Ch 9: Insurance Co Products

Question 1

annuity

Answer 1

contract b/w individual and a life insurance co, usually purchased for retirement income

at a future date, the annuitant (investor) is able to either surrender the policy and receive a lump-sum payout OR begin receiving regular income distributions for the rest of his/her life

Question 2

annuitant

Answer 2

investor who pays the premium in 1 lump sum or periodic payments

Question 3

2 major types of annuities

Answer 3

fixed

variable

Question 4

fixed annuities

Answer 4

guarantees a FIXED ROR. Fixed annuity remains fixed throughout investor/annuitant’s life.

payout is determined by acct’s value and annuitant’s life expectancy based in mortality tables.

Question 5

***because the insurance co guarantees the return and the annuitant bears NO RISK…

Answer 5

a fixed annuity is an insurance product and not a security.

a salesperson must have a LIFE INSURANCE LICENSE to sell fixed annuities but does NOT need to be securities licensed.

Question 6

variable annuities

Answer 6

money deposited in a variable annuity is directed into 1 or more subaccts fo the co’s separate acct; the separate acct can have many types of subaccts like MFs;

these accts will have a variety of investment objectives.

Question 7

Bc the separate acct is registered as…

Answer 7

an investment co, a prospectus must be delivered prior to/concurrent with the sale.

Question 8

greater potential gain of a variable annuity involves moer…

Answer 8

potential risk than a fixe annuity because it invests in securities rather than accepting the insurance co.’s guarantees.

Question 9

MAJOR DIFFERENCES BETWEEN FIXED AND VARIABLE ANNUITY

Answer 9

fixed:

• payments are invested in a general acct
• portf of fixed-income sec/real estate ONLY
• insurer assumes investment risk
• NOT A SECURRITY
• guaranteed ROR
• fixed admin expenses
• monthly payment never falls below guaranteed minimum
• purchasing power risk
• subject to insurance regulation

variable

• payments invested in a separate account
• portfolio of equity, debt, or MFs
• annuitant assumes investment risk
• IS a security
• return depends on separate acct performance
• monthly payments may fluctuate up or down (nothing guaranteed)
• typically protects against purchasing power risk
• subject to registration with state insurance commission and the SEC

BOTH

• payments made with after-tax dollars
• fixed admin expenses
• income guaranteed for life

Question 10

when you see the word “variable,” for variable annuity/life…

Answer 10

2 licenses are required for sale!!!
INSURANCE LICENSE AND SECURITIES LICENSE.
suitability must be determined and a prospectus must be delivered before or with solicitation of the sale.

Question 11

The Investm Co. Act of 1940 does NOT include…

Answer 11

variable annuities in its definition of investm co. But it DOES include separate accounts as a UIT.

Question 12

premium for life insurance co. is calculated according to.

Answer 12

insured’s health, age, sex, and policy’s face amount at issue

Question 13

Whole life insurance

Answer 13

designed to last until at least age 100 or date of the insured (whichever happens first). These policies also accrue cash value that may be borrowed for living needs.

An insurance license is required to be able to sell life insurance. Whole life insurance is NOT a security and is NOT sold as an investment.

Question 14

Term Life Insurance

Answer 14

insurance that’s protection for a SPECIFIC PERIOD. provides pursue protection and is the least expensive form of life insurance.

Term does NOT build cash values.

Question 15

Variable life insurance

Answer 15

has a FIXED, SCHEDULED PREMIUM but differs form whole life insurance in that the premiums paid are split; part of the premium is placed in the general assets of the insurance co.

These general assets are used to guarantee a minimum death benefit.

balance of premium is placed in the SEPARATE ACCT and reps the cash value of the policy. Cash value is NOT guaranteed bc it’s invested in the separate acct, which fluctuates in value.

Policy’s death benefit may increase above minimum guaranteed amt as a result of investment results, but may MEVER fall BELOW the min (as long as prems are paid)

Question 16

How often is value of separate acct calculated? Reported how often?

