Understanding Life Insurance

Article Courtesy of the Texas Dept of Insurance

(January 2008)

www.tdi

Life Insurance Basics

When you buy a life insurance policy, you specify whom you want to receive the policy’s death benefits when you die.  The people you specify are called “beneficiaries.”  It’s important to understand that the primary purpose of life insurance is to help your beneficiaries maintain their standard of living after you die.  Life insurance isn’t an investment.  A life insurance policy is generally guaranteed to pay death benefits when the policyholder dies.  With an investment, however, there’s a risk to the payoff – an investor might earn money, but he or she also might lose some or all of it.

While some types of life insurance include a savings component that can provide some retirement income, Texas law prohibits marketing life insurance as an investment or retirement income source.  If an agent or company tries to sell you a life insurance policy as a good investment, be careful.  Complicating matters somewhat, many life insurance companies also sell a legitimate investment product called “annuities” that are similar in principle to life insurance.  People often purchase these investments to provide for retirement because they can provide a steady stream of income over a long period of time. 

Insurance companies use a process called “underwriting” to determine which policy applicants to accept and what premium rates to charge.  The company will consider certain “risk factors,” including your age, gender, medical condition, and whether you smoke.  Younger applicants who are in good health and who don’t smoke will generally be charged lower premiums.  The insurer expects that these policyholders will live longer and thus be able to make more premium payments.  Older applicants who have health problems or those who smoke can expect to pay significantly more because their risk of early death is statistically higher.  Some companies may determine that, based on its review of an applicant’s risk factors, the applicant is too great a risk and may decline to issue coverage altogether.

If a company declines to cover you or charges you more for coverage because of your health status or other factors, keep shopping.  Different companies have different underwriting guidelines.  If you are accepted for coverage at a higher rate, ask whether your premium can be lowered later.  Some companies will lower your premium if you maintain good health for a specified period of time, give evidence that your health has improved, or change to a less-hazardous occupation. 

Who Needs Life Insurance?

When purchasing life insurance, be sure to consider your individual circumstances and the standard of living you want to leave for your dependents.  If you don’t have anyone depending on you for financial support, you may not need life insurance, or you may need only enough to cover funeral expenses or other financial obligations.  The following guidelines can help you decide if life insurance is right for you:

• Families, including single-parent households, generally need life insurance because children depend on their parents’ incomes.  Typically, the younger a child, the greater the family’s need for life insurance.  It’s a good idea to consider insuring both parents, even if only one is a primary wage earner.  This can help ensure that the surviving parent can pay for any increases in the cost of child care if the parent primarily responsible for child care dies. 

• Single adults typically don’t need life insurance, unless they are single parents or support someone such as an elderly parent. 

• Working couples without children or dependent parents typically don’t need life insurance, particularly if the survivor would earn enough to meet expenses and pay debts without exhausting savings.  However, life insurance may be a good idea if only one spouse is employed because the nonworking spouse could maintain his or her standard of living should the working spouse die.  Young couples who plan to start a family may want to consider purchasing life insurance since life insurance can cost significantly less when purchased at a younger age. 

• Older people whose children are grown and independent are less likely to need life insurance.  A well-planned savings program can decrease a family’s need for life insurance as wage earners near retirement age. 

Although life insurance is sometimes used to pay for prepaid funeral arrangements, it is often not the best funding source.  Make sure you fully review your needs and all of your options to pay for funeral expenses. 

You may purchase a life insurance policy on your own life or on the life of anyone who gives their consent for you to do so and agrees to undergo the insurer’s underwriting process.  The person who purchases the policy is known as the “policyholder” and is the person responsible for making the premium payments to keep the coverage in force. 

Most often, life insurance is purchased by policyholders to insure their own lives and provide a death benefit to a spouse, dependent child, or other family member.  However, in some cases you may wish to buy a life insurance policy on someone else and name yourself as the beneficiary.  For instance, if you are divorced and your former spouse provides child-support payments, you might want to purchase a life insurance policy on your ex-spouse to guarantee continued support payments if he or she dies.

