CFP - 2.1 Insurance Flashcards
Collateral Assignement
Policy owner assigns all or a portion of the death benefit to a creditor as security for the loan
Basis of contract equals
Premiums - dividends - outstanding loans or withdrawals-cost of insurance
What type of whole life policy provides constant protection, but premiums are higher and only paid for a specific term?
Limited-pay life
What type of hazard is high blood pressure?
Physical hazard
A type of whole life insurance where the cash values are based on the insurer’s current mortality, investment, and expense experience. An amassment account is credited with a current interest rate, which changes over time.
Current assumption whole life (CAWL)
Can you use a premium bonus on a new policy to cover surrender charges on an old policy?
NO NO NO
Are pure endowment policies sold in the US?
No
How are cash values treated for tax basis?
FIFO
Can MECs be converted?
No, once an MEC, always an MEC
Workers’ Compensation:
Do workers injured on the job need to prove employer’s negligence?
No, strict liability
When are Deferred Income Annuity payout times selected?
At the time of initial premium payments
Endorsements are AKA
Riders
Universal Life Option B (or 2) pays what type of death benefit?
Increasing, face plus cash value
Particular risks affect…
Individuals or small groups of people
How are MEC withdrawals treated for tax basis?
LIFO
Are interest-only payments on death benefits tax free?
No, taxed as ordinary income
What insurance types should be emphasized during the distribution phase? (2)
Health & Long Term Care
Hazard
A condition that increases the probability that a loss occurs
Vicarious liability can apply to… (3)
- Parents on behalf of children
- Employers OBO employees
- Principals OBO agents
How much of a surrendered cash value is taxable?
Excess cash received over the net paid premiums. Dividends usually just reduce basis via return of premium.
Accidental Death Rider:
Death must occur within _____ days of an accident.
90
Absolute Assignment
Policy owner assigns all rights in the policy to someone else (including access to the cash value)
A liability that may be imposed without proof of negligence or bad intent is known as _______.
Strict Liability
Universal Life Insurance premiums are fixed or flexible?
Flexible
Which life insurance options DO have cash values?
Whole, Universal
Risk of superannuation
Risk of choosing to take a lump sum or a lifetime stream of annuity payments
How are life policy surrenders taxed?
Taxable gain is cash surrender value minus investment in contract
What is an insurance policy’s basis?
Premiums paid minus distributions
The type of authority that the insured is led to believe the agent has is known as ______.
Apparent authority
If the insurance company is making the offer, what 4 conditions must occur for the contract to come into existence?
(P P G M)
Policy delivery
Payment of premium
applicant remained in Good health
no Medical treatment
What type of hazard is the chance of loss from dishonesty?
Moral hazard
Are speculative risks insurable?
No
What type of hazard is the location of a house?
Physical hazard
Are variable life investment gains tax deferred?
Yes
Static risks are…(2 things)
Regularly occurring
&
Insurable
How much does the accidental death rider usually pay out?
Twice the policy’s face amount
Guaranteed Insurability Rider
Allows policy owner to purchase additional life insurance at specified intervals (usually 3 years)
What is the exclusion ratio?
The amount of life insurance proceeds in the annuity payment that is a return of basis
Type of contract where only one party promises to perform
Unilateral
When an injured party’s own negligence contributes to his injuries, this is known as _______.
Contributory negligence - claimant usually recovers nothing
Are life insurance premiums deductible?
No
When are policy dividends taxed?
Once the amount received in dividends exceeds the policy’s basis
Grace Period
30 - 31 days from the due date to pay the premium
Disability Premium Waiver Rider exceptions
self-inflicted disabilities, war, violation of law
Last Clear Chance Rule
A claimant can still recover even in contributory negligence if the defendant had a last clear chance to avoid the accident but failed to do so
The failure to act in a way that a reasonably prudent person would have acted in those circumstances is known as ______ .
Negligence
Four elements of an insurable risk
- Large and similar sample of individuals to make losses predictable
- Loss must be measurable and definite
- Loss must be accidental
- Loss cannot be catastrophic to society (must be able to be spread)
Are pure risks insurable?
Yes
What is indemnity?
Recovery of up to the actual amount of damage
A fan chooses to sit behind first base at a baseball game and gets hit by a foul. This is known as ______.
Assumption of risk
The stated amount of money the insured is required to pay on a loss before the insurer will make any payments is the ________ .