Answer 16

calculated daily; variable life contract is reported monthly

Question 17

*** because variable life insurance policy has a minimum death benefit, the premiums necessary to fund this part of the death benefit are held in…

Answer 17

the insurer’s general acct. any policy benefit that’s guaranteed is invested in the insurer’ s general acc.t

ANY PREM ABOVEE what is necessary to pay for the minimum death benefit is invested in the separate acct. This portion of the premium is subject to investment risk and variable life insurance and therefore is also defined as a security.

once the premium has been determined and the expenses have been deducted, the NET PREMIUM IS INVESTED IN SUBACCTS OF SEPARATE ACCT. Just as with variable annuities there are a NUMBER OF SUBACCTS to choose from.

Question 18

Assumed Interest rate

Answer 18

AIR - minimum ROR necessary to provide the level death benefit; it’s simply a target though, not a projection

AIR HHAS NO EFFECT ON CASH VALUE ACCUMULATION IN A VARIABLE LIFE POLICY.
THE AIR DOES, HOWEVER, AFFECT DEATH BENEFIT.

death benefit payable under a variable life insurance policy is adjusted on an ANNUAL basis and can increase/decrease based on the performance of the separate acct compared with an assumed interest rate (AIR).

1 benefit of variable life insurance is that the death benefit can adjust upward and probably keep up with inflation.

Rules for death benefits for variable annuities:

• if separate acct returns aka performance of hte yr are > AIR, death benefit increases. so these extra earnings are reflected in an increase ind eath benfit and cash value.
• If separate acct = AIR, aka performance for the yr is = AIR, death benefit will stay the same. aka actual earnings meet estimated expenses, so no change in death benefit.
• If separate acct returns aka performance fo the yr are < AIR, death benefit will decrease (but never below the policy’s face amt)

Question 19

***variable death benefit is adjusted… how often?

Answer 19

annually

contrast with the MONTHLY VALUATION OF CASH VALUE

Question 20

*** all contributions to annuities are made wit __ dollar, unless…

Answer 20

made with after-tax dollar, unless the annuity is part of an employer-sponsored (qualified) retirement plan or held in an IRA

Question 21

3 different taxable scenarios

Answer 21

On withdrawal, the amount exceed the investor’s cost bases is taxed as ordinary income.

1) random withdrawals
2) lump-sum withdrawals
3)

Question 22

random withdrawals

Answer 22

from an annuity contract

taxed under LIFO; earnings are assumed to be one fo the last monies to hit the acct. The earnings are considered to be withdrawn FIRST from annuity and are TAXABLE AS ORDINARY INCOME.

After earnings gets withdrawed, the contributions representing cost basis may be withdrawn without tax.

Question 23

lump-sum withdrawals

Answer 23

taken by using LIFO accounting method. Tis means that earnings are removed BEFORE contributions.

If withdrawal occurs before age 59.5, then the earnings portion withdrawn is taxed as ordinary income and is subject to additional 10% tax penalty mauder most circumstances.

Question 24

*** even when the distribution is from a NONqualified annuity, if it’s made before the age of 59.5, subject to 10% additional tax still.

When contributions are made with after-tax dollars, these already taxed dollars are considered…

Answer 24

the investor’s cost basis and are NOT taxed when withdrawn. The earnings in excess of the cost basis are taxed as ORDINARY INCOME when withdrawn.

there is ONLY ordinary income tax on distributions from annuities.

Question 25

annuitization

Answer 25

annuitized payouts are typically made MONTHLY and are taxed according to an EXCLUSION RATIO. Each monthly payment consists of principal + earnings.

principal = return of the cost basis. (that is not subject to taxes; it’s simply getting your original investment back)

balance of the payment is the deferred earnings; that is what will be taxed!

exclusion ratio = the % of each monthly payment that is taxable

Question 26

1035 Exchange

Answer 26

is a tax-free exchange between like contracts.

