Once an insurance company determines that an applicant is insurable, they need to establish the payment (premium)
for the insurance policy. Life insurance premiums are calculated based on the following three primary factors:

Mortality Factor:  A measure of the number of deaths in a given population. Mortality is based on a large risk pool of people and time. Insurance companies use mortality tables to help predict the life expectancy and probability of death for a given group.

Interest Factor:  Insurance companies invest the premiums they receive in an effort to earn interest. This
interest is one of the ways an insurance company can lower the premium rates.

Expense Factor:  Insurance companies are just like any other business. They have operating expenses
which need to be factored into the premiums. The expense factor is also known as the loading charge.

Other factors that impact the premium amount include:

Age:  The older the person, the higher probability of death and disability
Sex / Gender:  Women tend to live longer than men, so their premiums are usually lower
Health:  Poor health increases probability of death and disability
Occupation:  Hazardous job increases the risk of loss
Hobbies:  High risk hobbies also increase the risk of loss
Habits:  Tobacco use presents a higher risk than non-smokers

Premium Mode: refers to the policy feature that permits the policyowner to select the timing of premium payments. Insurance policy rates are based on the assumption that the premium will be paid annually at the
beginning of the policy year and that the company will have the premium to invest (interest factor) for a
full year. If the policyowner chooses to pay the premium more than once per year (example monthly, quarterly, semi-
annually) there normally will be an additional charge because the company will have additional charges in billing and
collecting the premium payments. This is sometimes referred to as the Mode of Premium provision.

Premium Payment Options:

► Annual
► Semi-Annual
► Quarterly
► Monthly

Note: The higher the frequency of payments, the higher the premiums. This is because the interest earned to the insurer is decreased while the administrative costs are increased.

Level Premium Funding:  Policies that have a level premium average premiums over the policy period. The policyowner pays more in the early years for protection to help cover the cost in later years, which allows the premiums to remain level throughout the life of the policy.

Single Premium Funding:  The policyowner pays a single premium that provides protection for life as a paid-up policy. Normally associated with whole life insurance.

Reserves vs. Cash Value

Reserves: Money set aside (required by the state’s insurance laws) to pay future claims.

Cash Value: Cash value applies to the savings element of whole life insurance policies that are payable
before death. The cash value of a whole life insurance policy during the early policy years typically
will be less than the premiums paid.

Tax Treatment of Premiums

Premiums paid on individual life insurance policies are generally not deductible. Premiums for life insurance used for
business purposes are generally not tax-deductible. Here are the exceptions to these rules:

► Premiums used for a charity are tax-deductible

► Life insurance premiums paid by an ex-spouse as court-ordered alimony are tax- deductible

► Employer-paid premiums used to fund group life insurance for the benefit of employees are tax-deductible

Tax Treatment of Cash Values

If cash value is surrendered, the portion that exceeds the premiums paid is taxable. The total of the premiums paid into the policy minus total dividends received in cash or used to offset premiums is referred to as the cost basis. For policies that are not surrendered, the cash value grows tax-free. As long as the cash value stays in the policy, taxes will never be imposed on any portion, not even the amount that exceeds the cost basis.

Death Benefits: Death benefits are paid out in a variety of ways. These methods are known as settlement options.
The policyowner may select a settlement option at the time of the application and may change the option at anytime
during the life of the insured. Once selected, the settlement option cannot be changed by the beneficiary.

Death Benefit Settlement Options

► Lump Sum: Death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. The lump sum option is considered the automatic (or "default") option for most life insurance contracts.

► Interest Only: Insurance company holds death benefit for a period of time and pays only the interest
earned to the named beneficiary. A minimum rate of interest is guaranteed and the interest must be paid at least annually.

► Fixed Period: Also called period certain, the death benefit proceed is paid in equal installments
over a set period of years. Part of the installments paid to a beneficiary consists of interest calculated on
the proceeds of the policy. The dollar amount of each installment depends upon the total number of installments.

► Fixed Amount: The fixed amount installment option pays a fixed death benefit in specified installment
amounts until the principal and interest are exhausted. The larger the installment payment, the shorter the payout period.

► Life Income: The life income option provides the beneficiary with an income that they cannot outlive.
Installment payments are guaranteed for as long as the recipient lives. The amount of each installment is
based on the recipient’s life expectancy and the amount of principal. This gives the potential for a greater
return, or the potential for greater loss, based on how long the insured lives. A joint and survivor option
guarantees that benefits will be payed on a life-long basis to two or more people. This option may
include a period certain and the amount payable is based on the ages of the beneficiaries.

Living Benefits: A living benefit is the option to use some of the future death benefit proceeds when they may be
most needed, before their death, when the insured has a terminal illness.

Living Benefit Options

Accelerated Benefit – Allows someone that a physician certifies as terminally ill to access the death
benefit. The amount of benefit received will be tax free.

Viatical Settlement – Allows someone with a terminal illness to sell their existing life insurance policy to
a third party for a percentage of the face value. The new owner continues to make the premium payments
and will eventually collect the entire death benefit.

Note: The original policy owner is called the Viator and the new third party owner is called the Viatical, sometimes
called the Viatee.

Tax Treatment of Proceeds

► Premiums: Not tax deductible

► Death Benefit: Normally tax-free if taken as a lump sum. Subject to federal estate tax under certain
circumstances and normally included in the policyowners gross estate.

