2. Insurance Planning. - All Exam Tips and Practitioner's Advice Flashcards

Question

Describe Errors & Omissions Insurance

Answer 1

Many professionals, such as real estate agents, insurance agents, accountants and architects, need this type of liability protection to cover clients' claims alleging professional negligence. **Practitioner Advice: Errors & Omissions Insurance covers unintentional oversights by a planner that adversely impact a client’s financial circumstances. Though there may be certain policy exclusions (e.g., alternative investment products, private securities transactions, Regulation D offerings), E&O insurance is recommended for practitioners. The National Association of Professional Advisors (NAPA) provides E&O coverage options for several types of financial planning entities, including: Individual RIAs, RIA Firms & LLCs, and Registered Representatives. By joining the Financial Planning Association (FPA), membership benefits include preferred E&O coverage rates.**

Answer 2

* HO-2 Broad Dwelling and structures: Named peril; Contents coverage up to 50% of dwelling coverage. * HO-3 Special Losses are covered unless specifically excluded. Dwelling and structures: Open peril; Contents coverage up to 50% of dwelling coverage. * HO-4 Contents Broad Covers contents and personal liability of renters. No coverage on dwelling and other structures. * HO-5 Comprehensive Losses are covered unless specifically excluded. Open perils coverage on dwelling, structures, and contents. * HO-6 Unit Owners Property interest, contents, and personal liability of people owning a unit in a condominium or co-op. * HO-8 Modified Homes having a replacement cost greater than FMV. Typically, historic homes. Exam Tip: Work toward memorizing the type of residence that is covered by each homeowners form and the extent of the included coverage. For example, single-family, residential homes are covered by HO-2, HO-3, and HO-5 forms. The higher the number of these forms, the greater the extent of the coverage. **Audio: 6 types of homeowner's or residential types of insurance** * **HO-2, HO-3, and HO-5 forms** - covers traditional single-family, residential homes * **HO-3** - **open perils coverage for the dwelling**, but** broad form coverage for contents** * **HO-5** - **open perils coverage for the dwelling and the contents** * **HO-4** - for **renter's** personal belongings; the contents and some liability coverage * **HO-6** - for **condominium owners, wall studs in, contents and liability** * **HO-8** - **historic homes** (150yo home), replacement value would be so high that no insurer would be comfortable insuring it on a replacement basis

Answer 3

Section One (Property) of the HO consists of the following parts: * Coverage A: Dwelling * Coverage B: Other Structures (typically limited to 10% of Coverage A) * Coverage C: Personal Property (typically limited to 50% of Coverage A) * Coverage D: Loss of Use (typically limited to 20% of Coverage A) Section Two (Liability) of the HO consists of the following parts: * Coverage E: Personal Liability * Coverage F: Medical Payments to others * Homeowner Insurance **Exam Tip: Homeowners insurance policies are split into two major sections, Section 1, which provides insurance protection on the homeowners property, and Section 2, which provides liability coverage. Listen in for important exam-related information on the separate coverages within each Section.** Audio: * Important to know which section coverages what * A - for "**address**" - dwelling itself * B - for the barn out back, "**backyard**", shed, fence (10% of A) * C - "**contents** - clothing, couch, curtains" personal property (50% of A) * D - "**displacement**", fire in the home and uninhabitable while being (20% of A) replaced/repairs * Notice for B, C and D - all have maximum limits that pertain to Coverage A Dwelling. * Section 2 * E - personal liability "**exposure** to legal damages" * F - "**funding** for **medical fees** for others that might have been hurt on property"

Answer 4

Dwelling comes under Coverage A of Section 1 that provides property insurance protection. Coverage A insures the dwelling and all attached structures (such as an attached carport or deck) of the insured person. Coverage A applies to the insured's residence premises shown on the declarations. A second home or summer cottage, which might be considered a temporary residence, is not covered because it does not appear in the declarations and should be covered under a policy specific to that property. **Practitioner Advice: The rule of property insurance is that if you can get insurance for the property on its own, it isn't going to be covered under another property's policy. What this means is, if you own a rental property, which is separate from your primary residence, it is not covered under your homeowner's policy. This is because specific policies exist for non-owner occupied dwellings (Dwelling Fire Policies), which are more suitable for covering that type of risk. The same goes for your car. Since it should be insured under an auto policy, it is not covered under your homeowner's policy even if destroyed while in your garage.** The limits of coverage for the various insuring agreements found in Section 1 are determined as a percentage of Coverage A. If an insured needs additional protection, coverages B, C, or D may be increased. Coverage may not be reduced below the specified percentages. The insured must pay an additional charge for increased coverage.

Answer 5

The special limits of liability section of an insurance policy establishes the maximum dollar amounts that an insured can recover when the specifically identified property is damaged or stolen. In addition, some types of property, such as jewelry (limited to $1500 on homeowners), can be covered on a Scheduled Personal Property Endorsement. Its purpose is to provide open-perils coverage for specific items at higher amounts of coverage. For example, boats and their trailers are only protected up to $1500, so boats of higher value need to be insured separately. Silverware and gun collections are each limited to $2500, and the coverage is only for theft, not for loss. **Practitioner Advice: Valuable possessions like jewelry, fur, etc. that are worth more than the policy limit should be listed on a separate Scheduled Personal Property Endorsement. Other personal items such as cameras, musical instruments, fine arts and antiques, and stamp and coin collections can be covered as well, with the exception of fishing and hunting equipment. With a Scheduled Personal Property Endorsement not only can the amount of coverage be increased, but also the items are covered if they are misplaced or if the diamond falls out of a ring and is lost. There is an additional premium for this protection, and it typically requires having the items professionally appraised.**

Answer 6

Personal Liability comes under Coverage E of Section 2 and covers the obligations of the insured due to their negligence. The policy will pay up to the stated policy limits for legal obligations of the insured due to bodily injury or property damage. In addition, the insurer will pay for the legal defense costs, as long as it is a type of liability covered under the homeowner's policy. As with all insurance policies, there are some exclusions listed in the policy. For example, professional liability and motor vehicle liability are both excluded and should be insured elsewhere, e.g. through Malpractice insurance and Auto insurance. Aircraft liability and use of watercraft powered with inboard or inboard-outdrive motors are not covered. The standard coverage limit is $100,000, most agents recommend carrying at least $500,000. **Exam Tip: Section 2, Coverage E of a homeowners policy provides the residents of a covered abode with a minimum of $100,000 of personal liability coverage. Since one may be personally liable for large amounts as a result of litigation, this coverage serves as a baseline for protection. Listen in to find out how this coverage may coordinate with other liability insurance.** Audio: * Coverage E of a homeowner’s policy does not pertain to damage to the household, dwelling or personal property * It is personal liability insurance * Would help pay expense for someone seeking damages for an injury while a guest at your home. If they file a lawsuit and seek significant damages. If awarded, personal liability section can pay up to the policy limit. * Not uncommon to see minimum of $100k to several hundred thousand. * **Would be wise to place a personal liability umbrella on top of the HO policy** **Practitioner Advice: Most people who own homes are required to carry Homeowners insurance because they have a mortgage. Renters and Condominium owners often don't bother with insurance, thinking they don't have much in valuable furnishings. They are unconsciously retaining the liability risks of someone getting hurt in their apartment. The Renters Coverage (HO-4), or Condominium Owners (HO-6) is one of the least expensive types of insurance, costing less than $200 a year in Massachusetts.**

Answer 7

The settlement of covered property losses is detailed below. Loss of the following types of property is settled at actual cash value at the time of loss but not more than the amount required to repair or replace it based on the depreciated value at the time of loss: * Personal property * Awning, carpeting, household appliances, outdoor antennas and outdoor equipment, whether or not attached to buildings * Structures that are not buildings **Practitioner Advice: For an additional cost, usually about 25% of the base premium, an insured may choose to purchase Replacement Cost coverage on their personal property. If this coverage is in place, any items will be replaced at current fair market replacement value rather than depreciated value should a covered loss occur.**

Answer 8

https://www.youtube.com/watch?v=3XC6OHI7oMk In this 5-minute video, Mike explains a key aspect of homeowner’s insurance, the coinsurance clause. Understanding the coinsurance clause enables the planner to assist clients with decisions regarding adequate levels of homeowner’s insurance dwelling coverage. **Coinsurance clause** – dwelling coverage be maintained at a certain minimum percentage of the home’s replacement cost in order for a partial loss on the dwelling to be covered in full **Coinsurance application = ( Insurance Limit / Required % x Replacement Cost ) x Loss - Deductible** * Insurance Limit / Required % x Replacement Cost = ( DID HAVE / SHOULD HAVE) * Health insurance: deductible comes off the top. * In HO policy, deductible comes out the back end. * What advice would you give client? * At a minimum, recommend client to carry 80% of $500k * Insurance is never going to pay more than the policy limit * So best advice is to maintain coverage limit of the full replacement value. * That way in the event of a total loss, it would have $500k of coverage. If only had $400k required coinsurance application, wouldn’t have full coverage.

Answer 9

Practitioner Advice: **The insured does not have to purchase either coverage. However, if they have a car loan the lender will require both coverages within certain deductible limits until the loan is paid. This protects the collateral for the loan, which is the vehicle itself.**

Answer 10

The PAP provides coverage for four categories of insureds that have potential liability arising from the use of an auto. Category 1: The named insured and resident family members are covered for the ownership, maintenance, or use of any auto, whether it is owned or borrowed, unless an exclusion applies. **Practitioner Advice: In some states, such as Massachusetts, all licensed family members living in the same home as the insured must be identified and listed on the policy, whether or not they have their own policy. If a loss occurs due to a licensed family member's driving and the family member was not listed on the policy and does not have their own policy, the claim will be denied. This is to combat fraud, where a risky family member is unknown to the insurer, thus the premiums charged are less than what should have been assessed for the risk. Of course, if the household member is covered by another policy, merely listing them as a licensed household driver will not impact the insured's premiums. It is only when such a household driver does not have other coverage that their driving record will impact the insured's premiums.** Category 2: Covers any person using the named insured's covered auto. That is, the car owner's insurance, not the driver's insurance, would pay a claim if the owner let somebody borrow his or her auto. Categories 3 and 4: In some situations, people or organizations other than a driver can be sued due to a driver's negligence. In some of these instances, the PAP will cover the liability of these people. For example, assume that the Alpha Beta Gamma Omega fraternity sends a brother, Bozo, to get some refreshments for a "party." Assume that Bozo uses his own auto. If an accident results during the shopping trip, the PAP would cover the fraternity's liability in this suit. The fraternity's liability arises because Bozo was technically an agent of the fraternity while on this mission. The difference between Categories 3 and 4 is between the insured driving an owned or a nonowned vehicle.

Answer 11

Collision means collision (violent striking) of an automobile with another object (a car, a tree, or even standing water). The word "object" is quite broad and includes almost anything that can be seen or felt. However, the collision must occur while the car is being operated. Losses clearly not caused by collision include theft, vandalism, fire and windstorm. For example, an unoccupied car sitting in a driveway that has a tree fall on top of it is not involved in a collision. As might be expected, gray areas exist. Automobile policies providing collision and non-collision coverage deal with these questions by including wording such as the following: "For the purpose of this coverage breakage of glass and loss caused by missile, falling objects, fire, theft or larceny, explosion, earthquake, windstorm, hail, water, flood, malicious mischief or vandalism, riot or civil commotion, or colliding with a bird or animal shall not be deemed to be loss caused by collision." It makes a difference if a loss is a collision or not. Frequently, different loss settlement provisions, such as the dollar amount deducted from the loss before the insurer must pay, make this distinction important. The distinction would also be important if one or the other but not both of the coverages were purchased. **Exam Tip: As far as Personal Automobile Policy Collision and Comprehensive coverages are concerned, on the CFP exam "know the difference, score the points!"** **Practitioner Advice: While discussing the difference between collision and non-collision (comprehensive) coverage, a popular personal auto policy subject comes to mind. "Do I really need to purchase insurance when I rent a car?" The answer depends on the definition in your auto policy. For example, most auto policies extend collision coverage to a rental car. The reasoning is you can only be driving one car at a time, so while driving the rental, they aren't covering your car against collision. However, as for comprehensive coverage (theft or damage caused by everything but a collision), the rental car may only be covered if the insured's vehicle is parked at the normal place of garaging. To the insurer, leaving your car at the airport parking lot while on you are on vacation creates an unfair situation. The insurer is still protecting your car from a comprehensive loss when you also seek the same coverage on the rental. The insurer doesn't want to be covering two cars for the price of one at the same time. So, when deciding whether or not to purchase coverage for a rental car, know your policy's definitions.** Audio: **Understand the difference between auto collision and comprehensive Collision - when our automobile strikes another object (car, tree, light pole, typically inanimate) Comprehensive - theft, fire, striking an animal**

Answer 12

Because of the increasing size of settlements and jury awards in lawsuits, insurance companies developed an additional level of liability protection. Typically referred to as Personal Liability Umbrella Policy because it "sits on top of" underlying policies, the limit can range from $1 million to $10 million. Whether the claim is from general liability or auto-related, the Umbrella policy steps in when the basic policy has reached its maximum claim limits. In addition to providing excess coverage for claims, the umbrella policy offers broader coverage, for example, driving anywhere in the world is covered, rather than restricted to the U.S. and Canada. A Personal Liability Umbrella Policy will also provide coverage for some exposures that are not covered by the insured's basic coverage. A deductible or self insured retention is typically applied when the loss is covered by the umbrella coverage but is not covered by the basic contract or contracts. **Practitioner Advice: While high net worth clients need Umbrella policies due to their higher risk of being sued, many other clients could benefit from this inexpensive protection. Anyone with young drivers in the household, people who travel and drive internationally and those with higher risks like swimming pools and trampolines should learn more about the costs and benefits of this policy**. Audio: * One of the greatest tools - umbrella policy * Huge cushion of liability protection * Inexpensive way to get significant additional liability protection * Good for young drivers, swimming pool, trampoline * Can get $1 million for $300-400 * Each additional million is less expensive * Can get comprehensive coverage for your client through the use of umbrella policies **Exam Tip: A Personal Liability Umbrella function is just as it reads, it is like an umbrella, offering additional protection above and beyond the base limits of the liability sections of the personal automobile policy (PAP) (i.e., Part A) and homeowners policy (i.e., Coverage E).**

Answer 13

The perils facing mobile property are broader in scope than the perils facing real property. In addition to such perils as fire, lightning, and windstorm, mobile property may be sunk, confiscated, and hijacked as well as collided with and stolen more easily than property attached to the land. The broader scope of the perils, the difference in ability to investigate losses, and the differing potential for salvage operations have resulted in marine insurance practices that are quite distinct from comparable property insurance practices. Mobile property, such as property to be exported, is generally covered by transportation insurance. Inland marine insurance is essentially an American distinction. Other countries have not separated the underwriting powers of insurers to the extent Americans have. In the United States, the distinction between inland marine insurance and ocean marine insurance still remains because of separation of underwriting powers. **Exam Tip: Inland Marine Insurance coverage is a type of transportation policy that applies to any personal property items that are not attached to a structure and can be moved from one location to another. While a custom decorative rug from Morocco would qualify (it can be rolled-up and transported) installed carpeting does not (it is attached to the housing structure). Listen in for additional facts about Inland Marine Insurance coverage**. Audio: * Commercial property and casualty insurance is not a big part of exam * But may see question on Inland Marine Insurance (which has nothing to do with the ocean) * It's special insurance to cover equipment or materials, products that are shipping over land (by truck or train)

Answer 14

Major medical policies cause an insured to pay an amount of medical bills equal to a substantial deductible. This deductible lowers the insurer’s costs since the first dollars of all losses are not covered. In marginal cases where treatment may not be necessary, the insured has a strong incentive to avoid overuse of medical care. Some policies apply the deductible to each illness or accident, but limit the total amount deducted to some annual maximum. **Practitioner Advice: Remember, deductibles are a form of risk retention on the part of the insured. When an insured selects a higher deductible, the insurer does not have to provide coverage as soon, thus saving the insurer money. Insurers pass along some of these savings to those insured's who choose higher deductibles in the form of lower premiums**. * The opposite, however, is also true. **A lower deductible increases insurer cost, thus comes at a higher premium to the insured**. * So, **when selecting the proper deductible, the insured must balance risk tolerance (based on probability, frequency, and severity of loss) with affordability**.