Deductible
Can employers deduct premiums for group term life or for employee covered policies?
Yes
Product Liability:
If someone is injured by a defective product, do they need to prove the manufacturer was negligent?
No, strict liability
The likelihood that people with the highest risk of loss are also the most likely to purchase insurance is known as _____ .
Adverse selection
A flood is an example of a ______ .
Peril
What is the Law of Large Numbers?
The larger the number of members in the group, the greater the probability that actual loss experience will equal the expected loss experience
Double Indemnity
Twice the policy’s face amount, usually applies to the accidental death rider
Res ispa Loquitur
The thing speaks for itself. Incident wouldn’t have happened without negligence and burden of proof shifts to defendant.
Does the capital retention method consider inflation?
No
Investment in contract equals:
Premiums - dividends - outstanding loans or withdrawals-cost of insurance
What is the only type of insurance that can be transferred?
Life
Insurance contracts are what types of contracts?
A U C U A
Adhesion Utmost Good Faith Conditional Unilateral Aleatory
Where is the whole life cash value invested?
Insurance company’s general account
What insurance types should be emphasized during the accumulation phase? (2)
Life & Disability, especially if there are dependents
Compensation for measurable loss is known as ______.
Special Damages
The life insurance applicant is making the offer to the insurance company if…
The application is accompanied by the first premium (consideration)
Amounts assessed to the negligent party as punishment are known as _______.
Punitive Damages
Collateral Source Rule
Damages assessed against a negligent party should not be reduced simply because the injured party has other sources of recovery available
Can the insured modify alter or negotiate an insurance contract?
No, contract of adhesion
Riders are AKA
Endorsements
How is cash value taxed if the insurer dies?
It escapes taxation
Automatic Premium Loan Provision (APL)
Premium can be charged against cash value if it is not paid by due date. Considered a loan and is charged interest.
Net Cost Method
(Face value + total premiums - total dividends - future cash value)
Divided by # of years, divided by $1,000
Should unemployed spouses be covered by life insurance?
Yes
How do regular endowment policies pay?
Death benefit during endowment period, annuity after endowment period
Credit Life Policy
Insures lender and borrower from financial loss if the borrower dies before completing payment.
Authority that the agent is not expressly given, but that an agent in a similar position would normally possess is known as ______.
Implied authority
What method of insurance programming calculates the amount of insurance needed by using interest only to furnish the continued support of the family?
Capital retention method
What type of whole life policy begins with lower premiums that increase and level off after 5 - 10 years?
Graded premium whole life
Section 1035 exchanges say that no gain is recognized if an annuity is exchanged for what?
Another annuity
A qualified long-term care policy
What type of hazard is carelessness?
Morale hazard
(Life insurance policies) How is interest on reinvested dividends taxed?
Ordinary income in the year earned
Burden of proof rests with which party?
Injured
Use the surrender cost index to measure the cost of insurance for the following policy:
Face value: $10,000 Annual Premium: $100 Annual Dividend: $26.67 Inflated at 6% Cash value at 30 years: $4,000
Not done yet
PMT = 100
n = 30
I/Y = 6%
FV =
$2.71
Are life insurance premiums that are considered alimony payments taxable to payee?
Yes
The insurance company is making the offer to the life insurance applicant if…
The premium is not received at the time of the application.
Accidental Death Rider exceptions (S D W)
Suicide, death from disease, acts of war
(Life insurance policies) How are dividends exceeding premiums taxed?
Ordinary income
In a divorce settlement, does transfer of policy from one spouse to another cause a taxable event?
No
Which Universal Life Option costs more?
B or 2
Dividends can be…
C P I D T
paid in CASH
used to reduce PREMIUM
left with insurance company to earn INTEREST
used to purchase additional DEATH BENEFIT
used to purchase one-year TERM insurance
Dynamic risks are the result of…
The economy changing
Are death benefits paid to beneficiaries included in gross income?
No
Can an agent bind the principal in contract with a third party?
Yes
Conditional Receipt
Insured is deemed insurable and coverage begins
Risks that involve only the chance of loss or no loss are known as _______.
Pure risks
Modified Endowment Contract policies charge premiums during the first __#___ years
7
Fundamental risks affect…
A large group of people
How do you calculate the exclusion ratio?
Tax Basis / Total Benefit
Written authority given by the principal to the agent is known as _______.
