Review and use these key life insurance terms
When you explain key life insurance terms, your clients’ knowledge and confidence will increase. By using the concise definitions below, you can simplify purchase decisions and strengthen clients’ commitment to their life insurance programs.
Terms from A-E
Annual Renewable Term (ART) – Term life insurance coverage that is guaranteed for one year with a renewal option at the end of the year, without evidence of insurability. The coverage can be continued by renewing it each year, but premium costs typically increase with age and are not guaranteed.
Cash Value Accumulation Test (CVAT) – One test to determine the federal tax treatment of a life insurance policy. The test is passed when the policy’s cash surrender value does not exceed the net single premium-equivalent cost. If the test is failed and the policy doesn’t meet the Guideline Premium Test either, it does not qualify as life insurance and favorable tax benefits are lost.
Corridor – The difference between a policy’s death benefit and its cash value. To qualify as life insurance and receive favorable federal tax treatment, a life insurance policy must maintain at least a specified corridor. The size of the required corridor (death benefit in excess of cash value) declines with age and varies, depending upon whether CVAT or GPT is elected.
Cost of Insurance (COI) – The cost of pure life insurance protection in a life insurance policy. In a permanent policy, it is the portion of each premium that does not go toward cash value accumulation or other policy costs, apart from life insurance coverage. The monthly charge is based on net amount at risk (the difference between death benefit and policy account value). It varies with such factors as the insured’s attained age, underwriting class, gender, and tobacco use status.
Endowment – The point in the life of a life insurance policy when the cash value and initial face amount are equal. Endowment generally occurs at older ages, such as 100.
Terms from F-M
Guaranteed Insurability Option – The ability of the policyholder to maintain or increase the face amount of coverage, regardless of health or underwriting status and without evidence of insurability. Many term life insurance policies guarantee permanent insurability, at the current face amount and underwriting class, through a conversion of the policy to permanent life insurance. Some insurers offer a rider at additional cost, giving the policyholder an option to add additional coverage (subject to specified limits) up to a specified age, in the same underwriting class as the initial coverage, at certain intervals or upon occurrence of specified events such as marriage or the birth of a child.
Guideline Premium Test (GPT) – A two-part test to determine the federal tax treatment of a life insurance policy. To pass the test, the sum of all premiums paid into the contract may not exceed the greater of the two parts: 1) guideline single premium; and 2) guideline level annual premium. Certain policy changes can cause the guideline limit to decrease. If the limit is decreased to less than the previously paid premiums for guideline testing, the excess premium is forced out of the policy and returned to the policy owner.
Level-Premium Term – A term life insurance policy that guarantees both face amount coverage and premiums for a specified number of years, such as 5, 10, 15, or 20.
Life Insurance Retirement Plan (LIRP) – A type of life insurance strategy set up to maximize the tax benefits of life insurance for achieving a combination of protection and retirement income. LIRPs use the inherent tax benefits of life insurance, and they are not qualified retirement plans. They often use life insurance policies with growth potential, such as variable universal life, to accumulate cash value tax-deferred and distribute it on a tax-favored basis.
Modified Endowment Contract (MEC) – A life insurance policy in which cumulative premium payments exceed IRS guidelines. As a result, the policy is taxed similarly to an annuity, with lifetime distributions of cash value (e.g., loans, withdrawals) subject to income tax. If there is gain in the policy, the taxable amount will be subject to a 10% penalty if the owner is under age 59 ½. Any type of permanent policy may become an MEC if premiums are over-funded and cumulative premiums paid during the first seven years at any time exceed the cumulative “7-Pay Premiums.” Policy changes and partial withdrawals may impact 7-Pay Premium and MEC status.
Mutual Life Insurance Company – A life insurance company owned by its policyholders. Because mutual companies do not have stockholders to satisfy, they are able to issue “participating policies” that can pay non-guaranteed dividends to their policyholders. Dividends represent a portion of the company’s annual profits paid out to owners (policyholders).
