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Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION AND INDIVIDUAL LIFE INSURANCE .......................3 CHAPTER 2: REGULATION OF THE INSURANCE INDUSTRY ...................................5 CHAPTER 3: INTRODUCTION TO RISK AND INSURANCE .........................................8 CHAPTER 4: MEETING NEEDS FOR LIFE INSURANCE .............................................14 CHAPTER 5: THE INSURANCE POLICY ........................................................................18 CHARTER 6: PRICING LIFE INSURANCE. ....................................................................21 CHAPTER 7: TERM LIFE INSURANCE...........................................................................25 CHAPTER 8: PERMANENT LIFE INSURANCE AND ENDOWMENT INSURANCE.28 CHAPTER 9: SUPPLEMENTARY BENEFITS .................................................................34 CHAPTER 10: LIFE INSURANCE POLICY PROVISIONS.............................................40 CHAPTER 11: LIFE INSURANCE BENEFICIARY POLICIES.......................................46 CHAPTER 12: ADDITIONAL OWNERSHIP RIGHTS.....................................................48 CHAPTER 13: PAYING LIFE INSURANCE POLICY PROCEEDS................................55 CHAPTER 14: PRINCIPLES OF GROUP INSURANCE POLICY...................................59 CHAPTER 15: GROUP LIFE INSURANCE. .....................................................................64 CHAPTER 16: ANNUITIES AND INDIVIDUAL RETIREMENT SAVINGS PLANS ...68 CHAPTER 17: GROUP RETIREMENT AND SAVINGS PLAN......................................78 CHAPTER 18: MEDICAL EXPENSE COVERAGE..........................................................83 CHAPTER 19: DISABILITY INCOME COVERAGE. ......................................................87 CHAPTER 20:TRADITIONAL GROUP HEALTH INSURANCE PLANS ......................91 CHAPTER 21: TRADITIONAL INDIVIDUAL HEALTH INSURANCE POLICIES......97 CHAPTER 22: MANAGED CARE PLANS .....................................................................102 CHAPTER 23: REGULATION OF HEALTH INSURANCE ..........................................105

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CHAPTER 1: INTRODUCTION AND INDIVIDUAL LIFE INSURANCE Insurance companies are organized as either  Stock Insurance companies Company has stock that is bought by shareholders. So company is owned by shareholders. These share holders get dividends. No. of companies: 1604 Income from Premium: 226 billion Dollar amount of Life Insurance in force: 9.8 trillion 

Mutual Insurance companies This type of company is owned by its policy owners. Policy owners receive dividends out of operating profits. No. of companies: 91 Income from Premium: 127 billion Dollar amount of Life Insurance in force: 6 trillion

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Fraternal Benefit companies Provided by a society to its members who share a common ethnic, religious etc. background. No. of companies: 135 Income from Premium: 4.1 billion Dollar amount of Life Insurance in force: 238 billion

Mutualization: It is harder to raise money being mutual insurance companies. So most companies start as stock company and then convert to mutual companies when they have enough funds. This process of converting from share insurance company to Mutual Insurance Company is called mutualization. Demutualization: Self explanatory Home office: Headquarter of Insurance Company. Home office

Reg. Off

Reg. Off

Reg. Off

Field Off

Field Off

Field Off

Field office also known as Branch office or agency office. Insurance companies are financial intermediaries. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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A financial intermediary is an organization which uses surplus amount of savers ( for insurance company it is premium) and invests that in other sectors. Individual and Group Insurance: Individual Insurance covers individuals where as Group Insurance covers a group of people. Life Insurance: A policy where insurance company provides some benefits if insured person dies. They are of 3 types: Term Insurance: Pays benefit if insured dies within the covered time period. No cash value Permanent Insurance: Provides coverage throughout insured’s lifetime. Cash value available Endowment Insurance: Is similar to Term since pays benefit if insured dies while covered or till a stated date. Has cash value available. Annuity: Annuity is a series of periodic payments. If insured’s die then instead of paying a lump some benefit to the nominees, it can be spaced out in equal installments. Health Insurance: Protection towards sickness, accident and disability. Types of coverage:  Medical expense coverage: o Hospital expense o Surgery expense o Physician expense Specified expense coverage:  Long Term care: like for old people who need constant care and treatment  Dental coverage  Prescription Drug  Vision care  Dread disease coverage  Critical illness coverage

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CHAPTER 2: REGULATION OF THE INSURANCE INDUSTRY Every business must comply with several federal, state and provincial laws so that it operates in a fair manner. Insurance Regulation requires that the Insurance companies remain: 1. Solvent: They are able to meet their debts and to pay policy benefits when they come due 2. Conduct business fairly and ethically USA Regulations According to the McCarran-Ferguson Act (Public Law 15), regulations are made by State Government until the regulation made is adequate. If not, Congress interferes.  

Constitutional authority remains with Federal government State Government owns primary authority.

State Regulations State Insurance administration is governed by State Insurance Department (SID) under an Insurance Commissioner or State Superintendent of Insurance. SID ensures that the companies within the state comply with all state insurance laws and regulations. Most state regulations are similar in nature since they are based on a model by National Association Insurance Commissioners (NAIC). NAIC is a non-governmental organization consists of all state Insurance Commissioners. The NAIC develop model bill, a sample law that state insurance regulators are encouraged to use as a basis of state laws. To start business in a state, any insurance company requires two certificates:  Certificate of incorporation or corporate chapter: issued by state, required for any corporation to start its business in a state  Certificate of authority or license: issued by SID, only for insurance companies Solvency Regulation As per this regulation, the SID imposes a minimum limit on the amount of assets, liabilities and on owners’ equity. Assets = Liabilities + Owners’ Equity Assets: Cash and Investment Liabilities: Debts and future obligations (Policy reserves shares the large portion of liabilities for a insurance company) Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Owners’ Equity: Capital + Surplus (Capital is the money invested in the company by its owners, zero in case of a mutual insurer) The states oversee the Annual Statement, which each insurer prepares each calendar year and files with SID. This is the accounting report of a company. The NAIC has developed the format of this statement that is accepted by all state. Also the state regulators conduct an on-site examination to manually check the insurer’s business records, usually on every 3 to 5 yrs. In case an insurer become financially unsound, the State Insurance Commissioner have the authority to take certain actions: In case of domestic insurer (incorporated by the state): It can rehabilitate or liquidate, depending on the condition of the company. In case of a foreign insurer (incorporated under the laws of another state): Revoke or suspend the insurer’s license to operate in the state. Life and Health Guaranty Association: An organization that operates under the supervision of the SIC to protect policy owners, beneficiaries and specified others against losses that may occur in case of insolvency. This association provides funds to guarantee payment for certain policies up to stated limits. Regulation of Market Conduct Market Conduct Laws: This law regulates how insurance companies conduct their business within the state. As per this law, they perform periodic market conduct examinations of the insurers. Marketing of Insurance products: In order to obtain an agent’s license, a prospective agent must  Be sponsored for licensing by a licensed insurance company  Complete approved educational course work/ or pass a written examination  Provide a reputable character certificate The agent’s license must be typically renewed each year. A state may revoke a license if he/she engages in certain unethical practices and violates the state’s insurance laws. Policy Forms: It is a standardized contract forms that shows the terms, conditions, benefits and ownership rights of a particular insurance product. An insurance company must file this forms and receive the SID’s approval before launching a new product. SID may ask the company to revisit the form for reducing jargons so that it could be clearer to the general public. Federal Regulations  

This applies to the sale of investment type insurance product. Businesses that sell securities must comply with Securities and Exchange Commission (SEC). Ex: Variable life insurance, Variable annuities

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 

Before selling these products, the sales agent must be registered with the National Association of Securities Dealership (NASD). Employee benefit plans must comply with the terms of Employee Retirement Income Security Act (ERISA).

CANADA Regulations Unlike a US insurance company, a Canadian company may be incorporated under the authority of either the Fed government or one of the provincial governments. Federal Regulations The Insurance Companies Act is the primary Federal law that governs specified insurance companies operating in Canada. Companies that must comply with this act are: Federally incorporated insurers, Foreign Insurers (insurers incorporated in countries other than Canada) and specified provincially incorporated insurers. Office of the superintendents of financial institutions (OSFI): A federal agency that is responsible for overseeing all financial institutions in Canada including all life and health insurance companies. This institute runs under the direction of Superintendents of financial institutions (SFI). Every insurance company must file an Annual Return with the OSFI. This gives the financial statement of the company. OSFI also examine financial conditions of a company on a periodic basis (usually on every 3 year, but it may be anytime) SFI may take control or declare a company as insolvent or obtain a court order to liquidate to company if finds it financially unsound. Canadian Life and Health Insurance Association (CLHIA): An industry association of life and health insurance Company operating in Canada. Canadian Life and Health Insurance Compensation Corporation (CompCorp): It is a federally incorporated, non-profit company established by CLHIA to protect Canadian consumers against loss of benefits in the event of a life and health insurance company becomes insolvent. CompCorp collects money from all its member companies to fund these guaranteed payments. Provincial Regulations In most respects, laws to regulate insurance companies operating in different provinces are similar in all provinces except from Laws of Quebec. This is because the Quebec law is based on a Civil Law system but other jurisdictions’ laws are based on a common law system. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Office of the Superintendent of Insurance: An administrative agency, established in each province to enforce the province’s insurance laws and regulations. It operates under the direction of an individual known as the Superintendent of Insurance. The various provincial Superintendents of Insurance have voluntarily formed a collective body known as the Canadian Council of Insurance Regulators (CCIR). The purpose of CCIR is to discuss insurance issues and to recommend uniform insurance legislation to the provinces. The CCIR has adopted Superintendents’ Guidelines, a series of recommendations that concerns a variety of matters. These guidelines were developed in cooperation with the insurance industry, working through its industry association, the CLHIA. Solvency Regulation These laws require the Office of the Superintendent of Insurance to supervise companies that were incorporated by the province and to examine those companies periodically. Also the insurance company should obtain a license from the office to start business in a particular province. Most of the licensing requirements seek to ensure that insurance companies are financially able to provide the benefits they promise to pay when they issue insurance policies. Regulation of Market Conduct Unlike requirements in the US, however the provinces do not require that all policy forms be filed before being issued but the insurers are required to file policy forms in only two situations: 1) As a condition of obtaining a license to conduct an insurance business within the province 2) Before marketing a variable life insurance contract in the province The provinces also regulate many of the marketing activities of the companies to: 1) Prohibit from unfair trade practices, false or misleading advertisement 2) Agent should get the license form the state before marketing in that state. The licensing requirements are similar to requirements in the United States.

CHAPTER 3: INTRODUCTION TO RISK AND INSURANCE Concept of Risk: Risk exists when there is uncertainty about the future. Types of Risk: Both individual and businesses experience 2 kinds of risk. a) Speculative risk. b) Pure risk.

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What is speculative risk? This involves 3 possible outcomes: loss, gain or no-change. Example: Your purchase shares of stock. This is a speculative risk you are taking. If the value of the stock raises you gain. If the value of the stock falls you lose. If the value of the stock remains the same there is no change. What is pure risk? This involves no possibility of gain. Either there is a loss or no loss occurs. Example: The possibility of a professional getting physically disabled. If the disability renders the professional incapable of continuing in his profession, he suffers from a financial loss. If the professional does not get disabled he will incur no loss from that risk. Which type of risk is insurable and why? Pure risk is insurable. Speculative risk has the possibility of financial gain. The purpose of insurance is to compensate for financial loss. Hence speculative risk is not insurable. Risk Management: Risk management involves identifying and assessing the financial risks we face. In order to eliminate or reduce our exposure to a specific financial risk we may choose any of at least 4 options: a) Avoiding risk For example: One can avoid the risk of personal injury that may result from an air crash by avoiding travel by airplane. b) Controlling risk We can try to control risk by taking steps to prevent or reduce losses. For example: A shop owner might control the risk of suffering financial loss due to his shop burning down by installing fire extinguishers and banning smoking inside the shop. This way he reduces the likelihood of a fire breaking in his shop and also lessens the extent of damage in case of a fire. c) Accepting risk When an individual or a business assumes all the financial responsibility for a risk.

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Self-insurance This is a risk management technique by which a person or business accepts the financial responsibility for financial losses associated with a particular risk. d) Transferring risk When the financial responsibility for an associated risk is transferred from one party to another (generally in exchange of a fee), it is called transferring of risk. A most common example is purchasing an insurance coverage. Policy Written document that contains the terms of the agreement between the insurance company and the owner of the policy. This is a legally enforceable contract. Policy benefits or policy proceeds

The amount of money that the insurance company agrees to pay – when a specific loss covered by that policy occurs. Premium The fee that the insurance company takes from the owner of the policy in exchange of assuming the financial responsibility for losses incurred, if the specific risk covered by the policy occurs. What are the three types of pure risks that are generally covered by insurance companies? Property damage risk: risk of economic loss to your automobile, home or other personal belongings due to accident, theft, fire or natural disaster. Property insurance covers a property damage risk. Liability risk: risk of economic loss resulting from you being responsible for harming others or their property. Liability insurance covers a liability risk. Property and Casualty insurance or Property and Liability insurance Covers a property risk as well as a liability risk. The insurance company offering such insurance is called a Property and Casualty insurer or a Property and Liability insurer. Personal risk: Risk of economic loss associated with death, poor health, outliving one’s savings. Life and health insurers sell insurance policies to provide financial security from personal risk. How an insurance company can afford to be financially responsible for the economic risks of its insureds?

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Insurers use a concept called risk pooling. If the economic losses that actually result from a given peril, such as disability, can be shared by large numbers of people who are all subject to the risk of such losses and the probability of loss is relatively small for each person, then the cost to each person will be relatively small. Characteristics of Insurable risks: 1) The loss must occur by chance. (Unexpected event, not intentionally caused by the person covered) 2) The loss must be definite. (In terms of time and amount) 3) The loss must be significant. (In financial terms) 4) The loss rate must be predictable. (The probable rate of the loss must be predictable) 5) The loss must not be catastrophic to the insurer. (A single or few occurrence of the loss must not cause or contribute to catastrophic financial damage to the insurer) Classification of policies: Depending on the way in which a policy states the amount of the policy benefit, every insurance policy can be classified as being either of the following: Contract of indemnity: amount of the policy benefit payable for a covered loss is equal to the amount of the covered financial loss determined at the time of the loss or a maximum amount stated in the contract, whichever is less. Example: Many types of health insurance policies. Valued Contract: specifies the amount of benefit that will be payable when a covered loss occurs, regardless of the actual amount of the loss that was incurred. Example: Most life insurance policies. Some other important terms: Face amount: The amount of the benefit that is listed in the policy. Claim: The request for payment under the terms of the policy. Law of large numbers: It states that, typically, the more times we observe a particular event, the more likely is it that our observed results will approximate the “true” probability that the event will occur. Mortality tables: Charts that indicate to a great degree of accuracy the number of people in a given group (of 100,000 or more) who are likely to die at each age. Morbidity tables: Charts that indicate to a great degree of accuracy the incidence of sickness and accidents, by age, occurring among a given group of people.

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Reinsurance: is the insurance that one insurance company- known as the ceding company-sells to another insurance company-known as the reinsurer. Retention limit: The maximum amount of insurance that the insurer is willing to carry at its own risk on any one life without transferring some of the risk to a reinsurer. Retrocession: When a reinsurer cedes risks to another reinsurer then that transaction is called a retrocession. The reinsurer to which the risk has been ceded is called a retrocessionaire.

People who are involved in the creation and operation of an insurance policy Applicant: The person or business that applies for an insurance policy. Policy owner: The person or business that owns the insurance policy. Insured: The person whose life or health is insured under the policy. Third-party policy: When one person purchases insurance on the life of another person. Beneficiary: The person or party the policy owner named to receive the policy benefit.

Assessing the Degree of Risk Underwriting: This is the process of identifying and classifying the degree of risk represented by a proposed insured. There are 2 primary stages in this process: 1) Identifying the risks that a proposed insured presents. 2) Classifying the degree of risk that a proposed insured represents. Underwriter: The employee of the insurance company who is responsible for underwriting.

Identifying risks Insurers cannot predict when a specific individual will die, become injured, or suffer from illness. But there are a number of factors that can increase or decrease the likelihood that an individual will suffer a loss. The most important of these factors are the following: Physical hazard: Physical characteristic that may increase the likelihood of a loss. Example: A person with a history of heart attacks possesses a physical hazard that will increase the likelihood that the person will die sooner than a person of the same age group and sex without such a physical hazard. Moral hazard: The likelihood that a person may act dishonestly in the insurance transaction.

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Example: An individual with a confirmed record of illegal behavior is more likely to defraud an insurer than is a person with no such records.

Classifying risks The purpose of classifying a proposed insured into an appropriate risk category is to enable the insurer to determine the equitable premium rate to charge for the requested coverage. Underwriting guidelines: Rules of risk selection that are applied by underwriters to classify proposes insureds. The insurer establishes these guidelines. Generally the risk categories that are identified by all underwriting guidelines are: a) Standard risks: Proposed insureds that have the likelihood of loss that is not significantly greater-than-average. Premium rates that they are charged are standard premium rates. b) Substandard risks: Proposed insured who have significantly greater –thanaverage likelihood of loss but are still found insurable. This category is called special class risks. Premium rates that they are charged are higher and are called the substandard premium rate or special class rate. c) Declined risk: Proposed insureds that are considered to present a risk that is too great for the insurer to cover. d) Preferred risks / Super Preferred risks: Proposed insureds that present a significantly less-than-average likelihood of loss. They are generally charged a lower than standard premium rate.

Insurable Interest Requirement Laws in all states and provinces require that when an insurance policy is issued the policy owner must have an insurable interest in the risk that is insured- the policy owner must be likely to suffer a genuine loss or detriment should the event insured against occurs.

Insurable interest requirement in health insurance For health insurance an insurable interest exists if the applicant can demonstrate a genuine risk of economic loss should the proposed insured require medical care or become disabled.

Insurable interest requirement in life insurance An insurable interest exists when the policy owner is likely to benefit if the insured continues to live and is likely to suffer some loss or detriment if the insured dies. The figure below shows the family tree of a certain insured. The circles in the bold outline depict the relationships that create an insurable interest in the life of the insured.

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Grandmother

Grandfather

Aunt

Mother

Father

Uncle

Cousin

Spouse Sister-inlaw

Brother

Child’s spouse

Child Niece

Sister

Insure

Nephew

Grandchild

CHAPTER 4: MEETING NEEDS FOR LIFE INSURANCE Points to remember: 1) Insurance Agent / Sales Agent is an authorized person by an insurance Co. to represent the Co. in its dealings with applicants for insurance. 2) Insurance meets (a) Individual / Personal needs I. Funds to cover final expenses II. Dependents’ support III. Education costs IV. Retirement income V. Others (b) Business needs 2.a.I. Funds to cover final expenses Estate: All things of value, called “Assets”. Assets include cash, bank & investment A/Cs, real estate, and ownership interests in business.

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Estate Plans: A plan to settle one’s Estate as per one’s wishes. The Estate Plan considers the amount of assets and debts that one is likely to have when one dies and how best one can preserve those assets so that that can be passed to one’s heirs. Note: Settling an estate means identifying & collecting the deceased’s property, filing any required tax forms, collecting all debts owed to the deceased, and paying all outstanding debts owed by the deceased. 2.a.II. Dependents’ support To provide funds to support the family members, if the financially supporting member dies, until they obtain new methods of support or until they adjust to a lower income. In addition, LIP (Life Insurance Policy) can be used to supplement the family’s expense, which is tax-free as well. 2.a.III. Education costs To insure the education of the children even after the death of the parents. 2.a.IV. Retirement income To provide support to individuals with retirement income. LIP’s accumulated savings will not be reduced if the Company’s investments lose money, rather guarantees that owner will earn at least a specified interest rate on Moreover, LIPs provide income tax advantages.

Permanent Insurance the policy his funds.

2.a.V. Other Personal needs for LI To donate the proceeds of the LIP to a charitable organization, such as a Church or an Educational Institution. In this case, the premiums are deductible for federal income tax purposes. 2.b. Business needs A Key Person is a person / employee whose continued participation in the business is necessary to the success of the business and whose death would cause a significant financial loss. A Business Continuation Insurance Plan is an insurance plan designed to enable a business owner (or owners) to continue business operation if the owner or the Key Person dies.

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A Closely Held Business is a sole proprietorship / partnership / corporation that is owned by only a few individuals. This might need to establish a BCIP. Liquidation is the process of selling off for cash a business’ assets of the deceased, such as its building, inventory, etc, and using that cash to pay the business’s debts. Any funds remaining are then distributed among the owners of the business. Buy-Sell Agreement is an agreement in which (1) one party agrees to purchase the financial interest that the 2nd party holds in the business following the 2nd party’s death and (2) the 2nd party agrees to direct his estate to sell his interest in the business to the purchasing party. The BSAs vary based upon the form of the business organization as follows: Buy-Sell Agreements

Sole Proprietorship BSA

Partnership BSA

Closely Held Corporation BSA 1) Sole Proprietorship BSA: Here the 1st party is the owner and the 2nd party is an employee having the ability & the drive to take over the business after the owner’s death. The 1st party will identify the 2nd party. The 2nd party, however, may not have sufficient assets to fund the purchase of the business. In that case, individual LIP is the common way to fund for him. 2) Partnership BSA: Here the 1st party is one partner & the 2nd party is the other partner(s). The purchase of the deceased partner can be accomplished by one of the two methods – (I) Cross Purchase Method or (II) Entity Method. (I)

In Cross Purchase Method, each partner agrees to purchase a proportionate share of the deceased partner’s interest in the partnership. Each partner funds the BSA by purchasing an insurance policy on the life of each of the other partners. Thus each partner owns, pays the premium on, and is the named beneficiary of a policy on the life of each of the other partners. When a partner dies, other partners receive the proceeds of a LIP and can use those proceeds to purchase the proportionate of the deceased partner’s ownership interest in the partnership.

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(II)

In Entity Method, the partnership, rather than the individual partners, agrees to purchase the share of the deceased partner and distribute a proportionate share of that ownership interest to the surviving partners. The partnership purchases an LIP on the life of each of the partners, pays the premiums and is the named beneficiary of each policy. When a partner dies, the partnership uses the LIP proceeds to purchase the deceased partner’s share in the business from the deceased’s estate.

3) Closely Held Corporation BSA: It is similar to the Partnership BSA. Here also they can have their BSA either in Cross Purchase Method or in Entity Method. In the Entity Method, the Corporation buys the policies on each of the owners’ lives. Key Person Life Insurance: A key person could be an owner / a partner / an employee of the business. In Key Person Life Insurance, the corporation owns, pays the premiums on, and is the beneficiary of the Insurance Plan. Life Insurance as an Employee Benefit: Here Employers pay for all or part of the employee benefits as part of the total package under which the Co. compensate its employees. Employers may even offer individual benefit plans to certain employees along with the one that all other employees receive. There are two types of individual life insurance benefit plans – (I) SplitDollar LIP and (II) Deferred Compensation Plan. (I) Split-Dollar LIP is an agreement under which a business provides individual LIPs for certain selected employees who share in paying the cost of the policies. The employer agrees to pay the portion of each annual premium that is equal to the amount by which the policy’s cash value will increase that year. The employee agrees to pay the remainder of the premium. If the employee dies while the policy is in force, in most such cases, the employer will receive an amount equal to what it paid for the policy; the beneficiary named by the employee will receive the remainder of the policy proceeds. If the employee retires or leaves the firm, the employee will be the owner of the policy but must reimburse the employer for the premiums it paid on the employee’s behalf. (II) Deferred Compensation Plans is a plan established by an employer to provide income benefits to an employee at a later date, such as the

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employee’s retirement, if the employee does not voluntarily terminate the employment before that date. For this the employee needs to defer a part of his/her current compensation until some future date. The employer uses this deferred compensation to purchase an insurance policy on the employee’s life. Thus the employer owns, pays the premium for and is the named beneficiary of that policy. Note that, the policy is not a part of the Deferred Compensation Agreement between the employer & the employee, rather is the funding instrument for the agreement.