You may name any individual, organization, or trust as the beneficiary of the policy’s death benefit, or you may choose to name multiple individuals as “shared beneficiaries” and stipulate how the benefit will be divided among them.  You may also choose to name “secondary beneficiaries” who will only receive the benefit if the primary beneficiary is no longer living.

In some cases, a creditor may have an interest in the life of a loan recipient.  The creditor may purchase a life insurance policy to cover the balance of the loan in case the recipient dies before repayment.  Businesses also sometimes purchase policies on the lives of certain key employees who are vital to company operations.

This publication generally discusses life insurance from the perspective of an individual purchasing a policy on his or her own life to benefit a single named beneficiary.  Unless otherwise noted, however, the same rules apply to policies purchased by third parties and policies with multiple beneficiaries.

The Main Types of Life Insurance

Life insurance can generally be classified as either “term life,” “cash value life,” or a combination of the two.  Term life coverage is typically less expensive and less complex.  These policies pay only once – with a specified death benefit when the insured dies – and only if the person dies during the specified term that the coverage is in force.  Cash value life policies typically provide a variety of features and benefits in addition to the death benefit, and they typically cost more.  The key feature of all cash value life insurance is a savings component that accumulates over time and may be withdrawn, invested, or borrowed against during the policyholder’s lifetime, depending on the policy terms.

In addition to a basic life insurance policy form, your agent or company will likely offer a choice of “riders” that can be added to a policy to extend, limit, or modify the coverage.  Riders that increase coverage typically increase the premium.

Term Life Insurance

Term life policies take their name because coverage only lasts for a specific period of time – such as one, five, 15, or 20 years – or until the insured reaches a certain age.  The cost of term life generally increases as you get older.  For people under age 40, term life generally provides the largest death benefit per premium dollar of any type of life insurance.

Term life policies typically don’t include a savings component.  If you die during the term, the insurance company pays the amount of the death benefit specified by the policy.  If you don’t die during the term, the policy lapses, no benefit is paid, and you must either renew or purchase another type of coverage if you wish to keep life insurance.

Term life can be a good choice for young families with children.  You may only need coverage until the children are old enough and financially able to provide for themselves.

Common features of most term life policies include:

• Convertibility.  You can exchange the policy for permanent life insurance of equal value without taking a medical exam or any further underwriting.  For example, you could transfer a $100,000 convertible term policy into a $100,000 cash value policy without having to answer questions about your health or medical history.  However, your premium will probably increase because cash value coverage typically costs more than term life.  Convertibility can be an important feature if your health declines and you become unable to qualify for a permanent policy through a separate application.  Converting to a cash value policy can also allow you to begin using your policy to build savings.  Insurers typically only allow policyholders to convert term life policies before age 65. 

• Renewability.  You can extend the policy for additional terms, regardless of your health and without having to pass a medical exam.  This can be another advantage of term life coverage as you age or if you become ill.  Even if you no longer meet an insurer’s underwriting criteria, the company still must renew.  Terms can renew at 20, 10, or five years, or even annually.  Premiums generally increase at each renewal term.  Annually renewable premiums can be extremely high for policyholders past middle age.  If you’re paying high annually renewable premiums, you may want to convert to some other type of coverage. 

Term life insurance typically comes in one of three common policy variations:

1. Level term coverage pays a death benefit that remains constant over the term.  For example, a 20-year level term policy with a $100,000 death benefit will always pay that amount, whether the insured dies in the fifth or 15th year.  Depending on the policy, your premium for level term coverage will either remain constant or increase at a scheduled rate.

2. Decreasing term coverage pays a death benefit that decreases over the term at a scheduled rate.  For example, a 20-year decreasing term policy may begin with a $100,000 death benefit that decreases by $5,000 per year.  If you die in the 11th year, the policy pays $50,000.  Decreasing term coverage can be a good option to provide for children in the event of a parent’s early death since the need for coverage typically decreases as they near adulthood.  A disadvantage of decreasing term coverage is that its convertibility value also decreases each year.  Premiums typically remain constant over the term.

