Life Insurance

Question 1

Level Term Life Insurance

Answer 1

• initial premium guaranteed for some period of time (longer guarantee, higher premium cost)

Question 2

Re-Entry Term Life Insurance Policy

Answer 2

Permit the insured to be underwritten every five years or so. If the insured is still insurable in the same classification, the premium may actually drop in the sixth year, and for other policies the premium will increase minimally. Unfortunately, if the insured is not in the same physical condition, the premium will increase significantly. At some ages the premium cost may even triple or quadruple.

Question 3

Decreasing Term Insurance

Answer 3

• Premium remains level but amount of death benefit decreases
• have typically been sold to cover home mortgages
• ## one is is that uses straight-line depreciation, but principal of home loans doesn’t decrease in that manner

Question 4

Recommendation when purchasing term insurance to cover a mortgage

Answer 4

Insurance experts generally recommend that if term insurance is used to cover a mortgage, that one of two approaches be used. The first is to purchase a level death benefit policy. If, years down the road, the insured needs less insurance coverage, that policy may be able to be reduced. This strategy guarantees that when the reduction occurs, the policyowner wants it to happen. The preferred method is to incorporate the mortgage need into an overall life insurance needs analysis.

Question 5

Whole Life Insurance

Answer 5

• Premiums higher than those for term but remain throughout policy period
• Cash account is invested in company’s general account (typically conservative in nature)
• Nonforfeiture values provide a benefit payable to policy owner if they discontinue premiums before death of insured
• whole life policies owned by stock companies rarely pay dividends (nonparticipating whole life)
• Whole life offered by mutual companies sometimes pay dividends (participating)

Question 6

Variable Life (VL)

Answer 6

• Designed to combine protection/savings functions of traditional life insurance with growth potential of MF-type investment
• Cash value is not guaranteed and is invested in separate account
• Premiums fixed (and usually higher than whole life), but CV vary
• Typically includes guarantee that DB will never be less than initial face amount
• VL buyer must be willing to give up guarantee of stated cash value in exchange for possibility of enhanced DB and CVs

Question 7

Limited-Pay Life

Answer 7

• whole life policies with shorter premium-paying period (ex. paid up by age 65, then cease)
• due to shorter payment period, premiums higher than those on traditional whole life

Question 8

Single premium whole life

Answer 8

• lump sum premium payment made and no further premiums required
• if surrendered in first few years, there are substantial surrender charges
• considered modified endowment contracts (MECs)

Question 9

Modified Whole Life

Answer 9

• Whole life policy preceded by period of term insurance
• low, term-like premium for number of years that then increase to whole life levels
• Another type of modified whole life insures the lives of children. The policy provides term insurance until the insured reaches a specified age, typically somewhere between ages 18 and 25. When the child reaches this age, the policy converts to a whole life or limited-pay life policy with a lower premium than if the insured had waited until that age to purchase the insurance.

Question 10

Graded Premium Life

Answer 10

• ease people into whole life premium
• Its premium per thousand dollars of insurance is fairly low the first year; then, it increases each year for five to seven years, at which time it reaches its final premium and remains level for the life of the insured. The ultimate premium is typically equal to the premium for a whole life policy that could be purchased a year or two before the ultimate premium is reached.

Question 11

Universal Life Insurance

Answer 11

• no structured premium. Remains in force as long as cash surrender value supports monthly deductions
• no ability to direct investment of cash value
• determining account balance at end is based on: flexible premium paid less mortality charges less admin expenses plus interest
• For exam purposes, remember UL has flexible premiums, flexible DB and cash value is not guaranteed. If client wants flexibility, UL is best option

Question 12

Universal Life Option A (level death benefit option)

Answer 12

Pays a level death benefit. The net amount at risk (NAR) in the policy is defined as the difference between the cash value and the death benefit. Therefore, when the policy offers an Option A death benefit, the NAR decreases as the cash value increases. Although the monthly mortality cost increases with age, the rate is applied to a decreasing net amount at risk under Option A.
- Death benefit is greater of cash value or death benefit

Question 13

Universal Life Option B

Answer 13

Option B (also known as the increasing death benefit option) provides an increasing death benefit, which is the NAR plus the existing cash value. If an Option B death benefit is elected, the NAR remains level throughout the policy’s term. Because the NAR remains level and the monthly mortality cost increases with age, an Option B death benefit election will require greater funding to keep the policy in force than will an Option A death benefit election, all other things being equal.

