Common life insurance terms
Allianz Life Insurance Company of North America
Like most industries, life insurance has a language all its own.
This glossary may help explain some of the most common terms.
1035 exchange – Exchanging occurs when one life insurance policy is replaced with another. The rules governing taxation of life insurance contract exchanges are spelled out in Internal Revenue Code Section 1035 (thus, the term “1035 exchange”). There may be valid reasons to exchange a life insurance policy (for instance, if an insurer becomes insolvent, or if another policy offers a benefit to the client not available on the current policy). In general, under Section 1035 consumers can exchange one life insurance contract for another without having to immediately pay income taxes. However, they must be careful to follow the rules to qualify for favorable tax treatment under Section 1035.
7-pay premium – The maximum premium that can be contributed within a policy’s first seven policy years without turning the policy into a modified endowment contract (MEC).
7702 corridor – Part of the “Guideline Premium Test” for compliance with Internal Revenue Code 7702. Universal life insurance policies must maintain a difference between the cash value and the death benefit at all times. This difference is called the “corridor.” If the life insurance policy’s cash value approaches this corridor, the death benefit is automatically raised.
7702 test – IRC 7702 is a federal, statutory definition of life insurance policies that defines their taxation status. IRC 7702 mandates that cash value life insurance policies meet one of two tests for the life of the contract: The Guideline Premium Test or the Cash Value Accumulation Test. If the life insurance policy fails to meet both of these tests, it is treated as a combination of term insurance policy and a taxable side fund, and it loses its tax-deferred-growth status.
Accumulation value – The accumulation value is the greater of the current accumulation value or the guaranteed accumulation value.
At issue, the guaranteed accumulation value is equal to the net premium paid, minus the first monthly deduction. It is increased by any additional net premiums paid, interest credited at the guaranteed interest rate, and any earned bonuses credited. The guaranteed accumulation value will be decreased when there is a monthly deduction for benefits and expenses, partial surrender, or accelerated death benefit payment. Monthly deductions are based on the guaranteed maximum charges.
At issue, the current accumulation value is equal to the net premium paid, minus the first monthly deduction for benefits and expenses. It is increased by any additional net premiums paid, any index or interest credits, and any earned bonuses credited. The current accumulation value will be decreased when there is a monthly deduction for benefits and expenses, partial surrender, or accelerated death benefit payment. Monthly deductions are based on current charges.
Annual point-to-point crediting – A method of calculating indexed interest in which the value of each index is captured on the last business day before the contract is issued. It is then captured exactly one year later, and again on the last business day before each subsequent contract anniversary. The prior year’s index value is subtracted from the current year’s index value to determine how much the index has changed over that contract year. The difference is then divided by the prior year’s index value to determine the percentage of change that took place during the contract year. The participation rate and the annual cap are then applied to determine the indexed interest rate that will be credited to the portion of the policy value allocated to that index option for the contract year. If the result is a negative percentage, the portion of the policy value that is allocated to that index option will not lose any value, but it will receive no indexed interest for that contract year.
APS – Attending Physician’s Statement; copies of medical records, or summary of health completed by the proposed insured’s regular physician.
Autobind – The maximum amount of insurance coverage a carrier can automatically issue a client above their in-house retention limits, without getting prior approval from their reinsurer. Also called automatic acceptance limit, or binding limit.
Background check – Social Security verification, a credit check, and a court record/criminal history check completed by a third party; used as part of the underwriting process.
Basis or cost basis – The amount of premiums paid (plus any additions and reinvested earnings) that determines gains or losses at the time the policy is surrendered or the cash value is distributed.
Blood profile – Some underwriting cases may require a complete blood profile, which is drawn intravenously.
Burial expenses – One of the uses for life insurance; take burial expenses into account when determining how much life insurance a client may need.
Buy/sell agreement – One of the uses for life insurance in business planning. Sole proprietorships, partnerships, and closed corporations set up buy/sell agreements in case one of the owners dies or becomes disabled. The main goal is to provide enough money for the surviving partner(s) or owner(s) to purchase the deceased partner or owner’s share of the business.
