policy where the insured is covered only for a particular period of time.
Policy Benefit is payable if:
The specific period of time when the policy is active is called policy term.
After the policy term ends insurance provides option of continuing insurance. If it is not continued
then the policy coverage ends there.
This policy is designed to provide a death benefit amount that corresponds to the
decreasing amount owed on a mortgage loan. The amount of the outstanding principal
balance on a mortgage loan gradually decreases with time. It is designed so that the
amount of benefit payable at any point of time equals the amount the borrower owes
on the loan.
The renewal premium of the policy is generally level throughout.
When the insured dies the benefit is paid to the beneficiary. The intent is that the
beneficiaries will payoff the balance on the loan using the benefit received. But the
beneficiary is not bound legally to make the payoff. Therefore, mortgage lender puts
condition to purchase this policy and put the name of the lender as beneficiary.
This is a similar product but protects against loan or credit card bills. For this the
lender is tied up as beneficiary and gets the payoff for the credit card balance from the
benefit of the insurance
The loan could be furniture loan, personal loan, car loan etc.
This policy provides a stated monthly income benefit amount to the insured’s
surviving spouse if insured dies with policy term. The benefit continues till the end of
the term specified.
This is decreasing term since more the insured lives, lesser the amount insurer has to
pay out as monthly benefit.
Usually there is a minimum stated number of months that insurer ensures to pay.
Example:
A 10-year term policy which provides $1000 monthly family coverage benefit is
owned by X and Y.The minimum stated year is 3.
If X dies within the term 2 years from start of policy then benefit
= $1000 * 12 months * 8years = $96,000
If X dies within the term 6 years from start of policy then benefit
= $1000 * 12 months * 4years = $48,000
If X dies within the term 8 years from start of policy then benefit
= $1000 * 12 months * 3years = $36,000
This policy can also be purchased as rider with a whole life insurance.
Use: This policy is used to encounter the rising living cost etc. So suppose a $10,000
policy may start like that and keep on increasing by 5% on every anniversary. The
insured may choose to freeze this increase at some point of time.
The premium increases with the increase in benefit.
The policy might be added like a rider to a whole life insurance.
This is a feature which allows a insured to renew the policy without submitting proof of
insurability for the same term and face amount.
One year term policies and riders are usually renewable. They are known as YRT ( Yearly
Renewable Term) or ART( Annually Renewable Term) insurance.
Limitations:
1. Renewal might be limited to be continued till a certain age.
2. Renewal might be limited to happen only a certain number of times.
During renewal, the premium is recalculated based on the attained age of the insured.
This causes an increase since mortality risk of a person increases with age.
This is a feature which allows a insured to convert the policy to a whole life without submitting
proof of insurability.
Even if the health of the insured has deteriorated he cannot be excluded since proof of insurability
cannot be demanded. Neither the health condition be used to calculate premium. Only factor to be
considered is attained age.
Limitations:
1. Renewal might be limited to be continued till a certain age.
2. Renewal might be limited to happen only during a certain time period of
the term.
1. Attained age Conversion: This is the age of the insured when the conversion took place.
The premium rate calculated using the attained age conversion is costlier than the original age
conversion since the later is based on a younger age.
Original age conversion is not allowed in most cases. If allowed then there might be limitation that
attained age is not more than 5 years.
1. Term Insurance provides coverage for a specific period of time whereas Permanent Insurance
provides coverage throughout the lifetime of insured provided policy is in-force, i.e. active.
2. Term Insurance does not provide cash value whereas permanent does.
Cash Surrender value: The amount policy owner will get if he surrenders the policy at any point
of time.
Face amount: Typically, every policy has a cash value which keeps on increasing and eventually
equals the face amount on the policy. This does not happen until the age 99 or 100. At that age
cash value equals face amount.
Policy Loan: Any whole life policy which has accrued a cash value can be used to take loan
known as policy loan using the cash value as security.
If Insured dies before the end of specified last premium year then insurance will pay the death
benefit to the beneficiary and no premium is payable
Single premium policy: special case of limited payment policy. Only one premium payable.
2 types:
1. Modified Premiums: Premium is low in beginning years and then it rises after that period one
time to attain a level premium and that continues for the rest of the life. This is modified
premiums.
Sometimes, if the change of premium frequency is >1 and is attained after a series of change then
it is known as Graded Premium Policy.
Advantage: Policy owner can afford to buy a policy with higher face amount than he can presently
afford.
Advantage: If Insured thinks his coverage required might go down later in his/her life then this is
an ideal choice. With time financial obligation of people goes down , like house loan paid off,
children no more dependent etc.
Coverage to a couple. If one of them dies then survivor couple gets the benefit and coverage
terminates. Also known as first-to-die life insurance. After the death of one spouse the surviving
spouse
The benefit is paid only after both the insured has died and is paid to the beneficiary.
Also known as second-to-die life insurance.
Premiums are payable only until first survivor dies or may be payable until both dies.
Advantage: For couples who want to provide funds to pay estate taxes that maybe levied after the
after their deaths.
Family Policies:
This is a combination of one whole life insurance for the primary insured and term insurance for
spouse and each child. The amount on term insurance is a fraction of the whole life insurance on
primary.
Example;
Father 50,000 Whole Life
Spouse 30% 15000 Term
Son 20% 10,000 Term
Total coverage for Family Policy: 75,000
Each children born in the family is automatically covered on production of proof. The coverage
starts usually after 15 years of age. Extra premium maybe charged for added children.
• Flexible premium
• Flexible face amounts
• Flexible Death Benefit amounts
• Unbundling of pricing factors
o Mortality
o Interest
o Expenses
• Policy owners can determine premium which translates into coverage
1. Mortality charges:
Pays the cost of the life Insurance coverage. This charge typically increases with age
since this charge is a measure of the mortality risk which increases with age. This
charge is usually less than a specified amount.
3. Expenses:
Charges to administer policy
So evidently, Premium + Existing Cash Value should be enough to cover the mortality
charges and Expenses. If they become less then Insured is given 60 days time to make
a premium payment to cover these expenses. If the payment is not done the policy
lapses.
Option A Plan:
F
a
c Death Benefit
e
A
m Risk
o
u Cash Value
n
t
Years
Option B Plan:
F
a
c Death Benefit
e
A
m Risk
o
u Cash Value
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t
Years
If decreased, then care needs to be taken that the policy still meets the minimum limit for
an insurance contract.
Flexible Premium:
The initial premium might be higher than renewal premiums but both should be sufficient
to handle the expenses and mortality charges. The insurance forces to pay a minimum
initial premium amount.
Policy Loan:
Loans might be taken on the cash value accrued for the policy. Some withdrawal charges
are also applied.
Federal Regulation Section 7702 Corridor controls that the cash value of a policy does
not increase too much above face amount. A certain % is fixed to limit the excess. If it
does then it violates the rule for being an insurance product for tax purposes and is
considered as investment product. The Insurance products enjoy special benefits for tax
purposes and thus this restriction is enforced. In Canada, this rule is stricter and thus
Universal Life is rarely sold in Canada.
In this type, insured specifies the face amount and premium he can pay and a plan of
insurance is chalked out to provide insurance. The product can range from a term
insurance to a limited payment whole life policy.
Based on change to the premium or face amount either the term can be increased or
frequency of premium payment can be reduced.
It enables insurer to be flexible in premium pricing since this way they can change the
premium to counter all the expenses.
This also provides the option to insured that whether he wants favorable changes in
pricing assumptions to result in a lower premium or high cash value.
Default is cash value increase.
Endowment Insurance:
• Provides a specified benefit amount whether the insured lives to the end
of the term of coverage or dies during that term.
• Each policy has a maturity date when the benefits are payable
• The cash value reaches face amount value on maturity date
• Thus cash value buildup is much faster.
• If insured dies, death benefit is paid to beneficiary.
• Premiums are leveled throughout the term
• Premium could be single premium or limited premium payment
Policy Riders: A number of benefits can be added to various forms of life insurance policies.
These are provided by adding riders to the life insurance policy. In some cases the benefit is
provided through standard policy provisions.
Here we describe some of the supplementary benefits that are fairly standard in the industry.
Generally classified as a type of health insurance coverage. Some disability benefits however can
be added to the coverage provided by a life insurance policy.
Mainly there are 3 types of disability benefits that a life insurance policy or policy rider may
provide.
Under this rider the insurer promises to give up – to waive – its right to collect renewal premiums
that become due while the insured is totally disabled.
In case of a universal life insurance policy, the WP benefit can specify that the:
1) Insurer will waive any mortality and expense charges that become due while the insured is
totally disabled.
OR
2) Insurer will waive the amount of target premium that become due while the insured is
totally disabled.
Target premium is the amount of premium that, if paid on a regular basis, will maintain the
policy in force.
Total disability: Usually in a WP rider, total disability will be defined as the insured’s inability to
perform essential acts of her own occupation or any other occupation for which she is reasonably
suitable by education, training or experience.
Premiums are waived throughout the life of the policy as long as the insured remains totally
disabled. She may need to proof her total disability, periodically, to the insurance company.
The insurance company pays it. If the policy is one that builds up a cash value, it will continue
doing so. In case of a participating policy, the insurance company will continue to pay policy
dividends as if the policy owner were paying premiums.
1. There may be a waiting time (usually 3-6 months) after the insured becomes totally
disabled, before the insurer will waive renewable premiums.
2. WP benefit is usually available to cover only disabilities that begin during a specified age
span. For example that age span may be between the age 15 to 65.
3. In most WP riders, once disability begins, interval of payment of renewal premiums can’t
be changed.
This is designed for 3rd party policies such as juvenile insurance policies.
Juvenile insurance policy is issued on the life of a child but is owned and paid for by an adult,
usually the child’s parent or legal guardian.
WP for payor benefit provides that the insurance company will waive its right to collect a
policy’s renewable premiums if the policy owner – the person responsible for paying the
premiums – dies or becomes totally disabled.
The two part definition of total disability in case of WP for payor benefits:
During the first 2 years of the disability the policy owner is considered to be totally disabled only
if he is unable to perform the essential acts of his own occupation.
After the 2-year period, the policy owner will be considered to be totally disabled if he is unable
to perform the essential acts of any occupation for which he is reasonably suited by education,
training or experience.
1) Policy owner generally must provide satisfactory evidence of his own insurability in
addition to providing evidence of the insurability of the insured.
2) Usually insurance company will waive premiums until the insured reaches 18 or 21, when
the ownership and control typically passes to the insured. This is the case when a WP for
payor benefit is added as a rider to a juvenile insurance policy.
Provides a monthly income benefit to he policy owner – insured, if she becomes totally disabled.
The definition of a total disability is usually the same in this rider as in WP benefit rider.
Typically the amount of the monthly disability income benefit is a stated dollar amount – such as
$10 per $1000 of the life coverage.
DI benefit also usually includes a waiting period like the WP riders.
A point to note ** Policies issued with a disability income benefit generally include a WP benefit
as well.
ACCIDENT BENEFITS
Double indemnity benefit: When the amount paid due to the AD benefit is equal to the face
amount of the policy. So the total death benefit that the beneficiary gets becomes twice the face
amount of the policy.
Generally most AD benefit riders expire when the insured reaches the age 65 or 70.
AD benefit rider might be a payable only if the insured die during a certain time from the actual
accident, for example say 3 months.
DISMEMBERMENT BENEFIT
Accidental death and dismemberment (AD&D) rider specifies that the insurer will pay a stated
benefit amount to the insured if an accident causes a loss of any two limbs or sight in both eyes.
Amount of the dismemberment benefit is usually equal or lower to the accidental death benefit.
Usually AD&D riders state that the insurance company will not pay both AD benefit as well as
dismemberment benefit for injuries suffered in the same accident.
This sort of policy benefit became available from the late 1980’s.
Accelerated death benefit riders are also called living benefit riders. This rider provides that the
policy owner may elect to receive a part or all of the policy’s death benefit before the insured’s
death if certain conditions are met.
The payment of an accelerated death benefit will reduce the amount of the death benefit that will
be available for the beneficiary at the insured’s death.
3) Medical advances tend to postpone death and prolong the need for medical care.
Commonly offered types of accelerated death benefit riders are discussed here:
TI benefit is a benefit under which the insurer pays a portion of the policy’s death benefit to
the policy owner if the insured suffers from a terminal illness and has a physician-certified life
expectancy of 12 months or less.
Unlike other insurance policy riders, insurance companies usually don’t charge an additional
premium for TI benefit rider.
The amount of TI benefit payable is generally a stated % of the policy’s face amount. But it is
possible that the full face amount is paid as TI benefit in some types of policies.
This is one of the earliest forms of accelerated death benefit offered by insurers. DD benefit as it is
popularly known is a benefit under which the insurer agrees to pay a portion of the policy’s face
amount to a policy owner if the insurer suffers from one of a number of specified diseases.
Point to note **: Another form of dread disease coverage can be purchased as a stand-alone health
insurance policy.
