Life Insurance Flashcards
What are the 5 factors that influence risk of an individual dying?
1) age
2) gender
3) personal and family health history
4) smoking habits
5) job and income level
What 2 things is risk of death based on?
1) life expectancy
2) probability of death
In Canada, at birth, what is the life expectancy of males?
79.8 years
In Canada, at birth, what is the life expectancy of females?
83.9 years
What is a mortality table (life table)?
life expectancy and probability of death statistics compiled for each unique & defined group of people in a table
Describe the probability of death for:
a) before age 40?
b) after age 40?
a) before age 40 - low & slowly increases until age 40 (except the first few years of life)
b) after age 40 - increase more & more each year due to age-related problems
What are the 6 financial impacts of death?
1) loss of income
2) loss of caregiver
3) debt repayment
4) income taxes
5) estate creation
6) business impact
How can Death Benefit proceeds from life insurance be used to help?
1) loss of income
2) loss of caregiver
3) debt repayment
4) income taxes
5) estate creation
6) business impact
1) loss of income - minimize financial impact of death on the surviving family
2) loss of caregiver - provide the money to pay for a substitute caregiver
3) debt repayment - repay debts that might otherwise have to be taken from the value of the estate of deceased
4) income taxes - pay the tax liabilities owing on the estate
5) estate creation -
a) pay future education costs of deceased’s children
b) create a legacy (paying an inheritance)
c) give to charity
6) business impact - protect business assets by funding a partnership agreement
What are 4 ways to manage risk?
1) risk avoidance - avoid the situation or circumstance that exposes them to risk
2) risk reduction - when cannot avoid risk, strategy to lessen the risk being exposed to
3) risk retention - individual accepts some or all of the risk (eg. waiting periods or deductibles)
4) risk transfer - when some or all of the risk is transferred from one to another (eg. transfer financial risk from indiv to insurer in exchange of premium payments)
What are the 3 types of Term Insurance?
1) Single Life
2) Joint First-to-Die
3) Joint Last-to-Die
What is the purpose of Joint First-to-Die contract?
provides survivor with capital to use money in any way desired. some insurance companies may offer the survivor the opportunity to continue the same level of coverage on his/her own life under a new policy
What is the purpose of Joint Last-to-Die contract?
useful for estate planning including creating an inheritance for beneficiary and paying estate costs (income tax) - these policies are more commonly used with permanent insurance
What are 3 types of Term policies?
1) Level Term
2) Decreasing Term
3) Increasing Term
Is there tax on Death Benefit paid to beneficiary?
No. Death Benefit is paid tax-free
Why pick a Level Term policy?
- Death Benefit is same as initial face amount
- life insurance needs not expected to change over the term
- policy easy to understand
- cheapest form of life insurance
Why pick a Decreasing Term policy?
- Death Benefit becomes smaller over the life of the policy
- premiums on Decreasing Term are lower than Level Term
- usually offered on a group basis
- policyholder has an obligation (eg. mortgage) that will reduce over a period of time
Why pick an Increasing Term policy?
- Death Benefit grows larger over the length of the policy
- DB increase may be a set dollar amount or percentage of the face amount (total amount of increase may be limited to a maximum DB)
- policyholder expects an obligation to increase in the future (eg. debts or living expenses)
- pay lower premium cost for increasing term vs acquiring additional coverage in the future due to older age
- In Canada, increasing Term is increasingly difficult to find (same effect may be achieved by adding Rider). Increasing Term still offered in USA.
What are the payment options for premiums?
1) monthly
2) quarterly
3) semiannually
4) annually
What is the provincial premium tax on Term insurance?
Premiums are level over the term.
Provinces charge a premium tax on the premium (2-4%) included in the premium cost. Insurance company then pays the provincial government
When premiums are paid monthly, quarterly, or semiannually on Term policies? What is the modal factor used?
Modal factor table is determined by insurance company
Typically, monthly Term modal factor is 0.09
What is mortality cost?
mortality costs approximate the insurance company’s cost of paying out policy death benefits
Term life insurance can either be renewable or non-renewable. True or False?