Answer 15

With a major medical policy, the insurer agrees to pay a specified percentage of the insured's bills and the insured must pay the difference. This sharing of costs is called the participation provision, or coinsurance. Typically, the insurer pays 75% to 80% of the bills after the deductible requirement is met. The insured pays the remaining 20% or 25%. As with deductibles, the amount of coinsurance that the insured shares beyond the deductible is another form of risk retention. The more the insured shares, the lower the premium; the less shared, the higher the premium. **Exam Tip: The CFP Exam often tests concepts and definitions at the level of application by presenting a real-life scenarios. Health Insurance coverage provisions are commonly tested in this manner. Specifically, CFP Board may present a scenario in which the Health Insurance policy benefits will be accessed and ask the candidate to calculate the amounts paid by the insured and/or insurer. To do so with precision first requires an understanding of the core policy provisions and definitions (i.e., deductible, coinsurance provision, stop-loss, and maximum-out-of-pocket). Listen in below for a comparison of stop-loss limits and maximum-out-of-pocket provisions**. Audio: * A major medical policy has a deductible. Benefits don't kick in until deductible has been met. * After deductible is met, coinsurance kicks in (insurance may pay 80% and insured pays 20%) * **Stop-loss limits - the maximum amount of covered charges after the deductible has been paid to which the coinsurance provision applies**. * Ex. $1000 deductible. Stop-loss limit of $10,000. Insured will pay first $1000 (deductible). Then will pay 20% of the next $10,000 in eligible charges (insurance pays 80%). * **Total exposure is the sum of the two: deductible and coinsurance, which is Maximum-out-of-pocket provisions (MOOP)**.

Answer 16

Medicare is health insurance for people age 65 or older, under 65 with certain disabilities, and individuals of any age with End-Stage Renal Disease which is permanent kidney failure requiring dialysis or a kidney transplant. The cost for Medicare will vary depending on the plan, coverage, and services used. Most people get their Medicare health coverage in one of two ways, the original Medicare Plan or the Medicare Advantage plans like HMO’s and PPO’s which is called Part C. The original Medicare Plan provides Part A (Hospital Insurance) and optional coverage for Part B (Medical Insurance), Part D (Prescription Drug coverage), and Medigap (Medicare Supplement Insurance) Policy. Most people are eligible for Part A coverage without having to pay a monthly payment/premium if they or a spouse paid enough Medicare taxes while working. If someone does not qualify for premium-free Part A they may be able to buy it, but they may have to enroll in Part B and pay a premium for it too. Medicare Part A helps cover inpatient care in hospitals, including critical access hospitals and skilled nursing facilities, but not custodial or long term care. If you meet certain conditions it may cover hospice care and home health care as well. Medicare Part B helps pay for medical services like doctors’ services, outpatient care, and other medical services that Part A doesn’t cover. Part B helps pay for covered medical services and items when they are medically necessary and some preventive services. Most people will pay the standard monthly Part B premium. However, as of January 1, 2007 the Part B premium is based on modified adjusted gross income once annual income exceeds a certain amount. Medicare Part C alternative combines Part A (Hospital Insurance) and Part B (Medical Insurance). Most Part C plans cover prescription drugs. If it does not, then it may be possible to purchase Part D (Prescription Drug Coverage). Medicare Part D (Prescription Drug Coverage) is available through private companies that work with Medicare to provide prescription coverage. There are different types of Drug Plans. Once enrolled in a plan you may switch plans from November 15-December 31 of each year. In most cases a separate monthly premium is paid. Premiums vary by plan. If you decide not to enroll in a Medicare drug plan when you are first eligible you may pay a penalty if you choose to join later. A co-payment or coinsurance, and in some cases, an annual deductible will also need to be paid. Prescriptions are filled with pharmacies that have contracts with Medicare. **Exam Tip: To score Medicare-related CFP exam points, know your 'A-B-C-D's!' Each Part of Medicare has important characteristics, worthy of study, memorization, and practice. Listen in for an overview of each Medicare Parts in which key information is pointed out and examined**. Audio: * Know the structure of Medicare and what is covered under the respective parts. * A - hospitalizations - paid for during our working years. * B - optional, but nearly everyone enrolls in part B (doctors, labs, radiology) - monthly premium based on income. * C - alternative - HMO option, cost effective * D - prescription Drugs - newest of the medicare coverages. Forever in a constant state of change. **Practitioner Advice: Your clients who are enrolled in Medicare can register at my.medicare.gov for information about their health claims, preventative services, and how to get the most out of their Medicare benefits. They can also call 1-800-MEDICARE for information.**

Answer 17

The patient's share of Medicare cost is subject to change each year. To illustrate just one gap in Medicare coverage, consider inpatient hospital care. Medicare Part A Costs Example: In 2023, the patient is responsible for a one-time deductible of $1,600 for hospital stays for the first 60 days. For longer hospital stays, the patient's co-payment increases to $400 each day for stays between 61 and 90 days. Finally, Medicare charges a co-payment of $800 each day for additional days taken from the 60-day reserve that a patient can only use once in his or her lifetime. Moreover, other co-payments apply to such things as short-term stays in nursing homes and to certain charges by physicians and other service providers. Therefore, the great majority of Medicare beneficiaries have also purchased Medigap coverage. In recent years, more than 70% of the people enrolled under Medicare purchased some form of Medicare gap-filling coverage. Just 25 insurers earned almost 70% of the Medigap premiums. **Practitioner Advice: Understanding Medicare enrollment timeframes and associated costs can serve as a 'value-add' to your clients. The Medicare system is complex and navigating the process can be overwhelming for clients. Check out medicare.gov to view the current Medicare pricing on an annual basis and upon significant legislative changes.**

Answer 18

HMOs are organized in two different types: * Individual practice HMO, and * Group practice HMO. The individual practice HMO contracts with specific physicians and hospitals. These doctors and hospitals may provide service to the public in addition to members of other HMOs. Participants in the individual practice HMOs can choose a physician from among those participating in the plan. The physician then charges the HMO a fee for each patient seen. The group practice HMO has a limited number of medical providers that a member may use. These doctors and medical professionals often work exclusively for the HMO. **Practitioner Advice: If your clients are considering changing health insurance plans, either individually or through their employer, you should check to see if the client's current doctors are included in the HMO plan(s) up for consideration.**

Answer 19

Preferred Provider Organizations (PPOs) are another alternative to traditional health care provision. PPOs, usually an association of cooperating physicians and hospitals, agree to provide employers with health care services for their employees at discount prices. PPOs differ from HMOs, in the following 3 ways: * First, the employer’s cost with PPOs is determined by use. A fee is charged for each use, but the fee is lower than the provider’s usual charge for the service provided. * Second, covered employees do not have to use the personnel or facilities of the PPO. If employees use non-PPO providers, however, the employees pay higher costs. For example, physicians may agree to charge PPO members less than their customary fee for a particular service. In addition, the employer’s health care plan may provide reimbursement for 80 percent of the cost if a PPO provider is used, and only 60 percent if the employee uses a non-PPO physician. * Third, the PPO arrangement may not provide coverage for annual physical examinations. **Practitioner Advice: A common source of frustration for employees is deciding which health option is best for their family. Usually there is one plan that is less expensive up front, but imposes larger out-of-pocket expenses for seeking medical attention. The other option tends to provide more benefits for little out-of-pocket cost, but requires almost twice as much in payroll deductions. No one can predict future medical needs; however, if the family does not have young children who are active and exposed to illness in school, there are no senior family members with deteriorating health or anyone with a major health condition, it may be wise to choose the first plan. If potential medical visits and out-of-pocket costs are less than the additional premium required for the second plan, you may save money. If the opposite is true, it may be less risky to purchase the high premium plan. Either way, if a medical spending account is available, contribute an amount that approximates the anticipated out-of-pocket cost, as the deducted money avoids taxation.**

Answer 20

The Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA) was a major attempts by the federal government to increase access to health care. COBRA required that employees and particular beneficiaries be allowed to continue their group health insurance coverage if coverage was lost for specific reasons. COBRA applies to employers with group plans covering 20 or more employees. The COBRA election period starts with the date of the notification and lasts for 60 days. **Exam Tip: COBRA has several noteworthy elements that are highly testable on the CFP Exam. As you set out to study COBRA, begin with the basics: the qualifying categories of coverage and their associated coverage periods. From there, focus on the 'one-off,'bullet-point' facts such as required number of employees and percentage of premimus.** Listen in below for an overview of these essential COBRA-related topics and more! Audio: * Understand the qualifying statuses for eligibility and maximum period of coverage * **Termination - 18 months** * **Other ones - double that - 36 months** * Off one questions: * **Does not apply to companies with less than 20 employees** * When one is on COBRA, **company has the right to charge them up to 102% of premium (2% is for administrative charges)**

Answer 21

Disability contracts typically define disability in one of three ways: * Own occupation definition, which is usually referred to as "own occ." * Modified own occupation, with a time limit (e.g. 2 years) on "own occ" protection. * Any gainful occupation definition, which is commonly, if somewhat inaccurately, called "any occ." Listen in for a thorough comparison of the commonly-used definitions of disability. Audio: * Own occupation definition - if insured can't do regular occupation, but can do another, still qualify for benefits. Ex. surgeon is injured and can't perform delicate surgery, but can do other things in medicine. Most expensive type of coverage. Most detailed underwritten. * Modified own occupation - for a limited period (typically 2 years), it's on own occupation. For the balance of the benefit period, it's any any occupation definition. * Any gainful occupation definition - most restrictive for the insured. If they can do any occupation, then they are not considered disabled. (Ex. surgeon would not qualify for benefits with this type) **Practitioner Advice: After ensuring that the insurer being selected is strong and reputable, the most important factor in selecting a policy is its definition of disability. What good is a “cheap” premium if the insured will never be able to collect benefits due to restrictive definitions?**

Answer 22

An own occupation clause deems the insured to be totally disabled when they cannot perform the major duties of their regular occupations. This is considered the most liberal definition of disability available, and thus the best to have. Because the own occupation definition of disability is the most favorable for the insured the premium for this type of policy is higher than those policies with less restrictive definitions of disability. A regular occupation is the one in which the insured was engaged at the time the disability began. Under this definition, the insured can be at work in some other capacity and still be entitled to policy benefits if they cannot perform the important tasks of their own occupations in the usual way. Own Occupation Example: Doctor Smith was a 45-year-old neurosurgeon with a successful practice. Due to a car accident, he lost the use of his right hand, thereby ending his ability to perform surgery. After a long rehabilitation period, he was offered a teaching position at a prominent medical school. He had purchased an "Own Occ" disability policy when he was 30 and had selected a benefit period that would last until age 65. **Due to this "Own Occ" definition, he not only collected benefits while totally unable to work, but even after he started his teaching position**. **Practitioner Advice: Own Occuption level of protection is essential for any specialist (e.g. a trial attorney, a commercial architect, or a surgeon). Policies with "own occ" definitions are harder to find than previously, and there is an increased premium for the protection provided, but it is definitely worth the costs.**

Answer 23

The three basic components that establish the premium and define the payment of benefits under disability income policies are: * The elimination period, * The benefit period, and * The amount of monthly indemnity. All other parts of the policy relate to these common elements and are used to limit or expand their value in meeting the specific needs of the insured at the time of loss. The strength of a particular disability income plan lies in how liberally the insurance company permits these elements to operate within the policy provisions and through its own administrative practices. **Exam Tip: The elimination period, benefit period, and amount of monthly indemnity function as 'dials' that can be adjusted to secure a specific level of coverage and establish the premium amount. Listen in for additional facts about disability income insurance benefit provisions**. Audio: 3 main components (variables) in a disability policy. They impact the level of benefits and premiums. They're like dials that can be turned up or down to tailor it to the client's circumstances or needs. Or can change it over time. * The elimination period, * The benefit period (how long the benefits go to), and * The amount of monthly indemnity. Or can change it over time. Ex. Client picked up policy and now have enough funds to increase from 30 day to 180 day elimination period (would reduce the premium). Could then use the savings to increase the benefit period or monthly payment amount. Or could go somewhere else (umbrella ins).