Caps – A cap is a preset limit on the percentage of indexed interest that is credited to a policy each policy year under the annual point-to-point and monthly sum crediting methods. For annual point-to-point crediting, we apply an annual cap. If the percentage change for an index during a contract year exceeds its annual cap, the annual cap percentage is the indexed interest rate we credit to the policy. For monthly sum crediting, we use a monthly cap. If the monthly return for an index during a contract month exceeds its monthly cap, we use the monthly cap percentage to calculate the indexed interest rate we credit to the policy. Annual caps and monthly caps are declared at the beginning of each policy year and are guaranteed for the policy year.
Cash surrender value – The amount available to the policyholder if a cash value life insurance policy is surrendered (canceled). The cash surrender value is equal to the cash value of the policy, minus any surrender charges imposed by the insurer and any policy loans and interest that were outstanding when the policy was canceled.
Cash value – The amount of money that accumulates in a permanent life insurance policy. The amount of the cash value is the premium paid, minus the cost of insurance and expenses. Depending on the type of policy, the cash value may also include interest and/or indexed interest.
Cash value accumulation test (CVAT) – One of the tests used to determine whether a policy meets the IRC 7702 definition of life insurance. This test limits the cash value of the policy relative to the death benefit. In other words, the cash value of the policy determines the minimum death benefit it can have. The CVAT is best used when putting large sums of money into the policy.
College funding – One of the alternative uses for the cash value and/or death benefit of a life insurance policy.
Conditional receipt – The conditional receipt provides coverage during the underwriting process. If the applicant is denied coverage, the conditional receipt is null and void, and the conditional coverage is rescinded. When using the Life Application Builder system, conditional receipt coverage begins when the signed “Life worksheet” and the entire first modal payment have been received at the home office.
Cost of insurance (COI) – The actual cost charged for the death benefit coverage. Generally it is quoted as a rate per thousand. This rate is applied to the “net amount at risk” on the policy and is deducted from the policy’s cash value.
Crediting methods – The amount of indexed interest credited to your client’s policy is calculated by the crediting method they choose. Crediting methods available on Allianz FIUL policies include annual point-to-point, monthly average, and monthly sum. If your clients earn any indexed interest during a contract year, we credit the interest to their policy at the end of that policy year.
Cross-purchase plan – One form of a buy-sell agreement that is generally used in a business partnership. Each partner buys a life insurance policy on the other partner’s ownership of the business. Each partner owns, pays the premium on, and is the beneficiary of the insurance policies on the other partners. If one of the partners dies, the proceeds from this life insurance policy are used to purchase the deceased partner’s business interest from his or her heirs.
Debt payment – One of the uses for life insurance. When determining how much insurance someone needs, consider their debt liabilities (e.g., a mortgage or car loans) that may need to be paid from the proceeds from the death benefit.
EKG – Electrocardiogram; measures the electrical activity of the heart. May be ordered as part of the underwriting process.
Entity purchase plan – One form of a buy-sell agreement that is generally used in a business partnership. In this plan each partner owns, pays the premium on, and is the beneficiary of the insurance policies on the other partners. If one of the partners dies, his or her interest in the business is purchased from his/her estate by the partnership, and distributed back to the surviving partners.
Estate-tax exemption – The federal estate-tax exemption is the amount of property that passes free from the federal estate tax after an individual dies. The federal estate-tax exemption amount was $3.5 million for deaths occurring in 2009. Estates of decedents who died in 2010 have a choice: 1. The estate is subject to the federal estate tax with an estate-tax exemption of $5 million and generally all property in the estate would have a stepped-up cost basis; OR 2. The estate is not subject to the federal estate tax at all but the property has a limited amount of cost basis increase. For deaths occurring in 2011 or 2012, the federal estate-tax applies (there is no choice as in 2010) and the estate-tax exemption amount is $5 million. Currently the federal estate-tax exemption is scheduled to be $1 million for deaths in year 2013 or beyond.
Exercise EKG – An electrocardiogram that is performed while the proposed insured walks on a treadmill; measures the heart’s response to stress. May be ordered as part of the underwriting process.
