Chapter 10: Life Insurance Planning and Purchasing Decisions

Question 1

Financial Needs Analysis

Answer 1

Approach used to determine life insurance needs.
Lump sum needs at Death
Ongoing Income Needs

Question 2

Capital Needs Analysis

Answer 2

Determining how to meet income needs with earnings on a principal sum, without liquidating that sum.

Question 3

Cost of Life Insurance: Surrender Cost Index

Answer 3

Shows the average amount of each annual premium that is not returned if the policy is surrendered for its cash value.

Question 4

Cost of Life Insurance: Net Payment Cost Index

Answer 4

For clients more concerned with death benefit than cash value. Evaluates the cost of insurance protection based on the assumption that the insured dies after the policy’s 20th year.

Question 5

Illustration

Answer 5

Presentation of nonguaranteed elements of policy over a period of years.

Question 6

7 Required Elements of Illustration

Answer 6

1. Name of insurance company
2. Name and address of agent
3. name, age and gender of insured
4. Rating classification upon which illustration is based
5. Generic name of the policy
6. Initial death benefit amount
7. Dividend option election or application of nonguaranteed elements

Question 7

1035 Exchange

Answer 7

Tax advantages for replacement of life insurance contract
Must have:
-same insured and policyowner
-like for like (insurance for insurance; annuity for annuity)

Question 8

Substandard Applicants

Answer 8

• additional hazard increases with age
• additional hazard remain constant
• additional hazard decreases

Question 9

Rate Up Age Method

Answer 9

Used when extra mortality is increasing and will continue to increase.
Use standard policy but add years of age to applicant.

Question 10

Extra Percentage Tables

Answer 10

Most common method for substandard applicants.
Classify applicants into groups based on expected percentage of standard mortality and charge premiums that reflect increase in mortality.

Question 11

Flat Extra Premium

Answer 11

Premium is increased by flat amount and does not vary with age of applicant.
Used when hazard is constant and not likely to change.

Question 12

Lien

Answer 12

Policy issued at standard rates, lien applied if death before end of period specified; death benefit reduced.
Temporary in nature (first few years of policy) until recovery.

Question 13

Viatical Settlement

Answer 13

Sale of terminally ill insured’s life insurance in exchange for percentage of face amount.

Question 14

Life Settlement

Answer 14

Transfer of ownership of life insurance policy to third party investor when insured is not terminally ill.

Question 15

Stranger Originated Life Insurance (STOLI)

Answer 15

Speculators initiate coverage on older people and fund the premium payments with the intention of profiting upon death of insured.

Question 16

Key Employee Life Insurance

Answer 16

Policy taken out by company to protect against the possibility of an income loss or increase in expenses resulting from key employee’s death.
Business is owner and beneficiary of life insurance. Premiums are not deductible and death benefits are not taxable.

Question 17

Buy-Sell Agreement

Answer 17

Contract that binds owner of a business to sell at his or her death to a designated buyer at an established price.

Question 18

Entity Agreement

Answer 18

Firm enters into agreement to buy the business interest of the deceased. Firm liquidates interest of deceased and redeems stock.

Question 19

Cross Purchase Agreement

Answer 19

On death of one owner, his estate will sell the deceased’s interest and the other owners will buy it. All owners hold life insurance on other owners to fund this.

Question 20

Sec. 79 Plans

Answer 20

Group life insurance plans that allow employer a tax deduction for premium payments made on behalf of participants.

Question 21

Split Dollar Life Insurance Plans

Answer 21

Form of life insurance used as an executive compensation benefit. Corporation and employee split policy costs with corporation receiving return of its contributions and beneficiary receiving death benefit.

Question 22

Transfer for Value Rule

Answer 22

If a policy is transferred from one owner to another for consideration, the income tax exclusion is lost.

Question 23

Cash Value Accumulation Test

Answer 23

Cash value may not exceed the net single premium that would be needed to fund the policy’s death benefit.

Question 24

Guideline Premium and Corridor Test

Answer 24

Limits the total premium that may be paid into the policy at any given time. The corridor requirement is met if the death benefit exceeds a specified multiple of its cash value at all times.

Question 25

Inside Buildup

Answer 25

Increase in the cash value of a permanent life insurance policy. Not subject to tax as long as it is left inside the policy. Amounts taken out during life of insured are taxed.

Question 26

1035 Exchanges

Answer 26

Replacing one insurance policy for another is a nontaxable event when old policy is assigned to new insurer.

Question 27

Gift Tax

Answer 27

Tax imposed on transfers of property by gift during the donor’s lifetime.

Question 28

Gift

Answer 28

• a completed transfer and acceptance of property, including money
• a transfer for less than full and adequate consideration

Question 29

Annual Exclusion

Answer 29

Annual Limit of:

Lifetime amount of $5.25 million

Question 30

Nontaxable Gifts

Answer 30

• gifts that do not exceed the annual exclusion
• gifts to the donor’s spouse
• gifts to charities
• tuition paid directly to an educational institution for someone
• medical expenses paid directly to a medical institution for someone
• gifts to a political organization for its use

Question 31

Estate Tax

Answer 31

Imposed on the transfer of property at death.

Question 32

Gross Estate

Answer 32

• property individually owned by the decedent at the time of death
• property held jointly by the decedent at the time of death
• insurance on the decedent’s life
• property transferred by the decedent during his lifetime

Question 33

Incident of Ownership

Answer 33

Defined as an element of ownership or degree of control over a policy.