CHAPTER 5: THE INSURANCE POLICY Contract: A contract is a legally enforceable agreement between 2 or more parties. The parties are bound to carry out the promises they made when entering into the contract, any violation would be termed as breach of contract and can be legally challenged. Types of Contracts: 1) Formal and Informal contracts. FORMAL The type of contract in which the requirements concerning the form of agreement are met E.g:- Lease deed agreement which an owner and tenant have to enter before the tenant can occupy the house.

INFORMAL (I) * The type of contract in which the requirement concerning the substance of agreement are met. E.g:- Life and health insurance contracts.

Should be in written form and the Can be Written or Oral. In Canada provincial laws require Document should have some form Seal however to be legally enforceable Insurance contracts to be in writing.

Advantages of written contracts in case of life and health insuarnce contracts a) The written contract puts to rest any sort of confusion over the terms of Agreement. Without it legal problems might arise. b) The written contract provides a permanent record of agreement.

2) Unilateral & Bilateral contracts. UNILATERAL (I) * BILATERAL (I) * Only one party makes the legally Both parties make legally enforceable enforceable promises. Promises so that both are contractually bound. E.g:- A life insurance policy is a Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Unilateral contract in the sense that Policy holder can discontinue as and when he wishes, however the Insurer is legally bound to provide to provide coverage in return for Stated premium as long as the Premium is paid.

3) Commutative and Aleatory contracts. COMMUTATIVE The parties specify values in advance that they would exchange, moreover items and services are exchanged between parties are of relatively equal values.

ALEATORY (I) * One party provides something of value to another in exchange for a conditional promise. Only if the event occurs promise must be performed. Services can be of unequal values.

E.g:- Life insurance policy in which the E.g:Construction of house where insurer pays the insured certain sum only owner pays the contractor a promised if the insured dies. sum when the house is completed.

4) Bargaining and Adhesion contracts. BARGAINING Both parties as equals set terms and conditions of the agreement.

ADHESION (I) * One party prepares it and the other accepts or rejects as a whole.

* The (I) indicates that insurance contract fall under this category. Contracts can also be classified on the basis of their legal status.  Valid contract: One that is enforceable at law.  Void: One that was never enforceable at law.  Voidable: A contract which is otherwise enforceable may have grounds to reject or to avoid it. Formation of valid Life/Health insurance contract involves 4 general requirements. 

The parties to the contract must manifest their mutual assent to terms of contract. In case of life/health insurance policies the parties reach this mutual assent through a process of “Offer” and “Acceptance” in which one party makes an offer and another accepts it.

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

The parties to the contract must have contractual capacity. The insurance company must have the legal capacity to issue policy. They should be licensed or authorised by proper regualtory authority to do business. As far as the individual is concerned he/she shouldn’t be a minor or lack mental capacity. A minor is a person who has not attained the age of majority (18 in Canada and in most states in the US). If a minor takes an insurance policy then the beneficiary must be a member of the minor’s immediate family. In case an insurer issues a policy to a minor, then the company has to provide the promised insurance protection. The minor, however avoid the policy and the company would have to return the paid premiums. The contract entered into by a mentally incompetent person is void. The contract entered into by a mentally impaired (drug addicts, drunker, or insane) is generally voidable by the mentally impaired person.

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The parties to the contract must exchange legally adequate consideration. The application and the first premium are usually considered for a life insurance contract. Until the first premium is paid a valid contract is not entered into.

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The contract must be for a lawful purpose. No contract can be made for a purpose which is unlawful. Such a contract is a void contract. E.g.:- A contract that requires one person to kill would never be legally enforceable. The primary purpose of all insurance is to protect against financial loss, not to Provide means of possible financial gain. If the insurable interest are not met A valid contract is not formed. However if the insurable interest is met at the Time the contract was made, a continuing insurable interest is not reqd.

These requirements must be met when life/health insurance policies are formed. Insurance policy as a property Property: A bundle of rights a person has with respect to something. It is of two types. Real Property: is land and whatever is growing on or affixed to the land. Personal Property: All property other than the real property. It includes tangible goods such as clothing, furniture, and automobiles, as well as intangible property such as contractual rights. The insurance policies are Intangible personal property, as it represents intangible legal rights that have value and that can be enforced by the courts.

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Ownership of Property: is the sum of all the legal rights that exist in that property. The legal rights an owner has in property include the right to use and enjoy the property and the right to dispose of the property. Rights of policy owner: 1) Right to name the beneficiary. 2) Right to dispose the policy.

CHARTER 6: PRICING LIFE INSURANCE. In order for an insurer to have enough money available to pay policy benefits when they become due, the insurer determines the premium the company must charge for the specific insurance coverage. In this chapter we shall discus the methods evolved over the years for determining life insurance premiums Methods of Funding Life Insurance. Mutual Benefit Method: - Here the money is collected after the death of the person who was insured. This method was also known as post death assessment method. Each member of a mutual benefit society agreed to pay an equal amount of money when any other member died. This method had three main drawbacks---- 1) Collection of money. 2) Recruitment of new members. 3) As the members grew older, the number of deaths increased in each year. Assessment Method: - Under this method the insurance company estimated their cost for certain period of time, usually for one year. The organization then divided this amount among the participants. This method also faced the same drawbacks as the above method. Legal Reserve System: - This is the modern pricing system and is based on proper calculation and collection of premiums for the death benefit of the insured. The premium is directly related to the amount of risk covered. This system is based on laws requiring that insurance company should maintain Policy Reserves. Premium Rate Calculations. Insurance Company employs specialist, known as actuaries, who are responsible for calculating the premium rates the company will charge for its products. Premium rates must be adequate for the company to have enough money to pay policy benefits. Premium rates must be equitable so that each policy owner is charged premiums that reflect the degree of the risk covered. The following factors govern the premium calculations:  Rate of mortality.  Investment earnings.  Expenses. Rate of Mortality. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Following are the key points: 1. Block of policies. 2. Mortality Tables. a) Expected mortality. b) Mortality experience.

Mortality Tables, therefore, are charts that show the death rates an insurer may reasonably anticipate among a particular group of insured lives at certain ages-that is, how many people in each age group may be expected to die in a particular year. Although the rates that actually occur may fluctuate from group to group, the fluctuations will tend to offset one another, being higher in one group and lower in the other. In general, the higher the mortality rate, the higher the premium will be charged. It is the task of the underwriter to evaluate the risk of a group and to fix the premium for the group. The risk is generally categorized as – Standard Risk, Substandard Risk, Decline Risk. Following are the important points about the Mortality Tables:  For both the sexes mortality rates start high at birth and decreases dramatically at age 1.  For both sexes the mortality rates steadily decreases until about an age of 10.  For males the mortality rates increases sharply during teenage years, decreases in the mid 20s and then rises again in the early 30s  At any given age the mortality rate for the women is lower than the corresponding mortality rate of males. Investment Earnings. Premium dollars are the primary source of funds used to pay life insurance claims. Because most policies are in force for some time before they become payable, insurance companies have premium dollars to invest. The earnings from these investments provide the company to charge fewer premiums. Any investment earning can be expressed as rate of return. Expenses. A policies net premium is the amount that the insurer should pay in order to provide the benefits. The net premium depends on 3 factors:  Mortality rate.  Investment Earnings.  Lapse rate. (The rate at which the policies are dropped due to nonpayment of premiums.) To this net premium the Insurance Company adds their operating costs, known as loading. This total amount is known as gross premium.

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The Level Premium Pricing System. The level premium system allows the purchaser to pay the same amount of premium amount each year the policy is in force. It is used to price whole life insurance, term insurance that provides coverage for than one year, and endowment insurance. In this system higher premium rates are charged, than what required, during the early years of the policy. The extra money charged is invested and the return is used to meet greater risks during the later stage of the policy. Policies with Nonguranteed Returns. In our discussion, however, we have assumed that once each pricing element is assigned a value and the premium is set for a particular policy, the pricing process is finished. That is not always the case. For several type of policy the price can change even after it has been issued The first method is by paying policy dividends. The second method is by changing pricing elements as the policy is in force. Policy Dividends. Insurance policies.

Participating policies.

Non participating policies.

Participating policies are the one where the policy owners share the company’s divisible surplus. Surplus is the amount by which company’s assets exceed company’s liabilities. The share of the divisible surplus that the policy owner receives is known as policy dividend. By issuing participating policies, insurance companies can return money to the policy owner when the condition is favorable, yet establish premium rates that will be sufficient to meet unfavorable conditions. A participating policy contains a policy dividend provision that gives the policy owner several choices in the way policy dividends can be used. These choices are known as dividend options. Laws in the United States and Canada do not require insurance companies to declare regular policy dividends; the only thing that they need to indicate is when they will declare policy dividends. Non-participating policies are the one where the policy owners do not share the divisible surplus. Generally the premium paid for non-participating policies is less than the premium paid for participating policies of the same type.

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Changes in Pricing Factors. Certain policies mention all the cost elements and their minimum and maximum value. Based on these such a policy may declare a minimum or maximum rate of return. When the insurer gives a high rate of return the cost of the policy is reduced. The cost also depends on mortality rate. If the experienced mortality rate is less than expected mortality rate then the price of the policy is effectively reduced. With reference to Chp-1 Stock Companies can issue both participating and nonparticipating policies. In the past Mutual Fund Companies issued only participating policies. Today Mutual Companies issues non-participating policies (with changing pricing factors) but in order to do so it demutualizes a part of it as a subsidiary Stock Company. Life Insurance Reserves.

Life Insurance Reserves Liabilities for the Policy Reserves.

Contingency Reserves.

Policy Reserves represents the amount an insurer estimates it will need to policy benefits. Insurance companies must acquire assets that will exceed policy reserve so that they have funds to claims. To calculate the policy reserve liability the companies uses conservative mortality table that shows higher mortality rate than other available tables. By using conservative mortality table the companies set aside a greater amount of assets against policy reserve than it will be necessary to pay the claims. At any moment of time the difference between the Face amount – the amount that will be paid as a death benefit – and the policy reserve is known as the insurance company’s net amount at risk for the policy. Therefore with time policy reserve increases and the net amount of risk decreases. Contingency Reserves: - An insurance company must be able to pay death claims even when the conditions are not favorable. As for example during an epidemic the mortality rate will increase rapidly and the policy reserve may not be sufficient to pay the death claims. In order to cope up with this kind of situations, a part of the loading added to net premium is kept as a reserve. This is known as Contingency Reserve.

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CHAPTER 7: TERM LIFE INSURANCE The type of policy where the insured is covered only for a particular period of time. Policy Benefit is payable if: 1. Insured dies during the specified time and 2. Policy is in effect. The specific period of time when the policy is active is called policy term. After the policy term ends insurance provides option of continuing insurance. If it is not continued then the policy coverage ends there. Policy anniversary: The date on which policy became effective. Term policy can be an independent policy or a rider also. A rider, also known as endorsement, is an amendment to an existing policy to either extend or curtail the benefits payable under the contract. Types of Term Insurance: 1. Level Term Life Insurance: 1. Death benefit remains the same throughout the policy term. 2. Thus Amount of each renewable premium remains same. 2. Decreasing Term Life Insurance:  The death benefit keeps on going down with time. Example: A $50,000 policy in first year, becomes $40,000 policy in 2nd year and so on.  The amount of renewable premium remains same . Types of Decreasing Term Life Insurance:  Mortgage Redemption Insurance This policy is designed to provide a death benefit amount that corresponds to the decreasing amount owed on a mortgage loan. The amount of the outstanding principal balance on a mortgage loan gradually decreases with time. It is designed so that the amount of benefit payable at any point of time equals the amount the borrower owes on the loan. The renewal premium of the policy is generally level throughout. When the insured dies the benefit is paid to the beneficiary. The intent is that the beneficiaries will payoff the balance on the loan using the benefit received. But the beneficiary is not bound legally to make the payoff. Therefore, mortgage lender puts condition to purchase this policy and put the name of the lender as beneficiary. Joint Mortgage Redemption Insurance: Same as Mortgage Redemption Insurance but covers a couple. The policy expires if both insured live throughout the policy term. If one of them dies other gets the benefit.

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 Credit Life Insurance This is a similar product but protects against loan or credit card bills. For this the lender is tied up as beneficiary and gets the payoff for the credit card balance from the benefit of the insurance The loan could be furniture loan, personal loan, car loan etc.  Family Income Coverage This policy provides a stated monthly income benefit amount to the insured’s surviving spouse if insured dies with policy term. The benefit continues till the end of the term specified. This is decreasing term since more the insured lives, lesser the amount insurer has to pay out as monthly benefit. Usually there is a minimum stated number of months that insurer ensures to pay. Example: A 10-year term policy which provides $1000 monthly family coverage benefit is owned by X and Y.The minimum stated year is 3. If X dies within the term 2 years from start of policy then benefit = $1000 * 12 months * 8years = $96,000 If X dies within the term 6 years from start of policy then benefit = $1000 * 12 months * 4years = $48,000 If X dies within the term 8 years from start of policy then benefit = $1000 * 12 months * 3years = $36,000 This policy can also be purchased as rider with a whole life insurance. 3. Increasing Term Life Insurance Just opposite of Decreasing Term Life Insurance. Use: This policy is used to encounter the rising living cost etc. So suppose a $10,000 policy may start like that and keep on increasing by 5% on every anniversary. The insured may choose to freeze this increase at some point of time. The premium increases with the increase in benefit. The policy might be added like a rider to a whole life insurance. Features of Term Life Insurance Policies:  Renewable Term Life Insurance: This is a feature which allows a insured to renew the policy without submitting proof of insurability for the same term and face amount. One year term policies and riders are usually renewable. They are known as YRT ( Yearly Renewable Term) or ART( Annually Renewable Term) insurance.

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Limitations: 1. Renewal might be limited to be continued till a certain age. 2. Renewal might be limited to happen only a certain number of times. During renewal, the premium is recalculated based on the attained age of the insured. This causes an increase since mortality risk of a person increases with age. Renewable policies are usually costlier than non-renewable ones.  Convertible Term Life Insurance: This is a feature which allows a insured to convert the policy to a whole life without submitting proof of insurability. Even if the health of the insured has deteriorated he cannot be excluded since proof of insurability cannot be demanded. Neither the health condition be used to calculate premium. Only factor to be considered is attained age. Limitations: 1. Renewal might be limited to be continued till a certain age. 2. Renewal might be limited to happen only during a certain time period of the term. Convertible policies are usually costlier than non-convertible ones. Since permanent insurance provides a cash value factor hence the premium also increases due to that. The new premium also depends on the effective date of conversion: The effective date could be of 2 types: 1. Attained age Conversion: This is the age of the insured when the conversion took place. 2. Original Age Conversion: This is the age when insured had the original term policy issued. The premium rate calculated using the attained age conversion is costlier than the original age conversion since the later is based on a younger age. Original age conversion is not allowed in most cases. If allowed then there might be limitation that attained age is not more than 5 years.

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CHAPTER 8: PERMANENT LIFE INSURANCE AND ENDOWMENT INSURANCE Difference between Term Insurance and Permanent Insurance: 1. Term Insurance provides coverage for a specific period of time whereas Permanent Insurance provides coverage throughout the lifetime of insured provided policy is inforce, i.e. active. 2. Term Insurance does not provide cash value whereas permanent does. Permanent Insurance also known as whole life Insurance. Cash Surrender value: The amount policy owner will get if he surrenders the policy at any point of time. Face amount: Typically, every policy has a cash value which keeps on increasing and eventually equals the face amount on the policy. This does not happen until the age 99 or 100. At that age cash value equals face amount. Policy Loan: Any whole life policy which has accrued a cash value can be used to take loan known as policy loan using the cash value as security. Premium payment period: 1. Continuous premium policy Premium is payable throughout the life of the Insured Since premium is payable throughout the life thus premium is usually less than any other policy type Also known as straight life or ordinary life insurance policy 2. Limited payment policy – fixed number of payments a. may be specific number of yrs. b. may be till certain age After all premiums have been paid it is called paid-up policy. If Insured dies before the end of specified last premium year then insurance will pay the death benefit to the beneficiary and no premium is payable Single premium policy: special case of limited payment policy. Only one premium payable. Reserve buildup speed: Golden rule: Shorter the installments faster the buildup. Thus from faster to slower order: Single Premium Policy-Limited payment policy-Continuous Payment Policy

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Modified Whole Life Insurance: 2 types: 1. Modified Premiums: Premium is low in beginning years and then it rises after that period one time to attain a level premium and that continues for the rest of the life. This is modified premiums. Sometimes, if the change of premium frequency is >1 and is attained after a series of change then it is known as Graded Premium Policy. Advantage: Policy owner can afford to buy a policy with higher face amount than he can presently afford. 2. Modified Coverage: Coverage is changed with increasing age. Advantage: If Insured thinks his coverage required might go down later in his/her life then this is an ideal choice. With time financial obligation of people goes down, like house loan paid off, children no more dependent etc. Joint Whole Life Insurance: Coverage to a couple. If one of them dies then survivor couple gets the benefit and coverage terminates. Also known as first-to-die life insurance. After the death of one spouse the surviving spouse Last Survivor Life Insurance: The benefit is paid only after both the insured has died and is paid to the beneficiary. Also known as second-to-die life insurance. Premiums are payable only until first survivor dies or may be payable until both dies. The price is less than cost of either 1. 2 Individual Permanent insurance 2. 1 joint permanent insurance Advantage: For couples who want to provide funds to pay estate taxes that maybe levied after the after their deaths. Family Policies: This is a combination of one whole life insurance for the primary insured and term insurance for spouse and each child. The amount on term insurance is a fraction of the whole life insurance on primary. Example; Father 50,000 Whole Life Spouse 30% 15000 Term Son 20% 10,000 Term Total coverage for Family Policy: 75,000 Each children born in the family is automatically covered on production of proof. The coverage starts usually after 15 years of age. Extra premium maybe charged for added children. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Monthly Debit Ordinary:  This is a whole life insurance but provides less face amount.  The policy is sold under home service distribution system by home service agents  Agents provide personalized service like collection of premiums  Monthly premium  Assigned territory of agent is known as debit, agency or account. Pre Need Funeral Insurance:  Coverage to handle funeral and burial expenses  Sold by funeral homes who are themselves agents  Small face amount  Funeral homes are mentioned as beneficiary Universal Life Insurance:  Flexible premium  Flexible face amounts  Flexible Death Benefit amounts  Unbundling of pricing factors o Mortality o Interest o Expenses  Policy owners can determine premium which translates into coverage Unbundled Pricing factors: There are 3 factors: 1. Mortality charges: Pays the cost of the life Insurance coverage. This charge typically increases with age since this charge is a measure of the mortality risk which increases with age. This charge is usually less than a specified amount. The charge is expressed in terms of charge /$1000 of net amount of risk. Net Amount of risk = Death Benefit - Cash Value 2. Interest: Guaranteed minimum Interest Rate on policy’s cash value each year Interest rate can be of many types: 1. Could be tied to the market interest rate 2. Could be tied to rate of government investment tool like Treasury bills 3. Could be that it will pay guaranteed interest for first $1000 and higher interest for amount above $1000 4. Could be that if a policy loan has been taken then interest will be less but greater than the guaranteed minimum 3. Expenses: Charges to administer policy Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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How these matters: Cash value = ((Premium – Expenses - Mortality Charges + Existing Cash Value)(1 + Interest ) So evidently, Premium + Existing Cash Value should be enough to cover the mortality charges and Expenses. If they become less then Insured is given 60 days time to make a premium payment to cover these expenses. If the payment is not done the policy lapses. Relationship between Death Benefit and Face Amount: Option A Plan: F a c e A m o u n t

Death Benefit Risk Cash Value

Years

Death Benefit = Face Amount Net Amount at risk = Death Benefit – Cash Value Option B Plan: F a c e A m o u n t

Death Benefit Risk Cash Value

Years

Death Benefit = Face Amount + Cash Value Net Amount at risk = Face Amount Flexible Face Amount: After 1 year, the face amount can be increased or decreased. If increased, proof of continued insurability needs to be given since these increases the net risk. If decreased, then care needs to be taken that the policy still meets the minimum limit for an insurance contract.

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Flexible Premium: The initial premium might be higher than renewal premiums but both should be sufficient to handle the expenses and mortality charges. The insurance forces to pay a minimum initial premium amount. Policy Loan: Loans might be taken on the cash value accrued for the policy. Some withdrawal charges are also applied. Federal Regulation on Universal Life Policies: Federal Regulation Section 7702 Corridor controls that the cash value of a policy does not increase too much above face amount. A certain % is fixed to limit the excess. If it does then it violates the rule for being an insurance product for tax purposes and is considered as investment product. The Insurance products enjoy special benefits for tax purposes and thus this restriction is enforced. In Canada, this rule is stricter and thus Universal Life is rarely sold in Canada. Cash Value Terminology: Reserve Value Accumulation Value Cash Surrender Value

Net Cash Value

Adjustable Life Insurance: In this type, insured specifies the face amount and premium he can pay and a plan of insurance is chalked out to provide insurance. The product can range from a term insurance to a limited payment whole life policy. Based on change to the premium or face amount either the term can be increased or frequency of premium payment can be reduced. Indeterminate Premium Life Insurance: In this type 2 premium rates is provided by Insurance companies. 1. Minimum Premium Rate 2. Maximum Premium Rate The policy starts with the minimum rate for couple of years. In this time period , insurer evaluates the actual mortality, interest and expense bucket and comes up with a premium rate which lies between the previous 2 rates. This modification happens throughout the life of the policy. It enables insurer to be flexible in premium pricing since this way they can change the premium to counter all the expenses. Also known as non-guaranteed premium life insurance or variable premium life insurance policy. Interest Sensitive Whole Life Insurance: In this type 2 premium rates is provided by Insurance companies. 1. Minimum Premium Rate 2. Maximum Premium Rate Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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This also provides the option to insured that whether he wants favorable changes in pricing assumptions to result in a lower premium or high cash value. Default is cash value increase. Cash Value increase method Differences: Traditional Whole Life Universal Life Cash value increases by periodic premiums and interest accrued. The policy reserves are maintained in a General Investment Account where insurer maintains fund from guaranteed insurance products.

Variable Life

Cash value increases by periodic premiums and interest accrued. The policy reserves are maintained in a General Investment Account where insurer maintains fund from guaranteed insurance products.

