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Principles of Insurance
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MODULE 1
Basic Principles of Insurance
List of chapters
(click on chapter number/title below)
Chapter 1: Introduction to Risk and Insurance

Chapter 2: The Life and Health Insurance Industry
Chapter 3: The Insurance Contract
Chapter 4: Life Insurance Premiums
Copyright © 2017 LL Global, Inc. All rights reserved. www.loma.org

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ISBN 978-1-57974-455-7
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Contents
(click on chapter number/title or chapter headings)
Module 1: Basic Principles of Insurance
(Chapters 1–4)
Chapter 1: Introduction to Risk and Insurance.................. 1.1
The Concept of Risk.................................................................................... 1.2
Risk Management........................................................................................ 1.2
Avoiding Risk......................................................................................... 1.3
Controlling Risk...................................................................................... 1.3
Transferring Risk.................................................................................... 1.3
Accepting Risk........................................................................................ 1.3
Insurance...................................................................................................... 1.4
Managing Risks through Insurance.......................................................... 1.7
Characteristics of Insurable Risks........................................................... 1.7
Insurance Underwriting........................................................................ 1.10
Insurable Interest Requirement............................................................. 1.13
Chapter 2: The Life and Health Insurance Industry........... 2.1

Insurance Company Organization............................................................. 2.2
Types of Business Organizations............................................................ 2.2
Types of Insurance Company Organizations.......................................... 2.3
Insurance Companies as Financial Institutions........................................ 2.4
Financial Intermediaries......................................................................... 2.6
Evolution of the Financial Services Industry.......................................... 2.6
Role of Government in Insurance.............................................................. 2.8
Social Insurance Programs...................................................................... 2.8
Regulation of Insurance.......................................................................... 2.9
Taxation................................................................................................ 2.13
Chapter 3: The Insurance Contract...................................... 3.1

Fundamentals of Contract Law................................................................. 3.2
Types of Contracts.................................................................................. 3.2
General Requirements for a Contract..................................................... 3.6
The Policy as Property.............................................................................. 3.11
Right to Use and Enjoy Property.......................................................... 3.12
Right to Dispose of Property................................................................ 3.12
Chapter 4: Life Insurance Premiums................................... 4.1

The Legal Reserve System.......................................................................... 4.2
Establishing Premium Rates...................................................................... 4.3
Cost of Benefits....................................................................................... 4.4
Operating Expenses................................................................................ 4.6
Investment Earnings............................................................................... 4.8
Financial Models................................................................................... 4.11
The Level Premium System...................................................................... 4.12
Glossary......................................................................... GLOSS.1
Index.............................................................................. INDEX.1
Principles of Insurance Chapter 1: Introduction to Risk and Insurance 1.1
Chapter 1
Introduction to
Risk and Insurance
Objectives
After studying this chapter, you should be able to
1A Distinguish between speculative risk and pure risk
1B Describe four methods used to manage financial risk
1C Identify the five characteristics of insurable risks
1D Define antiselection and give examples of two factors that can increase
or decrease the likelihood that an individual will suffer a loss
1E Identify four risk classes for proposed insureds
1F Define insurable interest and determine in a given situation whether the
insurable interest requirement is met

1.2 Chapter 1: Introduction to Risk and Insurance Principles of Insurance
Outline
The Concept of Risk Insurance
Risk Management Managing Risks through Insurance
 Avoiding Risk  Characteristics of Insurable Risks
 Controlling Risk  Insurance Underwriting
 Transferring Risk  Insurable Interest Requirement
 Accepting Risk
L
ife is full of risk. You take risks when you travel, when you engage in recre-
ational activities, even when you breathe. Some risks are significant; others
are not. When you decide to leave your umbrella at home, you are taking
the risk that you might get wet in a rain shower. Such a risk is insignificant and
will probably not cause you a financial loss. Other risks, however, such as the risk
of a severe illness or the destruction of your home, may result in substantial—even
ruinous—financial loss. Risk is the chance or possibility of an unexpected result,
either a gain or a loss. To understand insurance and how it works, you first need to
understand the concept of risk.
The Concept of Risk

Risk exists whenever there is uncertainty about the future. Individuals and busi-
nesses experience two kinds of risk—speculative risk and pure risk. Speculative
risk involves three possible outcomes: loss, gain, or no change. For example, when
you purchase shares of stock, you are speculating that the value of the stock will
rise and that you will earn a profit on your investment. At the same time, you
know that the value of the stock could fall and you could lose some or all of the
money you invested. Finally, you know that the value of the stock could remain the
same—you might not lose money, but you might not make a profit.
Pure risk involves no possibility of gain; either a loss occurs or no loss occurs.
An example of pure risk is the possibility that you may become disabled. If you do
become disabled, you are likely to experience a financial loss due to lost income
and the costs incurred for your medical care. If, on the other hand, you never
become disabled, then you will incur no loss from that risk. This possibility of
financial loss without the possibility of gain—pure risk—is the only kind of risk
that can be insured. The purpose of insurance is to compensate for financial loss,
not to provide an opportunity for financial gain.
Risk Management
Because the effects of an unexpected financial loss can be severe, individuals and
businesses usually seek to minimize their exposure to risk whenever possible.
LEARNING AID
Risk management is the process in which individuals and businesses identify and
assess the risks they face and determine how to deal with their exposure to these
risks. Four general methods can be used to manage risk: (1) avoiding the risk,
(2) controlling the risk, (3) transferring the risk, and (4) accepting the risk.

Avoiding Risk
The first, and perhaps most obvious, method of managing risk is simply to avoid it
altogether. We can avoid the risk of personal injury that may result from a motor-
cycle accident by not riding a motorcycle, and we can avoid the risk of financial
loss in the stock market by not investing in stocks. Sometimes, however, avoiding
risk is not practical.
Controlling Risk
We can try to control risk by taking steps to prevent or reduce potential losses. For
example, people can reduce the likelihood of contracting certain diseases by exer-
cising regularly, eating a healthy diet, and not smoking. People who become ill can
often reduce the severity of the illness by taking proper medication or following
a prescribed course of medical treatment. Similarly, a business can install smoke
detectors and sprinkler systems in its office buildings to reduce the likelihood of
fire damage and lessen the severity of any damage that might occur.
Transferring Risk
Another method of managing risk is to transfer it. When you transfer risk to
another party, you are shifting the liability associated with that risk to the other
party, usually through financial products that involve a fee for the transfer. As we
shall see, the most common way for individuals, families, and businesses to trans-
fer risk is to purchase insurance coverage.
Accepting Risk
The final method of managing risk is to accept, or retain, risk. Simply stated, to
accept a risk is to assume all financial responsibility for that risk. Sometimes, as
in the case of an insignificant risk—such as losing an umbrella—the financial loss
is not great enough to warrant much concern. We assume the cost of replacing the
umbrella ourselves.
Some people consciously choose to accept more significant risks. For example,
a couple may decide not to purchase disability income insurance because they
believe they can reduce their standard of living if one of them becomes disabled.
Alternatively, accepting a risk can be an unconscious decision. Any risk you
face that is not managed by other methods is always accepted, whether you are
aware of it or not. For example, for a number of years, many people and busi-
nesses were unaware that hackers could gain access to the data on their computers.
Because they were unaware of this risk and therefore took no steps to manage it,
they often suffered significant financial losses if their information systems were
hacked. People and businesses can prevent the inadvertent acceptance of poten-
tially disastrous risks through risk management, which requires identifying all sig-
nificant potential risks and then determining the methods to use to manage them.

Note that individuals and businesses often use several risk management meth-
ods in combination. For example, to reduce the risk of an accidental injury, many
people avoid certain hazardous activities, such as sky diving. People also use
safety devices, such as automobile seat belts, to help control the risk of accidental
injuries. Finally, people purchase insurance to transfer the risk of financial loss
resulting from any injuries they do receive. Figure 1.1 illustrates the four methods
of risk management.
Insurance
In simple terms, insurance is a method in which an individual or entity transfers to
another party the risk of financial loss from events such as accident, illness, prop-
erty damage, or death. A company that accepts risk and makes a promise to pay
a policy benefit if a covered loss occurs is an insurer or an insurance company.
A policy benefit is a specific amount of money the insurer agrees to pay under an
insurance policy when a covered loss occurs. An insurance policy, also known as
a policy or insurance contract, is a written document that contains the terms of the
agreement between the insurer and the owner of the policy. The premium is the
specified amount of money an insurer charges in exchange for agreeing to pay a
policy benefit when a covered loss occurs.
Figure 1.1 Risk Management Techniques
Avoid Control
the risk the risk
Transfer
the risk
If you do not Avoid, Control, or Transfer the risk, then you:
Accept
the risk

In general, individuals and businesses can purchase insurance policies to cover

three types of risk:
Personal risk is the risk of economic loss associated with death, poor health,
injury, and outliving one’s economic resources. Life and health insurance
companies issue and sell products that insure against the financial losses that
result from personal risks. Figure 1.2 presents some of the products that life
and health insurers issue and sell and that we describe in the text.
Property damage risk is the risk of economic loss resulting from damage
to or loss of a person’s property. Property insurance provides a benefit if
insured items are damaged, destroyed, or lost because of various specific risks
described in the policy, such as fire, theft, or accident.
Liability risk is the risk of economic loss that results when a person is held
legally responsible for harming others or their property. For example, you
can be held liable for damage you cause to another person’s vehicle in an
automobile accident. A business can be held liable for injury to an individual
who slips and falls while walking through the building. Liability insurance
provides a benefit payable on behalf of a covered party who is legally respon-
sible for unintentionally harming others or their property. Property insurance
and liability insurance (also referred to as property and casualty insurance)
are commonly marketed together in one policy. In the United States, insurers
that issue and sell insurance policies to provide financial security from prop-
erty damage risk and liability risk are known as property/casualty (P&C)
insurance companies or property and liability insurers.
A number of terms are commonly used to describe the people who are involved
in the creation and operation of an insurance policy. The applicant is the person or
business that applies for an insurance policy. Once an insurer issues a policy, the
person or business that owns the insurance policy is known as the policyowner.
In most cases, the applicant is also the policyowner. The insured is the person
whose life, health, or property is insured under the policy. In some countries, the
term assured is used to refer to the person insured.
The policyowner and the insured of a particular policy are often the same per-
son. If, for example, you purchase an insurance policy on your life, you are both
the policyowner and the insured (sometimes called the policyowner-insured).
In contrast, if your spouse purchases a policy on your life, then she is the
policyowner and you are the insured. A third-party policy is a policy purchased
by one person or business on the life of another person.
If the person insured by a life insurance policy dies while the policy
is in force, the insurer usually pays the policy benefit to the beneficiary.
The beneficiary is the person or party the policyowner names to receive the life
insurance policy benefit. A request for payment under the terms of an insurance
policy is called a claim.

Figure 1.2 Types of Life and Health Insurance Products
The focus of this text is on the following life and health insurance products:
Life insurance: Insurance that provides protection against the economic

loss caused by the death of the person whose life is insured.
Important forms of life insurance are as follows:
•• Term life insurance provides a policy benefit only if the
insured dies during the period specified in the policy.
•• Cash value life insurance, also known as permanent life insurance, provides life insurance
coverage throughout the insured’s lifetime and also provides a savings element.
As premiums are paid for these policies, an accumulated s avings amount—known as the
policy’s cash value—gradually builds. A policy’s cash value is a valuable asset that the
policyowner can use in a number of ways.
•• Endowment insurance provides a policy benefit that is paid either when the
insured dies or on a stated date if the insured is still alive on that date.
Annuity contract: A contract under which an insurer promises

to make a series of periodic payments to a named individual in
exchange for a premium or series of premiums.
Health insurance: Insurance that provides protection against the

risk of financial loss resulting from illness, injury, or disability.
Three important forms of health insurance coverage are as follows:

•• Medical expense insurance provides benefits to pay for the t reatment
of an insured person’s illnesses and injuries and some preventive care.
•• Disability income coverage provides income replacement benefits if an insured is
unable to work because of illness or injury.
•• Long-term care insurance (LTCI) pays benefits for medical or other health-related
services needed by an individual who, because of his advanced age or the effects of a
serious illness or injury, needs care in his own home or a qualified facility.
All of the above products can be issued as either an individual insurance

policy or a group insurance policy:
•• An individual insurance policy is a policy that insures the life or

health of a named person. Some individual policies also insure the
named person’s immediate family or a second named person.
•• A group insurance policy is a policy that insures the lives or health of a specific group
of people, such as a group of employees.

Example:
Matthew Byrne applied to the Reliable Insurance Company for a $100,000
life insurance policy covering his wife, Nancy. Reliable issued the policy
as applied for. If Nancy dies while the policy is in force, Reliable will pay
$100,000 to the Byrnes’ son, Stephen.
Analysis:
In this situation, Matthew is the applicant and policyowner of this policy,
Reliable is the insurer, Nancy is the insured, and Stephen is the beneficiary.
The policy is a third-party policy, because the policyowner, Matthew, and
the insured, Nancy, are two different people. After Nancy’s death, Stephen
can file a claim with Reliable for the policy benefit of $100,000.
Managing Risks through Insurance

You may wonder how an insurance company can afford to be financially respon-
sible for the economic risks of its insureds. Insurers use a concept known as risk
pooling. With risk pooling, individuals who face the uncertainty of a particular
loss—for example, the loss of income due to a disability—transfer this risk to an
insurance company. Insurance companies know that not everyone who is issued a
disability income policy will suffer a disability. In reality, only a small percentage
of the individuals insured by this type of policy will actually become disabled.
By collecting premiums from all individuals and businesses that wish to transfer
the risk of disability, insurers spread the cost of the relatively few losses that are
expected to occur among all the insured persons.
Insurance thus protects against the risk of economic loss by applying a simple
principle:
If the economic losses that actually result from a given peril, such as
disability, can be spread across a large pool (or number) of people who
are all subject to the risk of such losses and the probability of loss is
relatively small for each person, then the cost to each person will be
relatively small.
Characteristics of Insurable Risks

Insurance products are designed in accordance with some basic principles that
define which risks are insurable. In general, for a risk—a potential loss—to be LEARNING AID
considered insurable, it must have the following characteristics:
The loss must occur by chance.
The loss must be definite.
The loss must be significant.
The loss rate must be predictable.
The loss must not be catastrophic to the insurer.
A loss without these characteristics generally is not considered an insurable risk.

The Loss Must Occur by Chance

For a potential loss to be insurable, the element of chance must be present. The
loss must result either from an unexpected event or from an event that the insured
person did not intentionally cause. For example, people generally cannot control
whether they become seriously ill. As a result, insurers can offer medical expense
insurance policies to protect against the financial losses caused by the chance
event that an insured person will become ill and incur medical expenses.
When this principle of loss is applied in its strictest sense to life insurance, an
apparent problem arises: death is certain to occur. The timing of an individual’s
death, however, is usually out of the individual’s control. Therefore, although the
event being insured against—death—is a certain event rather than a chance event,
the timing of that event usually occurs by chance.
The Loss Must Be Definite

For most types of insurance, an insurable loss must be definite in terms of time and
amount. In other words, the insurer must be able to determine when to pay policy
benefits and how much these benefits should be. Death, illness, disability, and old
age are generally identifiable conditions. The amount of the financial loss resulting
from these conditions, however, can be subject to interpretation.
One of the important terms of the contractual agreement between an insur-
ance company and the policyowner is the amount of the policy benefit that will
be payable if a covered loss occurs while the policy is in force. Depending on the
way in which a policy states the amount of the policy benefit, every insurance pol-
icy can be classified as being either a contract of indemnity or a valued contract.
A contract of indemnity is an insurance policy under which the amount of the
policy benefit payable for a covered loss is based on the actual amount of the
financial loss that results from the covered event, as determined at the time of the
event. For example, some types of health insurance policies pay benefits based on
the amount of the insured’s covered financial loss or a maximum amount stated in
the contract, whichever is less.
A valued contract specifies the amount of the policy benefit that will be pay-
able when a covered loss occurs, regardless of the actual amount of the loss that
was incurred. Life insurance policies are valued contracts because they specify the
benefit that the insurer will pay when the insured dies while the policy is in force.
Some life insurance policies, such as decreasing term life insurance policies, pro-
vide that the amount of the benefit may change over the life of the policy. These
policies are still considered valued contracts because the changes in the amount
of the benefit are based on factors that are not directly related to the amount of the
actual loss that will result from the insured’s death.
The Loss Must Be Significant

As described earlier, insignificant losses, such as the loss of an umbrella, are not
normally insured. The administrative expenses of paying benefits when a very
small loss occurs would drive the cost for such insurance protection so high in
relation to the amount of the potential loss that most people would find the protec-
tion unaffordable.

On the other hand, some losses would cause financial hardship to most people
and are considered to be insurable. For example, a person injured in an accident
may lose a significant amount of income if she is unable to work. Disability income
insurance coverage is available to protect against such a potential loss.
The Loss Rate Must Be Predictable

No one can predict the losses that a specific person will experience. We do not
know when a specific person will die or whether a person will become disabled or
need hospitalization, let alone how much these events may cost. However, insur-
ers must have some way of predicting future losses so that they can determine the
proper premium amounts to charge policyowners.
Although individual losses cannot be predicted, insurers can provide a specific
type of insurance coverage if they can predict the loss rate—the frequency of
losses—that the insureds are likely to experience. To predict the loss rate for a
given group of insureds, the insurer must be able to predict the number and timing
of covered losses that will occur in that group of insureds.
Insurers can predict with a fairly high degree of accuracy the number of people
in a given large group who will die, become disabled, or require hospitalization
during a given period of time. These predictions are based on observations of past
events and a concept known as the law of large numbers.
The law of large numbers states that, typically, the more times we
observe a particular event, the more likely that our observed results will
approximate the true probability—or likelihood—that the event will
occur in the future.
A classic example of the law of large numbers is the coin toss. If you toss a
“fair” coin—one that has not been altered to influence outcomes—there is a 50-50
probability that the coin will land with the head side up. If you toss the coin 10
times, you might not get an equal number of heads and tails. However, if you toss
the coin 10,000 times, in approximately 50 percent of the tosses, the coin will land
with the head side up and the other 50 percent of the tosses will land on tails. The
more often you toss the coin, the more likely you will observe an approximately
equal proportion of heads and tails.
Insurance companies rely on the law of large numbers when they make predic-
tions about the covered losses that a given group of insureds is likely to experi-
ence during a given time period. Insurers collect specific information about large
numbers of people so that they can identify the pattern of losses that those people
experienced. For many years, for example, U.S. life insurance companies have
recorded how many of their insureds of each sex have died and how old they were
when they died.
Using these statistical records, insurance companies have been able to develop
charts—called mortality tables—that indicate with great accuracy the number
of people in a large group (100,000 people or more) who are likely to die at each
age. A mortality rate is the rate at which death occurs among a specified group
of people during a specified period, typically one year. Mortality tables show the
mortality rates that are expected to occur in a group of people at a given age.

Insurance companies have developed similar charts, called morbidity tables,

which display morbidity rates, or the incidence of sickness and accidents, by age,
occurring among a given group of people. By using accurate mortality and mor-
bidity tables, life and health insurers can predict the probable loss rates for given
groups of insureds. Insurers use those predicted loss rates to establish premium
rates that will be adequate to pay claims.
The Loss Must Not Be Catastrophic to the Insurer

A potential loss is not considered insurable if its occurrence is likely to cause or
contribute to catastrophic financial damage to the insurer. Such a loss is not insur-
able because the insurer could not responsibly promise to pay benefits for the loss
and still meet its other obligations.
To prevent the possibility of catastrophic loss and ensure that losses occur
independently of each other, insurers spread the risks they choose to insure. For
example, major natural disasters such as hurricanes or earthquakes can damage
or destroy a large number of properties in a concentrated area. In the past, some
insurers failed because they were unable to pay claims following a disaster. For
this reason, property insurance companies today usually limit the number of prop-
erties they will insure in any particular geographic area.
Alternatively, by purchasing reinsurance, an insurer can reduce the possibility
that it will suffer catastrophic losses. Reinsurance is insurance that one insur-
ance company—known as the direct writer or ceding company—purchases from
another insurance company—known as the reinsurer or assuming company—
to transfer all or part of the risk on insurance policies that the direct writer issued.
For example, if Alpha Life Insurance Company (the direct writer) purchases rein-
surance from Celtic Reinsurance Company (the reinsurer), then Celtic accepts
some or all of the risk on the insurance policies Alpha has issued. By entering into
a reinsurance agreement with a reinsurer, an insurer can provide relatively large
amounts of coverage without exposing itself to an excessive amount of risk.
Figure 1.3 summarizes the characteristics of insurable risks.
Insurance Underwriting
Mortality and morbidity tables provide insurers with broad general statistics to
help them estimate how many people of a certain age and sex will die or become
ill in the future. However, not all individuals of the same sex and age have an equal
likelihood of suffering a loss. Individual insurance is sold on a case-by-case basis,
and insurers cannot presume that each proposed insured represents an average
likelihood of loss.
When an insurer receives an application for insurance, the company must
assess the degree of risk it will be accepting if it issues the policy. The process
of assessing and classifying the degree of risk represented by a proposed insured
and making a decision to accept or decline that risk is called underwriting or risk
selection. Insurance company employees who are responsible for evaluating pro-
posed risks are called underwriters.
Proper underwriting is vital for an insurer’s success and even its survival. The
premium rates that an insurance company establishes are based in large part on the
amount of risk the company is assuming for the policies it issues. The greater the

risk an insured represents, the higher the premium rate the insurer must charge. If
the insurer consistently underestimates the risks that it assumes, its premium rates
will be inadequate to provide the benefits promised to all its policyowners. On the
other hand, if the insurer overestimates the risks it will be assuming, its premium
rates may be considerably higher than those of its competitors, and potential cus-
tomers will purchase insurance elsewhere.
Underwriting becomes more difficult because of antiselection, also known as
adverse selection or selection against the insurer. Antiselection is the tendency of
individuals who believe they have a greater-than-average likelihood of loss to seek
insurance protection to a greater extent than do other individuals. For example,
people who believe they are in poor health are more likely to apply for life and
health insurance—and also to apply for larger amounts of coverage—than people
who believe they are in average or good health. The possibility of antiselection
requires an insurer to carefully review each application to assess the degree of risk
the company will be assuming if it issues the requested policy.
Underwriting consists of two primary stages: (1) identifying the risks that a
proposed insured presents and (2) placing the proposed insured into an appropri-
ate risk class.
Figure 1.3 Characteristics of Insurable Risks
For a risk to be insurable:
The loss must The loss must The loss must

occur by chance be definite be significant
The loss rate must The loss must not be catastrophic

be predictable to the insurer

Identifying Risks
Although predicting when a specific individual will die, become injured, or suffer
from an illness is impossible, insurers have identified a number of factors that can
increase or decrease the likelihood that an individual will incur a loss. The most
important of these factors are physical hazards and moral hazards. A physical
hazard is a physical characteristic that may increase the likelihood of loss.
For example, a person with a history of heart disease possesses a physical haz-
ard that increases the likelihood that the person will die sooner than a person of
the same age and sex who does not have a similar medical history. A person’s
activities or lifestyle can also present a physical hazard. Tobacco use and alcohol
or substance abuse are known to contribute to health problems, and those health
problems may result in higher-than-average medical expenses and a lower-than-
average life expectancy. Similarly, an occupation such as coal mining, which
exposes a person to a significantly greater-than-average risk of health problems
or accidental injury, can present a physical hazard. Underwriters must carefully
evaluate proposed insureds to detect the presence of such physical hazards.
Moral hazard is a characteristic that exists when the reputation, financial posi-
tion, or criminal record of an applicant or a proposed insured indicates that the
person may act dishonestly in the insurance transaction. For example, an individ-
ual who has a confirmed record of illegal or unethical behavior is more likely than
an individual without this type of background to act dishonestly in an insurance
transaction. The person may be seeking insurance for financial gain rather than as
protection against a financial loss. Therefore, an insurer must carefully consider
that fact when evaluating the individual’s application for insurance. Underwriters
also evaluate the moral hazards presented by individuals who provide false infor-
mation on their applications for insurance. In these cases, the applicants may be
trying to obtain coverage that they might not otherwise be able to obtain. When
underwriters evaluate applications, they take a variety of steps to identify pro-
posed insureds who present moral hazards.1
Classifying Risks
After identifying the risks that a proposed insured presents, the underwriter places
the proposed insured into an appropriate risk class. A risk class is a grouping of
insureds who represent a similar level of risk to the insurer. Assigning proposed
insureds to risk classes enables the insurer to establish equitable premium rates
to charge for the requested coverage. People in different risk classes are charged
different premium rates, much the same as people of different ages are charged
different rates. Without these premium rate variations, some policyowners would
be charged too much for their coverage, while others would be paying less than the
actual cost of their coverage.
Each insurer has its own underwriting guidelines, which are the general rules
it uses when assigning proposed insureds to an appropriate risk class. Individual
life insurers’ underwriting guidelines usually identify at least four risk classes for
proposed insureds: standard risks, preferred risks, substandard risks, and declined
risks.
Proposed insureds who have a likelihood of loss that is not significantly greater
than average are classified as standard risks, and the premium rates they are
charged are called standard premium rates. Traditionally, most individual
life and health insurance policies have been issued at standard premium rates.
Proposed insureds who present a significantly lower-than-average likelihood

of loss are classified as preferred risks and are charged lower-than-standard
premium rates known as preferred premium rates. Insurance company prac-
tices vary widely as to what qualifies a proposed insured as a preferred risk or
a standard risk.
Proposed insureds who have a significantly greater-than-average likelihood of
loss but are still found to be insurable are classified as substandard risks or
special class risks. For example, a proposed insured may have been diagnosed
with a disease such as diabetes, which can lead to a shorter life expectancy.
For individual life insurance, insurers typically charge substandard risks a
higher-than-standard premium rate, called a substandard premium rate or
special class rate.
The declined risk category consists of those proposed insureds who present a
risk that is too great for the insurer to cover. In addition to proposed insureds
with a poor health history, those who engage in exceptionally risky activities,
such as sky diving or mountain climbing, are sometimes classified as declined
risks.
Because tobacco use represents a major health hazard, almost all insurers today
take a proposed insured’s tobacco use into account in their underwriting guide-
lines. Some insurers have established separate rate classes for tobacco users and
tobacco nonusers, such as “standard tobacco user” and “standard tobacco non-
user.” Other insurers place proposed insureds who use tobacco in a less favorable
risk class than tobacco nonusers. For example, a tobacco user who might other-
wise be classified as a preferred risk is instead classified as a standard risk.
Insurable Interest Requirement

As noted earlier, insurance is intended to compensate an individual or a business
for a financial loss, not to provide an opportunity for gain. At one time, however,
LEARNING AID
people used insurance policies as a means of wagering. In eighteenth-century
England, for example, people frequently purchased life insurance on the lives of
famous people, especially those who were reportedly ill, hoping to make a profit
if the insured person died.
The practice of purchasing insurance as a wager is now considered against pub-
lic policy. As a result, laws in the United States and many other countries require
that a policyowner have an insurable interest in the risk that is insured at the time
the policy is issued. An insurable interest means that the policyowner must be
likely to suffer a genuine loss or detriment should the event insured against occur.
To understand how insurable interest requirements are met, we need to con-
sider two possible situations: (1) an individual purchases insurance on her own
life and (2) an individual purchases insurance on another’s life. In both cases, the
applicant for life insurance must name a beneficiary.
All persons are considered to have an insurable interest in their own lives.
A person is always considered to have more to gain by living than by dying. There-
fore, an insurable interest between the policyowner and the insured is presumed
when a person seeks to purchase insurance on her own life.

