- TYPES OF LIFE INSURANCE
- OTHER TYPES OF INSURANCE
- COMMON EMPLOYER PROVIDED INSURANCE
- RETIREE INSURANCE ISSUES
- LIFE INSURANCE AT-A-GLANCE
- FORMS AND CHECKLISTS
- Can an employer institute a life insurance plan for a small group of employees?
- What is a key employee life insurance program?
- How much life insurance do I need?
- What are the tax consequences of a key employee life insurance program?
- What are the tax benefits of a group-term life insurance plan?
- What are the features of whole-life policy?
- What is a split-dollar life insurance policy?
This section describes the various types of insurance available and the most popular employer-provided life and disability insurance coverages. For employers, the discussion focuses on administration, funding, tax consequences and legal compliance. For employees, it outlines some of the popular policies and options, as well as choices available to supplement employer-provided coverage and employees not covered by a group plan.
If your employer does not provide life insurance or provides insufficient insurance for your needs, you may want to purchase (additional) coverage. You can purchase a whole life or term policy. The following sections outline the various types of policies available. The type of policy you choose will depend on your particular needs and expectations.
The type of life insurance an individual will want to acquire will depend on the reason for the acquisition. Generally, a business owner or professional cannot afford not to purchase life insurance. In other words, the individual’s spouse, children, or business cannot afford the effects of the individual’s death without the proceeds of the insurance.
The need for insurance can fit in different time frames:
- Short-term needs. Some examples of short-term needs include a lender requiring that insurance be placed on the life of a borrower until the loan is repaid and providing coverage for a spouse with young children until the children grow older. Generally insurance that is needed for 15 years or less can be considered short term.
- Long-term needs. Most other needs would generally be of a long-term nature. Generally, insurance that is needed for more than 10 or 15 years can be considered long term.
- Permanent needs. A permanent need for insurance occurs where the need exists throughout the individual’s lifetime and is not expected to be eliminated. For example, providing liquidity in the estate to cover the taxes and settlement costs would be a permanent need if the estate was comprised of mostly illiquid assets and the individual had no intention of selling the business.
Life insurance is a contract between the policy owner and an insurance company under which the company agrees to pay a specified sum to the designated beneficiary upon the death of the insured, in return for premium payments. The basic types of life insurance products are term and permanent insurance. All life insurance contains a pure death benefit element. Permanent policies add a cash value component, whereas temporary or term insurance does not. See the section on Term Insurance for a complete discussion on the types of coverage available. The three major types of permanent insurance are:
- Universal life
- Whole life
Whereas temporary insurance (whether of short or long duration) is referred to as Term Insurance.
Universal life insurance is a form of permanent insurance. Therefore it combines pure death protection with cash value. The policy incurs a cost of insurance (increasing with age, similar to a one-year term policy) and an expense cost, and the balance is accumulated as cash value, which earns interest. The costs of insurance and expenses are illustrated in the policy, but they are typically not guaranteed. In fact, the contract contains a maximum cost of insurance that is typically so much higher than the current illustrated cost that a policy whose premium is projected to be paid to acquire a $1,000,000 policy if paid for life may in fact lapse after 5 or 10 years under the guaranteed contract.
This does not mean that universal life policies are bad. Rather, it means that the risks must be understood. This is why it is crucial to work with an insurance carrier that not only is financially strong but also has a history of being fair to policyholders and has been able to provide competitive earnings as well as low costs of insurance and expenses.
Whole life insurance policies enjoy a cash build-up feature. With whole life, the insured pays the same annual premium for life, up to a specified age, at which time the cash surrender value equals the face amount of the policy, and no further premiums need be paid.
The conventional whole life policy has fixed death benefits, maturity date, and level premiums. The progression of cash surrender value is fixed also. Any change in coverage necessitates a catch-up of premiums for an increase in coverage (or a refund if coverage is lowered). Some whole life policies contain automatic adjustments.
NOTE: Factors outside the control of the insured may trigger the adjustment, so be sure to periodically review and evaluate these type of policies.
Whole life is the most conservative form of permanent policy. It provides the strongest guarantees. The most popular whole life products are offered through “mutual” companies, where the policyholders in effect own the company.
Variable life is most popular with the universal life type of policy design. The major difference between a universal life and a variable universal life is that the policyholder bears the primary responsibility for the investment selection. The company will offer choices of investments (sub-accounts) similar to, but not the same as, mutual funds. There will normally be a domestic stock account, foreign stock account, fixed income account, and money market type of account. Some companies will offer a wider variety of choices than others.
This type of policy was designed for individuals who prefer to absorb the investment risk and are less conservative in nature.
Term insurance provides pure death benefit protection, generally with no cash accumulation.
- Coverage is typically for a fixed period of time and will cease at a given age.