Answer 24

The elimination period, sometimes called the waiting period, refers to the number of days at the start of disability during which no benefits are paid. It is a limitation on benefits that is somewhat like a deductible in medical expense and property insurance policies. It is meant to exclude the inconsequential illness or injury that disables the insured for only a few days and that is more economically met from personal funds. The major insurers allow for a temporary break in the elimination period so that the insured will not be penalized for any brief attempt to return to work before the elimination period has expired at the start of disability. The brief recovery is generally limited to six months or, if less, to the length of the elimination period. If the insured is then again disabled because of the same or a different cause after the interruption, the insurer combines the two periods of disability to satisfy the elimination period. **Practitioner Advice: Remember, deductibles, and elimination periods are forms of risk retention on the part of the insured. The more risk retained by the insured helps to reduce the premium charged. When a need exists and affordability is important, choosing a less than optimal elimination period, monthly benefit amount, or benefit period can be a good decision.**

Answer 25

As with group health insurance, premiums paid by an employer for disability income insurance for employees are generally tax deductible by the employer as a business expense and are not considered taxable income to the employee. Employee contributions, on the other hand, are not tax-deductible by the employee. Consistent with these two rules, the payment of benefits under an insured plan or a non-insured salary continuation plan result in taxable income to the employee to the extent that benefits received are attributable to employer contributions. Thus, under a non-contributory plan, the benefits are included in an employee's gross income. Under a partially contributory plan, benefits attributable to employee contributions are received free of federal income taxation and benefits attributable to employer contributions are included in gross income. A tax credit may be available to persons who are totally and permanently disabled. The benefits received from a disability income policy purchased individually with after-tax dollars are not subject to federal income tax and the premiums paid for the policy are not tax-deductible. If an employer pays the premiums for an individual policy insuring an employee and reports the premiums as compensation under IRC Section 162 the employee pays taxes on the premiums paid but the disability insurance benefits are then tax-free when paid. **Exam Tip: When determining disability benefit taxation, remember that the IRS will always get their share. Focus on the party that pays the premium and determine if the premium is paid with pretax or after-tax dollars. Tax-deductions for premiums paid are only available to an employer as a business expense. Individually-purchased policies are not eligible for a deduction**. Audio: * Taxation of disability insurance. Will most likely have a scenario on exam that employer is paying premiums (not includable in income to insured) and/or scenario with insured also has a privately paid disability policy that they pay with after tax dollars. * Question - how much is the taxable portion of the benefits? * Question - how much is tax free? * Look to see who was paying the premiums and if it was pre or post-tax * **If employer paid benefit - no contribution from insured - benefit would be taxable to insured** * **For private policy paid with after tax dollars - benefits received tax free**

Answer 26

The rehabilitation benefit generally allows a specific sum, often 12 times the sum of the monthly indemnity and any supplemental indemnities, to cover costs not paid by other insurance or public funding when the insured enrolls in a formal retraining program that will help him or her return to work. **Practitioner Advice: Some disability plans will cover the cost of the retraining program, and some group disability plans will even pay for daycare so the parent can go to training.**

Answer 27

All insurance contracts have a list of losses not covered and losses with limited coverage. This list is referred to as the contract Exclusions and Limitations. Exclusions / No benefits will be paid for disability as a result of: * War or act of war * Self-inflicted injury or sickness * Pregnancy (in some states (e.g. Massachusetts) state law requires that pregnancy be treated as any other illness, and therefore it is covered) * Aviation: Serving as pilot or crew member of an airplane * Narcotics: Use of llegal drugs or taking those not prescribed by your physician * Incarceration or loss of professional license * Illegal occupation * Committing or attempting to commit a felony Limitations: Benefits for disabilities related to mental/emotional disorders are paid only for two years. Alcohol and drug abuse can have the same two-year limitation on benefits. Pre-existing conditions can be handled in different ways by different insurance companies. Sometimes they are completely excluded, usually done by an "exclusion rider" with very specific language. For example, an applicant who has received treatment from a chiropractor will typically see the following: "no coverage for disability from injury to or disorder of the cervical spine, its muscles, ligaments, discs or nerve roots." Other carriers may use the following limitation: "Disabilities due to conditions not disclosed on the application, for which medical advice, treatment or medication was received, are not covered for the first 2 years that this policy is in force." **Practitioner Advice: Group long-term disability (LTD) has more liberal underwriting and may cover pre-existing conditions as long as disclosed on the application and not excluded. Other insurers use a waiting period such as 3/12: any condition treated in the prior 3 months is not covered for the first 12 months.**

Answer 28

The Social Insurance Supplement (SIS) or Social Insurance Substitute evolved as a response to the underwriting problem that was created by the existence of substantial benefits potentially available for disability under workers’ compensation or for disability or retirement under the U.S. Social Security Act. Most insurance companies take these substantial benefits into account and, to minimize moral hazard at a later time, sharply limit the amount of conventional disability income insurance that will be issued to applicants with incomes below $35,000, particularly those in their less favorable occupational classes. However, the insured may not always qualify for the anticipated benefits of the social insurance plans. He or she may suffer a loss that is not covered by workers’ compensation or that does not meet the highly restrictive definitions for total and permanent disability under Social Security. If the insurance company has limited the amount of personal insurance, the individual will be underinsured each month by several hundred dollars or more. The SIS benefit was developed to meet this potential coverage gap. The supplemental benefit provides an amount of monthly indemnity that approximates the amount the insured might reasonably expect to receive from Social Security for total disability. The SIS benefit is paid when the insured meets the policy’s definition for total disability but is not receiving benefits from any social service plan. It is payable as a fixed amount of indemnity that ceases when the insured begins to receive any income from a social insurance plan or it may be reduced by a dollar-for-dollar offset of the benefit actually paid under the social insurance plan. If the offset method is used, the insurer usually specifies a minimum amount below which the SIS benefit will not be reduced while total disability continues. **Practitioner Advice: Another way in which the Social Insurance Supplement (SIS) benefit is used is to reduce premiums when a client’s budget is tight. Because the cost per $100 of SIS benefit is considerably lower than that of the basic benefit, accepting a lower basic monthly benefit and adding an equivalent amount of SIS benefit can cut premiums. This tactic is only advisable when the alternative would be to drastically cut the monthly basic benefit to a point where the need is not adequately covered.**

Answer 29

The Inflation Protection Benefit, or Cost-of-Living-Adjustment (COLA) Benefit, under disability income policies provides for adjustments of benefits each year during a long-term claim so as to reflect changes in the cost of living from the time that the claim began. Adjustments are computed by the rate of change shown in a price index, such as the U.S. Consumer Price Index (CPI). At one time, insurers marketed COLA riders offering fixed-percentage increases. This practice resulted in some benefits outpacing the rate of inflation and led to moral hazard problems. The method of adjustment is relatively complex, but generally it calls for a comparison of the index for the current claim year with the index for the year in which the claim began. If the index increased or decreased since the start of the claim, benefits for the next 12 months are adjusted by the percentage change in the index. The percentage change is limited to a specified rate of inflation, generally ranging between 5% and 10%, compounded annually. The adjusted policy benefits may increase or decrease each year as the index rises or falls, but the benefits cannot be reduced below the level specified in the policy on the date of issue. Some insurers apply a cap to limit increased benefits to a maximum of two or three times the original indemnities. Others place no limit on the maximum increase of adjusted benefits before the insured is age 65. **Practitioner Advice: As a general rule of thumb, the younger the client purchasing a disability income insurance policy, the more important it is to include a Cost-of-Living Adjustment (COLA) rider. The reasons are simple; the erosion of the current value of a benefit due to inflation and the typically lower earnings of a client early in their career. Over a client's lifetime, the purchasing power of a dollar will continue to decline. As a result, it is important to preserve the benefit value until it is needed. Older client's and those for which the policy benefit amount is not maximized may consider passing on a COLA rider and using the money saved on the rider expense to increase their benefit. This provides needed protection for incidents of disability that are fewer than 12 months and enables the client to receive greater economic benefit from the policy**.

Answer 30

Often referred to as Automatic Benefit Increases, under an Increased Future Benefit optional rider the insurer offers to increase the monthly benefit at stated intervals, usually early in contract. Typically the increase is by a certain percentage (e.g., 5%) and a monthly benefit of $3,000 would become $3,150. This is designed to help the insured keep pace with inflation and pay raises. If the increase is accepted, the premium will also increase by a small amount. **Practitioner Advice: In most contracts, the insured can decline the increased benefit, but may lose privilege of future increase offers. It is usually a good idea to accept the higher benefit amount.**

Answer 31

Some insurers might include one or more benefits in the basic benefit provisions. However, they are more frequently available for an additional premium as optional benefit riders attached to the policy. The benefits and the premiums of each optional rider generally are shown on the schedule page. Among the leading insurers, the most common optional or supplemental benefits are: * Residual disability benefit, * Partial disability benefit, * Social insurance supplement, * Inflation-protection benefit, * Increased future benefit, and * Guaranteed insurability option. **Exam Tip: Residual disability benefits and partial disability benefits are similar sounding supplemental benefits, however, there are key differences between the two alternatives. Specifically, the extent of benefit payout, availability within a disability income insurance policy, and prerequisites vary between these provisions**. Listen in for a comprehensive comparison of residual disability benefits and partial disability benefits. Audio: * Both are able to provide income when the insured return to work, but can't do the same number of hours OR can't perform all same duties * Residual disability benefits - more liberal benefit. Will provide a proportional benefit. If insured loss 30% of income bc of restrictions, they can qualify for 30% of their monthly benefit from the disability insurance policy. Could also be used to satisfy the elimination period. Would not have to follow total disability. Often part of the own occupation policy. * Partial disability benefits - insured return to work after a period of TOTAL disability. Will pay up to 50% of monthly benefit for some stated time period (likely 6 months). Often offer as a rider policy.

Answer 32

In the United States, Medicaid is the "provider of last resort" for the impoverished. Medicaid is a joint federal and state entitlement program that pays for medical expenses for qualified recipients. Eligibility for Medicaid long-term care services is based on each state’s income and resource standards. Though specific thresholds vary from state-to-state, in general, individuals cannot have more than $2,000 in countable assets to apply, and some assets are not counted, such as household goods, personal possessions, clothing, furniture, jewelry, a car, and up to $500,000 or $750,000 of home equity. Assets that are considered countable include savings, CDs, money market accounts, real estate, stocks, bonds, and other investments. Until recently, many financially well-off families, facing the need to provide long-term care for an aged parent, would arrange for the transfer of the parent's assets either to children or to a trust, to voluntarily "impoverish" the parent who would then be eligible for Medicaid. In response, Congress imposed strict limitations on the transfer of assets when it passed the Deficit Reduction Act of 2005. Now certain transfers for less than fair market value made within the “look back” period will incur a penalty period of ineligibility. Medicaid payments would be withheld for a calculated period of time once the nursing home resident depletes his assets to the state’s qualifying levels. The penalty period begins on the later of: * the date of the asset transfer, or * the date a person entering a nursing home is eligible for Medicaid coverage if it weren’t for the imposition of the transfer penalty. The following provisions are applicable to all potential Medicaid recipients; they are intended to minimize financial manipulation: Property transferred to individuals, charities, or a trust within 60 months of application for Medicaid is considered as owned by the applicant and must be disclosed. Applicants must provide five years' worth of financial records to satisfy the "look back" period, regardless of whether transfers were made to a trust or to others. State Medicaid programs are required to attempt to recover any Medicaid payments from the estates of recipients. **Exam Tip: "Live in the moment" ... "the past is past" speak the sages and devout practitioners of mindfulness. Sadly, these words of wisdom get tossed to the side when it comes to the Medicaid Long-Term Care asset-counting qualifications. Listen in for a quick summary of the Medicaid 'five-year lookback and an explanation about why it counts**. Audio: Be aware of and understand the "look back" provision of Medicaid - where one cannot give away all their money and immediately go on Medicaid for LTC and nursing home. Applications - all financial records from past 5 years are subject to inspection. If transfers found, not immediately eligible. There will be a delay. Will look at total assets transferred in 5 years and divide it by a "penalty divisor", which is the typical cost of care in that state, and the result is the number of months they have to wait to be eligible for Medicaid. Ex. Transferred $100k in 5 year period. Typical cost of care is $4k/month. $100k/$4k = wait 25 months before eligible for Medicaid. **Practitioner Advice: Though Medicaid continues to provide some financial security to the truly needy, it will no longer be subject to the same types of manipulation as before. The message is clear: If there is any way for people to cover their own LTC expenses, they should try to do it. Many states now have long-term care “partnership” programs that allow buyers to qualify for Medicaid after the policy’s benefit period ends, and protect some assets from spend-down requirements. For example, if a policy is purchased with $100,000 in benefits, the buyer can keep that amount of assets and still qualify for Medicaid. Ownership of LTC insurance may also exempt the nursing home resident’s estate from payment recovery. See your specific state for details.**

Answer 33

Policies often provide for **three levels of LTC care**. They include **skilled nursing care, intermediate nursing care, and custodial care**. Formerly, most LTC policies required a hospital stay before admission to a nursing home. Also, the stay must have been certified "medically necessary." This is no longer the case. **Exam Tip: Understanding when and where Medicare may apply to the different levels of LTC care is a highly testable CFP Exam topic. For example, Medicare will never pay for Custodial Care while there is a specific scenario in which Skilled Nursing Care could receive Medicare coverage**. Listen in below for additional information on LTC coverage options and permitted expenses under Medicare. Audio: * Medicare will only pay for Skilled Nursing Care for a period of time following hospitalization of 3 days * Medicare will never pay for Custodial Care * Custodial Care would have to be self-pay or with LTCi

Answer 34

Most policies agree to pay benefits if the insured cannot perform basic living activities without assistance. The typical policy requires that the insured be unable to perform two of five or six ADLs (activities of daily living) for 90+ days, depending on the policy. Because LTCi contracts are not standardized, the policies can contain any of the following list of activities of daily living (ADLs): * Eating * Bathing * Dressing * Toileting * Continence * Transferring Some individuals can physically perform all ADLs and yet cannot be left alone safely. When substantial services are required to protect the individual due to Alzheimer’s, dementia, or cognitive deterioration. Can start LTC benefits alone (no 2 of 6 ADL requirement). This special coverage is referred to as the **cognitive impairment clause**. **Exam Tip: Memorize all of the ADLs (i.e., B-E-D, C-O-T) and be sure to know a few activities that will not be considered as an ADL (i.e., blindness or wheelchair use)**. Listen in below for a frequently tested application of ADLs and LTC coverage qualification. Audio: **Not ADLs - being blind or in a wheelchair**

Answer 35

Most elderly are happier and healthier when they can maintain as much control over their own affairs and experience independence. LTC policies usually provide benefit payments for those insured who require assistance but who are able to remain in their homes or communities. The benefits, usually stated as a percentage (such as 50 percent of the full nursing home benefit) are available for a variety of programs and services. Community Care serves as one of many broad categories of Long-Term Care Treatment Locations. In addition, there are Facility and Home Care services that may be appropriate for a given individual based on their health status and personal needs. **Practitioner Advice: Many LTC policies now offer a rider, for an additional premium, that increases the home care benefit to 100% of the daily benefit. This gives the client more financial support to stay in their community and makes the policy easier for them to understand, e.g. "I will get benefits up to $200 a day, whether I get care at home or in a nursing home."**

Answer 36

The policies offered provide a choice of elimination (waiting) periods before benefits become payable. Available elimination periods range from zero to 365 days. A longer waiting period warrants a lower premium, when all other policy provisions remaining the same. **Practitioner Advice: The 20-day elimination period may be selected to match the time period when Medicare stops paying 100%. The 60-day elimination period has a lower premium, and is more popular with clients who are willing to "self-insure" the first two months of care**. **Use a balance sheet to determine the cash needed for a 6-month reserve and determine the current ratio (current assets / current liabilities). Assume a client would like to purchase a long-term-care policy and that long-term-care expenses are estimated at $120,000 per year or $10,000 per month. The client gets several quotes, and, in an effort to minimize the insurance premium, chooses a longer elimination period. The advisor should discuss with the client the cash flow needed to bridge long-term-care expenses that will not be covered until the policy starts paying. For example, if the client chooses a 6-month elimination period, point out that approximately $60,000 (6 months x $10,000 long-term-care expenses) is required to cover all costs until the elimination period has passed.**

Answer 37

The benefit provisions in LTCi policies outline what will be payable by the insurer if an insured event occurs. These provisions relate to the types and levels of care for which benefits will be provided, any prerequisite for benefit eligibility, and the level of benefits which are payable. However, no policy guarantees to cover all LTCi expenses; there are always certain limits and/or “cost-sharing” amounts the insured incurs. The policies offered by many companies provide a choice of elimination periods before benefits become payable. The schedule of the benefit periods offered might range from two to five years. Some insurers even offer a lifetime benefit period, which works out to be quite an expensive option. Community-based care is less expensive than nursing home care, and is usually preferred by the elderly. The maximum daily benefit varies by contract from 50 percent to 100 percent of the maximum daily benefit for nursing home care. The length of the benefit period is often the same for both of the coverages, but different insurers require different waiting periods. LTCi policies now offer some kind of inflation protection rider for an additional premium. **Practitioner Advice: The average national long-term care expenses are inflating at a rate of 3.11%. However, there is great variability in the long-term care price point for a given level of care at the regional, state, or local level. Calculate the costs of LTC care in your region, state, or municipality by visiting the Genworth Cost of Care website.**