These specified diseases or medical procedures for which DD benefit is payable are known as
insurable events. They usually include
Life-threatening cancer
AIDS
End-stage renal (kidney) failure
Myocardial infarction (heart attack)
Stroke
Coronary bypass surgery
A LTC benefit is payable as a monthly benefit to a policy owner if the insured requires constant
care for a medical condition. For example, an insured who has severe arthritis or advanced
Alzheimer’s disease may need some form of constant care. The types of care that an LTC benefit
covers are specified in the rider.
Activities of daily living (ADL) include activities such as eating, bathing, dressing, going to the
bathroom, getting in and out of bed or a wheelchair, and mobility.
The amount of each monthly LTC benefit payment is generally equal to some stated percentage of
the policy’s death benefit.
The insurer usually continues to pay monthly LTC benefits until a specified percentage of the
policy’s basic death benefit has been paid out.
Most LTC benefit riders impose a 90 day waiting period before they are payable.
According to some LTC riders, coverage must be in force for a given period of time, usually 1
year or more, before the insured will qualify for LTC benefits.
Various riders can be added to life insurance policies to provide benefits if someone other than the
policy’s insured dies. These riders take several forms. Here we discuss some of the more common
ones in the industry.
A spouse and children’s insurance rider added to a permanent insurance policy provides a
coverage similar to that provided by a family insurance policy(which is a whole life policy that
provides coverage on the insured’s entire family).
The coverage provided by this rider is typically sold on the basis of coverage units. In contrast, in
the family insurance policy, the coverage provided is typically a percentage of the face amount
provided on the life of the insured.
The premium for the children’s coverage is a specified flat amount. It does not change with the
number of children in the family.
The term insurance coverage on each child expires when that child attains a stated age , usually 21
or 25. Such riders usually have a provision for the child to convert his term insurance rider to an
individual life insurance policy, and the coverage amount can also be changed to a certain number
of times over the current amount, in such a case.
Similar to the spouse and children’s coverage in its functionality. The spouse coverage is not
present. Generally aimed at single parents.
Also called an optional insured rider or an additional insured rider. This rider provides a term
insurance coverage on the life of another individual other than the policy’s insured. This second
individual is called a Second insured. This individual could be the spouse of the primary insured,
his relative or even an unrelated person.
INSURABILTY BENEFITS
Typically the amount of coverage that the policy owner can buy is limited to the policy’s face
amount to which the GI rider is attached or to an amount specified in the GI rider, whichever is
smaller.
Generally GI benefit can be exercised only up to a certain age (usually age 40).
The GI rider can be exercised until this specified age, only on certain dates.
If the life insurance policy with a GI rider also includes a WP rider and the insured is disabled at
the time an option to purchase additional insurance goes into effect, the insurance company
automatically issues the additional life insurance coverage. The insurance company also waives
the payment of the renewal premiums for all of the policy’s coverage’s to which the WP rider
applies until recovery or death of the insured.
This rider allows the owner of a whole life insurance policy to purchase single-premium paid-up
additions to the policy on stated dates in the future and thus to increase the amount of coverage
under the basic policy.
Many such riders allow the policy owner to purchase paid-up additional whole life insurance on
each policy anniversary. These paid-up additions have their own cash values.
Premiums for the paid-up additions are based on the net single premium rate for the coverage at
the insured’s age at the time the paid-up additions were purchased.
Most riders state that if the policy owner does not exercise the purchase option for a stated number
of years, then the rider will terminate. At that time the number of paid-up additions already bought
remains in force but the policy owner can no longer exercise the option to buy new paid-up
additions.
An Insurance policy is a written document that describes the agreement between two parties - the
insurer and the policyowners. Here we will know about all the provisions that are typically
included in the individual life insurance policies.
In the USA, state laws typically require individual life insurance policies to include specified
provisions that spell out the rights of policyowners and the beneficiaries. Other options may be
included at the insurer’s options. The SID reviews all these provisions in the Policy form and then
approves the policies.
In Canada, the common law provinces have all enacted insurance laws patterned, with minor
variations, on the Uniform Life Insurance Act. The Uniform Life Insurance Act is a model law
adopted by CCIR to regulate life insurance policies. Although, the province of Quebec has not
adopted this law but that law is also very similar to this act. These provincial laws require insurers
to include certain provisions in the life insurance policies. These provincial laws also directly grant
certain rights to the policyowners and impose certain obligations on insurers. Although Canadian
laws do not require policies to include provisions spelling out these rights and obligations but the
insurers routinely do so.
When the applicable insurance laws (in the US or in Canada) require a policy provision, the
insurer is free to include a provision that is more favorable to the policyowners than the required.
Individual life insurance policies generally contain the following standard provisions:
1. A free-look provision
2. An entire contract provision
3. An incontestability provision
4. A grace period provision
5. A reinstatement provision
6. A misstatement of age or sex provision
7. A settlement options provision
In addition, participating life insurance policies include a policy dividends provision, and
permanent life insurance policies that build a cash value generally must include a nonforfeiture
provision and a policy loan provision
1. Free-Look Provision
It is also known as free-examination provision that gives the policyowner a stated
period of time (usually ten days), after the policy is delivered in which to examine the
policy. During this period, the policyowner has the right to cancel the policy and
receive a full refund of the initial paid premium. The insurance coverage is in effect
throughout the free-look period, or until the policyowner rejects the policy, if sooner.
A closed contract is a contract for which only those terms and conditions that are printed
in, or attached to the contract are considered to be part of the contract. The entire contract
consists of the policy, any attached riders and the attached copy of the application for
insurance. Except fraternal insurers, all individual life insurance life policies issued in the
USA and Canada are closed contracts.
An open contract is a contract that identifies the documents that constitute the contract
between the parties, but the enumerated documents are not all attached to the contract.
Fraternal insurers (in US and Canada) generally issue policies as open contracts which
state that the entire contract consists of the policy and any attached riders, the fraternal
society’s charter/constitution/bylaws, the attached declaration of insurability, if any,
signed by the applicant.
3. Incontestability Provision
According the rules of contract laws, statements made by the parties when they enter into
the contract can be classified as either warranties or representations.
Warranty: A warranty is a statement made by a contracting party that will invalidate the
contract if the statement is not literally true.
The Incontestability Provision describes the time limit within which the insurer has the
right to avoid the contract on the ground of material misrepresentation in the application.
During evaluation of the application, if the company finds any material misrepresentation
it has full right not to issue the policy. But if it has issued a policy and at a later point of
time it finds any such statements in the application then the provisions are different in the
USA and Canada.
In Canada, the period is two years from when the policy takes effect or two years from the
date it has been reinstated, if later. The provincial insurance laws also contain an exception
that an insurer may contest a policy at anytime if the application contained a fraudulent
misrepresentation.
Insurance laws in the US and Canada require every individual life insurance policy to state
the period of grace within which a required renewal premium may be paid. The grace
period is a specified length of time within which a renewal premium that is due may be
paid without penalty.
If a renewal premium is not paid by the end of the grace period, the policy is said to be
lapse. Some insurers, however, do not consider a policy as having lapsed if that policy has
cash value (described later).
In case of a universal life insurance policy, the grace period will begin on either:
(1) the date on which the cash value is insufficient to cover the
policy’s entire monthly mortality and expense charges; grace
period is 61 or 61 days
(2) the date on which the cash value is zero; grace period is 30 or 31
days.
The provision also states that the insurer should notify (at least 30 or 31 days before) the
policyowner that the cash value is insufficient to meet the policy charges and that the
coverage will terminate if the policyowner does not make the payment that is large enough
to cover these expenses.
The Policy withdrawal Provision, also called as partial surrender provision, permits the
policyowner to reduce the amount in the policy’s cash value by withdrawing up to the
amount of the cash value in cash. The insurers do not charge any interest on policy
withdrawals.
6. Reinstatement Provision
Most insurers do not permit reinstatement if the policyowner has surrendered the policy
for its cash surrender value.
In the US, about one-half of the states require individual life insurance policies to include
this provision and the laws require policies at least a 3-year period during which the
policyowner has the right to reinstate a policy that has lapsed. It may be longer also
depending on the insurer.
Laws in Canadian provinces and territories also require individual life insurance policies
to include a reinstatement provision. Canadian laws specify the minimum reinstatement
period as 2 years.
A policyowner must fulfill certain conditions to reinstate:
• The policyowner must complete a reinstatement application within the time frame
stated in the reinstatement provision.
• The policyowner must present satisfactory evidence of the insured’s continued
insurability.
• The policyowner must pay a specified amount of money.
• The policyowner may be required to either pay any outstanding policy loan or
have the policy loan reinstated with the policy.
Also in most US states and provinces in Canada, a new contestable period begins on the
date on which the policy is reinstated. During this new contestable period, the company
may avoid a reinstated policy only on the basis of material misrepresentations made in the
application for reinstatement.
Redating: Under this practice, the insurance company changes the policy date to the date
on which the policy is reinstated. As a result, the premium rate charged for the redated
policy will be based on the insured’s attained age and will be charged for the original
policy.
Cash Surrender value nonforfeiture option: This states that a policyowner who
discontinues premium payments can elect to surrender the policy and receive the policy’s
cash surrender value. Following the surrender of a policy, all coverage under the policy
terminates.
The net cash value is the actual amount that a policyowner gets after adjustments of paid-
up additions, dividend accumulations, advance premium payments and policy loans
outstanding.
Laws throughout the US and Canada allows an insurer to reserve the right to defer
payment of any policy’s cash surrender value for a period of up to six months after the
owner of the policy requests payment.
Reduced Paid-Up Insurance: Under this option, the policy’s net cash value is used as a
net single premium to purchase paid-up life insurance of the same plan as the original
policy. The premium charged is based on the attained age of the insured. The face amount
will be smaller than the face value of the original policy. The coverage issued under this
option continues to have like building cash value, right to surrender the policy and
receiving dividends. But any supplemental benefits that were available on the original
policy such as accidental death benefits are usually not available with the reduced paid-up
insurance.
Extended Term Insurance: Under this option, the insurance company uses the policy’s
net cash value to purchase term insurance for the full coverage amount provided under the
original policy for as long a term as the net cash value can provide. The term-length
depends upon the amount of the coverage, amount of net cash value, sex of the insured
and his attained age.
However, the laws in a few jurisdictions require that policies include an Automatic
Premium Loan (APL) provision and specify that the automatic nonforfeiture option is
the automatic premium loan. This provision states that the insurer will automatically pay
an overdue premium for the policyowner by making a loan against the cash value as long
as the cash value equals or exceeds the amount of the premium due. Universal life
insurance policies usually do not include this provision.
Class Designation: A beneficiary designation that identifies a certain group of persons, rather than
naming each person, is called a class designation.
Primary Beneficiary: Party designated to receive the policy proceeds following the death of the
insured.
Proceed may be divided among the beneficiary if indicated by insured else it gets distributed
evenly.
No surviving Beneficiary:
If the insured is dead and all named beneficiaries are also dead then the proceeds are paid to policy
owner. If policy owner is dead then the proceeds goes to policy owner’s estate.
Preference Beneficiary Clause: If the policy owner does not name a beneficiary then insured
keeps a list of stated order of preference and proceed will be paid according to that order.
If no list is also available then the proceed will be paid to the insured’s estate.
Facility of Payment: Group Life, monthly debit ordinary etc contain a facility of payment clause
which permits the insurance company to pay a little part of the proceed to someone who has
incurred funeral expenses on behalf of the insured.
Revocable Beneficiary: A beneficiary is called revocable if the policy owner has the unrestricted
right to change the beneficiary while alive.
Irrevocable Beneficiary: Beneficiary where you cannot change your beneficiary without the
consent of the beneficiary.
Rights of any beneficiary, including revocable ones, are terminated with the death of the
beneficiary and the policy owner can then nominate a new beneficiary.
A community property state is one in which , by law, each spouse is entitled to equal share earned
by the other and property acquired during the marriage.
Insurance policy is also a property in these states. Thus, even if the other spouse is named as
revocable beneficiary, it might be required to take consent of the revocable beneficiary ( spouse) to
change the beneficiary if the change hurts the interest of the other spouse. Alternatively,
beneficiary can be changed for only half the proceeds.
A preferred beneficiary classification was maintained for a policy and policy owner can change the
beneficiary only within this class without consent or can change to someone outside the group
with consent of the group. All ownership rights are revoked as soon as the preferred beneficiary
died.
These laws were discontinued after the Universal Life Insurance Act of 1962
1. Recording method: Method of informing the insurance company in writing about the new
beneficiary by policy owner.
2. Endorsement Method: Policies have a document attached to the insurance contact and that
document contained the beneficiary name.
Apart from the right to name the beneficiary, the policy owner has a no# of other valuable rights.
These rights with respect to
1. Premium Payments.
2. Policy Dividends
Among these some rights vary depending on the type of the policy.
