Ch. 8 - Introduction to Financial Underwriting Flashcards
Insurable interest implies a degree of financial dependence on the part of the beneficiary towards the insured. What are examples of such financial dependence?
- The relationship between young children and their parents
- The relationship between a non-working partner and the family income earner
- A situation involving business owners who badly need the skills of their top salesperson to keep the company profitable
Who regulates life insurance in the United States?
Life insurance is regulated by individual states
Who regulates life insurance in Canada?
Life insurance is regulated both federally and provincially
What is “slayer’s rule”?
A rule that prevents beneficiaries and their heirs or representatives from profiting from murder
What is the length of the suicide clause in life insurance policies?
Up to two years after the contract is put in force. Note that some states have only a one-year suicide clause
What is a fraudulent claim?
Claims involving a misrepresentation of information relating to the insurability of the insured person or a falsification of the death of the insured
What is a contestable clause?
The contestable clause in life insurance contracts helps prevent claims due to a deliberate misstatement of information on the application. In the first two years a contract is in force, a misrepresentation of material underwriting information in the application voids the contract and prevents payment of the claim.
How are income replacement policies often justified?
Using the multiple of salary method, in which the maximum death benefit is a multiple of the insured’s income
What are advantages of the multiple of salary method?
- Easy to use
- Useful in simple sales situations
Disadvantages of the multiple of salary method are that it does not account for:
- The age of the surviving partner
- The existence of another family wage earner
- The number of dependents
- The number of years for which income may be needed
- Any changes in government benefits
- Monetary growth
- Income growth
What method is a measurement of the earnings potential of the insureds life?
The Human Life Value method
The methodology of the human life value concept is somewhat more sophisticated than the multiple of salary approach and considers more facts. These include:
- Actual after-tax earnings
- Projected rate of earnings growth
- Expected length of career
- Discount rate for future earnings
Income replacement needs can be calculated using a needs analysis approach. What does this approach identify?
It identifies the specific lump sum and income needs of the beneficiaries and translates them into a proposed death benefit. The needs analysis approach prioritizes both replacing the insured individual’s income and addressing the expenses that the beneficiaries will incur.
What are the pros and cons of the multiple of income method?
It is simple but may not be very accurate because it does not adjust to reflect individual circumstances
What are the pros and cons of the human life value approach?
It is more sophisticated but relies on an estimate of the future inflation rate and expected increases income. If these estimates are inaccurate, the insurance need could be underestimated or overestimated
What are the pros and cons of the needs analysis approach?
It can be comprehensive in its scope but in complex financial planning situations can require an exhaustive amount of research and computation. Also, the needs analysis approach ignores family earnings and can produce an insurance amount based purely on need, not income, creating a situation where the insured is worth much more death than alive
From a purely financial standpoint, most children a very high or low insurable value?
Low insurable value. Therefore, many life insurance contracts on children provide a very modest death benefit, mostly just enough to cover the costs of funeral expenses
What is the practice wherein wealthy family members seek to reduce the death tax due on their own estates by giving away money or property before they die?
Gifting. For 2024, each U.S. citizen can give away up to $18,000 per person each year without being subject to a gift tax. In Canada, there is no gift tax
Life insurance is commonly purchased for several reasons when addressing the needs of the estate planning process. What are they?
Offset probate costs, to provide cash for use by the estate, and to compensate the estate for the payment of estate taxes
What replaces estate taxes in Canada?
The deceased is deemed to have disposed of all property for its fair market value immediately before death and must pay capital gains taxes on their terminal income tax return
What are the four important questions that must be satisfactorily answered when reviewing charitable gifting sales?
- Is this a legitimate charity?
- What is the relationship between the proposed insured and the charity?
- How much is an appropriate amount?
- Is there a historical pattern of charitable giving?
What insurance covers the financial relationships that exist between business owners, employees, debtors, and creditors?
Business insurance
What are two challenges when underwriting key person insurance?
The first is qualifying the proposed insured as a key person. The second is quantifying the potential financial loss caused by their death
What are additional factors that should be considered for key person insurance?
- age of the proposed insured
- proposed insured’s level of expertise
- business history of the proposed insured
- stability of earnings over time
- number of key employees
- business history of the company
- current financial picture
Regarding key person insurance, would an older employee soon to retire qualify for more or less insurance?
An older employee soon to retire may not qualify for much, if any, key person insurance
What are two methods commonly used to compute and verify the amount of coverage?
Multiple of Earnings Approach and Business Loss Approach
What is the purpose of creditor insurance?
Ideally, creditor insurance is designed to replace the funds insureds would have provided for loan repayment, had they lived
Who is generally an excellent insurance risk for creditor insurance?
Business owners who can demonstrated that their companies are stable, well-funded, and profitable
What does buy-sell insurance allow?
Buy-sell insurance allows remaining business owners to purchase the business interest from the estate of the deceased
What are two types of buy-sell agreements commonly used?
Cross-purchase agreements and liquidation/stock redemption agreements
What is a cross-purchase agreement?
Each partner or stockholder is obligated to purchase buy-sell coverage on every other partner or stockholder. If one of the business owners dies, the insurance money buys that individual’s interest in the company from the estate and transfers it to the remaining owners
What is a liquidation or stock redemption agreement?
This agreement allows the company to purchase the business interest from the estate, and typically the stock is kept as inactive company “treasury” stock. As a result, the surviving owners automatically own a greater percentage of the active ownership shares remaining
What are fringe benefits?
Fringe benefits can be defined as non-salary compensation for employees. Common fringe benefits include health insurance, a company car, a travel expense account, education expense coverage, and group life insurance. Individual life insurance can also be a fringe benefit, operating as part of a program to compensate and retain highly valued employees. These programs are often structured as deferred compensation plans or executive bonus plans
In Canada, life insurance can be purchased to offset which tax:
1. Property
2. Estate
3. Capital Gains
4. Sales
- Capital Gains
In the United States, life insurance is used in the estate planning process for all of the following reasons EXCEPT to:
1. Offset probate costs
2. Provide cash for use by the estate
3. Pay estate taxes
4. Replace key person income
- Replace key person income
Which of the following statements regarding deferred compensation plans is/are correct?
A. They are in addition to the basic benefits available to all employees
B. They allow executives to accrue extra funds for retirement
C. They are usually permanent insurance plans with large internal values
A, B, & C are correct
The type of business insurance that indemnifies a company against the loss of an employee whose skills are critical to the firm is:
1. Creditor
2. Cross-purchase
3. Income replacement
4. Key person
- Key person
Methods of calculating income replacement for personal life insurance include which of the following?
A. Multiple of salary
B. Human life value
C. Needs analysis
A, B, and C are correct
Typical examples of insurance interest regarding financial dependence include which of the following?
A. The relationship between young children and their parents
B. The relationship between a non-working partner and the family breadwinner
C. A situation involving business owners who require the skills of a top salesperson to keep the company profitable
A, B, and C are correct
In the United States, the limit that differentiates larger, taxable estates from smaller non-taxable estates is:
1. The exclusion amount
2. Income tax
3. Tax Hike Prevention Act of 2010
4. Capital gain
- The exclusion amount
The human life value method considers all the following EXCEPT:
1. Actual after-tax earnings
2. Projected rate of earnings growth
3. The potential for unemployment
4. Discount rate for future earnings
- The potential for unemployment