Answer 38

If a policy is purchased with no inflation protection, the benefit amount remains at its original level indefinitely. The client needs to be aware of purchasing power risk (detailed further in the Investment Course), which is the risk that inflation will erode the real value of the investor’s assets. In this case, the value of the long-term-care policy is the client’s asset. Inflation and LTC Benefits Example: Assume a client purchases a long-term-care policy without inflation protection for $275 per day and a 3-year term. In addition, inflation for long-term-care costs is a constant 4.5% increase over the next 20 years. Twenty years later the client is a resident in a nursing home, receiving a $275 per day benefit when the actual cost per day is $663. This is calculated as: n = 20; I = 4.5; PV = ($275); FV = $663. A majority of LTC policies offer some kind of inflation protection for an additional premium, which is designed to ensure that the benefit amount increases with the cost of living. As shown in the example above, inflation protection of 4.5% would fully hedge the purchasing power risk. A 3% inflation protection on the policy would increase the daily benefit to $497, calculated as: n = 20; I = 3; PV = ($275); FV = $497. Any shortfall will erode assets that would normally be distributed to beneficiaries upon the policyholder’s death. As the financial planner, you will need to help the client determine whether it is worthwhile to pay the increased premiums or whether this would constitute paying for benefits that may never be utilized in the future. Many companies offer options such as: Increasing the benefit amount by 3% of the original amount per year. Increasing the benefit amount by 3% compounded annually. Adjusting the benefit amount annually according to increases in a price index, such as the consumer price index in the United States. **Practitioner Advice: The inflation rider is the most expensive LTCi rider. The Compound Inflation rider can equal half of the total premium, especially for younger insureds. For people in their fifties though, it doesn't make sense to buy LTCi without the inflation protection. Consider much coverage a daily benefit of $200 would actually provide twenty-five years from now if inflation averages 3%.**

Answer 39

In addition to the basic benefit provisions, Long-Term Care Insurance (LTCi) policies contain several other provisions that collectively define the quality of the policy. LTCi premiums are determined by the applicant's age, gender, medical condition, history, and the benefits provided. The three basic components that establish the premium and define the payment of benefits under LTCi policies are: * The elimination period * The benefit period, and * The amount of daily benefit. Issue ages vary widely by company, such as 50–84, 55–79, 40–79 and 20–74. When a company’s lowest premium is based on age 40, a person under age 40 wishing to purchase an LTCi policy would be charged the age 40 premium if found insurable. Actuaries remain uncertain about many aspects of LTCi pricing because they do not yet have a substantial body of experience on which to rely. The issue is further complicated as many LTCi policies rely on lapse-supported pricing; that is, those who lapse early subsidize persisting policyholders. Many believe that LTCi premiums are too high, even though premiums have declined in recent years. Typical first-year commissions paid to agents who sell the policies fall in the 50% to 80% range and are important factors in LTCi insurance pricing. Group commission rates, however, are much lower. A major reason for such commission rates is the degree of difficulty in selling LTCi policies. Historically, it has been difficult to convince individuals that the probability of their needing some kind of expensive care is increasing as they age. With increasing awareness and innovative marketing, such as worksite marketing, prices may decline further. As with several financial planning tools, the LTCi policy is exceptionally complex for both insurer and customer. As such, care must be taken in pricing and in purchase. **Practitioner Advice: When selecting a company for Long-Term Care Insurance, ask how long the insurance company has had LTCi policies. If they have more than 10 years experience in the market, the company's actuaries will have better information on claims experience, and can design a more accurate premium. Be wary of companies with their first LTCi product and unusually low premiums.**

Answer 40

All LTC policies contain some exclusions and limitations of coverage. Common exclusions include war, self-inflicted injuries, and chemical or alcohol dependency. Policies may also exclude coverage for mental illness that is not organically based. In the past, policies did not cover senile dementia, Alzheimer's disease or Parkinson's disease. Virtually all LTC policies now cover these conditions and all other illnesses that can be demonstrated as organically based. **Practitioner Advice: In the past, most policies had pre-existing condition limitations, meaning that illnesses already being treated would not be covered for long-term care services. Now, good quality policies will cover previous conditions if the person is accepted as insurable. Be aware that the older your clients are, the less likely it becomes that they will qualify for LTCi coverage. Even if an older client passes through the underwriting process, the cost of insurance may be exceedingly high. Take a look at the table below from the American Association of Long-Term Care Insurance (AALTCi) on the percentage of applicants that are denied coverage**.

Answer 41

The Long-Term Care Insurance Model Act specifies minimum standards that products must meet to be considered long-term care insurance. The model includes the following major provisions: Insurers must provide an outline of coverage and summarize the features of the policy. * Policies must contain the following minimum standards: * The individual policy-owners must have a 30-day "free-look" period during which the policy can be canceled and the premiums returned for any reason. * Waivers denying coverage for specific health conditions are prohibited. * Insurers may not offer substantially greater benefits for skilled nursing care than for intermediate or custodial care. * Insurers must have a minimum loss ratio of 60% on their LTCI policies. * Policies must be guaranteed renewable, although state insurance commissioners may allow cancellation under limited circumstances. * Coverage for Alzheimer’s disease must be included. * Inflation-protection option must be offered. * Policies must be incontestable for misrepresentation after 2 years. * Policies may not be cancelled for non-payment of premium without the insurer providing 30-day written warning sent to the insured and a person designated by the insured. (This is to avoid a mentally impaired insured forgetting to pay the premium.) **Practitioner Advice: Because of the complexity of LTCi policies, and the number of companies now competing in this market, it is essential to work with an experienced agent in the selection and purchase of the most appropriate policy**. **A high quality LTCi policy will include the following elements**: * Financially Strong Insurer * Adequate Daily Benefit * Inflation Protection * Comprehensive Coverage * Consistent Claims Processing * Stable Premiums

Answer 42

It is easy to conclude that health insurance benefits utilized to pay for an operation or a physician's examination should, as a matter of public and tax policy, be excluded from income. Uncertainty had existed about the tax treatment of LTCi mainly because LTC involves a combination of services. Some services qualify as health care, while others appear more like personal services, such as room and board in an assisted living facility. This uncertainty was resolved for certain types of policies with enactment of Health Insurance Portability and Accountability Act of 1996 (HIPAA). The legislation clarified that qualified LTC costs and benefits generally will be treated the same way as other health costs and benefits. To be tax-qualified, a policy must: * Be guaranteed renewable * Not provide a cash value for any reason other than upon full surrender or death of the insured * Other than at full surrender or death, any dividends or refund may only be used to reduce future premiums or increase future benefits. Generally, policies must not pay for services that would be covered by Medicare, unless Medicare is specified as a secondary payer. If policies and insurers follow the consumer protection standards included in the law, such policies will be considered tax-qualified and receive the following tax treatment: In general, benefits received under a LTC plan are excluded from taxable income. Insurers must report to the IRS the amount of LTC insurance benefits paid out to the recipient. Benefits paid by per diem-based policies to individuals are tax-free up to $380 a day in 2020, and are not taxable income as long as benefit payments above $380 per day do not exceed the actual cost of care for indemnity policies. This amount is indexed for inflation. Out-of-pocket spending for LTC services qualify as medical expense deductions subject to the standard limitation of 7.5% of AGI (adjusted gross income). Expenditures for long-term care insurance premiums that cover the taxpayer, spouse and dependents also qualify as medical deductions to the extent that total medical expenses, including the LTC premium, exceeds 7.5% of AGI. However, there are limits on the premium deduction based on the taxpayer's age. Self-employed individuals who are sole proprietors can deduct 100% of their LTC insurance premiums from their income and there is no 7.5% of AGI requirement. Employer contributions to an employee's LTC premium are excluded from the employee's taxable income. Consequently, the employee cannot take an income tax deduction for the premiums paid. Employers can deduct the premiums paid for LTC coverage for employees as an ordinary and necessary business expense. Long term care coverage cannot be offered as part of an employer's cafeteria plan. Passage of HIPAA has helped to increase interest in LTC insurance through these tax changes. HIPAA also prohibits cash refunds except at death or upon full surrender of the policy. **Exam Tip: Essentially every current LTC insurance policy that is sold is tax-qualified, and many riders on life insurance plans are tax-qualified as well. This offers clients necessary insurance protection and valuable tax benefit. Listen in to reinforce your understanding of the application of tax benefits to tax-qualified LTC benefits and premiums.** Audio * To be tax qualified LTCi - 4 requirements * Tax treatment of the premiums and benefits * LTCi benefits are tax free (generally) * LTCi premium is an eligible medical expense for itemized deduction purposes - premium plus any other medical expenses must exceed 7.5% AGI * Only the portion that exceeds 7.5% that is actually deductible * There is an annual limit per person in how much premium can be included in that calculation

Answer 43

Upon completion of this lesson, you should be able to: * Define life insurance * List the classifications of life insurance * Distinguish between group and individual insurance, and * Differentiate between industrial, ordinary, and credit insurance. **Exam Tip: Life insurance is a multifaceted test topic, offering several different angles for questions on your CFP exam. Listen in for the key life insurance knowledge categories that will serve as the cornerstone to building your understanding as you proceed in your studies**. **Audio: Expect several questions on life insurance. Can be tested in many different applications**: * Life insurance needs analysis * Testing on the structure of various contracts * The living benefits of life insurance * The income tax ramifications * Estate planning of life insurance **Start to categorize it out to the main points in each of the sections**

Answer 44

Credit Insurance is a special type of life insurance. Lending institutions, such as banks and credit unions, or retail stores selling merchandise on credit, offer credit insurance to their customers to cover debtors’ obligations if they die or become disabled. Credit Insurance in Action Example: Herb buys a $20,000 car, taking out a $15,000 loan for 4 years. The dealer offers credit life protection so that if he dies during the loan period, his family doesn’t have to pay the declining loan balance due. The policy is available for a one-time cost of $500, which can easily be financed into his loan. Is this a good deal? Assuming Herb is 35 years old and in good health, for $125 per year over a 4-year period, Herb could purchase a traditional level term life policy for at least $100,000 coverage. Dollar for dollar, the credit life insurance is much more expensive. **Practitioner Advice: Most experts agree that, dollar for dollar, credit life insurance is much more expensive than traditional life insurance. Unfortunately, credit life is packaged and sold at a time when consumers are making expensive purchases and may feel obligated. Companies selling credit life insurance know this, and are offering a limited product at high cost. Generally, it is best to avoid credit life insurance, and build the amount of protection into your overall life insurance need.**

Answer 45

There are three distinct classifications of interest in an insurance policy. * Insured * Owner * Beneficiary The insured is the person whose death causes the insurer to pay the claim. The policy owner is the person who may exercise the rights created by the insurance contract. The owner and the insured can be the same person. Ownership rights in life insurance policies include the right to: * Change ownership of the policy * Assign the policy as security for a loan * Name beneficiaries * Receive dividends * Take out cash surrender value * Borrow against the policy A beneficiary receives the life insurance proceeds when the insured dies. A person, trust, estate or a business may be a beneficiary of a policy. A person cannot be both the insured and a beneficiary, however. A beneficiary is a revocable beneficiary when the owner can change the initial beneficiary selected, but an irrevocable beneficiary cannot be changed. Generally, the revocable beneficiary has no rights in the policy while the insured is alive, while an irrevocable beneficiary has a vested or guaranteed interest in the death benefit. An irrevocable beneficiary can prevent the policy owner from taking any action that would reduce their own interest in the policy, such as borrowing from the policy or assigning the policy as security for a loan. Policy owners should name primary (first) or contingent (second, third, etc.) beneficiaries. A common example of successive beneficiary designations is: “Proceeds to my wife (Mary Smith). If my wife predeceases me, then to my children (Huey, Dewey and Louie Smith) share and share alike. If both my wife and children predecease me, then to the American Red Cross.” If a primary beneficiary is living when the insured dies, the contingent beneficiary has no rights to the death benefit proceeds. Contingent beneficiaries will only have death benefit rights if the primary beneficiary predeceases the insured. **Exam Tip: Listen in for an informative overview of the common exam application of incidents of ownership on life insurance policies**. Audio: * Incidents of ownership on life insurance policies * **For estate planning purposes, if an insured holds any incidence of ownership at the time of death, then the proceeds from the policy will be includable in the gross estate (something to avoid)**.

Answer 46

**Practitioner Advice: As there are numerous types of life insurance policies that exist today, it can be difficult to decide which one to purchase. It helps to remember that there are permanent needs and temporary needs for life insurance coverage. Permanent needs are those that the insured wishes to remain in effect for a majority of his or her life expectancy. Temporary needs tend to expire prior to life expectancy. Term insurance was created to cover temporary needs for specific terms of time; whole Life insurance was created to provide more permanent coverage. Keeping this basic concept in mind helps to avoid using the wrong type of policy for the wrong reasons**. **Exam Tip: Listen in for helpful tips to organize life insurance-related information that will serve as a foundation to build upon as you learn about the varieties of insurance policies.** Audio: * If you don't work with life insurance everyday, it can be confusing and frustrating. * With the types of life insurance, seek first to understand the general similarities and differences between the 4 types of life insurance - term, whole, universal, variable * In their differences, what makes that a benefit to the client?

