Business Glossary

whole life insurance policy requiring one premium payment. Since this large, up-front payment begins accumulating cash value immediately, the policy holder will earn more than holders of policies paid up in installments. With its tax-free appreciation (assuming it remains in force); low or no net-cost; tax-free access to funds through policy loan; and tax-free proceeds to beneficiaries, this type of policy emerged as a popular tax shelter under the tax reform act of 1986.

1. intaxation, a payment or receipt of proceeds to a specified beneficiary or beneficiaries by an employer, by virtue of the death of the employee. Under certain conditions, the first $5000 of such a payment may not be subject to federal income taxes.
2. portion (tax exempt) of the proceeds of a life insurance policy representing protection as distinguished from investment value. Policy loans reduce the death benefit by the amount of the outstanding loan balance.

technique to assess the proper amount of life insurance for an individual. The person, either on his or her own or with the help of an insurance adviser, must estimate the financial needs of survivors in case the person dies unexpectedly. Projections for expenses, income, taxes, funeral costs, and other financial factors lead to an understanding of the amount of insurance proceeds that would be needed to allow the survivors to continue in their present lifestyle. Once the optimal amount of insurance protection is determined, various kinds of term and cash value insurance programs can be designed to meet these needs.

gross income not subject to tax, including: (1) interest on municipal securities; and (2) annuities and pensions that are returns of capital.

insurance contract specifying what risks are insured and what premiums must be paid to keep the policy in force. Policies also spell out deductibles and other terms. Policies for life insurance specify whose life is insured and which beneficiaries will receive the insurance proceeds. homeowner's insurance policies specify which property and casualty perils are covered. Health insurance policies detail which medical procedures, drugs, and devices are reimbursed. Auto insurance policies describe the conditions under which car owners will be covered in case of accidents, theft, or other damage to their cars. Disability policies specify the qualifying conditions of disability and how long payments will continue. Business insurance policies describe which liabilities are reimbursable. The policy is the written document that both insured and insurance company refer to when determining whether or not a claim is covered.

policy taken out by the insured to pay the beneficiary a certain amount upon the insured's death. Proceeds on the death of the policyholder are includable in his or her gross estate under two sets of circumstances: (1) the insurance is payable to his or her estate and (2) the decedent possessed at least one incident of ownership in the policy. The latter means that the decedent either owned the policy until death, or transferred it but retained the right to change the beneficiary, borrow on the policy, and cancel it. o accomplish estate tax exclusion, transfer of the policy must occur more than three years prior to death.

life insurance benefits upon which the insured can draw cash while still alive. Some policies allow benefits to be paid to the insured in cases of terminal illness or illness involving certain long-term care costs. Beneficiaries receive any balance upon the insured's death. Also known as accelerated benefits.

person named in an insurance policy to receive the policy benefits if the primary beneficiary dies before the benefits become payable.

payment made by the insured in return for insurance protection. Premiums are set based on the probability of risk of loss and competitive pressures with other insurers. An insurance company's actuary will figure out the expected loss ratio on a particular class of customers, and then individual applicants will be evaluated based on whether they present higher or lower risks than the class as a whole. If a policyholder does not pay the premium, the insurance or policy may lapse. If the policy is a cash value policy, the policyowner can choose to take a paid-up insurance policy with a lower face value amount or an extended term policy.

life insurance that pays dividends to policyholders. The policyholders participate in the success or failure of the company's underwriting and investment performance by having their dividends rise or fall. The fewer claims the company experiences and the better its investment performance, the higher the dividends. Policyholders have many choices in what they can do with the dividends. They can have them paid in cash, in which case the income is taxable in the year received; they can use them to reduce policy premiums; they can buy more paid-up insurance, either cash value or term; or they can put them in an account with the insurance company that earns interest. The opposite of a participating policy is a nonparticipating life insurance policy.

cash value accumulated inside a life insurance policy. Acash value policy has two components: a death benefit paid to beneficiaries if the insured dies, and a savings element, which is the amount of premium paid in excess of the cost of protection. This excess is invested by the insurance company in stocks, bonds, real estate, and other ventures and the returns build up tax-deferred inside the policy. A policyholder can borrow against this cash value or take it out of the policy, at which point it becomes taxable income. Once a policyholder reaches retirement age, he or she can annuitize the accumulated cash value and receive a regular payment from the insurance company for life. Insurance companies encourage people to buy policies with a savings element because it provides a disciplined way to save.

tax rule allowing a taxpayer to exclude certain kinds of income from taxation on a tax return. For example, interest earned from municipal bonds must be reported, even though it is not taxed by the federal government. Proceeds from life insurance policies paid by reason of the death of the insured are not taxable. Gifts received of $12,000 or less are also not taxable, and are therefore subject to the annual exclusion rule. This $12,000 gift tax exclusion limit is subject to upward revision in $1,000 increments tied to the rate of inflation based on the taxpayer relief act of 1997.

conditions under which an insurance company is willing to insure a risk. Each insurance company applies its own standards based on its own underwriting criteria. For example, some life insurance companies do not insure people with high-risk occupations such as stuntmen or firefighters, while other companies consider these people insurable, though the premiums they must pay are higher than for those in low-risk professions.

options available to beneficiaries when a person insured by a life insurance policy dies. The death benefit may be paid in one lump sum, in several installments over a fixed period of time, or in the form of an annuity for the rest of the beneficiary's life, among other options.

equal installments payable to an insurance company for insurance or an annuity.

provision found in insurance contracts stipulating that policyholders cannot be denied coverage after a specific period of time, usually two years, even if the policyholder provided inaccurate or even fraudulent information in his or her insurance application. In order to contest the policy, the insurer must find out about the incorrect information before the clause goes into effect.