PREMIUM PAYMENTS :
This is the frequency at which renewal premiums are payable and both the insurer
& the policy owner must agree to that mode of payment. The frequency can be
annual/semiannual/quarterly/monthly. The applicant selects anyone of these modes at
the time of application but holds the right to change it after the policy is in force.
However, the policy owner cannot select a mode that results in a premium less than the
required minimum.
For example, if the minimum premium for monthly mode is $20, the policy owner
has to pay that. Otherwise he would be required to choose a less frequent mode of
payment, such as quarterly or semi annually.
b) By mail: - The P/Owner receives a premium notice fro the Ins. Co. before
each premium due date. In most cases the P/Owner returns a
portion of the notice along with the premium payment. The P/Owner
may pay the premium in cash / by MO / by check.
Payroll Deduction:
Note: The sales agents are authorized to accept only the initial premium. So thru them the
policy owner cannot pay his/her renewal premium.
Exception: Home service agents are authorized to accept renewal premium.
Policy Dividend: This is the insurer’s divisible surplus that is shared among the P/Owners
having the participating policies.
2) Premium Reduction Dividend Option: The insurer applies the policy dividends
towards the payment of the renewal premiums. The insurer notifies the P/Owner of the
amount of the policy dividend and bills for the difference, if any, between the
premium amount & the amount of the policy dividend.
3) Accumulation at Interest Dividend Option: The dividends are let on deposit with
the insurer to accumulate at interest. Allows the P/Owner to withdraw a part/all of
these dividends & the accumulated interest at any time during the life of the policy. If
the P/Owner surrenders the policy he is eligible to get the accumulated value of the
policy dividends along with the surrender value of the policy. In case the insured dies,
it goes to the named beneficiary.
4) Paid-up Additional Insurance Dividend Option: The insurer uses any declared
P/Dividend as a net single premium to purchase Paid-up Additional Insurance on the
insured’s life and this is issued on the same plan as the basic policy and in whatever
face amount the dividend can provide at the insured’s attained age.
5) Additional Term Insurance Dividend Option: The insurer uses each policy
dividend as a net single premium to purchase one-year Term Insurance on the
insured’s life. This is often called the Fifth Option.
Note: If the annual policy dividend is larger than the premium reqd. for the 1-year
term ins., the insurer will apply the remaining under any of the other options.
SETTLEMENT OPTIONS:
This comes into the picture if LIP when it’s the time for the insurer to pay the proceeds to
the beneficiaries after the insured dies. Normally insurer pays a lump sum directly to the
beneficiary in the form of a check.
Apart from lump-sum settlements of policy proceeds, Ins. Cos. provide several alternative
methods of receiving the proceeds of a LIP. These alternative methods are called
Settlement Options.
The P/Owner has the right to select any such option, shift to some other option and select
any of the settlement modes.
Two types of Settlement Mode are available.
A) Irrevocable: The beneficiary is not allowed to
shift to any other settlement option once the proceeds become payable.
B) Revocable: If not irrevocable. Default is
revocable if the settlement mode is not specified at the time of application.
Interest Option:
Under this the insurer invests the policy proceeds and periodically pays the
interest on those proceeds to the payee. It guarantees at least a specified minimum
interest rate.
Fixed-Period Option:
Under this the insurer agrees to pay the policy proceeds in installments of equal
amounts to the payee for a specified period of time. Each payment will consist
partly of the policy proceeds & partly of the interest earned on the proceeds. Here
also at least a specified minimum interest rate is guaranteed.
Fixed-Amount Option:
Under this the insurer pays equal installments of a stated amount until the (policy
proceeds + interest earned) are exhausted. Here also at least a specified minimum
interest rate is guaranteed.
Life Income with Period Certain Option -- The policy proceeds are used
to purchase a life income annuity with period certain. It guarantees that
the periodic benefits will be made throughout the lifetime of the annuitant
as well as guarantees that the payments will be made for at least a certain
period, even after the annuitant dies before the end of that period.
Refund Life Income Option -- The policy proceeds are used to purchase a
life income with refund annuity. It provides the periodic benefits will be
made throughout the lifetime of the annuitant as well as guarantees that at
least the purchase price of the annuity will be paid in benefits.
Joint & Survivorship Life Income Option -- The policy proceeds are
used to purchase a joint & survivor annuity. It provides a series of
payments to two or more individuals & those payments will continue until
both or all the individuals die.
If the owner of a life insurance policy has the contractual capacity, then she has the right
to transfer ownership of some or all of her rights in the policy. Following are the two ways of
transferring ownership: -
• Transfer of ownership by Assignment: - An assignment is an agreement under
which one party transfers some or all of his rights in a particular property to
another party. The property owner who transfers the right is known as assignor;
the party to whom the rights are transferred is known as assignee. The restrictions
to assignment are: - 1) The assignor should have the contractual capacity. 2) In
case of an irrevocable beneficiary or for a beneficiary of the preferred class in
Canada, the assignment can only be done with the consent of the beneficiary.
Because the right to assign any property is granted by law, insurers are not
required to give the policy owner notice of his rights to assign a life insurance
policy. Most life insurance policies, however, do not include assignment
provisions. The assignment provision describes the roles of the insurer and the
policyowner roles during an assignment. The insurance company is not obliged to
act in accordance to the provision unless it receives a written document. It
generally provided by the assignee. As the insurance company is not liable for the
validity of an assignment it considers an assignment to be valid whenever it
receives a written document. However the insurer might check the validity where
it has the preknowledge about the contractual inability of the policyowner.
Types of assignment: -
1. Absolute assignment is the one where complete transfer of rights occurs.
Thus the assignor no longer has any right and the assignee becomes the
policy owner. The transfer can be as a gift, where there is no exchange of
In this chapter we shall discus the routine process followed by the Life Insurance
Companies to process the life insurance claims. The claim examination process begins when the
claimant to policy proceeds notifies the insurance company that the insured has died. Typically,
the person who claims for the policy proceed is the primary beneficiary.
Upon being notified o the insured death, the insurance company typically provides the
claimant with a claim form on which the claimant provides the insurer the information the insurer
needs to begin processing the claim. In United States it is mandatory to provide claim form within
15 days from the day of requisition but in Canada there is no such hard and fast rule.
Proof of Loss.
Along with the claim form the claimant must also provide the proof for the death of the
insured. In United States generally the official death certificate is produced but in Canada, most
insurance company will accept official death certificate, an Attending Physician Statement
(APS), a coroner’s certificate of death.
The insurance company employee who is responsible for carrying out the claim
examination process is generally known as claim examiner. The following things are determined:
-
Status of Policy: - The claim examiner must check whether the policy was in
force when the insured died.
Identification of the insured: - The claim examiner examines the identity proof
present in the Claim from and the Proof of loss form with the information provided in the
company’s policy records. A claim is considered as fraudulent claim when the claimant
intentionally attempts to collect policy proceeds by providing false information. A claim is
considered as a mistaken claim when the claimant makes an honest mistake while making a claim.
Verification of Policy Coverage: - The examiner must review the terms of
insurance to determine what type of coverage it provides. Policies that contain exclusion criteria
provide that if the insurer dies if the insurer dies due to excluded causes then the insurer is not
liable to pay the proceeds.
Identifying the Proper Payee: - Once the validation of the claim has been done
the examiner now needs to identify the rightful owner of the benefits. The examiner generally
follows the following flow chart. There are 3 situations that require further investigation by the
claim examiner- common disasters, short-term survivorship, and conflicting claimants. Sometimes
both the insured and the primary beneficiary die due to a common disaster. In this case the
general law of Unites States and Canada states that
If the insured and the beneficiary die at the same time or under circumstances that
make impossible to determine which of them died first, then policy proceeds are payable as if the
insured survived the beneficiary. If the beneficiary survived the insured but died before the insurer
paid the proceeds then it becomes payable to beneficiary’s estate. The policyowner, however, may
prefer that the proceeds be pad to someone other than the beneficiary’s heirs if the beneficiary
survives the insured. Some insurance company includes common disaster clause or time clause,
according to this the beneficiary must survive the insured by a specified days, such as 30 or 60
days. If the beneficiary does not survive that period then the policy proceeds will be given as if
that the beneficiary deceased the insured.
In most cases the primary beneficiary makes the claim. In US in case of conflicting
claims the insurance company can take the help of an interpleader. Interpleader is a procedure
under which an insurance company that cannot determine the proper claimant may go to the court
in order to seek advice or decision. The court may hold the policy proceeds and would release the
insurer from any further liability. The court would then judge the rightful owner. In Canada, for
common law system the insurer pays to the court and then the court judges the proper recipient.
This is known as payment into court. In Quebec, an insurance company may to the Minister of
finance. The Minister holds the proceeds until the court settles the rightful recipient.
Determining the Amount of the Death Benefit: - To calculate the policy
proceeds the examiner will add certain things and would deduct other things. The examiner first
adds the following items:
• The amount of any basic death benefits payable ( In most cases this is equal
to the face amount. If the policy was in force under the reduced paid-up
insurance nonforfeiture option then the basic death benefit may be reduced,
also if the insured sex was misstated.)
• The accidental benefits payable.
• The accumulated policy dividends, including interests.
• The face amount of any paid-up additions.
• The amount of any unearned premiums paid in advance.
After adding these, the examiner deducts the following things to determine the final proceeds
payable.
• The amount of any outstanding policy loans.
• The amount of any premium due and unpaid. [This item appears if the
insured died during the policy grace period before the premium has been paid.
The insurance company requires the recipient of life insurance policy proceeds to sign a
written document, known as release. By signing this document, the claimant states that he has
received full payment of his claim to the proceeds of a life insurance policy and that he releases
the company from all sort of claims. In order for such a release form to be valid and binding on the
claimant, he must have the legal capacity required to provide the release. Claimants who are
minors or does not have sound mental capacity do not have the capacity to provide a release. One
way in which the insurance company can obtain a valid release when the beneficiary does not have
the legal capacity, is by paying the proceeds to a court-appointed guardian. The expenses for
appointing a guardian by the court are borne by the claimant. In some situations where policy
proceeds are payable to a minor, an insurance company may hold the proceeds at an interest to a
future date. This is generally the day when the minor reaches majority or the court appoints a
guardian who can give a valid release to the insurance company.
There are policies that may contain exclusion criteria. The claim examiner may pays
attention to death claims where the policy is contestable, the policy provides accidental benefits,
the insured disappeared or the beneficiary is responsible for insured death.
Policy Contest: - If any policy contains misinterpretation, then the insurer has
the right to avoid the contract during the policy’s contest period (which is usually 2 years from
the date when the policy becomes effective). Insurers in Canada have the right of canceling the
contract at moment of time based on fraud contracts. If the claim examiner has enough ground to
prove the charge of material misinterpretation, then the insurance company may cancel the
contract and may refund the premiums paid for the policy. Typically, the claim department
consults the legal department of the company before contesting a policy on the ground of material
misinterpretation.
Accidental Death Benefit Claim: - When a claim for accidental death benefit
comes to an insurer the claim examiner will determine whether the claim falls under policy’s
definition of “accidental”. In order to validate the examiner may ask for the following: -
1. Proof of loss. 2. APS. 3. Autopsy report.
The examiner may demand the above documents in case where: - a) unusual circumstances
surrounds the death of the insured; b) the policy provides accidental benefit; c) the insured dies
within the contest period of the policy.
Disappearance of the Insured: - When a claim appears against the
disappearance of the insured the claimant does not have enough proof to support his claim. In this
situation the insurance company cannot pay the proceeds. The claimant has the right to go to the
court to declare the insured as dead. If the insured disappeared under circumstances that made it
likely he is dead, then the court may be willing to find that the insured is dead. If the insured
disappeared without explanation, courts typically will find that the insured is dead or presumed to
be dead only if (1) the insured has been missing for certain period of time, typically seven years
(2) a diligent but unsuccessful search has been done for the insured (3) no one has had
communication with the insured since he disappeared. Upon receiving the court order the
insurance company may pay the proceeds to the claimant if the policy is in force to the presumed
death of the insured. Thus when an insured disappears the beneficiary, the policy owner, or any
other interested party will have to pay the due renewal premiums that will be due to keep the
policy in force. In any case where the policy lapses before the court issues the order then the
insurer will have no liability.
Group insurance policy covers a number of people rather than an individual or one family.
The Group insurance policy contract is called “Master Group Insurance Contract”. The contract
is between the insurance company (Group Insurer) and the Group Policyholder.
The role of Group Policyholder is almost same as that of a Policyowner of an individual insurance
policy. But here, the Policyowner has some ownership rights, which Group Policyholder doesn’t
have, like naming the beneficiary.
The insured people under the Group insurance policy is called as Group insured (in US), Group
life insured (in Canada, for life insurance), and Group person insured (in Canada, for health
insurance).
The Policyholder distributes a written document (Certificate of Insurance) to the group insureds
that describes:
• Coverage the contract provides
• Group insureds’ rights under the contract
Group Insureds are also called as Certificate holder.