Answer 47

Renewability is a feature of term life insurance that permits the policy owner to continue, or renew, the policy upon expiration of the term period, for a limited number of additional periods of protection. For example, a 20-year term policy may allow renewal for another 20 years at the end of the initial 20-year period. The premium, although level for a given period, increases with each renewal and is based on the insured’s attained age at renewal time. A scale of guaranteed future premium rates is contained in the contract, providing the insured a sense of security in knowing there is a maximum ceiling to future premiums. Usually the insurance company charges a rate lower than that stated in the policy. The stated maximum premium is there as a safety valve for the insurer, should there be a need to raise rates in the future beyond the current scale. As the premium rate increases with each renewal, mortality experience increasingly reflects adverse selection. Resistance to the higher premiums and lower-cost product opportunities cause many insureds in good health to fail to renew. The majority of those in poor health will renew even in the face of higher premiums. Insurers try to accommodate this problem in their pricing structure, or through other means, such as through altering dividends, by limiting renewability to stipulated maximum ages, or by product designs that encourage, or require, conversion. **The term renewability means simply that the policy can be continued beyond the original maturity date to the stipulated termination age, at a preset renewal rate, should the policy owner choose to pay the premium. Therefore, renewable term policies can be viewed as increasing-premium, level-benefit term life insurance**. **Exam Tip: Listen in to build your understanding of the facts on the renewability of level-premium term life insurance policies that will translate to exam points**. Audio: * Understanding the renewability feature of level-premium term life insurance policy is important * 10, 20, 30 year terms are most common * Premium stays the same until that original expiration * We have to match up that guaranteed period with the client's time table with the need that they have * Ex. Young family, with young children and 30 year mortgage - maybe shouldn't do 10 year term bc their need is much longer than 10 years * At the end of the 10 years, can renew, but will be at a higher premium * On the exam, pay attention to timelines given when asked to recommend a particular product

Answer 48

Premium remains level for set number of years. Initial premium level is higher than that of annual renewable term policy, but tends to be lower on average over the entire term selected. Either allows for another level premium period upon renewal, or reverts to annually renewable premiums to expiration. **Practitioner Advice: Most Term policies sold these days come with a Level Premium that is guaranteed for a set number of years. For example, Joe can buy a 20-year Level Term policy to cover the college education costs for his 5-year-old daughter. David can buy a 30-year Level Term policy to cover his new 30-year mortgage debt.**

Answer 49

All whole life policies involve some prefunding of future mortality costs. The degree of prefunding is a function of the premium payment pattern and period. Because of this prefunding, all whole life policies sold in the United States and some other markets are required to have cash values, which must build to the policy face amount, usually by age 100. **Practitioner Advice: One of the major advantages of any cash value type of life insurance contract is that the cash value grows on a tax-deferred basis. The funds in the savings part of the contract grow every year, and there is no income tax due unless the owner takes out more money than has been paid in.** Whole life cash values are available to the policy owner at any time by the policy owner’s surrendering, or canceling, the policy. Alternatively, cash values can be used in other ways, providing flexibility to the policy owner. Whole life policies usually contain cash-value schedules that show for selected time periods the guaranteed minimum amounts that the policy owner could receive from the company on surrender of the policy. Owners of whole life insurance policies do not have to surrender their policies to have access to funds. Under participating whole life policies in which dividends have purchased paid-up additional insurance, such additions may be surrendered for their attained cash-value with no impact on the policy. Also, policy owners normally can obtain a loan from the insurer for amounts up to that of the policy’s cash value. Of course, interest is charged for this loan, and the loan is deducted from the gross cash value if the policy is surrendered, or from the face amount if the insured dies and a death claim is payable. Policy loans may, but need not, be repaid at any time and are a source of policy flexibility. **Practitioner Advice: Many consumers misunderstand the concept of cash value. It is important to remember that this is not equal to the amount paid into the policy by the insured. Thus, cash values are typically non-existent in the first year of a policy and grow slowly over time to equal the face amount of the policy by age 100. Remember, premiums are not deposits; insurance is not an investment.**

Answer 50

Some life insurance policies represent better purchases than others. Which plan, par or non-par, must a consumer purchase? Cost comparisons must be made intelligently to make the best choice. At this point, the consumer must remember that one comparison is clearly illogical. A consumer cannot make a straight comparison of premium dollars between participating and excess interest life insurance policies. Insurance companies usually provide a dividend illustration to prospective purchasers of participating policies. This illustration shows the proposed insured dividends that would be paid under the policy if the mortality, expense and interest experience implicit in the current scale of illustrated dividends were to be the actual basis for all future dividends. The dividend illustration is usually based on the recent mortality, expense and interest experience of the company. Important differences exist in the way insurers allocate amounts to be paid as dividends, and these differences can have a major impact on the dividend levels illustrated as well as on the dividends that are actually paid. **Practitioner Advice: It is essential for clients to understand that dividends are simply projections, and not guaranteed. While insurance companies do a better job of highlighting the possibility of change, the planner or agent also needs to discuss this with the client.**

Answer 51

Dividends actually paid are, as the name implies, amounts actually paid as dividends. Dividends are not guaranteed, and, therefore, may not equal the dividend illustration. Dividends actually paid equal those illustrated only if their experience basis is the same as that implicit in the illustration. Future experience rarely tracks past experience exactly and never over an extended period. On the other hand, some insurers have “frozen” their dividend scales. They have paid dividends almost exactly as illustrated regardless of the developing experience. **Practitioner Advice: Having a loan against your cash value life insurance policy will probably have an impact on the dividends you receive. Most insurers that pay dividends use a direct recognition scale so that those with loans get lower dividends than those who have no loans from their cash value.**

Answer 52

A widely accepted equitable concept is known as the contribution principle. It holds that insurers selling participating policies must distribute surplus accumulated on behalf of a block of policies in the same proportions as the policies are considered to have contributed to the surplus. Dividends actually paid usually will exceed illustrated dividends in periods when investment returns are generally higher during the period after policy issuance than they were during the period before. Of course, the opposite also applies. Contribution Principle Example: During the high-yielding 1980s in the United States, high dividends were illustrated. The dividends actually paid, however, were less than illustrated, giving rise to disappointment and even lawsuits. **Practitioner Advice: The dividend received by the policyholder is actually a credit for an overpaid premium and is considered by the IRS to be a "return of premium." The dividend received is not taxable income to the insured unless it exceeds the cost basis. For example, if the policyholder’s cost basis is $1,000, any amount received of $1,000 or less is a return of basis and there are no tax consequences. However, if the dividend is $1,025, $1,000 is return of premium/basis and $25 is taxed as ordinary income.**

Answer 53

In 1979, a new type of policy, called universal life insurance, was created in an attempt to meet the interests of those consumers who liked the low cost nature of term insurance and the cash value features of whole life insurance. This new hybrid product was to be more flexible than its predecessors with features that allowed the insured to determine whether it would function more like term or more like a whole life policy. The name universal was used to describe how it could be tailored for many people's different needs. Some even touted universal life as the "last life insurance policy you ever need to buy." Assuming premiums are paid as planned, and based on interest rate performance, funds should typically grow over time. However, due to the flexible nature of the policy, the insured assumes some risk that the fund will actually decline, because of skipped premiums, loans or lower than expected interest rates, creating a future need to pay more premiums to cover the increased cost of insurance. **Practitioner Advice: Universal Life Insurance has more flexibility than Whole Life Insurance. It also carries surrender penalties that insureds would not encounter in Whole Life policies. Make sure that the agent explains all of the advantages and disadvantages of this product.** **Exam Tip: Listen in to learn about distinguishing characteristics associated with Universal Life Insurance Option A & Option B**. Audio: * In original universal life policy structure, there was an Option A death benefit and Option B death benefit * Option A - face amount remains level. If started at $200k, always remained $200k. * Option B - death benefit is the sum of both original face amount and the cash value in the policy at the time of death. $200k face value + $50k cash value = $250k death benefit

Answer 54

During the 1980s, some universal life policies added separate investment accounts from which insured's could choose in addition to the fixed interest rate. This increased the opportunity for the fund to grow, but with greater risk to the insured. The death benefits may vary directly with the insured's investment results. While these new variable universal life policies provide more options, they still operate in a similar capacity to the basic universal policy. **Exam Tip: Listen in for an overview of need-to-know exam-related information on variable life insurance separate accounts for cash value**. Audio: * Variable Life Insurance has separate accounts for the cash value. * Separate accounts look and perform like mutual funds, but called sub-accounts in an insurance product. * These funds are not part of a insurance company's general account. * Fixed income life insurance and annuities, term life, whole life insurance - all supported from the general account of the insured. * In the event of failure of insurance company, the general assets would be subject to creditors, but the funds in sub-accounts are not subject to the creditors.

Answer 55

Endowment policies promise to pay the policy face amount on the death of the insured during a fixed term such as 20 or 30 years, as well as the full face amount at the end of the term if the insured survives the term. This is in contrast to term policies, which provide for the payment of the full policy amount only if the insured dies during the policy term. Though these policies have a maturity date set before expected mortality and thus appear to be a form of temporary coverage, they are actually considered a form of permanent insurance. Policies payable only in the event of death are purchased chiefly for the benefit of others. On the other hand, endowment policies, although affording protection to others against the death of the insured during the fixed term, pay to the insured if he or she survives the endowment period to maturity. **Practitioner Advice: Endowment policies are no longer sold in the U.S. In 1984, Congress passed legislation that included definitions of life insurance. Because endowment policies have premiums that are much higher than required for the death benefit, these policies no longer qualify as life insurance, and as a result, lose the benefit of tax sheltered growth of the cash value.**

Answer 56

* Whole Life Insurance is a policy that provides coverage for the whole of the insured's life. * Whole Life Cash Values are provided by insurers and are available to the policy owner at any time by surrendering the policy. The policy owner can also borrow the cash value while keeping the policy in force. * Participating Whole Life policy owners have the right to share in surplus funds accumulated by the insurers, and the surplus is paid out as dividends. * Non-participating Whole Life policy elements are fixed and make no allowance for future values to differ. Concepts relevant to participating whole life policies include: * Dividend Illustration is provided by insurers to prospective purchasers of participating policies. * Dividends Actually Paid may not equal the dividend illustration. * Dividend History is the schedule of dividends actually paid. * Contribution Principle ensures that policy owners receive the surplus in proportion to their contribution. * Universal Life Policy combines the low cost nature of term and the cash value features of whole life. * Variable Life Policy offers an increased the opportunity for the cash value fund to grow, but with greater investment risk to the insured * Some specialized contracts intended to meet the needs of insureds in particular situations were also reviewed in this section.

Answer 57

The insurer will send the insured a notice of when the premium is due before the due date. If the insured neglects to pay a premium when it is due, the policy does not end immediately. If the insured forgets to pay the premium or decides to end the contract, the grace period provides 31 days to pay the premium without forfeiting any contractual rights and no questions asked. If there is enough cash value in the policy, the premium will be paid, reducing the cash value. If there is not enough cash value to pay the premium, the policy will lapse. The policyholder must pay the premium before the end of the 31 days provided by the grace period to avoid having the policy lapse. However, if the policyholder dies during the grace period, the insurer will pay the proceeds to the beneficiary, minus the overdue premium. Grace Period Example: Assume the policyholder has a stroke and is hospitalized on December 10th, and that the anniversary date of the policy is January 1st with an annual premium of $10,000 on a $450,000 Whole Life policy. If the $10,000 is not paid on January 1st and the policyholder dies on January 18th, the beneficiary of the policy will receive a death benefit of $440,000, as the premium is outstanding less than 31 days (January 1st - January 18th). If the policyholder makes the premium payment in time, the beneficiary will receive the entire $450,000 death benefit. **Exam Tip: Listen in for a quick discussion on the common exam application of the grace period on life insurance policies**. * Make note of key numbers (ex. days to do this or that) * **Grace period provision in a life insurance policy - 31 days to make the premium payment or the policy will lapse**.

Answer 58

After a policy lapses, the insured has an opportunity to reinstate it if specified conditions are met. The opportunity to renew a lapsed policy is called the reinstatement provision. New York has a limit of three years from the date of default in which the owner may reinstate the policy. Furthermore, the insured must not have withdrawn the cash surrender value, but must have chosen a non-forfeiture option that allows the policy to continue. **Practitioner Advice: As previously noted, some states have different regulations that can impact the insured’s rights. For example, the Commonwealth of Massachusetts does not allow for the reinstatement of term life insurance policies. The state has decided that, since term insurance is akin to renting coverage, it does not make sense to pay “back rent” when you know you did not use the policy. Unfortunately, by taking away the consumer’s right to make that decision, the state has created a situation where some people who have become uninsurable cannot buy a new policy. For this reason, it is important that policy owners and professional advisors fully understand existing policy features and options before making any changes**.

Answer 59

Insurance contracts are contracts made in utmost good faith. This means an applicant may not answer questions untruthfully or conceal information an honest person would reveal. If an insured is untruthful or conceals material facts, the insurer may go to court and contest the policy for the purpose of voiding the policy. The incontestable clause states that, if there is a valid contract between the insurer and insured, the insurer may not contest the policy to void it after the policy has been in force for two years during the lifetime of the insured. Thus, a life insurer has only a relatively short period of time in which to uncover any fraud. Generally, after the specified time has elapsed, even if a notorious fraud is uncovered, the insurer cannot void the policy. Overall, the incontestable clause prevents an insurer from avoiding claims payments. It is interesting to note this clause was included voluntarily in the contracts of some life insurers after 1850. The motive behind the inclusion was to establish public confidence. Such a public relations effort was required because a few disreputable life insurers were voiding contracts on the slightest technical grounds. **Exam Tip: Listen in for a quick discussion on the common exam application of the incontestable clause on life insurance policies.** Audio: * Incontestable Clause - highly testable feature of a contract * **Means after policy has been in force for 2 years, if insurance company discovers fraud, the insurance company cannot contest or void the contract**.

Answer 60

As the applicant’s age is a key factor in underwriting and pricing the insurance, a misstatement of age, either intentionally or by mistake, causes rating errors. The misstatement-of-age provision causes the insurer to adjust the face amount of insurance to reflect the insured’s true age, rather than allowing the insurer to void a policy if a misstatement is discovered. There is no time limit on this provision - typically the mistake is not discovered until a death claim is being processed. For example, if the insured, Amy Grafton, reported her age to be three years less than it actually was, the benefits, $100,000, would have to be reduced to $92,000, or whatever amount of insurance the premiums would purchase at the insured’s true age. Misstatement-of-Age Provision Example: Upon her death, Mrs. Smith’s son was reviewing her life insurance policies so that he could submit the claim. While reading one policy, he noticed that the photocopy of the original application indicated his mother had been born in 1905 instead of 1908. For all the years since the policy was purchased, his mother had been paying more than she should have for the policy. She obviously had not reviewed the policy information all these years. Fortunately, upon making his claim and pointing out the error, Mr. Smith received a larger death benefit payment based on the amount his mother had paid and her correct age. **Exam Tip: Listen in for a quick discussion on the common exam application of the misstatement-of-age provision on life insurance policies. If the applicant (intentionally or unintentionally) mis-states their age on the application, the insurance company may adjust the death benefit accordingly to what would've been purchased at the time of application, based on the correct age. They won't void the contract. But allowed to adjust the death benefit to the proper age**.