Policy reserves are maintained separately from general investment account. These are separate known as account in USA and segregated account in Canada. This reserve is then invested in stocks, bonds, funds etc. Returns can be anticipated Returns can be Returns can’t be anticipated anticipated Death Benefit stable Death Benefit stable Death benefit might get reduced with poor sock performance Considered as Insurance Considered as Insurance Considered as securities product product hence need to follow all SEC regulations Not Applicable Not Applicable Product needs to be registered with NASD Not Applicable Not Applicable Agents need to be licensed with NASD Not Applicable Not Applicable Funds can be changed once every year

Variable Universal Life Insurance:  Also called Universal Life II and Flexible-premium variable life insurance  Combines flexible premium and flexible death benefits of Universal Life with investment flexibility and risk of Variable Life Endowment Insurance:  Provides a specified benefit amount whether the insured lives to the end of the term of coverage or dies during that term.  Each policy has a maturity date when the benefits are payable  The cash value reaches face amount value on maturity date  Thus cash value buildup is much faster.  If insured dies, death benefit is paid to beneficiary.  Premiums are leveled throughout the term  Premium could be single premium or limited premium payment Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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CHAPTER 9: SUPPLEMENTARY BENEFITS Policy Riders: A number of benefits can be added to various forms of life insurance policies. These are provided by adding riders to the life insurance policy. In some cases the benefit is provided through standard policy provisions. Here we describe some of the supplementary benefits that are fairly standard in the industry. SUPPLEMENTAL DISABILITY BENEFITS Generally classified as a type of health insurance coverage. Some disability benefits however can be added to the coverage provided by a life insurance policy. Mainly there are 3 types of disability benefits that a life insurance policy or policy rider may provide. I. WAIVER OF PREMIUM FOR DISABILITY BENEFIT (WP) Under this rider the insurer promises to give up – to waive – its right to collect renewal premiums that become due while the insured is totally disabled. In case of a universal life insurance policy, the WP benefit can specify that the: 1) Insurer will waive any mortality and expense charges that become due while the insured is totally disabled. OR 2) Insurer will waive the amount of target premium that become due while the insured is totally disabled. Target premium is the amount of premium that, if paid on a regular basis, will maintain the policy in force. Total disability: Usually in a WP rider, total disability will be defined as the insured’s inability to perform essential acts of her own occupation or any other occupation for which she is reasonably suitable by education, training or experience. Premiums are waived throughout the life of the policy as long as the insured remains totally disabled. She may need to proof her total disability, periodically, to the insurance company. Who pays the premiums waived under a WP benefit? The insurance company pays it. If the policy is one that builds up a cash value, it will continue doing so. In case of a participating policy, the insurance company will continue to pay policy dividends as if the policy owner were paying premiums.

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Some limitations in the WP benefit: 1. There may be a waiting time (usually 3-6 months) after the insured becomes totally disabled, before the insurer will waive renewable premiums. 2. WP benefit is usually available to cover only disabilities that begin during a specified age span. For example that age span may be between the age 15 to 65. 3. In most WP riders, once disability begins, interval of payment of renewal premiums can’t be changed. 4. Some risks are typically excluded. Some of them are: a) Intentionally self-inflicted injuries b) Injuries suffered while committing a crime c) Pre-existing conditions d) Injuries from any act of war while insured is in military service

II. WAIVER OF PREMIUM FOR PAYOR BENEFIT This is designed for 3rd party policies such as juvenile insurance policies. Juvenile insurance policy is issued on the life of a child but is owned and paid for by an adult, usually the child’s parent or legal guardian. WP for payor benefit provides that the insurance company will waive its right to collect a policy’s renewable premiums if the policy owner – the person responsible for paying the premiums – dies or becomes totally disabled. The two part definition of total disability in case of WP for payor benefits: During the first 2 years of the disability the policy owner is considered to be totally disabled only if he is unable to perform the essential acts of his own occupation. After the 2-year period, the policy owner will be considered to be totally disabled if he is unable to perform the essential acts of any occupation for which he is reasonably suited by education, training or experience. Two important facts related to WP for payor benefit riders: 1) Policy owner generally must provide satisfactory evidence of his own insurability in addition to providing evidence of the insurability of the insured. 2) Usually insurance company will waive premiums until the insured reaches 18 or 21, when the ownership and control typically passes to the insured. This is the case when a WP for payor benefit is added as a rider to a juvenile insurance policy.

III. DISABILITY INCOME BENEFIT Provides a monthly income benefit to he policy owner – insured, if she becomes totally disabled. The definition of a total disability is usually the same in this rider as in WP benefit rider.

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Typically the amount of the monthly disability income benefit is a stated dollar amount – such as $10 per $1000 of the life coverage. DI benefit also usually includes a waiting period like the WP riders. A point to note ** Policies issued with a disability income benefit generally include a WP benefit as well.

ACCIDENT BENEFITS Most commonly offered accident benefits are

I. ACCIDENTAL DEATH BENEFIT A policy rider, which specifies that if the insured dies as a result of an accident, the insurer will pay the beneficiary an amount of money in addition to the basic death benefit provided by the life insurance policy. Double indemnity benefit: When the amount paid due to the AD benefit is equal to the face amount of the policy. So the total death benefit that the beneficiary gets becomes twice the face amount of the policy. Generally most AD benefit riders expire when the insured reaches the age 65 or 70. Limitations and exclusions in AD benefits: Some exclusions are: a) Self-inflicted injuries (causing suicide). b) War-related accidents. c) Accidents related to aviation activities, if, during flight insured acted in any other capacities other than a passenger. d) An accident resulting from the insured’s engaging in any illegal activities. Sometimes laws might be there which will prevent the insurer from excluding some of these causes from a AD benefit rider. A limitation could be: AD benefit rider might be a payable only if the insured die during a certain time from the actual accident, for example say 3 months.

II. DISMEMBERMENT BENEFIT Accidental death and dismemberment (AD&D) rider specifies that the insurer will pay a stated benefit amount to the insured if an accident causes a loss of any two limbs or sight in both eyes. Amount of the dismemberment benefit is usually equal or lower to the accidental death benefit. Usually AD&D riders state that the insurance company will not pay both AD benefit as well as dismemberment benefit for injuries suffered in the same accident. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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ACCELERATED DEATH BENEFITS This sort of policy benefit became available from the late 1980’s. Accelerated death benefit riders are also called living benefit riders. This rider provides that the policy owner may elect to receive a part or all of the policy’s death benefit before the insured’s death if certain conditions are met. The payment of an accelerated death benefit will reduce the amount of the death benefit that will be available for the beneficiary at the insured’s death. This rider has gained in popularity because of the following reasons: 1) Segment of the population consisting of elderly people is growing. They require medical care, as they are prone to illness in frequent intervals. 2) Cost of health care has continued to increase. 3) Medical advances tend to postpone death and prolong the need for medical care.

Insurance companies usually offer accelerated death benefit coverage to only policies with large face amount. This is done to keep their administrative costs down. Commonly offered types of accelerated death benefit riders are discussed here:

TERMINAL ILLNESS BENEFIT TI benefit is a benefit under which the insurer pays a portion of the policy’s death benefit to the policy owner if the insured suffers from a terminal illness and has a physician-certified life expectancy of 12 months or less. Unlike other insurance policy riders, insurance companies usually don’t charge an additional premium for TI benefit rider. The amount of TI benefit payable is generally a stated % of the policy’s face amount. But it is possible that the full face amount is paid as TI benefit in some types of policies.

DREAD DISEASE BENEFIT This is one of the earliest forms of accelerated death benefit offered by insurers. DD benefit as it is popularly known is a benefit under which the insurer agrees to pay a portion of the policy’s face amount to a policy owner if the insurer suffers from one of a number of specified diseases. Point to note **: Another form of dread disease coverage can be purchased as a standalone health insurance policy.

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These specified diseases or medical procedures for which DD benefit is payable are known as insurable events. They usually include: Life-threatening cancer AIDS End-stage renal (kidney) failure Myocardial infarction (heart attack) Stroke Coronary bypass surgery May also include: Vital organ transplants Alzheimer’s disease LONG-TERM CARE BENEFIT A LTC benefit is payable as a monthly benefit to a policy owner if the insured requires constant care for a medical condition. For example, an insured who has severe arthritis or advanced Alzheimer’s disease may need some form of constant care. The types of care that an LTC benefit covers are specified in the rider. Activities of daily living (ADL) include activities such as eating, bathing, dressing, going to the bathroom, getting in and out of bed or a wheelchair, and mobility. ADLs are used to determine the eligibility of the insured to receive LTC benefits. ADL assessment can be done by the following methods: 1) Rely on physician certification. 2) Contract with firm, which specializes in ADL assessment. 3) Develop own ADL assessment tools. The amount of each monthly LTC benefit payment is generally equal to some stated percentage of the policy’s death benefit. The insurer usually continues to pay monthly LTC benefits until a specified percentage of the policy’s basic death benefit has been paid out. Most LTC benefit riders impose a 90 day waiting period before they are payable. According to some LTC riders, coverage must be in force for a given period of time, usually 1 year or more, before the insured will qualify for LTC benefits. BENEFITS FOR ADDITIONAL INSUREDS Various riders can be added to life insurance policies to provide benefits if someone other than the policy’s insured dies. These riders take several forms. Here we discuss some of the more common ones in the industry.

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I. SPOUSE AND CHILDREN’S INSURANCE RIDER A spouse and children’s insurance rider added to a permanent insurance policy provides a coverage similar to that provided by a family insurance policy(which is a whole life policy that provides coverage on the insured’s entire family). The coverage provided by this rider is typically sold on the basis of coverage units. In contrast, in the family insurance policy, the coverage provided is typically a percentage of the face amount provided on the life of the insured. Most insurance companies do not provide more than 5 to 10 coverage units. The premium for the children’s coverage is a specified flat amount. It does not change with the number of children in the family. The term insurance coverage on each child expires when that child attains a stated age , usually 21 or 25. Such riders usually have a provision for the child to convert his term insurance rider to an individual life insurance policy, and the coverage amount can also be changed to a certain number of times over the current amount, in such a case.

II. CHILDREN’S INSURANCE RIDER Similar to the spouse and children’s coverage in its functionality. The spouse coverage is not present. Generally aimed at single parents.

III. SECOND INSURED RIDER Also called an optional insured rider or an additional insured rider. This rider provides a term insurance coverage on the life of another individual other than the policy’s insured. This second individual is called a Second insured. This individual could be the spouse of the primary insured, his relative or even an unrelated person. The amount of the coverage on this second insured is usually unrelated to the coverage that the basic policy provides. The premium amount is based on the risk characteristics of the second insured and not that of the primary insured.

INSURABILTY BENEFITS Two types of insurability benefits exist. I. GUARANTEED INSURABILITY BENEFIT GI benefit rider is also sometimes referred to as a guaranteed insurability option. This rider when attached to a life insurance policy gives the policy owner the right to buy additional insurance of the same type as to which the rider is attached. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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To buy these insurance policies the insured does not have to provide evidence for insurability. GI rider guarantees that the policy owner will be able to purchase additional life insurance even though the insured may no longer be in good health. Typically the amount of coverage that the policy owner can buy is limited to the policy’s face amount to which the GI rider is attached or to an amount specified in the GI rider, whichever is smaller. Generally GI benefit can be exercised only up to a certain age (usually age 40). The GI rider can be exercised until this specified age, only on certain dates. If the life insurance policy with a GI rider also includes a WP rider and the insured is disabled at the time an option to purchase additional insurance goes into effect, the insurance company automatically issues the additional life insurance coverage. The insurance company also waives the payment of the renewal premiums for all of the policy’s coverage’s to which the WP rider applies until recovery or death of the insured.

II. PAID-UP ADDITIONS OPTION BENEFIT This rider allows the owner of a whole life insurance policy to purchase single-premium paid-up additions to the policy on stated dates in the future and thus to increase the amount of coverage under the basic policy. Many such riders allow the policy owner to purchase paid-up additional whole life insurance on each policy anniversary. These paid-up additions have their own cash values. Premiums for the paid-up additions are based on the net single premium rate for the coverage at the insured’s age at the time the paid-up additions were purchased. Most riders state that if the policy owner does not exercise the purchase option for a stated number of years, then the rider will terminate. At that time the number of paid-up additions already bought remains in force but the policy owner can no longer exercise the option to buy new paid-up additions.

CHAPTER 10: LIFE INSURANCE POLICY PROVISIONS An Insurance policy is a written document that describes the agreement between two parties - the insurer and the policyowners. Here we will know about all the provisions that are typically included in the individual life insurance policies.

Regulations of Policy Provisions In the USA, state laws typically require individual life insurance policies to include specified provisions that spell out the rights of policyowners and the beneficiaries. Other options may be included at the insurer’s options. The SID reviews all these provisions in the Policy form and then approves the policies. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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In Canada, the common law provinces have all enacted insurance laws patterned, with minor variations, on the Uniform Life Insurance Act. The Uniform Life Insurance Act is a model law adopted by CCIR to regulate life insurance policies. Although, the province of Quebec has not adopted this law but that law is also very similar to this act. These provincial laws require insurers to include certain provisions in the life insurance policies. These provincial laws also directly grant certain rights to the policyowners and impose certain obligations on insurers. Although Canadian laws do not require policies to include provisions spelling out these rights and obligations but the insurers routinely do so. When the applicable insurance laws (in the US or in Canada) require a policy provision, the insurer is free to include a provision that is more favorable to the policyowners than the required. Standard Policy Provisions Individual life insurance policies generally contain the following standard provisions: 1. A free-look provision 2. An entire contract provision 3. An incontestability provision 4. A grace period provision 5. A reinstatement provision 6. A misstatement of age or sex provision 7. A settlement options provision In addition, participating life insurance policies include a policy dividends provision, and permanent life insurance policies that build a cash value generally must include a nonforfeiture provision and a policy loan provision 1. Free-Look Provision It is also known as free-examination provision that gives the policyowner a stated period of time (usually ten days), after the policy is delivered in which to examine the policy. During this period, the policyowner has the right to cancel the policy and receive a full refund of the initial paid premium. The insurance coverage is in effect throughout the free-look period, or until the policyowner rejects the policy, if sooner. 2. Entire Contract Provision This provision defines the documents that constitute the contract between the parties. This provision prevents oral statements from affecting the terms of the policy and prevents controversies from developing regarding the terms of the contractual agreement. Generally the contract can be classified as closed or open. A closed contract is a contract for which only those terms and conditions that are printed in, or attached to the contract are considered to be part of the contract. The entire contract consists of the policy, any attached riders and the attached copy of the application for insurance. Except fraternal insurers, all individual life insurance life policies issued in the USA and Canada are closed contracts. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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An open contract is a contract that identifies the documents that constitute the contract between the parties, but the enumerated documents are not all attached to the contract. Fraternal insurers (in US and Canada) generally issue policies as open contracts which state that the entire contract consists of the policy and any attached riders, the fraternal society’s charter/constitution/bylaws, the attached declaration of insurability, if any, signed by the applicant. The entire contract provision usually states that  Only specified individuals (such as certain officers of the insurer) can change the contract.  No change is effective unless made in writing  No change is effective will be made unless the policyowner agrees to it in writing 3. Incontestability Provision According the rules of contract laws, statements made by the parties when they enter into the contract can be classified as either warranties or representations. Warranty: A warranty is a statement made by a contracting party that will invalidate the contract if the statement is not literally true. Representation: A representation is a statement made by a contracting party that will invalidate the contract if the statement is not substantially true. (Statements made in an application for insurance are considered to be representations rather that warranties.) Misrepresentation: A false or misleading statement in an application for insurance is known as misrepresentation. Material Misrepresentation: A misrepresentation that would affect the insurance company’s evaluation of the proposed insured is called as material misrepresentation. Fraudulent Misrepresentation: A misrepresentation that was made with the intent to induce the other party to enter into a contract and that did induce the innocent party to enter into the contract. The Incontestability Provision describes the time limit within which the insurer has the right to avoid the contract on the ground of material misrepresentation in the application. During evaluation of the application, if the company finds any material misrepresentation it has full right not to issue the policy. But if it has issued a

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policy and at a later point of time it finds any such statements in the application then the provisions are different in the USA and Canada. In United States, the contestable period is two years from the date the policy was issued. This 2 year contestable period is the maximum period permitted by the laws in most states. A period shorter than two years is permitted because that would be more favorable to the policyowner. In Canada, the period is two years from when the policy takes effect or two years from the date it has been reinstated, if later. The provincial insurance laws also contain an exception that an insurer may contest a policy at anytime if the application contained a fraudulent misrepresentation. 4. Grace Period Provision Insurance laws in the US and Canada require every individual life insurance policy to state the period of grace within which a required renewal premium may be paid. The grace period is a specified length of time within which a renewal premium that is due may be paid without penalty. Minimum grace period: 30 or 31 days ( in US and Canada) If a renewal premium is not paid by the end of the grace period, the policy is said to be lapse. Some insurers, however, do not consider a policy as having lapsed if that policy has cash value (described later). In case of a universal life insurance policy, the grace period will begin on either: (1) the date on which the cash value is insufficient to cover the policy’s entire monthly mortality and expense charges; grace period is 61 or 61 days (2) the date on which the cash value is zero; grace period is 30 or 31 days. The provision also states that the insurer should notify (at least 30 or 31 days before) the policyowner that the cash value is insufficient to meet the policy charges and that the coverage will terminate if the policyowner does not make the payment that is large enough to cover these expenses. 5. Policy Loans and Policy withdrawal Provision The Policy Loan Provision grants the owner of a life insurance policy the right to take out a loan for an amount that does not exceed the policy’s net cash value less one year’s interest on the loan. Policy loan differs from a commercial loan in two ways:  The policyowner is not legally obligated to repay a policy loan. However he may repay it partially or fully anytime.

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

The insurance company does not perform a credit check on a policyowner who requests a policy loan.

The Policy withdrawal Provision, also called as partial surrender provision, permits the policyowner to reduce the amount in the policy’s cash value by withdrawing up to the amount of the cash value in cash. The insurers do not charge any interest on policy withdrawals. 6. Reinstatement Provision Reinstatement is the process by which a life insurance company puts back into force a policy that has either  been terminated because of nonpayment of renewal premiums  been continued under the extended term or reduced paid-up insurance nonforfeiture option Most insurers do not permit reinstatement if the policyowner has surrendered the policy for its cash surrender value. In the US, about one-half of the states require individual life insurance policies to include this provision and the laws require policies at least a 3-year period during which the policyowner has the right to reinstate a policy that has lapsed. It may be longer also depending on the insurer. Laws in Canadian provinces and territories also require individual life insurance policies to include a reinstatement provision. Canadian laws specify the minimum reinstatement period as 2 years. A policyowner must fulfill certain conditions to reinstate:  The policyowner must complete a reinstatement application within the time frame stated in the reinstatement provision.  The policyowner must present satisfactory evidence of the insured’s continued insurability.  The policyowner must pay a specified amount of money.  The policyowner may be required to either pay any outstanding policy loan or have the policy loan reinstated with the policy. Also in most US states and provinces in Canada, a new contestable period begins on the date on which the policy is reinstated. During this new contestable period, the company may avoid a reinstated policy only on the basis of material misrepresentations made in the application for reinstatement. Redating: Under this practice, the insurance company changes the policy date to the date on which the policy is reinstated. As a result, the premium rate charged for the redated policy will be based on the insured’s attained age and will be charged for the original policy. 7. Misstatement of Age or Sex Provision This provision describes the action the insurer will take to adjust the amount of the policy benefit in the event that the age or sex of the insured is incorrectly stated.

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If the insurer finds such error after the death, then it adjust the face amount of the policy to the amount the premium actually paid would have purchased if the insured’s age or sex had been stated correctly. If the misstatement discovered before the death, then the insurer may grant the policyowner the option to pay (or receive as a refund) any premium amount difference caused by the misstatement instead of having the insurer adjust the policy’s face amount. 8. Settlement Options Provision It is also called as payout option provision. Such provision grant a policyowner the right to decide how the policy benefits will be paid. 9. Policy Dividends Provision This provision gives the policyowners the right to choose from among several dividend payout options. Laws in most jurisdictions in the US and Canada require participating policies to describe the dividend options that are available to the policyowners. 10. Nonforfeiture Benefits These benefits are available to the owner of a life insurance policy that builds a cash value. State insurance laws require insurance companies to include non-forfeiture benefits in all individual life insurance policies that build a cash value. Although provincial laws do not require insurance companies to include these in the policies but companies usually do it. Cash Surrender value nonforfeiture option: This states that a policyowner who discontinues premium payments can elect to surrender the policy and receive the policy’s cash surrender value. Following the surrender of a policy, all coverage under the policy terminates. The net cash value is the actual amount that a policyowner gets after adjustments of paid-up additions, dividend accumulations, advance premium payments and policy loans outstanding. Laws throughout the US and Canada allows an insurer to reserve the right to defer payment of any policy’s cash surrender value for a period of up to six months after the owner of the policy requests payment. Continued Insurance Coverage Nonforfeiture Options Reduced Paid-Up Insurance: Under this option, the policy’s net cash value is used as a net single premium to purchase paid-up life insurance of the same plan as the original policy. The premium charged is based on the attained age of the insured. The face amount will be smaller than the face value of the original policy. The coverage issued under this option continues to have like building cash value, right to surrender the policy and receiving dividends. But any supplemental benefits that were available on the original policy such as accidental death benefits are usually not available with the reduced paid-up insurance.

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Extended Term Insurance: Under this option, the insurance company uses the policy’s net cash value to purchase term insurance for the full coverage amount provided under the original policy for as long a term as the net cash value can provide. The term-length depends upon the amount of the coverage, amount of net cash value, sex of the insured and his attained age. Automatic Nonforfeiture Benefits: This benefit becomes effective automatically when a renewal premium is not paid by the end of the grace period and the insured has not elected another nonforfeiture option. The most typical automatic nonforfeiture benefit is the extended term insurance benefit. However, the laws in a few jurisdictions require that policies include an Automatic Premium Loan (APL) provision and specify that the automatic nonforfeiture option is the automatic premium loan. This provision states that the insurer will automatically pay an overdue premium for the policyowner by making a loan against the cash value as long as the cash value equals or exceeds the amount of the premium due. Universal life insurance policies usually do not include this provision.

Life Insurance Policy Exclusions Although laws permit but generally companies does not included these exclusions: war exclusions clause, aviation exclusion provision (except for military or experimental aircraft or privately owned aircraft’s pilots & crew members). But Suicide exclusion provision is still included in individual life insurance policies. The provision in some policies states that the insurer will pay the larger of the policy’s cash value or the premiums paid for the policy in case it finds that the insured has committed suicide within the two year period after the issue of the policy.

CHAPTER 11: LIFE INSURANCE BENEFICIARY POLICIES Class Designation: A beneficiary designation that identifies a certain group of persons, rather than naming each person, is called a class designation. Primary Beneficiary: Party designated to receive the policy proceeds following the death of the insured. Proceed may be divided among the beneficiary if indicated by insured else it gets distributed evenly. In order to receive policy proceed, beneficiary must survive the insured.