Sometimes, the coverage, the benefits and the rights are mentioned in a booklet, called as, Special
Benefit booklet.
Since group insurance doesn’t require the evidence of insurability so the underwriter focuses on
the characteristics of the group.
• Reason for the group’s existence: As per the insurance laws in the US, there are seven
groups that are eligible for getting a group policy. These are
1. Single-Employer Group: The policyholder of a single-employer group insurance
contract is either the employer or the trustees of a trust fund created by the
2. Labor Union Group: The contract is issued to a labor union to insure the
members of the labor union. The federal Taft-Hartley Act in the US prohibits
employers from making premium contributions on behalf of employees who
belong to a labor union unless the contract is issued to a trust established for the
purpose of purchasing insurance for union members. Labor union groups are also
called as Taft-Hartley trustees or negotiated trusteeships.
5. Credit Union Group: This group consists of the members of one or more credit
unions.
6. Association Groups: These associations are formed for a purpose other than to
obtain insurance. These are the associations that are eligible for group insurance.
a) Trade Association: An association of firms that operate in a specific
industry
b) Professional Association: An association of individuals who share a
common occupation. Ex: Medical Doctors, Engineers, attorneys
c) Public Employee Association: An association of individuals employed
by a state, county, or city government or by a state or local school board
d) Common Interest Association: An association of individuals who share
a common state or a common interest. Ex: retired persons, alumni of a
specific college, participants of a specific sport
7. Discretionary Groups: Groups that does not fit in the above groups but SID
approves for group insurance coverage in called as Discretionary group. In
evaluating whether to approve such a group, SID consider factors such as whether
issuing the policy is in the best interest of the public and whether the policy
benefits are reasonable in relation to the premiums that will be charged for the
coverage.
Except Employee-Employer group, other group policyholders usually are not required
to pay a portion of the group insurance premium.
• Size of the group: The size of the group has a strong impact on the underwriter’s ability
to predict the group’s probable loss rate. The larger the group, the more likely that the
group will experience a loss rate that approximates the predicted loss rate.
When the group policy was introduced, minimum 50 people were required in the group for
policies. But now days, insurers are issuing the group policies for 10 to 15 group insureds
• Flow of new member in the group: Young and new members are needed 1) to replace
those who leave the group so that the size stable, 2) to keep the age distribution of the
group stable.
• Stability of the group: If the group does not remain a group for a reasonable length of
time then the administrative cost in issuing a policy would become high. Ex: a group of
temporary and seasonal workers
• Participation level of the group: In the US, most state laws require all eligible
employees to participate in a non-contributory plan (100% participation level). But in case
of a contributory plan, the participation level should be a minimum of 75%. But it varies
from state to state, also depends upon the insurer.
The provincial laws in Canada do not impose minimum participation requirements.
• Benefit levels: The group policyholder works with the insurer to establish the death
benefit levels provided to the insureds in a fair manner to avoid antiselection. Some group
policies allow covered group members to select additional coverage from a schedule of
optional coverages. In these situations the group insurer minimizes the effects of
antiselection by 1) limiting the optional coverages and 2) retaining the right to reject an
insureds’ election of the optional coverage if the benefit levels are high and the insureds
cannot provide satisfactory evidence of insurability.
• Termination Provisions:
1. Termination of the Group Insurance Policy: The group policyholder may
terminate the policy at any time by notifying the insurer in writing. The insurance
company also has the right to terminate the policy on any premium due date, if
certain conditions are met like participation levels. The insurer must provide a
written notification to the policyholder in advance regarding termination with the
date.
2. Termination of the Group Insured’s Coverage: The coverage of the group
insured will terminate if the group insured a) ceases to be a member of specified
class b) terminates her employment of group membership, or 3) fails to make a
required contribution to the premium.
• Manual Rating: A method to calculation by which the insurer uses its own past
experience (and other insurers’) to estimate a group’s expected claims and expenses.
• Experience Rating: A method to calculation by which the insurer considers the particular
group’s prior claims and expense experience.
• Blended Rating: : In this method, insurer uses a combination of Manual and
Experience Ratings.
Premium Rate: Set every year and stated as a rate per $1,000 of death benefit provided by the
policy
Premium Amount: Actual premium paid to the insurer for the coverage, varies every month
depending on the coverage
Premium Refunds:
It is usually called dividends.
Companies that do not issue participating policies generally call these refunds as Experience
refund.
It is payable to group policyholder, even if the plan is contributory. And in case of a contributory
plan policyholder doesn’t share the refunds with the groupmembers until the refund exceeds the
policyholder’s premium part and in case of excess, the employer may apply it to pay a portion of
the employees’ contributions during next year or to pay for additional benefits for covered
employees.
But in either case, the insurer receives monthly reports regarding the composition of the group and
any changes in the group.
We begin our discussion of group life insurance by describing how group life insurance is
regulated in the United States and Canada and some provisions that typically include group life
insurance. Then we shall discuss the various types of group life insurance policies and finally we
shall discuss how group creditor life insurance policies differ from other forms of group life
insurance.
• Regulation of Employee Benefits: - State, provincial, federal legislature has enacted laws
designed to ensure that all employers are treated equally in the workplace. Employment
laws prohibit any sort of discrimination regarding hiring, advancement, wage, and other
terms and condition. Terms and condition includes employee benefits such as group life
insurance. Thus the employer must ensure that all benefit plans comply with laws. A
number of federal laws in U.S. regulate the group insurance policies 1) Age
Discrimination in Employment Act (ADEA) 2) Americans with Disabilities Act
(ADA) 3) Employment Retirement Income Security Act(ERISA).
Most of the employee-employer group life and health insurance in U.S. must comply with
ERISA. ERISA defines any plan as a welfare benefit plan that an employer establishes to provide
specified facilities to the plan participant and their beneficiary. ERISA also contains detailed
provisions that regulate employer-sponsored retirement plans. ERISA requires the welfare benefit
plans to be maintained accordance a written document, which shall describe: -
The benefits that are provided by the plan
How the plan be funded
The procedure that will be followed to make amendments in the plan
The written document must also mention the names of the fiduciaries. ERISA sets detailed plan for
them. They are responsible for the benefit of the plan. In case of any loss they are personally
responsible. ERISA imposes a lot of disclosure and reporting laws for a plan. The plan
administrator is responsible for ensuring that the welfare plan complies with the disclosure and
reporting laws. A summary plan description must be providing to each of the participants and
federal Department of Labor (DOL). An annual report must be filled to Internal Revenue
Service (IRS).
• State and Provincial Regulation of Insurance: - In most of U.S. have enacted laws
based on the NAIC Group Life Insurance Model Act (NAIC Model Act) and thus the laws
are fairly uniform across the states. In Canada, common law jurisdictions, the insurance
laws are based on the Uniform Insurance Act. In Quebec, individual and group insurance
policies are according to the Quebec Civil Code. In addition to these the CLHIA governs
certain aspects of group insurance. These laws list the groups that are eligible for group
insurance and the various provisions that must be included in the policies.
In this section we shall explain the typical provisions that are included in the group insurance
policies: -
1. Benefit Amounts:- Every group life insurance policy must identify the amount- or the
method to determine the amount that the insurer will pay the group insured. Benefit
schedule defines the amount for the group insured. One type is that the benefit may be
calculated on the basis of a formula, as for example some multiple of the salary received
by the group insured. The other type specifies amount coverage either (1) for all group
insured or (2) for each class of group insured.
If the insurance coverage covers the dependents then the policy includes a
separate benefit schedule that defines the dependent benefit. Insurance company
requirements and the laws of many jurisdictions require that the amount of coverage
provided on the dependents should be less than the benefit paid to the group insured.
3. Conversion Privilege: - The NAIC Model Act and the CLHIA Guidelines require group
life insurance policies to include a conversion privilege. The conversion privilege allows
the group insured whose coverage terminates for certain reasons to convert her group
insurance to individual coverage. There are two cases for which the group insured’s group
coverage may terminate – (1) the group insured falls out of the group; (2) the group
insurance terminates.
Insured’s Eligibility for Group Insurance Terminates: In order to execute the
conversion privilege the insured must apply for the individual policy and must pay the
initial premium within 31 days from the day of termination of his group insurance
coverage. In accordance to NAIC Model Act, unlike CLHIA Group Guidelines, many
group life insurance companies allows conversion only after the age of 65 yrs. In general
the insured can buy any type of individual policy that insurer have at that time but the
benefit of the policy is limited. Many group insurance companies allows to convert to the
face amount of the original group life insurance, but most of the insurance company, in
accordance to the NAIC Model Act and CLHIA Group guidelines, state that the face
amount of the individual policy may not exceed the difference between (1) the amount of
the group insured’s coverage under the original group life policy and (2) the amount of the
group coverage for which the insured will become entitled within the 31 days conversion
period. In addition to this the CLHIA guidelines states that the face amount of such policy
to limit to $20,000.
Group Life Insurance Policy Terminates: According to the NAIC Model Act the
Conversion privilege remains to a group insured if the group insurance policy remained in
force for five years before termination. In such a situation the insured can buy a individual
policy without submitting the proof of insurability within the conversion period of 31
days. The maximum coverage is equal to the lesser of either (1) $10,000 (2) the amount of
coverage in force under the group plan minus the amount of group coverage for which the
insured becomes entitled within 31 days of the policy’s termination. In Canada, the
CLHIA Guidelines direct that group life insurance policy to include WP rider. So incase
the policy terminates, then the disabled member’s plan will continue as though the policy
remained in effect.
4. Misstatement of Age: - The amount of the benefit payable is decided by the benefit
schedule. Thus in case of a misstatement of age, most of the group insurance policy states
that if the amount of the premium is wrong due to misstatement of age, then the insurer
will retroactively adjust the amount of the premium required for the coverage to reflect the
correct age.
5. Settlement Options: - Generally the policy proceeds are paid in the lump-sum mode.
Sometimes settlement options are given; then in that case all the usual modes of settlement
options are made available.
1. Group Term Life Insurance: - 99% of the group life insurance polices are of YRT.
Evidence of the insurability is not required from the group insureds each year when
the coverage is renewed. These term policies do not build any cash value and the
insurer has the right to change the premium amount every year. Federal income tax
laws consider the employer’s contribution to policy premium as a taxable income. In
United States, except for certain policies, gives a certain tax relaxation regarding this
matter. For this an employee can receive up to $50,000 of non-contributory group
term insurance coverage. Thus if any coverage exceeds $50,000 then the employer has
to pay income tax for the employer contribution for the excess of $50,000. Group
YRT is sometimes used to pay supplementary benefits, as for example survivor
income plan. This plan provides periodic payments to the survived dependents. Most
of the policies pay a certain percentage of the group insured salary at the death time.
For example the plan may pay (1) 20% of the Salary to the survivor spouse if there is
no dependent child; (2) 30% if there is any dependent child. The benefits paid to the
surviving spouse will continue until the earlier of (1) to a certain time after the spouse
remarries; (2) the spouse reaches age of 65 years. The benefit paid to the unmarried
child may continue to (1) 19 years of age, the time by when she becomes a full-time
student (2) till the child is no longer a full time student or she reaches an age of 23
years, whichever earlier. As in the pervious case if the total the total coverage exceeds
$50,000, then the employee must pay income tax on the premium amounts that the
employer pays for the excess coverage.
2. Accidental Death and Dismemberment Plans: - AD&D benefits may be included as
a part of the group insurance or they may be given as separate plans. The low cost of
AD&D makes it an attractive policy. When accidental death benefit is added to a
group insurance policy, then generally the coverage is equal to basic benefit of the
group insurance coverage. Many companies provide accidental death benefit due to
travel to its employees. In such a situation the benefit is given if the accident occurs if
an accident occurs while travelling for the company.
3. Group Permanent Plans: - Group permanent plans are less popular since they do not
receive any tax privilege. In most cases the group permanent policies are issued as
supplementary coverage. This means that the coverage is provided as optional basis or
as additions to group term insurance coverage. Generally the following plans are
available under this plan: -
4. Group Creditor Life Insurance: - This sort of plans is issued to creditors to cover the life
of the present or the future debtors. Unlike all group life insurance plans, here the creditor
is the named beneficiary. At any time the amount of the benefit is the outstanding loan.
Most insurance company limits the amount of the coverage and the time period
irrespective of the loan. The premium for the group life insurance coverage is usually paid
by the debtor, although it may be entirely paid by the creditor or the may be shared by the
debtor and the creditor. The State and Provincial laws states a limit to premium paid by
the debtor. It is generally expressed as the amount per $1000 of the coverage. If the debtor
has to pay the premium then the debtor has the right to refuse to buy such a policy. The
debtor needs to buy any sort of insurance against the loan but the creditor can not bound
him to but the group creditor life insurance.
Definition of Annuity:
Annuity protect against the financial risk of outliving one’s financial resources.