Question 14

Equity-Indexed Universal Life (EIUL)

Answer 14

These policies provide for a minimum fixed interest rate, but also allow policyowners to use an index option to potentially earn better returns than the guaranteed rate. They are not variable policies, but they blend the security of fixed rate UL with the growth potential of market-indexed returns.

Like equity-indexed annuities (EIAs) (discussed later), these policies are tied to a specific market index—usually the S&P 500, although there are other indexes that may be used. There is no direct participation in the underlying index, and not all of the gains from the index are necessarily credited to the cash value. Participation rates and interest rate caps limit how much interest is actually credited to the policy. Insurance companies can generally change these limits at their discretion.

Question 15

Participation rates for equity-indexed universal life:

Answer 15

Dictates specific percentage of index gain that is credited to the policy

Question 16

Rate cap for equity-indexed universal life

Answer 16

Limits interest an EIUL can earn by placing an upper limit on credited rate

Question 17

Adjustable Life

Answer 17

• encompasses aspects of whole, term, and UL
• policy owner can increase or decrease face amount, premiums, and length of coverage
• can become very expensive term policy if only minimum paid and dividends not adequate to continue

Question 18

First-to-Die Policy

Answer 18

• Can be used in personal or business situation
• pays face amount on death of first of two or more covered persons
• can be used to fund buy-sell agreements
• might be used to cover a mortgage or education fund
• general more than cost of insurance on any one of people insured, but less than combined premium of individual policies on each

Question 19

Second-to-Die Policy

Answer 19

• Pays when last person dies
• Useful in estate tax planning situations when unlimited marital deduction is used
• Premiums for a second-to-die contract are generally lower than the cost of two separate policies. This type of policy is particularly advantageous in situations when one insured is highly rated and older, because the underwriting will concentrate on the person who is likely to be the second to die.
• Traditionally some form of cash value life insurance (like UL) has been used

Question 20

Low-Load Life Insurance

Answer 20

• an outcome of an interest in life insurance policies sold by individuals who do not earn commissions
• Can be any type of product, including term, whole, etc.
• usually marketed through alternate distribution systems - direct to consumer
• only appropriate for people who know what they want and don’t need advice

Question 21

Viatical Settlement

Answer 21

Arrangement in which a terminally ill person sells his life insurance policy at a discount from its face value for current cash. The buyer receives the full face value of the policy when the original owner dies. Here, the death benefit becomes subject to ordinary income tax and the new owner does not receive the favorable tax treatment. Policies can be transferred for value to select individuals, such as the insured, or partners of the insured without triggering this rule.

Question 22

Accelerated Death Benefits

Answer 22

Those benefits paid by a life insurance company to a terminally or chronically ill person—made under a viatical agreement—are paid to the insured income-tax-free. Terminally ill patients, those who have been certified by a physician as having less than two years to live, can use the advance life insurance proceeds for any purpose. Chronically ill patients, those who are disabled to such a degree by their illness that they require a level of care similar to that required to qualify for long-term care benefits (cognitive impairment or the inability to perform two or more activities of daily living), must use the advance life insurance proceeds for necessary care and only up to the IRS per diem limitation amount.

Question 23

Irrevocable Beneficiary Designation (readily testible)

Answer 23

Once a beneficiary is designated as irrevocable, the owner must get written permission from that beneficiary if the owner wants to do anything with the policy other than stop premium payments (and in some cases of divorce, if continued premium payments are court ordered, even this cannot be done). The owner may not change beneficiaries, borrow against the policy, surrender the policy, or assign it absolutely or collaterally without the irrevocable beneficiary’s written permission.