Answer 61

The suicide clause is commonly included in the life insurance contract and allows a life insurer to exclude payment for death by suicide if the suicide occurs within two years from the policy issue date. The purpose of the suicide clause is to control the moral hazard of a person purchasing a policy in contemplation of committing suicide. Note: Many insurance companies have a one-year restriction that is more favorable to the policyholder and permissible under law. The policy will pay for death caused by other illnesses, including mental illness. If, during the underwriting process, there is a history of mental illness that causes the insurer to be concerned about possible suicide, the policy will not be issued. Therefore, after the two-year restriction, the company will pay for suicide deaths because the suicide presumably has been caused by mental illness that occurred after the policy’s inception. Where there is no history of mental illness and the applicant is contemplating suicide, it is improbable that a suicidal person could wait two years to complete the act. Insurers often have a difficult time establishing that the insured’s death resulted from suicide. In one case, within two years of the policy’s effective date, an insured took between 30 and 40 sleeping pills, pulled the phone out of the wall and subsequently died. The autopsy and death certificates each listed suicide as the cause of death. Moreover, this was the second occasion within three months in which the insured had taken an overdose of sleeping pills. Nevertheless, the jury was instructed that the presumption is against suicide in all cases, and that suicide may be assumed only when no other conclusion could reasonably be drawn. As the jury thought it was possible the insured’s death may have been caused by the motive of “self-indulgence,” the insurer had to pay the claim. **Practitioner Advice: If the policyholder commits suicide within the two years of issuance, the insurance company will pay the policyholder’s estate all premiums paid without interest.**

Answer 62

Participating life insurance policies pay dividends to the policy owner. Owners may exercise a choice as to what form the dividends take. There are five potential dividend payout options. Dividends on participating life insurance policies may be: * taken in cash. * used to pay a portion of the next premium. * left to accumulate interest. * used to purchase single-premium, paid-up insurance. * used to purchase one-year term insurance (fifth dividend option). Example (Dividend Payout Options) A $50 dividend may purchase $123 of paid-up whole life insurance at age 40. At the insured’s death, the beneficiary receives the sum of the paid-up additions, plus the face amount of the policy. Even if the insured has become uninsurable, the owner still may acquire more life insurance using this dividend option. If the insured decides at a later date that he or she would like to take some of his or her accumulated dividends in cash, he or she can redeem some of the paid-up additions for the original cash dividend amount. Since this option provides a good benefit for beneficiaries upon death while still allowing access to the cash during life, most insurers use the paid-up additions as the default option. Some companies allow the purchase of a combination of term and paid-up whole life with dividends. Using dividend options allows insureds to increase coverage without incurring acquisition costs and without having to provide evidence of insurability. Thus, dividend options create flexibility in a consumer’s life insurance plan. **Practitioner Advice: Because dividends are small, particularly in the beginning of the contract, it's best to select the paid up additions options. This allows the dividend to be used to increase the cash value in the contract, as well as the death benefit. Some clients think of it as a way to have their death benefit keep up with inflation.**

Answer 63

Life insurance policies with cash surrender values have a loan provision. This provision gives the policy owner the ability to take a loan from the cash value of the policy. The company generally has the right to delay making the loan for up to six months. The interest rate charged for the loan is stated in the policy. Unless the policy provides for variable rates, it remains unchanged, even though general interest rates fluctuate. Interest rates typically range from 6% to 8%. Since 1980, life insurers typically have used variable rates that change with general interest rates. The policyholder loan is secured by the cash surrender value of the life insurance policy. There is no legal requirement for the insured to repay the loan. If the loan is outstanding when the insured dies, however, the insurer deducts the amount of the loan from the insurance proceeds. Taking a loan against a life insurance policy is one alternative to surrendering the policy for its cash value. Taking a loan leaves the policy and some of the life insurance protection in force. **Practitioner Advice: Policy loans are easy to get, do not show up on an insured's credit report, and do not have to be paid back. The disadvantages are that a loan will lower the projection of accumulated cash at retirement, and in most cases, will cause a lower dividend to be paid.**

Answer 64

The fixed-amount option provides the beneficiary with regular, fixed-income payments. Interest income is earned on balances remaining with the insurer. Federal income tax applies to the interest portion of these payments. The payments continue until the death proceeds and the interest thereon is exhausted. This option is a logical choice when people need income for a limited period, such as while social security benefits are unavailable or for an education fund. Using this option, the beneficiary can receive an insurance payment before each tuition bill. **Practitioner Advice: The fixed-amount option is useful for a client who wants to know she will get a certain needed amount, for example, a monthly check to cover her mortgage payment.**

Answer 65

Under the interest-only option, the proceeds are left with the insurance company. The insurer pays the first beneficiary, such as a widow, regular payments composed entirely of interest earnings. The beneficiary can request the full payment of principal at any time. It can be set up so that at the first beneficiary's death, the insurer pays the death proceeds to a second beneficiary, such as a child. The interest-only arrangement can be useful, for example, if the beneficiary has substantial investment, wage or social security income. **Practitioner Advice: The money received in this option is fully income taxable, as it is considered interest only, not a return of principal.**

Answer 66

The life-income option guarantees, for a lifetime, a series of regular payments to the beneficiary. This is the annuity option. The insurer only makes payments under this option if the beneficiary is alive. Assume that Mrs. Johann S. Bach receives the proceeds of a $400,000 policy under the life-income option. Assume she lives only three years beyond Johann. She received only $75,000 of benefits. The remainder of the money she did not receive is pooled to pay benefits to other annuitants. Despite the potential for losing some of the death proceeds, the life-income settlement option is often quite practical. A beneficiary’s need for income ceases when the beneficiary dies. In some cases, there may be no dependent beneficiaries other than a surviving spouse. The life-income option can provide a sure source of income because the payments are guaranteed for life. As the payments include a portion of principal, they will significantly exceed interest-only payments at later ages. The payments will be partly income taxable, with the return of principal portion being excluded form income. This settlement option makes good sense if the surviving spouse is inexperienced in investing money. It is also useful if the surviving spouse has an unscrupulous relative or friend who may talk the beneficiary out of the money if a large lump sum of cash were paid. **Practitioner Advice: There are also refund options available. The client will receive lower monthly payments, but any remainder will be paid to a named beneficiary, instead of being kept by the insurance company.**

Answer 67

Death proceeds are the policy face amount and any additional insurance amounts paid by reason of the insured’s death, less any loans taken against the policy and past due premiums during the grace period. When the beneficiary receives the death proceeds of a life insurance policy, generally no federal income tax applies to this amount. This is reasonable because premium payments for individually purchased life insurance are not deductible from a person’s federal income tax. Generally the only time a death benefit may be taxed deals with business life insurance. Often when a business owns a policy on the life of an employee, it will deduct the premiums paid as a cost of business. Since a tax advantage is taken up-front, the death benefit becomes taxable to the beneficiary upon receipt. If the beneficiary does not take the proceeds as a lump sum of cash, and instead takes a series of payments that includes interest earnings, there is federal income tax on the interest portion. **Practitioner Advice: Why does life insurance receive special tax treatment? Most clients are not aware of why this occurs. The federal government uses tax laws and regulations not only to influence the economy, but also to encourage certain behavior that is good for society. If families provide for themselves, fewer people will end up being dependent on social welfare programs. This alleviates pressures on the government. So, by providing tax incentives, the government hopes people will buy life insurance to support their survivors**.

Answer 68

If a business were to lose a key person, its earning power could be harmed, perhaps seriously. Key employee life insurance can protect business firms from financial problems caused by such losses. After identifying and measuring the potential loss, the business purchases a life insurance policy on the key employee's life. The business is the owner and the beneficiary of the policy, and the key employee is the insured. The business pays the premiums. The key person must be insurable and must give permission for the purchase for this arrangement to work. Key Employee Life Insurance: Risk Management Process * Identify. Key persons in the company must be identified. * Measure. The financial loss that would be caused by the key person’s death is measured. * Estimate. The effect on profits while a replacement is hired and trained is estimated. * Permission. The key person must give permission for the purchase of insurance. * Purchase. The business purchases life insurance for the value measured. * Premiums. Premiums are paid by the business. **Exam Tip: Listen in for an overivew of key employee life insurance characteristics**. Audio: * Key Points to know about key employee life insurance * Policy is on the life of the employee, but the benefits will be paid to the employers (to protect them). Money does not go the employee's family or estate. * Insurable interest need only exist at the beginning of the policy. * Ex. If employee leaves, ok for company to pay premiums, and ultimately collect death benefit when employee dies.

Answer 69

There are many different types of annuities which are based on how they are purchased, the types of benefits received, when benefits begin, and the number of annuitants in the contract. The method of payment can determine the type of annuity purchased. One method is to purchase annuities through serial payments. A level-premium deferred annuity is a series of fixed payments that will be made for a period of time before annuity payments actually begin. A flexible-premium deferred annuity is purchased by unequal payments over a fixed period of time, before annuity payments begin. This method of payment allows for smaller payments to be made by the annuitant, which are within minimum contribution limits set by the insurer. The annuitant often pays an expense charge for the administrative costs associated with this contract, which is a front-end load charge. There are also single premium annuities that are paid in full by one payment. An example is a single-premium immediate annuity, whereby a person will pay for the annuity with one payment at the time they want annuity payments to begin. Another example is a single-premium deferred annuity, which means that one payment is made before annuity payments are scheduled to begin. With a single-premium deferred annuity the deposit earns interest at a minimum guaranteed rate determined annually, which grows tax-deferred in the account. If the account has generated interest that exceeds the minimum guaranteed rate, the excess interest is credited to the account. This excess earnings provision applies to flexible-premium deferred annuities as well. Annuities can be purchased based on the minimum payments an annuitant wishes to receive. An annuity, five years certain guarantees that the annuity will be paid out for five years. If the annuitant dies before the five year period, their successor beneficiary will continue to receive the remaining payments. A period-certain life-income annuity is generally limited to a 20 year payout period, and payments are reduced for longer contract periods. With a cash refund annuity if the annuitant dies before receiving payments equal to the amount of premiums paid, the difference is paid as a refund to the beneficiary. An installment-refund annuity is similar to a cash refund annuity, but payments are made to the beneficiary over time equal to the amount of premiums the annuitant contributed. There are three types of annuities that provide different benefits and allow cash to be invested in various fashions: * Fixed Annuity: This contract provides a guaranteed rate of interest to the assets. The rate can be flexible or can be locked in for certain periods of time. * Variable Annuity: This contract provides a variety of separate accounts which allow assets to be invested in securities such as stocks, bonds, money market accounts, etc. The account owner can transfer assets between accounts. Variable annuities usually contain a fixed account which provides a guaranteed interest rate account. Variable annuities usually provide a death benefit. If death occurs during the accumulation period, the beneficiary may be guaranteed to receive the greater of the account value or the amount invested. * Index Annuity: This contract provides a return on the assets invested that is tied to a market index, typically the S&P 500 Index. There is often a participation rate and cap on these contracts. For example, the contract will pay interest equal to 65% of whatever the S&P 500 Index achieves over a certain time frame. However, the S&P 500 Index return may be capped at, say, 10%. Also, there may be a feature that has a floor. For example, if the S&P Index is less than 2% in a given year, the annuity will pay 2%. When a cap and floor is added to the contract, a collar is created. With the facts present above, a range of 2% - 10% is achieved regardless of how the S&P 500 Index performs for the year. **Exam Tip: Listen in for need-to-know descriptions of annuity payout options and their potential testing applications**. Audio: * Payout features of an annuity - ranges from life only (pays highest amount, but stops when annuitant dies, even if lump sum used to purchase has not been recovered. So riskiest) * 5 year certain annuity - annuity will pay original annuitant for life, but if they die, will pay beneficiary * Period certain life income annuity - defining a period of time, but if annuitant die, beneficiary will continue to be paid * Cash refund - at the time of the death of the annuitant, if original lump sum amount has not been recovered, balance will be paid to beneficiary * Installment refund annuity - same concept - if original purchase not recovered, will continue to pay installments to beneficiary (instead of lump sum)

Answer 70

The primary purpose of annuities is to convert assets into a stream of income that cannot be outlived. They provide tax-sheltered accumulation of assets which can help reduce income taxes during the accumulation period. Additionally, the tax sheltering of assets helps the owner avoid reaching certain income limits, which could trigger adverse conditions, such as taxation of Social Security benefits and phase-out of tax credits and/or deductions. **Practitioner Advice: Imagine a retiree collecting Social Security. They have assets invested primarily in Certificates of Deposit. The interest from the CD’s is simply reinvested rather than spent. That interest is factored into income to determine if the retiree will pay income taxes on their Social Security benefit. By transferring assets from CD’s to a fixed annuity, the reinvested income becomes tax-sheltered and no longer counts towards income for that purpose. This could possibly save Social Security benefits from being taxed.**

Answer 71

During the accumulation phase, the assets invested in an annuity contract grow tax-deferred. When distributions are withdrawn, and if they do not represent a contract that has been annuitized, the date of the insurance contract will determine whether first-in-first-out (FIFO) or last-in-first-out (LIFO) tax treatment will be utilized: * FIFO Method: Pre-August 14, 1982, for distributions. * LIFO Method: Post-August 13, 1982, for distributions. When the contract owner receives a distribution, the date that the original annuity was purchased will determine the appropriate accounting treatment used to calculate ordinary income, if any. Then, unless the owner of the contract is older than 59-1/2, has suffered a disability, or has died, the taxable portion will be subject to a 10% penalty. Annuity Distribution with FIFO Treatment Example: Assume a contract was purchased on 1/15/79 for $5,000 and the account is currently worth $75,000. If a 55-year-old takes a $3,000 distribution, the amount is a tax-free return of basis and not subject to a 10% penalty since it is a pre August 14, 1982, annuity and FIFO accounting is used. The remaining basis is now $2,000 ($5,000 original purchase price - $3,000 distribution). Annuity Distribution with LIFO Treatment Example: Assume the same facts as above except the contract purchase date is 1/15/89. The $3,000 is now taxed as ordinary income and a 10% penalty applies because the owner is age 55 and the disability exception is not applicable. The basis is still $5,000, as LIFO tax treatment was used. Understanding the tax basis of distribution is extremely important when a policyholder wants to annuitize an annuity contract. The net tax basis before the contract is annuitized is used to determine the amount of each annuity payment that is a tax-free return of basis calculated in the exclusion ratio. This net tax basis is the numerator of the formula given below. Continuing with our example, if the FIFO contract is annuitized, the numerator in the exclusion ratio is $2,000; otherwise, it is $5,000, based on the LIFO contract. **Exclusion Ratio: (Basis in Contract ÷ Expected Total Payments) x Annuity Payment Amount = Return of Basis**. Note: If the contract is a deferred annuity with no post-tax basis (e.g., tax-deductible IRA contributions), then the exclusion ratio is zero, because all distributions are taxed as ordinary income.) **Exam Tip: CFP Board frequently tests the tax treatment of annuty withdrawals and post-annuitization distributions. When presented with a question on annuitization distributions and asked to identify the correct taxation, remember that the exclusion ratio formula will provide you with the tax-free portion of the payment. To find the taxable portion, subtract the excluded amount from the entire payment.** Audio: * Annuity Exclusion Ratio: (Basis in Contract ÷ Expected Total Payments) x Annuity Payment Amount = Return of Basis. * We're talking about non-qualified tax-deferred annuities or non-qualified immediate annuities. * Lump sum is exchanged for payments over a specified period of time or over a lifetime. * Each payment will be a return of basis (tax free). * Life expectancy factor - would have to turn to a government table for a factor * Total investment divided by total payments - that amount is received tax free.