3. Increasing term coverage pays a death benefit that increases over the term at a scheduled rate, which is often pegged to inflation.  For example, a 20-year increasing term policy may begin with a $100,000 death benefit that increases by 5 percent of the face value per year.  If you die in the 12th year, the policy would pay about $155,000.  Premiums typically increase each year for increasing term policies relative to the benefit increase. 

Cash Value Life Insurance

Cash value life policies provide both a death benefit and a way to accumulate funds over time.  However, the primary purpose of cash value coverage is to provide permanent life insurance protection, not to serve as a retirement or savings plan.

Initial premiums for cash value insurance are typically higher than for term life insurance because you’re also purchasing the savings feature.  However, cash value premiums generally increase at a slower rate.  If you buy a cash value policy at a young age and continue the policy into middle age, your premium will likely be lower than they would for a term life policy with a comparable death benefit.

A portion of each cash value premium is placed into an account that accumulates over time.  This is the policy’s “cash value.”  The amount may grow at a fixed interest rate, be tied to indexed interest rates, or increase according to the performance of stocks, bonds, or other securities in which the account is invested, depending on the policy type.

A policy may allow you to withdraw from the cash value, use it as collateral for a loan, or use it to make future premium payments, depending on the terms.  Withdrawing all of the cash value cancels the policy and ends coverage, however.

When you die, beneficiaries may receive only the policy’s stated death benefit or the benefit plus any remaining cash value, depending on the policy terms.  Premiums will be higher for the second option.
It typically takes at least three to five years for a policy to build significant cash value.  Moreover, if you withdraw some or all of the money before a specified time period, you will likely incur a substantial “surrender charge,” which can be as high as 10 percent or more.  You may also be liable for income taxes on the money.  If you purchase a cash value policy, try to keep it for at least 15 to 20 years.  About half of the people who purchase these policies cash them in within five years, which is often a financial mistake.

Cash value life insurance can be a good option for people with financial discipline.

The two most common variations of cash value insurance are:

1. Whole life insurance.  Whole life insurance remains in force for the duration of the insured’s lifetime or until the policy is cashed in, provided that the premium is paid.  You never have to renew.  Premiums either remain constant or increase at a scheduled rate.  Part of each premium goes to pay for the death benefit, part to pay the insurer’s overhead costs and profit, and part to increase the cash value.  Some whole life policies are “participating,” meaning they may also pay a dividend depending on the performance of the cash value investment account.  Typically you will have the choice of receiving the dividend in cash, adding it to your policy’s cash value to purchase additional death benefits, or using it to pay future premiums. 
   
   Dividends are not guaranteed.  Some policies fail to pay dividends at the insurer’s projected rate, while others may exceed the projection.  Your agent may present you with a detailed chart called an “illustration” that shows a policy’s projected earnings.  Ask for the company’s history of dividends projected versus dividends actually paid.  The agent shouldn’t object. 
    

2. Flexible premium universal life insurance.  The key feature to this type of policy is flexibility.  Within certain limits, a flexible premium universal policy will allow you to choose the amount of coverage, the premium you pay, and the cash value you build.  As long as the premiums continue to be paid and the monthly deductions don’t deplete the cash value, the policy will remain in force until the “maturity date,” at which point coverage ends and the cash value is paid to the policyholder.
   
   Some flexible premium policies pay a guaranteed rate of return.  Others are “variable universal life” policies whose value depends on the performance of stocks, bonds, or other investments.  For this reason, agents and brokers who sell variable life insurance in Texas are required to maintain a federal securities license in addition to the standard state insurance license.  The precise rules and policy terms for flexible premium policies can be complex.  It is a good idea to consult a financial or estate planning adviser to ensure you fully understand the policy details before purchase.
   
   A flexible premium policy will allow you to adjust the amount you pay in premium, the death benefit, or the cash value at any time.  Any adjustment you make will impact one or both of the other areas: Increasing your premium will build either your cash value, death benefit, or both.
   
