The whole idea of insurance has developed on the fact that human life is full of uncertainties and the life of a person itself is very uncertain. Eventualities do cast their shadows, and therefore one has to equip oneself with possible means so as to face the unforeseen. It is well said that “Life is full of risks. For property, there are fire risks, for shipment of goods, there are perils of sea, for human life, there is the risk of death or disability and so on and so forth”.Life insurance is a husband‟s privilege, a wife‟s right and a child‟s claim. The scheme of life insurance provides an assurance that if such an event happens, the person or his dependents would get financial assistance to bear the loss. It has been aptly said that life insurance offers the safest and surest means of establishing a socialistic pattern, perhaps not without a lot of sweat but certainly without blood and tears. It stabilizes the economic security of the policy holder and at the same time contributes its might to promotion of industry by providing the necessary capital and supports various social security measures.
Meaning and Definition
To understand life insurance we have to first understand the scheme of insurance. Insurance is a co-operative device to spread the loss caused by a particular risk over a number of persons who are exposed to it and who agree to insure themselves against the risk.4 Under the plan of insurance, a large number of people associate themselves to share different types of risks attached to human life and property. The aim of all types of insurance is to make provision against such risks. In other words, it is a provision which a prudent man makes against inevitable contingencies, loss or misfortune. In this way, life insurance is a social device to share the risk of loss of life.
Nature of life insurance
Life insurance provides payment of a death benefit at the death of the insured(s). However, life insurance has many unique characteristics that may make it an appropriate solution for a variety of uses in addition to the death benefit protection. Some of these characteristics include:
- Policy cash values accumulate on a tax-deferred basis.
- Policy death benefits are received income tax-free.
- Policy cash values may be accessed on a tax advantaged basis. Please keep in mind loans and partial withdrawals may decrease the death benefit and cash value and may be subject to policy limitations and income tax.
Types of Life Insurance
Term – Provides death benefit coverage for a specified time period. Premiums may increase annually (annual renewable term) or remain level for period of time (e.g. 10 years) before increasing. Typically provides the lowest initial cost and the highest long term cost for coverage. Policies may be convertible to a permanent insurance policy for a limited period of time from as little as 2 years to possibly as late as age 65. Term insurance differs from permanent insurance in that term insurance does not accumulate cash value while permanent coverage has a cash value component.
Whole Life – Permanent death benefit coverage characterized by strong guarantees and premium payments until death of the insured. A purchaser of whole life typically sacrifices premium flexibility for the guarantees found in the contract. If the premium is paid as scheduled, the death benefit is guaranteed. Deviation from the premium schedule normally results in loss of the death benefit guarantee. Premiums for whole life are normally the most expensive compared to the other policy types.
Universal Life – Permanent death benefit coverage recognized for its premium flexibility and cash value accumulation. The amount and timing of premium payments is flexible as long as policy cash values are sufficient to pay for the cost of insurance coverage. Typical death benefits options available include a level death benefit or an increasing death benefit. The increasing death benefit is usually a level amount plus either an amount equal to the cash value of the policy or an amount equal to the cumulative premium payments. When initially introduced, universal life insurance did not offer guarantees comparable to whole life contracts. However, in recent years many policies have begun to offer competitive death benefit guarantees if a minimum premium amount is satisfied. Of course, death benefit guarantees are dependent on the claims paying ability of the insurance company.
Annuity (Pension) Plan
Annuities are practically the same as pensions.101 We all know that each and every person is going to retire at some time or the other and the greatest risk after retirement is the lack of income, or a reduced earning capacity. To take care of this, different insurance companies have devised different plans providing annuity. A contract providing for regular periodic payments during a specified period is an annuity contract. It is designed to generate regular income for senior citizens when they retire.103 Once the pension starts, insurance protection is removed. The pension can be had monthly, quarterly, half yearly or yearly.
Endowment Assurance Policy
This is the most popular policy. There is a wonderful mixture of risk coverage and provision for old age in this policy scheme. If the holder dies while the policy is in force, his survivors get the compensation in the form of the sum assured. At the end of policy period, if he is alive, he gets the policy amount. These policies are both with and without bonus. This is considered to be a model insurance policy, and over 60 percent of all the policies are taken out under this scheme.113 It is suitable for middle aged to elderly professionals whose dependants might need assistance in clearing their debts in case of their unexpected demise. This policy bears no surrender value.