Answer 72

An absolute assignment is the complete transfer, by the existing policy owner of all of his or her rights in the policy to another person. In other words, it is a change of ownership. In the case of a gift, the assignment is a voluntary property transfer involving no monetary consideration. Gifts of life insurance policies are frequently made among family members, for both personal and tax-related reasons. Sometimes a life insurance policy is sold for a valuable consideration. This is known as a transfer-for-value. A life insurance policy that is sold or exchanged for valuable consideration may cause the death benefit to be taxed in certain situations. Under the transfer-for-value rule the death benefit amount that exceeds the new policy owner-beneficiary’s adjusted basis is subject to income tax at ordinary income rates when the insured dies. The transfer-for-value rule cannot be avoided by cancelling the transaction at a later time. There are exceptions to the transfer-for-value rule which will not cause the death benefit to be subject to income taxes at the insured’s death. This occurs when the insurance policy is transferred to the following individuals or entities. * The insured * The insured’s business partner in a partnership * The transferor’s spouse incident to a divorce * A new owner who takes the transferor’s basis in the contract * To a partnership in which the insured is a partner * To a corporation in which the insured is a shareholder or officer As with a gift, these transactions are accomplished through an absolute assignment of policy rights, typically by using an absolute assignment form furnished by the insurer. One of the most common circumstances in which absolute assignments are used is with viatical settlements. An irrevocable beneficiary must consent to an assignment of the policy, as he or she is, in effect, a joint owner. Of course, a revocable beneficiary has no rights respecting the transfer. The question arises, however, whether an absolute assignment, by itself, changes the beneficiary. Many courts have held that they do, whereas other courts have held the opposite. The new owner, of course, can change the beneficiary by following the customary procedures. **Exam Tip: Listen in for need-to-know information on transfer-for-value rules, exceptions, and common testing applications**. Audio: * Couple of good questions here * Transfer for value will change the tax treatment of the death benefit to the owner after the transfer for value * Normally, life insurance proceeds received tax free * But with transfer for value, excess death benefit over new owner's basis will be taxable at ordinary income at the death of the insured Exceptions to transfer for value rule: * Transfer to insured * Transfer to insured's partner in a partnership * Transfer to an insured spouse in a divorce setting * Transfer to a new owner who takes the transfer's basis in the contract (which could happen in a corporate reorganization) * Transfer to a partnership in which insured is a partner * Transfer to a corporation to which the insured is a shareholder or office **Not an exception - transfer to a fellow shareholder of a corporation**

Answer 73

A collateral assignment is a temporary transfer of only some policy ownership rights to another person. Collateral assignments are ordinarily used in connection with loans from banks or other lending institutions and persons. They are partial, meaning only some policy rights are transferred, in contrast to absolute assignments where all policy rights are transferred. They are temporary, in that the transferred partial rights revert to the policyowner upon debt repayment. The vast majority of life insurance policy collateral assignments in the United States use the insurance company's specific form or American Bankers Association (ABA) Collateral Assignment Form No. 10. The form attempts to provide adequate protection to the lender and, at the same time, permits the policyowner to retain certain rights under the policy. Thus, the assignee, for example, the lending institution, obtains the right to: Collect the proceeds at maturity/death Surrender the policy pursuant to its terms * Obtain policy loans * Receive dividends, and * Exercise and receive benefits of nonforfeiture rights. On the other hand, the policyowner retains the right to: * Collect any disability benefits * Change the beneficiary, subject to the assignment, and * Elect optional modes of settlement, subject to the assignment. Under the form, the assignee agrees: * To pay to the beneficiary any proceeds in excess of the policyowner’s debt * Not to surrender or obtain a loan from the insurance company, except for paying premiums, unless there is default on the debt or premium payments, and then not until 20 days after notification to the policyowner, and * To forward the policy to the insurer for endorsement of any change of beneficiary or election of settlement option. Note: If Mrs. Dean’s policy had as much cash value as she needed to borrow, she could have taken a policy loan directly from the insurance company, thus avoiding the scrutiny of a traditional bank loan. Such policy loans are faster to process, require no application or approval, and have extremely flexible repayment options. **Exam Tip: Listen in for an insightful discussion on collateral assignment and an overview of key facts to commit to memory**. Audio: * Absolute assignment - total and complete transfer of ownership of a policy to another party * **Collateral assignment - partial and temporary assignment (not permanent like the absolute assignment; does not change ownership, but it assigns some rights in the policy as collateral**. * Typically to a lender as a collateral for a loan. * Should the borrower default on the loan, lender could invade the policy, either cash value or received benefit (death benefit to repay the loan)

Answer 74

A viatical settlement firm is a specialized company, or group of investors, that purchases life insurance policies from terminally ill individuals for lump sum cash payment. It is a private enterprise and not considered an insurance company. Individuals, agents and financial planners typically bring potential sellers to the viatical settlement firm. In a viatical settlement transaction, people with chronic or terminal illnesses assign their life insurance policies to viatical settlement companies in exchange for a percentage of the policy's face value. The viatical settlement firm, in turn, may sell the policy to a third-party investor. The viatical settlement firm or the investor becomes the beneficiary to the policy. They pay the premiums and collect the face value of the policy after the original policyholder dies. **Practitioner Advice: Many people view viatical companies in a negative light. They are seen as investors looking for a quick profit rather than altruistic companies looking to help the terminally ill. The investors are happiest when the insured dies sooner rather than later, as they collect their profits faster. This view is legitimate based on the nature of how viaticals work. However, recent legislation has reduced the amount of fraud and deception that previously existed. Advisors should help the terminally ill to explore the accelerated death benefit (living benefit) options within their life policies before resorting to viaticals. Such policy options tend to provide a much larger payment (usually 90-95% of the death benefit) than would be received from a viatical company. Viaticals should be viewed as a last resort financial solution.**

Answer 75

Many insurers offer some type of terminal illness coverage that pays an amount, if the insured is diagnosed as having a terminal illness. This amount is a specified maximum percentage, typically 25% to 50%, of the life insurance policy’s face amount. Some companies will permit acceleration of the full policy face amount. Most provisions require that the insured have a maximum of either six months or one year to live. The insurer requires satisfactory evidence that the insured suffers from a terminal illness. Many companies have no explicit charge for the coverage because they believe that they can absorb the costs of prepaying a portion of what would be a certain death claim anyway. However, some companies assess an administrative expense charge, for example, up to $200, for processing the request and may reduce the amount payable to reflect lost interest. The benefit may be included in any type of policy. **Practitioner Advice: Since accelerated death benefit / terminal illness payout options vary among insurers, this is another reason why it is important for professional advisors to help consumers to select top-quality insurers. Most of the large, top-rated companies offer the highest payout percentages. It is important to research companies’ financial strength and policy provisions such as living benefit payout options.**

Answer 76

Insurers typically provide for a maximum total living benefit payout, irrespective the policy’s face amount. Also, they usually stipulate a minimum proportion that may be accelerated. Maximum Living Benefit Payout Example: An insurer may specify a maximum percentage such as 25% or an amount such as $25,000. A concern of many companies is that an unlimited benefit amount may create moral hazard in the form of more fraudulent claims. It is not unusual for the insurer to secure a release from all interested parties such as the beneficiary and the assignee, and not just the policyowner, to avoid any future misunderstanding. The decision to exercise the right to accelerate a policy’s payments will affect other policy benefits and values. Remaining death benefits, premiums, cash values and dividends are reduced proportionately. Thus, if a policyowner applies to accelerate 50 percent of the policy’s face amount and if the insurer finds that the insured meets the conditions for acceleration, future premiums, cash values, death benefits and dividends will be reduced by one-half. **Practitioner Advice: The Accelerated Death Benefit feature does not cost anything up front. While it is less confusing to request the benefit at the time of application, most insurers allow the feature to be added at any time. Only if the insured qualifies and decides to use the feature would there be a cost (represented as a percentage of the death benefit-typically between 5 and 10%). During any policy review, advisors should be sure to inform clients of this option.**

Answer 77

Terminal illness and catastrophic illness coverages provide that policy death benefits are reduced on a one-for-one payout basis. Cash values are reduced on either a one-for-one basis or in proportion to the death benefit reduction. According to the NAIC Accelerated Benefits Guideline for Life Insurance, prospective buyers of these coverages must be given numerical illustrations. These reflect the effects of an accelerated payout on the policy’s death benefit, cash values, premium and policy loans. Additionally, consumers must receive a brief description of the accelerated benefits and definitions of the conditions or occurrences triggering payment. Any separate, identifiable premium charge must be disclosed. The NAIC and others have been concerned that such benefits, especially the catastrophic illness coverage, could be “oversold.” In the 1960s and before, certain dread disease policies with limited coverage, fell into regulatory disfavor because of fear-based selling tactics and numerous claim disputes. Allegations of so-called post claim underwriting were widespread. Clearly, a weakness of these earlier policies and of this latest variation is that other illnesses can be equally devastating, yet no benefit is provided for them. The importance of an adequate health insurance program is underscored. **Practitioner Advice: When advising clients on financing options for long term care or terminal illness, it's important to consider all strategies, including newer options like Life Settlement Companies.**

Answer 78

The question to be asked is will anyone suffer financially from the stopped income? If no one needs the money to support them, then there is not a financial loss. The **Human Life Value formula** is based on the person's income-earning ability. Human life value is the present value of income lost as a result of the person's death. The question is, how much money is needed for investment now, in order to provide replacement income for a set number of years? This approach is still the most popular method of measuring the economic value of human life in situations like wrongful death lawsuits. This method is not an accurate way to estimate how much life insurance is needed because it does not take into consideration other resources. In some cases, part of the income may be replaced from other sources such as life insurance, group life, and social security survivor benefits. When interest rates are higher, it appears that less capital is needed to be invested. This approach also does not take into account whether there is anyone who needs to have the income replaced. The **Needs Analysis Approach** looks at how that income was being used, instead of simply replacing lost income. There are three steps to this analysis. * Identify the needs that would arise or continue following the death of the individual – death expenses, mortgage payoff, readjustment period, income for dependents. * Total the resources that would be available such as life insurance, employer-provided benefits, Social Security survivor benefits, savings, retirement plans. * Measure the difference between the needs and the resources available. The resulting shortfall is the insurance need. Note: For thorough examples of both the Human Life Value and Needs Approaches please see our Calculator Keystrokes reference page. **Exam Tip: Listen in to distinguish between the Human Life Value and Needs Analysis Approaches**. * Audio: * Life insurance needs analysis questions - can be rather long calculations. **More likely tested from a conceptual standpoint, but study the keystrokes for both approaches.** * **Human Life Value approach - focused on replacing the decedent's income; quick calculation, few variables. What percentage of income would be needed?** * **Needs Analysis Approach is quite detailed. Rather than just replacing income, it's looking at the expenses and financial goals of the family - resulting in an amount of insurance that can deliver the income to pay for all the line item things that were laid out.**

Answer 79

Assets normally are considered either liquid or illiquid. Liquid assets are those assets available to be liquidated with reasonable price certainty. These would be available to meet income or other monetary needs on an individual's death, loss of health or incapacity. They include stocks, bonds, money market and savings accounts, mutual funds and amounts available in pension, profit sharing or individual retirement accounts. Illiquid assets are those assets not available to meet income or other monetary needs because they are not easily liquidated. They include the family's house, automobiles, and personal possessions such as clothing, jewelry and household goods. These assets are usually passed intact to heirs or kept for personal use. **Practitioner Advice: Using a more conservative approach, you would not count Retirement Plan funds as usable assets, but rather leave them in place for the surviving spouse. This is less of a consideration if the surviving spouse is close to retirement age. Traditional pensions, funded solely by the employer's money, may not be accessible until retirement.**

Answer 80

Identifying an individual’s liabilities is an important part of the information gathering process. A review of an individual's liabilities shows which ones are to be paid at death and which ones should be transferred to heirs. Most liabilities are paid at death. However, some may be assumable by others (such as, some mortgage loans), or they may be in more than one person's name. If the home mortgage loan is to be paid, its outstanding balance is included. If it is not to be paid off at death or at incapacity, it is excluded. However, mortgage loan payments would be included as an ongoing income need. **Practitioner Advice: In addition to existing liabilities at the time of incapacity or death, planning must include those liabilities that are created by the incapacity or death. For example, costs not covered by medical insurance and/or final expenses such as funeral, probate and estate liabilities need to be considered. Individuals who do not seek professional advice with this process often tend to miss some of these variables when identifying their needs.**

Answer 81

Cash objectives require a single-sum cash amount to fulfill. They are the easiest to estimate. These objectives arise from the need or desire to pay outstanding liabilities such as auto and personal loans, credit card balances, payment of an outstanding mortgage loan balance and incurred income tax liabilities. Cash needs also might arise from a desire to establish or augment an educational fund. Final and medical expenses also fall into this category. **Practitioner Advice: It is important for clients to understand that cash need figures are being allocated for those specific needs. Thus, any resources earmarked to cover those specific funding needs will not be available for future income needs. Often clients will attempt to include these cash amounts when determining available resources for on-going income needs. For example, $250,000 of life insurance proceeds designated to fund a surviving child’s education should not be viewed as available funds to replace daily income needs.**

Answer 82

The capital liquidation approach assumes that both principal (capital) and interest are liquidated over the relevant time period to provide the desired income. This approach requires a smaller capital sum to provide a given income level than the retention approach. When the need for income is for the entire life of the survivor(s), the capital liquidation method can be approached in one of two ways: The future desired lifetime income could be funded through the purchase of a life annuity. The capital liquidation method could provide for the complete liquidation of principal and interest between the present and the maximum age to which the income recipient is likely to live. The critical decision variable in the second approach is the maximum age. If the life expectancy age is set too low, the income recipient may outlive the income. The higher the age, the higher the principal sum required to fund the income. The life annuity will generate a higher income than the other liquidation approach (assuming a long life expectancy), all other things being the same. Moreover, with the life annuity, the income recipient cannot outlive the income. **Practitioner Advice: The life annuity concept demonstrates why annuities should be considered as part of every person’s retirement plan. Bank accounts, CDs, and mutual funds that are being tapped for income do not provide a guaranteed life income. As a hedge against superannuation (outliving one’s money), an annuity can be a safe complement to a retirement portfolio.**

Answer 83

The capital retention approach assumes that the desired income is provided from investment earnings on the principal, and no part of the desired income is from the capital. In other words, the capital is retained undiminished, even after death. This approach permits a capital sum to be passed on to the family's next generation (or to whomever is designated). It is considered more conservative, because in an emergency, the principal itself can be accessed. The decision to follow the capital retention or one of the capital liquidation methods is not an all-or-nothing proposition. As each option does not have to pay out all capital or retain all capital, there is a continuum between the two extremes. **Practitioner Advice: The retention approach is both more conservative and more flexible. Having the principal available (rather than being distributed) means keeping more resources on hand for increasing inflation, unexpected medical costs or declining rates of return on investments.**

Answer 84

After completing this lesson, you should be able to: * Discuss the types of health insurance policies, * Discuss long-term care coverage, and * Explain the various benefit arrangements. **Exam Tip: The basic features of insurance coverage are discussed in this exam tip audio**. Audio: * This section touches on the major categories of insurance that typically make up a client's insurance portfolio * Can be tested on exam - given as a narrative or case study. * Question could be what are the vulnerabilities * Keen on knowing what these major categories are * What would you recommend at this time?