   Many flexible premium policies will even provide the option of lowering your premium payments below the amount needed to pay the insurer’s overhead expenses.  The company will then deduct that amount from your cash value.  But be careful with this option.  If the cash value reaches zero, you will have to resume paying the full amount of the premium out of pocket or the policy will lapse.  The contract will state that the insurer is required to send you an annual report of the state of your cash value and also notify you if at any point you’re in danger of losing your policy because of insufficient cash value.
   
   Most flexible premium policies contain a provision for a “secondary guarantee,” or a no-lapse premium benefit.  A “primary guarantee” is the payment of the premium necessary to cover the monthly deduction.  If the primary guarantee isn’t satisfied, a secondary guarantee may keep the policy from lapsing.  The secondary guarantee provides a benefit whereby payment of a premium that would not be large enough to pay for the monthly deduction satisfies the no-lapse condition and keeps the policy in force.

Comparing the Major Types of Life Insurance

Individual vs. Group Policies

As you shop for life insurance, you will find that policies are sold in one of two ways: either as “individual” or “group” coverage.  Group policies are most commonly offered through a company’s employee benefits plan, although other types of organizations may provide them as well.  Individual policies are those purchased by individual consumers directly from an agent or broker.  If you purchase a life insurance policy, the type you choose will have implications for price, the amount of coverage you receive, and level of underwriting required.

Individual life insures single or joint lives under a single policy.  Accordingly, this type of coverage will afford you the most choice, as you’re free to shop among multiple insurers for the policy that best meets your needs.  In addition, many insurers are willing to offer an individual policy that includes only the features you need and none that you don’t. 

Underwriting tends to be strict for individual policies because the insurer’s risk is concentrated on one person.  The company needs to be careful that it doesn’t sell a disproportionate number of policies to people who will die in the near term.  Younger people and those in good health can often obtain the most coverage for their premium dollar through an individual life policy.  People who are older or who have high risk factors can expect to pay more.  A company may even decline to issue coverage altogether for certain applicants that are deemed a high risk.

Group life insures a group of people under a single contract.  Most of these policies are offered by employers as part of an employee benefits plan, although group policies may also be offered as benefit of membership to other types of organizations, such as professional associations, trade unions, churches, fraternal groups, and other similar organizations. 

State and federal laws place restrictions on insurers’ underwriting criteria for group policies.  If you’re unable to qualify for an individual policy because of age or health reasons, group life coverage may be a good option.  Any organization that sponsors a group life policy must make it available to all members regardless of age or health status.  It is against the law to require group members to purchase a policy as a condition of membership.  Group life insurance may be sold as term life, whole life, or universal life coverage.

Modifying your Coverage

Policy “riders” and “endorsements” are additional policy benefits that you may be able to add to the basic coverage, usually for an additional premium.  You can use riders or endorsements to modify the coverage of an existing policy to better suit your needs.  Some of the most common endorsements are:

• Additional term insurance essentially adds term life coverage to a whole life or universal life policy.  For instance, if you need $500,000 worth of total coverage, you could purchase a $100,000 cash value policy with a $400,000 additional term insurance rider.  As your financial resources grow, you could convert some or all of the term rider into the main cash value policy, in the same manner that most stand-alone term life policies are convertible to cash value insurance. 

• Guaranteed insurability ensures that you will be able to purchase additional coverage from the insurer in the future, regardless of your age or health condition.  These factors may still be used to determine your premium rate.  Options to purchase additional coverage must generally be exercised by certain named dates or life events, such as retirement or reaching age 65. 

• Accidental death provides for an increased death benefit – typically double the value – if the insured dies as the result of an accident.  Certain restrictions may apply. 

• Disability waiver of premium suspends your obligation to pay premiums if you become disabled as defined by the rider.  The benefit lasts for the duration of the disability.  This rider is typically only available to individuals under age 60. 

• Accelerated death benefit option provides for prepayment of some or all of the death benefit while the insured is still living if the person is diagnosed with a terminal illness, specified disease, or a long-term care illness.  The rider is typically purchased to help pay the costs of end-stage care for the insured, which can be expensive.  To qualify as a long-term care illness, the rider will usually require a physician’s determination that the insured is unable to perform a specified number of defined “activities of daily living,” such as bathing, continence, dressing, eating, toileting, or transferring. 