Insurable interest laws do not require that the beneficiary have an insur-
able interest in the policyowner-insured’s life. In other words, the laws allow a
policyowner-insured to name anyone as beneficiary. Most insurance company
underwriting guidelines, however, require that the beneficiary also have an insur-
able interest in the life of the insured when a policy is issued. As a result, life insur-
ers typically inquire into the beneficiary’s relationship to the proposed insured and
may refuse to issue the coverage if the beneficiary does not possess an insurable
interest in the proposed insured’s life.
In the case of a third-party policy, laws in many countries and in most states in
the United States require only that the policyowner have an insurable interest in
the insured’s life when the policy is issued. Most insurance company underwriting
guidelines and the laws in some states, however, require both the policyowner and
the beneficiary of a third-party policy to have an insurable interest in the insured’s
life when the policy is issued.
Certain family relationships are assumed by law to create an insurable interest
between an insured and a policyowner or beneficiary. In these cases, even if the
policyowner or beneficiary has no financial interest in the insured’s life, the bonds
of love and affection alone are sufficient to create an insurable interest. According
to the laws in most jurisdictions, the insured’s spouse, mother, father, child, grand-
parent, grandchild, brother, and sister are deemed to have an insurable interest in
the life of the insured. Figure 1.4 illustrates the family relationships that create an
insurable interest.
An insurable interest is not presumed when the policyowner or beneficiary is
more distantly related to the insured than the relatives previously described. In
these cases, a financial interest in the continued life of the insured must be demon-
strated to satisfy the insurable interest requirement.
Example:
Mary Mulhouse obtained a $50,000 personal loan from the Lone Star
Bank.
Analysis:
If Mary dies before repaying the loan, Lone Star could lose some or all
of the money it lent her. Therefore, Lone Star has a financial interest and,
consequently, an insurable interest in Mary’s life, in the amount of the
outstanding loan.
Similar examples of financial interest can be found in other business relationships.

The insurable interest requirement must be met before a life insurance policy
will be issued. After the life insurance policy is in force, the presence or absence of
insurable interest is no longer relevant. Therefore, a beneficiary need not provide
evidence of insurable interest to receive the benefits of a life insurance policy.
The insurable interest requirement also must be met when a health insurance
policy is issued. For a health insurance policy, the insurable interest requirement
is met if the applicant can demonstrate a genuine risk of economic loss should the
proposed insured require medical care or become disabled. Typically, people seek
health insurance for themselves and for their dependents. In both of these cases,

the applicant has an insurable interest in the continued health of the proposed
insured. Additionally, for disability income insurance purposes, businesses have
an insurable interest in the health of their key employees.
Example:
Didactic Training is a small company that contracts with other companies
to conduct seminars for their management staffs. Shilpa Gouda works
for Didactic as its primary seminar leader. Because Shilpa’s expertise and
teaching skills are essential to the success of the business, Didactic has
applied for disability income coverage on Shilpa and has named itself as
the beneficiary of this coverage.
Analysis:
Didactic would be unable to meet its scheduled seminar commitments if
Shilpa were ill or injured and, thus, unable to conduct seminars. Therefore,
Didactic has a financial interest in Shilpa’s continued good health. This
financial interest creates the necessary insurable interest for Didactic to
purchase disability income coverage on Shilpa.
Figure 1.4 Family Relationships that Create an Insurable Interest
Grandfather Grandmother
Uncle Aunt Father Mother Uncle
Cousin
Sister-in-Law Brother INSURED Spouse Sister
Child’s
Niece Nephew Child Child Spouse
Grandchild

Key Terms
risk beneficiary
speculative risk claim
pure risk contract of indemnity
risk management valued contract
insurer law of large numbers
policy benefit probability
insurance policy mortality tables
premium mortality rate
personal risk morbidity tables
life and health insurance company morbidity rate
life insurance reinsurance
term life insurance direct writer
cash value life insurance reinsurer
cash value underwriting
endowment insurance underwriter
annuity contract antiselection
health insurance physical hazard
medical expense insurance moral hazard
disability income coverage risk class
long-term care insurance (LTCI) underwriting guidelines
individual insurance policy standard risk
group insurance policy standard premium rate
property/casualty (P&C) preferred risk
insurance company preferred premium rate
applicant substandard risk
policyowner substandard premium rate
insured declined risk
third-party policy insurable interest
Endnote
1. The term moral hazard is also used in the insurance industry to refer to the tendency of individuals
to alter their behavior because they have insurance. This tendency is typically of more concern with
health insurance than life insurance. For example, an injured person who has a disability income
policy with generous benefits may feel disinclined to follow a prescribed rehabilitation regime and get
back to work, and an individual in poor health who has medical expense insurance may be more likely
to pursue treatment for her medical conditions than if she had no medical expense insurance.

Principles of Insurance Chapter 2: The Life and Health Insurance Industry 2.1
Chapter 2
The Life and Health Insurance

Industry
Objectives
2A Distinguish among the three types of business organizations and
explain why insurance companies must be organized as corporations
2B Distinguish among stock insurers, mutual insurers, and fraternal benefit
societies
2C Describe the financial services industry and explain how insurance
companies function within that industry
2D Describe the roles that the federal and state governments play in
U.S. insurance regulation
2E Identify the two primary types of insurance regulation in most
countries

2.2 Chapter 2: The Life and Health Insurance Industry Principles of Insurance
Outline
Insurance Company Organization Role of Government in Insurance
 Types of Business Organizations  Social Insurance Programs
 Types of Insurance Company  Regulation of Insurance
Organizations  Taxation
Insurance Companies as
Financial Institutions
 Financial Intermediaries
 Evolution of the Financial Services
Industry
I
n some ways, a life insurance company functions just like any other busi-
ness. The company determines the needs of its customers, creates products
that meet those needs, and pursues profits to ensure its survival. Profit is the
money, or revenue, that a business receives for its products minus the expenses it
incurs to create and support the products.
What sets insurance companies apart, however, is the nature of the products
that they sell. The products of a typical life insurance company represent promises
of future payments, which may not be called upon for 20, 30, or even 50 or more
years into the future. This characteristic of a life insurance company greatly influ-
ences the way that the company is organized.
Insurance Company Organization

In many countries, including the United States, three primary types of business
organizations are sole proprietorships, partnerships, and corporations. Insurers
are organized as corporations. Let’s explore each type to find out why.
Types of Business Organizations

A sole proprietorship is owned and operated by one person. The owner receives
all the profits and is personally responsible for all the debts of the business. If the
business fails, the owner’s personal property may be used to pay the debts of the
business. If the owner becomes disabled or dies, the business often cannot con-
tinue to operate.
A partnership is a business that is owned by two or more people, who are
known as the partners. The partners divide the profits, and generally each of them
is personally responsible for all the debts of the business.
Example:
George Everett and Andrew Carter formed an equal partnership. At first,
the business was successful, and George and Andrew each received one-
half of the profits. However, the business eventually failed, and George
was unable to pay his share of the losses.
Analysis:
Because George and Andrew formed their business as an equal partner-
ship, Andrew was personally responsible for all the partnership’s debts.

If one of the partners dies or withdraws from the business, the partnership gener-
ally dissolves, although the remaining partners may form a new partnership and
continue to operate the business.
In most countries, insurance companies and most other major businesses are
organized as corporations. A corporation is a legal entity that is created by the
authority of a governmental unit (through a process known as incorporation) and
that is separate and distinct from its owners. LEARNING AID
A corporation has two major characteristics that set it apart from a sole propri-
etorship and a partnership:
As a legal entity that is separate from its owners, a corporation can sue or be
sued, enter into contracts, and own property. In addition, the corporation’s
debts belong to the corporation itself and not to its owners. The owners are not
personally responsible for the corporation’s debts.
The corporation continues beyond the death of any or all of its owners. This
characteristic of the corporation provides an element of stability and perma-
nence that a sole proprietorship and partnership cannot guarantee. Because
an insurer’s contractual obligations extend many years into the future, the
corporation is the ideal form of business organization for an insurance com-
pany. Recognizing the importance of such stability and permanence, laws in
the United States and many other countries require insurance companies to
operate as corporations.
Types of Insurance Company Organizations

Even though they must be corporations, life and health insurance companies have
some flexibility in how they are organized to do business. Typically, an insurer is
LEARNING AID
organized as a stock insurance company, a mutual insurance company, or a frater-
nal benefit society.
Stock Insurance Companies

Most corporations, including most life and health insurers, are stock corporations.
A stock corporation is a corporation whose ownership is divided into units known
as shares or shares of stock. A stockholder, or shareholder, is a person or organi-
zation that owns shares of stock in a corporation. The corporation’s stockholders
collectively are its owners. Insurers organized as stock corporations are known as
stock insurance companies.
If a stock insurance company has profits, the stockholders may receive a
stockholder dividend, which is a portion of the corporation’s earnings paid to the
owners of its stock. Many companies pay dividends quarterly or annually.
Mutual Insurance Companies

A mutual insurance company is an insurance company that is owned by its poli-
cyowners. Because a mutual insurance company does not have stockholders, it
does not pay stockholder dividends. Instead, a portion of the company’s operat-
ing profits may be distributed to its policyowners in the form of policy dividends.
We discuss policy dividends in more detail in Chapter 9.

Although stock insurers greatly outnumber mutual insurers in the United

States, mutual insurers historically have been older and larger than stock insurers
and thus provide a significant amount of the life insurance in force.
Fraternal Benefit Societies

A fraternal benefit society, also known as a fraternal insurer, is a nonprofit orga-
nization that is operated solely for the benefit of its members and that provides
social, as well as insurance, benefits to its members. The members of such societies
often share a common ethnic, religious, or vocational background, although mem-
bership in some societies is open to the general public. One of the legal require-
ments of being a fraternal benefit society is that the fraternal society must have a
representative form of government—that is, the members must elect the officers of
the fraternal society. In addition, fraternal societies must operate through a lodge
system, in which only lodge members and their families are permitted to own
the fraternal society’s insurance. Applicants for insurance automatically become
members once the society issues them a policy.
Figure 2.1 depicts the total number of stock insurers, mutual insurers, and fra-
ternal benefit societies operating in the United States in 2014, as well as the life
insurance in force for each type of insurance company.
Insurance Companies as
Financial Institutions
Insurance companies are financial institutions that function in the economy as
part of the financial services industry. A financial institution is a business that
owns primarily financial assets, such as stocks and bonds, rather than fixed assets,
such as equipment and raw materials. The financial services industry is an indus-
try that offers financial products and services to help individuals, businesses, and
governments meet their financial goals of protecting against financial losses, accu-
mulating and investing money and other assets, and managing debt and payments.
In addition to insurance companies, financial institutions include
Depository institutions, which specialize in accepting deposits from and
making loans to people, businesses, and government agencies. Commercial
banks, savings and loan associations, and credit unions are examples of depos-
itory institutions.
Finance companies, which specialize in making short- and medium-term
loans to people and businesses.
Securities firms, which specialize in the purchase and sale of securities.
A security is a financial asset that represents either (1) an obligation of indebt-
edness owed by a business, a government, or an agency, which is known as
a debt security, or (2) an ownership interest, which is known as an equity
security.
Mutual fund companies, which operate mutual funds. A mutual fund is an
investment vehicle that pools the funds of investors and uses the funds to buy
a variety of stocks, bonds, and other securities.

Figure 2.1 Comparison of Stock Insurers, Mutual Insurers, and Fraternal

Benefit Societies in the United States, 2014

Number of Life Insurers
Fraternal
Benefit Societies Other
81 7
Mutual
Stock
Insurers
Insurers
106
636
Life Insurance in Force (in millions)
Fraternal
Benefit Societies Other
$333,579 $165,617
Stock
Mutual Insurers
Insurers $13,774,670
$5,840,741
Source: Adapted from ACLI, Life Insurers Fact Book 2015, Copyright © 2015 American Council of Life Insurers, Washington, DC,
(November 2015, 19,) 2–3 https://www.acli.com/Tools/Industry%20Facts/Life%20Insurers%20Fact%20Book/Documents/FB15_All.pdf
(15 February 2016). Used with permission.

Financial Intermediaries
Financial institutions, including insurance companies, serve as financial interme-
diaries. A financial intermediary is an organization that collects funds from one
group of people, businesses, and governments, known as suppliers, and channels
them to another group, known as users. Insurers, for example, collect premiums
from policyowners and pay claims to beneficiaries. In the process of moving funds
from suppliers to users, financial intermediaries generate income for themselves.
As financial intermediaries, insurance companies take a substantial portion of
the money that their customers pay for insurance and invest that money in other
businesses and industries, primarily through the purchase of bonds issued by cor-
porations. The investments that insurers make provide funds that these businesses
need to operate and expand. For example, life insurance companies in the United
States have been the largest institutional holders of corporate bond financing since
the 1930s.1
Evolution of the Financial Services Industry

The financial services industry has undergone profound changes in the past few
decades. The evolution of the financial services industry is characterized by con-
vergence, consolidation, and globalization.
Convergence
Historically, the financial services industry was divided into distinct sectors, often
as a result of regulatory requirements in various countries. Banks provided bank-
ing services such as checking accounts, savings accounts, and loans. Securities
firms and mutual fund companies handled investments. Insurance companies
issued and sold insurance products.
Today, however, the financial services industry is characterized by convergence,
which is a movement toward a single financial institution being able to serve a cus-
tomer’s banking, insurance, and securities needs. Financial services companies
have entered into each other’s traditional businesses, either through expansion of
operations or affiliations. Thus, the distinctions among financial institutions based
on the products they offer have blurred.
In the United States, financial services companies may affiliate by means of a
financial holding company. A holding company, also known as a parent company,
is a company that owns and controls another company or companies, which are
referred to as subsidiaries or operating units. The various subsidiaries that are
under the common control of the holding company are known as affiliates of each
other because they are affiliated within a holding company system, often operat-
ing under a single brand name. A financial holding company is a holding company
that conducts activities that are financial in nature or incidental to financial activi-
ties, such as insurance activities, securities activities, banking, and investment and
advisory services. Figure 2.2 illustrates a financial holding company structure.
Affiliation in a financial holding company system allows companies to sell one
another’s products. For example, although banks in the United States still cannot
issue—that is, accept the risk on—insurance products, an insurance company can
design a product according to a bank’s specifications and issue a product that the
bank can sell. Such affiliations also increase the ability of insurance companies to
offer a wider variety of noninsurance products, such as mutual funds.

Figure 2.2 Financial Holding Company
Azalea Financial Services Holding Company

} PARENT COMPANY
} Tulip Life
Insurance
Company
Blueberry
National
Bank
Oleander
Securities } SUBSIDIARIES OF
PARENT COMPANY
AFFILIATES OF EACH OTHER
Consolidation
In the financial services industry, the term consolidation typically refers to the
combination of financial institutions within or across sectors. This consolidation
occurs primarily through mergers and acquisitions:
A merger is a transaction in which the assets and liabilities of two companies
are combined into one company. One of the companies survives as a legal
entity, and the other company ceases to exist.
An acquisition is a transaction in which one corporation purchases a control-
ling interest in another corporation, resulting in an ownership link between
two formerly independent corporations. After the transaction, both corpora-
tions survive as separate legal entities.
Consolidation has decreased the number of traditional financial institutions
within each sector of the financial services industry. As the number of financial
institutions has decreased, many of the remaining institutions have grown in size.
Figure 2.3 illustrates how the number of life insurance companies in the United
States has decreased steadily since 1989.
Globalization
Financial institutions operate in a global environment. Large financial services
enterprises, particularly those from Western Europe and North America, increas-
ingly are expanding their customer bases worldwide. For example, Canadian
life and health insurers generated 41 percent of their premiums abroad in 2014.2
In addition, the proportion of life insurance companies operating in the United
States that are foreign-owned was 11 percent in 2014.3

Figure 2.3 Number of U.S. Life Insurance Companies 1989–2014
2,500
Number of Companies
2,000
1,500
1,000
500
0
1989 1994 1999 2004 2009 2014
Year
(November 2015, 19,) 5 https://www.acli.com/Tools/Industry%20Facts/Life%20Insurers%20Fact%20Book/Documents/FB15_All.pdf
Role of Government in Insurance

Governments around the world perform a variety of functions, such as provid-
ing social insurance programs, acting as regulators, and influencing spending and
saving through taxation. In performing these functions, governments affect the
supply and demand for insurance in the private sector.
Social Insurance Programs

A social insurance program is a welfare plan that is established by law and
administered by a government and that provides assistance to specified groups of
the population, such as the elderly, disabled, and unemployed. Social insurance
may provide cash payments to replace income lost because of old age, disability,
death, occupational injuries, and unemployment. Social insurance also may pro-
vide services such as medical care.
In most countries, insurance companies cannot provide products that duplicate
the coverage of social insurance programs. Instead, insurers create and sell prod-
ucts that fill in the gaps not covered by social insurance and that supplement the
coverage that social insurance provides.
Example:
In the United States, one important social insurance program is Medicare,
which pays certain health care expenses for the elderly and people with
qualifying disabilities. Most Americans age 65 and older receive Medicare
coverage. Medicare doesn’t cover all of an individual’s medical expenses,
however. To complement Medicare coverage, private insurance companies
created Medigap policies, also known as Medicare supplement insurance
policies, which pay for many medical expenses not covered by Medicare.

Regulation of Insurance
Insurance companies protect millions of individuals against economic loss and
offer them opportunities to save and invest money. Because the financial health of
insurance providers is of such importance to so many people, insurers occupy a
special position of public trust. As a result, the insurance industry is subject to reg-
ulation designed specifically to safeguard the public trust in insurance companies.
Although insurance laws vary from one country to another, many insurance
laws are similar in principle throughout the world. For example, to operate as an
insurer, a company must incorporate in one particular jurisdiction. The jurisdic-
tion in which a company incorporates becomes the company’s domicile. The com-
pany must then obtain a certificate of authority from each jurisdiction in which it
plans to conduct business. A certificate of authority, or license, grants an insurer
the right to conduct an insurance business and sell insurance products in the juris-
diction that grants the certificate. An insurer must comply with all applicable laws
in each jurisdiction in which it is licensed.
Example:
The New Englander Insurance Company, a U.S. insurer, is incorporated in
the state of Connecticut. New Englander conducts business in Connecticut,
Massachusetts, and New Hampshire.
Analysis:
Connecticut is New Englander’s domicile. New Englander must have a
certificate of authority from each state in which it conducts business—
Connecticut, Massachusetts, and New Hampshire. New Englander must
also comply with all applicable laws in each of these three states.
Insurance regulatory systems also vary from country to country. In many coun-
tries, insurance regulation is centralized and under the supervision of the national
government. For example, in India, authority over insurance regulation rests solely
with the national Insurance Regulatory and Development Authority (IRDA). Some
countries, including the United States and Canada, have federal systems of gov-
ernment, in which a federal government and a number of lower-level governments,
known as state governments in the United States and provincial governments in
Canada, share governmental powers, including the power to regulate insurance.
Insurance Regulation in the United States

Although the power to regulate insurance in the United States is shared by the
state governments and the federal government, the states have the primary author-
ity to regulate the business of insurance. This authority was established through
the McCarran-Ferguson Act, a federal law in which the U.S. Congress agreed to
leave insurance regulation to the states, as long as Congress considers this regula-
tion to be adequate.
Each state has its own laws, usually referred to as the state insurance code,
which regulate insurance in that state. Each state also has an administrative
agency, typically known as the state insurance department, which is responsi-
ble for making sure that companies operating in the state comply with applicable

regulatory requirements. Each state insurance department is under the direction

of an insurance commissioner, known in some states as the superintendent of
insurance or director of insurance.
Although each state has its own set of laws and regulations governing insur-
ance, these laws and regulations are often similar across the various states because
they are based on models developed by the National Association of Insurance
Commissioners. The National Association of Insurance Commissioners (NAIC)
is a nongovernmental association of the insurance commissioners of all the states.
The NAIC’s primary function is to promote uniformity of state insurance regula-
tion by developing model laws and regulations as guidelines for the states. States
are not required to adopt model laws and regulations as written; instead, states
may either modify the models or choose not to adopt them at all.
In the United States, the federal government has long regulated certain aspects
of the insurance industry. For example, certain investment-linked insurance
products, such as variable life insurance and variable annuities, are considered
securities. Therefore, these products are subject to oversight by the Securities
and Exchange Commission (SEC), a federal agency that administers federal laws
governing securities. In addition, individuals who sell variable products or pro-
vide investment advice to owners of variable products must be registered with the
Financial Industry Regulatory Authority (FINRA), a nongovernmental organiza-
tion authorized by the SEC to regulate all securities firms doing business in the
United States.
Figure 2.4 describes the growing role of the federal government in insurance
regulation since the passage of the Dodd-Frank Act in 2010.
In some countries, insurance companies may also be regulated by self-
regulatory organizations (SROs), which are nongovernmental organizations that
exercise regulatory authority over an industry or profession. In the United States,
FINRA is an influential SRO for the life insurance industry. In Canada, an impor-
tant SRO for life insurance companies is the Canadian Life and Health Insurance
Association (CLHIA), which is a voluntary association whose member companies
include 99 percent of Canada’s life and health insurance business. Among other
directives, the CLHIA establishes guidelines for member companies that apply to
a broad range of business activities.
Two Primary Goals of Insurance Regulation

Throughout the world, insurance regulation has two primary goals:
To ensure that insurers remain solvent—that is, able to meet their debts and
pay policy benefits when they come due. Solvency regulation is known as
prudential regulation in many countries.
To ensure that insurance companies conduct their businesses fairly and ethi-
cally. Such regulation is referred to as market conduct regulation.
Solvency Regulation
To ensure the solvency of insurance companies, most countries impose minimum
financial requirements that an insurance company must meet before it obtains a
license to transact insurance; a company that is financially unsound cannot obtain
a license. In addition, governments have the authority to act to protect the public
interest if an insurance company becomes financially unsound.

Figure 2.4 The Dodd-Frank Act
As a result of the financial crisis of 2007–2010, the

Congress enacted the Dodd-Frank Wall Street
U.S.
Reform and Consumer Protection Act (Dodd-Frank),
which is designed to (1) promote the financial stability
of the United States by improving accountability and
transparency in the financial system and (2) protect con-
sumers from abusive financial services practices.
Dodd-Frank created several agencies, including the
•• Federal Insurance Office (FIO), which is a federal
agency authorized to monitor the insurance industry,
identify areas with inadequate state regulation, and
handle international insurance issues.
•• Financial Stability Oversight Council (FSOC), which is an independent agency responsible
for monitoring the safety and stability of the nation’s financial system, identifying threats to the
system, and coordinating regulatory responses to any such threats. The FSOC is empowered to
identify systemically important financial institutions (SIFIs), which are institutions—includ-
ing insurance companies—whose failure could potentially pose a risk to the financial system.
Financial institutions that are identified as SIFIs will be subject to more stringent regulatory
standards than other institutions.
A company’s solvency is evaluated by applying the basic accounting equation,

which states:
Assets = Liabilities + Owners’ Equity LEARNING AID
In the basic accounting equation,

Assets, such as cash and investments, are all items of value owned by a
c ompany.
Liabilities are the company’s debts and future obligations. A large portion of
an insurer’s liabilities consist of the company’s policy reserves, which repre-
sent the amount the insurer estimates it will need to pay policy benefits as they
come due.
Owners’ equity, which represents the owners’ financial interest in the com-
pany, is the difference between the amount of the company’s assets (what it
owns) and its liabilities (what it owes). For a stock insurer, owners’ equity has
two components: capital and surplus. Capital is the amount of money that
the company’s owners have invested in the insurer, usually through the pur-
chase of company stock. Surplus is the amount by which the company’s assets
exceed its liabilities and capital.
Because a mutual insurer does not issue stock, it has no capital. Therefore,
owners’ equity for a mutual insurer consists entirely of the company’s
surplus. Figure 2.5 illustrates the calculation of owners’ equity for stock and
mutual insurers.

Figure 2.5 Calculations of Owners’ Equity
Stock Insurance Company

Friendly Insurance Company has assets of $12 million and liabilities of $8 million.
The stockholders of Friendly have invested $3 million in the company.
Basic Accounting Equation:

$12 million (Assets) = $8 million (Liabilities) + Owners’ Equity (Capital + Surplus)
Owners’ Equity = $12 million (Assets) – $8 million (Liabilities)

= $4 million
$4 million (Owners’ Equity) = $3 million (Capital) + Surplus
Surplus = $4 million (Owners’ Equity) – $3 million (Capital)

= $1 million
Therefore, owners’ equity is $4 million, consisting of $3 million in capital and

$1 million in surplus.
Mutual Insurance Company
Pleasant Mutual Insurance Company has assets of $10 million and liabilities of
$4 million.
Basic Accounting Equation:

$10 million (Assets) = $4 million (Liabilities) + Owners’ Equity (Surplus)
Owners’ Equity = $10 million (Assets) – $4 million (Liabilities)

= $6 million
Therefore, owners’ equity is $6 million, all of which is surplus.
Governments have established methods to oversee the financial condition of

insurance companies operating within their jurisdiction. In the United States, the
states oversee the financial condition of insurance companies by reviewing an
accounting report, known as the Annual Statement, which every insurer prepares
each calendar year and files with the insurance department in each state in which
it operates. The NAIC has developed an Annual Statement form that all states
accept, so an insurer can file the same Annual Statement form in all the states in
which it operates. In addition, state regulators conduct an on-site financial condi-
tion examination of each insurance company every three to five years. In this
examination, state regulators physically check the insurer’s business records. State
regulators may conduct more frequent examinations of companies that appear
most likely to have financial difficulties.
As a general rule, when an insurer is experiencing financial difficulties, regula-
tors are authorized to intervene in the insurer’s operations to protect policyowner

interests. The specific actions that regulators are permitted to take when an insur-
er’s solvency is in question vary from country to country. In extreme cases where
an insurer’s solvency cannot be restored, countries typically have established
procedures to liquidate the company. In each case, the protection of policyowner
interests is the primary regulatory goal.
Market Conduct Regulation

Market conduct laws are designed to make sure that insurance companies conduct
their businesses fairly and ethically. These laws regulate most of the nonfinancial
operations of insurers, including sales practices, advertising, underwriting, poli-
cyowner service, complaint handling, and claims.
In the United States, each state regulates the market conduct of insurers operat-
ing in the state. Many market conduct laws are designed to ensure that customers
are presented with fair and accurate information before they buy insurance. For
example, laws require insurers to disclose specific information about a policy to
a potential customer before selling the policy. Other laws regulate the form and
content of insurance advertisements to make sure that consumers are not misled
about the features or limitations in advertised insurance policies.
In the United States, the state insurance departments perform periodic market
conduct examinations of insurers to ensure that the companies are complying with
the state’s market conduct laws. If the department determines that an insurer has
violated market conduct laws, it may impose sanctions against the insurer, includ-
ing fines and, in severe cases, suspending or revoking the insurer’s certificate of
authority.
In addition to regulating insurance companies, the states regulate the conduct
of the individuals who market and sell insurance. These individuals, typically
known as insurance producers or insurance agents, must be licensed by each state
in which they conduct business. The licensing process helps ensure that insurance
producers are reputable and knowledgeable about the insurance products they sell.
In conducting business, insurance producers must comply with all applicable state
and federal laws. A state insurance department may revoke or suspend the license
of a producer who engages in behavior that violates the state’s laws.
Taxation
Many governments use taxation as a mechanism for accomplishing social, in addi-
tion to economic, goals. Through taxation, governments can influence people to
act or refrain from acting in certain ways. For example, some governments tax
tobacco heavily not only to raise revenue, but to discourage tobacco use. Govern-
ments also offer taxpayers reductions in taxable income for contributions made to
qualified charities to encourage charitable giving.
Many governments also use tax policies to encourage people to purchase vari-
ous types of private insurance and financial products. Governments, for example,
provide tax incentives to encourage people to contribute to, and employers to pro-
vide, group retirement plans. Such tax incentives can be quite effective, and they
have benefitted insurers and other financial institutions by increasing the demand
for their products.

