Decoding Insurance Jargon

Clients are often confused by many of the terms stated within their insurance policies. To help, here are some of the most commonly used insurance jargon they are likely to encounter, and how to clearly explain what each of these really means:  

  • Modified Endowment Contracts (MECs): Before 1987, it was possible to place large amounts of money into a life insurance policy which would grow tax-deferred. If the money in the policy was ever needed, it could be accessed through tax-free withdrawals. These policies were being used in place of other investment vehicles which were fully subject to taxes. The government has since changed the system and closed this loophole. Luckily, your policy is still subject to essential tax benefits as long as it does not turn into a MEC. In order to become classified as such, it would need to become extremely “over-funded.” This is a problem most people can easily avoid.

    • The Danger of Owning an MEC: If you do fund your policy to such an extent that it surpasses the “MEC limit,” then some of the policy’s tax benefits will go away. For example, if you access money from it before you're 59 1/2 years old, you are assessed a 10% penalty and all your gains are taxed first.

    • The Good News: Every insurance carrier will let a policyholder know if he or she is close to reaching the MEC limit. The carrier will call to make certain that the insured party understands the tax benefits that would be forfeited if a large deposit is made into the policy. This is an additional stop gap measure to prevent someone from unknowingly creating an MEC.

  • Riders: A rider is an add-on to your policy that can give you additional benefits or options. In a life insurance policy, a common example of this is a disability waiver, which states that if the insured becomes disabled, he or she will not have to continue paying premiums anymore, but the policy will still remain in force. Riders usually cost extra. Sometimes policyholders may be charged more on the front end, in the form of higher premium prices; sometimes they are paid for by additional fees if they are actually exercised by the insured.

  • Accelerated Death Benefits: These are designed to benefit those individuals that have been diagnosed with a terminal illness and usually have life expectancies of 12 months or less. It allows them to access a portion of their benefits in advance of their deaths. The purpose is to give a person immediate access to capital. In most cases this money is used for expensive medical care and/or treatment to help make the last months go by as comfortably and painlessly as possible.

  • Policy Endorsements: These are essentially amendments to insurance policies. They often refer to how companies enroll those who want to purchase insurance but have preexisting medical conditions. For example, if an individual had knee surgery 6 months ago and applies for a disability contract, the carrier may only offer coverage that specifically excludes disabilities related to the surgically repaired knee.

    • Depending on the circumstances, the endorsements may be permanent or they may be temporary, and only exist to give the insurance company a bit of extra protection. In this case, if the endorsement was temporary, once the insured is examined a year into the policy and the knee is found to have healed perfectly, the carrier may agree to take the endorsement off and cover the individual, knee and all.

    • Policy endorsements also include some common restrictions on policies, like those that state you will not be covered if you are injured or killed due to your participation in any illegal activity.

Kellan Finley is managing director of Insurance Decisions, a leading insurance resource for independent financial advisors. Working exclusively with independent advisors, her primary focus is to help advisors better understand the value of insurance within a financial plan. She provides expert guidance in the areas of Life Insurance, Disability Insurance, Long Term Care, and Annuities. 

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