Life Insurance Products
Life insurance provides financial protection for beneficiaries upon the insured's death. Some policies also offer investment or savings components. Investment advisers must understand which life insurance products are securities and their appropriate uses in financial planning.
Types of Life Insurance
Term Life Insurance
Term life provides pure death benefit protection for a specified period with no cash value accumulation.
| Feature | Detail |
|---|---|
| Coverage Period | Fixed term (10, 20, 30 years) |
| Cash Value | None |
| Premiums | Lowest initially; may increase at renewal |
| Death Benefit | Fixed |
| Is It a Security? | No |
Types of Term Insurance
| Type | Description |
|---|---|
| Level Term | Premium and death benefit stay constant |
| Decreasing Term | Death benefit decreases over time (mortgage protection) |
| Renewable Term | Can renew without medical exam at higher premium |
| Convertible Term | Can convert to permanent policy without medical exam |
In Practice
A young family with limited budget buys 20-year level term insurance to protect against the death of a breadwinner during the child-rearing years. This provides maximum coverage at the lowest cost for the period when protection is most needed.
Permanent Life Insurance
Whole Life Insurance
| Feature | Detail |
|---|---|
| Coverage Period | Lifetime (to age 100+) |
| Premiums | Level for life |
| Cash Value | Yes; guaranteed growth rate |
| Death Benefit | Fixed |
| Investment Risk | Insurance company |
| Is It a Security? | No |
Key Features:
- Cash value grows at guaranteed rate in general account
- Policyholder can borrow against cash value
- Participating policies may pay dividends
- More expensive than term initially
Universal Life Insurance
| Feature | Detail |
|---|---|
| Coverage Period | Lifetime (if funded) |
| Premiums | Flexible (within limits) |
| Cash Value | Yes; credited interest based on current rates |
| Death Benefit | Adjustable |
| Investment Risk | Insurance company |
| Is It a Security? | No |
Key Features:
- Flexibility in premium payments
- Transparency in cost structure (cost of insurance disclosed)
- Cash value earns current interest rate (with minimum guarantee)
- Death benefit can be adjusted
Variable Life Insurance Products
Variable Life Insurance
Variable life invests cash value in subaccounts (like mutual funds), with the investment risk borne by the policyholder.
| Feature | Detail |
|---|---|
| Coverage Period | Lifetime |
| Premiums | Fixed and scheduled |
| Cash Value | Invested in subaccounts; fluctuates |
| Death Benefit | Varies with performance; minimum guaranteed |
| Investment Risk | Policyholder |
| Is It a Security? | YES |
Variable Universal Life (VUL)
VUL combines the investment component of variable life with the flexibility of universal life.
| Feature | Detail |
|---|---|
| Coverage Period | Lifetime (if funded) |
| Premiums | Flexible |
| Cash Value | Invested in subaccounts; fluctuates |
| Death Benefit | Adjustable; may fluctuate with performance |
| Investment Risk | Policyholder |
| Is It a Security? | YES |
On the Exam
Variable life and VUL are securities because the policyholder bears the investment risk. They require:
- Prospectus delivery
- Registration with SEC
- FINRA licensing for sales (Series 6 or 7)
- State insurance license
Whole life and universal life are NOT securities because the insurance company guarantees the cash value growth rate.
Separate Account vs. General Account
| Feature | General Account | Separate Account |
|---|---|---|
| Used In | Fixed, whole, universal life | Variable products |
| Investment Risk | Insurance company | Policyholder |
| Asset Ownership | Commingled insurer assets | Segregated for policyholder |
| Creditor Protection | May be subject to insurer creditors | Protected from insurer creditors |
| Returns | Guaranteed rate | Based on investment performance |
Life Insurance Comparison
| Feature | Term | Whole Life | Universal | Variable Life | VUL |
|---|---|---|---|---|---|
| Cash Value | No | Yes | Yes | Yes | Yes |
| Premiums | Low | High | Flexible | Fixed | Flexible |
| Death Benefit | Fixed | Fixed | Adjustable | Variable | Adjustable |
| Investment Risk | N/A | Insurer | Insurer | Owner | Owner |
| Is Security? | No | No | No | Yes | Yes |
Tax Treatment of Life Insurance
Death Benefits
Death benefits are generally received income tax-free by beneficiaries. However, they may be included in the deceased's estate for estate tax purposes.
Cash Value Growth
| Event | Tax Treatment |
|---|---|
| Cash value growth | Tax-deferred |
| Policy loans | Not taxable if policy remains in force |
| Surrender (cash-out) | Gain taxed as ordinary income |
| Withdrawal | FIFO treatment (basis out first) |
Modified Endowment Contracts (MECs)
If a policy is "overfunded" (too much premium relative to death benefit), it becomes a Modified Endowment Contract:
- Withdrawals taxed LIFO (earnings first)
- 10% penalty before age 59½
- Loans treated as taxable distributions
Insurance in Financial Planning
Common Uses
| Purpose | Appropriate Product |
|---|---|
| Income replacement | Term (temporary) or permanent |
| Estate planning | Permanent (whole, universal) |
| Business succession | Term or permanent |
| Tax-deferred savings | Permanent with cash value |
| College funding | Generally NOT recommended |
| Retirement supplement | Cash value policies |
Suitability Considerations
Variable life/VUL may be suitable for:
- Those seeking life insurance with growth potential
- Long time horizons
- Higher risk tolerance
- Adequate assets to maintain policy
Variable life/VUL is NOT suitable for:
- Those who primarily need death benefit (use term)
- Conservative investors
- Those who may not maintain premium payments
- Short time horizons
Key Takeaways
- Term life: Pure death benefit; no cash value; NOT a security; lowest cost
- Whole life: Permanent coverage; guaranteed cash value; NOT a security
- Universal life: Flexible premiums/death benefit; current interest credited; NOT a security
- Variable life/VUL: Cash value in subaccounts; policyholder bears risk; ARE securities
- Death benefits are generally income tax-free to beneficiaries
- Cash value growth is tax-deferred
- Separate account protects variable product assets from insurer creditors
- Variable products require prospectus and **securities licensing
Which type of life insurance is considered a security?
Life insurance death benefits received by a named beneficiary are generally:
Variable life insurance cash value is held in a separate account rather than the general account because:
8.1 Individual Clients
Chapter 8: Client Types & Profiles