Question 24

Automatic Premium Loan (APL)

Answer 24

• Prevents lapse from occurring if adequate cash value exists, policy loan is created to cover premium
• Interest on APL due on policy anniversary, and if doesn’t occur, loan amount increases to include interest due

Question 25

Reinstatement Clause

Answer 25

The reinstatement clause normally follows the grace period clause. With most companies, it provides that once the policy has lapsed, the owner may reinstate it by paying all back premiums, paying off or reinstating any policy loans that existed at the time of lapse, and providing proof of insurability satisfactory to the company. However, no insurance coverage will have been in place from the date of lapse to the date all reinstatement requirements are submitted, assuming the reinstatement is granted. Upon lapse, and following reinstatement, some companies begin a new full-term contestable period.

No company will allow reinstatement if a policy has been surrendered for its cash value. Unless otherwise requested, a whole life policy lapses to extended term insurance. This is one of the nonforfeiture options discussed later in this module.

Question 26

Contestable Clause

Answer 26

Once a life insurance policy is issued, the insurance company has no more than two years (some states specify one year) to determine if there is any reason that it should not have issued the policy. If the insured dies within the one-or two-year limit, the clock stops, and the insurance company can take any reasonable amount of time required to investigate and determine if there was any material misrepresentation or concealment in the application. Blatant fraud may have no statute of limitations and, in some cases, a fraudulent application allows the insurance company to avoid payment of a death claim even beyond the two-year contestable period. This process is handled on a case-by-case and state-by-state basis in the courts. Likewise, purely fraudulent claims are likely to be contestable at any time (e.g., submitting a death claim for someone who is still alive).

Question 27

Suicide Clause

Answer 27

Under the suicide clause, if the insured commits suicide within one or two years (again, this varies by state) after the policy was issued, the insurance company need only return the cumulative premiums minus any indebtedness (some companies also pay interest). Once the one or two years pass, suicide is treated as any other death.

Question 28

Nonforfeiture Options

Answer 28

3 options when policy owner no longer want to pay premium on whole life or other CV policy:

1) receive cash surrender value –> good when cash is needed, but protection no longer needed. Policy is surrendered and CV net of surrender fees & outstanding loans is sent.

2) Purchase reduced amount of paid-up insurance using CV as single premium –> DB will be reduced but no premium.

3) Purchase extended term insurance using CV for single premium. DB remains equal to face amount but no more premiums due. The length of time the term policy will last is a function of the age of the insured at the time and the current amount of cash value. Policyowners in need of the full face amount of coverage, but for a shortened time frame, and no longer want to pay premiums, would find this desirable.

Question 29

Standard Policy Loan

Answer 29

Policy owner may borrow entire cash value of policy, less amount equal to interest due on next policy anniversary. Most insurance companies charge interest in arrears (after time has passed for which interest is due) though some charge in advance (while state interest is lower, since its charged in advance its often equivalent to higher rate).

• The interest rate may be fixed or variable. More often than not, participating policies use a variable rate. A participating policy that has a fixed interest rate, such as 8%, typically includes a provision called direct recognition. This provision recognizes that the insurance company can earn either more or less than the 8% being charged for policy loans. If it can earn more, the dividends for the policy may be reduced when borrowing takes place. If the insurance company cannot earn as much as the 8%, dividends may be increased. When a variable interest rate is used for borrowing, the dividends are ordinarily the same whether or not borrowing takes place.
• When a policy loan is taken from a variable product, an amount of the cash value equal to the amount borrowed is moved to a guaranteed interest rate account within the policy. The insurance company is accepting the policy values as collateral for the loan, and as any good business would, it wants those values in a secure investment, not one where the values may fluctuate.