Terms from N-R
No Lapse Guarantee (NLG) – A life insurance policy feature (or rider) guaranteeing that a specified level of face amount coverage will continue for life, or up to a certain age, regardless of the policy’s performance, as long as the policyholder keeps paying required premiums. NLGs are commonly offered in some universal life (UL) insurance products to protect the policyholder against the impact of an insurer’s lowering crediting rates or increasing policy charges.
Paid Up Additions (PUA) – Paid up additions are amounts of life insurance that increase the policy’s cash value and death benefit. Each additional unit of a PUA is purchased with a single payment from either policy dividends or by additional premium payments that are in excess of the fixed premium on participating whole life insurance policies. The PUAs' cash surrender value can be surrendered to pay premiums or for supplemental income.
Permanent Life Insurance – A policy that typically possesses cash value and allows the policyholder to continue coverage as long as the policyholder is alive and keeps paying required premiums. Whole life, universal life, indexed universal life, and variable universal life are types of permanent life insurance coverage.
Preferred Risk – A series of classes used by life insurance companies to underwrite an applicant’s mortality risk. These classes give the policyholder attractive premiums (rates) based on good health, an active and healthy lifestyle, sound credit standing, and other criteria. They are more favorable for the policyholder than “standard” or “substandard” underwriting classes. The classes may include Super Preferred, Preferred Non-Smoker, and Preferred Smoker.
Premium Charge – A charge on life insurance premiums paid by the policy owner with the net amount added to the policy account. Part of the charge is used by the insurer to pay the state premium tax and federal deferred acquisition cost tax.
Terms from S-Z
Separate Account – Premiums in a variable life policy can be allocated to the Guaranteed Interest Account or to the investment options of a Separate Account, which is separate from the insurance company’s general account. Assets held in the Separate Account are protected from creditors of the insurance company. Amounts allocated to Separate Accounts are never guaranteed by the life insurance company, since they vary based on the performance of investment options selected by the policyholder.
Standard Risk – A series of risk classes below “preferred,” used by life insurance companies in underwriting an applicant’s mortality risk. These classes set premium rates based on the applicant’s health, lifestyle, credit standing, and other criteria. They can be used by the insurance company to offset above-average mortality risk, by charging higher costs.
Stock Life Insurance Company – A life insurance company that is owned by shareholders of its common stock. The company’s board of directors may choose to reward shareholders by paying them quarterly dividends. Stock life insurance companies do not usually pay dividends to their policyholders.
Substandard Risk – The lowest risk classes used by life insurance companies in underwriting an applicant’s mortality. These classes typically assign above-average premiums based on a history of illness or an occupation/avocation with above-average mortality risk. Applicants evaluated as substandard may be limited in their ability to acquire a desired amount of life insurance coverage. They are also differentiated generally by whether or not the insured uses tobacco products.
Surrender – The action of a policyholder to voluntarily give up (surrender) a life insurance policy before death. The main reasons for surrendering a policy are: 1) to avoid having to continue to pay premiums; and 2) to cash out its cash surrender value. Surrendering a life insurance policy usually has income tax consequences if there is gain in the policy.
Term Life Insurance – Life insurance coverage that is purchased for a specified number of years, which may be up to age 95 in annual renewable term policies or up to 20 or more years in level-premium term policies. The main benefit in term life insurance is the death benefit protection at an inexpensive initial premium. However, many term policies also have a convertibility feature, which enables them to be converted into permanent coverage without evidence of insurability for a number of years.
Underwriting – A life insurance company’s process for evaluating risk, for purposes of setting premium rates and providing specified levels of coverage. Underwriters apply company-specific and industry-standard guidelines to determine which risks the company can accept, and an appropriate level of premium. Although life insurance underwriters focus mainly on an applicant’s health and health habits (e.g., smoking), they also may consider other factors such as credit standing and job stability.
Waiver of Premium – A rider in a life insurance contract, at an additional cost, that permits the policyholder to not pay any required premiums during a period in which he/she is disabled and keeps the policy in effect, according to the definition of disability contained in the policy or rider.