Below we define many terms that are frequently used in the life insurance industry. While the definitions below are commonly used by insurance companies, a particular policy might have a different definition of these terms, and that definition will control as to that policy.
a policy owner abandons a life insurance policy by declining to pay more premiums into the policy, which eventually lapses.
Accumulated Cash Value:
the amount of money that is held in the savings account feature of a life insurance policy (other than a Term Policy, since term policies generally do not have a savings account feature). The Accumulated Cash Value is not necessarily held in cash but could be invested (within the policy) in other assets such as mutual funds.
Cash Value Life Insurance Policy (or Cash Value Policy):
A life insurance policy with a savings account component, such as a Whole Life or Universal Life policy. Cash Value and Cash Surrender Value: Cash Value refers to the monetary value of a life insurance policy that has a savings account feature of a Cash Vaue Policy. There are two kinds of cash values: Accumulated Cash Value refers to the amount of money in the savings account feature, which is not necessarily held in cash but could be invested (within the policy) in other assets such as mutual funds. Cash Surrender Value refers to the amount of money the policy owner would receive if they surrendered the policy; the Cash Surrender Value is equal to the Accumulated Cash Value minus any applicable Surrender Charge and minus any loans that the policy owner has taken out from the Cash Value.
this is the total amount of premiums that the policy owner has paid into a Cash Value Life Insurance Policy. The cost basis is reduced by the amount of any Withdrawals.
Cost of Insurance Charge:
a fee that an insurer will deduct (usually monthly) from the Cash Value of a life insurance policy that reflects in some way the risk that the insured person will die during that month and what the insurance company would have to pay if that happened. The Cost of Insurance Charge is usually calculated by multiplying the Cost of Insurance Rate (an amount reflecting the risk that the insured person will die) times the Net Amount at Risk, which is essentially the amount of money the insurance company would have to pay if the insured died.
the rate used in calculating what interest is added to the Cash Value of a Traditional or Indexed Universal Life Insurance Policy. Crediting rates are expressed as an annual percentage. For example, if the crediting rate for a Traditional Universal Life Insurance Policy is 5%, then a policy’s Cash Value would be enhanced by that rate – less the expenses (including the cost of insurance) applicable that year.
Current Scale of Rates and Charges:
this refers to a list of charges and cost of insurance rates that an insurance company has set and that it will charge in the future unless it makes a change to its Current Scale. Some rates or charges in a Current Scale may be guaranteed and not subject to change, but often the rates or charges are not guaranteed and may be changed by the insurance company at any time.
Death Benefit (or Death Benefit Proceeds):
the amount of money that the insurance company must pay if the insured dies while the policy is in force, usually calculated after deduction of any fees due to the insurance company for the most recent month and deduction of any loans that the policy owner has taken out from the policy’s cash value. With some policies, often called Option B Policies, the Death Benefit includes not only the Face Amount of the policy but also its Accumulated Cash Value (minus any loans taken by the policy owner against the policy’s Cash Value). With other policies, often called Option A Policies, the Accumulated Cash Value is not part of the Death Benefit.
the feature of a life insurance policy that provides money if the insured person dies while the policy is in force.
the amount of money stated in the declarations or schedule pages of a life insurance policy as the amount of insurance to be paid upon the death of the insured person. With a Cash Value Life Insurance Policy, the Face Amount is an important factor in determining the Death Benefit to be paid upon the death of the insured, but it is usually not the only factor.
we use this term generally to include any charge or expense that an insurance company deducts from the Cash Value of a life insurance policy, especially those charges that are deducted on a regular basis. Most regularly charged fees are assessed monthly, such as Cost of Insurance Charges, “administrative charges,” and “value charges” calculated as a percentage of the Accumulated Cash Value of the policy. Most universal life policies also have a fee called a premium expense charge, which is a percentage deduction (usually from 5% to 10% but sometimes as high as 15%) taken up front from every premium payment. For example, if the policy owner pays a premium of $1,000, an insurance company that charges a 6% Premium Expense Charge will deduct $60 from the $1,000 premium and put only $940 into the policy’s saving account feature. A Premium Expense Charge is similar to a front-end load on a mutual fund.
Flexible Premium Life Insurance Policy:
a policy that allows the insured to determine what premium to pay. Most universal life policies are flexible-premium policies. Most term and whole life policies are not.
