CFP Insurance Planning Flashcards
Is speculative risk insurable?
Speculative risk is generally voluntary risk and not insurable.
Objective Risk measures what?
Measurable and quantifiable
Measures the variation of an actual loss from expected loss
Which of the following is an insurable risk?
Objective Risk
Pure Risk
Subjective Risk
Speculative RisK
Pure Risk
It involves the risk of loss or not loss and is the only insurable risk
Definition of SEVERITY
Severity is the actual dollar amount of a loss
What is the Law of Large Numbers
Specifies that when more units are exposed to a similar loss, the predictability of such a loss to the entire pool increases
Definition of PERILS
Actual cause of a loss
EX: fire, wind, tornado, earthquake, burglary, collision
Definition of HAZARD
A condition that increases the likelihood of a loss occurring
Definition of MORALE HAZARD
The indifference created because a person is insured
Definition of PHYSICAL HAZARD
Tangible condition that increases the probability of a PERIL occurring
EX: Icy roads, defective equipment
What is ADVERSE SELECTION?
The tendency of persons with higher-than-average risks to purchase or renew insurance policies
Insurance risks are CHAD. What does CHAD stand for?
not Catastrophic
Homogenous exposure
Accidental
measurable and Determinable
Elements of a valid contract are COAL. What does COAL stand for?
Competent Parties
Offer and Acceptance
Legal consideration
Lawful purpose
What is the Principle of Indemnity?
An insured is only entitled to compensation to the extent of the insured’s financial loss
An insured cannot make a profit from a contract
What is the SUBROGATION CLAUSE?
The insured cannot receive compensation both from the insurer and a third party for the same claim.
What is the Principle of Insurable Interest?
Must have an emotional or financial hardship resulting from damage, loss, or destruction
Must have an insurable interest at the time of policy INCEPTION
VOID vs VOIDABLE
Void contract was never valid. Lacks COALL
Voidable contract is a valid contract that allows cancelation by one of the parties, other party is still bound.
What is a warranty?
A promise made by the insured to the insurer
Breach of warranty is grounds for avoidance
Representations definition
Statements made by the insured to the insurer during the application process.
What is CONCEALMENT?
When the insured is silent about a fact that is material to the risk.
Definition of ADHESION?
No negotiations over terms and conditions.
Ambiguities are found in favor of the insured.
Definition of ALEATORY?
The money exchanged may be unequal.
EX: small premium, large benefit possible
Definition of UNILATERAL?
Only one promise is made by the insurer
Insured is not obligated to pay the premiums. If not paid, no promise to the insurer
Meaning of CONDITIONAL?
The insured must abide by the terms and conditions of the insurance contract. If the terms are not followed, the insurer may not pay a claim
Definition of WAIVER?
When one party relinquishes a known right.
Definition of ESTOPPEL?
Takes place when a party is denied assertion of a right to which they are otherwise entitled.
Definition of WAIVER PROVISIONS?
an insurer may seek to avoid liability associated with a loss due to their agents offering policy changes not authorized by the company
Dispute Remedy:
Parol Evidence Rule
Once the contract is placed in written form, all previous and prior understanding may not contradict the compete understand of both parties
Dispute Remedy:
Reformation
Contractual remedy in which the contract is revised to express the original intent of all parties
Dispute Remedy:
Recission
Deems a contract void from inception
What is an agent?
legal representative of the insurer
Who does a BROKER represent?
the policy owner NOT the insurance company
What is EXPRESS AUTHORITY?
Given through an agency or written agreement
What is IMPLIED AUTHORITY?
Authority that the public perceives, and a valid agency agreement exists
What is APPARENT AUTHORITY?
Apparent authority is when the insured believes that agent has authority to act on behalf, when in fact, no authority actually exists
Insurance Contracts: CONDITIONS
Details the duties and rights of the insured and insurer
Insurance Contracts: DECLARATIONS
Includes the name of the insured, description of the property, amount of coverage, amount of premium, term of the policy, inception/termination dates
Insurance Contracts: EXCLUSIONS
This section outlines specifically what will not be covered
Insurance Contracts: RIDERS AND ENDORSEMENTS
Written additions to an insurance contract (customization)
These take precedence over conflicting terms
Who regulates the insurance industry? FED or STATE
State
Valuation of Insured Losses: REPLACEMENT COST
Current cost of replacing property with new materials of like kind
Valuation of Insured Losses: ACTUAL CASH VALUE
Replacement cost - depreciation
Almost all AUTO policies are ACV
Valuation of Insured Losses: AGREED UPON VALUE
Determined jointly by insured and insurer
Typically used for art and antiques
Definition of DEDUCTIBLES
A stated amount the insured must pay before the insurer will make payments
Form of retaining risk
Definition of COPAYMENTS
In addition to deductibles
Common with health insurance: $500 deductible and an 80/20 copayment clause
Insured is responsible for 20% expenses above deductible
Definition of COINSURANCE
Insured covers at least a stated percentage of the property value
Definition of SUPERANNUATION
Outliving funds saved for retirement
Mitigate risk: ANNUITIES
What does NAIC do?
