2.7 Personal Uses of Life Insurance
Life insurance serves a variety of personal and financial planning purposes, including the following:
Survivor Protection: Provides financial support for surviving spouses, children, or other dependents following the insured's death.
Estate Creation: Creates an immediate estate through a lump-sum death benefit, allowing the insured to transfer wealth to beneficiaries.
Estate Conservation: Supplies funds to pay estate taxes, debts, and other obligations at death, thereby preserving the value of the estate for heirs.
Cash Accumulation: Permanent life insurance policies may build cash value that the policyowner can access through loans, withdrawals, or surrender.
Liquidity: Provides immediate funds at death to cover final expenses, outstanding debts, and taxes. During the insured's lifetime, accumulated cash values may offer additional liquidity.
Pre-Need Planning: Offers coverage—often with a modest face amount—intended to cover funeral and burial expenses.
Charitable Giving: Allows the insured to designate a charitable organization as beneficiary to provide funding upon death.
Financial Security: Provides peace of mind by ensuring coverage is in place, protecting against the uncertainty of future insurability, as long as required premiums are paid.
Protection from Creditors and Probate: Policy proceeds are generally protected from creditor claims and may pass outside of probate, unless the policy has been assigned as collateral for an outstanding loan.
Viatical Settlements: Permit a terminally ill policyowner to sell a life insurance policy to a third party for an amount greater than the cash value but less than the death benefit, providing immediate funds. Life insurance reduces financial uncertainty by replacing the potential for a large income loss with the certainty of a smaller premium payment. While it does not eliminate risk, it transfers significant financial risk from the insured to the insurer.
Stranger Originated Life Insurance (STOLI) / Investor Originated Life Insurance (IOLI)
STOLI and IOLI arrangements involve investors, producers, or brokers who have no personal or business relationship with the insured but encourage the purchase of a life insurance policy for the purpose of transferring ownership to investors. The policy is acquired with the intent of selling it to institutional investors for more than its cash value but less than its death benefit.
In these arrangements, investors assume ownership and beneficiary rights and continue paying premiums. Upon the insured's death, the investors collect the death benefit.
Because these arrangements are often initiated without a legitimate insurable interest and may involve fraudulent practices, many states have restricted or prohibited STOLI and IOLI transactions.
Quiz
1. Which personal use of life insurance is intended to provide immediate financial support to surviving dependents?
A. Estate conservation
B. Survivor protection
C. Liquidity
D. Cash accumulation
Correct Answer: B
Rationale: Survivor protection refers specifically to providing funds to surviving spouses, children, or dependents to replace lost income and maintain financial stability after the insured's death.
2. A policyowner purchases life insurance to ensure funds are available to pay estate taxes and outstanding loans at death. This is an example of:
A. Estate creation
B. Estate conservation
C. Liquidity
D. Pre-need planning
Correct Answer: B
Rationale: Estate conservation preserves the value of the estate by providing funds to pay taxes and debts that would otherwise reduce the assets passed on to beneficiaries.
3. Which feature of permanent life insurance allows the policyowner to access funds during the insured's lifetime?
A. Survivor protection
B. Viatical settlement
C. Cash accumulation
D. Estate creation
Correct Answer: C
Rationale: Permanent life insurance policies may build cash value that the policyowner can access through loans, withdrawals, or surrender. This feature provides living benefits in addition to the death benefit.
4. Stranger-Originated Life Insurance (STOLI) arrangements are often restricted or prohibited because they:
A. Provide insufficient death benefits
B. Lack insurable interest and may involve fraudulent practices
C. Do not require premium payments
D. Are limited to charitable organizations
Correct Answer: B
Rationale: STOLI arrangements involve investors who have no legitimate insurable interest in the insured. These arrangements have been associated with fraud and have been restricted or banned in many states.
5. Life insurance reduces financial uncertainty primarily by:
A. Eliminating all financial risk
B. Increasing investment returns
C. Replacing the possibility of a large financial loss with a known premium cost
D. Guaranteeing estate growth
Correct Answer: C
Rationale: Life insurance does not eliminate risk; instead, it transfers the financial risk of a large potential loss (such as loss of income at death) to the insurer in exchange for a smaller, predictable premium payment.