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Contingent Beneficiary: Also known as secondary or successor beneficiary. A contingent beneficiary receives the policy proceeds if all primary beneficiaries have predeceased the insured. No surviving Beneficiary: If the insured is dead and all named beneficiaries are also dead then the proceeds are paid to policy owner. If policy owner is dead then the proceeds goes to policy owner’s estate. Preference Beneficiary Clause: If the policy owner does not name a beneficiary then insured keeps a list of stated order of preference and proceed will be paid according to that order. If no list is also available then the proceed will be paid to the insured’s estate. Facility of Payment: Group Life, monthly debit ordinary etc contain a facility of payment clause which permits the insurance company to pay a little part of the proceed to someone who has incurred funeral expenses on behalf of the insured. Revocable Beneficiary: A beneficiary is called revocable if the policy owner has the unrestricted right to change the beneficiary while alive. Right of revocation: Policy owner’s right to change beneficiary. Irrevocable Beneficiary: Beneficiary where you cannot change your beneficiary without the consent of the beneficiary. Policy owner loose their right of revocation by one of the 2 methods: 1. Policy owner volunteers to give up his rights 2. Legal limitations An irrevocable beneficiary has vested interest in the proceeds of the life insurance policy even during the lifetime of the insured. A vested interest is a property right that has taken effect and cannot be altered or changed without the consent of the person who owns the right. Rights of any beneficiary, including revocable ones, are terminated with the death of the beneficiary and the policy owner can then nominate a new beneficiary. USA: Community Property Sales A community property state is one in which , by law, each spouse is entitled to equal share earned by the other and property acquired during the marriage.

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The states are: ARIZONA, CALIFORNIA, NEW MEXICO, WISCONSIN, IDAHO, LOUISIANA, NEVADA, and TEXAS AND WASHINGTON. Insurance policy is also a property in these states. Thus, even if the other spouse is named as revocable beneficiary, it might be required to take consent of the revocable beneficiary (spouse) to change the beneficiary if the change hurts the interest of the other spouse. Alternatively, beneficiary can be changed for only half the proceeds. Canada: Common Law Jurisdiction 1962(applicable to policies before 1962 only) Preferred Beneficiary Law: A preferred beneficiary classification was maintained for a policy and policy owner can change the beneficiary only within this class without consent or can change to someone outside the group with consent of the group. All ownership rights are revoked as soon as the preferred beneficiary died. Beneficiary for Value: This group is also irrevocable beneficiary. This could be people like who lend money and policy owner names them beneficiary. These people also have vested interest but their rights are not revoked as soon as the value beneficiary dies and his rights are passed to beneficiary’s estate. These laws were discontinued after the Universal Life Insurance Act of 1962 Beneficiary Change procedure: 1. Recording method: Method of informing the insurance company in writing about the new beneficiary by policy owner. 2. Endorsement Method: Policies have a document attached to the insurance contact and that document contained the beneficiary name.

CHAPTER 12: ADDITIONAL OWNERSHIP RIGHTS Apart from the right to name the beneficiary, the policy owner has a no# of other valuable rights. These rights with respect to 1. Premium Payments. 2. Policy Dividends 3. Settlement Options. Among these some rights vary depending on the type of the policy. PREMIUM PAYMENTS : The policy owner has the right to choose Premium Payment Mode (frequency) Premium Payment Method

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1. A.

PREMIUM PAYMENT MODE This is the frequency at which renewal premiums are payable and both the insurer & the policy owner must agree to that mode of payment. The frequency can be annual/semiannual/quarterly/monthly. The applicant selects anyone of these modes at the time of application but holds the right to change it after the policy is in force. However, the policy owner cannot select a mode that results in a premium less than the required minimum. For example, if the minimum premium for monthly mode is $20, the policy owner has to pay that. Otherwise he would be required to choose a less frequent mode of payment, such as quarterly or semi annually.

1. B.

PREMIUM PAYMENT METHOD The policy owner can pay the premium a) In person to the Home Office / an authorized Branch Office b) By mail: - The P/Owner receives a premium notice fro the Ins. Co. before each premium due date. In most cases the P/Owner returns a portion of the notice along with the premium payment. The P/Owner may pay the premium in cash / by MO / by check. c) By automatic payment techniques: - The most common automatic payment techniques include  Preauthorized Check (PAC): The P/Owner authorizes the Ins. Co. to generate checks against the P/Owner’s checking/savings A/C. The Ins. Co. sends these checks there directly for payment. The P/Owner also authorizes the Bank/the Savings Institution to honor these checks & deduct the funds directly from the P/Owner’s A/C. The P/Owner usually receives a notification of each such transaction on his/her bank statement.  Electronic Funds Transfer (EFT): The P/Owner authorizes his/her bank to pay the premiums automatically on premium due dates. The premium is simply transferred from the bank to the insurer w/o any paper check. The P/Owner receives a notification only of each such transaction on his/her bank statement.  Payroll Deduction: In this particular case the cooperation of the P/Owner’s employer is needed. The employer deducts insurance premium directly from the employee’s paycheck.

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Advantages of Automatic Premium Payment Methods: Reduced insurer’s administrative expenses for policies with monthly/quarterly premium payments mode. 2. Reduced the instances in which the P/Owners forget to pay renewal premiums. 3. As a consequence, most insurers reduce the extra charges that would otherwise be added for semiannual/quarterly/monthly premium payment mode. 4. Some insurers offer quarterly/monthly premium payment modes only for those P/Owners who have selected an automatic payment technique. Note: The sales agents are authorized to accept only the initial premium. So thru them the policy owner cannot pay his/her renewal premium. Exception: Home service agents are authorized to accept renewal premium. 1.

POLICY DIVIDEND OPTIONS: Policy Dividend: This is the insurer’s divisible surplus that is shared among the P/Owners having the participating policies. General Terms & Conditions: 1) The policy must be a participating one. 2) The policy is supposed be in force for a long period of time. 3) The dividend is payable on the policy’s anniversary date. 4) The policy must me in force for a certain (generally 2 years, may vary from one insurer to another) period of time before the policy is eligible for the dividend. 5) The amount payable as policy dividend is determined annually by the Board of Directors of the Insurance Co.

What does the dividend amount reflect? 1) 2) 3) 4)

The insurer’s actual mortality, interest, and expenses during that year. The plan of insurance. The policy’s premium amount. The length of time the policy has been in force. (Generally the dividend amount increase substantially with the age of the policy)

What is meant by Dividend Options? Dividend options refer to a number of different ways in which the P/Owners of participating LIPs receive policy dividends. There are five such options. The P/Owner can select any of these five options at the time of application & that can be changed any time. Certain restrictions are applied for Additional Term Insurance Option.

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The Five Options are: 1) Cash Dividend Option: The insurer sends the P/Owner a check in the amount of the policy dividend that was declared. For some policies, if the check is not cashed within a stated period, then the insurer will apply the amount of the dividend under another option. 2) Premium Reduction Dividend Option: The insurer applies the policy dividends towards the payment of the renewal premiums. The insurer notifies the P/Owner of the amount of the policy dividend and bills for the difference, if any, between the premium amount & the amount of the policy dividend. 3) Accumulation at Interest Dividend Option: The dividends are let on deposit with the insurer to accumulate at interest. Allows the P/Owner to withdraw a part/all of these dividends & the accumulated interest at any time during the life of the policy. If the P/Owner surrenders the policy he is eligible to get the accumulated value of the policy dividends along with the surrender value of the policy. In case the insured dies, it goes to the named beneficiary. 4) Paid-up Additional Insurance Dividend Option: The insurer uses any declared P/Dividend as a net single premium to purchase Paid-up Additional Insurance on the insured’s life and this is issued on the same plan as the basic policy and in whatever face amount the dividend can provide at the insured’s attained age. Advantages of this option: A) The premium charged, does not include the amount to cover expenses. So the cost is lesser than a new LIP. B) Does not require establishing the insurable interest. C) If the basic policy is one that builds cash value, then the paid-up additions purchased with policy dividends will also build cash value and the P/Owner has the right to surrender those additions for their cash value at any time while the policy is in force. D) Though the face amount of paid-up additions, purchased each year, is relatively small, over the life of the policy, the total additional insurance available can be substantial. 5) Additional Term Insurance Dividend Option: The insurer uses each policy dividend as a net single premium to purchase one-year Term Insurance on the insured’s life. This is often called the Fifth Option. Restrictions applied to the Fifth Option: A) The max amount of 1-year term insurance. That could be purchased each year is often limited to the amount of the policy’s cash value. B) Does require establishing the insurable interest in case, the P/Owner wishes to change from another dividend option to this one.

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Note: If the annual policy dividend is larger than the premium reqd. for the 1-year term ins., the insurer will apply the remaining under any of the other options. SETTLEMENT OPTIONS: This comes into the picture if LIP when it’s the time for the insurer to pay the proceeds to the beneficiaries after the insured dies. Normally insurer pays a lump sum directly to the beneficiary in the form of a check. Apart from lump-sum settlements of policy proceeds, Ins. Cos. provide several alternative methods of receiving the proceeds of a LIP. These alternative methods are called Settlement Options. What is Settlement Agreement? When the P/Owner selects an optional mode settlement mode at any time while the policy is in force, a contractual agreement, called Settlement Agreement, is done. This agreement governs the rights & the obligations of the parties after the insured’s death. The P/Owner has the right to select any such option, shift to some other option and select any of the settlement modes. Two types of Settlement Mode are available. A) Irrevocable: The beneficiary is not allowed to shift to any other settlement option once the proceeds become payable. B) Revocable: If not irrevocable. Default is revocable if the settlement mode is not specified at the time of application.

What is Supplementary Contract? This is a settlement agreement between the Ins. Co. & the beneficiary when the later selects a settlement mode, as the insured did not.

Who is a Payee? The person/party who is supposed to receive the proceeds as per the terms of a settlement agreement is referred to as the Payee.

Who is a Contingent Payee? A Contingent payee / Successor payee is one who will receive any proceeds still payable at the time of the payee’s death. What are the common settlement options? Four options are normally available. 1) Interest Option 2) Fixed-Period Option 3) Fixed-Amount Option 4) Life Income Option

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

Interest Option: Under this the insurer invests the policy proceeds and periodically pays the interest on those proceeds to the payee. It guarantees at least a specified minimum interest rate.



Fixed-Period Option: Under this the insurer agrees to pay the policy proceeds in installments of equal amounts to the payee for a specified period of time. Each payment will consist partly of the policy proceeds & partly of the interest earned on the proceeds. Here also at least a specified minimum interest rate is guaranteed.



Fixed-Amount Option: Under this the insurer pays equal installments of a stated amount until the (policy proceeds + interest earned) are exhausted. Here also at least a specified minimum interest rate is guaranteed.



Life Income Option: Under this the insurer agrees to pay the policy proceeds in periodic installments over the payee’s lifetime. Here basically the Ins. Co. agrees to use the policy proceeds as the net single premium to purchase a life annuity for the beneficiary.

What is a Life Annuity? Life annuity is an annuity that provides periodic benefits for at least the lifetime of a named individual. The beneficiary of a Life Income Option can choose one among of the several types of annuities and based upon the type of the annuity there are the following types of Life Income Option:  Straight Life Income Option – The policy proceeds are used to purchase a straight life annuity. It guarantees that the periodic benefits will be made throughout the lifetime of the annuitant.  Life Income with Period Certain Option -- The policy proceeds are used to purchase a life income annuity with period certain. It guarantees that the periodic benefits will be made throughout the lifetime of the annuitant as well as guarantees that the payments will be made for at least a certain period, even after the annuitant dies before the end of that period.  Refund Life Income Option -- The policy proceeds are used to purchase a life income with refund annuity. It provides the periodic benefits will be made throughout the lifetime of the annuitant as well as guarantees that at least the purchase price of the annuity will be paid in benefits. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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 Joint & Survivorship Life Income Option -- The policy proceeds are used to purchase a joint & survivor annuity. It provides a series of payments to two or more individuals & those payments will continue until both or all the individuals die. TRANSFER OF POLICY OWNERSHIP: If the owner of a life insurance policy has the contractual capacity, then she has the right to transfer ownership of some or all of her rights in the policy. Following are the two ways of transferring ownership:  Transfer of ownership by Assignment: - An assignment is an agreement under which one party transfers some or all of his rights in a particular property to another party. The property owner who transfers the right is known as assignor; the party to whom the rights are transferred is known as assignee. The restrictions to assignment are: - 1) The assignor should have the contractual capacity. 2) In case of an irrevocable beneficiary or for a beneficiary of the preferred class in Canada, the assignment can only be done with the consent of the beneficiary. Because the right to assign any property is granted by law, insurers are not required to give the policy owner notice of his rights to assign a life insurance policy. Most life insurance policies, however, do not include assignment provisions. The assignment provision describes the roles of the insurer and the policyowner roles during an assignment. The insurance company is not obliged to act in accordance to the provision unless it receives a written document. It generally provided by the assignee. As the insurance company is not liable for the validity of an assignment it considers an assignment to be valid whenever it receives a written document. However the insurer might check the validity where it has the preknowledge about the contractual inability of the policyowner. Types of assignment: 1. Absolute assignment is the one where complete transfer of rights occurs. Thus the assignor no longer has any right and the assignee becomes the policy owner. The transfer can be as a gift, where there is no exchange of money, or as a sale of the policy where an equivalent amount of money is exchanged. 2. Collateral assignment of a life insurance policy is a temporary assignment of the monetary value of a life insurance policy as collateral—security – for a loan. This type of assignment differs from the previous one as a) the collateral assignee’s rights are limited to those ownership rights that directly concern the monetary value of the policy; as for example the rights to select the beneficiary or the policy dividend option remains with the assignor, but the assignor can not take any policy loan or surrender the policy as these decision are related to the monetary value of the policy.

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b) the collateral assignee has a vested right to a policy’s monetary values, but the rights are limited; because of this the assignor has right over the amount of indebtedness. Thus when the policy proceeds will be paid the only the amount that the assignor owes will be paid to the assignee. c) the collateral assignee’s right to the policy values are temporary. If the assignor pays back the assignor then the assignment terminates. Once the loan is repaid the assignor secures a release from the assignee and forwards it to the insurance company to cancel the assignment. Problems resulting from assignment: - The most common problem arises when the assignment is not notified to the insurance company through a written document. If the insurer was not notified of the assignment before it paid the policy benefits, then it has no liability to pay the proceeds again to the assignee. 

Transfer of Ownership by Endorsement: - Many life insurance companies in United States specify endorsement method of transferring ownership. Under this method, ownership is transferred without requiring the owner to enter a separate contract. This is generally used where the policy is transferred as a gift. According to this provision, in order to change the ownership the present owner must notify the insurance company, in writing. When the insurer records the change, change actually becomes effective from the date when the policy owner signed the notification. The policy must be returned to the company to include the endorsement and to transfer the ownership. But in certain situations only a written document can be considered to transfer the ownership (as for example in case of an unfriendly divorce.)

CHAPTER 13: PAYING LIFE INSURANCE POLICY PROCEEDS. In this chapter we shall discus the routine process followed by the Life Insurance Companies to process the life insurance claims. The claim examination process begins when the claimant to policy proceeds notifies the insurance company that the insured has died. Typically, the person who claims for the policy proceed is the primary beneficiary. Upon being notified o the insured death, the insurance company typically provides the claimant with a claim form on which the claimant provides the insurer the information the insurer needs to begin processing the claim. In United States it is mandatory to provide claim form within 15 days from the day of requisition but in Canada there is no such hard and fast rule.

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Proof of Loss: Along with the claim form the claimant must also provide the proof for the death of the insured. In United States generally the official death certificate is produced but in Canada, most insurance company will accept official death certificate, an Attending Physician Statement (APS), a coroner’s certificate of death. Claim Examination Process: The insurance company employee who is responsible for carrying out the claim examination process is generally known as claim examiner. The following things are determined: Status of Policy: - The claim examiner must check whether the policy was in force when the insured died. Identification of the insured: - The claim examiner examines the identity proof present in the Claim from and the Proof of loss form with the information provided in the company’s policy records. A claim is considered as fraudulent claim when the claimant intentionally attempts to collect policy proceeds by providing false information. A claim is considered as a mistaken claim when the claimant makes an honest mistake while making a claim. Verification of Policy Coverage: - The examiner must review the terms of insurance to determine what type of coverage it provides. Policies that contain exclusion criteria provide that if the insurer dies if the insurer dies due to excluded causes then the insurer is not liable to pay the proceeds. Identifying the Proper Payee: - Once the validation of the claim has been done the examiner now needs to identify the rightful owner of the benefits. The examiner generally follows the following flow chart. There are 3 situations that require further investigation by the claim examiner- common disasters, short-term survivorship, and conflicting claimants. Sometimes both the insured and the primary beneficiary die due to a common disaster. In this case the general law of Unites States and Canada states that If the insured and the beneficiary die at the same time or under circumstances that make impossible to determine which of them died first, then policy proceeds are payable as if the insured survived the beneficiary. If the beneficiary survived the insured but died before the insurer paid the proceeds then it becomes payable to beneficiary’s estate. The policyowner, however, may prefer that the proceeds be pad to someone other than the beneficiary’s heirs if the beneficiary survives the insured. Some insurance company includes common disaster clause or time clause, according to this the beneficiary must survive the insured by a specified days, such as 30 or 60 days. If the beneficiary does not survive that period then the policy proceeds will be given as if that the beneficiary deceased the insured. Proceeds Payable to policy owner, if living; otherwise to Policy

Approve to Pay Claims.

NO NO Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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YES Primary Beneficiary

NO Livin g? YES Pay the Primary Beneficiary.

Contingent Beneficiary ? YES NO Livin g? YES

Other Contingent Beneficiar

Pay the Contingent Beneficiary. In most cases the primary beneficiary makes the claim. In US in case of conflicting claims the insurance company can take the help of an interpleader. Interpleader is a procedure under which an insurance company that cannot determine the proper claimant may go to the court in order to seek advice or decision. The court may hold the policy proceeds and would release the insurer from any further liability. The court would then judge the rightful owner. In Canada, for common law system the insurer pays to the court and then the court judges the proper recipient. This is known as payment into court. In Quebec, an insurance company may to the Minister of finance. The Minister holds the proceeds until the court settles the rightful recipient. Determining the Amount of the Death Benefit: - To calculate the policy proceeds the examiner will add certain things and would deduct other things. The examiner first adds the following items:  The amount of any basic death benefits payable ( In most cases this is equal to the face amount. If the policy was in force under the reduced paid-up insurance nonforfeiture option then the basic death benefit may be reduced, also if the insured sex was misstated.)  The accidental benefits payable.  The accumulated policy dividends, including interests.  The face amount of any paid-up additions.  The amount of any unearned premiums paid in advance. After adding these, the examiner deducts the following things to determine the final proceeds payable.  The amount of any outstanding policy loans.  The amount of any premium due and unpaid. [This item appears if the insured died during the policy grace period before the premium has been paid.

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Payment of Policy Proceeds. The insurance company requires the recipient of life insurance policy proceeds to sign a written document, known as release. By signing this document, the claimant states that he has received full payment of his claim to the proceeds of a life insurance policy and that he releases the company from all sort of claims. In order for such a release form to be valid and binding on the claimant, he must have the legal capacity required to provide the release. Claimants who are minors or does not have sound mental capacity do not have the capacity to provide a release. One way in which the insurance company can obtain a valid release when the beneficiary does not have the legal capacity, is by paying the proceeds to a court-appointed guardian. The expenses for appointing a guardian by the court are borne by the claimant. In some situations where policy proceeds are payable to a minor, an insurance company may hold the proceeds at an interest to a future date. This is generally the day when the minor reaches majority or the court appoints a guardian who can give a valid release to the insurance company. Special Claim Situations. There are policies that may contain exclusion criteria. The claim examiner may pays attention to death claims where the policy is contestable, the policy provides accidental benefits, the insured disappeared or the beneficiary is responsible for insured death. Policy Contest: - If any policy contains misinterpretation, then the insurer has the right to avoid the contract during the policy’s contest period (which is usually 2 years from the date when the policy becomes effective). Insurers in Canada have the right of canceling the contract at moment of time based on fraud contracts. If the claim examiner has enough ground to prove the charge of material misinterpretation, then the insurance company may cancel the contract and may refund the premiums paid for the policy. Typically, the claim department consults the legal department of the company before contesting a policy on the ground of material misinterpretation. Accidental Death Benefit Claim: - When a claim for accidental death benefit comes to an insurer the claim examiner will determine whether the claim falls under policy’s definition of “accidental”. In order to validate the examiner may ask for the following: 1. Proof of loss. 2. APS. 3. Autopsy report. The examiner may demand the above documents in case where: - a) unusual circumstances surrounds the death of the insured; b) the policy provides accidental benefit; c) the insured dies within the contest period of the policy. Disappearance of the Insured: - When a claim appears against the disappearance of the insured the claimant does not have enough proof to support his claim. In this situation the insurance company cannot pay the proceeds. The claimant has the right to go to the court to declare the insured as dead. If the insured disappeared under circumstances that made it likely he is dead, then the court may be willing to find that the insured is dead. If the insured disappeared without explanation, courts typically will find that the insured is dead or presumed to be dead only if (1) the insured has been missing for certain period of time, typically seven years (2) a diligent but unsuccessful search has Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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been done for the insured (3) no one has had communication with the insured since he disappeared. Upon receiving the court order the insurance company may pay the proceeds to the claimant if the policy is in force to the presumed death of the insured. Thus when an insured disappears the beneficiary, the policy owner, or any other interested party will have to pay the due renewal premiums that will be due to keep the policy in force. In any case where the policy lapses before the court issues the order then the insurer will have no liability. Beneficiary Wrongfully Kills the Insured: - Throughout Canada and United States, a beneficiary who is convicted in a criminal court proceeding of intentionally killing the insured is not eligible to receive the proceeds. In certain states and throughout in Canada if the beneficiary is convicted of less crime- like manslaughtering- is not eligible to receive the policy proceeds. In Quebec the civil laws are more stringent as it revokes the beneficiary rights if the beneficiary attempts to kill the insured, even if the attempt fails. Without the outcome of the criminal court the civil can determine that the beneficiary has wrongfully killed the insured. In most cases where the beneficiary is denied of the proceeds the insurer is liable to pay to someone—may be the contingent beneficiary. If however, it is proven that the policy was taken to earn benefit by killing the insured, then the lawful purpose requirement is not satisfied and the insurance policy becomes void.

CHAPTER 14: PRINCIPLES OF GROUP INSURANCE POLICY Group insurance policy covers a number of people rather than an individual or one family. The Group insurance policy contract is called “Master Group Insurance Contract”. The contract is between the insurance company (Group Insurer) and the Group Policyholder. The role of Group Policyholder is almost same as that of a Policyowner of an individual insurance policy. But here, the Policyowner has some ownership rights, which Group Policyholder doesn’t have, like naming the beneficiary. The insured people under the Group insurance policy is called as Group insured (in US), Group life insured (in Canada, for life insurance), and Group person insured (in Canada, for health insurance). The Group insurance policy is of two types:  Non-contributory Plan: In this plan, the insured group members are not required to contribute any part of the premium.  Contributory Plan: In this plan, the insured group members have to pay some or all of the premium part. Formation of the Contract

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 Mutually agree to the contract’s terms  Both parties must have the contractual capacity  Must exchange legally adequate considerations  Must form the contract for a lawful purpose The first three are same as that of an individual policy contract. The last point is somewhat different here. In case of an individual contract, the presence of insurable interest must be present for this. But in case of a group contract, the purpose of benefit is sufficient to verify the fourth point, not necessarily the insurable interest. The Policyholder distributes a written document (Certificate of Insurance) to the group insureds that describes:  Coverage the contract provides  Group insureds’ rights under the contract Group Insureds are also called as Certificate holder. Sometimes, the coverage, the benefits and the rights are mentioned in a booklet, called as, Special Benefit booklet. Group Insurance Underwriting Since group insurance doesn’t require the evidence of insurability so the underwriter focuses on the characteristics of the group. These are the Group Underwriting Considerations:  Reason for the group’s existence: As per the insurance laws in the US, there are seven groups that are eligible for getting a group policy. These are 1. Single-Employer Group: The policyholder of a single-employer group insurance contract is either the employer or the trustees of a trust fund created by the employer, and the employees are the insured group members. A trust is a fiduciary relationship in which one or more persons (trustees) hold legal title to property (trust fund) for the benefit of another person (trust beneficiary). A fiduciary is a person who holds a position of special trust. 2. Labor Union Group: The contract is issued to a labor union to insure the members of the labor union. The federal Taft-Hartley Act in the US prohibits employers from making premium contributions on behalf of employees who belong to a labor union unless the contract is issued to a trust established for the purpose of purchasing insurance for union members. Labor union groups are also called as Taft-Hartley trustees or negotiated trusteeships. 3. Multiple-employer Group: A group insurance contract insuring the employees of more than one employer may be issued to a trust that is created by a) two or more employers b) two or more labor unions or 3) one or more employers and one or more labor unions. 4. Debtor-Creditor Group: These groups consist primarily of persons who have borrowed funds from a lending institution, such as a bank. The creditor is the policyholder. 5. Credit Union Group: This group consists of the members of one or more credit unions.