• Spousal rider provides an amount of additional term insurance coverage for the spouse of the primary insured.  Essentially, this rider combines two policies into one. 

• Children’s rider provides additional term insurance for the insured’s children.  Age limitations for this coverage typically extend from at least 14 days old until age 21 or 25.

Special Case Life Insurance

Some policies provide only certain narrowly defined types of coverage or are sold in unique circumstances:

Credit life refers to a type of policy purchased by lenders to cover the balance of a loan in the event the borrower dies before repayment.  A bank or lender may require you to purchase a credit life policy as a condition of a loan.  “Credit accident and health” coverage, technically health care coverage and not life insurance, is frequently also required in case the loan recipient becomes sick or injured and unable to repay the loan.  The premium for these coverages is usually automatically factored into the loan’s payment schedule. 

You should expect to be required to undergo some level of underwriting for credit life insurance.  Texas law contains several restrictions on the circumstances under which purchasing credit life and credit accident and health insurance may be required by a lender, however:

• A lender may never require credit life or credit accident and health coverage as a condition of any home loan.  In this case you will probably be required to purchase a “mortgage guaranty policy” instead, which is a type of coverage that protects a lender from default under more general circumstances. 

• Credit life and credit accident and health coverage may never be required for any loan of more than 10 years. 

• A lender may never charge a loan recipient more than the amount of the insurer’s premium for the coverage or otherwise profit by requiring the coverage. 

• The lender may never require you to purchase the coverage from any specific insurer. 

• If you already have a life insurance policy, you may not need credit life.  You may instead agree to an “assignment of benefits” to the lender promising to repay the loan balance using the death benefit of your existing coverage.

Prepaid funeral insurance is a special type of policy to prearrange payment of funeral services.  An advantage of this insurance is that it “locks in” the funeral cost at current prices.  However, funeral insurance can be relatively expensive compared with other types of life insurance.  Often the amount of premium individuals pay exceeds the amount of the death benefit within a few years.  At the same time, many policies will not pay the full amount of funeral expenses if you die before paying a required amount.  A standard life insurance policy or a well-planned savings program may be a better way to pay funeral costs.  You should shop carefully before you buy funeral insurance and make sure you understand a policy’s details.

Home service life refers to any type of insurance that is sold door to door.  Some companies also market these policies as “industrial life insurance.” Be careful with these policies.  Some home service life policies can be a good deal, but many offer low death benefits, accumulate cash value at a low rate, and have high premiums.

Settlement Options

A policy’s death benefit is typically paid in cash as a single lump sum.  However, there are other payout options.  A policy’s settlement may be specified by the policyholder or chosen by the beneficiary if no terms are designated.  Common settlement options include:

• Interest option.  The amount of the death benefit remains with the insurance company, and the interest on the amount is paid to the beneficiary on a regular basis.  Withdrawal of the principal is often allowed under certain conditions. 

• Fixed period.  The death benefit is paid out at regular intervals, with interest, over a period of time specified in the policy. 

• Life refund.  The insurance company pays a set monthly amount to the beneficiary for the remainder his or her lifetime.  Under this option it’s possible for the beneficiary to receive more than the policy’s stated death benefit if he or she lives for a long time.  However, if the beneficiary dies after a short time, he or she might have received substantially less.  The amount of the monthly payment is determined by the face value of the policy and the beneficiary’s age and health status. 

• Joint and survivor.  Periodic payments are made for the duration of two lifetimes, rather than one.  Joint and survivor settlement is a common option when a policy beneficiary is married.  If the spouse who is the primary beneficiary dies first, the surviving spouse will still receive regular payments.  The amount of a joint and survivor payment is determined by the age and health factors of both spouses. 

Know Your Rights

Prompt Payment of Death Benefits

Insurance companies must acknowledge your claim within 15 days and either make payment within 45 days or explain why the claim is delayed.  For an individual life policy, the company must also pay interest on a death benefit from the time the company receives the proper proof of loss statement to the time the company pays the death benefit.