Single Life Coverage – This coverage provides death benefit protection on the life of one insured. Policy proceeds are payable at the death of the insured. This coverage is used for a variety of concepts.
Joint Life Coverage – Also known as second-to-die and survivorship life insurance, this coverage provides death benefit protection on two insureds. Policy proceeds are payable at the second death of the two insureds. This coverage is typically utilized in an estate planning context where use of the unlimited marital deduction allows estate tax to be avoided at the first death with the tax paid at the second death.
First-to-Die Coverage – This coverage provides death benefit protection on a small group of insureds. Policy proceeds are payable at the first death among the group. Typically purchased only in a business situation for buyout of an ownership interest at death, first-to-die coverage availability has been on the decline in recent years due to its complexity and the increased affordability of other coverage types.
Purposes of Life Insurance
Life insurance is used in many personal, business and charitable contexts. Some of the most common uses of life insurance are:
- Key Employee: provide funds to aid in the search for a replacement in the event of death of a key employee.
- Executive Recruitment and Retention: used to provide a variety of non-qualified benefit programs to help attract and retain key employees.
- Business Continuation: provide funds to aid in the continuation of business in the event of death of a key revenue generator.
- Succession Planning: provides liquidity to purchase the ownership interest of a deceased owner.
- Debt Protection: creates a pool of money that can be used to pay off lines of credit.
- Family Protection: provides a source of cash for surviving family members to utilize for living expenses.
- College Funding: provides a funding source for college education of children or grandchildren.
- Debt Protection: generates cash to pay off an existing mortgage or other personal debt.
- Wealth Creation: provides funds to leave as an inheritance or to equalize inheritances among family members; provides funds for special needs trusts.
- Estate Tax Liquidity: creates liquidity to pay estate taxes rather than requiring liquidation of existing estate assets.
- Gifting Leverage: leverages the use of the annual gift tax exclusion, the applicable exclusion, and/or Generation Skipping Transfer Tax exemption.
- Wealth Replacement: used with many charitable gifting programs to replace for heirs the value of estate assets that were gifted to charity.
- Gift Creation: used to create a significant donation to charity at death.
- Gift Leverage: used to maximize the eventual charitable donation at the death of the insured.
Principles of life insurance
Life insurance operates on some basic principles common to many individuals. How the policy works is actually a function of the fact that many individuals come together as a group, and each person shares in the risk of death of the other people in the group. Life insurance companies manage this risk quantitatively and provide an organized structure for the transfer of risk from one individual to a large group of individuals.
Law of Large Numbers
All life insurance policies operate on the principle of the law of large numbers. Insurance companies must use a large sample size of the population to predict death rates. While no one single person’s death can be predicted, the law of large numbers allows insurers to predict death rates by looking at a large group of people. A large sample size means that a probability can be predicted as a percentage of the population. Insurers have gotten to the point where they can predict death rates every year with very good accuracy.
Life insurance requires the principle of insurable interest. The person who is insured under the contract must have some kind of personal relationship to the policyholder. In order to purchase insurance on the life of another person, you must have a personal and economic interest in the other person’s life. A person buying life insurance on the life of a stranger is doing nothing more than investing in the other person’s death. Life insurance companies would not be able to accurately predict mortality rates if this was allowed to occur, and if their contracts were allowed to be used for unethical or illegal purposes, such as buying a life insurance policy on someone and killing them or having them killed.
Transfer of Risk
The transfer of risk is essential to life insurance. You do not retain the risk of death in your life insurance policy. Instead, this risk is spread out among all policyholders that the insurer does business with. All customers of the insurance company contribute money to the general account. This money is invested, and then claims are paid out when an individual from the group dies.
Jesus Huerta deSoto describes life insurance as a perfected savings. You purchase a death benefit for your family’s future. However, the contract actually matures at a predetermined age, or after a preset time. With permanent insurance, this is most obvious. A whole life insurance policy, for example, matures at age 100. If you die prior to this age, the insurer pays the money to your family. But, the policy builds a cash reserve during your lifetime. If you live to age 100, the cash reserve equals the death benefit and the insurer pays out the death benefit to you.
Contract of life insurance
A contract of insurance is a contract either to indemnify a person against a loss which may arise on the happening of an event or to pay a sum of money on the happening of some or any event for an agreed consideration. Under such a contract one party agrees to take the risk of another person‟s life, property or liability in consideration of certain comparatively small periodic payments.