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6. Association Groups: These associations are formed for a purpose other than to obtain insurance. These are the associations that are eligible for group insurance. a) Trade Association: An association of firms that operate in a specific industry b) Professional Association: An association of individuals who share a common occupation. Ex: Medical Doctors, Engineers, attorneys c) Public Employee Association: An association of individuals employed by a state, county, or city government or by a state or local school board d) Common Interest Association: An association of individuals who share a common state or a common interest. Ex: retired persons, alumni of a specific college, participants of a specific sport. 7. Discretionary Groups: Groups that does not fit in the above groups but SID approves for group insurance coverage in called as Discretionary group. In evaluating whether to approve such a group, SID consider factors such as whether issuing the policy is in the best interest of the public and whether the policy benefits are reasonable in relation to the premiums that will be charged for the coverage.





Except Employee-Employer group, other group policyholders usually are not required to pay a portion of the group insurance premium. Size of the group: The size of the group has a strong impact on the underwriter’s ability to predict the group’s probable loss rate. The larger the group, the more likely that the group will experience a loss rate that approximates the predicted loss rate. When the group policy was introduced, minimum 50 people were required in the group for policies. But now days, insurers are issuing the group policies for 10 to 15 group insureds also. In case of small groups, group insurers may ask to submit satisfactory evidence of insurability for each group insureds separately. Flow of new member in the group: Young and new members are needed 1) to replace those who leave the group so that the size stable, 2) to keep the age distribution of the group stable.



Stability of the group: If the group does not remain a group for a reasonable length of time then the administrative cost in issuing a policy would become high. Ex: a group of temporary and seasonal workers.



Participation level of the group: In the US, most state laws require all eligible employees to participate in a non-contributory plan (100% participation level). But in case of a contributory plan, the participation level should be a minimum of 75%. But it varies from state to state, also depends upon the insurer. The provincial laws in Canada do not impose minimum participation requirements. Benefit levels: The group policyholder works with the insurer to establish the death benefit levels provided to the insureds in a fair manner to avoid



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antiselection. Some group policies allow covered group members to select additional coverage from a schedule of optional coverages. In these situations the group insurer minimizes the effects of antiselection by 1) limiting the optional coverages and 2) retaining the right to reject an insureds’ election of the optional coverage if the benefit levels are high and the insureds cannot provide satisfactory evidence of insurability. 

Activities of the group: A group is assigned a risk classification – Standard, Substandard, or declined based on the group’s normal activities. Ex: a group of coal miners is sub-standard.

Group Insurance Policy Provisions: 

 



Eligibility Requirements: Policies are permitted by law to define eligible employees related to conditions of employment such as salary, occupation, or length of employment. Some group policies provide coverage both for group members and for their dependents. But generally the dependents does not have the right to name the beneficiary of his coverage, instead the group member will be the beneficiary for dependents’ coverage. For new members, these are the two provisions: Actively-at-work provision: An employee must be actively at work (rather than on leave or ill) on the day the coverage is to take effect Probationary Period provision: It states the length of time (usually 1 to 6 months) that a new member must wait before becoming eligible to enroll in the group insurance plan. This period is called Probationary period. But if the plan is contributory, then this period is followed by eligibility period (enrollment period), usually 31days. This is the time during which a new member may first enroll for coverage. As part of the enrollment process, the employee must sign a written authorization to make payroll deduction. If any employee wants to enroll in the plan after eligibility period then she can join only after submitting satisfactory evidence of insurability. Grace period Provision: 31 days. But if the policy terminates after the grace period because of non-payment of the renewal premiums, the policyholder is legally obligated to pay the premium during the grace period. Incontestability Provision: Contestable period is same as for the individual policies. But in case of group policies this provision also allows an insurance company to contest an individual group member’s coverage without contesting the validity of the master group contract. Termination Provisions: 1. Termination of the Group Insurance Policy: The group policyholder may terminate the policy at any time by notifying the insurer in writing. The insurance company also has the right to terminate the policy on any premium due date, if certain conditions are met like participation levels.

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The insurer must provide a written notification to the policyholder in advance regarding termination with the date. 2. Termination of the Group Insured’s Coverage: The coverage of the group insured will terminate if the group insured a) ceases to be a member of specified class b) terminates her employment of group membership, or 3) fails to make a required contribution to the premium. Group Insurance Premiums: Unlike individual policies, the premium rate for a group policy usually recalculated every year. Insurers use three kind of ratings to establish the initial premium rate and to calculate the renewal premium rates in succeeding years.  Manual Rating: A method to calculation by which the insurer uses its own past experience (and other insurers’) to estimate a group’s expected claims and expenses.  Experience Rating: A method to calculation by which the insurer considers the particular group’s prior claims and expense experience.  Blended Rating: : In this method, insurer uses a combination of Manual and Experience Ratings. Premium Rate: Set every year and stated as a rate per $1,000 of death benefit provided by the policy Premium Amount: Actual premium paid to the insurer for the coverage, varies every month depending on the coverage Premium Refunds: It is usually called dividends. Companies that do not issue participating policies generally call these refunds as Experience refund. It is payable to group policyholder, even if the plan is contributory. And in case of a contributory plan policyholder doesn’t share the refunds with the groupmembers until the refund exceeds the policyholder’s premium part and in case of excess, the employer may apply it to pay a portion of the employees’ contributions during next year or to pay for additional benefits for covered employees. Group Plan Administration: Insurer-administered Plan: The insurer keeps the contain name of each plan participants, the amount of insurance on each participant, and name of each beneficiary. Self-administered Plan: The group policyholder keeps the contain name of each plan participants, the amount of insurance on each participant, and name of each beneficiary. But in either case, the insurer receives monthly reports regarding the composition of the group and any changes in the group.

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CHAPTER 15: GROUP LIFE INSURANCE. We begin our discussion of group life insurance by describing how group life insurance is regulated in the United States and Canada and some provisions that typically include group life insurance. Then we shall discuss the various types of group life insurance policies and finally we shall discuss how group creditor life insurance policies differ from other forms of group life insurance. Regulation of Group Life Insurance.  Regulation of Employee Benefits: - State, provincial, federal legislature has enacted laws designed to ensure that all employers are treated equally in the workplace. Employment laws prohibit any sort of discrimination regarding hiring, advancement, wage, and other terms and condition. Terms and condition includes employee benefits such as group life insurance. Thus the employer must ensure that all benefit plans comply with laws. A number of federal laws in U.S. regulate the group insurance policies 1) Age Discrimination in Employment Act (ADEA) 2) Americans with Disabilities Act (ADA) 3) Employment Retirement Income Security Act(ERISA). Most of the employee-employer group life and health insurance in U.S. must comply with ERISA. ERISA defines any plan as a welfare benefit plan that an employer establishes to provide specified facilities to the plan participant and their beneficiary. ERISA also contains detailed provisions that regulate employer-sponsored retirement plans. ERISA requires the welfare benefit plans to be maintained accordance a written document, which shall describe:  The benefits that are provided by the plan  How the plan be funded  The procedure that will be followed to make amendments in the plan The written document must also mention the names of the fiduciaries. ERISA sets detailed plan for them. They are responsible for the benefit of the plan. In case of any loss they are personally responsible. ERISA imposes a lot of disclosure and reporting laws for a plan. The plan administrator is responsible for ensuring that the welfare plan complies with the disclosure and reporting laws. A summary plan description must be providing to each of the participants and federal Department of Labor (DOL). An annual report must be filled to Internal Revenue Service (IRS).  State and Provincial Regulation of Insurance: - In most of U.S. have enacted laws based on the NAIC Group Life Insurance Model Act (NAIC Model Act) and thus the laws are fairly uniform across the states. In Canada, common law jurisdictions, the insurance laws are based on the Uniform Insurance Act. In Quebec, individual and group insurance policies are according to the Quebec Civil Code. In addition to these the CLHIA governs certain aspects of group insurance. These laws list the groups that are eligible for group insurance and the various provisions that must be included in the policies.

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Group Life Insurance Policy Provisions. In this section we shall explain the typical provisions that are included in the group insurance policies: 1. Benefit Amounts:- Every group life insurance policy must identify the amountor the method to determine the amount that the insurer will pay the group insured. Benefit schedule defines the amount for the group insured. One type is that the benefit may be calculated on the basis of a formula, as for example some multiple of the salary received by the group insured. The other type specifies amount coverage either (1) for all group insured or (2) for each class of group insured. If the insurance coverage covers the dependents then the policy includes a separate benefit schedule that defines the dependent benefit. Insurance company requirements and the laws of many jurisdictions require that the amount of coverage provided on the dependents should be less than the benefit paid to the group insured. 2. Beneficiary Designation: - Under the terms of a group life insurance policy— unless it is a creditor group life policy—each insured group member has the right to name a beneficiary who will receive the insurance benefit that is payable when the group insured dies. The insured group member has the right of revocation and the not the policyowner. If the policy has dependent coverage then the group insured has the right to designate the beneficiary in this case also. According to NAIC model Act, only sums up to $2000 can be paid as facility payment clause. 3. Conversion Privilege: - The NAIC Model Act and the CLHIA Guidelines require group life insurance policies to include a conversion privilege. The conversion privilege allows the group insured whose coverage terminates for certain reasons to convert her group insurance to individual coverage. There are two cases for which the group insured’s group coverage may terminate – (1) the group insured falls out of the group; (2) the group insurance terminates. Insured’s Eligibility for Group Insurance Terminates: In order to execute the conversion privilege the insured must apply for the individual policy and must pay the initial premium within 31 days from the day of termination of his group insurance coverage. In accordance to NAIC Model Act, unlike CLHIA Group Guidelines, many group life insurance companies allows conversion only after the age of 65 yrs. In general the insured can buy any type of individual policy that insurer have at that time but the benefit of the policy is limited. Many group insurance companies allows to convert to the face amount of the original group life insurance, but most of the insurance company, in accordance to the NAIC Model Act and CLHIA Group guidelines, state that the face amount of the individual policy may not exceed the difference between (1) the amount of the group insured’s coverage under the original group life policy and (2) the amount of the group coverage for which the insured will become entitled within the 31 days conversion period. In addition to this the CLHIA guidelines states that the face amount of such policy to limit to $20,000.

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Group Life Insurance Policy Terminates: According to the NAIC Model Act the Conversion privilege remains to a group insured if the group insurance policy remained in force for five years before termination. In such a situation the insured can buy a individual policy without submitting the proof of insurability within the conversion period of 31 days. The maximum coverage is equal to the lesser of either (1) $10,000 (2) the amount of coverage in force under the group plan minus the amount of group coverage for which the insured becomes entitled within 31 days of the policy’s termination. In Canada, the CLHIA Guidelines direct that group life insurance policy to include WP rider. So incase the policy terminates, then the disabled member’s plan will continue as though the policy remained in effect. Extension of Death Benefit: The NAIC Model Act states that if the group insured dies within the conversion period without converting her policy to an individual policy then the insurer is bound to pay the amount that would have been covered if the insured had opted for an individual policy. In Canada there is no such provision but the insurance companies generally put a similar provisions. 4. Misstatement of Age: - The amount of the benefit payable is decided by the benefit schedule. Thus in case of a misstatement of age, most of the group insurance policy states that if the amount of the premium is wrong due to misstatement of age, then the insurer will retroactively adjust the amount of the premium required for the coverage to reflect the correct age. 5. Settlement Options: - Generally the policy proceeds are paid in the lump-sum mode. Sometimes settlement options are given; then in that case all the usual modes of settlement options are made available. Group Life Insurance Plans. 1. Group Term Life Insurance: - 99% of the group life insurance polices are of YRT. Evidence of the insurability is not required from the group insureds each year when the coverage is renewed. These term policies do not build any cash value and the insurer has the right to change the premium amount every year. Federal income tax laws consider the employer’s contribution to policy premium as a taxable income. In United States, except for certain policies, gives a certain tax relaxation regarding this matter. For this an employee can receive up to $50,000 of non-contributory group term insurance coverage. Thus if any coverage exceeds $50,000 then the employer has to pay income tax for the employer contribution for the excess of $50,000. Group YRT is sometimes used to pay supplementary benefits, as for example survivor income plan. This plan provides periodic payments to the survived dependents. Most of the policies pay a certain percentage of the group insured salary at the death time. For example the plan may pay (1) 20% of the Salary to the survivor spouse if there is no dependent child; (2) 30% if there is any dependent child. The benefits paid to the surviving spouse will continue until the earlier of (1) to a certain time after the spouse remarries; (2) the spouse Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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reaches age of 65 years. The benefit paid to the unmarried child may continue to (1) 19 years of age, the time by when she becomes a full-time student (2) till the child is no longer a full time student or she reaches an age of 23 years, whichever earlier. As in the pervious case if the total the total coverage exceeds $50,000, then the employee must pay income tax on the premium amounts that the employer pays for the excess coverage. 2. Accidental Death and Dismemberment Plans: - AD&D benefits may be included as a part of the group insurance or they may be given as separate plans. The low cost of AD&D makes it an attractive policy. When accidental death benefit is added to a group insurance policy, then generally the coverage is equal to basic benefit of the group insurance coverage. Many companies provide accidental death benefit due to travel to its employees. In such a situation the benefit is given if the accident occurs if an accident occurs while travelling for the company. 3. Group Permanent Plans: - Group permanent plans are less popular since they do not receive any tax privilege. In most cases the group permanent policies are issued as supplementary coverage. This means that the coverage is provided as optional basis or as additions to group term insurance coverage. Generally the following plans are available under this plan: Group Paid-Up Plans: The plan is generally coupled with decreasing term insurance. The plans are contributory; the premium paid by the employee is used for buying single premium paid-up permanent policy. The premium paid by the employer is used to provide the group decreasing term insurance coverage. The total coverage under the paid up policies increases every year and the term coverage decreases every year thus keeping the total coverage to a predetermined limit. The same logic regarding the income tax also applies in this case. Level Premium Whole Life Plans: Level premium group policies are also available. It is generally paid-up whole life policy at the age 65 years. Because these policies have cash value, employers use these to provide retirement benefit. If the plan is non-contributory then the employee does not have any vested right on the policy, thus it the policy terminates then the accumulated cash value goes to the employer. If the plan is contributory then the employee has the vested right upon the amount of the cash value accrued by the premium paid by her. A small portion of the premium paid by the employer for this type of policies. Group Universal Life Plans: Group Universal Life Plans are very similar to individual life insurance policies. Here the employee has the right to choose the premium he wants to pay. Generally the employer does not pay anything. Group underwriting methods may be used, but if the coverage is very high then the insurer may ask for the proof of insurability. The employee may also increase or decrease the coverage, in case of increment the insurer may ask for proof of insurability. The expenses for group universal life insurance coverage are less than corresponding individual universal insurance policy. Group Universal Life Insurance Policies are known as portable coverage, which means that the group universal plans can be carried as group plans even if the group insured falls out of the group. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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4. Group Creditor Life Insurance: - This sort of plans is issued to creditors to cover the life of the present or the future debtors. Unlike all group life insurance plans, here the creditor is the named beneficiary. At any time the amount of the benefit is the outstanding loan. Most insurance company limits the amount of the coverage and the time period irrespective of the loan. The premium for the group life insurance coverage is usually paid by the debtor, although it may be entirely paid by the creditor or the may be shared by the debtor and the creditor. The State and Provincial laws states a limit to premium paid by the debtor. It is generally expressed as the amount per $1000 of the coverage. If the debtor has to pay the premium then the debtor has the right to refuse to buy such a policy. The debtor needs to buy any sort of insurance against the loan but the creditor can not bound him to but the group creditor life insurance.

CHAPTER 16: ANNUITIES AND INDIVIDUAL RETIREMENT SAVINGS PLANS Definition of Annuity: In general terms an annuity is a series of periodic payments. In the financial services industry, the term annuity means a contract under which one party-the insurer-promises to make a series of periodic payments in exchange for a premium or a series of premiums. The need of annuity: Annuity protect against the financial risk of outliving one’s financial resources. Who can issue annuity? Historically, by law, only insurance companies. Other providers of financial services now market annuity products issued by insurers. Some of these providers may wish to issue annuities in the long run. The Annuity Contract: The terms of an annuity contract govern the rights and duties of the contracting parties. The parties to an annuity contract are the  

The insurer that issued the contract and The person who applied for and purchased the contract, known as the contract holder.

The insurer will issue a policy to the contract holder, which will contain all the terms of the contractual agreement entered into by the parties. Annuities can be of two types:  Individual  Group

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As per the terms of the contract the contract holder will pay the insurer a series of premiums or a single premium. Premiums that the insurers receive for annuities are generally referred to as annuity considerations. The insurer calculates the amount of the periodic annuity benefit payments that it will be liable to pay under as annuity policy based on the following basic mathematical concept: A sum of money, known as principal, that is invested for a certain period of time at a stated rate of interest can be paid out in a series of periodic payments-in an annuity-over a stated period of time. Some important facts and figures: Individual and Group Annuities in force in 1998 (as a percentage of premiums):  In USA: Group 54%, Individual 46%  In Canada: Group 42%, Individual 58% 

Classifications of Annuities Annuities can be classified on the following criterion:  How the annuity was purchased  How often periodic annuity benefits are to be paid  When annuity benefit payments are scheduled to begin  The number of annuitants covered by the annuity policy  Whether annuity values are guaranteed or variable How the annuity was purchased: The categories of annuities under this parameter are the following:  Single-premium annuity: An annuity that is purchased by the payment of a single, lump-sum premium. Benefit payments under a single-premium annuity may begin shortly after the premium is paid or may begin after a considerable duration of time from the premium payment date.  Periodic level-premium annuity: The contract holder pays equal premium for the annuity at regularly scheduled intervals, such as monthly or annually, until some pre-determined future date.  Flexible-premium annuity: The contract holder pays premiums on a periodic basis over a stated period of time, the amount of each premium payment, can vary between a set min. and max. Amount. The contract holder may choose to even skip the payment of premium of a particular installment. The requirement is to pay the minimum stated premium for a year. Single-premium annuities are the most popular followed by Flexible-premium annuities. Periodic level-premium annuities are the least preferred.

How often benefits are paid Annuity period: The time span between each of the payments in the series of periodic annuity benefit payments. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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The frequency of periodic annuity benefit payments depends on the length of the annuity period.  

Monthly annuity: When the annuity period for an annuity policy is 1 month. Annual annuity: When the annuity period for an annuity policy is 1 year.

There could be quarterly or semiannual annuities also.

When Benefit payments begin The date on which the insurer begins to make the annuity benefit payments is known as the annuity’s maturity date or the annuity date. Depending on when the insurer is to begin making periodic annuity benefit payments we could have Immediate annuities and Deferred annuities. Immediate annuity: These are annuities where the benefit payments are scheduled to begin one annuity period after the annuity is purchased. Generally these are singlepremium annuities. Such an annuity policy is called single-premium immediate annuity (SPIA). Deferred Annuity: An annuity under which the periodic benefits are scheduled to begin more than one annuity period after the date on which the annuity was purchased. The period during which the insurer makes the annuity benefit payments is known as the payout period or liquidation period. The period between the contract-holder’s purchase of the policy annuity and the onset of the payout period is known as the accumulation period. Deferred annuities could be both Single-premium deferred annuities (SPDA) and Flexible-premium deferred annuities (FPDA). A point to note is that any annuity purchased with the payment of periodic premiums is by definition a deferred annuity. Accumulated value of a deferred annuity = Net amount paid for annuity + Interest – Withdrawals The manner in which the policy provides for investment earnings on the accumulated value depends on whether the deferred annuity is a fixed-benefit annuity or a variable annuity. Withdrawal provision: This provision grants the contract holder the right to withdraw all or a portion of the annuity’s accumulated value during the accumulation period.

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Withdrawal Charge: Most policies imposes a ceiling on the amount withdraw able from the accumulated value for a deferred annuity per year without charge. If the contract holder wants to withdraw more than this amount, then the insurer generally imposes a withdrawal charge. Cash surrender value: At any point of the accumulation period the contract holder has the right to surrender the policy for its accumulated value less any surrender charges included in the policy. Surrender Charge: This is typically imposed if the policy is surrendered within a stated number of years after it was purchased. The amount of surrender charge usually decreases over time. Cash Surrender Value on deferred annuity = Accumulated value – Surrender Charges

Payout option provision is an annuity policy that lists and describes each of the payout options from which the contract holder may select.

When Benefit Payments End There are three general types of payout options available:  Life annuity  Annuity certain  Temporary life annuity Life Annuity is an annuity that provides periodic benefit payments for at least the lifetime of a named individual. Some life annuities also provide further payment guarantees. The named individual whose lifetime is used as the measuring life in a life annuity is often referred to as the annuitant. Annuity Beneficiary is the person or party that the contract holder names to receive any survivor benefits that are payable during the accumulation period of a deferred annuity. Payee is the person who receives the annuity benefit payments during the payout period. Annuity Certain is an annuity policy, which will provide periodic payments over a period of time that is unrelated to the lifetime of an annuitant. The stated period over which the insurer will make benefit payments is called the period certain. At the end of the period certain the annuity payments cease. Temporary Life Annuity provides periodic benefit payments until the end of a specified number of years or until the death of the annuitant, whichever occurs first. Once the stated period expires or the annuitant dies, the annuity benefits cease.

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For example in a 5 years temporary life annuity the max. Length of time in which the annuity benefits will be payable is 5 years. But if the annuitant dies before that time the payment ceases.

The number of annuitants covered by the policy Joint and survivor annuity or joint and last survivor annuity is an annuity, which provides benefit payments throughout the lives of both the annuitants. The terms of a Joint and survivor annuity determines whether the amount of each periodic benefit payment remains the same after the death of one of the annuitants or whether it decreases and in that case by what percentage or amount.

