A former insurance producer, Laura understands that education is key when it comes to buying insurance. She has happily dedicated many hours to helping her clients understand how the insurance marketplace works so they can find the best car, home, and life insurance products for their needs.

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Dan Walker graduated with a BS in Administrative Management in 2005 and has been working in his family’s insurance agency, FCI Agency, for 15 years. He is licensed as an agent to write property and casualty insurance, including home, auto, umbrella, and dwelling fire insurance. He’s also been featured on sites like Reviews.com.

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Reviewed by Daniel Walker
Licensed Car Insurance Agent

UPDATED: Jan 25, 2017

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Don't miss these facts...

  • Life insurance contracts are constructed in a very unique way, unlike that of many business contracts
  • Life insurance has two different types of contracts, term and permanent insurance
  • Permanent life insurance has a cash value that can be borrowed or paid to the policy owner if the policy is surrendered
  • Life insurance is one of the most unique concepts in the world because of its flexibility and track record for 200 years

How a Life Insurance Contract Is Constructed

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Life insurance is a unique financial instrument because it is so flexible, yet does so much. Any individual can purchase a life insurance policy on their life if they can qualify from a medical, financial and moral standpoint.

Life insurance companies carefully judge potential applicants to be sure that they are a good risk and that they can pay their premiums on the policy.

A life insurance contract is a one way or unilateral contract. It promises to pay a death benefit to a named beneficiary, or a person or persons, who will receive a monetary benefit upon the death of the insured person.

That death may not occur until years have passed, but the contract between the insured and the company will be carried out.

In other words, the life insurance company is obligated by the contract to live up to its promises as long as the policyholder pays the premiums. However, the premium payor can quit paying the premiums any time they wish.

The dynamics of the life insurance contract spells it all out because that is exactly how the entire plan gets worked out over time.

The formula of mortality, interest, and expense are the factors that solidify the operation of life insurance.

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How Does The Life Insurance Company Do It?

It takes lots of planning and foresight for a life insurance company to be able to live up to its obligations. When you pay your premiums for a policy, a certain percentage goes for expenses, such as office expenses, promotions, and commissions.

Then a reserve is established each year that the policy is in effect. The insurance company knows that not everybody will die right away, but that so many people will die each year, and so they allow for that.

Insurance companies work on a principle called the “law of large numbers.” The law of large numbers makes the insurance principle work.

The larger the group of people that the principle is applied to, the more accurately will be the predictions of how many people will live and how many will die in a given year.

While it is not known who will die, the number of individuals who will pass on in each year can be predicted very accurately.

Two Kinds of Life Insurance

There are two forms of life insurance that are sold in the marketplace today:

Term Life provides a death benefit for a certain period, then it ceases to exist. The period of coverage is usually sold in 10, 15, 20 and 30 year time periods. Term life insurance is usually described as temporary coverage, although it does last for years.

Permanent Life Insurance lasts until a person dies, or until the age of 100 is attained.

Age 100 is deemed to be the life expectancy of a person, and if a person reaches that age, the policy is said to mature or endow. This means the face amount of the policy will be paid to the policy owner at that age.

Term life insurance is less expensive because the coverage is for a limited time and the insurance company does not have to plan for the entire lifetime of the insured.

Permanent life insurance has a higher year-to-year cost because it covers the insured for his or her entire lifetime.

Permanent life insurance has a monetary reserve embedded in the contract which is designed to keep the premiums on a level plane all throughout the policy.

If that did not exist, the mortality costs of the policy would get so high in the later years of the policy that no one would be able to afford to keep paying the premiums.

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Cash Value Life Insurance

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Permanent life insurance is also called “Cash Value Life Insurance” because the reserve that is designed to keep the premium level over the life of the policy is available to the policy owner in the form of a loan, or for surrender if the policy is discontinued.

Permanent life insurance is also called “Whole Life” since it covers a person for the “whole of life.”

If a loan is taken against the cash value, the death benefit is reduced by a corresponding amount until, and if, the loan is repaid.

A nominal rate of interest is paid by the policyholder as long as the loan is outstanding. If the policy is surrendered, the full amount of the cash value is paid to the policyholder.

Keep in mind that only the owner of the life insurance will usually have the right to surrender a policy or borrow from the policy unless that right is given by the owner to another person or entity.

This feature of having cash available is a unique feature for any insurance. Many occasions for the need for ready cash have been satisfied by the cash value of life insurance.

Walt Disney used cash values from his life insurance to start Disneyland when all the banks told him no because Disneyland was a crazy idea. J.C. Penny kept his chain of dry goods stores in business during the depression with his life insurance as values.

Acturial Science

Actuarial science is the profession of assessing and appraising the risks of insurance by the application of mathematics and statistics.

A person who is trained and who works in this discipline is called an actuary.

Actuaries determine the facts and figures to be used in making insurance work, and particularly in life insurance.

They also devise the schedules used for the amounts of premiums, cash values, statistics and facts used to calculate long term results for the payments of death benefits and collection of premiums.

Long Term Projections

As one can well imagine, it takes very accurate planning to determine what amounts of funding it will take to be sure that a life insurance policy will work over a period of 50 to 80 years.

Life insurance companies have been coming up with extremely accurate figures for their cash values and death benefit projections for over 200 years, and there is no equal to that in business anywhere.

In Conclusion

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Life insurance is the miracle product because of the financial force it has in society. It not only offers death benefits, but it has very robust living benefits.

The cash values of life insurance are available for surrender or for collateral for a loan, which can be used for any purpose that is needed by the policyholder.

Over the many years of the existence of modern life insurance, cash values have been used to purchase homes, for emergency reasons, to foster the launching of businesses, and for medical purposes.

The permanent life policy can be surrendered for its cash value, or a loan can be taken, and the premiums continued. Complete flexibility is available to meet the specific needs of the policy owner.

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