What is Life Insurance
What is Life Insurance
An early form of life insurance dates to Ancient Rome; “burial clubs” covered the cost of members' funeral expenses and assisted survivors financially.
Life insurance is a contract between an insurer and a policyholder in which the insurer guarantees payment of a death benefit to named beneficiaries upon the death of the insured.
The purpose of life insurance is to provide financial protection to surviving dependents after the death of an insured. It is essential for applicants to analyze their financial situation and determine the standard of living needed for their surviving dependents before purchasing a life insurance policy.
History of Life Insurance
An early form of life insurance dates to Ancient Rome; "burial clubs" covered the cost of members' funeral expenses and assisted survivors financially. In 1816, an archeological excavation in Minya, Egypt (under an Eyalet of the Ottoman Empire) produced a Nerva–Antonine dynasty-era tablet from the ruins of the Temple of Antinous in Antinoöpolis, Aegyptus that prescribed the rules and membership dues of a burial society collegium established in Lanuvium, Italia in approximately 133 AD during the reign of Hadrian (117–138) of the Roman Empire. In 1851, future U.S. Supreme Court Associate Justice Joseph P. Bradley (1870–1892), once employed as an actuary for the Mutual Benefit Life Insurance Company, submitted an article to the Journal of the Institute of Actuaries detailing an historical account of a Severan dynasty-era life table compiled by the Roman jurist Ulpian in approximately 220 AD during the reign of Elagabalus (218–222) that was included in the Digesta seu Pandectae (533) codification ordered by Justinian I (527–565) of the Eastern Roman Empire.
The earliest known life insurance policy was made in Royal Exchange, London on 18 June 1583. A Richard Martin insured a William Gybbons, paying thirteen merchants 30 pounds for 400 if the insured dies within one year. The first company to offer life insurance in modern times was the Amicable Society for a Perpetual Assurance Office, founded in London in 1706 by William Talbot and Sir Thomas Allen. Each member made an annual payment per share on one to three shares with consideration to age of the members being twelve to fifty-five. At the end of the year a portion of the "amicable contribution" was divided among the wives and children of deceased members, in proportion to the number of shares the heirs owned. The Amicable Society started with 2000 members.
The first life table was written by Edmund Halley in 1693, but it was only in the 1750s that the necessary mathematical and statistical tools were in place for the development of modern life insurance. James Dodson, a mathematician and actuary, tried to establish a new company aimed at correctly offsetting the risks of long term life assurance policies, after being refused admission to the Amicable Life Assurance Society because of his advanced age. He was unsuccessful in his attempts at procuring a charter from the government.
His disciple, Edward Rowe Mores, was able to establish the Society for Equitable Assurances on Lives and Survivorship in 1762. It was the world's first mutual insurer and it pioneered age based premiums based on mortality rate laying "the framework for scientific insurance practice and development" and “the basis of modern life assurance upon which all life assurance schemes were subsequently based”.
Mores also gave the name actuary to the chief official—the earliest known reference to the position as a business concern. The first modern actuary was William Morgan, who served from 1775 to 1830. In 1776 the Society carried out the first actuarial valuation of liabilities and subsequently distributed the first reversionary bonus (1781) and interim bonus (1809) among its members. It also used regular valuations to balance competing interests. The Society sought to treat its members equitably and the Directors tried to ensure that policyholders received a fair return on their investments. Premiums were regulated according to age, and anybody could be admitted regardless of their state of health and other circumstances.
Life insurance premiums written in 2005
The sale of life insurance in the U.S. began in the 1760s. The Presbyterian Synods in Philadelphia and New York City created the Corporation for Relief of Poor and Distressed Widows and Children of Presbyterian Ministers in 1759; Episcopalian priests organized a similar fund in 1769. Between 1787 and 1837 more than two dozen life insurance companies were started, but fewer than half a dozen survived. In the 1870s, military officers banded together to found both the Army (AAFMAA) and the Navy Mutual Aid Association (Navy Mutual), inspired by the plight of widows and orphans left stranded in the West after the Battle of the Little Big Horn, and of the families of U.S. sailors who died at sea.
What is Life Insurance
Life insurance is a contract between an insurer and a policyholder in which the insurer guarantees payment of a death benefit to named beneficiaries upon the death of the insured. The insurance company promises a death benefit in consideration of the payment of premium by the insured.
The life insurance application must accurately disclose the insured’s past and current health conditions and high-risk activities to enforce the contract.
Types of Life Insurance
Many different types of life insurance are available to meet all sorts of needs and preferences. Depending on the short- or long-term needs of the person to be insured, the major choice of whether to select temporary or permanent life insurance is important to consider.