Whether Annuity values are Guaranteed or Variable The investors to annuities have different purposes in mind with those funds and also have different capacities for assuming financial risk when they place money in annuities. Many insurers offer 2 general options to annuity purchasers:  Guarantee to pay at least a stated interest on the annuity funds it holds Or  Pay interest at a rate that is not guaranteed, instead, the interest rate will vary according to the earnings of certain investments held by the insurer. Fixed-Benefit Annuities are annuities under which the insurer guarantees that at least a defined amount of monthly annuity benefit will be provided for each $ applied to purchasing the annuity. Most fixed-benefit annuities specify that once the insurer begins paying the annuity benefits, the amount of the benefit payment may not change. But this is not a rule. In some cases the insurer may declare a change of the amount of the benefit amount. In case of single premium immediate annuities the benefit amount is generally fixed. In case of deferred annuities annuity policy includes a chart of annuity values. This chart will list the amount of annuity benefit that is guaranteed per $1000 of accumulated value. A fixed-benefit deferred annuity policy also describes the manner in which the insurer will credit investment earnings to the policy’s accumulated value. Variable Annuities are annuities in which the amount of the policy’s accumulated value and the amount of the monthly annuity benefit payment fluctuate in accordance with the performance of a separate account. The individual who purchases a variable annuity assumes the investment risk of the policy. Because the insurer makes no guarantees regarding the investment earnings or the amount of a variable annuity’s benefit payments, the insurer retains no risk under the policy.

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The mechanism that allows this investment risk transfer from the insurer to the purchaser is the separate account. This is called the segregated account in Canada. This account is completely separate from the insurer’s general investment account. Insurers typically offer a number of different separate accounts and they follow a different investment strategy for each such account. The value of a separate account may increase or decrease depending on the performance of the account’s investments. Variable annuity contract holders may select from this list of separate accounts and may periodically transfer funds from one such account to another. Accumulation units represent the ownership shares of a variable annuity contract holder in a separate account. The number of units that a contract holder can own depends on the premium that he pays. As premiums are paid throughout the accumulation period, the number of accumulation units that a contract holder owns increases. The insurer must periodically recalculate the value of an annuity unit based on the investment experience of the separate account. The insurer then recalculates the amount of the periodic benefit payment by multiplying the total number of annuity unit times the current value of an annuity unit.

Life Expectancy Factor In the case of life annuities, the length of payout period is linked to the annuitant’s lifetime. So the life expectancy factor is considered when calculating the amount of periodic annuity benefit that can be provided for a specified premium amount. Annuity mortality rates-the mortality rates experienced by persons purchasing life annuities-are not identical to the mortality rates experienced by persons insured by LI policies for a given age and gender. The difference in form of antiselection in the case of annuities compared to that in LI policies: People in good health and who anticipate a long life are more interested in purchasing life annuities then are those in poor health. This is just the opposite of that happens in the case of a LI policy. Mortality rates depending on gender and annuity premium rates: Mortality stats show those females as a group may anticipate living longer than males as a group. This is why; insurers generally tend to charge higher premium rates from females than for males of the same age. In recent years, legislatures and courts are examining whether the use of gender-based premium rate is a form of unlawful discrimination on the basis of gender.

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Some insurers use unisex mortality tables and charge males and females with the same premium rates for annuities. Types of Life Annuities: The 3 variations of life annuity that insurers commonly offer are 1. Straight life annuity 2. Life income annuity with period certain 3. Life income with refund annuity Straight life annuity provides periodic payments for only as long as the annuitant lives. This form of annuity is the least popular as there is a risk of the annuitant paying much more money as premium than he actually receives as payout from the annuity, as he expired early during the payout period. Life income annuity with period certain guarantees that the annuity benefits will be paid thru out the annuitant’s life and guarantees that the payments will be made for at least a certain period, even if the annuitant dies before the end of that period. In this case, the contract holder selects a contingent payee who receives the payout benefits in case the annuitant dies. Please note that if the annuitant dies after the expiration of the period certain, the no extra benefits are paid to the contingent payee. Life income with refund annuity also known as a refund annuity, provides annuity benefits thru out the lifetime of the annuitant and guarantees that at least the purchase price of the annuity will be paid in benefits. This guarantees that if the annuitant dies before the total benefit payments equal the purchase price of the annuity, a refund will be made to the contingent payee. This refund is the difference between the purchase price of the annuity and the total amount of benefits that had been paid during the lifetime of the annuitant. Refund annuity is available in 2 forms:  

Cash refund annuity where the refund is paid as a lump sum. Installment refund annuity where the refund is payable in a series of periodic payments.

Comparison of Premium Rates: Premium rates for the straight life annuities are the lowest. Annuity Contract Provisions:   

Entire contract provision: Same as that of LI Free-look provision: Same as that of LI Incontestability provision: Typically an application of an annuity does not contain questions regarding the insurability of the applicant. So he does not need to provide any representations on which the insurer bases his decision of issuing an

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 



annuity. In such cases, the incontestability provision states that, once the contract becomes effective, the insurer may not contest the validity of the contract. In case the annuity product has any supplementary benefit riders associated with it then the applicant for such a rider generally must provide proof of insurability. In such a case the incontestability provision gives the insurer a specified period – such as one or two years – in which to contest the validity of the coverage provided by the rider based on a material misrepresentation in the application. Misstatement of age or sex provision: states that if the annuitant’s age or sex was misstated, then the annuity benefits payable will be those that the premiums paid would have for the correct age or sex. Assignment provision: Unlike in the case of LI policies, here the contracts generally state that if the contract is part of specified types of qualified retirement plans, then the contract may not be sold, assigned, transferred, or pledged as collateral for a loan or any other purpose to any other person. Such contracts are not assignable by federal laws. Settlement options or Payout options provision: identifies and describes each of the payout options that a contract holder may elect for the payment of annuity benefits.

Some additional provisions, which are possible, based on the type of the annuity contract are: 

Beneficiary provision: gives the contract holder the right to name the beneficiary who will receive any survivor benefits payable if the annuitant or the contract holder dies before annuity benefit payments begin.



Withdrawal provision: right to withdraw all or part of the annuity’s accumulated value during the accumulation period. Surrender provision: the right to surrender the annuity for its surrender value during the accumulation period.

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Fixed-premium annuities generally include the following additional provisions:  

Grace period provision: Same as in LI. Reinstatement provision: Same as LI.

Regulation of Annuities The regulations are same in both USA and Canada, as is in the case of LI policies. This is because, its only insurance companies which are allowed to sell annuities. For variable annuities the regulations are the same as is in the case of variable LI policies.

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Taxation of Annuities Annuities are an increasingly popular product in the US and the fact that a product that qualifies as an annuity in accordance with federal tax laws provides favorable federal tax treatment is partly responsible for that. For the purpose of income taxes, each annuity benefit payment is considered to consist of the following 2 parts: 1. One portion is the return of principal, which is not taxable because the purchaser has already paid income taxes on that amount. 2. The remainder portion of each benefit payment is considered taxable investment income because the purchaser has never paid income taxes on the policy’s investment earnings. By contrast, Canada’s tax laws do not provide this favorable treatment for annuities. Investment incomes for annuities are taxable incomes thru out the life of the annuity. The one exception is annuity used to fund a qualified retirement plan. Individual Retirement Savings Plans Both the Govt. of USA and Canada have enacted laws that provide federal IT advantages to individuals who deposit funds into government-qualified retirement savings plans. Here we will describe some of these qualified individual retirement savings plans, focusing on the plans that may be marketed by LI companies. For federal IT purposes, the amount that certain individuals deposit into qualified retirement savings plans-up to a stated maximum-are usually deductible from their gross incomes in the year in which those funds were deposited into the plans. In addition, the investment earnings on a qualified account generally are not taxed until the funds are withdrawn. In United States of America: There are 2 types of individual retirement savings plans, which qualify to receive favorable federal IT treatment:  IRA  Keogh (HR 10) plans Federal laws    

Define which individuals may establish each type of qualified plan. Place limits on the amounts a taxpayer may contribute to each type of qualified plan. Establish rules for the taxation of plan withdrawals.

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IRA (Individual Retirement Arrangement) IRA may take one of the following 2forms: Individual retirement account is a trust account created in the US for the exclusive benefit of an individual and his beneficiaries; the trustee must be a bank, investment company, stock brokerage, or similar organization. Individual retirement annuity is an individual annuity issued by an insurance company. Insurers use the acronym IRA to refer to an individual retirement annuity. The sponsoring financial institution handles the administrative aspects of an IRA plan. It ensures that the IRA plan meets the legislative requirements to qualify as an IRA arrangement and obtain approval from the Internal Revenue Service (IRS) that the plan qualifies. Tax treatment on IRAs varies on the basis of whether it’s a Regular IRA or a Roth IRA. Regular IRA has been established in 1974. The following is a summary of the tax treatment on a regular IRA: 1. Anyone who is less than age 70 1/2 and who has earned income may contribute up to $2000 per year of the earned income into a regular IRA. 2. Taxation of investment earnings is deferred until funds are withdrawn. With only a few exceptions, however, penalties are imposed on withdrawals made before the taxpayer attains age 59 ½. 3. Taxpayers must begin making annual withdrawals of at least a specified minimum amount when they reach age 70% and after that time they may not make additional contributions to their IRAs. Roth IRAs have been established since Jan 1, 1998. The primary difference in the tax treatment of a Roth IRA and a Regular IRA are as follows:  No current tax deductions are allowed for contributions to a Roth IRA. Thus, Roth IRA contributions are made with after-tax dollars, whereas Regular IRA contributions are made with pre-tax dollars.  Qualified withdrawals from a Roth IRA that the taxpayer has held for at least 5 years aren’t subject to income taxation. Qualified withdrawal includes withdrawals taken after the age 59 ½ and the withdrawals made by a 1st time homebuyer.  Unlike Regular IRAs, Roth IRAs aren’t subject to minimum distribution requirements. Keogh Plans (HR 10 Plans) Available for self-employed individuals. A financial institution, such as an insurance company or an investment company, must sponsor the plan. Insurance companies market individual annuity contracts that qualify as Keogh plans. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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The administrative aspects of the Keogh are handled by the sponsoring organization. IRS approval is necessary for Keogh plans. Following is a summary of important information about Keogh plans.  Funds of the Keogh plans may be placed in any of the several types of investments, such as stocks, bonds, or real estates etc.  The deposit to a Keogh plan is deductible from taxable income up to a certain limit.  Withdrawals from a Keogh account are taxable as income.  Penalties on the withdrawals may be payable if the legislatively defined requirements for making withdrawals are not met. In Canada: A qualified retirement account is known as a registered retirement savings plan (RRSP). Any gainfully employed individual, including an employee who is covered by an employer-sponsored pension plan, can establish this RRSP. The following is a summary of information about RRSP.  The contribution to an RRSP is deductible from taxable income up to a stated maximum.  This may also depend on whether the individual is an active participant in a qualified pension plan. Such an individual will have a lower ceiling to the contribution eligible for deduction from taxable incomes.  Funds in RRSP may be placed in a number of investment vehicles.  RRSP accounts must begin withdrawing the accumulated funds by the time they reach age 69.

CHAPTER 17: GROUP RETIREMENT AND SAVINGS PLAN. In this chapter we shall learn about the following:  REGULATION OF RETIREMENT PLANS.  TYPES OF RETIREMENT PLANS.  COMPONENTS OF RETIREMENT PLANS.  GOVERNMENT SPONSERED RETIREMENT PLANS. Regulation of retirement plans. In order to encourage employers and labor union to buy retirement plans for the members, both in United States and in Canada, federal income tax laws provide income tax benefits to both the plan sponsors – the employers that establish the plan, and the plan participants – the employees. In order to have the tax benefit the plans have to meet certain regulations. In United States these plans are known as qualified plans and in Canada they are known as registered plans. In Canada the plans have to be approved and registered with Revenue Canada prior to the establishment of such plans. In United States, plan sponsors are not required to obtain prior approval of Internal Revenue Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Service, yet they choose to obtain prior approval form IRS. We shall now discus the salient laws that govern the formulation of such plans in U.S. and in Canada. United States: - Most of the legislation part comes from Employee Retirement Income Security Act (ERISA). Following are the requirements that ERISA imposes on retirement plans. 1. Non discrimination requirements prohibit qualified plans from going for the benefit of highly paid employees. 2. Vesting requirements must be clearly stated in a plan. This right give vested interest of the employee on the benefits of plan even he leaves the service prior to retirement. This requirement should clearly state that when the employee has the right to policy benefits and when does she have the vested interest on the employer’s contribution. 3. Security requirements must be fulfilled to safeguard the interest of the plan participants. 4. Reporting has to be done by the plan sponsor to government agencies and to the plan participants regarding the plan provisions. 5. Fiduciaries are responsible to administrate the plan and to hold the plan assets. They are bound to do their duty in accordance to the statutory guidelines mentioned in ERSIA. 6. Tax benefits: a) Within stated limits the contributions made from the employers end is considered as a part of employer’s current expense and hence is not considered as taxable income. b) The employer’s contribution to thee plan is not considered as taxable income for the employee. The tax on employer’s contribution is deferred till she actually receives the benefits from the plan. c) All the interest earnings are allowed to accrue tax-free. The plan participant actually pays the tax on the interest earnings on receiving the benefits from the plan. Retirement plans can either be contributory or non-contributory. Since there is no tax benefit on the employee’s contribution most of the retirement plans in U.S. are of non-contributory type. Canada: - The Canadian federal government and all the provincial government have each enacted a Pension Benefits Act. The Pension Benefits Acts require that when an employer establishes a pension plan, it must be registered with a specified government agency. In order to qualify for registration it must comply various numbers of rules, which are quite similar with requirements imposed by ERISA. The different requirements for the Pension Benefit Act are: 1. The plan must contain specified minimum vesting requirements. 2. The plan must be portable; i.e. the benefits can be transferred from one registered plan to the other. 3. Plan assets must be invested in accordance to PBA. In order to get favorable tax benefits the plan must be approved and registered by Revenue Canada. In order to get registered by Revenue Canada the plan must be Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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registered in accordance to Pension Benefit Act. The requirements that are mentioned for Revenue Canada are: 1. Employer’s contributions, within specified limits, are deductible from employer’s current taxable income. 2. Employer’s contribution is not considered as employee’s taxable income. 3. Within specified limits, employee’s contributions are tax fee. 4. Investment earnings are allowed to accrue tax-free until participants receive the benefits. Types of Retirement Plans. Employers establish three general types of qualified (registered) retirement plans in the United States and in Canada. Pension plans: - These are plans according to which the employer promises to pay pension to the employees after their retirement. Most employers sponsored pension plans, in U.S., are qualified pension plans and are referred as qualified plan. In Canada such a plan is known as a registered pension plan (RPP). Both qualified and registered can be categorized as the following:  Defined Benefit Plans: This plan defines that the participant will receive a fixed amount as retirement benefit. The benefit is usually given as monthly annuity. The services of an actuary are typically required to determine the amount of contribution required for the plan. Contributions made for all the plan participants are pooled into one investment account and are allocated to individual plan participants as they retire according to the plan’s provision.  Defined Contribution Pension Plans: In this plan the employer states the amount of contribution that will be paid for each plan participants. The contributions are invested into separate accounts for each participant. The participants get the entire accrued amount as a lump sum or as monthly annuity. There are advantages that the Defined Contribution Plans have over Defined Benefit Plans—firstly, the employer knows the amount that will be paid for the plan in advance, secondly, the employer does not have to depend on the actuary’s estimation. Moreover ERSIA imposes more complicated laws for Benefit Plans. Profit Sharing Plans: - This is a retirement plan that is primarily funded from the employer’s profits. In Canada these plans are known as deferred profit sharing plan (DPSP). The features are quite similar to the defined contribution plans. Since the employer is making contribution from the profits, so it might not pay the contributions when the contribution warrants them. Qualification rules in U.S. states that employer’s contribution must be substantial and recurring and should not benefit high paid employees. To qualify as DPSP in Canada, a plan that defines the amount of the employer’s contributions “by reference to profits” must provide that at least 1% of those profits will be contributed. If the plan defines the amount of the employer’s contributions “out of profit” then limitations are imposed, but those are not as stringent as 1-% rule. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Qualified Retirement Savings Plans. United States: An employer may provide a thrift and savings plan. This plan works in the same way as Profit Sharing Plans; the only difference is that the employer’s contribution is obligatory. An account is established for each plan participants. The employee’s contribution is subjected to statutory limits and the employer generally pays an amount equal to the employee’s contribution. The employee’s contribution to this plan does not enjoy any federal income tax benefits. In order to provide tax benefits laws in U.S. allows the employees to participate in special type of thrift and savings plan known as 401(k) plan. The employee’s contribution is considered as taxable income, but she has to pay tax when she withdraws the money from such a plan. In order to participate in 401(k) plan the employee enters into a salary reduction agreement. Another type of qualified retirement plan that is established for employer with not more than 100 employees in the preceding year. This type of plan is known as Savings Incentive Match Plans for Employees (SIMPLE plan). The employee agrees to reduce her compensation but the reduction is also taxable. The limitations to the contribution to the SIMPLE IRA are generally higher than other type of IRAs but that is lower than the limitations provided to other qualified plans. The employer also needs to contribute to the plans, but within certain limits. There is clause for nondiscrimination and other regulations are quite simple. All contributions to a SIMPLE IRA accounts must be vested in the employee. Canada: An individual who wishes to establish a retirement plan in Canada can buy Registered Retirement Savings Plan, and within stated limits can deduct from his current taxable income. Many employers buy group RRSP. Employees and employers are permitted to make contribution to the plan but the contribution from the employer’s end is considered as that the employee made them. Hence the employee has the vested right over the amount of the plan form very beginning. Any contribution to the plan is tax-free. Nonqualified Retirement Savings Plans. Many nonqualified plans are established to avoid the complex legislative norms that govern the qualified (registered) plans. We shall now discuss the nonqualified retirement plans in U.S. and in Canada. United States: For small employers there is simplified employee pension (SEP) plan. The employee is required to establish her own IRA in which the employer will add her contribution. The contribution made by the employer is considered as her expenses and hence deductible from her current income. The employer’s contribution is considered as taxable income for the employee, but she is allowed to take certain tax deductions. The deductible for the contribution maid to SEP IRA is more than in other IRAs. SEP are easier to administrate since it involves less amount of paper work. Canada: Some Canadian employers have established employee’s profit sharing plans (EPSPs) that are nonregistered saving plans. Contributions must be made every year. The contributions made by the employer are deductible from his present taxable income. To get the tax benefit the employer must share the profit under “reference to profit” that is the share must be 1%. The employee has to pay tax on both the contributions made by the employer and herself. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Components of a Retirement Plan. 





The plan: The terms of a plan are written in a document known as plan document. This document spells out the different provisions; as for example: the plan must state the eligibility criteria for the plan participants, the time by when the participants are fully vested, the time by when she will receive the benefits form the assets of the plan. Plan administrator: The plan sponsor names a plan administrator who is responsible for various aspects of the plan’s operation. The administrator can be the sponsoring employer or a board of committee that will be established by the employer. The administrator is responsible for maintaining the records for all participants. The administrator uses these records to provide reports to the governmental agencies and to the plan participants. In many cases the administrator may require many other services in order to maintain the plan. She is responsible for hiring these services. Life insurers provide both plans and administrative services. Funding vehicles: A funding vehicle is the means of investing the plan’s assets as they are accumulated. The means can be an annuity, mutual fund, life insurance contract, others. The plan sponsor is required to follow certain limits while selecting the funding vehicle for the plan. Funding vehicle provided by the insurance companies are guaranteed against certain financial loss and mortality rates. The various funding vehicle provided by the insurance company are: 1. Group Deferred Annuity: Each year the contributions made for each plan participants, are used to buy single premium deferred annuity. When the participant retires the benefits from the plan are given as usual retirement benefits. Because the contributions are used to buy plans before the retirement of the of the participants, these plans are also known as fully insured products. 2. Deposit Administration Contracts: The plan sponsor places the assets of the plan in the General Investment Account of the insurer. When the participant retires the insurer buys an immediate annuity with the amount of his share from the account. The insurer generally guarantees against investment losses and states a minimum amount that the participant will receive. 3. Immediate Participation Guarantee Contracts (IPG): Here also the assets of the plan are placed in the General Investment Account of the insurer, but this contract does not guarantee against investment losses. Instead the contract allows the sponsor to participate in the gain and the loss of the insurer. However there is a limit to which the sponsor shares the loss of the insurer. 4. Separate account Contracts: This is sometimes called as investment facility contract, the insurer invests the assets in stocks, short-term investments, mutual funds, etc. The insurer maintains investment strategies for different accounts, and the sponsor chooses one or more accounts in which the assets will be invested. Generally the separate accounts do not guarantee the performance of the account.

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5. Guaranteed Investment Contracts (GIC): Here the insurer accepts the assets form the sponsor for a certain number of years. The interest is generally guaranteed. The interest earned on the investment can be annually returned to the sponsor or can be accumulated till the period ends. At the end of the period the accumulated sum is returned to the sponsor. Government Sponsored Retirement Plans. Canada: In Canada we have the following retirement plans that are sponsored by the government: Old age Security Act: This act provides pension to all Canadians of age above 65 years. The pension amount is not dependent on the preretirement wage, marital status, current occupation, etc. Everyone who has reached an age of 65 and has met certain residential criteria is eligible to receive the pension. The money to fund these pensions is taken form federal government general tax revenues. Canada Pension Plan and Quebec Pension Plan: These are federal programs that provide pension to workers who have contributed money into the plan during their working years. The CPP and QPP work very closely and hence the participants can be easily transferred from one plan to another. Participation for all workers in these plans is mandatory. The covered employee must pay a certain amount of her income into the plan and the employer has to pay the same amount as the employee. The self-employed worker needs to pay a higher amount. The benefit of the plan depends on the amount contributed but is limited to a legislatively established amount. United States: Nearly all people in U.S. are covered by the Old Age, Survivors, Disability and Health Insurance (OASDHI) Act, or better known as Social Security; excepting few groups. As for example federal civil service workers are covered by Civil Service Retirement Act, railroad workers are covered by Railroad Retirement Act, and some state and municipal civil workers. At present moment it is not mandatory for state civil workers to participate in Social Security and most of the state covers their civil workers in their own retirement programs. Other states have voluntarily joined the Social Security. Social Security provides pension to the covered persons of age more than 62 years; however people retiring before 65 years receive a less amount of pension. The act covers the dependant spouse or children in case the covered dies. The act also covers the disabled. The workers must contribute a percentage of their annual income to the plan. The employer also need o contribute the same amount as the employee. The amount of the monthly benefit is dependent on the contribution made by the individual. The monthly benefit is increased in order to reflect the increase in cost of living measured by CPI.

CHAPTER 18: MEDICAL EXPENSE COVERAGE Medical expense coverage are indemnity benefits. Medical expense coverage are maintained by Managed care plans.

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Managed care Plans are medical expense plans that combine financing and delivery of health care within a system that manages the cost , accessibility and quality of care. 2 Managed care plans are: 1. Health Maintenance Organizations (HMO) 2. Preferred Provider Organizations (PPO) Basic medical expense coverage: Consists of separate benefits for each covered medical care cost. Some common basic expense coverages: Hospital expense: Hospital expenses like room, board, medication, lab tests etc. Surgical expenses: Inpatient and Outpatient surgery Physician’s expense coverage: Physician’s visit both in and out of the hospital. There could be one policy for each coverage or one policy of all kinds of coverages. These are also known as first-dollar coverage since insurance companies starts reimbursing right from the first dollar of the expense and no contribution is asked from insured. Major medical insurance: This medical expense plan provides substantial benefit to the same category of expenses provided by basic expense coverage and sometimes also contains preventive care. A maximum benefit limit or lifetime unlimited maximum benefit is specified. 2 types available: 1. Supplemental major medical policy: Provides coverage for amount that exceed the limit that comes with basic medical coverage or coverages that can be bought separately. 2. Comprehensive Major medical policy: Combination of basic medical coverage and supplemental medical coverage. Most plan are of this type. Usual, reasonable and customary fees: UCR is the maximum dollar amount of a given covered expenses that the insurer will find eligible for reimbursement. Based on statistics from national study of fees, a standard expense level is set for a locality for a certain covered expenses by applying a predetermined formula. This benefit amount is UCR fee. When a claim is processed the proceed is determined whether the amount is within UCR or not. Expense participation: Encourages insured(s) to keep benefit amount to a minimum and thus help in reducing the coverage premium.