► Death Benefit Installments: Principal is tax free – interest is taxable

Taxation of Proceeds Paid at Death

Life insurance proceeds paid to a beneficiary are generally exempt from taxes if taken as a lump sum. The
exception to this rule is the transfer for value rule, which applies when a life insurance policy is sold to another
party before the insured’s death.

Taxation of Proceeds Paid During the Insured’s Lifetime

Policy Surrender: When a policy is surrendered for the cash value, some of the cash value received may be
taxable, if the value was more than the amount of the premiums paid for the policy.

Accelerated Death Benefit: When benefits are paid under a life insurance policy to a terminally ill person, the
benefits are received tax free.

Note: Most states still require a viatical company to inform the client that under a viatical arrangement, the proceeds
could be taxable in certain situations and recommend they consult a tax advisor.

1035 Exchange: When an existing life insurance policy is assigned to another insurer for a new contract,
the transaction may be treated for tax purposes as a Section 1035 exchange. Policy exchanges that qualify as a
1035 exchange are not taxable.

► A Section 1035 exchange enables the postponement of tax consequences

Comparing life insurance policy costs

Life insurance cost comparison methods are used to evaluate the cost of one life insurance policy in relation to another so that consumers can be better informed when shopping for the most competitively priced offering for their particular needs. Although the cost of life insurance depends largely upon an individual's specific circumstances and requirements, cost estimates are nonetheless useful so that the consumer has the opportunity to consider every factor when making a buying decision. When evaluating different policies, it’s not enough to simply compare premiums. A lower premium does not automatically mean a lower-cost policy. To that extent, cost indexes have been developed to help in the process of measuring an insurance policy’s actual cost. Here are two of these indexes:

Surrender Cost Index: Uses a complicated calculation formula where the net cost is averaged over the number of years the policy was in force to arrive at the average cost-per-thousand for a policy that is surrendered for its cash value at the end of that period.

Net Payment Cost Index: Uses the same the same formula as the Surrender Cost Index with the exception that it doesn’t assume that the policy will be surrendered at the end of the period. The net payment cost index is useful if one's primary concern is the amount of death benefits provided in the policy. It is helpful in comparing future costs, such as in 10 to 20 years, if one will continue to pay premiums and does not take the policy's cash value.

Qualifications

The beneficiary of a life insurance policy is the person or entity designated in the policy to receive the death
proceeds. There are few restrictions on who may be named a beneficiary of a life insurance policy. The owner of the
policy is the ultimate decision maker and may change the beneficiary at any time, unless designated as irrevocable.
However, in the underwriting process, the underwriter may consider the issue of insurable interest. When the
policyowner lists themselves as the beneficiary, they will require proof of insurable interest. Problems are more likely to
occur when an estate is named as beneficiary of a life insurance policy.

Who can be beneficiaries?

►Individuals
► Businesses
► Trust  (Provides management of the proceeds; Policy proceeds may be reduced by trust administration fees)
► Estates (Creditors have rights to life insurance policy proceeds when the beneficiary is the insured's estate)
► Charities
► Minors  (Guardian may need to be appointed)

Types of Beneficiaries

A beneficiary can be either specific (a person identified by name and relationship), or a class designation (a group of individuals such as the “children of the insured”). If no one named, or if all beneficiaries die before the insured dies,
death benefit will go to insured’s estate.

By Order of Succession:

► Primary: First in line to receive death benefit proceeds
► Secondary (contingent): Second in line to receive death benefit proceeds
► Tertiary: Third in line to receive death benefit proceeds. If no one is named, death benefit will go to insured’s estate

Distribution by Descent

Per Stirpes: (meaning by the bloodline) In the event that a beneficiary dies before the insured, benefits from that
policy will be paid to that beneficiary’s heirs.

Per Capita: (meaning by the head) Evenly distributes benefits among all named living beneficiaries.

Changing a Beneficiary

Revocable Beneficiary – The policy owner may change the beneficiary at any time without notifying or getting
permission from the beneficiary

Irrevocable Beneficiary – An irrevocable designation may not be changed without the written consent of the
beneficiary. The irrevocable beneficiary has a vested interest in the policy, therefore the policyowner may not
exercise certain rights without the consent of the beneficiary.

Special Situations

Simultaneous Death: If the insured and the primary beneficiary die at approximately the same time for a common
accident with no clear evidence as to who died first, the Uniform Simultaneous Death Act law will assume that the
primary died first, this allows the death benefit proceeds to be paid to the contingent beneficiaries.

Common Disaster Provision: With a common disaster provision, a policyowner can be sure that if both the
insured and the primary beneficiary die within a short period of time, the death benefits will be paid to the
contingent beneficiary. It also states that the primary beneficiary of the policy must survive the insured by a certain number of days (usually from 60 to 90) to qualify to receive the policy's benefits. Otherwise the benefits will be paid to the insured's estate as if the primary beneficiary died before the insured.

Spendthrift Clause: Prevents a beneficiary from recklessly spending benefits by requiring the benefits to be paid in
fixed amounts or installments over a certain period of time. A spendthrift clause in a life insurance policy would have no effect if the beneficiary receives the proceeds as one lump sum payment. The spendthrift clause is selected at the time of application.

►A spendthrift clause is also a statement in a settlement agreement that indicates that the proceeds of the policy will be free from attachment or seizure by the beneficiary’s creditors

Facility of Payment: Typically found in industrial policies, it allows the insurance company to pay all or part of the
proceeds to someone not named in the policy that has a valid right. This is usually done on behalf of a minor.