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How does life insurance policy work

how do they calculate rates?

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The transaction takes place between three parties: The owner- who pays premiums, the insured- person whose name appear as nominee (one who will get the benefit after death of owner) and the insurer- the person/ the agent /the firm who has your policy and to whom you pay up your premiums. Many times the owner and the insured person are the same. For example: if Michel buys a policy on his own life then he is owner and insured both. But if he buys a policy on his wife’s is insured. Grantee is one who will pay the premium for insurance; he is therefore a holder of the policy. Beneficiary is one/more person/s who are involved in this procedure. They play an important part, as they are the one who will receive the money after death of the owner.

Life insurance policy is a legal contract that specifies the terms and conditions, as well as risk involved in life insurance policy. There is a special clause for suicide. If the owner of the policy commits suicide then the policy is nullified. However this contract generally applies for two years only.

There is a face amount, which is paid when the policy matures. However some agencies do offer a greater or a lesser amount. The policy is said to be matured when the owner or the insured dies or when the set period of time is over. Generally people buy life insurance policy for financial security. The insurance will provide the costs involved in funeral as well as any such other costs involved in death. But if the policy has matured because the set time period is over, then the insurance provides additional wage to the insured.

The company providing life insurance will calculate its costs adding up the claim that is to be recovered, plus the administrative cost and the profit. Actuaries calculate the cost using mortality tables. Mortality tables show the average life expectancy. It includes age, gender and the use of tobacco. Actuaries also consider family history and present health of the insured. The current mortality table used in United States was calculated in 1980s. The current mortality table states that only 2 in 1000 will die at the age of 25 during the coverage and 25 in 1000 die at the age of 65. So, if we take a group of 1000 males of 25yrs old, who has the policy of $100, 000 then, a life insurance company will have to ask each one to pay at least $200. The rates of premium are directly proportionate to the insured’s age.

Insurance companies collect each detail about the insured. Group policies are though exceptions. Each insured is asked questions about their health and their lifestyle. All life insurance companies in USA support medical information bureau which keeps a record of health of all those who has ever applied for a life insurance policy. As a part of policy the company also gains a permission from the insured to get all their health related report from their physician. These reports are further processed to gain accurate in formation about the insured. Depending on these reports the proposal for life insurance policy is made. It is left to company’s discretion whether the person should be insurable or not.

There are four categories in which each insured is divided - Preferred Best, Preferred, Standard, and Tobacco. Those who fall under the preferred best category have no family memebers with adverse medical history that is they have never suffers from cancer, diabetes or any such other dieases or he himself is not a victim of any such deadly disease. Those who fall under the preferred category are somewhat like the preferred best, but they are undergoing so kind of medication or medical treatment and have some adverse medical history. Most people fall under the standard category. The policy rates/ whether the person is insurable or not also depends on their profession (if a person is in a profession where he has to travel to the country with high risks then he may be denied the policy.), travel and lifestyle.

If the insured person is dead then the benificiary has to produce a death certificate, a form duly signed and completed by the insured and sometime notarized. If the insured’s death is suspicious and has some legal obtructions then the insurer may investigate the cause of death etc before paying the claim. The claim can be paid as a lump sum amount or can be in regular time intervals till specified period of time or till specified person’s life time.

Types of life insurance policies:

There are primarily two types of life insurance policy:

A. Temporary
B. Permanent

Temporary:

There is a defined time period in this type of insurance. The coverage is provided for one year in this kind of insurance.

Term life insurance:

The original form of life insurance is term life insurance. Since it builds no cash value it is considered to be pure insurance for protection. Beneficiary will get the benefit if the insured dies. Such type of insurance policy is brought when the insured seek for financial security. These responsibilities can be some kind of consumer debt, or the college education for dependent or mortgages etc. this policy is generally income tax free. There are three factors, which contribute to tem life insurance.

1. face amount
2. premium
3. the term

Permanent life insurance:

this is second type of life insurance. The policy is either matured or expired. (when the insured fail to pay the premium.) insurer can only cancel the policy in a fraud case where he has to abid by the term of law which is usually of two years. This type of life insurance builds cash value. This reduces risk of the insurance company and thus you get much more benefit than you actually pay. The owner has access to his own money in exchage of his policy or he can withdraw some amount of money which will be deducted from the cover. There are three kind of permanent life insurance: whole life, universal life and endowment.

Whole life:

In this type of policy the company gives level premiums and cash value tables as per policy terms.The first hand benefits of this type of policy is are guaranteed death benefits, guaranteed cash values, fixed and known annual premiums, and mortality and expense charges will not bring down the cash value directed in the policy.The main drawback of whole life are inflexible premium, and the policy internal rate of return may be inadequate compared with other savings options.One can avail of riders that can increase the death benefit by paying extra premium. They can also use policy dividends to achieve more death benefits. The premiums are comparitively cheaper of term insurance in the short-term, where as cumulative premiums of whole life comes to almost the same value if policies are conitued until average life expectancy. Policy "loans" can help to access the cash value at any point of time. Since death benefits are reduced on non payment of these, repayment is volentary. Beneficiary doesnot receive cash values on death occurance of the insured; he only receives the death benefits.

Universal life:

Universal life insurance is comparitively recent insurance product targetted to provide timeless insurance coverage with greater comfort in payment of premium and the power to earn higher internal rate of return. A cash account is a part of universal life policy and with premium they increase. Predetermined rate of interest is paid within the policy which is credited on the account by the company where as mortality charges and administrative costs are debited (deducted) in cash account.

Surrender value of the policy = Remaining balance in the cash account - surrender charges (if applicable).

All life insurance, are based on two functions mortality function and a cash function. The mortality function described as classical notion of collective risk where death benefit for the few who will die for a specified period of time will be covered by the premiums paid by rest.According to the cash function in all life insurance is that if a person is to reach a perticular age depending on state and company, then the policy matures and endows the face value of the policy.

So, it's simply inferred that in group of 1000 people, if 10 of also lives to matuarity age, then the cash function cannot be covered only by mortality function. On policy maturity a nominal rate of investment return on the premiums will be required in order to balance the cash function.

Universal life policies only covers you for the death function, not the cash function.So you avail of the flexible premiums and interest returns. The interest rates are balanced with dividends,higher interest lower premium and vice-verse,so when interest rate is less then the customer will pay higher premiums to keep the policy running. And when interest returns are above the minimum required, then the client has the ease to pay less as the balance amount is filled in from investment returns.

But disadvantages with universal life starts basically the flexibility. The policy lacks the primary guarantee that the policy will be active unless sufficient premiums have been paid and there ia no guarantee of cash values.

Endowments

In Endowment policies the death benefit (face amount) at a certain age are equal to the cash value build up inside the policy. The term endowment age means this commenced age. Other aspect of endowments is that the annual premiums are higher as compared to other life insurances because the premium paying period is shortened and the endowment date is earlier. Endowment Insurance is paid out whether the insured lives or dies, after a specific period or a specific age.