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2 kinds of participation: 1.Deductible: A flat amount that insured needs to pay first before the coverage level starts. Like first $20. The deductible of group policies is usually lower than individuals ones. 2.Calendar year deductible: Total maximum deductible incurred in a year for various covered expenses. 3.Coinsurance: After the deductible has been paid the benefit reimbursement level starts. However this provision states that for this level also insured needs to pay a percentage of the expense. 4.Stop Loss provision: All expenses incurred during a year are totaled as out-ofpocket expense. There is a limit on the out-of-pocket expense. This provision states that once the insured has paid the max. out-of-pocket the rest of the claims will be paid at 100% Common exclusions: 1. Cosmetic surgery for beautification 2. Self inflicted injury treatment 3. Treatment of Injury while In military service 4. Routine dental, eye exams and corrective lenses 5. Treatment in a free of charge govt. facility or that is paid by any other organization. Supplemental medical expense coverage: 1. Dental Covers routine dental exams, dental procedures and preventive work Both coinsurance and deductible applied 2. Prescription Drugs: Benefit to purchase drugs and medicines Usually contains a small deductible of $5-$10 called co-payment Pharmacist submits a claim for the rest of the amount to the insurer Sometimes insured might also be needed to file a claim 3. Vision care 1 routine eye checkup each year Limit on benefit for lenses, frames and contacts 4. Dread disease Coverage for a special specified disease like cancer Can supplement basic medical expense coverage and can serve the same purpose as supplemental major medical coverage. Not sellable in many states 5. Critical Illness This plan pays a lump some money if the insured is diagnosed with a particular disease. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Example: Heart attack, stroke, life threatening stroke Typically includes return of premium if the insured dies without incurring the disease. 6. Long Term Care: This plan provides coverage for people who because of old age or any other cause. Medicare Supplement Coverage: In USA, the Old Age, Survivors, Disability and Health Insurance ( OASDHI ) also known as social security provides medical coverage under Medicare program. Insurance companies have insurance products which provide supplemental coverage over Medicare. These are known as Medigap policies. Govt. Sponsored Programs: Medicare and Medicaid Medicare: Eligibility: 1. Age 65+ and have social security benefits 2. Have 2 years of eligible disability income benefits 3. Have retirement benefits under Railroad retirement act 4. Those who are afflicted with – or are the dependent of a person afflicted with – kidney disease that requires dialysis or transplant There are 2 parts of this program: Part A: Basic insurance coverage and is automatically extended to everyone without any premium. Deductible and coinsurance provision is present. Includes 1. Hospitalization 2. Confinement in an extended care facility after hospitalization and 3. home health care services. Financed by payroll tax imposed on employees through Social Security program. Part B: Supplementary coverage can be bought by paying premium of 45.50. Finance by premium of people insured and federal government general revenues. Intermediaries: Third parties who administer Part A. Carriers: Third parties who administer Part B. Medicaid:       

Program for poor people. State and federal funded program. Each state administers its own program and establishes its own eligibility criteria. Thus Medicaid varies hugely from state to state must all follow a minimum federal mandate for requirements. Medicaid must cover long-term custodial nursing-home care. Person receiving Supplemental Social Security (SSI) must receive Medicaid. Disabled and blind person must receive Medicaid Medicaid is always the secondary payor of benefits

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Major Differences between Life and Health Insurance:

Life Insurance

Health Insurance

Valued Contact One time payment Smaller Effect

Contract of Indemnity Multiple Effect of inflation, changes in economy and changes in medical practice effect the amount of benefits largely. Effected by geographical location

Independent

Claim Costs: Cost the insurer predicts that it will incur to provide the policy benefits promised. It is calculated for every type of expenses like : 1. Surgery 2. Hospital expense 3. Physician fee 4. major medical expense. For each type the claim cost is calculated as: Claim Cost: Frequency of expected claim * Avg. amount of each claim Gross premium = Net premium + Loading. Since number of claims for Health Insurance is much more, so insurer always adds an extra amount to actual Loading to counter unforeseen contingency conditions Loss Ratio: Ratio of Benefits an insurer paid out for a block of policies to the premium received. Loss Ratio is calculated to keep a check on the insurer so that they cannot add too much to the Loading as a measure of protection against contingency situations.

CHAPTER 19: DISABILITY INCOME COVERAGE. Individual and commercial insurance companies provide disability income coverage that provides a specified, periodic income replacement benefits to an insured that becomes unable to work because of an illness or an accidental injury. Definition of Total Disability. Each disability income policy specifies the definition of total disability that the insurer uses to determine whether a covered person is entitled to get the disability benefits.  Any Occupation: At one time the disability was defined as the state where the covered person becomes disable to perform any sort of occupation. Because of the strict sense of the definition most of the covered person will never be entitled to the benefits. Thus the insurance companies now use a more liberal definition.  Current Usual Definition: This provides that an insured is considered totally disabled if at the start of disability, the disability prevents him from performing the essential duties of his regular occupation. At the end of the specified period, Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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





usually two or five years, an insured is considered as totally disabled if his disability prevents him from working at any occupation for which he is reasonably fitted by education, training, or experience. Policies that use this definition however may state that the insured will not be considered as disabled if he voluntarily returns to any occupation. Own Previous Occupation: This definition which is generally included in individual policies rather than group policies, states that the policy will pay disability benefits if the insured becomes unable to perform the acts of her own previous occupation. Thus even if the insured starts working at any other gainful occupation different from his previous occupation, he is entitled to receive the benefits. Income Loss: This definition is generally included in disability coverage known as income protection coverage. The definition of total disability for the insured states that the insured is disabled if he suffers an income loss for his disability. As a result, the insurer pays the benefit both while the insured is totally unable to work and while he is able to work but his disability has reduced his income. The policy specifies both (1) a maximum benefit amount that will be paid when an insured will be completely unable to work and (2) a method of determining the amount of lost income when the disabled insured is working. Presumptive Disabilities: A presumptive disability is a stated condition that, if present, automatically causes the insured to be considered totally disabled; thus the insured will receive the full benefits even he resumes his original occupation. This generally includes total and permanent blindness, loss of the use of any two limbs, and loss of speech or hearing.

Benefit Period. Benefit period is time for which the insurer pays the disability income benefits. Based on this the policy can either be classified into short term or long term.  Short-term group disability income coverage provides a maximum benefit period of less than one year; such coverage commonly specifies maximum benefit period of 13, 26, or 52 weeks. Long-term group disability income coverage provides a maximum benefit period of more than one year; the maximum benefit period commonly extends to the insured’s normal retirement age or to age 70. 

Individual disability income coverage is seldom offered with a maximum benefit period of less than one year. Thus, short-term individual disability income coverage provides a maximum benefit period of one to five years. Long-term individual disability income coverage provides a maximum benefit period of at least five years. The benefit period in this case may extend until the insured reaches 65years of age; in some cases, benefits are provided for the insured’s lifetime.

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Elimination Period. An elimination period is the waiting period for which the insured has to be disabled to receive the benefits. The elimination period reduces the cost for providing the benefits for disability that lasts for very short periods. Longer the elimination period shorter will be the cost of the coverage. The length of elimination period for both short and long-term individual disability income coverage last from 30 days to 6 months. Most short-term group life disability income coverage contains no elimination period for disability due to accidents and an elimination period of 1 week for disability for sickness. Most long-term disability coverage has an elimination period of 30 days to 6 months. Benefit Amount. As a general rule, the benefit amount available through disability income coverage is not intended to replace fully an individual’s predisability income. Instead the benefits are limited. Disability income amounts however should not be so low that the insured faces a drastic income loss. The insurer generally uses either of the following two methods to determine the benefit amounts. The methodology depends on whether the policy is a group policy or individual policy or on whether the policy is a short-term or long-term policy.  Income Benefit Formula: This is generally used for group disability income benefit policies. Here the insurer states the benefit as some percentage of the insured’s predisability income. The insurer considers all sort of disability income. For group long-term disability income coverage the benefit generally amounts to 65-75 % of the predisability income. For example, the insurer may state that the insured will receive 70% of his predisability income and the benefits will be reduced if he receives disability income form any other sources. Group short-term disability income coverage has this percentage as 90-100%.  Flat Amount: This is generally used for individual policies. Here the insurer mentions a flat amount to be paid when the insured becomes totally disabled. The amount of the benefit depends on the insured’s earnings at the time he purchased the policy. But here the benefit does not depend on earnings form any other source. The insurer carefully limits the maximum benefit for which the insured can buy the policy. The insurer generally considers the following factors while setting up the maximum benefit from the policy: 1. The amount of the applicant’s usual earned income, before tax. 2. The amount of the applicant’s unearned income, such as dividends and the interest, that will continue when the insured become disabled. 3. Additional income during disability, such as income benefits from group policy and government sponsored policy. 4. The applicant’s current tax bracket. In general, the maximum amount of disability income benefit that insurer will provide is 50 to 70 % of his pre-tax earnings.

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Supplemental Benefits. We shall now describe certain supplemental benefits that are usually added to disability income coverage. These are either added automatically with the policy or are added as an option by paying extra premium for such benefits.  Partial Disability Benefits: In this case certain benefit is provided to the insured if he has partial disability—a disability that prevents the insured from performing certain acts of his own occupation or prevents him from being a full time employee of his present occupation. This amount is typically either a flat amount or often 50% of the total disability benefit. Using the formula method the benefit may vary depending on the insured’s loss of income due to partial disability.  Future Purchase Option Benefit: In case of flat benefit the insurer may provide a future purchase option, which grants the insured to increase the benefits as his income increases. The option is generally provided if the insured can show that his income will increase considerably in the future. However the increment of such benefits is limited. The insurer does not need to provide proof of insurability to increase the benefit amount.  Cost of Living Adjustment Benefit: COLA benefit states that the insured will provide the disabled insured a benefit amount that increases to reflect the increase in cost of living. Generally the increment depends on certain standard indices such as CPI. Exclusion: Following are the exclusion criteria for the disability income benefits: 1. Injuries or sickness that result from war, declared or undeclared. 2. Intentionally self-inflicted injuries. 3. Injuries receive as a result of active participation in a riot. 4. Occupation-related disabilities or sickness for which the insured is entitled to receive income benefits under some group or government disability program. Specialized Types of Disability Coverage. These coverage are designed to provide benefits, other than loss in come if the insured gets disabled. In Chapter 4 we described that a closely held business will suffer from a financial loss if the key person or any of the partners dies. Likewise the business may suffer from a loss of income if the key person or any of the partners gets disabled.  Key Person Disability Coverage: This coverage provides benefits to offset the losses that a business suffers if the key person gets disabled. The benefit goes to the company.  Disability Buyout Coverage: This for the BSA. Here the benefits are provided to buyout the partner’s or owner’s interest should he become disabled.  Business Overhead Expense Coverage: Should the owner gets disabled, still he might incur expenses to operate his business. For example office rent, mortgage payments, etc. This coverage provides disability benefits to cope up with the overhead expenses. Insurers describe overhead expenses as the usual and necessary business expense including employee’s salary, rent, telephone, electricity, gas, and other expenses that are required to keep the business open. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Government-Sponsored Disability Income Programs. United States: U.S. workers who are under age 65 and who have paid a specified amount of Social Security Tax for a prescribed number of quarter-year periods are eligible to receive Social Security Disability Income (SSDI). For this the disability is described as a person’s inability to work because of a physical or mental sickness or injury that have lasted or expected to last at least for one year or might lead to death of the insured. The monthly benefit is equal to the amount of retirement benefit that the person would have received. The benefit does not begin until the insured is disabled for 5 months. Hence approximately the benefits start after 6 months. The benefit continues up to (1) 2 months after the disability ends; (2) the insured dies; (3) the insured reaches 65 years of age when he becomes entitled to receive retirement benefits. The disability plan might also provide dependent benefits. However there is a limit to the maximum family coverage. Canada: Short-term income benefits are available under the federal Unemployment Insurance Act. This is given to all workers who have worked for a specified no. of weeks in the preceding 52 weeks period. The benefit begins after a short waiting period if the absence from work is result due to an accident or sickness or pregnancy. The plan is financed by compulsory contribution of the employee and the employer. The employer can reduce his contribution by getting insured through private plans. In this case the private plans are the first payor. Long-term disability is available from CPP and QPP. To qualify the worker must (1) have made contribution for a stated period; (2) be under 65 years of age; (3) be afflicted with severe and prolonged disability. Severe disability prevents the worker from engaging himself into any gainful occupation and prolonged disability states that the disability is going to last long or might cause the covered worker’s death. The amount of the benefit depends on the worker’s predisability wage and his contribution to the plan. The benefit continues the disability is recovered, or till the insured reaches an age of 65 years or till he dies. Dependent children benefit is also present in these plans.

CHAPTER 20: TRADITIONAL GROUP HEALTH INSURANCE PLANS Group Health Insurance Policy: It’s a contract between the Insurer & the GPH (group policyholder) that purchased the group insurance coverage.

Group Health Insurance Policy

Group Medical Expense Policy

Group Disability Income Policy

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What does the Group Medical Expense IP specify? 1. The type of medical expenses to be covered. 2. The benefit maximums (if any). 3. The deductible amount. 4. The coinsurance features.  What does the Group Disability Income IP specify? 1. The elimination period. 2. The method of determining the amount of the disability income benefit. 3. The maximum benefit period. Important points to remember 1) Group Medical Expense Policies (GMEP) provide an option to cover employees’ dependents. But for this the employee cum insured has to bear the additional premium for the dependent(s). 2) Group Disability Income Policies (GDIP) do not provide the option at all. 



What are the extra provisions included only in the Group Health Insurance Policies & not in The Group Life Insurance Policies? There are 4 such provisions & they are: 1. Pre-existing conditions provision. 2. Conversion provision. 3. Coordination of benefits provision. 4. Physical examination provision.

1) Pre-Existing Conditions Provision: In Group Policies, a pre-existing condition is defined to be a condition for which an individual receives medical cares during the three months immediately prior to the effective date of his/her coverage. This provision states that the benefits are not payable for pre-existing conditions until the insured has been covered under the policy for a specified length of time. 



What are/is the criteria/n that decide/s the eligibility of an insured for the coverage? 1. The insured has not received treatment for that condition for 3 consecutive months Or 2. The insured has been covered under the policy for 12 consecutive months. What is HIPPA? HIPPA stands for Health Insurance Portability and Accountability Act. It was enacted by the U.S. Congress in ’96. This Act imposes a no# of requirements on employer sponsored group health insurance plans, health insurance companies & health maintenance organizations. According to this act the maximum look-back period against “ Pre-existing Conditions” is six months.

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2) Conversion Provision: This provision grants an insured, who is leaving the group, a limited right to purchase an Individual MEP with the presenting the evidence of insurability. The right is limited in that the insurer can refuse to issue the individual policy if the coverage results in the insured group member becoming over-insured. For instance, an employee who’s changing his/her job & will be eligible for GMEP from his/her new employer would be considered over-insured if he were also issued an Individual MEP. Disadvantages of Conversion from GMEP to IMEP: 1. Higher premium is charged. 2. Benefits provided are more restricted. In most states in the U.S. require to include this provision for GMEP. However, this is not a mandatory provision to be included in GMEP in Canada

3) Coordination of Benefits (COB) Provision: COB is designed to prevent a group-insured, who is covered under more than one GMEP, from receiving benefit amounts greater than the medical expenses actually incurred. For instance, spouses, who both work, are eligible for coverage under their own employers’ group policy & their spouses’ group policy. If benefits payable under such duplicate coverage were not coordinated, the insured could receive full benefits from both the policies & consequently would profit from an illness or injury. 

How is it taken care of? By defining one Plan as the Primary & the other as the Secondary. The Primary Provider pays the full benefit promised under the plan. Once the insured receives this benefit, and then the insured can claim to the secondary plan, along with the description of the benefit amounts the primary plan paid. The Secondary Provider then determines the amount payable for the claim in accordance with the terms of that plan.



What are the different types of COB Provision? 1. Allowable Expenses. 2. Non-duplication of Benefits.



What is Allowable Expense? This is the reasonable & customary expense that the insured incurred & that is covered under at least one of the insured GMEP. Note here that the Secondary Provider pays the difference between the amount of Allowable Expense & the amount already received from the Primary Plan. Under this type of a COB, the insured does not pay any portion of the expenses.

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

What is Non-duplication of Benefits? It’s a COB provision, if included in a secondary provider’s plan, limits the amount payable by the secondary plan to the difference, if any, between the amount paid by the primary plan & the amount that would have been payable by the secondary plan, had that plan been the primary plan. This provision requires the insured to bear a portion of the of covered medical expenses. (Please go thru the examples. [Pg No.- 379-381])

A few facts about COB:  If an individual is covered by two plans, one in which she acts as the employee and the other in which she acts as the dependant, then the primary payor is the former plan.  If an individual is covered by two plans one of which has the COB provision then it becomes the primary payor.  If individual is covered as dependant by two plans, such as a child covered by plans of her parents, then according to “Early Birthday Rule” the primary payor will be the plan of the parent who has the earlier Birthday.

4) Physical Examination Provision: This is included in most GDIP & grants the insurer the right to examine the insured, who has claimed a disability income, by a doctor of the insurer’s choice & at the insurer’s expense. This provision also allows the insurer to make the disabled undergo medical examinations at regular intervals so that the insurer can verify that the insured is still disabled.

Group Health Insurance Underwriting: A group’s risk classification – standard, substandard, or declined – will be established on the basis of the group’s morbidity rate. 

What are the factors that decide the expected morbidity rate of a group? 1. The nature of the industry the group members work 2. The age distribution of the group. The rate increases as increases the age of the group members. 3. The distribution of the males & the females in the group. Females experience higher morbidity rates than do males of the same age.

Funding Mechanisms: The way in which a group insurance plan’s claim costs & administrative expenses are paid is known as the plan’s Funding Mechanism. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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

What are the two main funding mechanisms for Group Insurance Plans? 1.

2. 3.

Fully Insured Plans – Here the group policyholder makes the monthly premium payments to the Insurance Co and the Insurance Co. bears the responsibility for all claim payments. This is also known as Traditional Funding Arrangement. Fully Self Insured Plans – Here the employer takes the complete responsibility for all the claim payments & related expenses. Other funding mechanisms fall between those two.

Following three mechanisms are built upon the Fully Insured Plans:  Retrospective Rating Arrangements Under this the insurer agrees to charge the group policyholder a lower monthly premium than it would normally charge based upon the group’s prior claim experience. On the other hand, the Group Policy Holder agrees to pay an additional amount to the insurer if at the end the policy year; the group’s claim experience becomes unfavorable. RRA usually includes an experience refund feature, which means if the group’s claim experience is favorable, the insurer will refund some amount to the group policyholder.  Premium Delay Arrangements This allows the group policyholder to postpone paying monthly group insurance premium for a stated period of time (usually 60 or 90 days) beyond the expiration of the policy’s grace period. This helps the group policyholder to make use of that amount in its own purpose. But the group policyholder must pay the deferred premiums, if any, to the insurer when the contract terminates.  Minimum Premium Plans Under MPP, the group policyholder deposits into a special account funds an amount that is sufficient to pay a stated amount of claims. The insurer pays the claims until this fund is exhausted. Thereafter, the insurer is responsible for paying the claims from its own fund against a very nominal premium from the group policyholder. In MPP the premium taxes get considerably reduced.

Following three mechanisms are built upon the Self Insured Plans:  Salary Continuation Plan Under this plan, the employer provides 100% of the insured employee’s salary on the first day of the employee’s absence due to sickness or injury & continuing that for some specified time.  Stop Loss Coverage If a self-insured group experiences several catastrophic medical claims in one year, the employer may not have that much fund to cover all such claims. To deal with such situations many employers purchase Stop-Loss Insurance from an

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insurance co. so that they can transfer their liability to the insurance co. when the claims exceed a certain dollar amount. There are two types of stop-loss coverage available. Under Individual Stop-Loss Coverage / Specific Stop-Loss Coverage the insurer pays a portion of the each claim that exceeds a stated amount. Under Aggregate Stop-Loss Coverage the insurer pays when the employer’s total claims exceed a stated dollar amount within a stated period of time (usually 12 months). Note:

1) The insurer in Stop-Loss Coverage is known as the Stop-Loss Carrier. 2) The carrier does not pay the benefits directly to the insured. It reimburses the employer, who stands responsible for making the payments to the group insured.

Plan Administration Some self-insuring employers purchase Administrative Service Only (ASO) contracts from any insurance company or a Third Party Administrator (TPA) to deal with the administrative aspects of a group insurance plan. A TPA is an organization other than an insurance company that provides administrative services to the sponsors of Group Benefit Plans. Under an ASO contract, the employer pays a fee in exchange for the administrative services provided by the insurer or the TPA. These fees are not subject to state premium taxes. 

What are the benefits of Fully Self Insurance to the Fully Insured Plans? 1) No premiums need to be paid any insurer. 2) So avoids insurer’s expense charges. 3) Avoids paying profit of the insurer. 4) Avoids paying commissions to agents. 5) Employer retains the money for the premium with it, which leads having an improved cash flow & earning interest on that.

More importantly, self-insured plans are exempted from State Laws providing more freedom to the self-insurance employer in designing the plans. However, many selfinsured plans in the US, are subject to regulation by the federal ERISA.

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CHAPTER 21: TRADITIONAL INDIVIDUAL HEALTH INSURANCE POLICIES People who are otherwise not eligible for group health insurance coverage generally purchase individual health insurance policies. This is a contract between the insurer and the policy owner. The policy will describe the coverage provided, the benefits payable, and the premium amounts and their due dates. The policy owner and the insured are usually the same person. The insurer typically pays the benefits directly to that person or to a medical-care provider on behalf of that person. The number of coverage options that insurers offer to group policyholders is usually not available to individual policy owners. But the applicant of an individual health insurance policy is generally permitted to make choices concerning the following:    

Benefit levels Renewal provisions Amount of the policy’s deductible (for individual medical expense policies) Combinations of elimination periods and maximum benefit periods (for individual disability income policies)

Individual Health Insurance Policy Provisions Many of the provisions for Individual Health Insurance policies are same as with the Group Health Insurance policies. Here we discuss some of the provisions typically included in the Individual Health Insurance policies.

Renewal Provision This provision describes  

The circumstances under which the insurer has the right to refuse to renew or the right to cancel the coverage. The insurer’s right to increase the policy’s premium rate.

Traditionally, Canadian insurers and US have used the following 5 general classifications of individual health insurance policies.     

Cancelable Policy. Optionally renewable policy. Conditionally renewable policy. Guaranteed renewable policy. Non-cancelable policy.