Historically, by law, only insurance companies. Other providers of financial services now market
annuity products issued by insurers. Some of these providers may wish to issue annuities in the
long run.
The terms of an annuity contract govern the rights and duties of the contracting parties.
The parties to an annuity contract are the
The insurer will issue a policy to the contract holder, which will contain all the terms of the
contractual agreement entered into by the parties.
As per the terms of the contract the contract holder will pay the insurer a series of premiums or a
single premium. Premiums that the insurers receive for annuities are generally referred to as
annuity considerations.
The insurer calculates the amount of the periodic annuity benefit payments that it will be liable to
pay under as annuity policy based on the following basic mathematical concept:
A sum of money, known as principal, that is invested for a certain period of time at a stated rate
of interest can be paid out in a series of periodic payments-in an annuity-over a stated period of
time.
• Periodic level-premium annuity: The contract holder pays equal premium for the
annuity at regularly scheduled intervals, such as monthly or annually, until some pre-
determined future date.
• Flexible-premium annuity: The contract holder pays premiums on a periodic basis over a
stated period of time, the amount of each premium payment, can vary between a set min.
and max. Amount. The contract holder may choose to even skip the payment of premium
of a particular installment. The requirement is to pay the minimum stated premium for a
year.
Annuity period: The time span between each of the payments in the series of periodic annuity
benefit payments.
The frequency of periodic annuity benefit payments depends on the length of the annuity period.
• Monthly annuity: When the annuity period for an annuity policy is 1 month.
• Annual annuity: When the annuity period for an annuity policy is 1 year.
The date on which the insurer begins to make the annuity benefit payments is known as the
annuity’s maturity date or the annuity date.
Depending on when the insurer is to begin making periodic annuity benefit payments we could
have Immediate annuities and Deferred annuities.
Immediate annuity: These are annuities where the benefit payments are scheduled to begin one
annuity period after the annuity is purchased. Generally these are single-premium annuities. Such
an annuity policy is called single-premium immediate annuity (SPIA).
Deferred Annuity: An annuity under which the periodic benefits are scheduled to begin more
than one annuity period after the date on which the annuity was purchased.
The period during which the insurer makes the annuity benefit payments is known as the payout
period or liquidation period.
The period between the contract-holder’s purchase of the policy annuity and the onset of the
payout period is known as the accumulation period.
Deferred annuities could be both Single-premium deferred annuities (SPDA) and Flexible-
premium deferred annuities (FPDA).
A point to note is that any annuity purchased with the payment of periodic premiums is by
definition a deferred annuity.
The manner in which the policy provides for investment earnings on the accumulated value
depends on whether the deferred annuity is a fixed-benefit annuity or a variable annuity.
Withdrawal provision: This provision grants the contract holder the right to withdraw all or a
portion of the annuity’s accumulated value during the accumulation period.
Withdrawal Charge: Most policies imposes a ceiling on the amount withdraw able from the
accumulated value for a deferred annuity per year without charge. If the contract holder wants to
withdraw more than this amount, then the insurer generally imposes a withdrawal charge.
Cash surrender value: At any point of the accumulation period the contract holder has the right
to surrender the policy for its accumulated value less any surrender charges included in the
policy.
Surrender Charge: This is typically imposed if the policy is surrendered within a stated number
of years after it was purchased. The amount of surrender charge usually decreases over time.
Payout option provision is an annuity policy that lists and describes each of the payout options
from which the contract holder may select.
• Life annuity
• Annuity certain
• Temporary life annuity
Life Annuity is an annuity that provides periodic benefit payments for at least the lifetime of a
named individual. Some life annuities also provide further payment guarantees.
The named individual whose lifetime is used as the measuring life in a life annuity is often
referred to as the annuitant.
Annuity Beneficiary is the person or party that the contract holder names to receive any survivor
benefits that are payable during the accumulation period of a deferred annuity.
Payee is the person who receives the annuity benefit payments during the payout period.
Annuity Certain is an annuity policy, which will provide periodic payments over a period of time
that is unrelated to the lifetime of an annuitant. The stated period over which the insurer will make
benefit payments is called the period certain. At the end of the period certain the annuity
payments cease.
Temporary Life Annuity provides periodic benefit payments until the end of a specified number
of years or until the death of the annuitant, whichever occurs first. Once the stated period expires
or the annuitant dies, the annuity benefits cease.
For example in a 5 years temporary life annuity the max. Length of time in which the annuity
benefits will be payable is 5 years. But if the annuitant dies before that time the payment ceases.
Joint and survivor annuity or joint and last survivor annuity is an annuity, which provides
benefit payments throughout the lives of both the annuitants.
The terms of a Joint and survivor annuity determines whether the amount of each periodic benefit
payment remains the same after the death of one of the annuitants or whether it decreases and in
that case by what percentage or amount.
The investors to annuities have different purposes in mind with those funds and also have different
capacities for assuming financial risk when they place money in annuities. Many insurers offer 2
general options to annuity purchasers:
Or
• Pay interest at a rate that is not guaranteed, instead, the interest rate will vary according to
the earnings of certain investments held by the insurer.
Most fixed-benefit annuities specify that once the insurer begins paying the annuity benefits, the
amount of the benefit payment may not change. But this is not a rule. In some cases the insurer
may declare a change of the amount of the benefit amount.
In case of single premium immediate annuities the benefit amount is generally fixed.
In case of deferred annuities annuity policy includes a chart of annuity values. This chart will list
the amount of annuity benefit that is guaranteed per $1000 of accumulated value.
A fixed-benefit deferred annuity policy also describes the manner in which the insurer will credit
investment earnings to the policy’s accumulated value.
Variable Annuities are annuities in which the amount of the policy’s accumulated value and the
amount of the monthly annuity benefit payment fluctuate in accordance with the performance of a
separate account.
The individual who purchases a variable annuity assumes the investment risk of the policy.
Because the insurer makes no guarantees regarding the investment earnings or the amount of a
variable annuity’s benefit payments, the insurer retains no risk under the policy.
The mechanism that allows this investment risk transfer from the insurer to the purchaser is the
separate account. This is called the segregated account in Canada.
This account is completely separate from the insurer’s general investment account.
Insurers typically offer a number of different separate accounts and they follow a different
investment strategy for each such account. The value of a separate account may increase or
decrease depending on the performance of the account’s investments.
Variable annuity contract holders may select from this list of separate accounts and may
periodically transfer funds from one such account to another.
Accumulation units represent the ownership shares of a variable annuity contract holder in a
separate account. The number of units that a contract holder can own depends on the premium that
he pays. As premiums are paid throughout the accumulation period, the number of accumulation
units that a contract holder owns increases.
The insurer must periodically recalculate the value of an annuity unit based on the investment
experience of the separate account. The insurer then recalculates the amount of the periodic benefit
payment by multiplying the total number of annuity unit times the current value of an annuity unit.
In the case of life annuities, the length of payout period is linked to the annuitant’s lifetime. So the
life expectancy factor is considered when calculating the amount of periodic annuity benefit that
can be provided for a specified premium amount.
Annuity mortality rates-the mortality rates experienced by persons purchasing life annuities-are
not identical to the mortality rates experienced by persons insured by LI policies for a given age
and gender.
The difference in form of antiselection in the case of annuities compared to that in LI policies:
Mortality stats show those females as a group may anticipate living longer than males as a group.
This is why; insurers generally tend to charge higher premium rates from females than for males of
the same age.
In recent years, legislatures and courts are examining whether the use of gender-based premium
rate is a form of unlawful discrimination on the basis of gender.
Some insurers use unisex mortality tables and charge males and females with the same premium
rates for annuities.
Straight life annuity provides periodic payments for only as long as the annuitant lives. This form
of annuity is the least popular as there is a risk of the annuitant paying much more money as
premium than he actually receives as payout from the annuity, as he expired early during the
payout period.
Life income annuity with period certain guarantees that the annuity benefits will be paid thru
out the annuitant’s life and guarantees that the payments will be made for at least a certain period,
even if the annuitant dies before the end of that period.
In this case, the contract holder selects a contingent payee who receives the payout benefits in
case the annuitant dies.
Please note that if the annuitant dies after the expiration of the period certain, the no extra benefits
are paid to the contingent payee.
Life income with refund annuity also known as a refund annuity, provides annuity benefits thru
out the lifetime of the annuitant and guarantees that at least the purchase price of the annuity will
be paid in benefits. This guarantees that if the annuitant dies before the total benefit payments
equal the purchase price of the annuity, a refund will be made to the contingent payee. This refund
is the difference between the purchase price of the annuity and the total amount of benefits that
had been paid during the lifetime of the annuitant.
Premium rates for the straight life annuities are the lowest.
Some additional provisions, which are possible, based on the type of the annuity contract are:
• Beneficiary provision: gives the contract holder the right to name the beneficiary who will
receive any survivor benefits payable if the annuitant or the contract holder dies before
annuity benefit payments begin.
• Withdrawal provision: right to withdraw all or part of the annuity’s accumulated value
during the accumulation period.
• Surrender provision: the right to surrender the annuity for its surrender value during the
accumulation period.
The regulations are same in both USA and Canada, as is in the case of LI policies. This is because,
its only insurance companies which are allowed to sell annuities.
For variable annuities the regulations are the same as is in the case of variable LI policies.
Taxation of Annuities
Annuities are an increasingly popular product in the US and the fact that a product that qualifies as
an annuity in accordance with federal tax laws provides favorable federal tax treatment is partly
responsible for that.
For the purpose of income taxes, each annuity benefit payment is considered to consist of the
following 2 parts:
1. One portion is the return of principal, which is not taxable because the purchaser has
already paid income taxes on that amount.
2. The remainder portion of each benefit payment is considered taxable investment income
because the purchaser has never paid income taxes on the policy’s investment earnings.
By contrast, Canada’s tax laws do not provide this favorable treatment for annuities. Investment
incomes for annuities are taxable incomes thru out the life of the annuity. The one exception is
annuity used to fund a qualified retirement plan.
Both the Govt. of USA and Canada have enacted laws that provide federal IT advantages to
individuals who deposit funds into government-qualified retirement savings plans.
Here we will describe some of these qualified individual retirement savings plans, focusing on the
plans that may be marketed by LI companies.
For federal IT purposes, the amount that certain individuals deposit into qualified retirement
savings plans-up to a stated maximum-are usually deductible from their gross incomes in the year
in which those funds were deposited into the plans. In addition, the investment earnings on a
qualified account generally are not taxed until the funds are withdrawn.
There are 2 types of individual retirement savings plans, which qualify to receive favorable federal
IT treatment:
• IRA
• Keogh (HR 10) plans
Individual retirement account is a trust account created in the US for the exclusive benefit of an
individual and his beneficiaries; the trustee must be a bank, investment company, stock brokerage,
or similar organization.
The sponsoring financial institution handles the administrative aspects of an IRA plan. It ensures
that the IRA plan meets the legislative requirements to qualify as an IRA arrangement and obtain
approval from the Internal Revenue Service (IRS) that the plan qualifies.
Tax treatment on IRAs varies on the basis of whether it’s a Regular IRA or a Roth IRA.
Regular IRA has been established in 1974. The following is a summary of the tax treatment on a
regular IRA:
1. Anyone who is less than age 70 1/2 and who has earned income may contribute up to
$2000 per year of the earned income into a regular IRA.
2. Taxation of investment earnings is deferred until funds are withdrawn. With only a few
exceptions, however, penalties are imposed on withdrawals made before the taxpayer
attains age 59 ½.
3. Taxpayers must begin making annual withdrawals of at least a specified minimum amount
when they reach age 70% and after that time they may not make additional contributions
to their IRAs.
Roth IRAs have been established since Jan 1, 1998. The primary difference in the tax treatment of
a Roth IRA and a Regular IRA are as follows:
• No current tax deductions are allowed for contributions to a Roth IRA. Thus, Roth IRA
contributions are made with after-tax dollars, whereas Regular IRA contributions are made
with pre-tax dollars.
• Qualified withdrawals from a Roth IRA that the taxpayer has held for at least 5 years
aren’t subject to income taxation. Qualified withdrawal includes withdrawals taken after
the age 59 ½ and the withdrawals made by a 1st time homebuyer.
• Unlike Regular IRAs, Roth IRAs aren’t subject to minimum distribution requirements.
• Funds of the Keogh plans may be placed in any of the several types of investments, such
as stocks, bonds, or real estates etc.
• The deposit to a Keogh plan is deductible from taxable income up to a certain limit.
• Withdrawals from a Keogh account are taxable as income.
• Penalties on the withdrawals may be payable if the legislatively defined requirements for
making withdrawals are not met.
In Canada:
A qualified retirement account is known as a registered retirement savings plan (RRSP). Any
gainfully employed individual, including an employee who is covered by an employer-sponsored
pension plan, can establish this RRSP.
The following is a summary of information about RRSP.
• The contribution to an RRSP is deductible from taxable income up to a stated maximum.