Illustration (or Policy Illustration):
a key document (which may be shown to a consumer on computer or in hard copy) used in the sale of a Cash Value Life Insurance Policy that shows an example of how the policy would perform financially given certain criteria. Specifically, it shows how the Accumulated Cash Value and Cash Surrender Value would develop over time based upon assumptions stated in the Illustration concerning levels of Fees and Crediting Rates. Technically, as defined in the NAIC’s Life Insurance Illustrations Model Regulation, an illustration is “a presentation or depiction that includes non-guaranteed elements of a life insurance policy over a period of years.” “Non-guaranteed elements” may include premiums, benefits, values, credits, or charges so long as the amount of the element is not guaranteed by the policy. If an insurance company chooses to market a particular policy design using an Illustration, which they almost always do, then every policy owner must receive an Illustration and must sign it.
Indexed Universal Life Insurance Policy:
a universal life policy in which the savings account earns interest according to the performance of a specified index or indices, such as the S&P 500. For example, if the policy is indexed to the S&P 500, and the S&P 500 goes up 6% in a given year, the savings account in the policy will earn 6% interest. The interest is typically subject to a yearly minimum (e.g., 0%) and is often subject to a yearly maximum (e.g., 10%). These minimum and maximum percentages may be changed by the insurance company, although the minimum is usually guaranteed to be no lower than o% or 1%.
this occurs when the Accumulated Cash Value of a policy falls below the amount of the Surrender Charge that would apply if the policy owner voluntarily surrendered the policy. If this happens, most insurers will then apply the Surrender Charge, eliminating the Cash Value of the policy and causing it to Lapse, even though the policy owner did not choose to surrender the policy. For example, if the amount of the Surrender Charge is $20,000, and Cost of Insurance Charges or other Fees reduce the Accumulated Cash Value to $19,900, then the insurance company would apply the Surrender Charge of $20,000, eliminating the Cash Value of the policy and causing it to Lapse (i.e., terminate).
For a policy to “lapse” means for it to terminate for some reason other than the expiration of the term of a term policy or the payment of a claim for Death Benefits. Policies lapse either because they are surrendered by the policy owner or because the policy owner does not pay sufficient premiums into the policy to offset the fees charged against the policy by the insurer. Most insurers will lapse a Cash Value Policy if the Accumulated Cash Value of the policy falls below the amount of the applicable Surrender Charge, applying the Surrender Charge to eliminate the remaining cash value and terminating the policy without value.
for any particular type of policy, the Lapse Rate is the percentage of those policies that do not remain in force until the death of the insured. The Lapse Rate is the opposite of the Persistency Rate.
this term is used to describe those pages of a policy illustration that show Cash Values; ledger pages typically project Cash Values out over a long period of time (often until the insured’s 100th birthday, or even longer).
Level Death Benefit:
a Death Benefit that does not change over the life of the policy.
“Underwriting” is what insurance companies do when they decide whether to insure someone and how much to charge based on the risk class to which the insurance company assigns the person. “Medical underwriting” occurs when the insurer requires medical information about the proposed insured, which could include a medical examination by a doctor or paramedic.
this term is often used to describe an optional rider that can be purchased with some Indexed Universal Life Insurance Policies. It has the effect of increasing (by a multiple) the interest that is credited to the policy’s Cash Value.
a mutual life insurance company is a life insurance company that is owned by its policyholders, not by shareholders. Many consumers prefer mutual companies because they do not have incentives to make profits from policyholders in order to please shareholders. Life insurance policies sold by mutual companies generally have been reported to have lower lapse rates than policies sold by companies that are owned by shareholders, which are called “stock companies.”
this is the National Association of Insurance Commissioners, which is a group of state insurance commissioner that, among other things, prepares model laws to regulate aspects of the insurance industry.
Net Amount at Risk:
the amount of money the insurance company would have to pay out of its own funds if the insured died, in other words, the amount for which the insurance company is “at risk.” It is equal to the Death Benefit minus the Accumulated Cash Value.