Facultative review – An in-depth, complete file review of an individual risk that is conducted by a reinsurer at the request of the ceding company; the reinsurer can accept or reject the offer, and may specify its own ratings or terms for the reinsurance.
Financial underwriting – Indicates that additional financial information is required before a life insurance policy can be issued; may need third-party verification of financial statement.
Guaranteed accumulation values – Allianz illustrates guaranteed accumulation values using the guaranteed minimum interest rate of 2.00%, the guaranteed maximum cost of insurance rates, and the guaranteed maximum policy fees and expenses.
Guideline premium and corridor test – As the name suggests, this qualification is actually two separate tests in one. The corridor test is an evaluation of the relationship between a policy’s death benefit and its cash value at any point during the life of the policy. To meet the eligibility requirement, the cash value must not be greater than a designated percentage of the policy’s total death benefit.
The second part of this qualification, the guideline premium test, considers the amount of premiums paid. If the policy fails to meet the requirements of both parts of the guideline premium and corridor test, it will not be granted qualification as a life insurance product. To meet the Internal Revenue Code’s definition of life insurance, a policy must satisfy either the cash value accumulation test or the guideline premium and corridor test.
Guideline premium or face amount – When solving proposals, solving for the guideline premium will give you the maximum level premium allowed to be paid into the policy for a given death benefit. Solving for a guideline face amount will give the lowest face amount allowed for a given level premium.
HOS – Stands for “Home Office Specimen;” refers to a urine sample requested by the underwriter.
Illustration – A hypothetical projection showing how the cash value of a life insurance policy may accumulate, based on certain assumptions. The illustration, however, does not guarantee actual policy values.
Income replacement – One of the uses for life insurance. When determining how much insurance someone needs, consider their beneficiaries’ ongoing income replacement needs.
Increasing death benefit (also known as Option B) – When applying for a universal life insurance policy, applicants are given a choice of death benefits. Option B increases the death benefit annually by the amount of cash value in the policy. The option choice can be changed at any time during the life of the policy.
Insurable interest – A relationship between the owner, insured person, or property and the potential beneficiary of the insurance. This requirement must be present when the life insurance policy is applied for, but doesn’t need to exist at the time of the insured’s death. Insurable interest exists because there is a reasonable expectation that the beneficiary will benefit from the continued life of the insured, or experience a loss at the death of the insured.
IR – Inspection report; completed by a third party. Allianz obtains this information through the personal history interview and background check.
Irrevocable life insurance trust (ILIT) – This type of trust is used for large estate plans, to remove an estate’s ownership and control of a life insurance policy. Without an ILIT, life insurance proceeds are included in the value of the estate, which may have estate-tax consequences.
Jumbo limit – For automatic reinsurance, the jumbo limit is the cap on the amount of coverage that may be in force and applied for with all insurance companies on an individual life. If the insurance applied for exceeds the jumbo limit, the application must be submitted for facultative review.
Key person insurance – One of the uses for life insurance in business planning, in which a company purchases insurance on the life of an employee whose death would adversely affect the company. The company is the owner, premium payer, and beneficiary of the policy.
Lapse – A policy will lapse if it doesn’t have enough cash value to support the cost of Insurance (COI) and other policy deductions, and if it also fails to meet the Guaranteed Death Benefit Test (if applicable). A policyholder is generally given 60 days to add more premium to prevent a policy from lapsing. A policy can also lapse if the premium is not paid.
Level death benefit (also known as Option A) – When applying for a universal life insurance policy, applicants are given a choice of death benefits. As its name implies, this option keeps the death benefit level for the life of the policy. The option choice can be changed at any time during the life of the policy.
Maturity date – The date on which a policy’s death benefit is equal to its cash value.
MD exam – A physical exam performed by a medical doctor, as part of the underwriting process.
MDI – Physical measurements including height, weight, pulse, blood pressure, and review of major body systems, completed by a medical doctor as part of the underwriting process.
MIB – MIB, Inc., which was formerly known as Medical Information Bureau, is a nonprofit membership organization of insurance companies that operates an information exchange on behalf of its members. If a proposed insured applies to an MIB-member company for life or health insurance coverage, upon request MIB will supply that company with the information it has on file (online at www.mib.com). For additional information refer to the Notice of Disclosure (NB5025), which is part of the application.