• This may also depend on whether the individual is an active participant in a qualified
pension plan. Such an individual will have a lower ceiling to the contribution eligible for
deduction from taxable incomes.
• Funds in RRSP may be placed in a number of investment vehicles.
• RRSP accounts must begin withdrawing the accumulated funds by the time they reach age
69.
In order to encourage employers and labor union to buy retirement plans for the members,
both in United States and in Canada, federal income tax laws provide income tax benefits to both
the plan sponsors – the employers that establish the plan, and the plan participants – the
employees. In order to have the tax benefit the plans have to meet certain regulations. In United
States these plans are known as qualified plans and in Canada they are known as registered plans.
In Canada the plans have to be approved and registered with Revenue Canada prior to the
establishment of such plans. In United States, plan sponsors are not required to obtain prior
approval of Internal Revenue Service, yet they choose to obtain prior approval form IRS. We shall
now discus the salient laws that govern the formulation of such plans in U.S. and in Canada.
United States: - Most of the legislation part comes from Employee Retirement Income Security
Act (ERISA). Following are the requirements that ERISA imposes on retirement plans.
1. Non discrimination requirements prohibit qualified plans from going for the benefit of
highly paid employees.
2. Vesting requirements must be clearly stated in a plan. This right give vested interest of
the employee on the benefits of plan even he leaves the service prior to retirement. This
requirement should clearly state that when the employee has the right to policy benefits
and when does she have the vested interest on the employer’s contribution.
3. Security requirements must be fulfilled to safeguard the interest of the plan participants.
4. Reporting has to be done by the plan sponsor to government agencies and to the plan
participants regarding the plan provisions.
5. Fiduciaries are responsible to administrate the plan and to hold the plan assets. They are
bound to do their duty in accordance to the statutory guidelines mentioned in ERSIA.
6. Tax benefits: -
a) Within stated limits the contributions made from the employers end is considered
as a part of employer’s current expense and hence is not considered as taxable
income.
b) The employer’s contribution to thee plan is not considered as taxable income for
the employee. The tax on employer’s contribution is deferred till she actually
receives the benefits from the plan.
c) All the interest earnings are allowed to accrue tax-free. The plan participant
actually pays the tax on the interest earnings on receiving the benefits from the
plan.
Retirement plans can either be contributory or non-contributory. Since there is no tax
benefit on the employee’s contribution most of the retirement plans in U.S. are of non-
contributory type.
Canada: - The Canadian federal government and all the provincial government have each enacted
a Pension Benefits Act. The Pension Benefits Acts require that when an employer establishes a
pension plan, it must be registered with a specified government agency. In order to qualify for
Employers establish three general types of qualified (registered) retirement plans in the
United States and in Canada.
Pension plans: - These are plans according to which the employer promises to pay
pension to the employees after their retirement. Most employers sponsored pension plans,
in U.S., are qualified pension plans and are referred as qualified plan. In Canada such a
plan is known as a registered pension plan (RPP). Both qualified and registered can be
categorized as the following: -
• Defined Benefit Plans: This plan defines that the participant will receive a
fixed amount as retirement benefit. The benefit is usually given as monthly
annuity. The services of an actuary are typically required to determine the
amount of contribution required for the plan. Contributions made for all the plan
participants are pooled into one investment account and are allocated to
individual plan participants as they retire according to the plan’s provision.
• Defined Contribution Pension Plans: In this plan the employer states the
amount of contribution that will be paid for each plan participants. The
contributions are invested into separate accounts for each participant. The
participants get the entire accrued amount as a lump sum or as monthly annuity.
There are advantages that the Defined Contribution Plans have over Defined
Benefit Plans—firstly, the employer knows the amount that will be paid for the
plan in advance, secondly, the employer does not have to depend on the
actuary’s estimation. Moreover ERSIA imposes more complicated laws for
Benefit Plans.
Profit Sharing Plans: - This is a retirement plan that is primarily funded from the
employer’s profits. In Canada these plans are known as deferred profit sharing plan
(DPSP). The features are quite similar to the defined contribution plans. Since the
employer is making contribution from the profits, so it might not pay the contributions
when the contribution warrants them. Qualification rules in U.S. states that employer’s
contribution must be substantial and recurring and should not benefit high paid employees.
To qualify as DPSP in Canada, a plan that defines the amount of the employer’s
contributions “by reference to profits” must provide that at least 1% of those profits will
be contributed. If the plan defines the amount of the employer’s contributions “out of
profit” then limitations are imposed, but those are not as stringent as 1-% rule.
United States: An employer may provide a thrift and savings plan. This plan works in
the same way as Profit Sharing Plans; the only difference is that the employer’s contribution is
obligatory. An account is established for each plan participants. The employee’s contribution is
subjected to statutory limits and the employer generally pays an amount equal to the employee’s
contribution. The employee’s contribution to this plan does not enjoy any federal income tax
benefits. In order to provide tax benefits laws in U.S. allows the employees to participate in special
type of thrift and savings plan known as 401(k) plan. The employee’s contribution is considered as
taxable income, but she has to pay tax when she withdraws the money from such a plan. In order
to participate in 401(k) plan the employee enters into a salary reduction agreement. Another type
of qualified retirement plan that is established for employer with not more than 100 employees in
the preceding year. This type of plan is known as Savings Incentive Match Plans for Employees
(SIMPLE plan). The employee agrees to reduce her compensation but the reduction is also
taxable. The limitations to the contribution to the SIMPLE IRA are generally higher than other
type of IRAs but that is lower than the limitations provided to other qualified plans. The employer
also needs to contribute to the plans, but within certain limits. There is clause for
nondiscrimination and other regulations are quite simple. All contributions to a SIMPLE IRA
accounts must be vested in the employee.
Canada: An individual who wishes to establish a retirement plan in Canada can buy
Registered Retirement Savings Plan, and within stated limits can deduct from his current taxable
income. Many employers buy group RRSP. Employees and employers are permitted to make
contribution to the plan but the contribution from the employer’s end is considered as that the
employee made them. Hence the employee has the vested right over the amount of the plan form
very beginning. Any contribution to the plan is tax-free.
Many nonqualified plans are established to avoid the complex legislative norms that govern the
qualified (registered) plans. We shall now discuss the nonqualified retirement plans in U.S. and in
Canada.
United States: For small employers there is simplified employee pension (SEP) plan.
The employee is required to establish her own IRA in which the employer will add her
contribution. The contribution made by the employer is considered as her expenses and hence
deductible from her current income. The employer’s contribution is considered as taxable income
for the employee, but she is allowed to take certain tax deductions. The deductible for the
contribution maid to SEP IRA is more than in other IRAs. SEP are easier to administrate since it
involves less amount of paper work.
Canada: Some Canadian employers have established employee’s profit sharing plans
(EPSPs) that are nonregistered saving plans. Contributions must be made every year. The
contributions made by the employer are deductible from his present taxable income. To get the tax
benefit the employer must share the profit under “reference to profit” that is the share must be
1%. The employee has to pay tax on both the contributions made by the employer and herself.
• The plan: The terms of a plan are written in a document known as plan document. This
document spells out the different provisions; as for example: the plan must state the
eligibility criteria for the plan participants, the time by when the participants are fully
vested, the time by when she will receive the benefits form the assets of the plan.
• Plan administrator: The plan sponsor names a plan administrator who is responsible for
various aspects of the plan’s operation. The administrator can be the sponsoring employer
Canada: In Canada we have the following retirement plans that are sponsored by the government:
-
Old age Security Act: This act provides pension to all Canadians of age above 65 years.
The pension amount is not dependent on the preretirement wage, marital status, current
occupation, etc. Everyone who has reached an age of 65 and has met certain residential criteria is
eligible to receive the pension. The money to fund these pensions is taken form federal
government general tax revenues.
Canada Pension Plan and Quebec Pension Plan: These are federal programs that
provide pension to workers who have contributed money into the plan during their working years.
The CPP and QPP work very closely and hence the participants can be easily transferred from one
plan to another. Participation for all workers in these plans is mandatory. The covered employee
must pay a certain amount of her income into the plan and the employer has to pay the same
Managed care Plans are medical expense plans that combine financing and delivery of health
care within a system that manages the cost , accessibility and quality of care.
Basic medical expense coverage : Consists of separate benefits for each covered medical care
cost.
Hospital expense : Hospital expenses like room, board, medication, lab tests etc.
Surgical expenses: Inpatient and Outpatient surgery
Physician’s expense coverage: Physician’s visit both in and out of the hospital.
There could be one policy for each coverage or one policy of all kinds of coverages.
These are also known as first-dollar coverage since insurance companies starts reimbursing right
from the first dollar of the expense and no contribution is asked from insured.
Major medical insurance: This medical expense plan provides substantial benefit to the same
category of expenses provided by basic expense coverage and sometimes also contains preventive
care.
2 types available:
1. Supplemental major medical policy: Provides coverage for amount that exceed the limit that
comes with basic medical coverage or coverages that can be bought separately.
Usual, reasonable and customary fees: UCR is the maximum dollar amount of a given covered
expenses that the insurer will find eligible for reimbursement.
Based on statistics from national study of fees, a standard expense level is set for a locality for a
certain covered expenses by applying a predetermined formula. This benefit amount is UCR fee.
When a claim is processed the proceed is determined whether the amount is within UCR or not.
Expense participation: Encourages insured(s) to keep benefit amount to a minimum and thus help
in reducing the coverage premium.
2 kinds of participation:
2.Calendar year deductible: Total maximum deductible incurred in a year for various covered
expenses.
3.Coinsurance: After the deductible has been paid the benefit reimbursement level starts.
However this provision states that for this level also insured needs to pay a percentage of the
expense.
4.Stop Loss provision: All expenses incurred during a year are totaled as out-of-pocket expense.
There is a limit on the out-of-pocket expense. This provision states that once the insured has paid
the max. out-of-pocket the rest of the claims will be paid at 100%
Common exclusions:
1. Dental
2. Prescription Drugs:
4. Dread disease
5. Critical Illness
This plan pays a lump some money if the insured is diagnosed with a particular disease.
Example: Heart attack, stroke, life threatening stroke
Typically includes return of premium if the insured dies without incurring the disease.
In USA, the Old Age, Survivors, Disability and Health Insurance ( OASDHI ) also known as
social security provides medical coverage under Medicare program. Insurance companies have
insurance products which provide supplemental coverage over Medicare. These are known as
Medigap policies.
Medicare:
Eligibility:
Part A: Basic insurance coverage and is automatically extended to everyone without any
premium. Deductible and coinsurance provision is present.
Includes 1. Hospitalization 2. Confinement in an extended care facility after hospitalization and 3.
home health care services.
Financed by payroll tax imposed on employees through Social Security program.
Medicaid:
Claim Costs: Cost the insurer predicts that it will incur to provide the policy benefits promised. It
is calculated for every type of expenses like :
1. Surgery 2. Hospital expense 3. Physician fee 4. major medical expense.
Since number of claims for Health Insurance is much more, so insurer always adds an extra
amount to actual Loading to counter unforeseen contingency conditions
Loss Ratio: Ratio of Benefits an insurer paid out for a block of policies to the premium received.
Loss Ratio is calculated to keep a check on the insurer so that they cannot add too much to the
Loading as a measure of protection against contingency situations.
Individual and commercial insurance companies provide disability income coverage that provides
a specified, periodic income replacement benefits to an insured that becomes unable to work
because of an illness or an accidental injury.
Each disability income policy specifies the definition of total disability that the insurer
uses to determine whether a covered person is entitled to get the disability benefits.
• Any Occupation: At one time the disability was defined as the state where the covered
person becomes disable to perform any sort of occupation. Because of the strict sense of
the definition most of the covered person will never be entitled to the benefits. Thus the
insurance companies now use a more liberal definition.
• Current Usual Definition: This provides that an insured is considered totally disabled if
at the start of disability, the disability prevents him from performing the essential duties of
his regular occupation. At the end of the specified period, usually two or five years, an
insured is considered as totally disabled if his disability prevents him from working at any
occupation for which he is reasonably fitted by education, training, or experience. Policies
that use this definition however may state that the insured will not be considered as
disabled if he voluntarily returns to any occupation.
• Own Previous Occupation: This definition which is generally included in individual
policies rather than group policies, states that the policy will pay disability benefits if the
insured becomes unable to perform the acts of her own previous occupation. Thus even if
the insured starts working at any other gainful occupation different from his previous
occupation, he is entitled to receive the benefits.
• Income Loss: This definition is generally included in disability coverage known as
income protection coverage. The definition of total disability for the insured states that the
insured is disabled if he suffers an income loss for his disability. As a result, the insurer
pays the benefit both while the insured is totally unable to work and while he is able to
work but his disability has reduced his income. The policy specifies both (1) a maximum
benefit amount that will be paid when an insured will be completely unable to work and
(2) a method of determining the amount of lost income when the disabled insured is
working.