Question 30

Conversion Clause

Answer 30

Term insurance policies frequently include a provision that permits the policyowner to convert the term insurance into a cash value form of insurance. Individuals may be compelled to purchase term insurance to meet their long-term needs because the cost of cash value insurance is prohibitive. Once their income increases, they may be able to replace all or part of the term insurance with a policy that more appropriately addresses their long-term needs. This clause often limits conversion to specific forms of cash value insurance and usually permits conversion only up to the policy anniversary nearest the insured’s age 65. Some low-cost term insurance policies further limit the conversion right or exclude it altogether. When the conversion right is restricted, it is often limited to the first five years or so after the issue date of the original term policy.

Question 31

Common Disaster Clause

Answer 31

The common disaster clause is also referred to as a payment delay clause. Simply stated, if the insured and the primary beneficiary die in a common disaster, even if the deaths occur as much as 30 days apart, the beneficiary is presumed to have died first. This automatically delivers the proceeds to the secondary beneficiaries. This can be a good clause to include in order to prevent children from being inadvertently disinherited, especially in the case of a second marriage.

Question 32

Spendthrift Clause

Answer 32

The spendthrift clause also may be attached to the beneficiary agreement. This clause essentially prevents a beneficiary (who may be presumed to be a spendthrift or otherwise unable to handle money well) from assigning any benefits they may eventually get from the insurance company. It prevents this only while the insurer has the money. Once it is in the hands of the beneficiary, there are no restrictions on how they may use the money.

Question 33

Dividend Options for policies issued by MF insurance companies

Answer 33

1. Cash
2. Reduced Premium
3. Accumulate at interest
4. Paid-up dividend additions
5. One-year term (aka 5th dividend option)

Question 34

Dividend - Cash Option

Answer 34

Dividend is paid in cash on policy anniversary. Considered return of premium and is not taxed.

Question 35

Dividend Option - Reduced Premium

Answer 35

• Premium will be reduced by any dividends paid (if exceeds premium due, then one of other options used with balance)

Question 36

Dividend Option - Accumulate at Interest

Answer 36

• Holds dividend in separate account and pays current rate of interest on accumulated dividends.
• At death or surrender, fund is paid out in addition to other policy proceeds
• While dividends on participating policies not taxed as considered return of premium, the interest earned on accumulated dividends is taxable.

Question 37

Dividend Option - Paid-Up Additions

Answer 37

• Small amount of insurance is purchased that has cash value equal to dividend without any medical or underwriting required. This amount is fully paid up and no premiums due to keep that amount in force.
• Cash value of this amount of add’l paid up insurance increases at guaranteed interest rate and generates more dividends. All the growth of these additions is fully tax-deferred.
• Creates greatest long-term increase in death benefit and cash accumulation.

Question 38

Dividend Options - One-Year Term (aka Fifth Dividend Option)

Answer 38

• can purchase one-year term insurance

Question 39

Term Rider

Answer 39

Whole life owner can add term rider for specific period of time. May cost less than separate term policy.
-Terms are available for # of years designed to cover mortgage or other needs that are anticipated to end after certain time.

Question 40

Cost of Living Rider (Increasing Death Benefit)

Answer 40

Increases DB by inflation each year and requires no evidence of insurability

Question 41

Accidental Death Benefit Rider

Answer 41

Another common rider is the accidental death benefit (ADB) rider. The ADB is no longer synonymous with the term double indemnity. In years past, the amount of ADB was approximately double the basic policy. Over the last 20 years or so, the amount of ADB has often been limited in amount, and may be much lower than the death benefit of the basic policy. Today, with million-dollar policies being commonly issued, the maximum amount of ADB offered by an insurance company is substantially less than the face amount.

Question 42

Guaranteed Insurability Option Rider

Answer 42

The guaranteed insurability option, also known as a guaranteed purchase option, permits policyowners to purchase more life insurance on a younger insured at specified times and in specified amounts without providing evidence of insurability up to a specified age limit, which is most often in the insured’s 40s. It is typically offered to purchasers of cash value policies. Furthermore, it provides that the policies purchased under the rider will be issued with the same classification as the original policy.