insurance company technique to determine the correct price of a policy premium. The company analyzes past loss experience for others in the insured group to project future claims. The premium is then set at a rate high enough to cover those potential claims and still earn a profit for the insurance company. For example, life insurance companies charge higher premiums to smokers than to non-smokers because smokers' experience rating is higher, meaning their chance of dying is much higher.

request for payment from the insurance company by the insured. For example, a homeowner files a claim if he or she suffered damage because of a fire, theft, or other loss. In life insurance, survivors submit a claim when the insured dies. The insurance company investigates the claim and pays the appropriate amount if the claim is found to be legitimate, or denies the claim if it determines the loss was fraudulent or not covered by the policy.

a situation in which all payments due have been made. For example, if all premiums on a life insurance policy have been paid, it is known as a paid-up policy.

feature offered as an option in life and health insurance policies that enables the insured to add coverage at specified future times and at standard rates without evidence of insurability.

payment of proceeds from an insurance policy to the insured under the terms of an insurance contract. Insurance settlements may be either in the form of one lump-sum payment or a series of payments.

test of the extent to which the value of an asset, such as real property, securities, or a contract subject to currency exchange rates, is protected from potential loss either through insurance or hedging.

insurance policy that pays a death benefit upon the death of the spouse who dies last. Such insurance typically is purchased by a couple wanting to pass a large estate on to their heirs. When the first spouse dies, the couple's assets are passed tax-free to the second spouse under the marital deduction. When the second spouse dies, the remaining estate could be subject to large estate taxes. The proceeds from the second-to-die insurance are designed to pay the estate taxes, leaving the remaining estate for the heirs. Such insurance is appropriate only for those facing large estate tax liabilities. Because the policy is based on the joint life expectancy of both husband and wife, premiums typically cost less than those on traditional cash value policies on both lives insured separately. Also called survivorship life insurance.

dividend paid from participating preferred stock.

in foreign exchange, ability to exchange money for other currencies or for gold without government restriction. Also said of a currency that foreign residents will accept as payment for goods or services.

money paid to cash value life insurance policyholders with participating policies, usually once a year. Dividend rates are based on the insurance company's mortality experience, administrative expenses, and investment returns. Lower mortality experience (the number of policyholders dying) and expenses, combined with high investment returns, will increase dividends. Technically, dividends are considered a return of the policyholder's premiums, and are thus not considered taxable income by the IRS. Policyholders may choose to take these dividends in cash or may purchase additional life insurance.

individual, group, or property that is covered by an insurance policy. The policy specifies exactly which perils the insured is indemnified against. The insured may be a particular individual, such as someone covered by a life insurance policy. It may be a group of people, such as those covered by a group life insurance policy purchased by a company on behalf of its employees. The insured may also refer to property, such as a house and its possessions which are covered by a homeowner's insurance policy.

life insurance policy in which all premiums have been paid. Some policies require premium payments for a limited number of years, and if all premium payments have been made over those years, the policy is considered paid in full and requires no more premium payments. Such a policy remains in force until the insured person dies or cancels the policy.

life insurance that combines a death benefit with a potential tax-deferred buildup of money (called cash value) in the policy. The three main kinds of cash value insurance are whole life insurance, variable life insurance, and universal life insurance. In whole life, cash value is accumulated based on the return on the company's investments in stocks, bonds, real estate, and other ventures. In variable life, the policyholder chooses how to allocate the money among stock, bond, and money market options. In universal life, a policyholder's cash value is invested in investments such as money market securities and medium-term Treasury bonds to build cash value. All cash values inside an insurance policy remain untaxed until they are withdrawn from the policy. Unlike cash value insurance, term life insurance offers only a death benefit, and no cash value buildup.

large payment of money received at one time instead of in periodic payments. People retiring from or leaving a company may receive a lump-sum distribution of the value of their pension, salary reduction or profit-sharing plan. (Special tax rules apply to such lump-sum distributions unless the money is rolled into an IRA rollover account.) Some annuities, called single premium deferred annuities (SPDAs) require one upfront lump sum which is invested. Beneficiaries of life insurance policies may receive a death benefit in a lump sum. A consumer making a large purchase such as a car or boat may decide to pay in one lump sum instead of financing the purchase over time.

representative of an insurance company who sells the firm's policies. captive agents sell the policies of only one company, while independent agents sell the policies of many companies. Agents must be licensed to sell insurance in the states where they solicit customers.

contract between an insurance company and the insured setting out the provisions of the life insurance coverage. These provisions include premiums, loan procedures, face amounts, and the designation of beneficiaries, among many other clauses. Policies may be for term or permanent cash value types of coverage.

relationship between an insured person or property and the potential beneficiary of the policy. For example, a wife has an insurable interest in her husband's life, because she would be financially harmed if he were to die. Therefore, she could receive the proceeds of the insurance policy if he were to die while the policy was in force. If there is no insurable interest, an insurance company will not issue a policy.

life insurance policy that does not pay dividends. Policyholders thus do not participate in the interest, dividends, and capital gains earned by the insurer on premiums paid. In contrast, participating insurance policies pay dividends to policyholders from earnings on investments.

termination or forfeiture of an item-for example, when coverage under an insurance contract expires because of nonrenewal.

sales charge which may not be immediately apparent to an investor. For example, a 12b-1 mutual fund assesses an annual asset base charge of up to 0.75% to cover marketing, distribution, and promotion expenses incurred by the fund. Even though it has been disclosed in the prospectus, many investors do not realize that they are paying this load. The sales charges levied on insurance policies are also hidden, because they are not explicitly disclosed to customers, and are instead subtracted from premiums paid by policyholders.