National Association of Insurance Commissioners
Watch list of insurance companies
Based upon financial ratio analysis
NO regulatory power!! Reg occurs on STATE level
Involved in accrediting state insurance regulatory offices
Steps in RISK MANAGEMENT
D-I-E-D-I-E
Determine objectives of risk management
Identify risks
Evaluate probability
Determine alternatives
Implement
Evaluate, monitor, review.
GENERAL INSURANCE UNDERWRITING
Insurance companies issues 1 of 4 underwriting policy standards
- Preferred (lowest policy premiums)
- Standard (avg risk for insurance company)
- Rated (greater premium in return for providing the insurance)
- Decline (insurance company doesn’t accept risk)
Factors that effect PREMIUMS
health
family health history
risk factors
credit rating
driving record
An insurable interest for life insurance must exist when?
Beginning of policy?
Middle?
End of policy?
At policy INCEPTION only
Mortality Cost
Face amount of a policy and the chance the policy is going to have to pay out as a claim
Directly tied to cost of insurance
Term Insurance
Very closely approximate MORTALITY COSTS
PURE insurance protection ( NO investment, NO cash value )
Protection ceases at the end of the term
Very inexpensive at young ages, good for clients with children
Term Life Policies : ANNUABLE RENEWABLE TERM
Premium increases annually (STEPS)
NO cash value
Death benefit is FIXED
INEXPENSIVE
Can be CONVERTED to a permanent policy.
Think “renting” insurance.
Term Life Policies : LEVEL TERM
For a specified PERIOD OF TIME
NO cash value
Death benefit is FIXED
Premiums are LEVEL (overpay premiums initially)
Can be CONVERTED to a permanent policy.
Term Life Policies : DECREASING TERM
Premiums are level
Death benefit DECLINES over time
NO cash build-up within the policy
(EX: Most appropriate use would be to payoff a mortgage)
whole life
lifetime protection
pre-fund future higher mortality costs
death benefit level
premium level (NO flexibility)
CASH value can be used for loans or may be received if surrendered
may received DIVIDENDS
modified whole life
stair step premiums
Universal life
Very flexible, can change premiums/face value/cash value
May increase above initial face value amount, depending on cash value
NO control over investments
Cash value can be used to pay the premium
Variable whole life
What does it mean?
Death benefit?
Insured directs investments
Opportunity for higher OR lower returns
Death benefit AND cash value FLUCTUATE based on PERFORMANCE
Participating Whole Life Insurance
2 Options?
Taxable?
Dividends paid to insured
Goes toward premiums
NOT taxable, return of basis
Ordinary Whole Life
Pay premiums until age 120
Cash value INCREASES TO FACE VALUE at age 120
Death Benefit is LEVEL
Limited Pay Whole Life
Pay in X payments instead of every year
Premiums are HIGHER than ordinary life because the insured only pays premiums until a certain age
Whole Life Advantages / Disadvantages
ADVANTAGES:
-Whole life
-Earnings tax deferred
-ESTATE PLANNING (liquidity at death)
DISADVANTAGES
-policy is expensive
-premium is not flexible
-there is a gradual cash value growth
-insured may not be able to purchase as much protection
First-to-Die - Customized Whole Life Policy
Will pay when the first person out of two dies
Dividend Options on life insurance policy
Check
Buy more insurance
Increase cash value
Reduce premiums
One-year term insurance (5th dividend)
Nonforfeiture OPTIONS
Cash surrender Value received
Reduced Paid-up insurance
Extended term insurance (change to specified duration)
Taxation of DEATH BENEFITS
Generally EXCLUDABLE from taxable income
Dividends are NOT taxable until withdrawn
Distributions for amounts GREATER THAN basis are TAXABLE
Modified Endowments Contract (MEC)
Money going in too fast
in IRS eyes, investment
7-pay test FAIL (pay for ins. w/in 7 yrs)
Withdraws treated on LIFO basis (earnings taxed before premiums)
10% penalty
ONLY AN ISSUE IF WITHDRAWING MONEY
If the insured surrenders the policy prior to death, the insured may take cash value as:
Lump Sum
Interest only
Installment payments
Are premiums tax-deductible for an individual?