Question 43

Spouse or Children’s Rider

Answer 43

Certain insurance companies will allow a spouse or child to be added to the cash value policy as an insured for a specified amount. The amounts are typically small, such as $10,000 or $25,000 of coverage. The spouse or children’s rider is generally a level term rider and may permit conversion to cash value coverage without evidence of insurability prior to termination or at the death of the insured. The life insurance needs of both spouses tend to be similar and are normally better served with individual policies; however, a rider with fewer or no underwriting requirements is an excellent tool when insurability issues exist.

A children’s rider has a number of significant benefits. The first is that insurance on children can prevent a financial problem in the event a child dies. The second is the provision that the child normally can convert the rider into a cash value policy when they become an adult. This particular benefit may be for an amount three to five times larger than the amount of the rider. The conversion can include a guaranteed insurability rider as well. The third benefit is the insurability of uninsurable children. If the rider is in place prior to the birth of a child (generally this must be the second child), as soon as the infant is 15 days old, they are insured regardless of any birth defects.

Question 44

Riders Increasing Death Benefit

Answer 44

1) Term Rider
2) Cost of Living Rider
3) Accidental Death Benefit Rider
4) Guaranteed Insurability Option
5) Spouse or Children’s Rider

Question 45

Disability Waiver of Premium Rider

Answer 45

This rider waives the policyholder’s premium payments if they become totally disabled and unable to work for a specified period (usually 6 months or more).

Question 46

Presumptive Disability

Answer 46

Presumptive disability is a provision that may result in the waiver of premium being effective without a total disability of the policyowner.

Presumptive loss can be either “loss of use” or a more restrictive definition (such as loss of eyes, both hands, both feet, or one of each, etc.), and is very specific.

Question 47

Disability Income Rider (DIR)

Answer 47

Some companies offer a disability income rider (DIR), which provides both a waiver of premium and a supplemental income if the insured is totally disabled under the same definitions for waiver of premium. Generally, monthly benefits equal a percentage of the face amount. A common percentage is 1%; therefore, a $100,000 policy would pay $1,000 per month. There may also be restrictions as to the maximum monthly benefit and coordination of benefits with other disability policies or benefits to avoid creating moral hazard. Generally, individual disability benefit policies are more appropriate but underwriting may be less strict, so it may be a viable option for those clients who may have difficulty acquiring the coverage they need.

Question 48

Critical Illness Rider

Answer 48

Accelerate a portion of death benefit for specified illnesses

Question 49

Long-Term Care Rider

Answer 49

This rider allows the policyowner to access the death benefit to pay for long-term-care-related expenses. The amount of death benefit and long-term care allowance are based on the insured’s age, gender, and health at the time of purchase. The death benefit is reduced by the amount used for long-term care expenses plus a service charge.

Restoration of benefit rider can be added too where rider restores death benefit at death.

Question 50

Accelerated Death Benefit Rider

Answer 50

Accelerated payments of the death benefit may be triggered when the insured meets the definition of terminally ill. When this is the case, a percentage of the death benefit can be accessed. IRS law changes were made so that terminally ill patients accessing the cash benefit would not be taxed and the cash received would be treated as if it were a death benefit. The wider availability of the accelerated death benefit riders has reduced the need for the viatical market.

Question 51

Family Income Benefit Rider

Answer 51

This rider provides that the benefit payout will automatically be spread out in monthly benefits, removing the choice of payout options from the beneficiary. It is especially beneficial for minors, spouses who have difficulty managing money, special needs children, or anyone else who is concerned about the beneficiary managing the money. There may or may not be a charge associated with the family income benefit rider.

Question 52

Return of Premium Rider (for term insurance)

Answer 52

Some clients will purchase term insurance and prefer to pay a premium so if they do not die within the time frame, they will receive their premiums back. Requirements are that the policy must be kept the entire time and can cost 20%–40% more than a policy without such a rider. It may make sense for short, level term policies such as 10 or 15 years designed to cover specific items such as buy-sell agreements or a specific loan. Completing an opportunity cost calculation will help answer the question and that will be highly based on the expected rate of return an alternate investment can earn. As with all policy provisions and riders, review the terms carefully. Most policies will just return the premiums paid, while some might credit a small interest rate in addition.