04 - Risk Management and Insurance Planning part 2

Question 1

In regards to an insurance policy contract, what is an assignment?

Answer 1

Assignment refers to the transfer of a policy owner’s legal rights and/or interests in an insurance policy contract to a third party.

Question 2

In regards to an insurance policy contract, what is an automatic premium loan?

Answer 2

An automatic premium loan is a provision authorizing the insurance company to take a loan from the cash value to pay any premiums still due at the end of the grace period.

Question 3

In regards to an insurance policy contract, what is a cash surrender value?

Answer 3

The cash surrender value of an insurance policy is the amount available in cash upon voluntary termination of a policy by its owner before it becomes payable by death or maturity. The amount is the “gross” cash value stated in the policy minus a surrender charge and any outstanding loans and any interest thereon.

Question 4

In regards to an insurance policy contract, what is a dividend?

Answer 4

A dividend is a return of part of the premium on a participating insurance policy to reflect the difference between the premium charged and the combination of actual mortality, expense, and investment experience. Dividends are not considered to be taxable distributions because they are interpreted as a refund of a portion of the premium paid.

Question 5

In regards to an insurance policy contract, what is a free look provision?

Answer 5

A free look provision is a state-mandated amount of time (usually between 10 and 30 days) that a policy owner has to examine an insurance policy and, if not satisfied, to return it to the company for a full refund.

Question 6

What is an insurable interest?

Answer 6

An insurable interest is an economic interest in the life of the insured. For persons related by blood, a substantial interest is established through love and affection. For all other persons and entities, it is a lawful and substantial economic interest in having the life of the insured continue. An insurable interest is required when purchasing life insurance on another person.

Question 7

What is an incontestable clause?

Answer 7

An incontestable clause notes an insured’s statements in the application cannot be contested by the insurer after the policy has been in effect for a given period of time (usually two or three years). Keep in mind that some statements, such as statements made fraudulently, are always contestable.

Question 8

What is a loan provision?

Answer 8

A loan provision allows a policy owner to borrow a portion of the cash value of an insurance policy without a credit check. Repayment of a loan is made back to the policy. If a loan is outstanding at death, the outstanding balance is deducted from the final payout.

Question 9

What is mortality cost?

Answer 9

Mortality cost is the face value of a policy multiplied by the probability an insured will die. The probability comes from a mortality table. Because the probability of dying increases with age, the relationship between premium costs and age is positive.

Question 10

What is the difference between a mutual insurer and a stock insurer?

Answer 10

A mutual insurer is one owned by policyholders. This compares to a stock insurer, where capital is contributed and ownership is held by stockholders.

Question 11

In terms of insurance, what is nonforfeiture?

Answer 11

Nonforfeiture is a choice available if a policy owner discontinues premium payments on a policy with a cash value. Options available are to take the cash value in cash or to use it to purchase extended term insurance or reduced paid-up insurance.

Question 12

What is a nonparticipating life insurance policy?

Answer 12

A nonparticipating life insurance policy is one in which the company does not distribute to policy owners any part of its surplus.

Question 13

What is a participating policy?

Answer 13

A participating policy is a life insurance policy under which the company agrees to distribute to policy owners the part of its surplus that its board of directors determines is not needed at the end of the business year. The distribution serves to reduce the premium the policy owners had paid.

Question 14

What is a rating?

Answer 14

Rating refers to the basis for an additional charge to the standard premium because the insured is classified as a greater-than-normal risk, usually resulting from impaired health or a hazardous occupation.

Question 15

What is reduced paid-up insurance?

Answer 15

Reduced paid-up insurance is available as a nonforfeiture option. This nonforfeiture provision provides for continuation of the original insurance plan, but for a reduced amount, without further premiums.

Question 16

What is an unholy trinity (or “Goodman triangle”)?

Answer 16

An unholy trinity (or “Goodman triangle”) exists if the three parties in a contract are different. Generally, at least two of the parties should be the same (e.g., the wife is the owner and beneficiary of a policy, but the husband is the insured). A gift tax and possible income taxes can be triggered if each of the parties is different.

Question 17

What is Term insurance?

Answer 17

Term insurance provides protection for a specified period of time. This period can be as short as one year (yearly renewable term) or as long as 40 years; however, 20- and 30-year term policies are most common. Policies are sold with various premium variances

Question 18

When does term insurance pay out?

Answer 18

Term insurance pays the beneficiary(ies) only when the insured dies within the stated term of the policy. The payment is made up entirely of the face value of the policy. No payment will be made to someone who outlives the term of the policy.

Question 19

What is a convertible policy?

Answer 19

Term insurance policies may be convertible. A convertible policy is one that allows the policy holder to exchange the policy for permanent insurance. Although most term policies provide a level benefit over the term of the policy, some policies provide decreasing coverage as the insured ages.

Question 20

Under term insurance, what are several types of term insurance policies that can be recommended?

Answer 20

1. Renewable term
2. Convertible term
3. Level term
4. Decreasing term
5. Adjustable premium

Question 21

What are the three cash value options allowed by a nonforfeiture provisions

Answer 21

1. Reduced paid-up life: This option uses the cash value in the policy to purchase a fully paid-up life insurance policy.
2. Extended term insurance: This option uses the cash value in the policy to purchase a term insurance equal to the face amount of the policy.
3. Cash: This option allows the policy owner to withdraw the cash value after paying fees and other expenses.