Key Terms
profit McCarran-Ferguson Act
sole proprietorship state insurance code
partnership state insurance department
corporation insurance commissioner
stock corporation National Association of Insurance
share Commissioners (NAIC)
stockholder Dodd-Frank Wall Street Reform and
stock insurance company Consumer Protection Act (Dodd-
stockholder dividend Frank)
mutual insurance company Federal Insurance Office (FIO)
fraternal benefit society Financial Stability Oversight Council
financial institution (FSOC)
financial services industry systemically important financial
security institution (SIFI)
financial intermediary solvent
convergence assets
consolidation liabilities
social insurance program owners’ equity
domicile capital
certificate of authority surplus
federal system Annual Statement
market conduct law
Endnotes
1. ACLI, Life Insurers Fact Book 2015 (Washington, DC: American Council of Life Insurers, 2015), 8,
https://www.acli.com/Tools/Industry%20Facts/Life%20Insurers%20Fact%20Book/Pages/RP15-010.
aspx (27 January 2016).
2. CLHIA, Canadian Life and Health Insurance Facts, 2015 ed. (Toronto: Canadian Life and Health
Insurance Association Inc., 2015), 5, http://clhia.uberflip.com/i/563156-canadian-life-and-health-
insurance-facts (26 January 2016).
3. ACLI, Life Insurers Fact Book 2015 (Washington, DC: American Council of Life Insurers, 2015), 2,
https://www.acli.com/Tools/Industry%20Facts/Life%20Insurers%20Fact%20Book/Pages/RP15-010.
aspx (26 January 2016).

Principles of Insurance Chapter 3: The Insurance Contract 3.1
Chapter 3
The Insurance Contract
Objectives
3A Distinguish between formal and informal contracts, bilateral and
unilateral contracts, commutative and aleatory contracts, and contracts
of adhesion and bargaining contracts, and identify which types
characterize an insurance contract
3B Explain the difference between a valid contract, a void contract, and a
voidable contract
3C Identify the four general requirements for the creation of a valid
informal contract and describe how each of these requirements can be
met in the formation of an insurance contract
3D Identify the property rights that a policyowner has in the insurance
policy he owns

3.2 Chapter 3: The Insurance Contract Principles of Insurance
Outline
Fundamentals of Contract Law The Policy as Property
 Types of Contracts  Right to Use and Enjoy Property
 General Requirements for  Right to Dispose of Property
a Contract
R
emember our point that life and health insurance products represent
promises—promises that, in some cases, could extend over decades?
This characteristic influences the form that such a product takes: in return
for an initial payment, an applicant typically receives an insurance policy, which
is a written record of the promise that the insurance company is making.
Recall that an individual insurance policy is an insurance policy that insures the
life or health of a named person. Some individual policies also insure the person’s
immediate family or a second named person. A group insurance policy insures the
lives or health of a specific group of people. For example, most group insurance
policies are purchased by employers to provide life or health insurance coverage to
their employees and, sometimes, to the dependents of covered employees.
Unless otherwise noted, the information presented in this chapter applies to
both individual and group insurance policies.
Fundamentals of Contract Law

Before an insurance policy is purchased, the applicant for insurance and the
insurance company must reach an agreement: the applicant must agree to buy
the insurance coverage from the company at the stipulated rate, and the company
must agree to issue that coverage under the offered terms. The insurance policy
describes the terms of their agreement.
An insurance policy represents a special kind of agreement known as a con-
tract. A contract is a legally enforceable agreement between two or more parties.
The two parties to an individual life or health insurance contract are the insurance
company that issued the policy and the individual who owns the policy, known
as the policyowner. The parties to a group insurance contract are the insurer that
issued the policy and the group policyholder, which refers to the person or orga-
nization that decides what types of group insurance coverage to purchase for the
group members, negotiates the terms of the insurance contract, and purchases the
group insurance coverage.
The fact that a contract is legally enforceable means that the parties are bound
to carry out the promises they made when entering into the contract. If a party
does not carry out its promise, then that party has breached the contract. Laws
provide innocent parties with remedies they can pursue to recoup losses resulting
from a breach of contract.
Types of Contracts
In Chapter 1, we described contracts of indemnity and valued contracts. As noted
LEARNING AID
in that chapter, health insurance policies typically are contracts of indemnity,

and life insurance policies are valued contracts. Contracts may be categorized in
other ways—for example as either
Formal or informal contracts
Bilateral or unilateral contracts
Commutative or aleatory contracts
Bargaining contracts or contracts of adhesion
Formal and Informal Contracts

Contracts are either formal or informal. A formal contract is a written contract
that is enforceable because the parties met certain formalities concerning the form
of the agreement. Historically, a formal contract had to be stamped with a seal, but
that is no longer a requirement.
Life and health insurance contracts are informal contracts. An informal
contract is an oral or a written contract that is enforceable because the parties met
requirements concerning the substance of the agreement rather than requirements
concerning the form of the agreement.
As informal contracts, life and health insurance contracts could theoretically
be made in either written or oral form. However, laws in some jurisdictions require
insurance contracts to be in writing. Life and health insurance contracts typically
are expressed in written form—whether required by law or not—for practical rea-
sons. For example, a written contract provides a permanent record of the agree-
ment. Life insurance policies often remain in effect for many years. The memory
of someone’s oral promises made many years in the past may not be reliable, even
under the best circumstances. Putting the contract in writing helps prevent misun-
derstandings between the parties as to the terms and conditions of their agreement.
Bilateral and Unilateral Contracts

A contract between two parties may be either bilateral or unilateral. A bilateral
contract is one in which both parties make legally enforceable promises when
they enter into the contract.
Example:
Shi-Fay Cheng contracts with the Dependable Heating Company to have
the company install a heating system in her home for a mutually agreed-
upon price. Dependable promises to perform the work, and Shi-Fay
promises to pay a stated amount in exchange for the work.
Analysis:
This contract is bilateral—both Shi-Fay and Dependable have made legally
enforceable promises. If either Shi-Fay or Dependable fails to perform its
promise, the other party can take legal action to enforce the contract.

In contrast to a bilateral contract, a unilateral contract is one in which only one

of the parties makes a legally enforceable promise when entering into the contract.
Life and health insurance policies are unilateral contracts. The insurer promises
to pay a policy benefit if the insured dies, gets sick, or is injured. As long as the
premiums are paid, the insurer is legally bound by its contractual promises. The
purchaser of the policy, on the other hand, does not promise to pay the premiums
and cannot be compelled by law to pay them. In fact, the policyowner has the right
to stop paying premiums and cancel the policy at any time. Figure 3.1 illustrates
the difference between a bilateral and a unilateral contract.
Figure 3.1 Bilateral vs. Unilateral Contracts
Promise: Pay for Heating System
Promise: Install System
BOTH PARTIES HAVE MADE ENFORCEABLE PROMISES
Promise: Provide Insurance Coverage
ONLY THE INSURER MADE AN ENFORCEABLE PROMISE

Commutative and Aleatory Contracts

Contracts may also be classified as either commutative or aleatory. A commutative
contract is an agreement in which the parties specify in advance the values that
they will exchange. Moreover, the parties generally exchange items or services
that they think are of relatively equal value. In the case of Shi-Fay Cheng and the
Dependable Heating Company, both parties essentially agreed that the installation
of the heating system and the price to be paid were of equal value. Contracts for
the sale of goods or services usually are commutative contracts.
In an aleatory contract, one party provides something of value to another party
in exchange for a conditional promise. A conditional promise is a promise to
perform a stated act if a specified, uncertain event occurs. If the event does not
occur, the promise will not be performed. Also, under an aleatory contract, if the
specified event occurs, one party may receive something of greater value than that
party gave.
Life and health insurance policies are aleatory contracts. A life insurance pol-
icy is an aleatory contract because the insurer’s promise to pay the policy benefit is
contingent upon the death of the insured while the policy is in force. The insured’s
death is an uncertain event because no one can say with certainty when the insured
will die.
A life insurance policy is also an aleatory contract because one of the parties
may receive something of greater value than that party gave. For example, a policy
may terminate prior to the death of the insured, and the insurer’s promise to pay
the policy benefit will never be performed—even if the insurer has received a
number of premiums. Conversely, death may occur soon after an insurer issues a
life insurance policy. In this case, the insurer must pay the policy benefit, which
will be more than the premiums the insurer received for the policy.
Bargaining Contracts and Contracts of Adhesion

Contracts may be further classified as either bargaining contracts or contracts of
adhesion. Suppose two individuals, Jean and Dylan, had the following conversation:
Jean: I will sell you my car for $3,000.

Dylan: I would like to buy your car but not for $3,000. How about $2,000?
Jean: I can’t sell you the car for $2,000; how about $2,500?
Dylan: Okay, I will buy your car for $2,500.
Jean and Dylan have entered into a bargaining contract, one in which both par-
ties, as equals, set the terms and conditions of the contract.
In contrast, life and health insurance policies are contracts of adhesion. A
contract of adhesion is a contract that one party prepares and that the other party
must accept or reject as a whole, generally without any bargaining between the
parties to the agreement. Although the applicant for individual life or health insur-
ance has choices about some of the contract provisions, generally he must accept
or reject the contract as the insurance company has written it. As a result, if any
policy provision is ambiguous, the courts usually interpret the provision in what-
ever manner would be more favorable to the policyowner or beneficiary. In contrast
to individual insurance policies, group insurance agreements often are subject to

some negotiation between the parties. Nevertheless, group insurance contracts are
contracts of adhesion. Figure 3.2 lists the various types of contracts and identifies
which types characterize life and health insurance contracts.
General Requirements for a Contract

According to the laws in most states in the United States and many other coun-
tries, an agreement must meet the following four general requirements to be a
LEARNING AID
valid informal contract:
1. The parties to the contract must express mutual assent, or agreement, to the
terms of the contract.
2. The parties to the contract must have contractual capacity.
3. The parties to the contract must exchange legally adequate consideration.

4. The contract must be for a lawful purpose.
Figure 3.2 Types of Contracts
Characterizes
Type of Contract Life and
Health
Insurance
Contracts
Contract is based on the form of the agreement No

(Formal contract)
Contract is based on the substance of the agreement Yes

(Informal contract)
Both parties make legally enforceable promises No

(Bilateral contract)
Only one party makes a legally enforceable promise Yes

(Unilateral contract)
The parties exchange things of equal value No

(Commutative contract)
One party provides something of value in exchange for a conditional promise Yes
(Aleatory contract)
Both parties set the terms No

(Bargaining contract)
One party sets the terms that the other party accepts or rejects Yes
(Contract of adhesion)

In describing the legal status of a contract, the words valid, void, and voidable
are often used:
Valid. A valid contract is one that is enforceable by law. Valid contracts sat-
isfy all legal requirements.
Void. The term void is used in law to describe something that was never valid.
A void contract is one that does not satisfy one or more of the legal require-
ments to create a valid contract and, thus, is never enforceable.
Voidable. At times, one of the parties to an otherwise valid contract may have
grounds to reject, or avoid, it. A voidable contract is one in which a party has
the right to avoid her obligations under the contract.
Let’s look at the four requirements in more detail.
Mutual Assent
Whether a contract is made when the parties sign a written agreement or shake
hands, the parties involved have agreed to do something. The requirement of
mutual assent is met when the parties reach a meeting of the minds about the
terms of their agreement.
For life and health insurance policies, as well as for other contracts, mutual
assent is expressed through a process of offer and acceptance. An offer is a pro-
posal to enter into a binding contract with another party. The party that makes
the offer is the offeror, and the party to whom the offer is made is the offeree.
An acceptance of the offer is the offeree’s unqualified agreement to be bound to
the terms of the offer. If an offer is accepted according to its terms, mutual assent
has occurred.
Example:
Denise Chung said to her neighbor, Graham Spader, “I will sell you my old
lawn mower for $100.” Graham replied, “I like your lawn mower, so I will
buy it for $100.”
Analysis:
Denise’s statement to Graham was an offer, and Denise was the offeror.
Graham was the offeree. Graham’s reply was an acceptance of the offer.
Through their offer and acceptance, Denise and Graham expressed their
mutual assent to the terms of the contract.
Contractual Capacity
For an informal contract to be binding on the parties, the parties must have
contractual capacity—that is, they each must have the legal capacity to make a
contract. Individuals and insurance companies can enter into binding contracts,
but the criteria for determining contractual capacity are somewhat different for
individuals than for insurers and other corporations.

Contractual Capacity of Individuals

Every individual is presumed to have the legal capacity to enter into a valid con-
tract. The law, however, has established some exceptions to this general rule to
protect certain individuals who may not understand the consequences of their
actions. In most jurisdictions, these individuals include (1) minors and (2) people
with diminished mental capacity.
Minors. The laws in nearly all jurisdictions establish a particular age, referred
to as the age of majority or age of maturity, at which people are considered adults
who are capable of managing their own affairs and accepting the legal obligations
created by their actions. A minor is a person who has not attained the age of major-
ity. In most countries and most states in the United States, the age of majority is 18.
Generally, a contract entered into by a minor is voidable by the minor.1 A minor
is usually permitted to reject a contract before reaching the age of majority or
within a reasonable time afterward.
Many jurisdictions have, by law, lowered the age of majority for the purpose of
entering into life insurance contracts. These laws permit younger people—gener-
ally those who are at least age 15 or 16—to purchase life insurance and to exercise
some of a policy’s ownership rights as though they were adults. In most such situ-
ations, the beneficiary of the life insurance policy must be a member of the minor’s
immediate family.
If an insurance company sells an insurance policy to a person who is younger
than the permissible age to purchase insurance, then the company is required
to provide the promised insurance protection as long as the premiums are paid.
The minor, however, could sue to avoid the policy, and the insurance company
would have to return the premiums the minor paid for the policy.
Example:
Caridad Mendoza, age 17, purchased a life insurance policy from Totem
Life Insurance Company and paid the initial premium. The minimum
permissible age to purchase life insurance in the jurisdiction in which
Caridad lives is 18 years.
Analysis:
Because Caridad is younger than the permissible age, this life insurance
policy is voidable by Caridad. She can reject the contract before she turns
18 or within a reasonable time afterward, and Totem must refund any
premiums she has paid. In contrast, as long as Caridad pays the premiums
for the policy, Totem is bound by the contract.
Mental Capacity. Two situations arise in which a person’s lack of mental

capacity affects her contractual capacity:
A court declares the person to be insane or mentally incompetent. A contract
entered into by such a person is usually void.

The person’s mental competence is impaired, but a court has not declared her
to be insane or mentally incompetent. For example, the person can be mentally
impaired as a result of being intoxicated or mentally ill. Contracts entered
into by such a person are generally voidable by that person. If the person later
regains mental competence, she may either reject the contract or require that
it be carried out. In contrast, the other party to the contract does not have the
right to reject the contract and must carry out its terms if required to do so.
Contractual Capacity of Organizations

Corporations are generally presumed to have the contractual capacity of a men-
tally competent adult. Therefore, a corporation that was created in accordance
with the laws of the applicable jurisdiction has the contractual capacity to enter
into a contract, including a contract to purchase insurance.
An insurer acquires the legal capacity to issue an insurance contract by being
licensed or authorized to do business as an insurer by the proper regulatory author-
ity. A company that is neither licensed nor authorized as an insurance company
does not have the legal capacity to issue an insurance contract. Should an unau-
thorized insurer issue a policy to a person who is unaware of the insurer’s lack of
legal capacity, the policy may be enforceable against the insurer. The legal effect
of such a contract depends on the laws of the particular jurisdiction. In some juris-
dictions, the contract is void; in others, the contract is voidable by the policyowner.
Legally Adequate Consideration

For an informal contract to be valid, the parties to the contract must exchange
consideration, which means that each party must give or promise something that
is of value to the other party. In addition, the consideration exchanged must be
legally adequate. In general, consideration is legally adequate as long as it has
some value to the parties.
An applicant submits the application and the initial premium—the first pre-
mium paid for an insurance policy—as consideration for a life or health insurance
policy. The applicant gives this consideration in return for the insurer’s promise to
pay the policy benefit if the conditions stated in the policy occur. If the applicant
does not pay the initial premium, then no contract is formed, because the appli-
cant has not provided the required consideration. Renewal premiums, which are
premiums payable after the initial premium, are a condition for continuance of the
policy and are not consideration for the policy.
Figure 3.3 illustrates legally adequate consideration for an insurance policy.
Lawful Purpose
No contract can be made for a purpose that is illegal or against the public inter-
est—a contract is valid only if it is made for a lawful purpose. For example, all
jurisdictions have laws that make certain acts punishable as crimes. An agreement
between two parties to commit a criminal act, such as an agreement to kill an
individual in exchange for money, is not legally enforceable.
As we mentioned in Chapter 1, early life insurance policies were sometimes
used to gamble on an individual’s life. As a result, many jurisdictions enacted

Figure 3.3 Legally Adequate Consideration for Insurance
Completed insurance application

Initial premium
Promise to pay policy

benefits if conditions
stated in policy occur
insurable interest laws as a matter of public policy to prevent such wagering.

The requirement that an insurable interest be present when a policy is issued pro-
vides assurance that a life insurance contract is being made for the lawful purpose
of providing protection against financial loss rather than for an unlawful purpose,
such as speculating on another person’s life in hopes of making a profit.
The requirement of lawful purpose in making an individual life insurance con-
tract is met if an insurable interest is present when the policy is issued. After
issuance, a continuing insurable interest is not required for the contract to remain
valid.
Example:
Harvey Atkinson purchased a life insurance policy insuring his wife, Lily.
Harvey and Lily divorced several years later.
Analysis:
As Lily’s spouse, Harvey had an insurable interest in her life when the
policy was issued. Therefore, the policy remains valid and in effect as
long as premiums continue to be paid even if Harvey no longer has an
insurable interest in Lily’s life.
An insurable interest usually is not required in a group insurance contract

because the group policyholder’s interest in the contract does not encourage
wagering as does a policyowner’s interest in an individual insurance contract.
For a group insurance contract, the lawful purpose requirement is met when the
group policyholder enters into the contract to provide benefits to covered group
members.
Figure 3.4 summarizes the requirements for a valid informal contract.

Figure 3.4 Requirements for a Valid Informal Contract
Mutual Assent
Contractual Capacity
Legally Adequate Consideration
Lawful Purpose
The Policy as Property

In addition to being governed by contract law, insurance policies are a type of
property and, thus, are also subject to the principles of property law. In legal ter-
minology, property is defined as a bundle of rights a person has with respect to
something. In most countries including the United States, property is character-
ized as either real property or personal property. Real property is land and what-
ever is growing on or attached to the land. All property other than real property is
characterized as personal property and includes tangible goods such as clothing,
furniture, and automobiles, as well as intangible goods such as contractual rights.
An insurance policy is intangible personal property—it represents intangible legal
rights that have value and that can be enforced by the courts. The owner of an
insurance policy—rather than the insured or beneficiary—holds these ownership
rights in an insurance policy.
Ownership of property is the sum of all the legal rights that exist in that prop-
erty. The legal rights an owner has in property include the right to use and enjoy
the property and the right to dispose of the property.

Right to Use and Enjoy Property

The right to use and enjoy property that one owns is an inherent feature of prop-
erty ownership. The owner of an insurance policy has the right to deal with the
policy in a number of ways. For example, the owner of an individual life insurance
policy has the right to name the policy beneficiary. The policyowner also usually
has the right to change the beneficiary designation at any time while the policy is
in force. We describe naming and changing the beneficiary of an individual life
insurance policy in Chapter 9. We describe the right to name the beneficiary of a
group life insurance policy in Chapter 13.
Right to Dispose of Property

The owner of property generally has the right to dispose of the property. For
example, if you own an automobile, you have the right to give it away or sell it.
Similarly, the owner of an insurance policy can dispose of it. The policyowner
may transfer ownership of the policy by making a gift of the policy to someone
else. We describe some of these aspects of policy ownership in later chapters. For
now, just remember that, as property, an insurance policy consists of a bundle of
ownership rights.
Key Terms
contract voidable contract
group policyholder mutual assent
formal contract offer
informal contract acceptance
bilateral contract contractual capacity
unilateral contract minor
commutative contract consideration
aleatory contract initial premium
conditional promise renewal premium
bargaining contract property
contract of adhesion real property
valid contract personal property
void contract ownership of property
Endnote
1. The general rule that a minor’s contract is voidable by the minor has some exceptions. One important
exception is that a minor’s contract for necessaries, which are goods and services that a minor requires
for her well-being, is valid and binding on both parties.

Principles of Insurance Chapter 4: Life Insurance Premiums 4.1
Chapter 4
Life Insurance Premiums
Objectives
4A Define policy reserves and explain the premises of the legal reserve
system
4B Define premium rate and calculate the annual premium amount for a
given life insurance policy
4C Explain how actuaries account for the cost of benefits, operating
expenses, and investment earnings in developing premium rates
4D Explain how insurers use mortality tables in pricing products and
describe the effect that mortality rates have on the cost of benefits and
the premium rate for a block of policies
4E Describe the effect of compound interest on investment earnings and
calculate the amount of interest earned on a given sum of money
4F Explain the purpose of using conservative values in financial models
4G Explain how the level premium system operates

4.2 Chapter 4: Life Insurance Premiums Principles of Insurance
Outline
The Legal Reserve System The Level Premium System
Establishing Premium Rates
 Cost of Benefits
 Operating Expenses
 Investment Earnings
 Financial Models
S
uppose you have just purchased a life insurance policy and made your ini-
tial premium payment. How did the insurance company decide what the
policy’s premium would be? And assuming that your policy has renewal
premiums, how did the company come up with an amount for those as well?
To determine the proper premiums to charge, insurers employ specialists
known as actuaries. An actuary is an expert in financial risk management and
the mathematics and modeling of insurance, annuities, and financial instruments.
In insurance companies, actuaries are responsible for ensuring that products are
financially sound and profitable. Actuaries accomplish this dual objective by
establishing for every product a premium rate that will enable the company to
both cover its costs of developing and administering the product and generate a
reasonable profit for the company and its owners.
Unlike previous chapters, which applied to a broader spectrum of life and
health insurance products, this chapter focuses on life insurance products.
The Legal Reserve System

The system that insurers use to set financial values for life insurance products is
generally known as the legal reserve system. The legal reserve system derives its
name from legal requirements that apply to insurers in the United States and many
other jurisdictions. Insurers are required by law to establish policy reserves, some-
times referred to as contractual reserves, legal reserves, or statutory reserves.
These reserves represent the amount an insurer estimates it needs to pay future
benefits.
Of all the terms used in the insurance industry, reserves is one of the most
important and also one of the most easily misunderstood. In our everyday lives,
we use the term reserves to mean something extra, something that is available in
addition to our usual supply. For example, in a broad sense, people use the term
reserves to refer to a sum of additional money that is put aside in case a special
need arises. Used in this sense, a reserve fund is an asset.
In the insurance industry, however, reserves are not assets. Rather, they are lia-
bilities representing the amount of money an insurer estimates it will need to pay
its future obligations. Policy reserves represent the largest portion of an insurer’s
total liabilities. By law, the insurer is required to maintain assets that are at least
equal to the amount of its policy reserve liabilities. Accordingly, the insurer must
price its life insurance products so that it can meet its policy reserve requirements
at all times.

The legal reserve system is based on the following premises:

The amount of benefits payable should be specified or calculable in advance
of the insured event.
Companies should collect in advance the money needed to fund a policy
reserve so that they will have sufficient funds available to pay claims and
expenses as they occur.
The premium an individual pays for a life insurance policy should be directly
related to the amount of risk the insurance company assumes for the policy.
Establishing Premium Rates

In pricing life insurance products, actuaries do not determine the exact premium
amount that each policyowner pays. Rather, they establish premium rates for
blocks of policies. A block of policies is a group of policies issued to insureds who
are all the same age and sex and in the same risk classification.
Example:
An insurer may classify into one block all term life insurance policies to
be issued to male tobacco nonusers, age 35, with no significant medical
history.
A premium rate is a charge per unit of insurance coverage. In most cases,

premium rates for a block of policies are based on a $1,000 life insurance cover-
age amount, known as a coverage unit. Thus, the premium rate for an individual
life insurance policy is typically expressed as the rate per thousand per year. An
annual premium amount for a policy is calculated by multiplying the premium rate
by the number of coverage units.
Example:
The annual premium rate for a $500,000 life insurance policy is expressed
as $4 per $1,000 of coverage.
Analysis:
The annual premium amount for the policy is $2,000, which is calculated
as follows:
LEARNING AID
Annual Premium
Premium Rate Amount
Number of Units
(Payment per Unit × ($1,000 of Coverage)
=
(Customer’s Annual
per Year)
Payment)
500, found as
$4 × ($500,000 ÷ $1,000)
= $2,000
Note that other factors, such as the application of policy fees and policy dividends,
may affect the premium amount actually charged to a policyowner.

