Frequently Asked Questions
1. What happens when an insurance company goes out of business?
Insurance companies that experience severe financial difficulties are taken over by the insurance department of the state in which they are based. Clients should be notified by the insurance department if this occurs. Even if the company is placed under the control of the insurance department, claims will continue to be honored as long as premiums are paid or cash value exists. The claims will be covered by state Guaranty Associations (up to a certain amount depending on the state), which will either pay them directly or transfer the policies to a financially stable insurance company.
For life insurance policies, annuities, and structured settlement annuities, the Association will provide the following coverage:
80% of death benefits but not to exceed $300,000
80% of cash surrender or withdrawal values but not to exceed $100,000
Annuities and Structured Settlement Annuities:
80% of the present value of annuity benefits, including net cash withdrawal and net cash surrender values but not to exceed $250,000
The maximum amount of protection provided by the Association to an individual, for all life insurance, annuities and structured settlement annuities is $300,000, regardless of the number of policies or contracts covering the individual. The individual is covered by the Association if the they lived in California at the time the insurance company is determined by a court to be insolvent. Coverage is also provided to policy beneficiaries, payees or assignees, whether or not they live in California.
2. What is the main difference between a mutual and stock insurance company?
A mutual insurance company is an insurance company owned entirely by its policyholders. Any profits earned by a mutual insurance company are either retained within the company or paid to policyholders in the form of dividend distributions or reduced future premiums. In contrast, a stock insurance company is owned by investors who have purchased company stock; any profits generated by a stock insurance company are distributed to the investors without necessarily benefiting the policyholders.
As of year-end 2013, stock insurance companies accounted for an overwhelming majority of the overall U.S. insurance industry at approximately $4.3 trillion book/adjusted carrying value (BACV) in cash and invested assets, out of an overall $5.5 trillion industry. Mutual insurance companies comprised about $985 billion in BACV assets (about 18% of total U.S. insurance industry cash and invested assets).
3. What is reinsurance?
Reinsurance is insurance that is purchased by an insurance company. In the classic case, reinsurance allows insurance companies to remain solvent after major claims events. The company that purchases the reinsurance policy is called a "ceding company" or "cedent" or "cedant" under most arrangements. The company issuing the reinsurance policy is referred simply as the "reinsurer".
A company that purchases reinsurance pays a premium to the reinsurance company, who in exchange would pay a share of the claims incurred by the purchasing company. The reinsurer may be either a specialist reinsurance company, which only undertakes reinsurance business, or another insurance company.
Most agents run into reinsurance first through a substandard risk situation. When an insured poses a higher than normal health risk, insurance companies frequently enter the reinsurance market to move some of the risk off themselves. Reinsurance also comes into play when a case starts to become too large. Once a policy goes beyond a company's in-house retention, reinsurance becomes the next step to move some off the risk off the individual insurance company.
4. What is the difference between in-house retention, auto bindings, and jumbo limits?
In-house retention – The amount of risk (death benefit) the insurance company is willing to retain (issue by itself). This is the amount the insurance company will leave up to it's own underwriters to review and approve (or decline) at whichever risk class they deem necessary. There are some benefits to falling within the company's internal retention limit, the major ones are a speedier underwriting decision and potentially more favorable underwriting decision.
Auto bindings – A pre-established agreement with reinsurers that gives an individual life insurance company's underwriting department authority to “underwrite” on the behalf of the reinsurer. In other words, the amount of coverage goes beyond the individual company's in-house retention limit, but is within it's auto-binding limit so underwriting can more expeditiously choose which reinsurer will cover the additional risk based on underwriting treaties.
Jumbo limits – The maximum amount of coverage an individual insurer will issue taking all other coverage into account (i.e. coverage at other insurance companies).
5. How is the cost of life insurance determined?
The premium rate for a life insurance policy is based on two underlying concepts: mortality and interest. A third variable is the expense factor which is the amount the company adds to the cost of the policy to cover operating costs of selling insurance, investing the premiums, and paying claims.
Mortality – Life insurance is based on the sharing of the risk of death by a large group of people. The amount at risk must be known to predict the cost to each member of the group. Mortality tables are used to give the company a basic estimate of how much money it will need to pay for death claims each year. By using a mortality table a life insurer can determine the average life expectancy for each age group.
Interest – The second factor used in calculating the premium is interest earnings. Companies invest your premiums in bonds, stocks, mortgages, real estate, etc., and assume they will earn a certain rate of interest on these invested funds.
Expense – The third consideration is the expenses of operating the company. The company estimates such expenses as salaries, agents’ compensation, rent, legal fees, postage, etc. The amount charged to cover each policy’s share of expenses of operation is called the expense loading. This is a cost area that can vary from company to company based on its operations and efficiency.