Model Regulation states – The following states have adopted the NAIC Model Regulations and may have different forms or application requirements: AL, AZ, CO, HI, IA, LA, MD, MS, MT, NC, NH, NJ, NM, OR, UT, VT. (For example, in Model Regulation states, forms NB3033 and NB 5040 are required to be sent in, regardless of whether a policy is being replaced.)
Modified endowment contract (MEC) – A life insurance policy becomes a MEC when it is funded with too much premium too early in the contract (for instance, if premium payments exceed the 7-pay premium limits). If a policy is defined as a MEC, withdrawals from the policy come out as gain first and are taxable, and may also be subject to the 10% IRS excise penalty. In contrast, withdrawals from a non-MEC policy come out premium first, and the death benefit remains income-tax-free to the beneficiary. To receive favorable federal tax treatments on distributions made during the lifetime of the insured (including loans), a life insurance policy must satisfy a 7-pay premium limitation during the first seven policy years. A new 7-year limitation will be imposed after certain material policy changes. The new limitation will be based on actual account values at the time of the change and may be different than illustrated.
Monthly average crediting – With monthly average crediting, the value of each index is captured on the last business day before the policy is issued. It is captured again 12 more times each year, on the last business day before each policy’s monthly anniversaries. At the end of the policy year, the 12 values are added together and then divided by 12 to find the average. The starting index value for that policy year is subtracted from this average, and the difference is divided by the starting index value to determine the percentage of change that took place during the policy year. If the result is positive, this is the indexed interest rate that we will credit to the portion of the policy value allocated to that index option for that policy year. If the result is a negative percentage, the portion of the policy value allocated to that index option will not lose any value, but it will receive no indexed interest for that contract year.
Monthly sum crediting – With monthly sum crediting, the value of each index is captured on the last business day before the policy is issued. It is captured again 12 more times each year, on the last business day before each of the policy’s monthly anniversaries. The prior month’s index value is subtracted from the current month’s index value to determine how much the index has changed over that contract month. The difference is then divided by the prior month’s index value to determine the percentage of change that took place during the contract month. For any month in which the monthly percentage of change exceeds the monthly cap for that index, the monthly cap percentage will be used to calculate the indexed interest rate the policy will receive. At the end of each contract year, we apply the participation rate to the total of the 12 monthly percentages (whether positive or negative) to determine the indexed interest rate that we will credit to the portion of the policy value allocated to that index option for the policy year. If the result is a negative percentage, the portion of the policy value that is allocated to that index option will not lose any value, but it will receive no indexed interest for that policy year.
Mortality table – An actuarial table showing people’s life expectancies and death rates depending on demographic factors such as gender and age used for calculating life insurance premiums.
MVR – Motor Vehicle Record; used in some cases to evaluate risk factors in underwriting.
Net amount at risk – The difference between the cash value and the death benefit of a policy, and the amount on which cost of insurance (COI) charges are based. For example, a policy with a $75,000 cash value and a $125,000 death benefit has a $50,000 net amount at risk.
Net cash value – The life insurance policy’s cash value, minus any outstanding loan(s).
Net payment cost index – This index can help consumers compare the cost of different universal life products by showing the annual cost per $1,000 of death benefit. For example, assuming a $100,000 death benefit and paying a level premium of $2,000 per year, the net payment cost index would be 20.0. For comparison purposes, the lower the number, the better. The net payment cost index can be found on the Supplemental Footnotes page of most universal life insurance policy illustrations.
Option A (Level death benefit) – A choice consumers make when applying for a universal life insurance policy. Option A keeps the death benefit level for the life of the policy, or until the cash value approaches the 7702 corridor, in which case the death benefit will be automatically increased to maintain the corridor. This choice will tend to have higher cash values compared to a policy using Option B (see below). The option choice can be changed at any time during the life of the policy.
Option B (Increasing death benefit) – A choice consumers make when applying for a universal life insurance policy. Option B increases the death benefit annually by the amount of cash value in the policy. Because the death benefit changes with the cash value, an Option B policy will generally have lower cash values than an Option A policy (see above). The option choice can be changed at any time during the life of the policy.