Missing a Premium Payment

Most policies have a 31-day grace period after your premium’s due date during which you can pay with no interest charged.  If the insured dies during this period, the beneficiary receives the death benefit minus the premium owed.

If Your Policy Lapses

To reinstate a lapsed policy, you may be required to pay some or all the overdue premium, with interest, and repay or reinstate any loans obtained using the policy as collateral.  Most companies will reinstate a policy within a five-year period, but may require you to answer additional health questions or take another medical exam.

Financial Implications of Owning Life Insurance

Medicaid

The cash value of a life insurance policy is generally considered to be an asset when determining Medicaid eligibility.  Some or all of the proceeds from a loan using the policy as collateral might not be considered an asset under certain circumstances, however.  If you’re on Medicaid, you may want to consult an attorney or financial adviser to fully understand any consequences of owning a life insurance policy.

Taxes

The cash value of a life insurance policy generally accumulates tax deferred.  Withdrawals from the cash value are generally nontaxable until the withdrawal amount exceeds the total amount of premiums paid into the policy.

If a policy has a named individual as the beneficiary, the law generally considers the death benefit to be reimbursement for the person’s loss, and not income.  For this reason, the death benefit is typically exempt from the federal income taxes and inheritance taxes that otherwise apply to the insured’s estate.  However, if a policy does not have a named beneficiary, or the beneficiary is deceased, the death benefit is paid to the insured’s estate.  Heirs to the estate will then have to pay full taxes on the money.  If you are considering purchasing life insurance as an estate planning vehicle, you may wish to consult an attorney or financial adviser to fully understand the tax consequences.

Bankruptcy

The cash value and death benefit of a life insurance policy are fully exempt from creditors, all demands in any bankruptcy proceeding, and from execution, attachment, garnishment, or other legal processes unless a statutory exemption, such as fraud, is applicable.

Replacing Your Policy with a New One

Price competition and the development of new types of policies can make it a good idea to review the price and coverage of your policy periodically.  However, replacing an old insurance policy with a new one is not always a good idea.  Consider the following:

• New policies usually take longer to build cash values and to pay dividends.

• The two-year contestable period begins again under the new policy.  During this period, if you die and the insurer discovers a material misrepresentation on your policy application, the death benefit will go unpaid. 

• If changing to a new policy means withdrawing early from a cash value policy, you could pay substantial surrender fees.  Also, the withdrawal counts as income for tax purposes.  

•  The new policy may not provide the same benefits and coverages as the old one, causing you to become underinsured. 

• You will probably have to answer additional health questions or have another medical exam.

State law requires agents to give life insurance policyholders a consumer notice with advice regarding
discontinuing or changing an existing policy. The notice urges consumers to carefully consider whether a replacement is in their best interest.

If you exchange a policy, your agent will earn a commission on the sale.  Persuading a consumer to switch to a new policy for the purpose of earning a commission, without regard to the implications for coverage, is a practice called “churning” and is against the law.  If you believe an agent has improperly encouraged you to sell a policy in order to purchase a new one, you may file a complaint with TDI.
 

Buying Life Insurance

Whey you apply to buy a life insurance policy, the company will generally evaluate your risk factors to determine whether to accept you and what rates to charge.  At a minimum, you can expect to fill out a health questionnaire as part of the company’s underwriting process.  If you are applying for a policy with more than $100,000 in coverage, you can also expect to provide medical records and take a physical exam.

It’s important that you provide full and accurate information on your application.  All life insurance policies have a two-year “contestable period.” If the insured dies within this period, the company may investigate the cause of death and reverify the information provided on the application.  If the company discovers the insured withheld any information that might have impacted the decision to issue coverage – even if the information is unrelated to the actual cause of death – the company can deny payment of the death benefit.  If payment is denied, the company must refund the premiums paid into the policy.

By law, the contestable period may not exceed two years.  If the insured dies for any reason after this period, the company must pay the death benefit.  Information the insured disclosed truthfully can never be used as the basis to deny payment.  Never allow someone else – including an agent – to fill in personal information on your application, and don’t allow anyone else to sign it on your behalf.