6. Does life insurance/annuities affect federal financial aid?
Under the federal government's financial aid formula, four main types of assets are excluded from consideration when determining your child's financial need:
All retirement accounts (e.g., IRAs, 401k's, 403b's)
Home equity in a primary residence
Cash value in life insurance
These assets are known as nonassessable assets. All other assets that belong to you and your child are known as assessable assets and include items like checking and savings accounts, stocks, bonds, mutual funds, 529 plans, Coverdell education savings accounts, custodial accounts, trusts, and investment property. The more assessable assets you have, the more money you will be expected to contribute to college costs before any financial aid is forthcoming.
For example, Mr. and Mrs. Green have a Roth IRA worth $50,000, home equity of $75,000, cash value life in insurance of $100,000, and a mutual fund worth $25,000. Under the federal financial aid formula, the Greens are considered to have only $25,000 worth of assets (i.e., the mutual fund).
By contrast, Mr. and Mrs. White have stock holdings worth $50,000, a 529 plan worth $35,000, a Coverdell account worth $15,000, and home equity of $100,000. Under the federal financial aid formula, the Whites are deemed to have $100,000 worth of assets (i.e., stock holdings, 529 plan, and Coverdell account).
Keep in mind that financial aid programs that are funded by individual colleges may use a formula that differs from the one used by the federal government to determine financial need. Specifically, the formula may take into account the value of your retirement accounts and/or home equity, and may even expect you to borrow against these assets.
7. What is a Modified Endowment Contract (MEC)?
A life insurance policy where premium payments made during the first seven years of the contract, or during the first seven years after a material change, exceed the Modified Endowment Premium limit as defined by section 7702A of the Internal Revenue Code. Withdrawals and loans from these contracts are subject to less favorable tax treatment than distributions from policies which are not Modified Endowment Contracts. This does not apply to distributions for Long Term Care benefits nor the acceleration of the death benefit.
8. What is a replacement and how do regulators view the different types of transactions?
Regulators continue their hard look at all replacement transactions. We have shared responsibility with you to ensure any replacement is identified properly, due diligence is taken to determine any recommendation to replace is suitable and all questions regarding a replacement are fully and accurately answered on all applications, suitability forms and replacement forms.
There are many types of transactions that may be viewed by regulators as replacements. Generally, a replacement occurs when a new life policy or annuity contract is purchased and an existing life policy or annuity contract is:
Lapsed, forfeited, surrendered or partially surrendered (including penalty-free withdrawals), assigned to the replacing insurer or otherwise terminated;
Converted to paid-up insurance, continued as extended term insurance, or continued under another form of non-forfeiture benefit, or otherwise reduced in value by other policy values;
Amended so as to effect either a reduction in benefits or in the term for which coverage would otherwise remain in force or for which benefits would be paid;
Reissued with any reduction in cash value; or
Used in a “financed purchase,” which occurs when the purchase of a new policy or contract involves the use of funds obtained by the withdrawal or surrender of some or all of the policy/contract values to pay all or part of any premium or payment due on the new policy or contract. In short, a financed purchase will reduce the value of the existing policy and may reduce the amount paid upon the death of the insured.
With this in mind, regulators have shown particular interest in sales methods, which could be considered to utilize either “twisting” or “churning.” While not all states use these specific terms in relation to insurance sales, nearly all states have regulations against unfair practices that utilize the concepts behind these terms.
“Twisting” happens when a producer knowingly makes misleading or incomplete representations, comparisons or omissions in the sale of an annuity product. “Churning” occurs when the values in an existing life insurance policy or annuity contract are directly or indirectly used to purchase another policy/contract for the purposes of earning additional fees, commissions or other compensation, without an objectively reasonable basis for believing the replacement will result in an actual and demonstrable benefit to the owner.
Any sale or recommendation, if not properly documented during the suitability process to demonstrate a reasonable benefit to the owner, in particular if such a transaction involves a replacement as defined above, could lead to a finding by a state regulator as being twisted or churned. It is important you complete the suitability form, application form and any replacement form completely with as much detail as necessary to validate and support your recommendation. Additionally, you should ensure your files and records contain any materials used in the solicitation and recommendation of a product, so if a question arises later, you have those records available to support your position.
9. What is "express underwriting" and how does it work?
Carriers are beginning to adopt more efficient underwriting technologies (aka Risk Classifier Tools) that allow them to evaluate an insured's overall risk beyond the traditional medical underwriting method. One such example is LexisNexis' Electronic Inspection Report.
The LexisNexis Electronic Inspection Report provides insurance underwriters with instant access to the public records information they need to evaluate risks presented by life insurance applicants. Instead of waiting weeks for traditional inspection reports, underwriters can now gain virtually instant access to public records information through the Electronic Inspection Report. The Electronic Inspection Report allows underwriters to independently confirm information that the proposed insured submitted on the application. It also provides a holistic view of the proposed insured’s:
Public records footprint
Criminal records history
Public records data can also extend the underwriting reach, particularly for hard-to-reach population segments with little or no credit history. In addition, most carriers cross-reference with several other databases such as:
Medical Information Bureau (MIB)
Prescription Data Base
Motor Vehicle Records
Third Party Telephone Interview
These tools help provide quick and efficient underwriting risk assessment without having the insured be subjected to completing a blood profile, urinalysis, paramedical examination and EKG.