J is issued a Life insurance policy with a death benefit of $100,000. She pays $600 per year in premium for the first 5 years. The premium then increases to $900 per year in the sixth year, and remains level thereafter. The policy’s death benefit also remains at $100,000. Which type of Life insurance policy is this?

 Options:

a) Endowment b) Graded Premium Life c) Straight Life d) Modified Premium Life

The Correct Answer Is:

d) Modified Premium Life

Correct Answer Explanation:

d) Modified Premium Life:

➦ This life insurance policy is a modified premium life insurance policy because it starts with a lower premium that starts with a lower premium that increases after a certain period, typically around the sixth year.

➦ During the first five years, J will pay a premium of $600 per year, and after that her premium will increase to $900 per year, at which point it will remain the same.

Modified premium life insurance policies are characterized by the following characteristics:

i. Initial Lower Premium:

➦ It is usually cheaper to purchase a modified premium life insurance policy with a similar death benefit than to purchase a level premium policy.

➦ Compared to a level premium policy with a $100,000 death benefit, this policy requires a lower initial premium of $600 per year for the first five years.

ii. Premium Increase:

➦ A modified premium life insurance policy is characterized by an annual premium increase.

➦ In this case, the premium is increased to $900 in the sixth year. This is a characteristic of modified premium policies.

iii. Level Premium After Increase:

➦ After the premium increase, the policy’s premium remains level for the duration of the policy. In this case, the premium remains at $900 per year after the sixth year.

iv. Constant Death Benefit:

➦ Another important aspect is that the death benefit remains constant throughout the policy’s term. In this case, the death benefit is consistently $100,000.

Why the Other Options are Incorrect?

a) Endowment:

➦ A life insurance policy combining a death benefit with a savings or investment component is an endowment policy.

➦ The key characteristics of an endowment policy are the following: An endowment policy pays out a lump sum upon the death of the insured or at the end of a specified term.

➨ Either upon death or at the end of a specified term, the policy pays a lump sum (endowment).

➨ Life insurance premiums for endowment policies are generally higher than those for standard policies.

➨ A minimum maturity value is usually guaranteed, making it an attractive savings option.

➦ The provided policy does not align with these characteristics.

➦ It does not offer a lump sum payout upon the insured’s death or at the end of a specified term, and the premium amounts are not reflective of the higher premiums typically associated with endowment policies.

➦ Therefore, option (a) is not the correct answer.

b) Graded Premium Life:

➦ There is a type of permanent life insurance policy called graded premium life insurance, which starts with lower premiums than a standard whole life policy, but gradually increases over time.

➦ Individuals with limited budgets will find these policies attractive in the early years since they are designed to be more affordable.

➦ Life insurance policies with graded premiums are characterized by the following characteristics:

➨ Compared to a standard whole life policy, premiums start lower.

➨ It is predictable that premiums will increase over time.

➨ During the term of the policy, the death benefit remains the same.

➦ While this policy does have a premium increase, it does not align with the typical characteristics of a graded premium life insurance policy because the premium increase is not gradual or predictable.

➦ Instead, it starts at $600 for the first five years and then jumps to $900 in the sixth year.

➦ Additionally, graded premium life policies usually maintain a level death benefit, while this policy does maintain a level death benefit. Therefore, option (b) is not the correct answer.

c) Straight Life:

➦ A straight life insurance policy provides coverage for the entire life of the insured, and is also known as whole life insurance.

➦ Straight life insurance policies have the following key characteristics:

➨ During the lifetime of the policyholder, premiums remain level.

➨ A death benefit is usually paid out to the beneficiary upon the death of the insured.

➨ The cash value component also grows over time.

➦ The provided policy does not align with these characteristics because it has a premium increase in the sixth year, whereas straight life insurance policies have level premiums for the entire lifetime of the insured.

➦ Additionally, straight life policies usually have higher initial premiums compared to term life insurance, which is not the case here. Therefore, option (c) is not the correct answer.

In Conclusion,

➦ The provided life insurance policy is a modified premium life insurance policy because it starts with a lower premium, increases in the sixth year, and then remains level thereafter, all while maintaining a constant death benefit.

➦ This type of policy is designed to make life insurance more affordable in the early years while accommodating premium increases later on.

➦ The other options, including endowment, graded premium life, and straight life, do not align with the key characteristics of the provided policy, making them incorrect choices.

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