Express authority
What is the maximum QLAC (qualified longevity annuity contract) amount for a 401(k) or IRA?
$125,000 or 25% of account balance, whatever is less
Suicide Clause
If insured commits suicide within 2 years, premiums without interest are refunded, but no death benefit is paid
Which approach consumes part of the interest, but no death benefit?
Annuity Approach
Purchasing Power Preservation Model
Purchasing Power Preservation Model
Cost of Living Rider
offers additional insurance as inflation protection, usually indexed to CPI
Section 1035 exchanges say that no gain is recognized if a life policy is exchanged for what?
Another life policy
An endowment policy
An annuity
A qualified long-term care policy
Is income earned but not withdrawn taxable to the policy owner?
No, accumulates tax free until withdrawal
Twisting (insurance)
Misrepresentations to induce policy owner to change to a new policy with a different company
Section 1035 exchanges say that no gain is recognized if an endowment policy is exchanged for what?
Another endowment policy
An annuity
A qualified long-term care policy
What type of contract is accepted in exact terms?
Contract of adhesion
What is the face amount of a Credit Life Policy?
Balance of the loan
Use the net cost method to compare the following policies
1: 30 years $100,000 face value $1,000 annual premium $250 annual dividends Cash value at 30 years = $40,000
2: 30 years $150,000 face value $1,200 annual premium $100 annual dividends Cash value at 30 years = $60,000
1: $2.75/$1,000
2: $4.1/$1,000
Maximum age of commencement of income for Deferred Income Annuities
85
Written additions to an insurance contract are known as _______ .
Riders or Endorsements
Type of contract where the outcome is determined by chance
Aleatory
Subrogation
If the insurer pays the insured for a loss caused by a third party, the insured is required to assign his right to recover from the third party to the insurer
Are life insurance premiums that are considered alimony payments tax deductible to payor?
Yes
Estoppel
Prevents denying a fact that was previously admitted
Universal Life cash value accumulation is determined by…
Interest rates
Which life insurance options do NOT have cash values?
Term, variable, universal variable
If the act itself constitutes negligence, this is known as ______.
Negligence per se
What type of hazard is indifference to loss?
Morale hazard
Risks that involve the chance of both loss or gain are known as _______.
Speculative risks
Peril
Cause of financial loss
Life insurance gain at surrender equals:
Cash surrender value - investment in contract
Do variable universal policies have a guaranteed death benefit?
No, can decline to 0
What type of whole life policy begins with lower premiums for 3 - 5 years, then increase to an amount slightly more than whole life premium at the age of inception?
Modified premium whole life
What method of insurance programming calculates the remaining work-life expectancy calculates the present value?
Human life value method
Compensation for intangible loss (pain and suffering) is known as _______.
General Damages
What happens if the insured dies during the grace period?
Beneficiary gets death benefit minus the amount of premium due
When are MEC withdrawals subject to penalty and how much?
10%, before 59 1/2
Are dynamic risks generally insurable?
No
_______ are perils that are not covered in a policy.
Exclusions
Spendthrift Clause
Protects the proceeds from the beneficiary’s creditors
Universal Life Option A (or 1) pays what type of death benefit?
Level, the face amount of the policy
Which approach consumes both interest and death benefit?
Annuity Approach
Purchasing Power Preservation Model
Annuity approach
Being legally liable for someone else’s tort is known as _______.
Vicarious liability
Extraordinarily dangerous activities are covered under….
Strict liability
5 elements of an insurance contract (OC OCF)
- Offer & acceptance
- Consideration
- Legal object (must be legal business)
- Legal capacity (must be age of majority and competent, if not, the insured can void, not insurer)
- Legal form (must be in an approved form ie written)
What licenses are required to sell variable life insurance?
Insurance AND securities
Nonforfeiture Provision
An insured party can receive full or partial benefits or a partial refund of premiums after a lapse due to non-payment
Section 1035 exchanges say that no gain is recognized if a qualified long-term care policy is exchanged for what?
Another qualified long-term care policy
Do life insurance death benefits generally avoid probate?
Yes, if there is a named beneficiary
Life insurance death benefits go through probate if the decedent gifted the policy within _____ years of the decedent’s death.
3
Life insurance death benefits go through probate if the proceeds are payable to:
1.
2.
3.