Nature of Life Insurance Contract
The nature of contract of life insurance may be summarized under the following heads:
It is that type of contract where only one party to the contract makes legally enforceable promise.Here it is the insurer who makes an enforceable promise. The insurer can repudiate the contract of payment of full policy, but he cannot compel the insured to pay the subsequent premiums. On the other hand, if the insured continues to pay the premium, the insurer has to accept them and continue the contract.
Contract of Utmost Good Faith
An insurance contract is a contract of utmost good faith and therefore, the contracting parties are placed under a special duty towards each other, not merely to refrain from active misrepresentation but to make full disclosure of all material facts within their knowledge.54 It has been said that „there is no class of documents to which the strictest good faith is more rightly required in courts of law than policies of insurance‟.55
Life insurance is subject to the conditions and privilege provided on the back of the policy. The conditions put the obligation on a party to fulfill certain conditions before the proof of death or of disability are the parts of the contract. The conditions whether precedent or subsequent of the legal rights must be fulfilled in order to complete the contract.
Contract of Certain Amount
The life insurance contract does not provide an indemnity. It is in the nature of a contingency contract by providing for the payment of the agreed amount on the happening of the event.
Difference between life insurance and other insurances
The primary point of distinction between life insurance and fire and marine insurances is that the subject matter of insurance in the former is human life, which is invaluable in terms of money and further the event insured against is death, which is a certain event; while in fire and marine insurance, the subject matter of insurance is property or a ship, which has economic value and the event insured against is fire or maritime peril which may or may not occur. The difference between life insurance and other forms of insurance flow from the following characteristics:
1. Life insurance is not a contract of indemnity but fire and marine insurances are contracts of indemnity and the assured cannot recover more than the actual loss suffered by him.
2. In life insurance, the event insured against is death which is a certain event.116 The uncertainty lies only in the time when it occurs. In fire and marine insurances, the event insured against may not happen at all.
3. In life insurance, the insurable interest need to exist only at the time of the contract but in fire and marine insurances, the assured must have an insurable interest at the time of loss.
4. In life insurance, the insurable interest is incapable of being valued in terms of money. In fire and marine insurances the insurable interest is capable of valuation in terms of money and so where there is gross over-valuation, the policy may become void as a wager.
5. In life insurance, the contract is for a longer duration or generally for whole life and is a continuous contract and cannot be cancelled by the insurance companies, however, if the premium is not paid annually or at stated intervals the contract may lapse. In fire and marine insurances, the contract is for short time, usually year to year only, and the insurance automatically comes to end after the expiry of the year.
6. The life insurance possess the elements of protection as well as investment but other forms of insurance only involves the element of protection.
7. The principle of subrogation is not applicable to life insurance whereas it applies to other forms of insurance, fire and marine. 8. Life insurance contract provides credit facility but against other forms of insurance policies credit cannot be obtained.
Life insurance is a financial cover for a contingency linked with human life, like death, disability, accident, retirement etc. It provides a definite amount of money in case the life insured dies during the term of the policy or becomes disabled on account of an accident.138 When a human life is lost or a person is disabled permanently or temporarily there is loss of income to the household. So everyone who has a family to support and is an income earner needs life insurance. The idea underlying the concept of life insurance is that „when your family members or dependents depend on you financially: you need to secure their future‟. Having your life insured is akin to promising your family that they won’t ever face a financial problem, whether you are there or not because your responsibilities do not end with you. It means buying life insurance is like buying peace of mind for lifetime. Thus, the significance of having a life insurance lies in the “peace of mind” that it brings along. Apart from this it promotes savings, assist the family in odd situations, gives tax benefits and facilitates easy loans thereby securing the future of insured. But in order to have a financially secured future, you have to pay the insurer a “life insurance premium”, which is either a regular annual payment or onetime payment as the case may be.
Life Insurance is the most popular form of Insurance as it transfers the financial risks associated with your death to an insurance company. General Insurance like fire, marine, property, vehicle etc. transfer the risk associated with your property to an insurance company so that you don’t have to pay out of pocket for any property damage covered under the terms of the insurance policy. The central point of difference between the two is that life insurance is a non-indemnity policy and the event insured is certain.