IRS allows annuity and life insurance policyholders to exchange their policies without tax liability. This provision applies to transfers of cash vales from:

• annuity for annuity
• life to life
• life to annuity
• NOT annuity to life insurance policy transfer

Question 27

***FINRA is concerned about Section 1035 exchange abuses where…

Answer 27

the registered rep emphasizes the tax-free nature of the exchange without pointing out possible disadvantages. Those include:

• possible surrender charges on the old policy
• a new surrender charge period on the new policy
• and possible loss of a higher death benefit that existed on the old policy

Question 28

Qualified ANnuities

Answer 28

contributions to these annuities are made with PRETAX DOLLARS. That meant he investor’s cost basis is 0. Therefore, with any withdrawal, everything is taxed as ordinary income.

If the investor has NOT reached age 59.5, the additional 10% tax penalty applies

Question 29

key difference between the rules for funds and those for variable contracts?

Answer 29

FINRA rule does NOT place a max sales charge on variable annuities.

Mutual funds DO have max load of 8.5% of the offering price.

Question 30

Suitability of variable life insurnce

Answer 30

FINRA is concerned that the sale if variable life insurance is not misrepresented. Although legally defined as a security, it CANNOT BE SOLD SOLELY ON THAT BASIS.

Suitability of a recommendation for variable life, remember these 3 points:

• there must be a life insurance NEED
• the applicant must be comfortable with the separate acct and the fact that the cash value is NOT guaranteed
• the applicant must understand the variable death benefit feature

Question 31

Member’s responsibilities regarding deferred variable annuities

Answer 31

rule APPLIES TO RECOMMENDED PURCHASES and exchanges of deferred (not immediate) variable annuities and recommended initial subaccount allocations.

This rule does NTO apply to reallocations among subaccts made or to funds paid after the initial purchase or exchange of a deferred variable annuity.

In other words, ONCE THE INVESTOR HAS MADE THE INITIAL SUBACCT DECISIONS HAVE BEEN MADE, LATER CHANGES ARE NOTTT COVERED BY THE RULE!

The rule makes the obv statem that NO MEMBER/PERSON ASSOCIATED WITH A MEMBER SHHALL RECOMMEND TO ANY CUSTOMER THE PURCHASE/EXCHANGE OF A DEFERRED VARIABLE ANNUITY UNLESS THE MEMBER OR PERSON ASSOCIATED WITH A MEMBER HAS A REASONABLE BASIS TO BLEIVE THAT IT IS SUITABLE.

Question 32

***1 example of egregious behavior stated int he role is…

Answer 32

recommending that a client take a home equity loan and use the proceeds to fund this purchase of a deferred variable annuity

Question 33

specific suitability requirements…

Answer 33

ruue specifies that, to be considered suitable, there is a reasonable basis to believe that:

• customer has been informed of various features of deferred variable annuities (ie. potential surrender period and surrender charge) which may include: potential tax liability (if customers sell/redeem deferred variable annuities before reaching the age of 59.5), mortality and expense fees, investment advisory fees, potential charges for and features of riders, insurance and investm components of deferred variable annuities, and market risk
• customer would benefit from certain features of deferred variable annuities, such as tax-deferred growth, annuitization, or a death or living benefit, and
• the particular deferred variable annuity as a whole, the underlying subaccts to which funds are allocated at the time of the purchase or exchange of the deferred variable annuity, and riders and similar product enhancements, if any, are suitable for a particular customer based on the info required in the rule

Question 34

1 concern that regulars have with variable annuities is a sales person recommending that an investor…

Answer 34

switch from an existing contract to a new one.