• Presumptive Disabilities: A presumptive disability is a stated condition that, if present,
automatically causes the insured to be considered totally disabled; thus the insured will
receive the full benefits even he resumes his original occupation. This generally includes
total and permanent blindness, loss of the use of any two limbs, and loss of speech or
hearing.
Benefit Period.
Benefit period is time for which the insurer pays the disability income benefits. Based on
this the policy can either be classified into short term or long term.
• Short-term group disability income coverage provides a maximum benefit period of
less than one year; such coverage commonly specifies maximum benefit period of 13, 26,
or 52 weeks. Long-term group disability income coverage provides a maximum benefit
period of more than one year; the maximum benefit period commonly extends to the
insured’s normal retirement age or to age 70.
Elimination Period.
An elimination period is the waiting period for which the insured has to be disabled to
receive the benefits. The elimination period reduces the cost for providing the benefits for
disability that lasts for very short periods. Longer the elimination period shorter will be the cost of
the coverage. The length of elimination period for both short and long-term individual disability
income coverage last from 30 days to 6 months. Most short-term group life disability income
coverage contains no elimination period for disability due to accidents and an elimination period
of 1 week for disability for sickness. Most long-term disability coverage has an elimination period
of 30 days to 6 months.
Benefit Amount.
As a general rule, the benefit amount available through disability income coverage is not
intended to replace fully an individual’s predisability income. Instead the benefits are limited.
Disability income amounts however should not be so low that the insured faces a drastic income
loss. The insurer generally uses either of the following two methods to determine the benefit
amounts. The methodology depends on whether the policy is a group policy or individual policy or
on whether the policy is a short-term or long-term policy.
• Income Benefit Formula: This is generally used for group disability income benefit
policies. Here the insurer states the benefit as some percentage of the insured’s
predisability income. The insurer considers all sort of disability income. For group long-
term disability income coverage the benefit generally amounts to 65-75 % of the
predisability income. For example, the insurer may state that the insured will receive 70%
of his predisability income and the benefits will be reduced if he receives disability
income form any other sources. Group short-term disability income coverage has this
percentage as 90-100%.
• Flat Amount: This is generally used for individual policies. Here the insurer mentions a
flat amount to be paid when the insured becomes totally disabled. The amount of the
benefit depends on the insured’s earnings at the time he purchased the policy. But here the
benefit does not depend on earnings form any other source. The insurer carefully limits the
maximum benefit for which the insured can buy the policy. The insurer generally
considers the following factors while setting up the maximum benefit from the policy: -
1. The amount of the applicant’s usual earned income, before tax.
2. The amount of the applicant’s unearned income, such as dividends and the
interest, that will continue when the insured become disabled.
3. Additional income during disability, such as income benefits from group policy
and government sponsored policy.
4. The applicant’s current tax bracket.
In general, the maximum amount of disability income benefit that insurer will provide
is 50 to 70 % of his pre-tax earnings.
We shall now describe certain supplemental benefits that are usually added to disability
income coverage. These are either added automatically with the policy or are added as an option
by paying extra premium for such benefits.
• Partial Disability Benefits: In this case certain benefit is provided to the insured if he has
partial disability—a disability that prevents the insured from performing certain acts of
his own occupation or prevents him from being a full time employee of his present
occupation. This amount is typically either a flat amount or often 50% of the total
disability benefit. Using the formula method the benefit may vary depending on the
insured’s loss of income due to partial disability.
• Future Purchase Option Benefit: In case of flat benefit the insurer may provide a future
purchase option, which grants the insured to increase the benefits as his income increases.
The option is generally provided if the insured can show that his income will increase
considerably in the future. However the increment of such benefits is limited. The insurer
does not need to provide proof of insurability to increase the benefit amount.
• Cost of Living Adjustment Benefit: COLA benefit states that the insured will provide the
disabled insured a benefit amount that increases to reflect the increase in cost of living.
Generally the increment depends on certain standard indices such as CPI.
Exclusion.
Following are the exclusion criteria for the disability income benefits: -
1. Injuries or sickness that result from war, declared or undeclared.
2. Intentionally self-inflicted injuries.
3. Injuries receive as a result of active participation in a riot.
4. Occupation-related disabilities or sickness for which the insured is entitled to receive
income benefits under some group or government disability program.
United States: U.S. workers who are under age 65 and who have paid a specified amount
of Social Security Tax for a prescribed number of quarter-year periods are eligible to receive
Social Security Disability Income (SSDI). For this the disability is described as a person’s
inability to work because of a physical or mental sickness or injury that have lasted or expected to
Group Health Insurance Policy: It’s a contract between the Insurer & the GPH (group
policyholder) that purchased the group insurance coverage.
2) Group Disability Income Policies (GDIP) do not provide the option at all.
2) Conversion Provision:
This provision grants an insured, who is leaving the group, a limited right to purchase an
Individual MEP with the presenting the evidence of insurability. The right is limited in that the
insurer can refuse to issue the individual policy if the coverage results in the insured group
member becoming over-insured.
For instance, an employee who’s changing his/her job & will be eligible for GMEP from
his/her new employer would be considered over-insured if he were also issued an Individual
MEP.
In most states in the U.S. require to include this provision for GMEP. However, this is not a
mandatory provision to be included in GMEP in Canada
COB is designed to prevent a group-insured, who is covered under more than one GMEP, from
receiving benefit amounts greater than the medical expenses actually incurred.
For instance, spouses, who both work, are eligible for coverage under their own employers’ group
policy & their spouses’ group policy. If benefits payable under such duplicate coverage were not
coordinated, the insured could receive full benefits from both the policies & consequently would
profit from an illness or injury.
The Primary Provider pays the full benefit promised under the plan. Once the
insured receives this benefit, and then the insured can claim to the secondary plan,
along with the description of the benefit amounts the primary plan paid. The
Secondary Provider then determines the amount payable for the claim in
accordance with the terms of that plan.
Note here that the Secondary Provider pays the difference between the amount of
Allowable Expense & the amount already received from the Primary Plan.
Under this type of a COB, the insured does not pay any portion of the expenses.
This is included in most GDIP & grants the insurer the right to examine the insured, who has
claimed a disability income, by a doctor of the insurer’s choice & at the insurer’s expense. This
provision also allows the insurer to make the disabled undergo medical examinations at regular
intervals so that the insurer can verify that the insured is still disabled.
A group’s risk classification – standard, substandard, or declined – will be established on the basis
of the group’s morbidity rate.
What are the factors that decide the expected morbidity rate of a group?
1. The nature of the industry the group members work
2. The age distribution of the group. The rate increases as increases the age of
the group members.
3. The distribution of the males & the females in the group. Females experience
higher morbidity rates than do males of the same age.
Funding Mechanisms:
The way in which a group insurance plan’s claim costs & administrative expenses are paid is
known as the plan’s Funding Mechanism.
What are the two main funding mechanisms for Group Insurance Plans?
1. Fully Insured Plans – Here the group policyholder makes the monthly
premium payments to the Insurance Co and the Insurance Co. bears the
responsibility for all claim payments. This is also known as Traditional
Funding Arrangement.
2. Fully Self Insured Plans – Here the employer takes the complete
responsibility for all the claim payments & related expenses.
Following three mechanisms are built upon the Fully Insured Plans:
Following three mechanisms are built upon the Self Insured Plans:
Under Individual Stop-Loss Coverage / Specific Stop-Loss Coverage the insurer pays a
portion of the each claim that exceeds a stated amount.
Under Aggregate Stop-Loss Coverage the insurer pays when the employer’s total claims
exceed a stated dollar amount within a stated period of time (usually 12 months).
What are the benefits of Fully Self Insurance to the Fully Insured Plans?
1) No premiums need to be paid any insurer.
2) So avoids insurer’s expense charges.
3) Avoids paying profit of the insurer.
4) Avoids paying commissions to agents.
5) Employer retains the money for the premium
with it, which leads having an improved cash flow & earning interest on that.
More importantly, self-insured plans are exempted from State Laws providing more freedom to the
self-insurance employer in designing the plans. However, many self-insured plans in the US, are
subject to regulation by the federal ERISA.
People who are otherwise not eligible for group health insurance coverage generally purchase
individual health insurance policies.
This is a contract between the insurer and the policy owner. The policy will describe the coverage
provided, the benefits payable, and the premium amounts and their due dates.
The policy owner and the insured are usually the same person. The insurer typically pays the
benefits directly to that person or to a medical-care provider on behalf of that person.
The number of coverage options that insurers offer to group policyholders is usually not available
to individual policy owners.
But the applicant of an individual health insurance policy is generally permitted to make choices
concerning the following:
• Benefit levels
• Renewal provisions
• Amount of the policy’s deductible (for individual medical expense policies)
• Combinations of elimination periods and maximum benefit periods (for individual
disability income policies)
Many of the provisions for Individual Health Insurance policies are same as with the Group Health
Insurance policies. Here we discuss some of the provisions typically included in the Individual
Health Insurance policies.
Renewal Provision
• The circumstances under which the insurer has the right to refuse to renew or the right to
cancel the coverage.
• The insurer’s right to increase the policy’s premium rate.
Traditionally, Canadian insurers and US have used the following 5 general classifications of
individual health insurance policies.
• Cancelable Policy.
• Optionally renewable policy.
• Conditionally renewable policy.
• Guaranteed renewable policy.
• Non-cancelable policy.
Cancelable Policy grants the insurer the right to terminate the policy at any time, for any reason,
simply by notifying the policy owner that the policy is cancelled and by refunding any advance
premium that has been paid for the policy. Some states in the US do not permit insurers to issue
cancelable policies.
A class of policies consists of all policies of a particular type or all policies issued to a particular
group of insured.
Conditionally Renewable Policy grants the insurer a limited right to refuse to renew an individual
health policy at the end of a premium payment period. The decision must be based on one or more
specific reasons stated in the policy. The reasons cannot be related to the insured’s health.
The age and employment status of the insured are often listed as reasons for possible non-renewal.
Guaranteed Renewable Policy means that the insurer must renew the policy-as long as premium
payments are made-at least until the insured attains the age limit stated in the policy.
Mostly this age is 60 or 65. Sometimes it could be 70 and there are cases when the policy is a
guaranteed renewable policy through the lifetime of the insured.
Non-cancelable Policy is guaranteed to be renewable until the insured reaches the limiting age
stated in the policy. In addition, the insurer does not have the right to increase the premium rate for
a non-cancelable policy under any circumstances; the guaranteed premium rate is specified in the
policy.
Disability income policies typically are non-cancelable, medical expense policies are rarely non-
cancelable.
In the US, HIPAA enacted in 1996 imposes a general requirement that the insurers must renew or
continue an individual medical expense insurance policy in force at the option of the policy owner.
In common-law jurisdictions of Canada, most individual medical expense policies are cancelable
and most disability income policies are non-cancelable.
In the province of Quebec, individual health insurance policies have several classifications, from
which the applicant can choose the one to purchase.
Premium rates for non-cancelable policies are higher than equivalent policies in the other
classifications.
Reinstatement Provision
States that if certain conditions are met, the insurer will reinstate a policy that has lapsed for
nonpayment of premiums. The policy owner usually must pay any overdue premiums and must
complete a reinstatement application.
Insurer has the right to evaluate the reinstatement application and to decline to reinstate the policy
on the basis of statements in that application.
If the insurer does not complete the evaluation within a stated number of days-in most states, 45
days-after receiving the reinstatement application, or if the insurer accepts an overdue premium
without a reinstatement application, then the policy is usually considered to be automatically
reinstated.
Coverage under a reinstated policy is limited to accidents that occur after the date of reinstatement
and to sicknesses that begin more than 10 days after the date of reinstatement.
Incontestability provision
Most individual medical expense policies contain a provision entitled time limit on certain
defenses. This is also known as incontestable clause or incontestability provision. This states
that after the policy has been force for a specified period, usually 2 or 3 years, the insurer can’t use
material misrepresentations in the application either to void the policy or to deny a claim unless
the misrepresentations were fraudulent.
Most individual disability expense policies contain a incontestability provision which states that
after the policy has been force for a specified period, usually 2 or 3 years, the insurer can’t contest
the policy’s validity on the ground of material misrepresentations in the application. This does not
include a reference to fraudulent misrepresentation. Essentially this is same as that of the
incontestability provision in LI policies in USA.
The insurer has the opportunity to evaluate such a condition and, thus, can specifically exclude the
condition from the policy’s coverage.
In most states and throughout Canada, 2 years is the maximum period during which an insurer is
permitted to exclude pre-existing conditions from coverage. Insurers are permitted to specify a
shorter exclusion period because a shorter exclusion is more favorable to the insured.
In USA, HIPAA prohibits insurers from including a pre-existing condition in the individual health
insurance policy issued to specified individuals.
Claims Provisions
In Canada, the policy usually requires the insured to notify the insurer of a claim in writing within
30 days from the date the claim arose and to furnish the insurer with proof of loss within 90 days
from the date the claim arose.