Actuaries consider many variables as they perform the calculations necessary

to establish premium rates. In performing these calculations, actuaries seek to
ensure that premium rates are
Adequate. Adequate premium rates are high enough so that the insurer will
have enough money to pay policy benefits as well as operating expenses.
Because most insurance companies operate for a profit, their premium rates
should be high enough to provide a reasonable profit as well.
Equitable. Equitable premium rates ensure that each policyowner is charged
a premium that reflects the degree of risk the insurer assumes in providing
the coverage. Insureds who represent similar degrees of risk to the company
should be charged similar rates.
Not excessive. If an insurer’s premium rates are too high, potential custom-
ers may instead purchase policies from competitors that offer lower premium
rates. In addition, sales producers may prefer to represent other insurers that
offer lower premium rates.
The three most important factors that actuaries consider in the calculation of
life insurance premium rates are (1) the cost of benefits, (2) operating expenses,
LEARNING AID
and (3) investment earnings.
Cost of Benefits
The cost of benefits, sometimes known as the cost of insurance, is the value of
all the contractually required benefits a product promises to pay. For a given life
insurance product, the projected cost of benefits generally equals the sum of all
the potential benefit payments under the product multiplied by the probability that
each benefit will be payable. We can express the projected cost of a given benefit
as follows:
Projected cost of a Potential benefit Probability that the
given benefit = amount payable × benefit will be payable
The primary policy benefit payable by an insurer when an insured dies while
the policy is in force is the death benefit. Insurers determine the probability that
death benefits will be payable in a given year by referring to mortality tables,
which estimate the mortality rate for a given group of insureds.
The cost of benefits for a group of insureds depends in part on the mortality rate:
In general, the higher the mortality rate for a group of insureds of the same age
and sex, the higher the cost of benefits and, thus, the higher the premium rate.
Conversely, the lower the mortality rate for a group of insureds of the same
age and sex, the lower the cost of benefits and the lower the premium rate.
Because life expectancy and mortality rates vary widely from one country to
another, insurers usually rely on mortality tables developed for use in a particular
country. Figure 4.1 illustrates a portion of a mortality table.

Figure 4.1 Sample Mortality Table—Male
Mortality Rate
Age Number Living Number Dying
per 1,000
59 100,000 1,100 11
60 98,900 1,200 12
61 97,700 1,300 13
The group of males age 59 begins the year with 100,000 members. During the year, 1,100 of the
men are expected to die. The mortality rate during the year is 11 per 1,000, calculated by dividing
the number dying at age 59 by the number living at age 59 at the beginning of the year.
1,100 ÷ 100,000 = 0.011
According to this mortality table, 11 out of every 1,000 men are expected to die after attaining age
59 but before attaining age 60.
We can check this number—the 1,100 dying during their 59th year—by subtracting it from 100,000,
the number of men expected to be alive at the beginning of their 59th year. This calculation should
give us the number of men expected to be alive at the beginning of their 60th year:
100,000 – 1,100 = 98,900
Most mortality tables are known as sex-distinct mortality tables because they
contain separate statistics for males and females. In contrast, other mortality
tables, known as unisex mortality tables, show a single set of mortality rates to be
used for both males and females.
Mortality statistics show that, at nearly all ages, females have lower mortality
rates than males of the same age. To reflect this difference, most insurers set lower
life insurance premium rates for equivalent coverage for women than for men of
the same age and underwriting risk. Figure 4.2 shows the differences in average
life expectancies at birth by country and by sex, as of 2013.
Most mortality tables that insurers use to price products divide the mortality
rates into two additional categories: tobacco users and tobacco nonusers. In other
words, sex-distinct mortality tables often show mortality rates for four catego-
ries of people: male tobacco users, male tobacco nonusers, female tobacco users,
and female tobacco nonusers. A mortality table that does not show separate mor-
tality rates for tobacco users and tobacco nonusers is referred to as a composite
mortality table. For the purpose of setting premium rates, mortality tables in some
countries, such as the United States and Canada, are also divided into even more
categories, such as preferred, standard, and substandard risk classifications.

Figure 4.2 Average Life Expectancy by Country, 2013
Male Life Female Life

Expectancy at Expectancy at
Birth Birth
Australia 80 85
Brazil 72 79
Canada 80 84
China 74 77
Indonesia 69 73
Japan 80 87
Mexico 73 78
Spain 80 86
United States 76 81
Source: From Global Health Observatory Data Repository: Life expectancy—Data by country. http://apps.who.int/gho/data/node.
main.688?lang=en Chapter 4. Figure 4.2. displayed as a chart showing Male and Female Life expectancy at Birth for countries
Australia, Brazil, Canada, China, Indonesia, Japan, Mexico, Spain, United States
Operating Expenses
For life insurance companies, operating expenses are the costs of operations other
than expenses for contractual benefits, or the cost of benefits. In setting a premium
rate for a product, the insurer must estimate the expenses associated with develop-
ing the product, selling it, and supporting it over the years it is expected to remain
in force. Examples of these expenses include
Product development costs
Distribution and promotion costs
Payroll costs for staff, as well as employee benefit costs
The costs of providing customer service to policyowners, such as producing
and mailing account statements and answering customer service phone calls
The costs associated with maintaining the company’s offices and its computer
systems
In general, insurers spend considerably more on benefit payments to customers
than on their operating expenses. Figure 4.3 shows the typical portion of insurance
company expenses that was attributable to paying benefits and the portion that was
attributable to operating expenses.
A significant risk associated with an insurer’s operating expenses is that custom-
ers will terminate or reduce the value of a life insurance policy before the policy
becomes profitable. During the policy’s early years, the insurer incurs substantial
product expenses. Underwriting expenses and other expenses are incurred when
an insurer issues a policy. For example, insurers often pay a substantial portion of a
policy’s initial premium as a commission to the producer who sold the policy. Thus,
a policy generally must remain in force for several years for it to be profitable.

Figure 4.3 Distribution of U.S. Life Insurance Company Expenditures, 2014
Operating
expenses
13%
Investment
expenses
1%
Taxes
3%
Additions to
policy reserves
17% Benefit
Payments
66%
(November 2015, 19,) 50 https://www.acli.com/Tools/Industry%20Facts/Life%20Insurers%20Fact%20Book/Documents/FB15_All.pdf
An example of a situation in which an insurer may lose money on a product is

when the product’s actual lapse rate exceeds the rate built into the product’s pre-
mium rate. The termination of an insurance policy for nonpayment of premium is
known as a lapse. Therefore, the lapse rate is the percentage of a specified group
of policies in force at the beginning of a specified period, such as a year, that are
terminated by the end of that period for reasons other than the death of the insured.
Example:
The Reliable Insurance Company had a block of 10,000 life insurance
policies in force at the beginning of last year. During the year, 1,000 of the
policies lapsed.
Analysis:
For last year, the actual lapse rate for this block of policies was 10%, found
as follows:
1,000 lapses ÷ 10,000 policies in force = 10% lapse rate
If this 10% lapse rate exceeded the rate that Reliable’s actuaries built into
the product’s premium rate, Reliable may have lost money on this product.

Investment Earnings
In setting a product’s premium rate, an insurer must take into account investment
earnings—the money the insurer earns from investing the funds it receives from
customers. Many life insurance policies remain in force for a number of years
before benefits become payable. During that time, the funds paid for these policies
are available for the insurer to invest. The earnings on these investments allow
insurance companies to charge policyowners less than if companies relied solely
on the premiums and charges that policyowners paid.
As financial intermediaries, insurance companies invest the funds received
from customers in many different ways—in government and corporate bonds,
mortgages, real estate, and corporate stock. In fact, insurance companies can place
money in any safe investment that is likely to provide good earnings and is not
prohibited by government regulation.
How Investments Create Earnings

Many investments earn money in the form of interest payments. Interest is a pay-
ment for the use of money. The rate of interest is expressed in terms of a percent-
age, such as 10 percent. The principal is the sum of money originally invested,
loaned, or borrowed.
Simple interest is interest on the principal only. Consider an example of
a simple-interest loan. In such a transaction, the lender is considered to be the
investor. A 10 percent interest rate on a loan indicates that the borrower must pay
the lender the amount originally borrowed, plus an additional 10 percent of that
amount each year.
Example:
Casper O’Hare loaned Riley Nugent $1,000 for two years at an annual
interest rate of 10%. Riley did not repay any of the principal or interest on
the loan for two years.
Analysis:
At the end of one year, Riley owed Casper $1,100, calculated as
$1,000 principal + ($1,000 principal × 0.10)
At the end of two years, Riley owed Casper another $100 in interest,
calculated as
$1,000 principal × 0.10 = $100
Therefore, at the end of the second year, Riley owed Casper a total of
$1,200, calculated as
$1,100 + $100
Calculating interest on both the principal and the accrued interest is called
compounding, and the interest in this case is called compound interest.
Today, the interest on most loans and investments is compound interest. When
interest is compounded, the interest earned each investment period is equal to the

accumulated balance at the beginning of the period multiplied by the interest rate.
The amount of interest earned that period is then added to the accumulated bal-
ance to determine the beginning balance on which interest will be paid during the
next period. In this way, interest is earned on both the original principal and on all
accumulated interest.
Example:
Olivia Sandoval loaned Shu-Ling Lee $1,000 at an interest rate of 10%,
compounded annually. Shu-Ling did not repay any of the principal or
interest on the loan for two years.
Analysis:
At the end of the first year, Shu-Ling owed Olivia $1,100, calculated as
$1,000 principal + ($1,000 principal × 0.10)
At the end of the second year, Shu-Ling owed Olivia $110 in interest,
calculated as
($1,100 accumulated balance) × 0.10
Therefore, at the end of the second year, Shu-Ling owed Olivia a total of
$1,210, calculated as
$1,100 + $110
The interest in this example was compounded annually. However, interest can be
compounded with any frequency—quarterly, monthly, or daily, for example.
Although the additional $10 earned by compounding interest in the previous
example may seem small, over a long period of time, compounding interest has a
dramatic effect on the total amount of interest that is earned.
Example:
Kalinda Patel deposited $1,000 in a bank account that pays 5% simple
interest. She made no other deposits for the next 25 years.
Analysis:
After 25 years, Kalinda’s account earned $1,250 in simple interest ($50
× 25). Had her account paid compound rather than simple interest, she
would have earned a total of $2,386 in compound interest at the end of
the 25-year period.
The example of the bank account shows how much money a single amount
can earn over time. Many insurance policies require annual premium payments,
which usually allow the insurer to invest an additional amount from premiums
every year the policy remains in effect. Figure 4.4 shows the amount of money that
can be earned over various periods of time by investing $1,000 a year at 5 percent
interest, compounded annually.

Figure 4.4 Value of $1,000 Annual Investment at 5% Interest,

Compounded Annually
$60,000
Principal +
 Compound Interest
 Principal
$50,000 
Value of Investment
$40,000

$30,000

$20,000




$10,000 


$0


1 5 10 15 20 25
Number of Years
Value of Investment
1 year Principal $1,000 Interest $50 Total $1,050
5 years Principal $5,000 Interest $802 Total $5,802
10 years Principal $10,000 Interest $3,207 Total $13,207
For the sake of simplicity, we illustrated investment earnings in terms of an

interest rate earned on a loan and on a bank account. However, companies can
receive investment earnings from many other types of investments. For example,
insurance companies invest money by buying stock in other companies. While an
insurance company owns the stock, the company may collect dividend payments
on that stock. In addition, the insurer might be able to sell the stock for more than
it paid. In both instances, the insurer’s investment earnings can be expressed as a
rate of return, which is the investment earnings expressed as a percentage of the
principal.

Example:
Reliable Insurance Company purchased stock in the Mimosa Corporation
for $100,000. One year later, Reliable sold the Mimosa stock for $120,000.
Analysis:
Reliable earned a return of $20,000 on its investment ($120,000 - $100,000).
The percentage rate of return on the investment was 20% ($20,000 return
÷ $100,000 = 0.20 or 20%).
Financial Models
Actuaries need to be able to establish premium rates for products that will satisfy
the company’s objectives over the many years that the products are expected to be
in force. Product outcomes can vary, however, based on economic conditions, the
insurer’s claim experience, policy terminations, and other factors. Companies can
evaluate the potential effects of various future conditions on a product’s financial
values by using financial models. In general, a financial model is a computer-
based mathematical model that approximates the operation of real-world financial
processes. Companies use product development software that simulates the poten-
tial financial processes likely to occur over the time that a product is expected to
remain in force.
Examples of financial values that insurers use in modeling are values for inter-
est rates, mortality rates, expenses, and lapses. A typical financial model runs hun-
dreds or even thousands of scenarios, with each scenario representing a different
set of financial values that the product is likely to experience.
Insurers build into their financial models the risk that they will face unexpected
outcomes. One way they do this is by using projections that are designed to be
more than adequate; such projections are said to be conservative.
Conservative values for specific life insurance product elements generally take
the form of
Mortality rates that are higher than expected
Investment earnings that are lower than expected
Operating expenses that are higher than expected
Example:
An insurer may project mortality rates that are 10% higher than expected
to ensure that the premium rate for a product will be more than adequate.
In calculating premium rates, actuaries use conservative values to provide a

buffer against adverse product results.

The Level Premium System

If insurers always charged policyowners the amount it cost to provide coverage at
the insured’s current age, the mortality expense would be low when the insured
LEARNING AID
was young and increase as the insured grew older. Most people would not be able to
afford the cost of insurance in their later years when mortality rates and expenses
are high. Therefore, insurers developed the level premium system, which is a life
insurance premium system that allows a policyowner to pay the same premium
amount each year a policy is in force. Insurers use the level premium system to
price many types of cash value life insurance, term life insurance that provides
coverage for more than one year, and endowment insurance.
Level premiums are possible because, in the early policy years, premium rates
for level premium policies are higher than needed to pay claims and expenses.
Relatively few insureds will die during those early policy years, and few claims
will be payable. The insurer can invest the premium dollars that are not needed to
pay claims and expenses in those years.
As people insured under a block of level premium policies grow older, the
insurer expects to receive an increasing number of death claims each year. Under
a level premium system, the insurer uses premium dollars from the early policy
years, plus the investment earnings, to help pay the increased number of death
claims in the later years. Thus, the premium rate on any of these policies can
remain level throughout the duration of the policy. Figure 4.5 illustrates the dif-
ference between the premiums required for a level premium policy and those
required for a series of similar one-year term life policies. We discuss term life
insurance in Chapter 5.

Figure 4.5 Level Premiums Contrasted with One-Year Term Life Premiums
One-Year Term Policy Cost
Level Premium Policy Cost

Premium
Age
Key Terms
actuary investment earnings
legal reserve system interest
policy reserves principal
block of policies simple interest
premium rate compounding
cost of benefits compound interest
death benefit rate of return
operating expenses financial model
lapse level premium system
lapse rate

Principles of Insurance Glossary GLOSS.1
Glossary
401(k) plan. A type of qualified retirement plan that employers establish for the
benefit of employees and that allows both employers and employees to make
specified contributions to the plan that reduce current taxable income. [14]
403(b) plan. A tax-advantaged retirement plan available only to tax-exempt orga-
nizations established for religious, charitable, and educational purposes and
public schools. [14]
457(b) plan. A deferred compensation plan established by a state or local govern-
ment or a tax-exempt organization. [14]
absolute assignment. An irrevocable assignment of a life insurance policy under
which a policyowner transfers all of his policy ownership rights to the assignee.
Contrast with collateral assignment. [9]
ACA. See Patient Protection and Affordable Care Act.
accelerated death benefit. A supplemental life insurance policy benefit that
typically provides that a policyowner may elect to receive all or part of the
policy’s death benefit before the insured’s death, if certain conditions are met.
Also known as a living benefit. [7]
acceptance. The offeree’s unqualified agreement to be bound to the terms of the
offer. [3]
accidental death and dismemberment (AD&D) benefit. A supplemental life
insurance policy benefit that provides an accidental death benefit and also pro-
vides a dismemberment benefit payable if an accident causes the insured to lose
any two limbs or sight in both eyes. [7]
accidental death benefit. A supplemental life insurance policy benefit that requires
the insurer to pay a specified amount of money in addition to the policy’s basic
death benefit if the insured dies as a result of an accident. [7]
account value. See accumulated value.
accumulated value. For a deferred annuity, the amount paid for the annuity, plus
the interest earned, minus the amount of any withdrawals and fees. Also known
as the accumulation value, contract value, or account value. [10]
accumulation at interest dividend option. A policy dividend option under which
the policy dividends are left on deposit with the insurer to accumulate at inter-
est. Sometimes called dividends on deposit option. [9]
accumulation period. The period between the contract owner’s purchase of a
deferred annuity and either the date when the annuity’s payout period begins or
the date when the annuity is terminated. [10]

GLOSS.2 Glossary Principles of Insurance
accumulation unit. An ownership share in a selected subaccount held during the

accumulation period of a variable deferred annuity. [10]
accumulation value. See accumulated value.
actively-at-work provision. A group insurance policy provision that states that, to
be eligible for coverage, an employee must be actively at work—rather than ill
or on leave—on the day the insurance coverage is to take effect. [13]
activities of daily living (ADLs). Activities used to measure a person’s functional
status, such as eating, bathing, dressing, continence, toileting, and transferring
into or out of a bed, chair, or wheelchair. Contrast with instrumental activities
of daily living. [12]
actuary. An expert in financial risk management and the mathematics and model-
ing of insurance, annuities, and financial instruments. [4]
AD&D benefit. See accidental death and dismemberment benefit.
additional insured rider. See second insured rider.
additional term insurance dividend option. A policy dividend option under
which the insurer uses each policy dividend to purchase one-year term insur-
ance on the insured’s life. [9]
ADLs. See activities of daily living.
advanced life deferred annuity. See longevity annuity.
adverse selection. See antiselection.
Affordable Care Act. See Patient Protection and Affordable Care Act.
aleatory contract. A contract in which one party provides something of value to
another party in exchange for a conditional promise. Contrast with c ommutative
contract. [3]
annually renewable term insurance. See yearly renewable term insurance.
Annual Statement. An accounting statement that every U.S. insurer prepares
each calendar year and files with the insurance department in each state in
which it operates. [2]
annuitant. The person whose lifetime the insurer uses to determine the amount
and duration of annuity payments under an annuity contract. [10]
annuity. A series of periodic payments. [10]
annuity benefit payments. See annuity payments.
annuity certain. See fixed period annuity.
annuity commencement date. See annuity start date.
annuity contract. A contract under which an insurer promises to make a series of
periodic payments to a named individual in exchange for a premium or series
of premiums. [1]
annuity income payments. See annuity payments.

annuity options. The choices a contract owner has as to how the insurer will dis-
tribute the annuity payments. Also known as payout options. [11]
annuity payments. The monthly, quarterly, semiannual, or yearly payments that
the insurer promises to make under an annuity contract. Also known as annuity
benefit payments, annuity income payments, and periodic income payments.
[10]
annuity period. For an annuity, the time span between each of the annuity
payments. [10]
annuity start date. The date when the insurer is required to begin making annu-
ity payments under the contract. Also known as the annuity commencement
date, income date, or maturity date. [10]
annuity unit. A share in an insurer’s subaccount that is used in the calculation of
variable annuity payments. [11]
antiselection. The tendency of individuals who believe they have a greater-than-
average likelihood of loss to seek insurance protection to a greater extent than
do other individuals. Also known as adverse selection or selection against the
insurer. [1]
APL option. See automatic premium loan option.
applicant. The person or business that applies for an insurance policy. [1]
assets. Items of value, such as cash, buildings, and investments, that a company
owns. [2]
assignee. The party to whom life insurance property rights are transferred. [9]
assignment. An agreement under which the policyowner transfers some or all of
his ownership rights in a life insurance policy to another party. [9]
assignment provision. A life insurance policy provision that describes the roles of
the insurer and the policyowner when the policy is assigned. [9]
assignor. The policyowner who makes an assignment of a life insurance policy. [9]
assuming company. See reinsurer.
attained age. The age the insured has reached (attained) on a specified date. [5]
attained age conversion. A conversion of a term life insurance policy to a cash
value insurance policy in which the premium rate for the cash value policy is
based on the insured’s age at the time the policy is converted. [5]
automatic dividend option. A specified policy dividend option that the insurer
will apply if the owner of a participating policy does not choose an option. [9]
automatic nonforfeiture benefit. A specific nonforfeiture benefit that becomes
effective automatically when a renewal premium for a cash value life insurance
policy is not paid by the end of the grace period and the policyowner has not
elected another nonforfeiture option. [8]
automatic premium loan (APL) option. A cash value life insurance policy non-
forfeiture option under which the insurer will automatically pay an overdue
premium for the policyowner by making a loan against the policy’s cash value
as long as the cash value equals or exceeds the amount of the premium due. [8]

bargaining contract. A contract in which both parties, as equals, set the terms
and conditions of the contract. Contrast with contract of adhesion. [3]
basic medical expense coverage. Medical expense insurance coverage that pro-
vides separate benefits for each type of covered medical care cost: hospital
expenses, surgical expenses, and physicians’ expenses. [12]
beneficiary. (1) For a life insurance policy, the person or party the policyowner
names to receive the policy benefit. [1] (2) For an annuity, the person or legal
entity who may receive benefits accrued or values remaining in an annuity con-
tract upon the death of the contract owner or annuitant. [10]
benefit formula. A formula that describes the calculation of a plan’s financial
obligation to participants in a retirement plan. [14]
benefit period. In a disability income insurance policy, the time period during
which the insurer agrees to pay income benefits to the insured. [12]
benefit schedule. A schedule included in group life insurance policies to define
the amount of life insurance the policy provides for each group insured. [13]
benefit trigger. A long-term care insurance policy feature specifying the condi-
tions that establish an insured’s eligibility to receive long-term care benefits.
[12]
benefit waiting period. See elimination period.
bilateral contract. A contract in which both parties make legally enforceable
promises when they enter into the contract. Contrast with unilateral contract.
[3]
blended rating. A method of setting group insurance premium rates in which the
insurer uses a combination of manual rating and experience rating. Contrast
with manual rating and experience rating. [13]
block of policies. A group of policies issued to insureds who are all the same age,
the same sex, and in the same risk classification. [4]
business continuation insurance plan. An insurance plan designed to ensure the
continued financial viability of a business when faced with the death or disabil-
ity of the business owner or other key person. [5]
buy-sell agreement. An agreement in which (1) one party agrees to purchase the
financial interest that a second party has in a business following the second
party’s death, and (2) the second party agrees to direct his estate to sell his inter-
est in the business to the purchasing party. [5]
calendar-year deductible. In medical expense insurance, a deductible that applies
to the total of all allowable expenses an insured incurs during a given calendar
year. [12]
capital. The amount of money that a company’s owners have invested in the com-
pany, usually through the purchase of company stock. [2]
cash dividend option. A policy dividend option under which the insurance com-
pany sends the policyowner a check in the amount of the policy dividend that
was declared. [9]

cash payment nonforfeiture option. A cash value life insurance policy nonfor-
feiture option under which the policyowner discontinues premium payments,
surrenders the policy, and receives the policy’s cash surrender value in a lump-
sum payment. [8]
cash surrender value. The amount that a policyowner is entitled to receive upon
surrendering a cash value life insurance policy, before adjustments for factors
such as policy loans and applicable charges. Also known as the surrender value
or the surrender benefit. [6]
cash value. The savings element of a cash value life insurance policy. [1]
cash value life insurance. Life insurance that provides coverage throughout the
insured’s lifetime and also provides a savings element, known as the cash value.
Also known as permanent life insurance. Contrast with term life insurance. [1]
CDHP. See consumer-driven health plan.
ceding company. See direct writer.
certificate holder. An individual who is insured under a group insurance plan and
who has received a certificate of insurance. [13]
certificate of authority. A document that grants an insurer the right to conduct an
insurance business and sell insurance products in the jurisdiction that grants the
certificate. Also known as a license. [2]
certificate of insurance. A document that is provided to each person insured by
a group insurance plan that describes (1) the coverage that the master group
insurance contract provides and (2) the group insured’s rights under the
contract. [13]
children’s insurance rider. A supplemental life insurance policy benefit that pro-
vides term life insurance coverage on the insured’s children. [7]
claim. A request for payment under the terms of an insurance policy. [1]
class designation. A life insurance beneficiary designation that identifies a certain
group of people rather than naming each person individually. [9]
closed contract. A contract for which only those terms and conditions that are
printed in—or attached to—the contract are considered to be part of the con-
tract. Contrast with open contract. [8]
cognitive impairment. A reduction in a person’s ability to think, reason, or
remember. Contrast with physical impairment. [12]
coinsurance. In medical expense insurance, an expense participation requirement
in which the insured must pay a specified percentage of all allowable expenses
that remain after he has paid the deductible. [12]
COLA benefit. See cost-of-living-adjustment benefit.
collateral assignment. A temporary assignment of the monetary value of a life
insurance policy as collateral—or security—for a loan. Contrast with absolute
assignment. [9]

commutative contract. A contract in which the parties specify in advance the

values that they will exchange, and the parties generally exchange items or
services that they think are of relatively equal value. Contrast with aleatory
contract. [3]
compounding. Calculating interest on both the principal and the accrued interest.
[4]
compound interest. Interest on both the principal and accrued interest. Contrast
with simple interest. [4]
conditional promise. A promise to perform a stated act if a specified, uncertain
event occurs. [3]
consideration. A requirement for the formation of a valid informal contract that
is met when each party gives or promises something that is of value to the other
party. [3]
consolidation. In the financial services industry, typically refers to the combina-
tion of financial institutions within or across sectors. [2]
consumer-driven health plan (CDHP). An employer-sponsored health benefit
plan that gives individuals the freedom to choose health care providers and ben-
efits, but also requires them to assume the financial risk for their choices. [12]
contingent beneficiary. The party named to receive the policy proceeds only if
all designated primary beneficiaries have predeceased the insured. Also called
a secondary beneficiary or successor beneficiary. [9]
contingent deferred sales charge. See surrender charge.
contingent payee. For a life insurance policy, the person or party who will receive
any proceeds still payable at the time of the payee’s death. Also known as the
successor payee. [9]
continuous-premium whole life insurance policy. A whole life insurance policy
under which premiums are payable until the death of the insured. Also called a
straight life insurance policy or ordinary life insurance policy. [6]
contract. A legally enforceable agreement between two or more parties. [3]
contract fee. For fixed deferred annuities, a periodic charge that an insurer
assesses to cover the general expenses of administering the contract, such as
the preparation of account statements. [11]
contract maintenance fee. For variable deferred annuities, a periodic charge that
an insurer assesses to cover the general expenses of administering the contract,
such as the preparation of account statements. [11]
contract of adhesion. A contract that one party prepares and that the other party
must accept or reject as a whole, generally without any bargaining between the
parties to the agreement. Contrast with bargaining contract. [3]
contract of indemnity. An insurance policy under which the amount of the policy
benefit payable for a covered loss is based on the actual amount of the financial
loss that results from the covered event, as determined at the time of the event. [1]

contract owner. The person or other entity who owns and exercises all the rights
and privileges of an annuity contract. [10]
contract value. See accumulated value.
contractual capacity. The legal capacity to make a contract. [3]
contractual reserves. See policy reserves.
contributory plan. A group insurance plan in which group members are
required to pay part or all of the premium for their coverage. Contrast with
noncontributory plan. [13]
convergence. A movement toward a single financial institution being able to serve
a customer’s banking, insurance, and securities needs. [2]
conversion privilege. (1) For individual life insurance, a term life insurance pro-
vision that gives the policyowner the option to change—or convert—the term
insurance policy to a cash value policy without providing evidence of insurabil-
ity. [5] (2) In group life insurance, a policy provision that allows a group insured
whose coverage terminates for certain reasons to convert her group life insur-
ance coverage to an individual life insurance policy, usually without presenting
evidence of insurability. [14]
convertible term insurance policy. A term insurance policy that gives the poli-
cyowner the option to convert the term policy to a cash value life insurance
policy without providing evidence of insurability. [5]
cooling-off provision. See free-look provision.
copayment. In managed care plans, a specified, fixed amount that a plan member
must pay to a network provider for certain medical services at the time the ser-
vices are received. [12]
corporation. A legal entity that is created by the authority of a governmental unit,
through a process known as incorporation, and that is separate and distinct
from its owners. [2]
cost of benefits. The value of all the contractually required benefits a product
promises to pay. Sometimes known as the cost of insurance. [4]
cost of insurance. See cost of benefits.
cost-of-living-adjustment (COLA) benefit. In disability income insurance poli-
cies, a benefit that provides for periodic increases in the disability income ben-
efit amount that the insurer will pay to a disabled insured. [12]
credit life insurance. A type of term life insurance designed to pay the balance
due on a loan other than a mortgage if the borrower dies before the loan is
repaid. [5]
critical illness benefit. See dread disease (DD) benefit.
current interest-crediting rate. (1) For universal life (UL) insurance policies, the
rate of interest that an insurer declares and pays on the policy’s cash value for
a specified period of time. [6] (2) For fixed deferred annuities, the rate of inter-
est that an insurer declares and pays on the annuity’s accumulated value for a
specified period of time. [10]