It’s mandatory that registered reps and their supervisors evaluate the suitability of the exchange in light of the investor’s financial condition, objectives, and pros and cons of switch

some of the negative conditions to be aware of are:

• surrender charges imposed by insurance co
• beginning of a new surrender period
• possible reduction in death benefit
• how the expenses fo the new contract compare with those fo the old contract, and
• the benefits included in the new contract may not be needed by the purchaser

Question 35

36-month rule

Answer 35

1 of the factors in determining if the exchange is suitable is taking into consideration whether the costumer has had another deferred variable annuity exchange within the preceding 36 months.

It’s also required that the member mUST HAVE REASONABLE EFFORTS TO ASCERTAIN WHETHER THE CUSTOMER RHAS HAD AN EXCHANGE AT ANY OTHER BROKER-DALER WITHIN THE PRECEDING 36 MONTHS.

An inquiry to the customer asking whether the customer has had an exchange at another BD within 36 months would count as “reasonable effort.”

Members must document this in writing both the nature of the inquiry and the response of the customers.

Question 36

policy loans

Answer 36

variable life insurance contract allows insured to borrow against the cash value that has accumulated in the contract. BUT certain restrictions exist.

Usually, the insured may only borrow a % of the cash val use. Th minimum % that must be made available is 75% after the policy has been in force for 3 yrs.

Question 37

***test topics about policy loans:

Answer 37

• minimum of 75% of the cash value must be available for policy loan after the policy has been in force 3 yrs
• the insurer is never acquired to loan 100% of the cash value. full cash value is obtained by surrendering the policy to the insurer
• if the insured dies with a loan outstanding, the death benefit is reduced by the amount of the loan
• if the insured surrenders the contract with a loan outstanding, cash value is reduced by the amount of the loan

Question 38

variable life insurance contract exchange

Answer 38

a unique feature of variable life insurance is the ability for the insured to have a change of heart!

you have the right to exchange a variable life insurance contract for a form of permanent insurance issued by the co. with comparable benefits (usually whole life).

The length of time this exchange privilege is in effect varies from co to co, but UNDER NO CIRCUMSTANCES MAY THE PERIOD BE LESS THAN 24 MONTHS (FEDERAL LAW).

exchange is allowed without evidence of insurability. If contract is exchanged, the new permanent policy has the same contract date and death benefit as the minimum guaranteed in the variable life insurance contract.

Premiums equal the amts guaranteed in the new permanent contract (as if it were the original contract)

Question 39

testable facts about contract exchange provision:

Answer 39

• the contract exchange provision must be available for a minimum of 2 yrs
• no medical underwriting (evidence of insurability) is required for the exchange
• the new policy is issued as if everything were retroactive. That is, the age of the insured as if the original date is the age used for premium calculations for the new policy

Question 40

sales charges

Answer 40

SALES CHARGES ON A FIXED-PREMIUM VARIABLE LIFE CONTACT MAY NOT exceed 9% of the payments to be made over the life of the contract.

Contract’s life (for purposes of the charge) is a max of 20 yrs.

Question 41

refund provisions

Answer 41

insurer must extend a free-look period to the policy-owner fo r45 days from the execution of the application, or for 10 days from the time the owner receives the policy (whichever is long). During the free-look period, the policy-owner may terminate the policy and receive all payments made.

the refund provisions extend for 2 yrs from issuance of the policy. IF within the 2 yr period, the policy-owner terminates participation int he contract, insurer must REFUND THE CONTRACT’S CASH VALUE (VALUE CALCULATED AFTER THE INSURER RECEIVES THE REDEMPTION NOTICE) PLUS a % of sales charge deducted.

After the 2-yr period has lapsed, only the cash value need to be refunded, the insurer retinas all sales charges.

Question 42

several testable facts about sales charges and refunds are…

Answer 42

• max sales charge over the life of the contract is 9%
• policy-owner who wants a refund within 45 days receives all money paid
• from 45 days to 2 yrs, there is a partial refund of sales charge
• after a variable life policy has been in effect for 2 yrs, the surrender value of the policy is the cash value; there is NO sales charge refund