Permanent Life Insurance Policy (or Permanent Policy):
a “permanent” policy is one that has no specified term and obligates the insurer to continue insuring the life of the insured person for as long as the policy owner keeps the policy in force. Keeping the policy in force may require the owner to keep paying money into the policy, but a Permanent Policy (at least one issued after 2003) does not expire or terminate due simply to the passage of time. Permanent Policies typically have a savings account feature that allows the owner to build up “Cash Value” in the policy by paying more in premiums over time than the insurer deducts in fees. If the cash value is higher than any Surrender Charge that may be in effect, the policy owner can typically access any Cash Value that is greater than the Surrender Charge by either withdrawing or borrowing money from the policy. Whole Life and Universal Life policies are permanent policies; Term Policies are not.
a policy “persists” when it remains in force until the death of the insured person.
for any particular type of policy, the Persistency Rate is the percentage of those policies that remain in force until the death of the insured. The Persistency Rate is the opposite of the Lapse Rate.
Policy Charges (or Policy Expense) Report:
a report that is sometimes produced as part of a policy Illustration that shows the Fees that would be paid by the consumer in the scenario shown in the Illustration.
a policy owner may borrow money from the Accumulated Cash Value of a Cash Value Policy. The interest rate on the loan is determined by the insurance company subject to any limits stated in the policy.
this term usually refers to any amount that a policy owner pays to an insurance company other than a loan repayment. For a Term Policy, the premium can be thought of as the cost to the policy owner of maintaining the policy. But for a Cash Value Policy, the premium may include not only the cost to maintain the policy but also an additional amount that gets added to the Accumulated Cash Value of the policy and represents the policy owner’s money rather than money that belongs to the insurance company.
a person who acts as an agent for an insurance company in selling policies to consumers.
refers to money that a policy owner takes from a life insurance policy that exceeds the policy owner’s Cost Basis in the policy and on which the policy owner is able to legally avoid paying taxes.
Term Life Insurance Policy (or Term Policy):
a “term life” policy is a policy that insures the life of the insured person for a specified period of time called the “term” of the policy. The term is often 10 or 20 years. After the term expires, the insurer is no longer obligated to continue the insurance, although the policy owner may be able to continue the policy with substantially higher, annually renewable term premiums specified by the carrier. She may also be able to buy a new term policy from that insurer or another insurer, but likely at a higher price and only after new underwriting that may include a medical examination of the insured person. A term life policy typically does not have any savings account component and therefore has no Cash Value.
a policy owner “surrenders” a policy by cashing in a policy that has a Cash Value that is larger than the applicable Surrender Charge. The policy is terminated, and the policy owner receives a check for the Cash Value of the policy minus a Surrender Charge. Typically, surrender charges are quite large in the first few years of a policy, declining over time and disappearing after ten or twenty years.
a charge that is deducted from the Cash Value of a policy if the policy owner chooses to Surrender a Cash Value Life Insurance Policy. Most insurance companies will also apply a Surrender Charge if the Accumulated Cash Value of the policy falls below the amount of the Surrender Charge that would apply if the policy owner voluntarily surrendered the policy. This situation is accurately considered as an Involuntary Surrender.
Traditional Universal Life Insurance Policy:
a universal life policy in which the savings account earns interest at a specified percentage (e.g., 4%). The percentage may be changed by the insurance company but is typically subject to some minimum amount.
Universal Life Insurance Policy:
a “universal life” policy is a permanent policy that does not have a required premium but instead has a “flexible premium” that allows the policy owner to pay premiums in whatever amount and at whatever time the owner wants. The policy may nevertheless Lapse if the owner does not pay enough premiums to cover Fees deducted from the policy’s Cash Value. Universal life policies include Traditional, Indexed and Variable Universal Life Policies.
Variable Universal Life Insurance Policy:
a universal life policy in which the money paid into the savings account is used to buy securities, typically mutual fund-like sub-accounts. The policy’s Cash Value will rise or fall according to how the investment accounts perform in the stock market. Variable universal life policies have the highest lapse rates and the accounts can be risky, since it is the policy owner who is making the investment decisions, not the insurance company.
the policy owner can usually withdraw money from the Accumulated Cash Value of the policy up to the amount that the policy owner has paid in Premiums and provided that the loan does not cause the Cash Surrender Value to become negative. No interest is charged on withdrawals. No taxes are due when a policy owner withdraws money from a policy unless the total withdrawals exceed the total tax basis in the policy.
Whole Life Insurance Policy:
a “whole life” policy is a permanent policy with specified premium that, if paid, will keep the policy in force until the death of the insured. Whole life policies generally have lower lapse rates and are therefore less risky than universal life policies.