DD benefit. See dread disease benefit.

death benefit. (1) For a life insurance policy, the primary policy benefit payable by
an insurer when an insured dies while the policy is in force. [4] (2) For a deferred
annuity, an amount of money payable to a beneficiary designated by the contract
owner if the contract owner or annuitant (depending on the contract) dies before
the annuity payments begin. Also known as a survivor benefit. [10]
declined risk. A proposed insured who presents a risk that is too great for the
insurer to cover. [1]
decreasing term life insurance. Term life insurance that provides a death benefit
that decreases in amount over the policy term. [5]
deductible. In medical expense insurance, a flat dollar amount of eligible medical
expenses that an insured must pay before the insurer begins making any benefit
payments under the policy. [12]
deferred annuity. An annuity under which the annuity payments are postponed
for at least one year after the annuity is purchased. Contrast with immediate
annuity. [10]
deferred income annuity (DIA). A fixed annuity that an individual typically buys
in the years nearing retirement that locks in a guaranteed stream of income
when it is purchased, although the annuity payments do not begin until a speci-
fied future date. [10]
defined benefit formula. A retirement plan benefit formula that specifies the
amount of the retirement benefit a plan sponsor agrees to provide to each plan
participant. Contrast with defined contribution formula. [14]
defined benefit pension plan. A type of qualified retirement plan that provides
plan participants with a lifetime monthly income benefit at retirement. [14]
defined benefit plan. A retirement plan that specifies the amount of the bene-
fit that each plan participant will receive at retirement. Contrast with defined
contribution plan. [14]
defined contribution formula. A retirement plan benefit formula that specifies
the contributions that the plan sponsor agrees to make to the plan. Contrast with
defined benefit formula. [14]
defined contribution plan. A retirement plan that describes the annual contribu-
tion that the plan sponsor will deposit into the plan on behalf of each plan par-
ticipant. Contrast with defined benefit plan. [14]
dental expense coverage. A type of medical expense coverage that provides ben-
efits for routine dental examinations, preventive dental work, and dental proce-
dures needed to treat tooth decay and diseases of the tooth and jaw. [12]
DIA. See deferred income annuity.
director of insurance. See insurance commissioner.
direct writer. In a reinsurance transaction, the insurance company that purchases
reinsurance to transfer all or part of the risks on insurance policies the company
issued. Also known as a ceding company. Contrast with reinsurer. [1]

disability buyout coverage. A type of disability income insurance coverage that

provides benefits designed to fund the buyout of a partner’s or owner’s interest
in a business should he become disabled. [12]
disability income benefit. A supplemental life insurance policy benefit that pro-
vides a monthly income benefit to the insured if she becomes totally disabled
while the policy is in force. [7]
disability income coverage. A type of health insurance coverage that provides
income replacement benefits if an insured is unable to work because of illness
or injury. [1]
distribution period. See payout period.
dividend options. Specified methods by which the owner of a participating life
insurance policy or the contract owner of a participating annuity may receive
dividends. [9, 10]
dividends on deposit option. See accumulation at interest dividend option.
divisible surplus. A portion of an insurance company’s surplus set aside specifi-
cally for distribution to owners of participating policies. [9]
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank). A U.S. federal law designed to (1) promote the financial stability of
the United States by improving accountability and transparency in the financial
system and (2) protect consumers from abusive financial services practices. [2]
Dodd-Frank. See Dodd-Frank Wall Street Reform and Consumer Protection
Act.
domicile. The jurisdiction in which a company incorporates. [2]
dread disease (DD) benefit. An accelerated death benefit under which the insurer
agrees to pay a portion of the policy’s death benefit to the policyowner if the
insured suffers from one of a number of specified diseases. Also known as a
critical illness benefit. [7]
eligibility period. In contributory group insurance plans, the period of time—
usually 31 days—during which a new group member may first enroll for con-
tributory group insurance coverage without providing evidence of insurability.
Also called the enrollment period. [13]
elimination period. (1) In a disability income insurance policy, the specific
amount of time that the insured must be disabled before becoming eligible to
receive policy benefits. Also known as a waiting period or a benefit waiting
period. [12] (2) In a long-term care insurance policy, the number of days that
the insured must receive care before becoming eligible to receive benefits. [12]
Employee Retirement Income Security Act (ERISA). A U.S. federal law designed
to protect covered employees and their beneficiaries by ensuring that employee
benefit plans, such as retirement plans, meet specified requirements. [14]
employee stock ownership plan (ESOP). A type of qualified retirement plan in
which employer contributions are invested primarily in the employer’s stock. [14]
endorsement. See policy rider.

endowment insurance. Life insurance that provides a policy benefit payable

either when the insured dies or on a stated date if the insured is still alive on
that date. [1]
enrollment period. See eligibility period.
entire contract provision. An insurance policy or annuity contract provision that
defines the documents that constitute the contract between the insurance com-
pany and the policyowner or contract owner. [8, 10]
equity indexed universal life insurance. See indexed universal life insurance.
ERISA. See Employee Retirement Income Security Act.
ESOP. See employee stock ownership plan.
estate. The accumulated assets that an individual owns when he dies. [5]
estate plan. A plan that considers the amount of assets and debts that a person is
likely to have when he dies and how best to preserve those assets so that they
can be distributed as he desires. [5]
evidence of insurability. Proof that a given person is an insurable risk. [5]
exchange. See health insurance exchange.
exclusion. An insurance policy provision that describes circumstances under
which the insurer will not pay the policy benefit following an otherwise cov-
ered loss. [8]
experience rating. A method of setting group insurance premium rates in which
the insurer considers the particular group’s prior claims and expense experi-
ence. Contrast with manual rating and blended rating. [13]
extended term insurance nonforfeiture option. A cash value life insurance pol-
icy nonforfeiture option under which the policyowner discontinues paying pre-
miums and uses the policy’s net cash surrender value as a net single premium to
purchase term insurance for the full coverage amount provided under the origi-
nal policy, for as long a term as the net cash surrender value can provide. [8]
face amount. The amount of life insurance policy benefits for which an individual
applies and that the insurer approves. [5]
family income coverage. A plan of decreasing term life insurance that pays the
beneficiary a stated monthly income benefit amount if the insured dies during
the policy term. [5]
family income policy. A cash value life insurance policy with a decreasing term
insurance benefit that usually pays the death benefit as a lump sum when the
insured dies and provides a stated monthly income benefit amount for a prede-
termined period to the insured’s beneficiary—typically the surviving spouse. [5]
family insurance rider. See spouse and children’s insurance rider.
family policy. A whole life insurance policy that includes term life insurance cov-
erage on the primary insured’s spouse and children. [6]

Federal Insurance Office (FIO). Created by Dodd-Frank, a U.S. federal agency

authorized to monitor the insurance industry, identify areas with inadequate
state regulation, and handle international insurance issues. [2]
federal system. A system of government in which a federal government and a
number of lower-level governments share governmental powers. [2]
FIA. See fixed indexed annuity.
financial institution. A business that owns primarily financial assets, such as stocks
and bonds, rather than fixed assets, such as equipment and raw materials. [2]
financial intermediary. An organization that collects funds from one group of
people, businesses, and governments, known as suppliers, and channels them
to another group, known as users. [2]
financial model. A computer-based mathematical model that approximates the
operation of real-world financial processes. [4]
financial services industry. The industry that offers financial products and ser-
vices to help individuals, businesses, and governments meet their financial
goals of protecting against financial losses, accumulating and investing money
and other assets, and managing debt and payments. [2]
Financial Stability Oversight Council (FSOC). Created by Dodd-Frank, a U.S.
independent agency responsible for monitoring the safety and stability of the
nation’s financial system, identifying threats to the system, and coordinating
regulatory responses to any such threats. [2]
FIO. See Federal Insurance Office.
first beneficiary. See primary beneficiary.
first-dollar coverage. Medical expense coverage under which the insurer begins
to reimburse the insured for eligible medical expenses without first requiring an
out-of-pocket contribution from the insured. [12]
first-to-die life insurance. See joint whole life insurance.
fixed account. For variable annuities, an account that guarantees payment of a
fixed rate of interest for a specified period of time. [10]
fixed amount annuity. An annuity option in which the insurer provides annuity
payments of a specified amount. Contrast with fixed period annuity. [11]
fixed amount option. A life insurance policy settlement option under which the
insurance company pays equal installments of a stated amount until the policy
proceeds, plus the interest earned, are exhausted. [9]
fixed annuity. An annuity contract under which the insurer guarantees (1) the
minimum interest rate that it will apply to any accumulated value and (2) the
minimum amount of the annuity payments that it will make. Contrast with
variable annuity. [10]
fixed indexed annuity (FIA). A fixed deferred annuity that offers principal and
interest rate guarantees as well as the possibility of additional earnings based
on changes in an index. Also known as an indexed annuity. [10]

fixed period annuity. An annuity option in which the insurer provides annuity
payments for a specified period of time. Also known as a period certain annuity
or annuity certain. Contrast with fixed amount annuity. [11]
fixed period option. A life insurance policy settlement option under which the
insurance company agrees to pay policy proceeds in equal installments to the
payee for a specified period of time. [9]
fixed-premium universal life insurance policy. A universal life insurance policy
that requires a series of scheduled premium payments of a specified amount for
a specified length of time (typically 8 to 10 years) or until the insured’s death,
whichever comes first. [6]
flexible-premium annuity. An annuity that allows the contract owner to make
additional premium payments after the contract is purchased. Contrast with
single-premium annuity. [10]
flexible-premium variable life insurance. See variable universal life (VUL)
insurance.
flexible-premium universal life insurance policy. A universal life insurance pol-
icy that allows the policyowner to alter the amount and frequency of premium
payments, within specified limits. [6]
formal contract. A written contract that is enforceable because the parties
met certain formalities concerning the form of the agreement. Contrast with
informal contract. [3]
fraternal benefit society. A nonprofit organization that is operated solely for the
benefit of its members and that provides social, as well as insurance, benefits to
its members. Also known as a fraternal insurer. [2]
fraternal insurer. See fraternal benefit society.
fraudulent misrepresentation. A misrepresentation that was made with the
intent to induce another party to enter into a contract that results in the giving
up of something of value or a legal right and that did induce the innocent party
to enter the contract. [8]
free-examination provision. See free-look provision.
free-look provision. An insurance policy or annuity contract provision that gives
the policyowner or contract owner a stated period of time—usually at least 10
days—after the policy is delivered within which to cancel the policy. For an
insurance policy, the policyowner receives a refund, and for an annuity con-
tract, the contract owner receives a refund of the premiums paid or the con-
tract’s accumulated value. Also called a free-examination provision or cooling-
off provision. [8, 10]
front-end load. For deferred annuities, a charge that an insurer imposes when a
contract owner pays an initial premium and any additional premiums to help
cover the costs of selling the annuity. [11]
FSOC. See Financial Stability Oversight Council.

fund operating expense charge. For variable deferred annuities, an annual charge
that each investment fund underlying a subaccount assesses to cover the advi-
sory and administrative expenses of the fund. [11]
funding instrument. See funding vehicle.
funding vehicle. An arrangement for investing a retirement plan’s assets as the
assets are accumulated. Also known as an investment vehicle or a funding
instrument. [14]
future purchase option benefit. In certain disability income policies that specify
a flat benefit amount, an option that grants the insured the right to increase the
benefit amount in accordance with increases in the insured’s earnings. [12]
general account. An asset account in which an insurer maintains funds that sup-
port its contractual obligations to pay benefits under its guaranteed insurance
products, such as whole life insurance, fixed annuities, and other nonvariable
products. [6]
GI benefit. See guaranteed insurability benefit.
GLBs. See guaranteed living benefit riders.
GLWB. See guaranteed lifetime withdrawal benefit.
GMAB. See guaranteed minimum accumulation benefit.
GMDB. See guaranteed minimum death benefit rider.
GMIB. See guaranteed minimum income benefit.
GMWB. See guaranteed minimum withdrawal benefit.
grace period. A specified time (often 31 days) following each premium due date
during which the contract remains in effect regardless of whether the premium
is paid. [8]
grace period provision. An insurance policy provision that specifies a length of
time following each renewal premium due date within which the premium may
be paid without loss of coverage. [8]
group annuity. In a retirement plan, an annuity that is purchased by a plan spon-
sor to provide annuity payments to plan participants at retirement. Contrast
with individual annuity. [10]
group creditor life insurance. Group life insurance issued to a creditor, such as a
bank, to insure the lives of the creditor’s current and future debtors. [14]
group insurance. A method of providing life or health insurance coverage for a
group of people under one contract. [13]
group insurance policy. A policy that insures the lives or health of a specific
group of people, such as a group of employees. [1]
group insured. In most jurisdictions, an individual covered by a group insurance
policy. Also known simply as the insured. [13]
group policyholder. The person or organization that decides what types of group
insurance coverage to purchase for a specific group, negotiates the terms of the
group insurance contract, and purchases the group insurance coverage. [3]

guaranteed insurability (GI) benefit. A supplemental life insurance policy ben-

efit that gives the policyowner the right to purchase additional insurance of
the same type as the basic life insurance policy—for an additional premium
amount—on specified option dates (typically every three years) during the
life of the policy without supplying evidence of the insured’s insurability.
Also known as a guaranteed insurability option. [7]
guaranteed insurability option. See guaranteed insurability (GI) benefit.
guaranteed lifetime withdrawal benefit (GLWB). A guaranteed living benefit
rider that allows the contract owner to take withdrawals for life without annui-
tizing the contract, even if the accumulated value is completely depleted. [11]
guaranteed living benefit riders (GLBs). For many variable annuities and some
fixed indexed annuities, riders that offer contract owners protection from down-
turns in the market by guaranteeing certain income, withdrawal, or accumula-
tion amounts. [11]
guaranteed minimum accumulation benefit (GMAB). A guaranteed living ben-
efit rider that offers the contract owner a minimum protected amount if the
annuity stays in force for a specified period of time, regardless of the investment
performance of the accumulated value. [11]
guaranteed minimum death benefit rider (GMDB). A variable deferred annu-
ity rider that guarantees that, if the annuitant dies before the annuity payments
begin, the beneficiary will receive a stated minimum amount, regardless of the
contract’s accumulated value at the time. [11]
guaranteed minimum income benefit (GMIB). A guaranteed living benefit rider
that offers a lifetime minimum annuity payment amount when the benefit base
is annuitized, regardless of the investment performance of the accumulated
value. [11]
guaranteed minimum interest-crediting rate. (1) For universal life (UL) insur-
ance policies, the minimum interest rate that an insurer must pay on the policy’s
cash value. [6] (2) For fixed deferred annuities, the minimum interest rate that
an insurer must pay on the annuity’s accumulated value. [10]
guaranteed minimum withdrawal benefit (GMWB). A guaranteed living ben-
efit rider that allows the contract owner to withdraw a specified percentage of
the benefit base annually—but not for life—regardless of the investment per-
formance of the accumulated value. [11]
HCFSA. See health care flexible spending account.
HDHP. See high-deductible health plan.
health care flexible spending account (HCFSA). An employer-sponsored health
plan that allows employees to set aside a predetermined amount of their pre-tax
wages to pay for qualified medical expenses. [12]
health insurance. Insurance that provides protection against the risk of financial
loss resulting from illness, injury, or disability. [1]

health insurance exchange. Created as a result of the Patient Protection and

Affordable Care Act, an online insurance marketplace in which individuals
and small businesses can purchase medical expense insurance coverage. Also
known as an insurance marketplace or an exchange. [12]
health maintenance organization (HMO). In the United States, a health care
financing and delivery system that provides comprehensive health care services
to plan members, often referred to as subscribers, in a particular geographic
area. [12]
health reimbursement arrangement (HRA). An employer-sponsored health
plan that is used to pay for qualified medical expenses and that allows contribu-
tions only by the employer. [12]
health savings account (HSA). A tax-advantaged account in which an individual
can accumulate money to pay for qualified medical expenses. [12]
high-deductible health plan (HDHP). A medical expense insurance plan that
has a high deductible (usually at least $1,300 or more) and typically costs less
than traditional medical expense insurance. [12]
HMO. See health maintenance organization.
hospital expenses. Medical expenses that include charges for specific inpatient
and outpatient hospital services, such as room and board, medications, labora-
tory services, and other fees associated with a hospital stay. [12]
HRA. See health reimbursement arrangement.
HSA. See health savings account.
IADLs. See instrumental activities of daily living.
immediate annuity. An annuity that provides annuity payments that begin no
later than one year after the annuity is purchased. Contrast with deferred
annuity. [10]
income date. See annuity start date.
incontestability provision. A life insurance policy or annuity contract provision
that denies the insurer the right to rescind—or cancel—the contract on the
grounds of a material misrepresentation in the application after the contract has
been in force for a specified period of time. [8, 10]
increasing term life insurance. Term life insurance that provides a death benefit
that starts at one amount and increases by some specified amount or percentage
at stated intervals over the policy term. [5]
indemnity benefit method. In long-term care insurance policies, a benefit pay-
ment method in which the insurer pays a stated benefit amount to the insured,
regardless of the amount of expenses incurred. Also known as the per diem
method. [12]
indemnity benefits. Contractual benefits that are based on the actual amount of
the insured’s financial loss. Also known as reimbursement benefits. [12]
index account. The portion of the cash value of an indexed universal life insurance
policy for which the crediting rate is determined by changes in an index. [6]

indexed annuity. See fixed indexed annuity.

indexed universal life (IUL) insurance. A type of universal life insurance that
offers the same features as universal life insurance, but also offers the possibil-
ity of additional earnings based on changes in a published index. Also called
equity indexed universal life (EIUL) insurance. [6]
individual annuity. An annuity that is purchased and owned by a person or pur-
chased by a legal entity, such as a trust, on behalf of a person. Contrast with
group annuity. [10]
individual insurance policy. A policy that insures the life or health of a named
person. [1]
individual retirement account. An individual retirement arrangement that takes
the form of a trust or custodial account created in the United States for the exclu-
sive benefit of a taxpayer or a taxpayer’s beneficiaries. Contrast with i ndividual
retirement annuity. [11]
individual retirement annuity. An individual retirement arrangement that
takes the form of an annuity issued by an insurance company. Contrast with
individual retirement account. [11]
individual retirement arrangement (IRA). In the United States, a tax-favored
retirement savings vehicle that allows a person with taxable compensation to
deposit a stated amount of that compensation into the vehicle. [11]
informal contract. An oral or a written contract that is enforceable because the
parties met requirements concerning the substance of the agreement rather
than requirements concerning the form of the agreement. Contrast with formal
contract. [3]
initial premium. The first premium paid for an insurance policy. [3]
instrumental activities of daily living (IADLs). Activities that are necessary
for an individual to live independently but that are not essential to daily func-
tioning, such as managing finances, cooking, doing laundry, shopping for food
and clothing, using transportation, taking medications, and using the telephone.
Contrast with activities of daily living. [12]
insurable interest. The interest an insurance policyowner has in the risk that is
insured. A policyowner has an insurable interest if he is likely to suffer a genu-
ine loss or detriment should the event insured against occur. [1]
insurance commissioner. The individual who is responsible for directing the
operations of the state insurance department. Also known as the superintendent
of insurance or director of insurance. [2]
insurance company. See insurer.
insurance contract. See insurance policy.
insurance marketplace. See health insurance exchange.
insurance policy. A written document that contains the terms of the agreement
between the insurer and the owner of the policy. Also known as a policy or an
insurance contract. [1]

insured. (1) The person whose life, health, or property is insured under an insur-
ance policy. [1] (2) In group insurance plans, an alternate term for a group
insured. [13]
insurer. A company that accepts risk and makes a promise to pay a policy benefit
if a covered loss occurs. Also known as an insurance company. [1]
insurer-administered group plan. A group insurance plan in which the insurer
is responsible for handling the administrative and recordkeeping aspects of the
plan. Contrast with self-administered group plan. [13]
interest. A payment for the use of money. [4]
interest option. A life insurance policy settlement option under which the insur-
ance company invests the policy proceeds and periodically pays interest on
those proceeds to the payee. [9]
investment earnings. The money an insurer earns from investing the funds it
receives from customers. [4]
investment vehicle. See funding vehicle.
IRA. See individual retirement arrangement.
IUL insurance. See indexed universal life insurance.
irrevocable beneficiary. A life insurance policy beneficiary whose designation as
beneficiary cannot be changed by the policyowner unless the beneficiary gives
written consent. Contrast with revocable beneficiary. [9]
joint and survivor annuity. An annuity option in which the insurer provides a
series of annuity payments based on the life expectancies of two or more annui-
tants, with payments continuing until the last annuitant dies. [11]
joint mortgage life insurance. A variation of mortgage life insurance that pro-
vides the same benefit as a mortgage life insurance policy except the joint pol-
icy insures the lives of two people. [5]
joint whole life insurance. A plan of whole life insurance that has the same fea-
tures and benefits as individual whole life insurance, except that it insures two
people under the same policy. Often referred to as first-to-die life insurance. [6]
juvenile insurance policy. An insurance policy that is issued on the life of a
child but is owned and paid for by an adult, usually the child’s parent or legal
guardian. [7]
key employee life insurance. See key person life insurance.
key person. For insurance purposes, any person or employee whose continued par-
ticipation in a business is vital to the success of the business and whose death or
disability would cause the business to incur a significant financial loss. [5]
key person disability coverage. A type of disability income insurance coverage
that provides benefit payments to the business if an insured key person becomes
disabled. [12]
key person life insurance. Individual life insurance that a business purchases on
the life of a key person. Also known as key employee life insurance. [5]

lapse. The termination of an insurance policy for nonpayment of premium. [4]

lapse rate. The percentage of a specified group of policies in force at the begin-
ning of a specified period, such as a year, that are terminated by the end of that
period for reasons other than the death of the insured. [4]
last survivor life insurance. A variation of joint whole life insurance under which
the death benefit is paid only after both people insured by the policy have died.
Also known as second-to-die life insurance or survivorship life insurance. [6]
law of large numbers. A concept that states that, typically, the more times we
observe a particular event, the more likely that our observed results will approx-
imate the true probability that the event will occur in the future. [1]
legal reserves. See policy reserves.
legal reserve system. The system insurers use to set financial values for life insur-
ance products. [4]
level premium system. A life insurance premium system that allows a policyowner
to pay the same premium amount each year a policy is in force. [4]
level term life insurance. Term life insurance that provides a death benefit that
remains the same over the policy term. [5]
liabilities. A company’s debts and future obligations. [2]
license. See certificate of authority.
life and health insurance company. A company that issues and sells products
that insure against financial losses that result from personal risks. [1]
life annuity. An annuity that provides annuity payments for at least the lifetime
of a named individual. [9]
life income option. A life insurance policy settlement option under which the
insurance company agrees to pay the policy proceeds in periodic installments
over the payee’s lifetime. [9]
life income with period certain annuity. An annuity option that guarantees that
the insurer will make annuity payments throughout the annuitant’s life and for
at least a specified period, even if the annuitant dies before the end of that
period. [11]
life income with refund annuity. An annuity option that provides annuity pay-
ments throughout the annuitant’s lifetime and guarantees that at least the pur-
chase price of the annuity will be paid out. Also known as a refund annuity. [11]
life insurance. Insurance that provides protection against the economic loss
caused by the death of the person whose life is insured. [1]
life only annuity. An annuity option in which the insurer provides annuity pay-
ments for only as long as the annuitant lives. Also known as a single life annuity
or a straight life annuity. [11]
limited-payment whole life insurance policy. A whole life insurance policy
for which premiums are payable only for a stated period of time or until the
insured’s death, whichever occurs first. [6]

liquidation period. See payout period.