Question 22

What are the three provisions in order for permanent insurance to receive preferred tax treatment?

Answer 22

1. Provide coverage up to at least age 95,
2. Limit the amount of premium that may be paid in relation to the face amount of coverage, and
3. Establish a minimum ratio between the cash value and face amount of insurance.

Question 23

What are two types of permanent life insurance?

Answer 23

1. Whole life

2. Ordinary life

Question 24

What are six variations of a traditional whole life policy?

Answer 24

1. Nonparticipating whole life
2. Participating whole life
3. Indeterminate premium whole life
4. Economatic whole life
5. Limited payment whole life
6. Single premium whole life

Question 25

What is a Nonparticipating whole life policy?

Answer 25

Nonparticipating whole life: A nonparticipating whole life policy sets a level premium and face value during the insured’s life. These polices provide fixed costs and generally low out-of-pocket premium payments. These policies do not pay dividends.

Question 26

What is a participating whole life policy?

Answer 26

Participating whole life: A participating whole life policy pays dividends. The dividends represent excess investment earnings made by the insurance company. Dividends can be taken in cash, used to reduce premiums, left to accumulate in the policy, or used to purchase paid-up additional insurance. Dividends are not guaranteed.

Question 27

What is an Indeterminate Premium whole Life Policy?

Answer 27

Indeterminate premium whole life: An indeterminate premium whole life policy is like a nonparticipating whole life plan of insurance except that it provides for adjustable premiums. The insurance company bases premiums on the firm’s current investment earnings, mortality, and expense costs. If the estimates change in later years, the company can adjust the premium but never above a maximum guaranteed premium stated in the policy.

Question 28

What is an Economatic Whole Life Policy?

Answer 28

Economatic whole life: An economatic whole life policy provides for a basic amount of participating whole life insurance with an additional supplemental coverage provided using dividends. This additional insurance is usually a combination of decreasing term insurance and paid-up dividend additions. These policies are designed so that the dividend additions equal the original amount of supplemental coverage. Keep in mind, however, that because dividends may not be sufficient to purchase enough paid-up additions at a future date, it is possible that a client could experience a substantial decrease in the amount of supplemental insurance coverage in the future.

Question 29

What is a Limited Payment Whole Life Policy?

Answer 29

Limited payment whole life: A limited payment whole life policy allows a policy owner to pay premiums for a limited time.

Question 30

What is a Single Premium Whole Life Policy?

Answer 30

Single premium whole life: A single premium whole life policy is a limited payment policy where one large premium payment is made by the policy owner. No further premiums are required. These policies typically have substantial surrender charges if the policy owner needs or wants to cash in the policy during the first few years.

Question 31

What is an Interest-Sensitive Permanent Life Policy?

Answer 31

An interest-sensitive permanent life policy is one in which the allocation of investment earnings is based on current market rates rather than predetermined interest allocations. There are four types of interest-sensitive permanent life policies

Question 32

What are the four types of Interest-Sensitive Permanent Life Policies?

Answer 32

1. Universal Life
2. Excess Interest Whole Life
3. Current Assumption Whole Life
4. Single Premium Whole Life

Question 33

What is a Universal Life Policy?

Answer 33

A Universal Life policy is an Interest-Sensitive Permanent Life Policy. It treats as separate the three elements of the policy: premium, death benefit, and cash value.

Question 34

What is an Excess Interest Whole Life Policy?

Answer 34

An excess interest whole life policy maximizes the deferred tax growth of the policy cash value by allowing interest credit to the policy cash value to vary over time. In other respects, this type of policy is like a traditional whole life policy.

Question 35

What is a Current Assumption Whole Life Policy?

Answer 35

A current assumption whole life policy is similar to a universal life policy with one exception: the insurance company determines the amount of premium to be paid.

Question 36

What is a Single Premium Whole Life Policy?

Answer 36

A single premium whole life policy is one in which a single premium payment is made. Keep in mind that it is possible that a policy owner may be asked to make additional premium payments if the credit interest is insufficient to continue covering costs within the policy.

Question 37

How are variable-basis (life insurance) policies paid?

Answer 37

With a variable-basis policy, the face and cash value are specified in units. The value of these units may increase or decrease, depending on the investment results obtained within the cash account. Variable products allow the policy owner to allocate premiums among investment pools (e.g., stock, bond, money market, mutual funds, and real estate).

Question 38

What does Section 1035 of the tax code allow clients to do?

Answer 38

Section 1035 of the tax code allows clients to exchange an existing insurance contract for other contracts without paying income or gift tax on the income and investment gains in the current account. These tax-free exchanges, known as 1035 exchanges, can be useful if another life insurance policy has better features (e.g., lower premiums and fees, larger death benefit, desirable riders like chronic illness benefits, different annuity payout options, or a wider selection of investment choices). Unlike annuities, life insurance may be exchanged for life insurance, endowment contracts, or annuities.

Question 39

Other than payment in cash, what are four additional distribution options generally allowed by State insurance regulators?

Answer 39

1. Interest settlement option
2. Fixed amount settlement option
3. Fixed period settlement option
4. Life income settlement option

Question 40

What is the definition of “viatical settlement” as a contractual agreement with a life insurance policy owner?

Answer 40

State insurance regulators typically define a viatical settlement as a contractual agreement to provide a life insurance policy owner immediate cash in exchange for the sale and transfer of life insurance policy ownership rights.