Answer 85

The benefit provisions in LTC policies set forth what will be payable by the insurer if an insured event occurs. These relate to the types and levels of care for which benefits will be provided, any prerequisites for benefit eligibility, and the actual level of benefits payable. No policy covers all LTC expenses. The policies offered by many companies provide: * A choice of elimination (waiting) periods (0 to 365 days) before benefits. * A schedule of maximum daily benefits and length of benefit periods. The schedule of the benefit periods offered might range from two to five years. Very few insurers offer a lifetime benefit period, which is an expensive option. * A maximum lifetime approach to defined benefit payments. Thus, if the benefit amount is $250 per day and the benefit period four years, the maximum lifetime payout would be $250 times 365 days times 4 years, for a total of $365,000. This $365,000 pool of money can be used for covered services in whatever way desired, subject to the daily maximum. * Some companies pay a set amount monthly, as with disability income insurance. Thus, the policy may agree to pay $5,000 per month or a per day amount such as $265 regardless of actual charges. * Community-based care can be less expensive than nursing home care (if they need less than 24-hour care). The maximum daily benefit is often 50 percent of the maximum daily benefit for nursing home care. The length of the benefit period is often the same for both coverages, but some policies require a different waiting period. **Practitioner Advice: Policies can now be designed with 100% of the daily benefit for community-based care. This is more appealing to clients, and easier for them to understand and remember (e.g. $200 a day, no matter where the care is given).**

Answer 86

All LTCi policies contain some exclusions and limitations of coverage. Common exclusions include war, self-inflicted injuries, and chemical or alcohol dependency. Policies also exclude coverage for mental illness not organically based. Virtually all LTCi policies now cover conditions like senile dementia, Alzheimer's disease, Parkinson's disease, and all other mental illnesses that can be demonstrated to be as organically based. Most LTCi policies restrict coverage of preexisting conditions - sicknesses that started, or injuries that occurred, prior to the issuance of the policy. The most common pre-existing condition restriction is for six months (some policies use 12 or 24 months), although a few policies have no preexisting condition exclusions. **Practitioner Advice: When determining LTCi need, one must consider: Family history (What is typical life expectancy and how is health in later years?) Availability / ability of loved ones to provide care (Are there younger generations available nearby? Are they willing / able to provide care?) A number of adult children express the emotional strain and sadness felt from bathing a parent, especially of the opposite gender. Also, there is the guilt of placing a parent in a home. But what about the strain on the adult child’s personal life when a parent has to be cared for at home? Financial ability to pay for LTC out-of-pocket. (Is an LTCi policy needed? Is Medicaid an option?) Desire for options in care. (Qualifying for Medicaid may sound like a cheap way out, but limitation of choice can create a terrible strain on the individual and family members.) The elderly person’s sense of independence and dignity. (How does the parent feel about their children having to care for him/her?) These are only some of the issues to be considered. Due to the numerous psychological aspects of LTC planning, this area of risk management and insurance planning is often neglected.**

Answer 87

There are three basic components that establish the premium and define the payment of benefits under disability income policies: * The elimination period * The benefit period * The monthly indemnity amount **Practitioner Advice: Disability protection is perhaps the most overlooked of all needs. Most people assume they have some form of coverage through their employer or the government. Unfortunately, the qualification requirements for Social Security benefits for disability are very strict, with approximately 70% of all first-time applicants being denied. Additionally, only about 30% of the workforce is covered by some form of sick pay / salary-continuation program. The vast majority of this coverage is short-term (less than a year of coverage). Ignorance of what coverage really exists as well as denial that a disability may happen to them (it impacts approximately 1 in 3 people during their working years), causes most people to avoid doing a true assessment of this need.**

Answer 88

The elimination period is also called a waiting period and refers to the number of days at the start of disability during which no benefits are paid. It is a limitation on benefits, somewhat like a deductible in medical expense and property insurance policies. It is meant to exclude the inconsequential illness or injury that disables the insured for only a few days and that is more economically met from personal funds. Elimination periods range from 30 days to one year, with three months being a common elimination period. Premiums are lower for policies with longer elimination periods. The major insurers allow for a temporary break in the elimination period. Thus, the insured is not penalized for any brief attempt to return to work before the elimination period has expired at the start of disability. **Practitioner Advice: The 90-day elimination period is the most popular and the most economical. Clients need to realize that since disability benefits are paid monthly, they won't receive their first check until after they have been out of work for 120 days. The financial planner can help minimize this shortfall by having the client keep 3 – 6 months of liquid assets in an emergency fund.**

Answer 89

The maximum amount the insured could collect is the sum of all the coverages. That is, if a property loss is total, an insured theoretically could collect the total amount of Section 1, Coverages A through D. If a liability loss occurred in addition to a property loss, the Section 2 coverages, E and F, would add to the amount the insured could collect under the policy. The homeowners package provides divided coverage. Each coverage (A through F) is treated separately. Dollars may not be transferred among the various coverages. **Practitioner Advice: When considering the need for homeowners insurance, a few things come into play. If there is a mortgage, the lender will require a guarantee that there is enough coverage to protect the amount of the loan. Beyond that, the homeowner should consider**: * Fire exposure * Safety of neighborhood * Exposure to liability to others (do many people come on the property; are there any unique risks such a pool, animals, guns, etc.) * What are the habits of the inhabitants? (Smoking, carelessness, children’s behavior, etc.) **A key rule to remember is “Don’t risk a lot for a little.” In other words, don’t purchase “cheap” coverage and expose yourself to a large loss just to save a little bit on the premium payments.**

Answer 90

If Juan injures Hector with his car, causing $400,000 in damage, then Hector must sue Juan to collect for the damage. To sue successfully, Hector must establish Juan’s negligence. A basic premise is that all drivers have a duty to use reasonable care in operating their vehicles. Injuring another with a vehicle because of inattention, speeding, or improper maintenance of the car, or for any other reason, is considered a breach of this duty. Most people rely on a personal automobile insurance policy to protect themselves against being sued because of an automobile accident. Traditionally, compensation for the damage done to others has come through the tort liability system. **Practitioner Advice: The need for auto insurance is often governed by the laws of a particular state. Most states require some form of compulsory coverage in order to register a vehicle. Usually, compulsory coverage is minimal and a person who wants to protect themselves against property damage or liability to others will purchase additional coverage. If a loan exists on the vehicle, the lender will dictate some of the coverage to protect its interest. If no loan exists, the insured may wish to consider the value of replacing the vehicle compared to the cost of acquiring collision protection. Also, based on the number of miles driven in a year, their driving record, type of average driving conditions and the need to drive regardless of weather conditions should be considered when determining the potential of a loss. The amount of coverage may be decided by the amount someone may sue for based on value of their property and the wealth of the insured. Someone with assets is a better target for a lawsuit.**

Answer 91

Incidents of ownership include any economic benefit in a life insurance policy. A life insurance policy owner has incidents of ownership in the policy that may include the right to borrow against the policy, assign or transfer the policy, receive cash values and dividends or change the beneficiaries. Retaining any incidents of ownership in a policy causes the death benefit to be included in the insured’s estate, which may be subject to estate tax. Inclusion occurs even if the policy is transferred to a new owner or to a trust more than three years before the insured’s death if any incidents of ownership are retained. Now, assume instead that six years ago John transferred all ownership rights in the life insurance policy to his wife Abigail, not to Fred, and that he died this year. In this case, the life insurance proceeds would not be included in John’s estate because he did not own the policy or have any incidents of ownership at his death, and he had transferred the policy more than three years before he died. If Abigail had died before John, however, then the value of the policy at the time of her death – the replacement cost value – would be included in her estate. Fred as beneficiary would owe no federal income tax on the proceeds he received, but his mother (as policy owner who is not the insured) would have given him a $1 million gift of the proceeds. This complication is one reason why people often use irrevocable trusts to own life insurance as part of their estate plans. If, however, the gross estate is below the lifetime applicable exclusion amount, there will be no federal income tax or estate tax due, and therefore, perhaps no need to create an irrevocable life insurance trust (ILIT). **Practitioner Advice: Remember, estate taxation is not the same as income taxation. The beneficiary will generally receive the death proceeds without having to pay any income taxes on those funds. Also, if the beneficiary has no incidents of ownership in the policy, his or her estate will not need to include any policy values upon death. Also, although there may be no federal estate tax consequences, there may be state estate tax liabilities due to lower limits than the $12,920,000 (2023) federal exemption and inheritance taxes.**

Answer 92

The estate tax, introduced at a modest level in 1916, can have a great impact on wealthy estates. The federal estate tax is arrived at by adding the taxable estate to adjusted taxable gifts, which are taxable gifts made after 1976, to yield the tentative tax base. The reason for this addition is that the estate tax law is part of a unified transfer tax law that applies to transfers made at death and even during life. It is necessary to add the value of lifetime taxable transfers (gifts) back to the tax base to derive the appropriate marginal tax bracket. The appropriate tax rate is then applied to the tentative tax base to derive the tentative federal estate tax. From this tentative tax is subtracted certain credits for gifts and other taxes paid as well as the unified credit. Generally, a federal estate tax return must be filed and any estate taxes paid within nine months of the death of any U.S. citizen or resident who leaves a gross estate of more than a specified exempted amount. The exempted amount in 2023 is $12,920,000. An extension of up to 10 years may be granted for payment of taxes by the IRS for "reasonable cause," including those taxes associated with certain closely held businesses. The federal estate tax is a graduated tax, starting at 18 percent and building to a 40 percent marginal rate for taxable amounts over $12,920,000 in 2023. The gross estate, the starting point for estate tax computation, consists of the value of the decedent's interest in all property. Allowable deductions are then subtracted from the gross estate, which results in the taxable estate. However, the unified credit is a tax credit that can be applied to offset the taxable estate. **Practitioner Advice: In the past, people focused their estate planning strategies primarily on federal tax laws. Now that Congress has reduced the federal estate tax, many states have revised their laws so that they can continue to collect taxes. In some states (e.g., Massachusetts), there may be state taxes owed on estates that are exempt from federal estate tax.**

Answer 93

After completing this lesson, you should be able to: * Describe how an individual can benefit from an insurance policy, * Differentiate between saving through insurance and ordinary savings vehicles, * Describe how annuities are a source of assured income, * List the steps in selecting a suitable insurance policy, * Define the purchase selection rules of insurance, and * List the guidelines for proper policy pricing. **Practitioner Advice: Many class-action lawsuits occurred during the mid- to late-1990’s due to consumers feeling they were mislead by insurance agents who oversold the investment features of certain life insurance policies. Investment terms such as deposit and contribution were used to describe premium payments into policies that did in fact provide for cash accumulation and offered investment account returns. However, when the underlying investments or interest rates did not perform as originally estimated, consumers complained that they were misled. Agents and insurers argued that the consumers forgot they were also paying for the cost of protection, which logically reduces the net returns on such policies. Regardless of who was to blame, it is evident that agents must be very clear when explaining the primary and additional benefits of any policy being sold. Also, consumers must be aware that some policies provide investment features, and they should not discount such benefits solely based upon past lawsuits. The bottom line is that a need-based assessment is the primary form of discovery in determining what amount and which type of policy should be purchased, with the client’s budget constraints as a major factor.**

Answer 94

It has been frequently asserted that life and health insurance can be regarded not so much as producers of wealth, but as mechanisms for distributing funds from the fortunate to the unfortunate. In reality, life and health insurance can be important forces in the production of wealth, in that they can relieve the policyowner of worry and increase his or her efficiency. To the extent that concern about the financial consequences of loss of life or health causes an individual uncertainty and worry, life and health insurance could help reduce this concern. **Practitioner Advice: The primary reason clients buy disability income and life insurance is to create a sense of security for themselves and their family. It's important for adults to fulfill their need to provide for their dependents and to know they have prepared for life's challenges as well as possible.**

Answer 95

Determining the consumer’s financial goals is the starting point when choosing the proper amount of life or disability insurance. How much money is needed to solve financial problems if death or disability were to occur immediately? Choosing the proper amount of insurance, like choosing the proper policy, begins with knowledge of the need for insurance. The need for insurance is related to the severity and the probability of a potential loss. In property insurance, the need for protection usually is based on either the acquisition cost or the replacement value of a physical asset. This need can be readily calculated. In cases of business income insurance or liability claims, estimates of potential losses are needed. Trends suggest that people tend to buy too much insurance for low severity, high-frequency losses, and purchase inadequate coverage for high severity, low frequency exposures. An example of such a mistake would be to purchase a service contract on a new car extending the warranty several years, while simultaneously driving with the minimum amount of liability coverage. The most one could lose in terms of a car repair bill is far less than the most one could lose in a liability suit. **Practitioner Advice: It is important to review all of the client's insurance coverages to see if their money is being well spent. For example, could the deductibles on the Homeowners and Auto policies be increased so that the premium savings could be used to buy Life Insurance?**

Answer 96

Useful hints for consumers will help them to pay the right price, but few absolute rules exist. **Practitioner Advice: When selecting the right policy at the right price one must consider the financial strength of the insurer to back up its promise to pay in the event of a loss. What good is a policy that costs less when the insurer is very slow or disagreeable in paying claims? When choosing policies, be sure to narrow the field to only those insurers you have determined to be worthy of your business. “You get what you pay for” is a popular saying for a good reason.** The right price is the one providing the consumer with the greatest amount of insurance after giving consideration to the other criteria just described. That is, the right price for insurance is not necessarily the lowest price. The lowest price may come from a company that has other drawbacks, such as: A company whose financial strength is questionable A company that too frequently resists or denies its insureds’ legitimate claims An insurer whose agents are not trained adequately, and A company whose policies do not offer coverage as valuable as that offered by other companies. For these and other reasons, the consumer should first consider all the other criteria and then search for the right price. One rule in finding the right price is to engage in comparison-shopping. Researchers have found considerable price variation for comparable insurance policies offered by similar insurers. The need for shopping is true in both life and property insurance. A consumer should consider shopping from both mutual and stock insurers, and from both independent agents and direct writers. Changing insurers to save a small amount of money, especially if a consumer’s current insurer gives discounts for insureds of long standing, may not be an efficient strategy. **Practitioner Advice: Life insurance regulations require all policy illustrations (detailed numeric and narrative representations of what the policy will do over time) to be presented in a similar format to make comparisons easier. Also, policy illustrations must use standard indexes to provide a numeric per unit cost for comparison. All else being equal, the policy with the lower index number is the most cost-effective choice.**

Answer 97

* An uninformed insurance consumer risks buying an unsuitable policy because he is not well prepared to choose the right company, agent, policy, and amount of protection. * There are five main rating firms that rate insurance firms but all these rating firms use different scaling systems to rate a company. * The insurance consumer makes the right choice if (s)he gathers relevant information from the Internet and makes a comparative study of the ratings of the various rating firms before choosing his company. **Practitioner Advice: While it can be confusing to compare an insurance company's ratings from the different agencies, there are a few guidelines to follow.** * **Get the ratings for a number of years, (not just the last 2) and watch out for a downward trend**. * **Look for excellent ratings for more than 5 years**. * **Look for very high ratings from at least 2 of the 5 ratings services.**

Answer 98

All states have solvency laws and guaranty funds to protect insureds from losses caused by insolvent insurers. State regulators are likely to intervene in an insurer's independent operations when the company's surplus accounts reach an unacceptably low level, or if the company's conduct appears to be jeopardizing the policy owner's interests. Regulators call the first phase of intervention conservatorship, rehabilitation, or receivership. If this phase fails to correct the problems, regulators can order the next level of intervention: liquidation. In the case of small insurers, the state may try to rehabilitate the company, find a solvent insurer to assume the business, or liquidate the company using the guaranty fund. The failure of both large and small insurers can require policy owners to give up some contractual rights including access to their funds for stated periods. In some cases involving life insurance companies, policy owners received lower investment returns than called for in contracts issued by failed insurers. The money to finance the state guaranty funds comes from assessments on all insurers doing business in a particular state. Thus, there is a transfer of funds from solvent insurers to support the insureds of insolvent insurers. The fairness and logic of such a transfer are subject to criticism, since the most likely transfer is from insureds purchasing coverage from insurers charging adequate (higher) premiums to insureds of companies charging inadequate (lower) premiums The 1989 NAIC Guaranty Fund Model Act provides some national uniformity among the various state regulations. Critics note that insureds having already paid a higher price now must pay more to support those insureds who, voluntarily, chose to purchase insurance at a lower price. State regulators are likely to intervene in an insurer's independent operations when the company's surplus accounts reach an unacceptably low level, or if the company's conduct appears to be jeopardizing the policy owner's interests. **Practitioner Advice: States prohibit insurers or agents from implying that Guaranty Funds make financial strength of the carrier a non-issue. Discussion of these Funds should be avoided and only when the consumer specifically mentions them. To remain compliant and to avoid any chance of misunderstanding, an agent should stress the importance of insurer stability and direct consumer Guaranty Fund questions to the State's insurance department.**