living benefit. See accelerated death benefit.
longevity annuity. A fixed annuity that an individual at or near retirement pur-
chases with a lump sum that at the time of purchase locks in a guaranteed
stream of income to begin at a specified advanced age—typically age 80 or 85.
Also known as an advanced life deferred annuity or longevity insurance. [10]
longevity insurance. See longevity annuity.
longevity risk. The risk that a person will live longer than expected and will
exhaust her assets. [10]
long-term care insurance (LTCI). A type of health insurance that pays ben-
efits for medical or other health-related services needed by an individual who,
because of his advanced age or the effects of a serious illness or injury, needs
care in his own home or a qualified facility. [1]
long-term care (LTC) insurance benefit. An accelerated death benefit under
which the insurer agrees to pay a monthly benefit to a policyowner if the insured
requires constant care for a medical condition. [7]
long-term group disability income coverage. Group disability income coverage
that provides a maximum benefit period of more than one year. Contrast with
short-term group disability income coverage. [12]
long-term individual disability income coverage. Individual disability income
coverage that provides a maximum benefit period of five years or more. Contrast
with short-term individual disability income coverage. [12]
LTC insurance benefit. See long-term care insurance benefit.
LTCI. See long-term care insurance.
lump-sum distribution. For deferred annuities, an annuity option in which the
contract owner chooses to have the accumulated value of the annuity distrib-
uted in a single payment. [11]
M&E charge. See mortality and expense risks (M&E) charge.
major medical expense coverage. Medical expense insurance that provides sub-
stantial benefits for (1) basic hospital expenses, surgical expenses, and physi-
cians’ expenses; (2) additional medical services related to illness or injuries;
and (3) preventive care. [12]
managed care plan. An arrangement that integrates the financing and manage-
ment of health care with the delivery of health care services to a group of indi-
viduals who have enrolled in the plan. [12]
manual rating. A method of setting group insurance premium rates in which the
insurer establishes rates for very broad classifications of group insureds using
its own experience with a product and information collected by various gov-
ernmental and trade associations rather than the experience of one particular
group. Contrast with experience rating and blended rating. [13]

market conduct law. A law designed to make sure that insurance companies con-
duct their businesses fairly and ethically. [2]
market-value-adjusted (MVA) annuity. A type of fixed deferred annuity that
adjusts withdrawal and surrender values based on changes in market interest
rates. [10]
master group insurance contract. A contract that describes the relationship
between an insurer and a group policyholder and specifies the benefits provided
by the contract to the insured group members. [13]
material misrepresentation. A statement made in an application for insurance
that is not true and that caused the insurer to enter into a contract it would not
have agreed to if it had known the truth. [8]
maturity date. (1) The date on which the insurer will pay an endowment policy’s
face amount to the policyowner if the insured is still living. [6] (2) For annuities,
an alternate term for annuity start date. [10]
maximum out-of-pocket provision. A major medical expense insurance policy
provision that states that the policy will cover 100 percent of allowable medi-
cal expenses after the insured has paid a specified amount out of pocket to
satisfy the deductible and coinsurance requirements. Also known as a stop-loss
provision. [12]
McCarran-Ferguson Act. A U.S. federal law under which Congress left insur-
ance regulation to the state governments, as long as Congress considers this
regulation to be adequate. [2]
Medicaid. In the United States, a joint federal and state program that provides
basic medical expense and nursing home coverage to low-income individuals
and to certain elderly and disabled individuals. [12]
medical expense insurance. A type of health insurance coverage that provides
benefits to pay for the treatment of an insured’s illnesses and injuries and some
preventive care. [1]
Medicare. In the United States, a federal government program that provides
medical expense benefits to people age 65 and older and those with certain
disabilities. [12]
minor. A person who has not attained the age of majority. [3]
misrepresentation. A false or misleading statement in an application for
insurance. [8]
misstatement of age or sex provision. An insurance policy or annuity contract
provision that describes the action the insurer will take in the event that the age
or sex of the insured or annuitant is incorrectly stated. [8, 10]
modified coverage whole life insurance policy. A whole life insurance policy
under which the amount of insurance provided decreases by specific percent-
ages or amounts either when the insured reaches certain stated ages or at the
end of stated time periods. [6]

modified-premium whole life insurance policy. A whole life insurance policy

for which the annual premium amount changes after a specified initial period
(typically 5 or 10 years). [6]
moral hazard. A characteristic that exists when the reputation, financial posi-
tion, or criminal record of an applicant or a proposed insured indicates that the
person may act dishonestly in the insurance transaction. Contrast with physical
hazard. [1]
morbidity rate. The incidence of sickness and accidents, by age, occurring among
a given group of people. Contrast with mortality rate. [1]
morbidity tables. Charts that show the incidence of sickness and accidents, by age,
occurring among a given group of people. Contrast with mortality tables. [1]
mortality and expense risks (M&E) charge. For variable deferred annuities, a
charge that covers various risks and expenses assumed by the insurer, such as
the risk of providing the death benefit and certain other guarantees. [11]
mortality charge. The insurer’s cost to cover the mortality risk assumed in issu-
ing a life insurance policy. [6]
mortality rate. The rate at which death occurs among a specified group of people
during a specified period, typically one year. Contrast with morbidity rate. [1]
mortality tables. Charts that indicate the number of people in a large group who
are likely to die at each age. Contrast with morbidity tables. [1]
mortgage life insurance. A plan of decreasing term insurance designed to pro-
vide a benefit amount that corresponds to the decreasing amount owed on a
mortgage loan. Also known as mortgage redemption insurance. [5]
mortgage redemption insurance. See mortgage life insurance.
mutual assent. A meeting of the minds about the terms of an agreement. [3]
mutual insurance company. An insurance company that is owned by its
policyowners. Contrast with stock insurance company. [2]
MVA annuity. See market-value-adjusted annuity.
NAIC. See National Association of Insurance Commissioners.
National Association of Insurance Commissioners (NAIC). In the United
States, a nongovernmental association of the insurance commissioners of all
the states whose primary function is to promote the uniformity of state insur-
ance regulation by developing model laws and regulations as guidelines for the
states. [2]
net cash surrender value. The amount the policyowner actually receives—after
the insurer makes any additions or subtractions to the cash surrender value—
upon surrendering the policy. [8]
network. A group of physicians, hospitals, and ancillary service providers that a
specific managed care plan has contracted with to deliver health care services
to plan members. [12]

noncontributory plan. A group insurance plan in which group members are

not required to pay any part of the premium for their coverage. Contrast with
contributory plan. [13]
nonforfeiture provision. A cash value life insurance policy provision that sets
forth the options available to the owner of a cash value policy if the policy
lapses or if the policyowner decides to surrender—or terminate—the policy. [8]
nonpar policy. See nonparticipating policy.
nonparticipating policy. A type of insurance policy under which the policyowner
does not share in the insurance company’s divisible surplus. Also called a
nonpar policy. [9]
nonqualified annuity. An annuity that is purchased outside of a tax-advantaged
retirement plan or individual retirement arrangement. Contrast with qualified
annuity. [11]
offer. A proposal to enter into a binding contract with another party. [3]
open contract. A contract that identifies the documents that constitute the con-
tract between the parties, but all the enumerated documents are not necessarily
attached to the contract. Contrast with closed contract. [8]
open enrollment period. In group insurance, a period of time—typically a speci-
fied 30 or 31 days per year—during which eligible people who did not join the
group insurance plan at the first opportunity may join the plan without provid-
ing evidence of insurability. [13]
operating expenses. The costs of operations other than expenses for contractual
benefits, or the cost of benefits. [4]
Option 1 plan. See Option A plan.
Option 2 plan. See Option B plan.
Option A plan. A universal life insurance policy under which the amount of the
death benefit at any given time is level; the death benefit payable is always equal
to the policy’s face amount. Also known as an Option 1 plan. [6]
Option B plan. A universal life insurance policy under which the amount of the
death benefit at any given time is equal to the policy’s face amount plus the
amount of the policy’s cash value. Also known as an Option 2 plan. [6]
optional insured rider. See second insured rider.
optional modes of settlement. See settlement options.
ordinary life insurance policy. See continuous-premium whole life insurance
policy.
original age conversion. A conversion of a term life insurance policy to a cash
value insurance policy in which the premium rate for the cash value policy is
based on the insured’s age when the original term policy was issued. [5]
other insured rider. See second insured rider.

owners’ equity. The owners’ financial interest in a company, which is the differ-
ence between the amount of the company’s assets (what it owns) and the amount
of its liabilities (what it owes). [2]
ownership of property. The sum of all the legal rights that exist in a piece of
property. [3]
P&C insurance company. See property/casualty insurance company.
paid-up additional insurance dividend option. A policy dividend option under
which the insurer uses any declared policy dividend to purchase paid-up addi-
tional insurance on the insured’s life. [9]
paid-up additions option benefit. A supplemental life insurance policy benefit
offered in connection with a whole life insurance policy that allows the poli-
cyowner to purchase single-premium paid-up additions to the policy on stated
dates in the future without providing evidence of the insured’s insurability. [7]
paid-up policy. A life insurance policy that requires no further premium pay-
ments but continues to provide coverage. [6]
par policy. See participating policy.
partial disability. A disability that prevents the insured either from performing
some of the duties of his usual occupation or from engaging in that occupation
on a full-time basis. [12]
partial surrender provision. See policy withdrawal provision.
participating policy. A type of insurance policy under which the policyowner
shares in the insurance company’s divisible surplus. Also called a par policy. [9]
partnership. A business that is owned by two or more people, who are known as
the partners. [2]
Patient Protection and Affordable Care Act. Enacted by the U.S. Congress in
2010, legislation intended to make health insurance more affordable for and
accessible to Americans. Also known as the Affordable Care Act or the ACA. [12]
payee. (1) For a life insurance policy, the person or party who is to receive the
policy proceeds under a settlement option. [9] (2) For an annuity, the person or
entity designated by an annuity contract owner to receive the annuity payments.
[10]
payout factor. The amount of each annuity payment per thousand dollars of pre-
mium (for an immediate annuity) or accumulated value (for a deferred annuity).
[11]
payout options. See annuity options.
payout period. For an annuity, the period during which the insurer makes annuity
payments. Also known as the liquidation period or the distribution period. [10]
PCP. See primary care provider.
pension. A lifetime monthly income benefit paid to a person upon her retirement.
[14]
per diem method. See indemnity benefit method.

period certain. For a fixed period annuity, the stated period over which the insurer
will make the annuity payments. See fixed period annuity. [11]
period certain annuity. See fixed period annuity.
periodic income payments. See annuity payments.
permanent life insurance. See cash value life insurance.
personal property. All property other than real property. Contrast with real
property. [3]
personal risk. The risk of economic loss associated with death, poor health,
injury, and outliving one’s economic resources. [1]
physical hazard. A physical characteristic that may increase the likelihood of
loss. Contrast with moral hazard. [1]
physical impairment. A treatable, but generally incurable, chronic condition such
as arthritis, emphysema, heart disease, diabetes, and hypertension. Contrast
with cognitive impairment. [12]
physicians’ expenses. Medical expenses that include charges associated with phy-
sicians’ visits both in and out of the hospital. [12]
plan administrator. The party responsible for handling the administrative aspects
of a retirement plan. [14]
plan document. A detailed legal agreement that establishes the existence of a
retirement plan and specifies the rights and obligations of the various parties to
the plan. [14]
plan participant. A member of a covered group who is eligible to participate in
a retirement plan and who actually chooses to take part in the plan or whose
participation is automatic. [14]
plan sponsor. A business, government entity, educational institution, nonprofit
organization, or other group that establishes a retirement plan for the benefit of
its members. [14]
point-of-service (POS) plan. A managed care plan that offers incentives for plan
members to use providers who belong to the plan’s network of providers, but
allows plan members to choose, at the point of service, whether to seek medical
care from inside or outside the network. [12]
policy. See insurance policy.
policy anniversary. The anniversary of the date on which coverage under an
insurance policy became effective. [5]
policy benefit. A specific amount of money an insurer agrees to pay under an
insurance policy when a covered loss occurs. [1]
policy dividend. An amount of money that an insurer pays to the owner of a par-
ticipating policy from the insurer’s divisible surplus. [9]
policy loan. A loan a policyowner receives from an insurer using the cash value of
a life insurance policy as security. [6]

policy loan provision. A cash value life insurance policy provision that specifies
the terms under which the policyowner of a cash value insurance policy can
obtain a loan from the insurer against the policy’s cash value. [8]
policy loan repayment dividend option. A policy dividend option under which
the insurer applies policy dividends toward the repayment of an outstanding
policy loan. [9]
policyowner. The person or business that owns an insurance policy. [1]
policy proceeds. The total monetary amount paid by an insurer if the insured dies
while the policy is in force. [9]
policy reserves. Liabilities that represent the amount an insurer estimates it needs
to pay future benefits. Sometimes referred to as contractual reserves, legal
reserves, or statutory reserves. [4]
policy rider. An amendment to an insurance policy that becomes part of the insur-
ance contract and changes its terms. Also known as an endorsement. [5]
policy term. The specified period of time during which a term life insurance
policy provides coverage. [5]
policy withdrawal provision. A universal life insurance policy provision that
permits the policyowner to reduce the amount of the policy’s cash value by
withdrawing up to the amount of the cash value in cash. Also called a partial
surrender provision. [8]
portability provision. A provision in a group insurance policy that allows a group
insured whose coverage terminates for certain reasons to continue her coverage
under the group plan. [14]
portable coverage. Group insurance coverage that can be continued if an insured
employee leaves the group. [14]
POS plan. See point-of-service plan.
PPO. See preferred provider organization.
preference beneficiary clause. A provision included in some life insurance poli-
cies that states that if the policyowner does not name a beneficiary, then the
insurer will pay the policy proceeds in a stated order of preference. Also called
a succession beneficiary clause. [9]
preferred premium rate. A lower-than-standard premium rate charged to
insureds who are classified as preferred risks. [1]
preferred provider organization (PPO). A managed health care plan that
arranges with providers for the delivery of health care at a discounted cost and
that provides incentives for PPO members to use the providers who have con-
tracted with the PPO, but also provides some coverage for services rendered by
providers who are not part of the PPO network. [12]
preferred risk. A proposed insured who presents a significantly lower-than-aver-
age likelihood of loss. [1]
premium. A specified amount of money an insurer charges in exchange for agree-
ing to pay a policy benefit when a covered loss occurs. [1]

premium payment mode. The frequency at which an insurance policy’s renewal

premiums are payable. [9]
premium rate. The amount an insurer charges per unit of insurance coverage. [4]
premium reduction dividend option. A policy dividend option under which the
insurer applies policy dividends toward the payment of renewal premiums. [9]
prescription drug coverage. A type of medical expense coverage that provides
benefits for the purchase of drugs and medicines that are prescribed by a physi-
cian and are not available over the counter. [12]
presumptive disability. According to the terms of some disability income poli-
cies, a stated condition that, if present, automatically causes an insured to
be considered totally disabled and thus eligible to receive disability income
benefits. [12]
primary beneficiary. The party designated to receive a life insurance policy’s
proceeds following the death of the insured. Also known as a first beneficiary.
[9]
primary care physician. See primary care provider.
primary care provider (PCP). In a managed care plan, a network member
selected by a plan member who coordinates the plan member’s medical care
and treatment. Also known as a primary care physician. [12]
principal. The sum of money originally invested, loaned, or borrowed. [4]
probability. The likelihood that a given event will occur in the future. [1]
probationary period. In group insurance, the length of time—typically, from one
to six months—that a new group member must wait before becoming eligible to
enroll in a group insurance plan. [13]
profit. The money or revenue that a business receives for its products minus the
expenses it incurs to create and support the products. [2]
profit sharing plan. A type of qualified retirement plan that allows the plan spon-
sor to make discretionary contributions funded primarily from its profits. [14]
property. A bundle of rights that a person has with respect to something. See real
property and personal property. [3]
property and liability insurer. See property/casualty (P&C) insurance
company.
property/casualty (P&C) insurance company. An insurer that issues and sells
insurance policies that cover property damage risk and liability risk. Also
known as a property and liability insurer. [1]
pure risk. A risk that involves no possibility of gain; either a loss occurs or no
loss occurs. [1]
qualified annuity. An annuity that is purchased to fund or distribute funds from a
tax-advantaged retirement plan or individual retirement arrangement. Contrast
with nonqualified annuity. [11]
rate of return. The investment earnings expressed as a percentage of the principal.
[4]

real property. Land and whatever is growing on or attached to the land. Contrast
with personal property. [3]
reduced paid-up insurance nonforfeiture option. A cash value life insurance
policy nonforfeiture option under which the policyowner discontinues paying
premiums and uses the policy’s net cash surrender value as a net single premium
to purchase paid-up life insurance of the same plan as the original policy. [8]
refund annuity. See life income with refund annuity.
regular individual retirement arrangement. See traditional individual
retirement arrangement.
reimbursement benefits. See indemnity benefits.
reimbursement method. In long-term care insurance policies, a benefit payment
method in which the insurer reimburses eligible expenses that are incurred by
the insured, up to the policy’s daily or monthly benefit amount. [12]
reinstatement. The process by which an insurer puts back into force an insur-
ance policy that either has been terminated because of nonpayment of renewal
premiums or has been continued under the extended term or reduced paid-up
insurance nonforfeiture option. [8]
reinstatement provision. An individual life insurance policy provision that
describes the conditions that the policyowner must meet for the insurer to rein-
state a policy. [8]
reinsurance. Insurance that one insurance company, known as the direct writer
or ceding company, purchases from another insurance company, known as the
reinsurer or assuming company, to transfer all or part of the risk on insurance
policies that the direct writer issued. [1]
reinsurer. An insurance company that accepts risks transferred from another
insurer in a reinsurance transaction. Also known as an assuming company.
Contrast with direct writer. [1]
renewable term insurance policy. A term life insurance policy that gives the
policyowner the option to continue the coverage at the end of the specified term
without presenting evidence of insurability, although typically at a higher pre-
mium because the premium amount is based on the insured’s attained age. [5]
renewal premium. An insurance policy premium payable after the initial
premium. [3]
renewal provision. A term life insurance policy provision that gives the
policyowner the option to continue the coverage for an additional policy term
without providing evidence of insurability. [5]
return of premium (ROP) term insurance. A form of term life insurance that
provides a death benefit if the insured dies during the policy term and promises
a return of all or a portion of the premiums paid for the policy if the insured
does not die during the policy term. [5]
revocable beneficiary. A life insurance policy beneficiary whose designation as
beneficiary can be changed by the policyowner at any time before the insured’s
death. Contrast with irrevocable beneficiary. [9]

right of revocation. A life insurance policyowner’s right to change the beneficiary

designation at any time during the insured’s lifetime. [9]
risk. The chance or possibility of an unexpected result, either a gain or a loss. [1]
risk class. A grouping of insureds who represent a similar level of risk to an
insurer. [1]
risk management. The process in which individuals and businesses identify and
assess the risks they face and determine how to deal with their exposure to
these risks. [1]
risk selection. See underwriting.
ROP term insurance. See return of premium term insurance.
Roth individual retirement arrangement (Roth IRA). A type of individual
retirement arrangement that permits people within certain income limits to
make nondeductible contributions and to withdraw money on a tax-free basis,
provided certain requirements are met. Contrast with traditional individual
retirement arrangement (IRA). [11]
Roth IRA. See Roth individual retirement arrangement.
savings incentive match plan for employees (SIMPLE) IRA. For small busi-
nesses with 100 or fewer employers, a tax-advantaged retirement plan that
offers retirement benefits through employee salary reductions and employer
contributions. [14]
secondary beneficiary. See contingent beneficiary.
second insured rider. A supplemental life insurance policy benefit that provides
term insurance coverage on the life of a person other than the policy’s insured.
Also known as an optional insured rider, other insured rider, or additional
insured rider. [7]
second-to-die life insurance. See last survivor life insurance.
security. A financial asset that represents either (1) an obligation of indebtedness
owed by a business, a government, or an agency, which is known as a debt
security, or (2) an ownership interest, which is known as an equity security. [2]
segregated account. See separate account.
selection against the insurer. See antiselection.
self-administered group plan. A group insurance plan in which the group policy-
holder is responsible for handling the administrative and recordkeeping aspects
of the plan. Contrast with insurer-administered group plan. [13]
SEP. See simplified employee pension.
separate account. An asset account the insurer maintains separately from its gen-
eral account to isolate and help manage the funds placed in its variable prod-
ucts. Also called a segregated account. [6]
service fee. For deferred annuities, a fee that is charged for specific services or
transactions requested by the contract owner. [11]

settlement options. Alternative methods that the owner or beneficiary of a life

insurance policy can elect for receiving payment of the policy proceeds. Also
known as optional modes of settlement. [9]
settlement options provision. A life insurance policy provision that grants a poli-
cyowner or a beneficiary several choices as to how the insurance company will
distribute the proceeds of a life insurance policy. [9]
share. A unit of ownership in a stock corporation. Also known as a share of stock.
[2]
shareholder. See stockholder.
share of stock. See share.
short-term group disability income coverage. Group disability income coverage
that provides a maximum benefit period of one year or less. Contrast with long-
term group disability income coverage. [12]
short-term individual disability income coverage. Individual disability income
coverage that provides a maximum benefit period of one to five years. Contrast
with long-term individual disability income coverage. [12]
SIFI. See systemically important financial institution.
simple interest. Interest on the principal only. Contrast with compound interest.
[4]
SIMPLE IRA. See savings incentive match plan for employees IRA.
simplified employee pension (SEP). A written arrangement that allows a plan
sponsor to make deductible contributions to a traditional IRA—referred to as a
SEP IRA—set up for each plan participant. [14]
simultaneous death act. A law in many jurisdictions that governs how insurance
companies evaluate common-disaster situations. [9]
single life annuity. See life only annuity.
single-premium annuity. An annuity that is purchased with the payment of a
single, lump-sum premium amount. Contrast with flexible-premium annuity.
[10]
single-premium deferred annuity (SPDA). An annuity that is purchased with
a lump-sum premium payment and provides annuity payments that are post-
poned for at least one year after the annuity is purchased. [10]
single-premium immediate annuity (SPIA). An annuity that is purchased with a
lump-sum premium payment and provides annuity payments that begin no later
than one year after the annuity is purchased. [10]
single-premium whole life insurance policy. A type of limited-payment whole
life insurance policy that requires only one premium payment. [6]
social insurance program. A welfare plan that is established by law and admin-
istered by a government and that provides assistance to specified groups of the
population, such as the elderly, disabled, and unemployed. [2]

Social Security. A U.S. federal insurance program that provides specified ben-
efits—such as monthly retirement income benefits—to eligible individuals. [14]
sole proprietorship. A business that is owned and operated by one person. [2]
solvent. A term used to describe an insurance company that is able to meet its
debts and pay policy benefits when they come due. [2]
SPDA. See single-premium deferred annuity.
special class rate. See substandard premium rate.
special class risk. See substandard risk.
speculative risk. A risk that involves three possible outcomes: loss, gain, or no
change. [1]
SPIA. See single-premium immediate annuity.
spouse and children’s insurance rider. A supplemental life insurance policy
benefit offered by some insurers that provides term life insurance coverage on
the insured’s spouse and children. Also known as a family insurance rider. [7]
spouse insurance rider. A supplemental life insurance policy benefit that pro-
vides term life insurance coverage on the insured’s spouse. [7]
standard premium rate. A premium rate charged to insureds who are classified
as standard risks. [1]
standard risk. A proposed insured who has a likelihood of loss that is not signifi-
cantly greater than average. [1]
state insurance code. A set of laws in each state that regulates insurance in that
state. [2]
state insurance department. An administrative agency in each state that is
responsible for making sure that companies operating in the state comply with
applicable regulatory requirements. [2]
statutory reserves. See policy reserves.
stock corporation. A corporation whose ownership is divided into units known as
shares or shares of stock. [2]
stockholder. A person or organization that owns shares of stock in a corporation.
Also known as a shareholder. [2]
stockholder dividend. A portion of a corporation’s earnings paid to the owners of
its stock. Contrast with policy dividend. [2]
stock insurance company. An insurance company that is owned by the people and
organizations that own shares of the company’s stock. Contrast with mutual
insurance company. [2]
stop-loss provision. See maximum out-of-pocket provision.
straight life annuity. See life only annuity.
straight life insurance policy. See continuous-premium whole life insurance
policy.

subaccount. (1) One of several investment funds to which a variable life insurance
policyowner allocates the premiums she has paid and the cash values that have
accumulated under her policy. [6] (2) An investment fund within an insurance
company’s separate account; used with variable life insurance policies and vari-
able annuities. [6, 10]
substandard premium rate. A higher-than-standard premium rate charged to
insureds who are classified as substandard risks. Also known as a special class
rate. [1]
substandard risk. A proposed insured who has a significantly greater-than-aver-
age likelihood of loss but is still found to be insurable. Also known as a special
class risk. [1]
succession beneficiary clause. See preference beneficiary clause.
successor beneficiary. See contingent beneficiary.
successor payee. See contingent payee.
suicide exclusion provision. A life insurance policy provision that states that the
insurance company does not have to pay the death benefit if the insured dies as
the result of suicide as defined by the policy within a specified period following
the date of policy issue. [8]
superintendent of insurance. See insurance commissioner.
surgical expenses. Medical expenses that include charges for inpatient and outpa-
tient surgical procedures. [12]
surplus. The amount by which a company’s assets exceed its liabilities and capital.
[2]
surrender benefit. See cash surrender value.
surrender charge. (1) For a cash value life insurance policy, a specific charge
imposed if the owner surrenders the policy for its cash surrender value. [8] (2)
For a deferred annuity, a fee an insurer imposes if the contract owner makes
excess withdrawals as defined in the contract or fully surrenders the contract
before the surrender period is over. Also known as a contingent deferred sales
charge. [10]
surrender value. (1) For cash value life insurance, an alternate term for cash
surrender value. [6] (2) For deferred annuities, the amount of the annuity’s
accumulated value, less any surrender charges, that the contract owner is enti-
tled to receive if the contract is surrendered during its accumulation period. [10]
survivor benefit. For annuities, an alternate term for death benefit. [10]
survivorship clause. A provision included in some life insurance policies that
states that the beneficiary must survive the insured by a specified period, usu-
ally 30 or 60 days, to be entitled to receive the policy proceeds. [9]
survivorship life insurance. See last survivor life insurance.

systemically important financial institution (SIFI). As identified by the Finan-

cial Stability Oversight Council, a financial institution whose failure could
potentially pose a risk to the U.S. financial system and that is therefore subject
to more stringent regulatory standards than other institutions. [2]
terminal illness (TI) benefit. A supplemental life insurance policy benefit under
which the insurer typically pays a portion of the policy’s death benefit to a poli-
cyowner if the insured suffers from a terminal illness and has a physician-cer-
tified life expectancy of less than a stated time, generally 12 or 24 months. [7]
term life insurance. Life insurance that provides a policy benefit only if the
insured dies during the period specified in the policy. Contrast with cash value
life insurance. [1]
third-party policy. A policy purchased by one person or business on the life of
another person. [1]
TI benefit. See terminal illness benefit.
total disability. A disability that meets the requirements of a disability benefit
provision in an insurance policy or policy rider and that qualifies a covered
person to receive disability income benefits. [12]
traditional individual retirement arrangement (IRA). A type of individual
retirement arrangement into which a person with taxable compensation can
make annual contributions, which may be tax deductible. Also known as a
regular individual retirement arrangement. Contrast with Roth individual
retirement arrangement (IRA). [11]
traditional IRA. See traditional individual retirement arrangement.
UCR fee. See usual, customary, and reasonable fee.
UL insurance. See universal life insurance.
underwriter. An insurance company employee who is responsible for evaluating
proposed risks. [1]
underwriting. The process of assessing and classifying the degree of risk repre-
sented by a proposed insured and making a decision to accept or decline that
risk. Also known as risk selection. [1]
underwriting guidelines. The general rules that an insurer uses when assigning
proposed insureds to an appropriate risk class. [1]
unilateral contract. A contract in which only one of the parties makes a legally
enforceable promise when entering into the contract. Contrast with bilateral
contract. [3]
universal life (UL) insurance. A form of cash value life insurance that is char-
acterized by its separation of the three primary policy elements and its flexible
face amount, death benefit amount, and premiums. [6]
usual, customary, and reasonable (UCR) fee. The amount that medical care pro-
viders within a particular geographic region commonly charge for a particular
medical service. [12]

valid contract. A contract that is enforceable at law. Contrast with void contract
and voidable contract. [3]
valued contract. An insurance policy that specifies the amount of the policy ben-
efit that will be payable when a covered loss occurs, regardless of the actual
amount of the loss that was incurred. [1]
variable annuity. An annuity under which the amount of any accumulated value
and the amount of the annuity payments fluctuate in accordance with the perfor-
mance of one or more specified investment funds. Contrast with fixed annuity.
[10]
variable life (VL) insurance. A form of cash value life insurance in which pre-
miums are fixed, but the death benefit and other values may vary, reflecting the
performance of the investment subaccounts that the policyowner selects. [6]
variable universal life (VUL) insurance. Cash value life insurance that com-
bines the premium and death benefit flexibility of universal life insurance
with the investment flexibility and risk of variable life insurance. Also called
flexible-premium variable life insurance. [6]
vested interest. A property right that has taken effect and cannot be altered or
changed without the consent of the person who owns the right. [9]
vesting requirements. For a retirement plan, requirements that define when a plan
participant is entitled to receive partial or full benefits under the plan even if he
terminates employment prior to retirement. [14]
vision care coverage. A type of medical expense coverage that provides the
insured with benefits for expenses incurred in obtaining eye examinations and
corrective lenses. [12]
VL insurance. See variable life insurance.
voidable contract. A contract under which one party has the right to avoid his obli-
gations under the contract. Contrast with valid contract and void contract. [3]
void contract. A contract that does not meet one or more of the legal requirements
to create a valid contract and, thus, is never enforceable. Contrast with valid
contract and voidable contract. [3]
VUL insurance. See variable universal life insurance.
waiting period. See elimination period.
waiver of premium for disability (WP) benefit. A supplemental life insurance
policy benefit under which the insurer promises to give up—to waive—its
right to collect premiums that become due when the insured is totally disabled
according to the policy or rider’s definition of disability. [7]
waiver of premium for payor benefit. A supplemental life insurance policy
benefit that provides that the insurer will waive its right to collect a renewal
premium if the payor—the person who pays the policy premiums—dies or
becomes totally disabled. [7]
whole life insurance. A type of cash value life insurance that provides lifetime
insurance coverage, usually at a level premium rate that does not increase as
the insured ages. [6]

will. A legal document that directs how an individual’s property is to be distrib-

uted after her death. [5]
withdrawal provision. For deferred annuities, a provision that gives the contract
owner the right to receive a portion of the contract’s accumulated value during
the accumulation period. [10]
WP benefit. See waiver of premium for disability benefit.
yearly renewable term (YRT) insurance. A one-year term insurance policy or
rider that is renewable for a stated number of years. Also known as annually
renewable term (ART) insurance. [5]
YRT insurance. See yearly renewable term insurance.