NO
Are premiums tax-deductible for an employer?
YES, for the first $50,000 of coverage
typically group-term
Premiums paid by the employee are w/after-tax dollars
Exceptions to Transfer for Value Rule
Transfers to:
-the insured
-partnership of insured
-corporation in which insured is a shareholder
-transfer that results in carryover basis from transferor to transferee
Taxation of Viatical Settlements
Viatical company has to pay taxes on gains over sale price
Current Assumption Whole Life
Insurer uses new money rates and new mortality rates to establish premiums
Insurer reserves the right to adjust the premium once, usually at the 5-yr mark
Why is Whole Life Insurance appropriate for Estate Planning?
Whole life provides liquidity to pay transfer taxes.
Second or Last-to-die policy
Provides death benefits when second or last insured dies.
Appropriate for estate taxes/provide liquidity
If held in a trust, it will not add to the insured estate tax
Participating - Dividend options
- Cash
- Reduce premiums
- Accumulate interest (tax free)
- Paid-Up Additions of insurance
- One-year Term (also known as the 5th dividend option)
“CRAP - O”
Settlement Options for Life Insurance
LUMP SUM PAYMENT
Lump Sum Payment
Pay the lump sum directly int he form of a check to the beneficiary
Settlement Options for Life Insurance
INTEREST ONLY
Receive periodic payments of interest on the policy proceeds.
Settlement Options for Life Insurance
ANNUITY PAYMENT FROM LIFE INSURANCE
Fixed Amount - receive fixed payments until depleted
Life Income - converts into annuity contract for the life of the beneficiary
Fixed period - converts into annuity contract for a specified number of yrs
Life Income with Period Certain - transforms the death benefit into a life annuity based on age/health of beneficiary yet promises to make a specified number of payments under the contract
Joint and Last Survivor Income - Annuity payments are made over the joint lives of two individuals
Life Insurance Nonforfeiture Options
CASH SURRENDER VALUE
Insured receives the accumulated cash value when terminating the life insurance policy (less surrender charges)
Life Insurance Nonforfeiture Options
REDUCED PAID-UP INSURANCE
Insured receives the cash value in the form of a paid-up policy with a smaller face amount
Life Insurance Nonforfeiture Options
EXTENDED TERM INSURANCE
The insured receives the cash value in the form of a paid-up term policy for a specified duration, with the same face amount as the original policy.
ACCELERATED DEATH BENEFITS due to terminal illness
Any payments are deducted from the policy’s face value
Life expectancy must be 24 months or less
Income from benefit not taxable
No restrictions on USE.
Universal A vs Universal B
A: If cash value gets high enough, the death benefit will increase
B: Death benefit varies directly with cash values. More expensive than A because the death benefit is equal to a specified amount of insurance plus the cash value.
Direct Recognition Program
Dividends are reduced by any outstanding loan against the policy
Suicide rule
Coverage is excluded if suicide is committed with one or two years of purchasing the policy (premiums returned)
Life Annuity Contracts
-Periodic payment to individual
-Protection from outliving assets
-Commonly used to fund retirement
-Not a hedge against inflation
-not appropriate if you want to leave assets to your heirs
Are dividends earned on cash value taxable?
Yes, but not until withdrawn
Are loans against life insurance taxable?
No, tax free, unless MEC.
How are withdrawals from life insurance taxed?
Considered a return of principal until accumulated premiums have been distributed.
Then, taxed as ordinary income.
Characteristics of Group-Term life insurance
Coverage amounts may be based upon salary level
Payout are almost always made in lump sum payment, unless otherwise specifically requested by the beneficiary
The minimum group size is 10, unless specific requirements are met
Can a group life insurance plan provided by employers be converted to permanent?
Yes, without evidence of insurability
The policy may be converted from a term policy to an individual permanent life policy.
At conversion, the billing is switched to the insured.
The only time a viatical company will purchase a life insurance policy is if the insured is
Terminally ill or Chronically ill
Are premiums paid by the insured tax deductible?
NO
Chronically ill defined as unable to do at least two Activities of Daily Living. What are the 6 ADLs?
Eating
Toileting
Transferring
Bathing
Dressing
Continence
Pre August 14, 1982 what method is used for withdrawals prior to the start of an annuity?
FIFO
Basis before earnings
For contracts dated after August 14, 1982 what method is used for withdrawals prior to the start of an annuity?
LIFO
Earnings before basis
1035 Exchange, one annuity contract for another, taxable?
NO
Annuity for life insurance contract, taxable?
YES