The insurer must pay benefits within 60 days of receipt of proof of loss for a medical expense
claim and within 30 days of receipt of proof of loss for a disability income claim. Policies issued
in the US contain similar requirements.
After the insured submits a claim, the insurer has the right to have the insured examined by a
doctor of the insurer’s choice, at the insurer’s expense. The insurer, therefore, has the ability to
verify the validity of disability income claims.
This provision limits the time during which a claimant who disagrees with the insurer’s claim
decision has the right to sue the insurer to collect the amount the claimant believes is owed under
the policy.
The length of this time period varies from jurisdiction to jurisdiction, but varies between 1 to 3
years after the claimant provides the insurer with proof of the loss.
This allows the insurer to adjust the policy’s premium rate or the amount of benefits payable under
a policy if the policy owner changes his occupation. The insurer is typically permitted to reduce
the maximum benefit payment amount payable under the policy if the insured changes to a more
hazardous occupation. If the insured changes to a less hazardous occupation, the provision permits
the insurer to reduce the policy’s premium rate.
This is intended to prevent an insured from profiting from a sickness or injury. This provision
states that the benefits payable under the policy will be reduced if the insured is over insured.
An over insured person is one who is entitled to receive either
• More in benefits from his medical expense policies than the actual costs incurred by
treatment.
• A greater income amount during disability than he earns while working.
The underwriter evaluates an application for individual health insurance policy to determine the
degree of morbidity risk represented by the proposed insured.
Morbidity Factors
The primary factors that affect the degree of morbidity risk presented by a proposed insured are
the individual’s age, current and past health, sex, occupation, avocations, work history, and habits
and lifestyle.
Risk Classifications
• Standard risk
• Substandard risk
• Declined risk
Exclusion rider, also called the impairment rider, specifies that benefits will not be provided for
any loss that results from the condition specified in the rider.
1. Eliminate the fact that more frequent visit by patient to doctor means more financial benefit for
doctors.
2. Broaden the circle of financial risk to include health care providers. Health care providers
should be encouraged to deliver the necessary care in a cost-effective way.
Utilization management: Process by which a plan manages an insured’s use of medical services
and assures that she receives necessary, appropriate, high quality care in a cost effective manner.
Utilization management broadens and combines utilization review and case management
techniques.
Utilization Review is a process by which a plan evaluates the necessary and quality of a patient’s
medical care.
UR includes:
3. Retrospective reviews: Same as preadmission but is done after the patient’s release from
hospital. This is a concurrent review step of the whole analysis. This might reveal erroneous
charges and billing errors.
Case Management
Case Management is an extension of UR and is a process by which a plan evaluates not only the
medical necessity of care but also alternative treatments or medical care.
A HMO is a health care financing and delivering system that provides comprehensive health care
services for subscribing members (Subscribers) in a particular geographic area. HMOs can be
owned or sponsored by many different types of organizations: by national HMO organizations, by
commercial insurers, and by medical schools and hospitals. HMOs can be operated as either not-
for-profit or for-profit organizations.
1) Comprehensive Care: HMO subscribers are eligible to receive comprehensive health care
services, including impatient and outpatient treatment in a hospital. Unlike traditional indemnity
plans, HMO emphasize the practice of preventive care, including routine physical examinations,
diagnostic tests, pre-natal and well-baby care, and immunizations.
2) Prepaid Care: In a traditional HMO, subscribers receive comprehensive health care in exchange
for the payment of a periodic fixed fee. Most HMOs require the subscriber to pay an additional fee
(co-payment) for certain medical services. HMOs shift all or part of the financial risk to the health
care providers.
3) Network Providers and Negotiated Fees: HMOs contract with physicians and hospitals to make
up a network of health care providers. HMO subscribers must choose their medical care providers
from within this network. By Contracting, HMOs achieve advantages like:
• Can control the quality of the providers
• Can negotiate fees and thus reduce the cost
These are the fee structure arrangements that are used to pay the providers.
Capitation: Under this arrangement the providers gets paid PMPM (per member per month) for a
subscriber regardless of number of visits. But PMPM may be different for each HMO subscriber
Salary: Physicians get a pre-determined salary based on the average salaries of local physicians in
the same field. They also receive certain types of performance bonuses or incentive pay.
Discounted fee-for-service: HMO pays physicians a certain percentage of their normal fees (like
90%). It is not as widely used as other fee structures.
Fee Schedule: The HMO will pay up to a specified maximum fee for each procedure. In this case
it is transferring more risk to the service providers.
4) Intensive Use of Managed Care Techniques: HMO requires subscribers to select Primary care
physician (PCP) who serves as the first contact with the HMO. If additional care needed, PCP
refers the subscriber to specialists within the network. That is why they are often called
gatekeepers.
Types OF HMOs
Open Panel HMO: any physician or provider who meets the HMO’s specific standards can
contract with the HMO (2 type)
Closed Panel HMO: physicians either must belong to a special group of physicians that has
contracted with the HMO or must be employees of the HMO (2 type)
Open Panel
• Individual Practice Association (IPA) model: Under this arrangement, HMO enters into
a contract with an IPA, which is an association of physicians (independent practitioners)
that agrees to provide services. Physicians provide services to their own patients as well as
to the HMO subscribers. This model requires less start-up capital and can offer a broad
range of specialists. IPA model is generally compensated by ‘capitation’ or ‘discounted
fee-for-service’ arrangements. Some HMO requires subscribers to pay co-payment also.
But in this case the financial risk rests with an IPA.
Closed Panel
• Staff Model: Physicians are actually employees of the HMO and generally out of offices
in the HMO’s facilities. The staff model HMO may own or contract with hospitals,
laboratories, pharmacies, and other organizations to provide non-physician medical
services. Uses ‘Salary’ structures. Financial risks on the HMO, costly to start up but have
greater control over physicians so can manage utilization of health care services better
than other models.
• Group Model: Functions same as a staff model, except that the physicians are employees
of a physicians’ group practice, rather than employees of the HMO. The physicians in
such a group share office space, staff, and medical equipment at a common health center
or clinic. Ex: Kaiser Permanentre in the US. If the group HMO contracts with more than a
group, then it is called a network model HMO. Pay to the group by ‘capitation’ method,
group pays the physician ‘salaries’ based on their performance, expertise and amount of
administrative work. Financial risk on the physicians’ group.
Unlike HMO, PPO does not provide health care directly rather it acts as a broker or middleman by
contracting between health care providers and health care purchasers (employers, third-party
administrations, insurance companies, and unions). PPOs can be organized or sponsored by group
of physicians, hospitals, Blue Cross or Blue shield plans, TPAs, or employers. In the US,
insurance companies are the dominant sponsors of PPOs.
PPOs also use a network of providers but also offer some coverage for members who choose to
use the services of non-network or out-of-network providers. Out-of-pocket expense (generally
30%) will be more in case of out-of-network provider selection, only to encourage the subscribers
to choose the network provider.
PPOs typically compensate health care providers on a fee-for-service basis. As a result, PPOs do
not accept the financial risk of providing health care services to insureds but they pass it on to
either the insurer or the policyholder.
Hybrid Plans
• Open-ended HMOs or Point of service (POS) Plan: This plan has some features of a
traditional HMO and some of a traditional indemnity plan. The subscriber of this plan
either uses the HMO network or may choose to use a provider that does not participate in
the HMO. The subscriber typically pays higher out-of-pocket expense than under a
traditional indemnity plan. But this plan contains financial incentives to encourage
subscribers to use network providers.
• Gatekeeper PPOs: This PPO plan requires plan members to choose PCP (gatekeepers)
within the PPO network of physicians. In this case, the out-of-pocket expense will be
lower than the usual PPO.
Another difference is this plan is the compensation method to the providers. Here PCP is
compensated on a capitation basis. Thus gatekeeper PPOs transfer financial risk to
providers.
NAIC has developed these model laws to regulate the health insurance:
• Uniform Individual Accident and Sickness Policy Provision Law
• Group Health Insurance Definition and Group Health Insurance Standard Provisions
Model Act
• Model Newborn Children Bill
• Group Health Insurance Mandatory Conversion Privilege Model Act
• Group Coordination of Benefits Regulations and Guidelines
Most state regulations for individual health insurance are similar as they are patterned with the
NAIC model laws, but state regulations for group health insurance differs widely from state to
state as they are not patterned with the NAIC model laws.
Policy Provisions:
Most state insurance laws require including these provisions in the policy:
• Minimum grace period be included in individual and group policies
• Incontestable clause in individual and group policies
• Most states limit the time within which pre-existing conditions can be excluded from
coverage (in individual and group policies)
• Cancellation and renewal provisions (in individual policies)
• Reinstatement provision (in individual policies), and Conversion provision (in group
policies)
• Coordination of Benefit (COB) provision in group policies, and overinsurance provision in
individual policies.
Mandated Benefits:
Applicable to both group and individual policies. The benefits that have been mandated include,
among others, coverage of newborn children, treatment of alcoholism and drug addiction,
coverage of services provided by chiropractors, psychologists and podiatrists; coverage of certain
diagnostic tests such as mammograms. But these benefits widely vary from state to state.
HIPAA requires the guaranteed availability of individual medical expense coverage to certain
individuals who have had group medical coverage. The insurers are exempt from this requirement
if the state implements an alternative mechanism by which such eligible individuals may obtain
coverage.
Regulation of individual Medical Expense Policies: HIPAA imposes that insurers must renew or
continue an individual policy in force at the option of the policyowner. However the insurer can
discontinue the coverage in case of nonpayment of premium, fraud or intentional
misrepresentation, complying with statutory requirements, insured no longer resides or works in
the network’s geographic (in case of a network health care plan) or no longer an association
member (in case coverage available thru an association).
Mental Health Parity Act: This Act imposes that if the plan is offering the mental health plan
then it may not set an annual or lifetime maximum mental benefits limit that is lower than any
such limits for medical and surgical benefits. And if it does not set a limit on medical benefits
may not impose such a limit on mental health benefits.
Newborns’ and Mothers’ Health Protection Act of 1996: This law does not require policies
to provide benefits for maternity and newborn care but it imposes specific requirements on
plan that do provide such benefits. Such policies must provide coverage for at least 48-hour
hospital stay following a normal delivery and 96 hours for a cesarean section.
Women’s Health and Cancer Rights Act of 1998: According to this act, insureds who
receive benefits in connection with a mastectomy and who elect to have breast reconstruction
following the mastectomy are entitled to receive benefits for the reconstruction.
Health Maintenance Organization (HMO) Act of 1973: Federally qualified HMOs and
employers that have 25 or more employees and that make contributions to an employee health
care plan must comply with this act. The HMO act encouraged the establishment and
development of HMOs by providing grants and low-interest loans to start up HMOs that met
Taxation:
In most cases, the employer’s contributions are not considered taxable income to the
employee. But in case of a self-funded group health plan, if it fails to meet the
nondiscrimination requirements of the federal tax laws then the part of the benefits that highly
compensated employees receive are considered taxable income to those employees.
Medical expense benefits that employees receive are not considered taxable except disability
income benefits. Disability income benefits are not taxable income when received under an
individual disability income policy purchased by the insured.
The federal Canada health Act establishes the following criteria that provincial hospital and
medical expense plans must meet in order to qualify for federal financial assistance:
• The plan must be administered on a nonprofit basis by the province or a provincial agency.
• The plan must be comprehensive, covering specified health services provided by hospitals,
medical practitioners, and dentists.
• The plan must provide universal coverage (cover all residents of province).
• Plan benefits must be portable.
• The plan must provide insured services on a nondiscriminatory basis.
In order to encourage the continuance of private disability income plans, the Unemployment
Insurance Act allows employers to register qualified, private disability income plans with Human
Resources Development Canada. In order to qualify for registration, a private plan must meet the
following criteria:
• Benefits must begin no later than the 15th day of disability and must continue for at least
15 weeks.
• The benefit level must be at least 60 percent of insurable earnings.
• Employees must become eligible for benefits after completing no more than three months
of continuation service.
Provincial Insurance Laws: In most respect, the regulation of health insurance is similar
throughout Canada since they have adopted the Uniform Accident and Sickness Insurance Act
(Uniform A&S Act) developed by CCIR. The provincial insurance laws contain requirements
relating to several provisions that are typically included in health insurance policies:
• Incontestability Provision: 2 years for misrepresentation, anytime in case of a fraudulent
misrepresentation
• Pre-existing Condition: 2 years
• Continuation of coverage when a group policy terminates
• How disability income benefits must be paid when an insured person is overinsured.
A number of provisions that insurers typically not required by provincial insurance laws to include
in the policies like, reinstatement provision, grace period provision, conversion provision.
Taxation:
Province of Quebec treats contributions an employer pays on behalf of an employee under a
private health insurance plan as taxable income to the employee. Otherwise it is non-taxable
everywhere.
In case of a disability benefits, the taxable amount part is the one for which the employer (and not
the taxpayer) has paid the premium.