Principles of Insurance Index INDEX.1
Index
Numbers in italics indicate figures aleatory contract, 3.3, 3.5, 3.6

allowable expenses, 12.4
——— ancillary service providers, 12.8
annually renewable term (ART) insurance,
A 5.15
Annual Statement, 2.12
absolute assignment, 9.10 annuitant, 10.3–10.4
ACA. See Patient Protection and Affordable annuities, 9.18, 10.2
Care Act classifications of, 10.10
accelerated death benefits, 7.2, 7.7–7.9 deferred, 10.4, 10.5–10.6, 10.8, 10.10,
acceptance, 3.7 10.11, 10.13–10.14
accidental death benefit, 7.6–7.7, 8.13, fees and charges for, 11.11–11.12
9.15–9.16, 14.6 financial aspects of, 11.7–11.12
accidental death and dismemberment (AD&D) fixed, 10.7–10.8, 10.10, 10.11, 11.7
benefit, 7.7 immediate, 10.4–10.5, 10.6, 10.8, 10.10,
accidental death and dismemberment 10.11
insurance, 14.6 incontestabililty provision for, 10.13
accident benefits, 7.2, 7.6–7.7 individual, 10.12–10.13
account value. See accumulated value issuance of, 10.2
accumulated policy dividends, 9.15–9.16 as life insurance products, 10.2
accumulated value, 10.5, 10.8, 10.9 marketing and distribution of, 10.2
accumulation at interest dividend option, payment amounts for, determining,
9.6, 9.7 11.7–11.11
accumulation period, 10.5, 10.9 regulation of, 2.10
accumulation units, 10.9, 11.10 sales of, 10.12, 11.13
accumulation value. See accumulated value taxation of, 11.12–11.13
acquisition, 2.7 types of, 10.3
actively-at-work provision, 13.4–13.5 use of, 10.7
activities, risk and, 1.12, 1.13, 8.15 variable, 10.7, 10.9–10.10
activities of daily living (ADLs), 12.21 annuity benefit payments. See annuity
actuaries, 4.2, 4.4, 4.11, 14.12 payments
AD&D benefit. See accidental death and annuity certain. See fixed period annuity
dismemberment benefit annuity commencement date. See annuity
additional insured rider. See second start date
insured rider annuity contracts, 1.6, 10.2
additional term insurance dividend option, provisions for, 10.12–10.14
9.6, 9.8 types of, 10.4–10.11
ADLs. See activities of daily living annuity guarantee riders, 11.6–11.7
administrator, 5.4 annuity income payments. See annuity
advanced life deferred annuity. payments
See longevity annuity annuity options, 11.2–11.6
adverse selection. See antiselection annuity payments, 10.2, 11.7–11.13
advertisements, 2.13 annuity period, 10.4
affiliates, 2.6, 2.7 annuity start date, 10.4
affinity group. See common interest annuity unit, 11.10–11.11
association antiselection, 1.11
Affordable Care Act. See Patient Protection conversion and, 5.17
and Affordable Care Act group underwriting and, 13.7, 13.8,
age, misstatement of. See misstatement of age 13.9, 13.10
provision; misstatement of age or sex reinstatement and, 8.8
provision renewability and, 5.14, 5.15
age of majority (age of maturity), 3.8 suicide exclusion and, 8.15
agents, 2.13 any occupation, 7.4, 12.16
alcohol abuse, 1.12 APL option. See automatic premium
loan option

INDEX.2 Index Principles of Insurance
applicant, 1.5, 1.7, 3.2, 3.5 benefit schedule, 13.10, 13.11

Argentina, annuity sales in, 10.2 benefit trigger, 12.21
ART insurance. See annually renewable benefit waiting period. See elimination period
term insurance bilateral contract, 3.3, 3.4, 3.6
assets, 2.4, 2.11, 2.12, 4.2, 5.3 blended rating, 13.12
assignee, 9.9–9.12 blindness, 12.17
assignment provision, 9.11–9.12 block of policies, 4.3
assignments, 9.5, 9.9–9.12 business continuation insurance plan, 5.5–5.6
assignor, 9.9–9.12 businesses
association group, 13.7, 13.8 needs of, 5.4–5.7
assuming company. See reinsurer organizational types for, 2.2–2.3
assured, 1.5 buy-sell agreement, 5.6, 12.20
attained age, 5.14, 7.11, 7.12, 8.9, 8.13
attained age conversion, 5.16–5.17
automatic dividend option, 9.7
C
automatic enrollment, 14.9 calendar-year deductible, 12.5
automatic nonforfeiture benefit, 8.11 Canada
automatic premium loan (APL) option, 8.13 government-sponsored retirement plans
aviation exclusion provision, 8.15 in, 14.14
medical expense coverage in, 12.2, 12.7
B mortgage life policies in, 5.10

survivor income benefit in, 5.12
banks, insurance and, 2.6 tax treatment in, of annuities, 11.13
bargaining contract, 3.3, 3.5, 3.6 universal life in, 6.18
basic accounting equation, 2.11, 2.12 waiver of premium for disability
basic medical expense coverage, 12.3 benefit in, 7.3
beneficiaries, 1.5, 1.7, 1.13–1.14 Canada Health Act, 12.7
for annuities, 10.3 Canada Pension Plan (CPP), 14.14
businesses as, 5.5 Canadian Life and Health Insurance
changing of, 3.12, 9.4–9.5 Association (CLHIA), 2.10
common disaster and, 9.14 cap, 6.16
contingent, 9.3–9.4 capital, 2.11
credit life insurance and, 5.12 cash dividend option, 9.6, 9.7
irrevocable, 9.4, 9.5 cashing in, 11.10
joint whole life insurance and, 6.8 cash payment nonforfeiture option, 8.12
minors as, 9.4 cash surrender value, 6.2, 6.11, 8.12, 9.6
mortgage life insurance and, 5.10 cash value, 1.6, 6.2
naming of, 3.12, 9.2–9.5, 13.2, 13.6, amount of, 8.12
13.16n1, 14.3–14.4 endowment insurance and, 6.19
primary, 9.2–9.4 grace period and, 8.7
revocable, 9.4–9.5 group life insurance and, 14.7
survivorship clause and, 9.14–9.15 growth of, 6.4, 6.5
vested interest of, 9.4–9.5 indexed universal life insurance and,
wrongfully killing the insured, 6.15–6.16
9.15, 9.19n3 paid-up additions and, 7.12
beneficiary designation, 9.2. See also reinstatement of, 8.9
beneficiaries, naming of single-premium whole life and, 6.6
benefit booklet, 13.4 size of, 6.4
benefit formula, 14.10 term insurance and, 5.8
benefit payments, 4.7 universal life policies and, 6.11, 6.12,
benefit period, 12.15, 12.22 6.14, 6.15
benefits variable life insurance and, 6.17
for additional insureds, 7.2 waiver of premium for disability benefit
cost of. See cost of benefits and, 7.3
for disability income coverage, 12.18
endowment insurance and, 6.19
for group insurance, 13.10
for long-term care insurance policies, 12.22
payments of, 4.6

cash value life insurance, 1.6, 4.12, 5.15, 5.16, contracts, 3.2
6.2. See also variable life insurance; consideration for, 3.9, 3.10
whole life insurance group insurance, 13.2
paid-up additions with, 9.8, 9.9 indemnity, 3.2–3.3
provisions unique to, 8.10–8.13 lawful purpose for, 3.9–3.10
surrender of, 6.2 legal status of, 3.7
taxation and, 6.2 provisions of, 8.2, 10.12–10.14
CDHP. See consumer-driven health plan requirements for, 3.6–3.11
CDSC. See contingent deferred sales charge types of, 3.2–3.6
ceding company. See direct writer valid, 9.15
certificate of authority, 2.9 valued, 3.3
certificate holder, 13.4 void, 9.15
certificate of insurance, 13.4 written, 3.3
chance, loss and, 1.8 contractual capacity, 3.6, 3.7–3.9, 3.11, 9.9
change of ownership provision, 9.12 contractual reserves. See policy reserves
children’s insurance rider, 7.10 contract value. See accumulated value
claim, 1.5, 1.7 contributory plan, 13.3, 13.10, 14.7
class designation, 9.2 convergence, 2.6
CLHIA. See Canadian Life and Health conversion privilege, 5.15, 7.10, 14.4
Insurance Association convertibility, value of, to insurers, 5.18
closed contract, 8.3 convertible term insurance policy, 5.15–5.17
cognitive impairment, 12.20–12.21 cooling-off provision. See free-look provision
coinsurance, 12.4, 12.5 copayment, 12.8–12.9
COLA benefit. See cost-of-living-adjustment corporations, 2.3, 3.7, 3.9, 5.6
benefit cost of benefits (cost of insurance), 4.4
collateral assignment, 9.10–9.11 cost-of-living-adjustment (COLA) benefit,
commercial loans, 8.10, 8.11 12.19
common disaster, 9.14 cost sharing, limitations on, 12.15
common interest association, 13.8 cost-sharing requirements. See expense
commutative contract, 3.3, 3.5, 3.6 participation requirements
composite mortality table, 4.5 coverage units, 4.3, 7.10
compounding, 4.8–4.9, 4.10 CPI. See Consumer Price Index
compound interest, 4.8–4.9, 4.10 CPP. See Canada Pension Plan
conditional promise, 3.5 crediting rate, 6.15
consideration, 3.6, 3.9, 3.10, 3.11 credit life insurance, 5.10, 5.12
consolidation, 2.7 creditor life insurance, 14.7
Consumer Price Index (CPI), 5.13, 5.19n4 credit union group, 13.7
consumer-driven health plan (CDHP), 12.2, credit unions, 13.7
12.9, 12.11–12.13, 12.14 critical illness benefit. See dread disease
contestable periods, 8.9, 8.16n1 benefit
contingent beneficiary, 9.3–9.4 current interest-crediting rate, 6.10, 10.8
contingent deferred sales charge (CDSC), customer service, costs of, 4.6
10.13, 11.12
contingent owner, 9.13
contingent payee, 9.17
D
continued insurance coverage nonforfeiture DD benefit. See dread disease benefit
options, 8.12, 8.13 death
continuous-premium whole life insurance cause of, 7.6
policy, 6.4, 6.6, 6.8 fear of, 10.2
contract of adhesion, 3.3, 3.5, 3.6 death benefit, 4.4, 9.15
contract fee, 11.11 accidental death and, 7.6–7.7
contract of indemnity, 1.8 for annuities, 10.14
contract law, fundamentals of, 3.2–3.10, 3.11 joint whole life insurance and, 6.8
contract maintenance fee, 11.11 policy loans and, 8.11
contract owner, 10.2, 10.4 term insurance and, 5.7
universal life insurance and, 6.12–6.13,
6.14, 6.15
variable life insurance and, 6.17
variable universal life insurance and, 6.18
whole life insurance and, 6.4

debtor-creditor group, 13.7 employee benefit plans, 14.8

debts, personal, payment of, 5.3, 5.4 employee benefits
debt security, 2.4 costs of, 4.6
declaration of insurability, 8.3 financial products as, 5.7
declined risk, 1.13 Employee Retirement Income Security Act
decreasing term life insurance, 5.9–5.13 (ERISA), 14.8
deductibles, 12.4–12.5 employee stock ownership plans (ESOPs),
deferred annuities, 10.4, 10.5–10.6, 10.8, 10.10, 14.11, 14.13
10.11, 10.13–10.14, 11.2–11.6, 11.11 employer-employee group, 13.7, 13.8
deferred income annuity (DIA), 10.11 employer-employee group insurance policies,
defined benefit formula, 14.10 13.3, 13.6
defined benefit pension plan, 14.11–14.12 employer-sponsored retirement plans,
defined benefit plan, 14.10, 14.11 11.13, 14.9
defined contribution formula, 14.10 endorsement. See policy rider
defined contribution plan, 14.10, 14.11 endorsement method, 9.12
dental expense coverage, 12.7 endowment insurance, 1.6, 4.12, 6.18–6.19
dependents, support of, 5.2–5.3 enrollment period. See eligibility period
depository institutions, 2.4 entire contract provision, 8.2, 8.3–8.4, 10.12
DIA. See deferred income annuity equity indexed universal life insurance.
director of insurance. See insurance See indexed universal life insurance
commissioner equity security, 2.4
direct writer, 1.10 ESOPs. See employee stock ownership plans
disability essential health benefits, 12.14, 12.15
definition of, 7.3, 7.4 estate, 5.3–5.4
exclusions for, 7.3 estate plan, 5.4
risk of, 1.2 estate taxes, 6.9
disability benefits, life insurance and, 7.2–7.5 evidence of insurability. See insurability,
disability buyout coverage, 12.20 evidence of
disability income benefit, 7.2, 7.4–7.5 exchange. See health insurance exchange
disability income coverage, 1.6, 12.15–12.20 exclusions, 7.3, 8.14–8.15
disability income policy, 1.7 accidental death benefit riders and, 7.6
disability income rider, 7.4 in disability income policies, 12.20
discretionary group, 13.7 from major medical expense policies, 12.6
dismemberment benefit, 7.7 executor, 5.3–5.4
distribution, costs of, 4.6 expense charges, 6.11, 8.7, 8.13
distribution period. See payout period expense participation requirements, 12.4–12.6
dividends, 13.14 expenses, 4.11, 6.11
options for, 9.6–9.7 experience rating, 13.12
withdrawal of, 9.7 experience refunds, 13.14
dividends on deposit option. See accumulation expiration date, 5.7
at interest dividend option extended term insurance, 8.11
dividends provision, 10.13 extended term insurance nonforfeiture option,
divisible surplus, 9.6 8.8, 8.13
Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank), 2.10, 2.11
domicile, 2.9
F
double indemnity benefit, 7.6 face amount, 5.7
dread disease (DD) benefit, 7.7, 7.8–7.9 accidental death benefit and, 7.6
“during the lifetime of the insured,” 8.5–8.6 death benefit and, 6.4
endowment insurance and, 6.19
E misstatement of age or sex and, 8.9–8.10

universal life insurance and,
education, funding of, 5.3 6.12–6.13, 6.14
eligibility period, 13.5 variable universal life insurance and, 6.18
eligibility provisions, for group insurance family income coverage, 5.10, 5.12–5.13
policies, 13.4–13.6 family income policy, 5.13
eligible group members, 13.9 family insurance rider. See spouse and
elimination period, 12.17, 12.21 children’s insurance rider
family maintenance policy, 5.19n3

family policy, 6.8 FPDA contracts. See flexible-premium

family relationships, insurable interest and, deferred annuity contracts
1.14, 1.15 fraternal benefit societies (fraternal insurer),
FDAs. See fixed deferred annuities 2.3, 2.4, 2.5, 8.3
federal government, 2.9 fraudulent misrepresentation, 8.5
Federal Insurance Office (FIO), 2.11 free-examination provision, 10.12. See also
federal securities laws, 10.9 free-look provision
federal system, 2.9 free-look provision, 8.2–8.3, 10.12
FIA. See fixed indexed annuity front-end load, 11.11, 11.12
final expenses, 5.3, 5.4 FSOC. See Financial Stability
finance companies, 2.4 Oversight Council
financial assets, 2.4 full retirement age, 14.14
financial condition examination, 2.12 funding vehicle (funding instrument), 14.11
financial holding company, 2.6, 2.7 fund operating expense charge, 11.12
Financial Industry Regulatory Authority future purchase option benefit, 12.19
(FINRA), 2.10
financial institutions, 2.4–2.7, 2.8
financial intermediaries, 2.6
G
financial model, 4.11 general account, 6.15–6.16, 10.8
financial products, needs met by, 5.2 GI benefit. See guaranteed insurability benefit
financial services industry, 2.4, 2.6–2.7 GIO. See guaranteed insurability benefit
Financial Stability Oversight Council GLBs. See guaranteed living benefit riders
(FSOC), 2.11 globalization, 2.7
FINRA. See Financial Industry Regulatory GLWB. See guaranteed lifetime
Authority withdrawal benefit
FIO. See Federal Insurance Office GMAB. See guaranteed minimum
first beneficiary. See primary beneficiary accumulation benefit
first-to-die life insurance. See joint whole life GMDB. See guaranteed minimum death
insurance benefit rider
first-dollar coverage, 12.3 GMIB. See guaranteed minimum
fixed account, 6.15, 6.17, 10.9 income benefit
fixed amount annuity, 11.3 GMWB. See guaranteed minimum
fixed amount option, 9.17, 9.18 withdrawal benefit
fixed annuities, 10.7–10.8, 10.10, 10.11, 11.7 government, role of, in insurance, 2.8–2.13
fixed assets, 2.4 government-sponsored medical expense
fixed deferred annuities (FDAs), 10.8, 11.7, coverage, 12.2, 12.7–12.8
11.8, 11.9 government-sponsored retirement plans, 14.13
fixed immediate annuities, 11.7 grace period, 8.6, 9.16
fixed indexed annuity (FIA), 10.11 grace period provision, 8.2, 8.6–8.7, 14.2
fixed period annuity, 11.3 group annuity, 10.3
fixed period option, 9.17–9.18 group cash value life insurance, 14.6–14.7
fixed-premium universal life insurance policy, group creditor life insurance, 14.7
6.13–6.14 group disability income coverage, 12.15–12.16
fixed single-premium immediate annuities group insurance, 13.2
(fixed SPIAs), 11.8 administration of, 13.13, 13.15
flat benefit amount, 12.18, 12.19 contracts for, 13.2–13.6
flat extra premium, 13.11 declining, 13.5
flexible-premium annuity, 10.6 eligibility for, 13.7
flexible-premium deferred annuity (FPDA) in force, 13.3
contracts, 10.6–10.7 participation levels and, 13.9–13.10
flexible-premium universal life insurance policyholder rights and, 13.2
policy, 6.13 premiums for, 13.12–13.15
flexible-premium variable life insurance. See underwriting for, 13.6–13.11, 13.16n2
variable universal life insurance group insurance certificate, 13.4
floor, 6.16 group insurance contracts
formal contract, 3.3, 3.6 as contracts of adhesion, 3.6
401(k) plans, 14.11–14.12, 14.13 insurable interest and, 3.10
403(b) plan, 14.13 parties to, 3.2
457(b) plan, 14.13 group insurance policy, 1.6, 3.2

group insureds, 13.2, 13.6 health insurance products, 3.2, 12.2

group life insurance, 9.14, 14.2–14.7 disability income coverage, 12.15–12.20
beneficiaries and, 3.12 long-term care coverage, 12.20–12.23
plans for, 14.5–14.7 medical expense coverage, 12.2–12.15
policy provisions, 14.2–14.5 health maintenance organization (HMO), 12.10
group long-term disability income policies, health reimbursement arrangement (HRA),
12.18 12.11, 12.12–12.13, 12.14
group policyholder, 3.2, 13.2 health savings account (HSA), 12.11–12.12, 12.14
group retirement plans, 14.8–14.13 hearing, loss of, 12.17
groups high-deductible health plan (HDHP),
nature of business for, 13.11 12.9–12.11, 12.12, 12.14
new members in, 13.9 HMO. See health maintenance organization
size of, 13.8–13.9 holding company, 2.6, 2.7
stability of, 13.9 hospital expenses, 12.3
group short-term disability income policies, 12.18 HRA. See health reimbursement arrangement
group term life insurance, 5.7, 14.5–14.6 HSA. See health savings account
group universal life plans, 14.7
group variable universal life plans, 14.7
growth cap, 6.16
I
growth floor, 6.16 IADLs. See instrumental activities of
guarantee riders, 11.2 daily living
guaranteed insurability (GI) benefit immediate annuities, 10.4–10.5, 10.6, 10.8,
(guaranteed insurability option), 7.11 10.10, 11.2–11.6, 11.11
guaranteed insurance products, 6.15 income benefit formula, 12.18
guaranteed issue, 12.13 income date. See annuity start date
guaranteed lifetime withdrawal benefit income replacement benefits, 12.15
(GLWB), 11.7 incontestability provision, 8.2, 8.4–8.6, 8.10,
guaranteed living benefit riders (GLBs), 11.6, 10.13, 14.3
11.7, 11.12 incorporation, 2.3
guaranteed minimum accumulation benefit increasing term life insurance, 5.9, 5.13
(GMAB), 11.7 indemnity benefit method, 12.23
guaranteed minimum death benefit rider indemnity benefits, 12.2, 12.3
(GMDB), 11.6, 11.12 indemnity contracts, 3.2–3.3
guaranteed minimum income benefit index, 10.11
(GMIB), 11.7 index account, 6.15
guaranteed minimum interest-crediting rate, index crediting rate, 6.16
6.10, 10.8 indexed annuity. See fixed indexed annuity
guaranteed minimum withdrawal benefit indexed universal life (IUL) insurance,
(GMWB), 11.7 6.15–6.16, 6.19
guaranteed renewal, 12.13 index performance rate, 6.16
India, insurance regulation in, 2.9
H individual annuities, 10.3, 10.12–10.13

individual disability income coverage, 12.15
hazardous activities exclusion provision, 8.15 individual insurance, 1.10
HCFSA. See health care flexible spending individual insurance company, 1.6
account individual insurance policy, 3.2
HDHP. See high-deductible health plan applicant’s choices for, 3.5
health care flexible spending account parties to, 3.2
(HCFSA), 12.11, 12.13, 12.14 individual life insurance policies
health insurance, 1.6, 1.8, 5.7 beneficiaries and, 3.12
health insurance policies, 3.2 provisions required in, 8.2
as aleatory contracts, 3.5, 3.6 individual retirement account, 11.14
as contracts of adhesion, 3.5, 3.6 individual retirement annuity, 11.14
as informal contracts, 3.3, 3.6 individual retirement arrangement (IRA), 11.2,
insurable interest and, 1.14–1.15 11.14
as unilateral contracts, 3.4, 3.6 individuals, contractual capacity for, 3.7–3.8
health insurance exchange, 12.13 informal contract, 3.3, 3.6, 3.11
initial premiums, 3.9, 3.10, 4.2, 4.6, 5.9, 6.13