Estate
Executor of the estate
Creditors of the estate
Life insurance death benefits go through probate if the decedent retains…
Incidents of ownership
What are the 3 incidents of ownership for a life insurance policy?
Right to…
Assign policy
Change beneficiary
Change policy provisions
How are life insurance proceeds payable to the spouse taxed?
Included in gross estate, but deducted from gross estate with the unlimited marital deduction - no estate tax
Sales proceeds for a viatical settlement are generally more than x and less than y
More than cash value
Less than death benefit
Viatical settlement sales proceeds are not subject to income tax if the insured is expected to die within _____ months
24 - certified by a doctor
Viatical settlement proceeds are not subject to income tax if the insured is chronically ill and the proceeds are used for _______.
Long term care
How do you calculate the tax due for the purchaser of a viatical settlement when the insured dies?
Death proceeds - purchase price of policy - premiums paid
Annuities purchased before DD/MM/YY are subject to _____ method of taxation.
August 14, 1982
FIFO
Annuities purchased after DD/MM/YY are subject to _____ method of taxation.
August 14, 1982
LIFO
Are there any penalties on annuity distributions?
Yes, 10% before 59 1/2, unless the contract was purchased before August 14, 1982
What is the exclusion ratio of a fixed annuity?
Investment in contract / (Annual Payments x life expectancy)
How many fixed annuity payments use the exclusion ratio?
Up until life expectancy is passed, then fully taxable
Exclusion ratio applies for the entire payment period for fixed annuity payments that began before what date?
December 31, 1986
What happens to unused basis if the annuity dies before life expectancy?
Deductible on final income tax return as a misc itemized deduction not subject to the 2% of AGI floor
What is the exclusion ratio of a variable annuity?
Investment in the contract / annuitant’s life expectancy
Bill purchased a variable annuity at the age of 63. The total cost was $15,000.0 The annuity will pay annual payments of $800. His life expectancy is 21.6 years. What is the exclusion ratio and what amount is included in gross income?
Exclusion ratio = 15,000/21.6 = 694.44
$800 - 694.44 = 105.56 included in gross income
Can you use 10 year forward averaging on annuities?
No
How are annuity earnings taxed for individuals?
Earnings accrue tax deferred until they are withdrawn
How are annuity earnings taxed for corporations?
Earnings are treated as ordinary income (or loss) for that given year.
Group term life premiums up to the first $XXXXX of coverage paid by the employer is tax exempt to the employee or retiree covered by plan.
$50,000
Employee age 56 is provided with $200,000 of group term life coverage.
IRS table cost per $1,000 for his age is $0.43 per month. He pays $350 annually towards the cost of the coverage. How much will be included in his gross income?
$200,000 - $50,000 = $150,000
150 x 0.43 x 12 = $774
$774 - 350 = $424
Non-discriminatory group life and health plans must cover:
X % or more of all employees
AND
X % or more of non-key employees
70%
85%
How are health insurance premiums taxed to the employee?
Tax exempt
How are health insurance premiums taxed to the employer?
Tax deductible
What is split-dollar life insurance?
Employer and employee share the costs and benefits of life insurance policy.
What does the employer pay in a split-dollar life insurance policy?
The premium equal to the current year’s increase in the cash surrender value of the policy
What does the employer get if an employee with a split-dollar policy dies?
Premium outlay is recovered from policy proceeds and the remaining amount goes to the employee’s beneficiary
Are split-dollar premiums tax deductible to the employer?
No
Can split-dollar policies be used with officers or directors?
No, Sarbanes-Oxley
In the endorsement method of the split-dollar policy, who owns the policy?
Employer
In the collateral assignment method of the split-dollar policy, who owns the policy?
Employee
How are premium payments treated in the endorsement method of the split-dollar policy?
Treated as a benefit received by the employee
How are premium payments treated in the collateral assignment method of the split-dollar policy?
Treated as a loan to the employee
Death benefits are included in the gross estate if the insured/owner transferred or assigned the policy within ____ years prior to death.
3
Are key employee life insurance premiums deductible?
No
Are death benefits on key employee life insurance policies tax free to the business?
Yes
Executive bonus life insurance plans are known as Section ___ Plans
162
Can Section 162 Plans be discriminatory?
Yes
How are executive bonuses taxed for Section 162 plans?
Ordinary income
Are Section 162 bonuses deductible to the employer?
Yes
Can IRAs hold life insurance?