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Cancelable Policy grants the insurer the right to terminate the policy at any time, for any reason, simply by notifying the policy owner that the policy is cancelled and by refunding any advance premium that has been paid for the policy. Some states in the US do not permit insurers to issue cancelable policies. Optionally Renewable Policy gives the insurer the right to refuse a policy on certain dates specified in the policy-usually either the policy anniversary date or any premium due date. Insurer is also allowed to add coverage limitations and to increase the premium rate if it does so for an optionally renewable policy. A class of policies consists of all policies of a particular type or all policies issued to a particular group of insured. Conditionally Renewable Policy grants the insurer a limited right to refuse to renew an individual health policy at the end of a premium payment period. The decision must be based on one or more specific reasons stated in the policy. The reasons cannot be related to the insured’s health. The age and employment status of the insured are often listed as reasons for possible nonrenewal. Guaranteed Renewable Policy means that the insurer must renew the policy-as long as premium payments are made-at least until the insured attains the age limit stated in the policy. Mostly this age is 60 or 65. Sometimes it could be 70 and there are cases when the policy is a guaranteed renewable policy through the lifetime of the insured. Non-cancelable Policy is guaranteed to be renewable until the insured reaches the limiting age stated in the policy. In addition, the insurer does not have the right to increase the premium rate for a non-cancelable policy under any circumstances; the guaranteed premium rate is specified in the policy. Disability income policies typically are non-cancelable, medical expense policies are rarely non-cancelable. In the US, HIPAA enacted in 1996 imposes a general requirement that the insurers must renew or continue an individual medical expense insurance policy in force at the option of the policy owner. In common-law jurisdictions of Canada, most individual medical expense policies are cancelable and most disability income policies are non-cancelable. In the province of Quebec, individual health insurance policies have several classifications, from which the applicant can choose the one to purchase. Premium rates for non-cancelable policies are higher than equivalent policies in the other classifications.

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Grace Period Provision Allows the policy owner to pay a renewal premium within a stated grace period following the premium due date. The length of the grace period varies, depending on how frequently renewal premiums are payable. Generally policies with monthly renewal premiums have a 10-day grace period. Policies with less frequent renewal premium periods have typically a 31-day grace period.

Reinstatement Provision States that if certain conditions are met, the insurer will reinstate a policy that has lapsed for nonpayment of premiums. The policy owner usually must pay any overdue premiums and must complete a reinstatement application. Insurer has the right to evaluate the reinstatement application and to decline to reinstate the policy on the basis of statements in that application. If the insurer does not complete the evaluation within a stated number of days-in most states, 45 days-after receiving the reinstatement application, or if the insurer accepts an overdue premium without a reinstatement application, then the policy is usually considered to be automatically reinstated. Coverage under a reinstated policy is limited to accidents that occur after the date of reinstatement and to sicknesses that begin more than 10 days after the date of reinstatement.

Incontestability provision Most individual medical expense policies contain a provision entitled time limit on certain defenses. This is also known as incontestable clause or incontestability provision. This states that after the policy has been force for a specified period, usually 2 or 3 years, the insurer can’t use material misrepresentations in the application either to void the policy or to deny a claim unless the misrepresentations were fraudulent. Most individual disability expense policies contain a incontestability provision which states that after the policy has been force for a specified period, usually 2 or 3 years, the insurer can’t contest the policy’s validity on the ground of material misrepresentations in the application. This does not include a reference to fraudulent misrepresentation. Essentially this is same as that of the incontestability provision in LI policies in USA.

Pre-Existing Conditions Provision Most individual health insurance policies include a pre-existing conditions provision stating that until the insured has been covered under the policy for a certain period, the insurer will not pay benefits for a pre-existing condition. A pre-existing condition is usually defined in individual health insurance policies as an injury that occurred or a sickness that first appeared or manifested itself within a specified period-usually 2 years-before the policy was issued and that was not disclosed on the application.

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The insurer has the opportunity to evaluate such a condition and, thus, can specifically exclude the condition from the policy’s coverage. In most states and throughout Canada, 2 years is the maximum period during which an insurer is permitted to exclude pre-existing conditions from coverage. Insurers are permitted to specify a shorter exclusion period because a shorter exclusion is more favorable to the insured. In USA, HIPAA prohibits insurers from including a pre-existing condition in the individual health insurance policy issued to specified individuals.

Claims Provisions This defines both the insured’s obligation to provide timely notification of loss to the insurer and the insurer’s obligation to make prompt benefit payments to the insured. In Canada, the policy usually requires the insured to notify the insurer of a claim in writing within 30 days from the date the claim arose and to furnish the insurer with proof of loss within 90 days from the date the claim arose. The insurer must pay benefits within 60 days of receipt of proof of loss for a medical expense claim and within 30 days of receipt of proof of loss for a disability income claim. Policies issued in the US contain similar requirements.

Physical Examination Provision After the insured submits a claim, the insurer has the right to have the insured examined by a doctor of the insurer’s choice, at the insurer’s expense. The insurer, therefore, has the ability to verify the validity of disability income claims. Legal Actions Provision This provision limits the time during which a claimant who disagrees with the insurer’s claim decision has the right to sue the insurer to collect the amount the claimant believes is owed under the policy. The length of this time period varies from jurisdiction to jurisdiction, but varies between 1 to 3 years after the claimant provides the insurer with proof of the loss.

Change of Occupation Provision This allows the insurer to adjust the policy’s premium rate or the amount of benefits payable under a policy if the policy owner changes his occupation. The insurer is typically permitted to reduce the maximum benefit payment amount payable under the policy if the insured changes to a more hazardous occupation. If the insured changes to a less hazardous occupation, the provision permits the insurer to reduce the policy’s premium rate.

Over insurance provision This is intended to prevent an insured from profiting from a sickness or injury. This provision states that the benefits payable under the policy will be reduced if the insured is over insured. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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An over insured person is one who is entitled to receive either  More in benefits from his medical expense policies than the actual costs incurred by treatment.  A greater income amount during disability than he earns while working. Individual Health Insurance Underwriting The underwriter evaluates an application for individual health insurance policy to determine the degree of morbidity risk represented by the proposed insured.

Morbidity Factors The primary factors that affect the degree of morbidity risk presented by a proposed insured are the individual’s age, current and past health, sex, occupation, avocations, work history, and habits and lifestyle. Age: Morbidity rates generally increase with age. Health: The current health and the individual’s health history are required in determining the morbidity risk. Sex: Females have a higher morbidity rate than males of the same age. Occupation: The morbidity risk also depends on the applicant’s occupation. An individual’s risk classification and corresponding premium rate correspond to the individual’s occupation class. Avocations: The individual’s avocations also have a strong bearing on his potential health insurance risk. Work history: An individual’s work history can also have a bearing on her morbidity risk. Habits and Lifestyle: The person’s habits and lifestyle can expose him to a high degree of risk and accidental injury or illness. Risk Classifications The risk classifications are:   

Standard risk Substandard risk Declined risk

Exclusion rider, also called the impairment rider, specifies that benefits will not be provided for any loss that results from the condition specified in the rider.

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CHAPTER 22: MANAGED CARE PLANS Managed Care Plans were created to: 1. Eliminate the fact that more frequent visit by patient to doctor means more financial benefit for doctors. 2. Broaden the circle of financial risk to include health care providers. Health care providers should be encouraged to deliver the necessary care in a cost-effective way. Utilization management: Process by which a plan manages an insured’s use of medical services and assures that she receives necessary, appropriate, high quality care in a cost effective manner. Utilization management broadens and combines utilization review and case management techniques. Utilization Review is a process by which a plan evaluates the necessary and quality of a patient’s medical care. UR includes: 1. Preadmission certification: Insured must contact a UR agent if he wishes to get admitted to hospital. UR agents then determines the kind of service needed and makes proper arrangements 2. Concurrent review: While patient is in hospital, UR staffs monitors the condition 3. Retrospective reviews: Same as preadmission but is done after the patient’s release from hospital. This is a concurrent review step of the whole analysis. This might reveal erroneous charges and billing errors.

Case Management Case Management is an extension of UR and is a process by which a plan evaluates not only the medical necessity of care but also alternative treatments or medical care. Health care coverage Continuum:

Traditional Indemnity Plans

PPO

Gatekeeper PPO

Open ended HMO

HMO

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Health Maintenance Organizations (HMO) A HMO is a health care financing and delivering system that provides comprehensive health care services for subscribing members (Subscribers) in a particular geographic area. HMOs can be owned or sponsored by many different types of organizations: by national HMO organizations, by commercial insurers, and by medical schools and hospitals. HMOs can be operated as either not-for-profit or for-profit organizations.

Characteristics of HMOs 1) Comprehensive Care: HMO subscribers are eligible to receive comprehensive health care services, including impatient and outpatient treatment in a hospital. Unlike traditional indemnity plans, HMO emphasize the practice of preventive care, including routine physical examinations, diagnostic tests, pre-natal and well-baby care, and immunizations. 2) Prepaid Care: In a traditional HMO, subscribers receive comprehensive health care in exchange for the payment of a periodic fixed fee. Most HMOs require the subscriber to pay an additional fee (co-payment) for certain medical services. HMOs shift all or part of the financial risk to the health care providers. 3) Network Providers and Negotiated Fees: HMOs contract with physicians and hospitals to make up a network of health care providers. HMO subscribers must choose their medical care providers from within this network. By Contracting, HMOs achieve advantages like:  Can control the quality of the providers  Can negotiate fees and thus reduce the cost These are the fee structure arrangements that are used to pay the providers. Capitation: Under this arrangement the providers gets paid PMPM (per member per month) for a subscriber regardless of number of visits. But PMPM may be different for each HMO subscriber Salary: Physicians get a pre-determined salary based on the average salaries of local physicians in the same field. They also receive certain types of performance bonuses or incentive pay. Discounted fee-for-service: HMO pays physicians a certain percentage of their normal fees (like 90%). It is not as widely used as other fee structures. Fee Schedule: The HMO will pay up to a specified maximum fee for each procedure. In this case it is transferring more risk to the service providers. 4) Intensive Use of Managed Care Techniques: HMO requires subscribers to select Primary care physician (PCP) who serves as the first contact with the HMO. If additional care needed, PCP refers the subscriber to specialists within the network. That is why they are often called gatekeepers.

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Types OF HMOs Open Panel HMO: any physician or provider who meets the HMO’s specific standards can contract with the HMO (2 type) Closed Panel HMO: physicians either must belong to a special group of physicians that has contracted with the HMO or must be employees of the HMO (2 type) Mixed Models: combine characteristics of two or more methods. Open Panel  Individual Practice Association (IPA) model: Under this arrangement, HMO enters into a contract with an IPA, which is an association of physicians (independent practitioners) that agrees to provide services. Physicians provide services to their own patients as well as to the HMO subscribers. This model requires less start-up capital and can offer a broad range of specialists. IPA model is generally compensated by ‘capitation’ or ‘discounted fee-for-service’ arrangements. Some HMO requires subscribers to pay co-payment also. But in this case the financial risk rests with an IPA. 

Direct Contract HMO: HMO contracts directly with the physicians (primary care physicians or specialists), not thru any associations or middleman. Fee structure, financial risk, less start-up capital (own clinic and staff) – same as above

Closed Panel  Staff Model: Physicians are actually employees of the HMO and generally out of offices in the HMO’s facilities. The staff model HMO may own or contract with hospitals, laboratories, pharmacies, and other organizations to provide nonphysician medical services. Uses ‘Salary’ structures. Financial risks on the HMO, costly to start up but have greater control over physicians so can manage utilization of health care services better than other models.  Group Model: Functions same as a staff model, except that the physicians are employees of a physicians’ group practice, rather than employees of the HMO. The physicians in such a group share office space, staff, and medical equipment at a common health center or clinic. Ex: Kaiser Permanentre in the US. If the group HMO contracts with more than a group, then it is called a network model HMO. Pay to the group by ‘capitation’ method, group pays the physician ‘salaries’ based on their performance, expertise and amount of administrative work. Financial risk on the physicians’ group. Preferred Provider Organizations (PPO) Unlike HMO, PPO does not provide health care directly rather it acts as a broker or middleman by contracting between health care providers and health care purchasers (employers, third-party administrations, insurance companies, and unions). PPOs can be organized or sponsored by group of physicians, hospitals, Blue Cross or Blue shield Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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plans, TPAs, or employers. In the US, insurance companies are the dominant sponsors of PPOs. PPOs also use a network of providers but also offer some coverage for members who choose to use the services of non-network or out-of-network providers. Out-of-pocket expense (generally 30%) will be more in case of out-of-network provider selection, only to encourage the subscribers to choose the network provider. PPOs typically compensate health care providers on a fee-for-service basis. As a result, PPOs do not accept the financial risk of providing health care services to insureds but they pass it on to either the insurer or the policyholder.

Hybrid Plans 



Open-ended HMOs or Point of service (POS) Plan: This plan has some features of a traditional HMO and some of a traditional indemnity plan. The subscriber of this plan either uses the HMO network or may choose to use a provider that does not participate in the HMO. The subscriber typically pays higher out-of-pocket expense than under a traditional indemnity plan. But this plan contains financial incentives to encourage subscribers to use network providers. Gatekeeper PPOs: This PPO plan requires plan members to choose PCP (gatekeepers) within the PPO network of physicians. In this case, the out-ofpocket expense will be lower than the usual PPO. Another difference is this plan is the compensation method to the providers. Here PCP is compensated on a capitation basis. Thus gatekeeper PPOs transfer financial risk to providers.

CHAPTER 23: REGULATION OF HEALTH INSURANCE Regulation in the United States State Regulation of Health Insurance: NAIC has developed these model laws to regulate the health insurance:  Uniform Individual Accident and Sickness Policy Provision Law  Group Health Insurance Definition and Group Health Insurance Standard Provisions Model Act  Model Newborn Children Bill  Group Health Insurance Mandatory Conversion Privilege Model Act  Group Coordination of Benefits Regulations and Guidelines Most state regulations for individual health insurance are similar as they are patterned with the NAIC model laws, but state regulations for group health insurance differs widely from state to state as they are not patterned with the NAIC model laws.

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Policy Provisions: Most state insurance laws require including these provisions in the policy:  Minimum grace period be included in individual and group policies  Incontestable clause in individual and group policies  Most states limit the time within which pre-existing conditions can be excluded from coverage (in individual and group policies)  Cancellation and renewal provisions (in individual policies)  Reinstatement provision (in individual policies), and Conversion provision (in group policies)  Coordination of Benefit (COB) provision in group policies, and overinsurance provision in individual policies. Regulations Unique to Group Health Insurance: About half of the states require a minimum number (usually 5 or 10) under a group policy. The insurer can rely solely on its own underwriting requirements to decide the minimum group size if state doesn’t require any minimum number. Most state laws also states the eligibility requirements for a group to have a group health insurance policy. NAIC model laws states that the group should be an employer, a labor union, a creditor, a trust established by an employer or union, an association, a credit union, or a discretionary group. Mandated Benefits: Applicable to both group and individual policies. The benefits that have been mandated include, among others, coverage of newborn children, treatment of alcoholism and drug addiction, coverage of services provided by chiropractors, psychologists and podiatrists; coverage of certain diagnostic tests such as mammograms. But these benefits widely vary from state to state. Regulation of Alternative Providers: In addition to regulating the insurance industry and traditional health insurance, the states also regulate HMOs, PPOs, and other alternative health care plans. State laws for regulating HMOs are based on the NAIC Model HMO Act. In order to qualify, an HMO must provide certain basic health care services and must meet a number of statutory requirements designed to ensure the financial and operational viability of the plan. Taxation: Health insurers are subject to state, as well as federal, taxes. Most states impose a premium tax on insurance premiums received by insurers operating within the state. The states do not tax to self-funded health insurance. The states generally do not tax premiums paid to the Blue Cross and Blue Shield and HMOs. In states, an employer may deduct as a business expense any group health insurance premiums it paid on behalf of the employees. Employees also generally are not taxed on premiums paid on their behalf except for disability income benefits.

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Federal Regulation of Health Insurance: Age Discrimination in Employment Act (ADEA): An employer having 20 or more employees must comply with this act. This Act protects workers who are age 40 and older from being discriminated against because of their age. As per this act, all active employees, regardless of age, must be eligible for the same health care coverages, and older employees cannot be required to pay more for that coverage than younger employer pay. Retired employees are not protected by the ADEA. Title VII of the Civil Rights Act of 1964: An employer having 15 or more employees and that are engaged in interstate commerce must comply with this act. This act prohibits employment discrimination on the basis of race, color, sex, religion, or national origin. A 1978 amendment to this act, Pregnancy Discrimination Act, requires employers to treat pregnancy, childbirth, or related medical conditions the same as any other medical conditions. (Applicable for employees as well as to their wives) Family and Medical Leave Act: An employer having 50 or more employees must comply with this act. As per this act, an employee can take up to 12 weeks of unpaid leave within any 12-month period upon the birth or adoption of a child, to care for a seriously ill family member, or while the worker is ill. The Act also requires that the employers continue to provide group health insurance to workers while they are on family and medical leave. Employee Retirement Income Security Act (ERISA): The terms of ERISA take precedence over any state laws that regulate employee benefit plans. An employer that sponsor welfare benefit plans (medical, surgical, hospital, disability, death, unemployment benefits, etc.) must comply with this act. ERISA requires group plans to have a written plan document, to have a summary plan description, and to file an annual report with the IRS, and establishes standards of conduct for plan fiduciaries. Consolidated Omnibus Budget Reconciliation Act (COBRA): An employer having 20 or more employees must comply with this act. COBRA requires that certain persons whose group health coverage would otherwise terminate be allowed to continue the coverage at their own expense for a stated period following a qualifying event. 18 month period in case of job termination. 36 month period in case of a death or divorce. 36 month period for a dependent child. The insurer can also add 2 percent of the actual premium as an administrative fee. Upon the occurrence of a qualifying period, plan administrator must notify the covered individuals of their rights under COBRA. The covered individuals have a specified time within which they can elect to continue. Health Insurance Portability and Accountability Act (HIPAA): This act imposes requirements on employer-sponsored group medical expense insurance plans (exception: accident only coverage, only disability income coverage) and insurers Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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that issue individual medical expense insurance coverage. HIPAA does not preempt state insurance laws that are more favorable to the insureds. HIPAA requires the guaranteed availability of individual medical expense coverage to certain individuals who have had group medical coverage. The insurers are exempt from this requirement if the state implements an alternative mechanism by which such eligible individuals may obtain coverage. Regulation of individual Medical Expense Policies: HIPAA imposes that insurers must renew or continue an individual policy in force at the option of the policyowner. However the insurer can discontinue the coverage in case of nonpayment of premium, fraud or intentional misrepresentation, complying with statutory requirements, insured no longer resides or works in the network’s geographic (in case of a network health care plan) or no longer an association member (in case coverage available thru an association). Regulation of Group Medical Expense Policies:  HIPAA imposes a number of requirements on group medical plans including indemnity plans and managed care plans:  HIPAA places limits on the pre-existing condition exclusion. These limits are designed to allow group insureds that have a pre-existing condition to change the job without losing coverage for the coverage. The maximum look-back period under HIPPA for pre-existing condition is six months.  HIPAA requires a group health benefits plan to provide a special enrollment period for specified individuals who declined the coverage first time.  HIPAA prohibits group health benefits plans from establishing eligibility rules for group health coverage based on health status, medical condition, claims experience, genetic information, and disability.  Insurers that offer group health coverages must renew such coverage at the option of the group policyholder. Although HIPAA permits insurers to increase the premium rates charged for such renewal charges. Mental Health Parity Act: This Act imposes that if the plan is offering the mental health plan then it may not set an annual or lifetime maximum mental benefits limit that is lower than any such limits for medical and surgical benefits. And if it does not set a limit on medical benefits may not impose such a limit on mental health benefits. Newborns’ and Mothers’ Health Protection Act of 1996: This law does not require policies to provide benefits for maternity and newborn care but it imposes specific requirements on plan that do provide such benefits. Such policies must provide coverage for at least 48-hour hospital stay following a normal delivery and 96 hours for a cesarean section. Women’s Health and Cancer Rights Act of 1998: According to this act, insureds who receive benefits in connection with a mastectomy and who elect to have breast reconstruction following the mastectomy are entitled to receive benefits for the reconstruction. Principles of Insurance: Life, Health & Annuities Dated: 26th Feb, 2003

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Health Maintenance Organization (HMO) Act of 1973: Federally qualified HMOs and employers that have 25 or more employees and that make contributions to an employee health care plan must comply with this act. The HMO act encouraged the establishment and development of HMOs by providing grants and low-interest loans to start up HMOs that met federal qualification requirements. These requirements include standards concerning plan solvency, plan design and benefits, and plan administration. Taxation: In most cases, the employer’s contributions are not considered taxable income to the employee. But in case of a self-funded group health plan, if it fails to meet the nondiscrimination requirements of the federal tax laws then the part of the benefits that highly compensated employees receive are considered taxable income to those employees. Medical expense benefits that employees receive are not considered taxable except disability income benefits. Disability income benefits are not taxable income when received under an individual disability income policy purchased by the insured. Regulation in the Canada Federal Regulation of Health Insurance: The federal Canada health Act establishes the following criteria that provincial hospital and medical expense plans must meet in order to qualify for federal financial assistance:     

The plan must be administered on a nonprofit basis by the province or a provincial agency. The plan must be comprehensive, covering specified health services provided by hospitals, medical practitioners, and dentists. The plan must provide universal coverage (cover all residents of province). Plan benefits must be portable. The plan must provide insured services on a nondiscriminatory basis.

In order to encourage the continuance of private disability income plans, the Unemployment Insurance Act allows employers to register qualified, private disability income plans with Human Resources Development Canada. In order to qualify for registration, a private plan must meet the following criteria:  Benefits must begin no later than the 15th day of disability and must continue for at least 15 weeks.  The benefit level must be at least 60 percent of insurable earnings.  Employees must become eligible for benefits after completing no more than three months of continuation service.

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Provincial Regulation of Health Insurance Provincial Insurance Laws: In most respect, the regulation of health insurance is similar throughout Canada since they have adopted the Uniform Accident and Sickness Insurance Act (Uniform A&S Act) developed by CCIR. The provincial insurance laws contain requirements relating to several provisions that are typically included in health insurance policies:  Incontestability Provision: 2 years for misrepresentation, anytime in case of a fraudulent misrepresentation  Pre-existing Condition: 2 years  Continuation of coverage when a group policy terminates  How disability income benefits must be paid when an insured person is overinsured. A number of provisions that insurers typically not required by provincial insurance laws to include in the policies like, reinstatement provision, grace period provision, conversion provision.

CLHIA Guidelines: The CLHIA has issued: Guidelines Governing Individual Accident and Sickness Insurance: addresses matters such as the renewal provision in an individual health insurance policy. Coordination of Benefits (COB) Guidelines: to ensure that the COB provisions included in group health insurance policies throughout Canada are consistent. Group Life and Group Health Insurance Guidelines: provide a minimum standard for group insurance policies. The CLHIA group guidelines, for example, include a number of provisions designed to protect group members when the policyholder has changed insurers. Taxation: Province of Quebec treats contributions an employer pays on behalf of an employee under a private health insurance plan as taxable income to the employee. Otherwise it is non-taxable everywhere. In case of a disability benefits, the taxable amount part is the one for which the employer (and not the taxpayer) has paid the premium.

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