In addition, almost all life insurance policies have a suicide clause.  This clause stipulates that the company will not pay the death benefit and will return premiums paid if the insured commits suicide during the first two policy years.

How Much Life Insurance is Right for You?

There is no precise formula to determine the amount of life insurance a person needs.  Some consumer groups recommend buying coverage in the amount of five times your annual household income, while some insurance industry organizations recommend 10 times your income.  To decide the amount that’s right for you, consider your family’s current and anticipated financial obligations and the amount of time your beneficiaries may have to meet these obligations.  It is also important to consider the value of services provided by nonwage earners.  For example, a stay-at-home parent’s duties of child care and household management should be included.

Shopping Smart for Life Insurance

• Get quotes from several companies.  Each insurance company uses its own underwriting guidelines.  One company may sell you a policy at a substantially lower premium than another.  Life insurance agents are “captive,” meaning they can only issue policies for the insurance company they work for.  Brokers, on the other hand, are “noncaptive” independent contractors who can sell policies of multiple insurers.  A broker may therefore be able to provide you with price quotes from several companies during a single visit. 

• Compare “apples to apples.”  Be sure any policies you compare offer similar levels of coverage.  The more features, options, and added benefits a policy includes, the more it will typically cost.  A policy that’s substantially cheaper than another may have fewer features or provide a substantially lower death benefit.  A more expensive policy might actually prove to be a better value when you calculate the amount of the death benefit per premium dollar charged.  However, don’t just decide on price; decide if the features are worth it. 

• Buy the policy that’s right for you.  The more a policy costs, the more an agent or broker typically earns as a commission.  When shopping for life insurance, keep in mind that the policy that’s best for your agent or broker might not be the best for your insurance needs. 

• Make sure your company and agent are licensed.  It is illegal for an agent or company to sell insurance in Texas without a state license.  The Life, Accident, Health, and Hospital Insurance Service Guaranty Association pays some or all of most claims for Texas-licensed companies that go bankrupt or become insolvent.  If your company is unlicensed and goes bankrupt, your death benefit could go unpaid. 

• Research your company.  An insurance company’s financial strength and customer service record can be good indicators of the level of service you can expect.  You can learn a company’s financial rating by calling TDI’s Consumer Help Line.  You can learn information about the frequency of a company’s customer complaints against a company by calling the Consumer Help Line or by using the “Insurer Search” feature on the TDI website. 

• Shop for a low-load policy.  You may save money, particularly on cash value life insurance, if you buy a policy with low commissions and administrative fees, collectively known as “the load.” Financial planners who are licensed insurance counselors often sell these policies.  Generally, financial planners charge clients a flat service fee as opposed to earning commissions, meaning they receive no benefit from a high load.  Since low load policies have fewer initial fees, your risk of losing money is also reduced if you cash out early from a cash value policy. 

• Use your “free-look” period.  Most Texas policies will provide you with a “free look” or “right to examine” period of at least 10 days, during which you may cancel the policy for a full refund for any reason.  Use this time to read your policy carefully to be sure the coverage is right for you.

Here are some additional tips to help you shop for life insurance:

• Agents often use charts called “illustrations” to show how a policy’s cash value might grow.  Confirm that the chart shows a cash value that is guaranteed by the insurance company, and not a financial projection.  Projections are based on assumptions and should never be relied upon as a promise of policy performance because you might earn much less.  Ask your agent for a history of a company’s projections versus the actual growth of cash values.  The agent shouldn’t object. 

• Be careful if an agent tells you that interest or dividends earned on your policy will cause your premiums to “vanish” during the life of the policy.  If interest rates or dividends drop, you may have to pay higher premiums or pay for a longer period of time than you expected. 

• Some agents also sell retirement investments and student loans.  The law prohibits agents from offering discounts on an investment or loan, or offering any type of gift, as an inducement to buy life insurance.  If you believe an agent has made an improper offer, call the TDI Consumer Help Line. 