No
Can life insurance be provided through a qualified plan?
Yes, but must meet the incidental death benefit requirement
What two tests make up the incidental death benefit requirement?
25% test: No more than 25% of the employer’s contributions can be used to purchase life insurance (50% for whole life)
100:1 ratio rule: A death benefit cannot exceed 100 times the expected monthly benefit to the employee
How are life insurance policies in qualified plans taxed at death?
included in gross estate
Are non-qualified deferred compensation plans subject to ERISA?
No
How do non-qualified deferred compensation plans benefit key employees?
Benefits and contributions can exceed qualified plan limits
Are non-qualified deferred compensation plan contributions tax deductible to the employer?
Yes, but not until the funds are constructively received
Non-qualified deferred compensation plans:
Are there limits to the amount of benefit given to any one employee?
No
Non-qualified deferred compensation plans:
What are the nondiscrimination requirements?
None
Non-qualified deferred compensation plans:
How are benefits taxed to the employee?
Tax deferred
Non-qualified deferred compensation plans:
What is a common way employers use?
Golden handcuffs
Non-qualified deferred compensation plans:
What types of corporations cannot take full advantage?
S corps and partnerships
Non-qualified deferred compensation plans:
What is constructive receipt?
Occurs if executive has access to the funds or if the funds are securely set aside
Non-qualified deferred compensation plans:
How are constructive receipt funds taxed?
NOT TAX DEFERRED - taxed as soon as they become constructively received, defeats the whole purpose!
Non-qualified deferred compensation plans:
When is the deferred compensation not treated as constructively received?
If there is substantial risk of forfeiture
What 2 things qualify as substantial risk of forfeiture?
- Unsecured promise to pay
2. Rabbi trust
Funded Non-qualified deferred compensation plans:
When is the executive taxed?
At the time of contribution or when he becomes vested
Non-qualified deferred compensation plans:
How does the salary continuation approach work?
Provides a specified deferred amount payable in the future without a reduction of current salary
Non-qualified deferred compensation plans:
How does the salary reduction design work?
Part of the executive’s current pay is deferred
What is a Rabbi trust?
Trust set up to fund a deferred compensation plan, funds are subject to employer’s general creditors
Who has claim to assets in a Rabbi trust?
Executives in the Non-qualified deferred compensation plan
AND
Employer’s general creditors
When are assets in a Rabbi trust taxed to the executive?
When received by executive, assets in a Rabbi trust have substantial risk of forfeiture
How can an executive minimize risk of not receiving the deferred compensation?
Purchase a surety bond
Does purchasing a surety bond on deferred compensation result in vesting and immediate taxation to the executive?
No
Who pays the premiums on surety bonds on deferred compensation?
The executive, no reimbursement from employer
What is a secular trust?
Irrevocable trust funded by the employer for the exclusive benefit of the employee to receive deferred compensation
Can employer’s creditors claim funds in a secular trust?
No
What form of Non-qualified deferred compensation funding does NOT have substantial risk of forfeiture?
Secular Trust
When are secular trust funds taxed to the executive?
When the employer places the funds in trust, or when the executive is vested
When can the employer deduct contributions to a secular trust?
When the payment is made to the trust
What does SERP stand for?
Supplemental Executive Retirement Plan
What type of deferred compensation plan is a SERP?
Salary continuation plan
Non-qualified deferred compensation plans:
Is disclosure in financial statements required?
Yes, sometimes
What aspects of ERISA are SERPs subject to?
reporting and disclosure, NOT subject to nondiscrimination testing
What does an Excess Benefit Plan pay to executives?
Pays the difference between the amounts payable under the qualified plan and the amount they would have received if annual additions limits did not exist
Long Term Care policies must have:
An expected loss ratio of _____%
60%
Long Term Care policies must have:
A _____ day free look period
30
Long Term Care policies must have:
If the policy is a replacement policy, does the insurer have to wive the time period for pre-existing conditions?
Yes
Long Term Care policies have to be ______ and ______
Guaranteed renewable and noncancellable
Are life insurance policy loans subject to taxation if they are more than the basis?
No, unless they are MEC’s
What is an MEC?
Life insurance policy issued after 6/21/1988 that fails the 7-pay test
What is the 7-pay test?
Fails if premiums paid during the first 7 years of the contract exceed the total of the net level premiums that would have been paid if the policy provided for paid up benefits after the seventh year