There are two types of life insurance, Term and Permanent and each type has several different products.
- Term life insurance.
- Level Term Insurance
- Increasing Term Insurance
- Decreasing Term Insurance
- Annual Renewable Term Insurance
- Permanent Life insurance
- Whole life insurance
- Universal life insurance
- Indexed universal life insurance
- Variable life insurance
How Does Life Insurance Work
The purpose of life insurance is to provide financial protection to surviving dependents after the death of an insured. It is essential for applicants to analyze their financial situation and determine the standard of living needed for their surviving dependents before purchasing a life insurance policy. Life insurance agents or brokers are instrumental in assessing needs and establishing the type of life insurance most suitable to address those needs. Several life insurance types are available see “Types of life insurance”. It is prudent to re-evaluate life insurance needs annually, or after significant life events like marriage, divorce, the birth or adoption of a child and major purchases, like a house.
Term Life Insurance
What Is Term Life Insurance?
Term life insurance, also known as pure life insurance, is a type of life insurance that guarantees payment of a stated death benefit if the covered person dies during a specified term. Once the term expires, the policyholder can either renew it for another term, convert the policy to permanent coverage, or allow the term life insurance policy to terminate.
How Term Life Insurance Works
When you buy a term life insurance policy, the insurance company determines the premiums based on the policy's value (the payout amount) and your age, gender, and health. In some cases, a medical exam may be required. The insurance company may also inquire about your driving record, current medications, smoking status, occupation, hobbies, and family history.
If you die during the policy term, the insurer will pay the policy's face value to your beneficiaries. This cash benefit which is, in most cases, not taxable may be used by beneficiaries to settle your healthcare and funeral costs, consumer debt, or mortgage debt, among other things.2 However, if the policy expires before your death, there is no payout. You may be able to renew a term policy at its expiration, but the premiums will be recalculated for your age at the time of renewal.
Term life policies have no value other than the guaranteed death benefit. There is no savings component as found in a whole life insurance product.
Term life is usually the least costly life insurance available because it offers a benefit for a restricted time and provides only a death benefit. For example, a healthy 35-year-old non-smoker can typically obtain a 20-year level-premium policy with a $250,000 face value for $20 to $30 per month.
Depending on the issuer, purchasing a whole life equivalent would have significantly higher premiums, possibly $200 to $300 per month, or more. Because most term life insurance policies expire before paying a death benefit, the overall risk to the insurer is lower than that of a permanent life policy. The reduced risk allows insurers to pass cost savings to the customers in the form of lowering premiums. Learn More
Permanent Life Insurance
What Is Permanent Life Insurance?
Permanent life insurance is an umbrella term for life insurance policies that do not expire. The three primary types of permanent life insurance are Whole Life, Universal Life and Index Universal Life, and most permanent life insurance combines a death benefit with a savings portion.
Whole life insurance offers coverage for the full lifetime of the insured, and its savings can grow at a guaranteed rate.
Universal life insurance also offers a savings element in addition to a death benefit, but it features different types of premium structures and earns based on market performance.
Indexed Universal Life (IUL) insurance is often pitched as a cash value insurance policy that benefits from the market’s gains tax-free—without the risk of loss during a market downturn.
Learn More about permanent life insurance.
How Permanent Life Insurance Works
There are three major components of a permanent (cash value) life insurance policy.
1. Death benefit is the amount of money the insurance company guarantees to the beneficiaries identified in the policy upon the death of the insured. The insured will choose their desired death benefit amount based on estimated future needs of surviving heirs. The insurance company will determine whether there is an insurable interest and if the insured qualifies for the coverage based on the company's underwriting requirements.
2. Premium payments are set using actuarially based statistics. The insurer will determine the cost of insurance (COI), or the amount required to cover mortality costs, administrative fees and other policy maintenance fees. Other factors that influence the premium are the insured’s age, medical history, occupational hazards and personal risk propensity. The insurer will remain obligated to pay the death benefit if premiums are submitted as required. With term policies, the premium amount includes the cost of insurance (COI). For permanent policies, the premium amount consists of the COI and a cash value amount.
3. Cash value of permanent life insurance is a component which serves two purposes. It is a savings account, which can be used by the policyholder, during the life of the insured, with cash accumulated on a tax-deferred basis, the tax-free withdrawals and policy loans can then be borrowed against cash value (See :IRC 7702). Some policies may have restrictions on withdrawals depending on the use of the money withdrawn. The second purpose of the cash value is to offset the rising cost or to provide insurance as the insured ages.