Participation rate – The participation rate determines how much of the percentage of indexed growth for an index option we use to calculate any indexed interest we credit to a life insurance policy. The percentage of indexed interest allowed by the participation rate will still be subject to the cap(s) for the selected index(es) and crediting methods.
PHI – Personal History Interview; a series of questions about the proposed insured’s health history, conducted over the phone by a representative from Allianz. Used as part of the underwriting process.
PM – Paramedical examination; can be performed in the proposed insured’s home or office by a nurse or a trained screener. Used as part of the underwriting process.
PMI – Physical measurements completed by a paramedic; can be performed in the proposed insured’s home or office. Used as part of the underwriting process.
Prequalification – A life insurance prequalification quote is based on the proposed insured’s risk profile. The final underwriting decision will depend on a full review of all the information obtained in processing the case.
Reconsideration – Reevaluation of the pricing classification of an in-force life insurance policy on an insured life, based on current evidence of insurability.
Reinsurance – Basically “insurance for insurance companies.” Most insurance companies use reinsurance to some extent, because it helps spread the risk pool by transferring some of the risk to another insurer.
Reinsurer – An insurance company that accepts the risk transferred from another insurance company in a reinsurance transaction; also called the “assuming company.”
Retention limit – The dollar amount or percentage of risk retained by the ceding company under a reinsurance agreement.
Section 162 bonus plan – One of the uses for life insurance in business planning. It allows an employer to give select employee(s) a pay increase, which the employee(s) use(s) to purchase a universal life insurance policy. Employers benefit because they can choose only specific employees, retain those employees, and possibly also get a tax deduction for the premium (consult a tax advisor). Employees get tax-deferred cash accumulation for their retirement in the form of the universal life insurance policy, with little or no out-of-pocket expense to them.
Split dollar plans – One of the uses for life insurance in business planning. Split dollar plans are an arrangement between an employer and an employee that involves “splitting” the premium payments, cash values, ownership, and death benefit proceeds of a life insurance policy. Employees can use their portion of the cash value to supplement their retirement income and provide a death benefit to their beneficiaries. Meanwhile, employers receive a portion of the death benefit equal to the total premiums paid into the policy.
Surrender cost index – The surrender cost index can help consumers compare the cost of different universal life insurance policies by showing the average basis for the “pure insurance cost” of each policy. For comparison purposes, the lower the number is, the better. The surrender cost index can be found on the Supplemental Footnotes page of most universal life insurance policy illustrations.
Table rating – A table rating is a percentage of premium increase above the standard rate. Table rating increases are typically caused by health issues, and each table is typically equal to a 25% increase in premium. Table ratings generally range from Table 2 (150%) through table 16 (500%).
Target premium – The target premium is used only to calculate the agent’s first-year commissions.
TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) – When universal life insurance policies started hitting the marketplace in the mid-1970s, many were being used as short-term investments to take advantage of tax-deferred growth. To close that loophole, Congress enacted TEFRA to provide a definition of universal life insurance products. In 1984, the provisions of TEFRA were expanded and refined with the addition of Section 7702 to the Internal Revenue Code.
Wash loans – Wash loans involve a policyholder who systematically takes loans on the cash value of a life insurance policy – at little or no cost – to produce an income-tax-free income stream. A word of caution: If the policy lapses before the policyholder dies, the entire loan balance becomes a taxable event.
For additional terms refer to such resources as the consumer glossary of terms on the National
Association of Insurance Commissioners website, at www.naic.org/consumer_glossary.htm.
This publication is designed to provide general information on the subjects covered. Pursuant to IRS Circular 230, it is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Allianz Life Insurance Company of North America, its affiliated companies, their representatives, and employees do not give legal or tax advice. Encourage your clients to consult their tax advisor or attorney.
Guarantees are backed by the financial strength and claims-paying ability of Allianz Life Insurance Company of North America. Products are issued by Allianz Life Insurance Company of North America, 5701 Golden Hills Drive, Minneapolis, MN 55416-1297. 800.950.7372 www.allianzlife.com
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