• Insurance companies sometimes market life insurance policies as retirement savings tools, estate plans, election funds, or mortgage protection.  Not clearly identifying a policy as life insurance is a misrepresentation and a violation of the law.  If you believe an agent or company has misrepresented a policy, call TDI’s Consumer Help Line. 

• A few simple guidelines can help you avoid becoming a victim of insurance fraud: Never pay cash for a policy.  Never sign a blank application.  Never buy insurance over the phone or on the first visit.  If you think you need help choosing the right policy for you, have a friend or family member visit the agent with you.  The agent shouldn’t object.

Viatical and Life Settlements

In some instances, you may need to access your policy’s death benefit or otherwise convert it to cash before you die.  This can happen when a policyholder outlives his or her retirement savings or develops a serious medical condition that requires extensive care.  A life insurance policy is considered personal property.  Therefore, it may be sold for cash in a similar manner to other property, although some special rules apply.

Life insurance policies can be sold to authorized viatical/life settlement providers for a percentage of the policy’s death benefit. 

A viatical settlement is the sale of a life insurance policy by a policyholder who has a catastrophic or terminal illness or condition.  In this case, money is often needed to pay for end-stage care.  The policyholder must be diagnosed as having a life expectancy of two years or less.  A life settlement, on the other hand, is one in which a policyholder who does not have a terminal illness sells a policy.  Under federal law, all earnings from a viatical settlement are tax free.  Earnings from a life settlement are taxed at the normal rate. 

The settlement provider will only pay a percentage of the policy’s face value.  For example, a viatical/life settlement provider might pay $75,000 now for a life insurance policy that will pay $150,000 when the policyholder dies.  There are no laws requiring a certain minimum sale amount, and settlements typically range from between 25 percent to 75 percent of a policy’s face value, depending on a number of factors.

A policy’s sale price is negotiable, and it’s a good idea to contact multiple settlement providers as prices offered may vary greatly.  The following factors primarily determine how much a settlement provider will be willing to pay:

• Life expectancy of the insured.  The longer the insured is expected to live, the longer the settlement provider may have to wait before the policy pays.  Therefore, settlement providers will pay more for policies where the insured has a shorter life expectancy.  For this reason, policies sold in viatical settlements typically receive much higher prices than life settlements.  In general, most settlement providers won’t buy a policy in a life settlement unless the insured is age 65 or older. 

• Current interest rates.  As time goes on, the amount of a policy’s death benefit typically does not increase in line with interest rates.  Therefore, when interest rates are high, other investment options become a more attractive alternative to viatical or life settlements, and you can expect to receive less for your policy.  When interest rates are low, however, your policy will be worth more. 

• Policy premium rates.  Because the settlement provider generally assumes all future payment obligations, the lower your premiums, the more a policy is worth. 

• Whether the policy is contestable.  The sales price will be substantially less if your policy is still in the contestable period because the insurer can deny payment of the death benefit under certain circumstances.  Most settlement providers will not purchase policies that are still in the contestable period.

It’s important to note that the income you earn from a viatical/life settlement may affect your eligibility for Medicaid or other government benefits.  The income may not be exempt from bankruptcy or creditor proceedings.  Before entering into a viatical or life settlement, it’s a good idea to consult an attorney or financial advisor regarding any potential consequences.

Viatical/life settlement providers, provider representatives, and brokers (agents who represent policyholders to negotiate settlement transactions) must register with TDI.  For a list of registered viatical/life settlement providers, provider representatives, and brokers, call the TDI Consumer Help Line or view “TDI Lists” on our website.  For questions and assistance with viatical/life settlements, call TDI’s Life, Annuity and Credit Section
512-322-3406

Alternatives to Consider

There are often other ways of converting a policy to cash than through a viatical or life settlement.  It can be a good idea to compare these other options when deciding whether selling your policy is the best financial decision for you:

• If your policy has a cash value, you can cash it in. 

• Many lending institutions will give you a loan using your policy as collateral. 

• A policy with an accelerated benefits provision or rider will prepay all or some of the death benefit before the insured dies if he or she is diagnosed with a terminal illness, specified disease, or long-term care illness