instrumental activities of daily living (IADLs), insurers, 1.4, 1.5, 1.7. See also insurance
12.21 companies
insurability, evidence of, 1.14, 5.14, 6.8 intangible property, 3.11
and additional term insurance dividend interest, 4.8–4.9
option, 9.8 policy loans and, 8.11
and annuity benefit riders, 10.13 policy withdrawals and, 8.11
and group insurance, 13.5–13.6, 13.9, 14.3, universal life insurance and, 6.10
14.4 interest option, 9.17
reinstatement provisions and, 8.8 interest rates, 4.11
universal life insurance and, 6.13 Internal Revenue Code, Section 7702, 6.13, 6.15
and waiver of premium for payor benefit, Internal Revenue Service, 11.14
7.4 investment earnings, 4.8–4.11, 4.12
insurability benefits, 7.2, 7.11–7.12 investment expenses, 4.7
insurable events, for dread disease benefit, 7.9 investment-linked insurance products, 2.10.
insurable interest, 1.13–1.15, 3.10, 9.10 See also variable annuities; variable life
insurable risks, 1.7–1.10, 1.11 insurance
insurance, 1.3, 1.4–1.7 investments, 4.8–4.11, 6.10, 10.8
government’s role in, 2.8–2.13. See also investment vehicle. See funding vehicle
taxation IRAs. See individual retirement arrangements
selling of, 2.13 IRDA. See Insurance Regulatory and
supply and demand for, 2.8 Development Authority
wagering and, 1.13 irrevocable beneficiary, 9.4, 9.5, 9.10
insurance agents, 2.13 issue age, 8.8
insurance commissioner, 2.10 IUL insurance. See indexed universal life
insurance companies, 1.7. See also insurers insurance
contractual capacity for, 3.7–3.9
expenses for, 4.6
financial condition of, 2.12
J
as financial institutions, 2.4–2.8 joint mortgage life insurance, 5.11
financial models for, 4.11 joint and survivor annuity, 11.4–11.5
investment earnings for, 4.8, 4.11, 4.12, joint whole life insurance, 6.8–6.9
6.10, 10.8 juvenile insurance policy, 7.4
nonfinancial operations of, 2.13
operating expenses for, 4.6, 4.8, 4.11 K
organization types for, 2.3–2.4 key person, 5.5–5.6
regulation of, 2.9–2.13 key person disability coverage, 12.20
taxes paid by, 4.7 key person insurance, 5.4
insurance contract. See also insurance policy key person life insurance (key employee life
acceptance of, 3.7 insurance), 5.5, 9.10
insurance marketplace. See health insurance
exchange
insurance policies, 1.4–1.5, 3.2 L
as contracts, 9.2 labor union, 13.7
policy riders and, 5.13 labor union group, 13.7
as property, 3.11–3.12 lapse, 4.7, 4.11, 6.11
provisions of, 8.2–8.14 lapse rate, 4.7
requirements for, 6.15 last survivor life insurance, 6.8, 6.9
termination of, 4.7, 8.11, 8.12 lawful purpose, 3.11
insurance producers, 2.13 law of large numbers, 1.9
insurance products, taxation and, 2.13 legal reserves. See policy reserves
insurance regulation, goals of, 2.10 legal reserve system, 4.2–4.3
Insurance Regulatory and Development lenders mortgage insurance (LMI), 5.19n2
Authority (IRDA; India), 2.9 level premiums, 5.9
insurance riders, 7.10 level premium system, 4.12, 4.13, 6.3
insureds, 1.5, 1.7, 7.10–7.11. See also group level premium whole life insurance, 14.7
insureds level term life insurance, 5.9
insurer-administered group plan, 13.15 liabilities, 2.11, 2.12, 4.2

liability insurance, 1.5 LMI. See lenders mortgage insurance

liability risk, 1.5 loans, payment of. See credit life insurance;
license. See certificate of authority mortgage life insurance; policy loan
life annuity, 9.18–9.19, 11.4, 11.9 lodge system, 2.4
life expectancies, 4.4, 4.5, 4.6 longevity annuity (longevity insurance), 10.11
Life Happens, 5.5 longevity risk, 10.2, 11.2
life and health insurance companies, 1.5 long-term care insurance (LTCI), 1.6,
life income option, 9.17, 9.18–9.19 12.20–12.23
life income with period certain annuity, 11.5 long-term care (LTC) insurance benefit, 7.7, 7.9
life income with refund annuity, 11.5–11.6 long-term group disability income
life insurance, 1.6 coverage, 12.16
amount purchased, 5.5 long-term individual disability income
applications for, 8.4–8.6 coverage, 12.15
in force, 2.5 loss, potential for, 1.7–1.10
loss and, 1.8 loss rate, 1.9
needs met by, 5.2–5.7 LTCI. See long-term care insurance
life insurance calculators, 5.5 LTC insurance benefit. See long-term care
life insurance companies. See also fraternal insurance benefit
benefit societies; mutual insurance lump-sum distribution, for deferred
companies; stock insurance annuities, 11.2
companies
expenditures for, 4.6–4.7
number of, 2.8
M
profit and, 2.2 major medical expense coverage, 12.3–12.6
life insurance contract. See life insurance managed care plans, 12.2, 12.8–12.9, 12.10
policies manual rating, 13.12
life insurance needs calculators, 5.5 market conduct examination, 2.13
life insurance policies, 3.3. See also life market conduct laws, 2.13
insurance contract market conduct regulation, 2.10, 2.13
as aleatory contracts, 3.5, 3.6 market-value-adjusted (MVA) annuity, 10.14
assignment of, 9.5 market value adjustment, 10.14
assignment provision in, 9.11 master group insurance contract, 13.2
cancellation of, 8.2–8.3 material misrepresentation, 8.4–8.6, 8.9, 14.3
contingent owner for, 9.13 maturity date, 6.18, 6.19. See also annuity
as contracts of adhesion, 3.5, 3.6 start date
exclusions in, 8.14–8.15 maximum out-of-pocket provision, 12.5–12.6
as informal contracts, 3.3, 3.6 McCarran-Ferguson Act, 2.9
insurer’s rescinding of, 8.4 M&E charge. See mortality and expense
ownership rights and. See ownership risks charge
rights Medicaid, 12.7, 12.8
requirements for, 6.13 medical expense insurance, 1.6, 1.8, 12.2–12.15
riders with, 7.2 ACA’s effect on, 12.13–12.15
supplemental benefits with, 7.2–7.12 traditional, 12.2–12.7
surrender of, 8.12 medical supplement coverage, 12.2
termination of, 4.7 Medicare, 2.8, 12.7
transfer of, 9.8–9.12 Medicare supplement insurance policies,
as unilateral contract, 3.4, 3.6 2.8, 12.7
life insurance products, 3.2, 4.2–4.3 Medigap policies, 2.8
life only annuity, 11.4 mental capacity, contracts and, 3.8–3.9
lifestyle, 1.12 merger, 2.7
lifetime income stream, guarantee of, 10.5 military service exclusion clause, 8.15
limb, loss of, 7.7, 12.17 minimum guaranteed interest rate, 9.17, 9.18
limited-payment whole life insurance policy, minimum participation percentages, 13.16n3
6.4–6.6 minimum participation requirements,
liquidation period. See payout period 13.9–13.10
living benefit. See accelerated death benefit

minors, 3.8
as beneficiaries, 9.4
O
contracts and, 3.8, 3.12n1 occupation, 1.12
misrepresentation, 8.4–8.6 offer, 3.7
misstatement of age provision, 14.4–14.5 offeree, 3.7
misstatement of age or sex provision, 8.2, offeror, 3.7
8.9–8.10, 10.13, 14.4 Old Age Security Act (Canada), 14.14
model laws and regulation, 2.10 one-year term insurance, policy dividends and,
modified coverage whole life insurance 9.8
policy, 6.7 open contract, 8.3
modified-premium whole life insurance policy, open enrollment period, 13.5–13.6
6.7, 6.8 operating expenses, 4.6, 4.7, 4.11
modified whole life insurance, 6.6–6.7, 6.8 operating units, 2.6
monthly deduction waiver benefit. See waiver optional insured rider. See second insured rider
of cost of insurance benefit optional modes of settlement. See settlement
moral hazard, 1.12, 1.16n1 options
morbidity rates, 1.10 Option A (Option 1) plan, 6.13, 6.14
morbidity tables, 1.10 Option B (Option 2) plan, 6.13, 6.14
mortality charges, 6.10, 6.11, 8.7, 8.13 Option C plan, 6.13
mortality expense, 4.12 oral statements, 3.3, 8.3
mortality and expense risks (M&E) ordinary life insurance policy. See continuous-
charge, 11.12 premium whole life insurance policy
mortality rates, 1.9, 4.4–4.5, 4.11 original age conversion, 5.16–5.17
mortality tables, 1.9, 1.10, 4.4–4.5, 6.4 other insured rider. See second insured rider
mortgage insurance, 5.19n2 owners’ equity, 2.11, 2.12
mortgage life insurance (mortgage redemption ownership of property, 3.11–3.12
insurance), 5.10–5.11 ownership rights
multiple-employer group, 13.7 for annuities, 10.2
mutual assent, 3.6, 3.7, 3.11 beneficiary designation and, 9.2–9.5
mutual fund, 2.4 and irrevocable beneficiary designations,
mutual fund companies, 2.4 9.5
mutual insurance companies, 2.3–2.4, 2.5, 2.11, for life insurance policies, 9.2–9.19
2.12, 9.6 policy dividends and, 9.6–9.8
MVA annuity. See market-value-adjusted policy transfer and, 9.8–9.12
annuity premium payment mode and, 9.5–9.6
transfer of, 9.2
N own previous occupation, 12.16–12.17
NAIC. See National Association of Insurance

Commissioners
P
Nasdaq 100, 6.15 paid-up additional insurance dividend option,
National Association of Insurance 9.6, 9.7, 9.8, 9.9
Commissioners (NAIC), 2.10, 2.12 paid-up additions, 9.15
necessaries, 3.12n1 paid-up additions option benefit, 7.12
net amount at risk, 6.10, 6.13, 6.14 paid-up insurance, 8.12
net cash surrender value, 8.12, 8.13 paid-up policy, 6.5–6.6, 6.13–6.14
network, 12.8 parent company, 2.6, 2.7
no-lapse guarantee, 6.11 par policy. See participating policy
noncontributory plan, 13.3, 13.10, 14.7 partial disability, 12.19
nonforfeiture options, 8.8 partial surrender provision. See policy
nonforfeiture provision, 8.6, 8.11–8.13 withdrawal provision
nonforfeiture values, guaranteed, 8.14 participating policy, 9.6
nonparticipating policy (nonpar policy), 9.6 participation rate, 6.16
nonqualified annuity, 11.12, 11.13 partners, 2.2–2.3
nonrenewable term life insurance policy, 5.15 partnership, 2.2–2.3, 5.6
Patient Protection and Affordable Care Act
(ACA), 12.13–12.15

payee, 9.17, 10.3–10.4 policy provisions

payor, 7.4 actively-at-work provision, 13.4–13.5
payout factor, 11.8 for annuities, 10.12–10.14
payout options. See annuity options assignment provision, 9.11–9.12
payout period, 10.4 aviation exclusion provision, 8.15
payout schedule, 11.9 for cash value policies, 8.10–8.13
payroll, costs of, 4.6 change of ownership provision, 9.12
PCP. See primary care provider dividends provision, 10.13
pension, 14.11–14.12 eligibility provisions, for group insurance
pension plans, 14.11–14.12 policies, 13.4–13.6
per diem method. See indemnity entire contract provision, 8.2,
benefit method 8.3–8.4, 10.12
period certain, 11.3 free-look provision, 8.2–8.3, 10.12
period certain annuity. See fixed grace period provision, 8.2, 8.6–8.7, 14.2
period annuity group life insurance, 14.2–14.5
period certain guarantees, 11.9 hazardous activities exclusion
periodic income payments. See annuity provision, 8.15
payments incontestability provision, 8.2, 8.4–8.6,
permanent life insurance. See cash value life 8.10, 10.13, 14.3
insurance maximum out-of-pocket provision,
personal property, 3.11 12.5–12.6
personal risk, 1.5 misstatement of age or sex provision, 8.2,
physical hazard, 1.12 8.9–8.10, 10.13, 14.4
physical impairment, 12.20–12.21 misstatement of age provision, 14.4–14.5
physicians’ expenses, 12.3 nonforfeiture provision, 8.6, 8.11–8.13
plan administrator, 14.10 policy loan provision, 8.10–8.11
plan document, 14.9 reinstatement provision, 8.2, 8.8–8.9
plan participant, 14.8 renewal provision, 5.14
plan sponsor, 14.8 settlement options provision, 9.16
PMI. See private mortgage insurance suicide exclusion provision, 8.14–8.15
point-of-service (POS) plan, 12.10 withdrawal provision, 10.13
policy. See insurance policies; policy listings policy reserves, 2.11, 4.2–4.3, 4.7
policy anniversary, 5.7 for annuities, 10.2
policy benefits, 1.4, 5.2. See also benefits distribution of, 10.3
amount of, 1.8 reinstatement and, 8.8
taxation of, 5.3 policy riders, 5.13, 7.2
use of, 5.2–5.7 policy term, 5.7
policy date, 5.7 policy withdrawal provision, 8.11
policy dividends, 2.3, 9.6–9.8 policy withdrawals, 8.10–8.11
declared but unpaid, 9.15 pool of money method, 12.22
rights and, 9.2 portability provision, 14.4
policy fee, 6.11 portable coverage, 12.12, 14.4
policyholder, 13.2, 13.15 POS plan. See point-of-service plan
policy loan provision, 8.10–8.11 PPO. See preferred provider organization
policy loan repayment dividend option, 9.6, 9.7 preference beneficiary clause, 9.13–9.14
policy loans, 6.2, 6.11, 8.10–8.11 preferred premium rates, 1.13
cash surrender value and, 8.12 preferred provider organization (PPO), 12.10
outstanding, 9.16 preferred risk, 1.13
universal life insurance and, 8.11 premium charges, for supplemental
policyowner, 1.5, 1.7, 3.2, 3.12, 9.12–9.13 benefits, 7.8
policyowner-insured, 1.5 premium payments
policy proceeds, 9.2, 9.4 modes of, 9.5–9.6
calculating, 9.15–9.16 rights and, 9.2
determining payee for, 9.13–9.15 universal life insurance and, 6.11
paid under settlement options, 9.16–9.19 premium rates, 1.10–1.13, 4.3, 4.12
rights to, 9.13–9.19 characteristics of, 4.4
withdrawal of, 9.17, 9.18 establishing, 4.3–4.11
for second-insured rider, 7.11
term life insurance policies and, 5.14–5.18

premium reduction dividend option, 9.6, 9.7

premium refunds, 13.14
R
premiums, 1.4, 4.2. See also premium rates rate of return, 4.10–4.11
annual, 4.3 real property, 3.11
back, payment of, 8.8 reduced paid-up insurance, 8.11
due and unpaid, 9.16 reduced paid-up insurance nonforfeiture
endowment insurance and, 6.19 option, 8.8, 8.12–8.13
for group insurance, 13.13–13.15 refund annuity. See life income with refund
initial, 3.9. See also initial premiums annuity
level, 4.12, 5.9. See also level premium regular IRA. See traditional individual
listings retirement arrangement
misstatement of age or sex and, 8.9–8.10 regular occupation, 12.16
paid in advance, 9.16 regulation, 2.8, 2.9–2.13, 6.15
payment periods for, with whole life reimbursement benefits, 12.3
insurance, 6.4–6.6 reimbursement method, 12.23
renewal, 3.9. See also renewal premiums reinstatement, 8.8–8.9, 8.15
universal life insurance and, 6.12, reinstatement provision, 8.2, 8.8–8.9
6.13–6.14 reinsurance, 1.10
variable universal life insurance and, 6.18 reinsurer, 1.10
waiver of, for disability, 7.2–7.4 renewability, value of, to insurers, 5.18
prescription drug coverage, 12.7 renewable/convertible term insurance
presumptive disability, 12.17 policies, 5.15
preventive care, 12.15 renewable term insurance policy, 5.14–5.15
primary beneficiary, 9.2–9.4 renewal premiums, 3.9, 4.2, 5.7, 5.9, 5.10
primary care physician. See primary care administrative costs and, 9.6
provider dividends applied to, 9.7
primary care provider (PCP), 12.8 payment modes for, 9.5
principal, 4.8–4.9, 10.8 universal life and, 6.13
private mortgage insurance (PMI), 5.19n2 renewal provision, 5.14
probability, 1.9 reserves, 4.2–4.3
probationary period, 13.4, 13.5 endowment insurance and, 6.19
producers, 2.13, 4.6 universal life policies and, 6.10
product development, costs of, 4.6 whole life insurance and, 6.4
professional association, 13.8 retirement age, 14.14
profit, 2.2
retirement plans, 5.7
profit sharing plans, 14.11, 14.12–14.13
return of premium (ROP) term insurance,
promotion costs, costs of, 4.6
5.17–5.18
property, 3.11–3.12
revenue, 2.2
property and casualty insurance. See property
revocable beneficiary, 9.4–9.5
insurance
revocation, right of, 9.4
property/casualty insurance (P&C)
right of revocation, 9.4
companies, 1.5
risk, 1.2
property damage risk, 1.5
acceptance of, 1.2, 1.3–1.4
property insurance, 1.5
property insurance companies, 1.10 assessment of, 1.10–1.13
property and liability insurers. See property/ avoidance of, 1.2–1.3, 1.4
casualty insurance companies classification of, 1.12–1.13
provincial governments, 2.9 control of, 1.2, 1.3, 1.4
prudential regulation. See solvency regulation declined, 1.13
public employee association, 13.8 identification of, 1.3, 1.12
pure risk, 1.2 insurable, 1.7–1.10, 1.11
liability, 1.5
Q

longevity, 10.2
personal, 1.5
QHPs. See qualified health plans preferred, 1.13
QPP. See Quebec Pension Plan spread of, 1.10
qualified annuity, 11.12, 11.13 standard, 1.12
qualified health plans, 12.13 substandard, 1.13
qualified medical expenses, 12.11 transfer of, 1.2, 1.3, 1.4
qualified retirement plan, 14.8–14.13 risk class, 1.12–1.13
Quebec Pension Plan (QPP), 14.14 risk management, 1.2–1.4, 1.7–1.15

risk pooling, 1.7 single-premium deferred annuity (SPDA),

risk selection. See underwriting 10.6, 10.7
ROP term insurance. See return of premium single-premium immediate annuity (SPIA),
term insurance 10.6, 10.7, 11.8
Roth contribution feature, 14.12 single-premium paid-up additions, 7.12
Roth individual retirement arrangement single-premium whole life insurance
(Roth IRA), 11.14, 11.15 policy, 6.6
social insurance programs, 2.8
S Social Security, 14.13–14.14
sole proprietorships, 2.2, 2.3, 5.6
savings incentive match plan for employees solvency regulation, 2.10–2.13
(SIMPLE) IRAs, 14.13 solvent, 2.10–2.13
SEC. See Securities and Exchange SPDA. See single-premium deferred annuity
Commission special class rate. See substandard
secondary beneficiary. See contingent premium rate
beneficiary special class risk. See substandard risk
second-to-die life insurance. See last survivor speculative risk, 1.2
life insurance speech, loss of, 12.17
second insured, 7.10–7.11 S&P 500. See Standard & Poor’s 500
second insured rider, 7.10–7.11 SPIA. See single-premium immediate annuity
Section 7702 corridor, 6.15 spouse and children’s insurance rider, 7.10
Securities and Exchange Commission spouse insurance rider, 7.10
(SEC), 2.10 SROs. See self-regulatory organizations
securities firms, 2.4 Standard & Poor’s (S&P) 500, 6.15, 10.11
securities laws, federal, 6.17, 6.18. See also standard premium rates, 1.12
Dodd-Frank Wall Street Reform and standard risk, 1.12
Consumer Protection Act state governments, 2.9
security, 2.4 state insurance code, 2.9–2.10
segregated account. See separate account state insurance department, 2.9–2.10
selection against the insurer. See antiselection statutory reserves. See policy reserves
self-administered group plan, 13.15 stock, 2.3, 4.10
self-regulatory organizations (SROs), 2.10 stock corporation, 2.3
separate account, 6.17, 10.9 stock dividends, 4.10
SEP IRA, 14.13 stockholder, 2.3
service fee, 11.12 stockholder dividend, 2.3
settlement stock insurance companies, 2.3, 2.5, 2.11,
irrevocable mode of, 9.17 2.12, 9.6
revocable mode of, 9.17 stop-loss provision. See maximum out-of-
settlement options, 9.16–9.19 pocket provision
group life insurance, 14.5 straight life annuity. See life only annuity
rights and, 9.2 straight life insurance policy. See continuous-
settlement options provision, 9.16 premium whole life insurance policy
sex, misstatement of, 8.2, 8.9–8.10 subaccounts, 6.17, 6.18, 10.9, 11.10, 11.12
sex-distinct mortality tables, 4.5 subscribers, 12.10
shareholder. See stockholder subsidiaries, 2.6, 2.7
shares, 2.3 substance abuse, 1.12
short-term group disability income substandard premium rate, 1.13
coverage, 12.15 succession beneficiary clause. See preference
short-term individual disability income beneficiary clause
coverage, 12.15 successor beneficiary. See contingent
SIFIs. See systemically important financial beneficiary
institutions successor payee. See contingent payee
sight, loss of, 7.7 suicide exclusion provision, 8.14–8.15
simple interest, 4.8 superintendent of insurance. See insurance
simplified employee pension (SEP), 14.13 commissioner
simultaneous death act, 9.14–9.15, 9.19n2 supplemental benefit riders, 10.13
single-employer group, 13.7 supplemental benefits, 7.2
single life annuity. See life only annuity supplemental disability benefits, 7.2–7.5, 12.19
single-premium annuity, 10.6 supplemental service providers, 12.8

suppliers, 2.6 United Kingdom

surgical expenses, 12.3 group term life premiums in, 14.6
surplus, 2.11, 9.6 medical expense insurance coverage in, 12.2
surrender benefit. See cash surrender value United States, insurance regulation in,
surrender charge, 8.12, 10.13–10.14, 11.12 2.9–2.13
surrender value, 10.14. See also cash surrender universal life (Canada), 6.18
value universal life (UL) insurance, 6.10–6.16, 6.19,
survivor benefit. See death benefit, for 7.3–7.4, 8.13
annuities flexibility features of, 6.12–6.14
survivor income benefit, 5.12. See also family grace period and, 8.7
income coverage lapse and, 6.11
survivorship clause, 9.14–9.15 operation of, 6.11, 6.12
survivorship life insurance. See last survivor periodic statements with, 6.15
life insurance policy loans and, 6.11
systemically important financial institutions policy provisions with, 8.11
(SIFIs), 2.11 premium payments and, 6.11
reserves and, 6.10
T sales of, 6.3
universal life plans, 14.7
taxation, 2.8, 2.13 users, 2.6
cash value life insurance and, 6.2 usual, customary, and reasonable (UCR)
endowment insurance and, 6.19 fee, 12.4
group term life insurance and, 14.6 UTMA. See Uniform Transfers to Minors Act
last survivor life insurance and, 6.9
term to age 65, 5.8
terminal illness (TI) benefit, 7.7, 7.8 V
term life insurance, 1.6, 4.12, 4.13, 5.2, valid contract, 3.7, 3.8, 3.11, 9.15
5.7–5.18, 6.2, 9.8 valued contract, 1.8, 3.3
benefits payable under, 5.8–5.13 variable annuities, 2.10, 10.7, 10.9–10.10, 11.7,
cash value and, 5.8 11.8, 11.10–11.11
family policies and, 6.9 variable deferred annuities, 10.9–10.10, 11.7,
features of, 5.13–5.18 11.12
newborn children and, 6.9 variable deferred annuity riders, 11.6–11.7
plans of, 5.8–5.13 variable life (VL) insurance, 2.10, 6.3,
product characteristics of, 5.7–5.8 6.16–6.17, 6.19
sales of, 5.8, 6.3 variable universal life (VUL) insurance,
temporary coverage and, 6.8 6.3, 6.17, 6.18, 6.19, 7.3–7.4
third-party policies, 1.5, 1.7, 1.14, 9.12–9.13 variable universal life plans, 14.7
TI benefit. See terminal illness benefit vested interest, 9.4–9.5
tobacco use, 1.12, 4.5 vesting requirements, 14.10
total disability, 7.3, 7.4, 7.5, 12.16–12.17 vision care coverage, 12.7
trade association, 13.8 VL insurance. See variable life insurance
traditional individual retirement arrangement voidable contract, 3.7, 3.8, 3.9, 3.12n1
(traditional IRA), 11.14, 11.15 void contract, 3.7, 3.8, 3.9, 9.15
travel accident benefit, 14.6 VUL insurance. See variable universal
travel insurance, 5.7 life insurance
U W
UCR fee. See usual, customary, and wagering, insurance and, 1.13, 3.9–3.10
reasonable fee waiting period, 7.3. See also elimination period
UL insurance. See universal life insurance for annuities, 11.7
underwriters, 1.10 long-term care insurance benefit and, 7.9
underwriting, 1.10–1.13, 13.6–13.11 waiver of cost of insurance benefit, 7.3–7.4
underwriting guidelines, 1.12 waiver of premium for disability (WP) benefit,
unearned premiums paid in advance, 9.16 7.2–7.4, 7.5
Uniform Transfers to Minors Act (UTMA), 9.4 waiver of premium for disability benefit rider,
unilateral contract, 3.3, 3.4, 3.6 10.13
unisex mortality tables, 4.5

waiver of premium for payor benefit,

7.2, 7.4, 7.5
war exclusion clause, 8.15
whole life insurance, 6.3–6.9
covering more than one insured, 6.8–6.9
modified, 6.6–6.8
premium payment periods for, 6.4–6.6
sales of, 6.3
will, 5.3–5.4
withdrawal provision, 10.13
WOP benefit. See waiver of premium for
disability benefit
WP benefit. See waiver of premium for
disability benefit
written contracts, 3.3
Y
yearly renewable term (YRT) insurance, 14.5,
5.15, 5.16

End of Module

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Principles of Insurance

Second Edition Online Course

Chapter 1: Introduction to Risk and Insurance

Copyright © 2017 LL Global, Inc. All rights reserved. www.loma.org

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Chapter 2: The Life and Health Insurance Industry........... 2.1

Chapter 3: The Insurance Contract...................................... 3.1

Chapter 4: Life Insurance Premiums................................... 4.1

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The Concept of Risk

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Figure 1.1 Risk Management Techniques

If you do not Avoid, Control, or Transfer the risk, then you:

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In general, individuals and businesses can purchase insurance policies to cover

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Figure 1.2 Types of Life and Health Insurance Products

Life insurance: Insurance that provides protection against the ­economic

Annuity contract: A contract under which an insurer promises

Health insurance: Insurance that provides protection against the

Three important forms of health insurance coverage are as follows:

All of the above products can be issued as either an individual insurance

•• An individual insurance policy is a policy that insures the life or

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Managing Risks through Insurance

Characteristics of Insurable Risks

 The loss must be definite.

 The loss must be significant.

 The loss rate must be predictable.

 The loss must not be catastrophic to the insurer.

A loss without these characteristics generally is not considered an insurable risk.

The Loss Must Occur by Chance

The Loss Must Be Definite

The Loss Must Be Significant

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The Loss Rate Must Be Predictable

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Insurance companies have developed similar charts, called morbidity tables,

The Loss Must Not Be Catastrophic to the Insurer

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Figure 1.3 Characteristics of Insurable Risks

For a risk to be insurable:

The loss must The loss must The loss must

The loss rate must The loss must not be catastrophic

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 Proposed insureds who present a significantly lower-than-average likelihood

Insurable Interest Requirement

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Similar examples of financial interest can be found in other business relationships.

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Figure 1.4 Family Relationships that Create an Insurable Interest

Uncle Aunt Father Mother Uncle

Sister-in-Law Brother INSURED Spouse Sister

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The Life and Health Insurance

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Insurance Company Organization

Life insurance: Insurance that provides protection against the economic

The loss must be definite.

The loss must be significant.

The loss rate must be predictable.

The loss must not be catastrophic to the insurer.

Proposed insureds who present a significantly lower-than-average likelihood

Bilateral or unilateral contracts

Commutative or aleatory contracts

Bargaining contracts or contracts of adhesion