- One-year renewable term insurance is the most basic type of term insurance and generally carries the lowest initial cost.
- Premiums increase periodically as the insured gets older.
- Features to look for include guaranteed renewability (regardless of insurability) and convertibiliy (to a cash value or other permanent life policy). These features can become crucial if the insured’s health deteriorates.
One of the basic objectives of estate planning is to provide liquidity at the time of death to pay debts, administration expenses, and estate taxes in an orderly fashion. Life insurance is often used to provide that liquidity. For example, in situations where closely held businesses, real estate investments, and other illiquid assets comprise a significant portion of the estate, sufficient funds may not be available to meet estate obligations. Proceeds from life insurance policies can provide funds that might otherwise have to be raised by selling estate assets, possibly at depressed market prices.
In the case of the estate of a married person, the estate tax can be eliminated at the death of the first spouse entirely through the use of the marital deduction. If the bulk of the estate is left to the surviving spouse, the burden of the estate tax must be faced at the death of the surviving spouse, and life insurance can provide funds to meet that obligation.
The question arises as to which spouse should be the insured. Survivorship life insurance policies have been designed to address this very question. Such policies provide for payment of the insurance proceeds on the death of the second to die. Because payment of the proceeds is delayed until after the death of both insureds, the cost of a survivorship policy will be less than the combined cost of separate policies on each spouse.
First-to-die insurance is basically whole life or universal life that pays at the first death of the two insureds. It is primarily used to insure co-owners of a business where there is a buy-sell agreement so that the proceeds are required to effect a buyout of the first deceased’s shares in a business (no matter which partner dies first). Some first-to-die policies cover as many as six or eight insureds at a time. The objective is to avoid having to purchase multiple policies, which can be more costly and cumbersome to administer.
Most employers provide some form of life and disability insurance to cover their employees. Benefits are relatively inexpensive to obtain at group rates available to the employer and are usually based on the employee’s salary.
If structured properly, group-term life insurance policies can obtain favorable tax treatment.
Split-dollar insurance is sometimes thought of as a means of providing executives with life insurance protection at low cost. Split-dollar might be considered as a possible alternative to group-term for non-executive retirees, as well.
Other Types of Employer Offered Insurance
Disability is by definition the worker’s inability to work and earn income. Disability benefits guarantee workers some income security during periods in which they may not be able to work owing to poor health or other causes. Accordingly, disability is one of the most important benefits an employer can offer to an employee because it provides income in those circumstances when workers’ compensation is either unavailable or insufficient.
Short-term disability coverage is required by law in several states; therefore, employers should check their states’ requirements. Disability benefits are subject to requirements of the Employee Retirement Income Security Act, including the requirement that a summary plan description be furnished to employees.
Recognizing that our society has changed to the point where individuals who require long-term care can no longer expect to have family members able and available to care for them; and that Medicare benefits do not adequately fill the gap, an as-yet modest number of employers are offering long-term care insurance benefits to employees.
Long-term care may mean nursing home care and/or care in the insured person’s own home. Although most long-term care is provided to seniors, the sad truth is that people of any age can find themselves permanently or temporarily unable to care for themselves without help. Further, applying for insurance at a relatively young age has its benefits, because most insurers base future premiums on the age at which the insured first applied for coverage.
In most cases, long-term care insurance benefits are unsubsidized; that is, employees are expected to pay the full premium. However, access to group insurance may reduce the premiums that employees pay. Employees are also likely to believe that they are benefiting from employer research into the range and quality of benefits offered and the financial security of the insurer, so employers should expect to do some ratings research and comparison shopping.
Application for Long-term Care Insurance is a sample of an application for group long-term care insurance.
Post-retirement Death Benefits
An employer may provide pre-retirement life insurance benefits and post-retirement death benefits as incidental benefits to a qualified retirement plan. However, such benefits are usually too limited to be of much use to an owner-employee.
A common goal of life insurance, especially for younger workers is to create what may be characterized as an “instant estate” for an insured who dies prematurely, before having had an opportunity to build an estate.
A retiree’s need for insurance does not conform to that proposition if he has reached the normal retirement age of 65, his subsequent death cannot readily be viewed as premature or as coming before he has had an opportunity to build an estate.
- For most employees, life insurance is an important employer-provided fringe benefit.
- With certain exceptions, the premiums paid by the employer for life insurance coverage and the benefits received under the plans are generally excluded from the employee’s income.
- An employer’s premium costs associated with employee life insurance plans generally will be deductible as an ordinary cost of doing business.
- Life insurance that is not part of a qualified group-term life insurance plan can be useful where the employer wants to provide life insurance for key employees.
- Features to look for in a term policy include guaranteed renewability and convertibility. These features can become crucial if the insured’s health deteriorates.