True.
Non-renewable: expires at the end of the term.
Renewable: right to renew is guaranteed regardless of heath of the life insured
- right to renew is limited to certain age (eg. age 70)
- premiums are higher for renewable than non-renewable
- there may be doubts of future insurability (eg. family health history indicate likelihood of future problems)
Renewable policy guarantees the right to renew the policy at the end of term - does this also guarantee premium rates?
No. Right to renew is guaranteed but new premiums will reflect the age of the life insured at renewal (most policies provide a guaranteed schedule of renewal rates)
Re-entry term is a form of renewable policy. What conditions are reviewed to determine premiums?
Renewal is guaranteed but renewal premium is based on health:
1) if health is better, a lower premium is offered
2) if health deteriorates, the guaranteed renewal rates are higher than those for a renewable policy that doesn’t have re-entry provision
Initial premiums for renewable policy are HIGHER than renewable policy with a re-entry provision. True or False?
True. Life insured doesn’t have to provide evidence of insurability on guaranteed renewal policies there insurance company is taking the risk of continuing coverage to someone whose health may have deteriorated by the time policy is up for renewal
Why pick a convertible Term contract?
- security of knowing Term can be converted to permanent insurance (WL, Term-100, UL)
- can be assured of future death benefit
- can convert without evidence of insurability
- premiums for convertible Term are higher
What is a contestability period?
contestability period is 2 years following issue date of the policy - insurance company can void a policy if it discovers material error made in the application. Material error: an error that would have affected whether the policy would have been issued
** after 2 yrs, a policy can be voided by insurance company only if there was a fraud committed
Does contestability period apply on convertible policies?
No. permanent policy issued after conversion is considered an extension of the initial term policy
What is the suicide exclusion period?
2 yrs following issue date of the original policy. Suicide committed after 2 yr suicide exclusion period will be covered
How to determine original age and attained age of the life insured?
Original age: age of the life insured when policy was first issued
Attained age: age of the life insured on his last, nearest, or next birthday
What is a disadvantage of using Original Age conversion?
a lump sum payment must be made when policy is converted (retroactive conversion) to be in line with what his cost would have been had he chosen permanent policy in the first place. This can be a significant sum
Original age vs Attained age - which of the premiums will be higher after conversion?
Attained age… Original age conversions result in lower premiums for the permanent life insurance
What are the Advantages & Disadvantages of Term Life?
Advantages:
1) low initial costs - more affordable for those who cannot afford permanent insurance
2) premiums are guaranteed over the term
3) renewable and convertible provisions can be used to extend coverage
4) term of coverage can be customized to meet a specific need
Disadvantages:
1) premiums & coverage are not guaranteed beyond the term or renewal period
2) premiums increase as the life insured ages & can become prohibitive
3) coverage is usually not available past a certain age
4) policy is worthless at the end of the term
What 3 situations would be appropriate for Term Insurance?
1) Short-term risks - if there is a possibility that the risk may extend for a longer but not a permanent period of time, then should consider a renewal term policy
2) Decreasing risks - risks that diminish over time (eg. mortgage insurance)
3) Limited cash flow - policyholder may not have enough cash for permanent policy
What are the 3 types of Permanent Insurance?
1) Whole Life
2) Term-100
3) Universal Life
What are the key factors of Whole Life?
1) provides coverage for entire lifetime of the life insured
2) premiums remain level
3) has a set death benefit
4) builds up a cash surrender value (CSV) - can receive payment of CSV minus surrender charges if policy is surrendered prior to death
What are key factors of Term-100?
1) provides coverage for entire lifetime of the life insured
2) has set level premium lower than WL
3) has set death benefit
4) no cash surrender value
5) policy matures at age 100 (ie. premium payments stop at age 100, but life insurance coverage continues)
What are key factors of Universal Life?
1) provides coverage for lifetime of the life insured
2) has 2 parts to the policy - insurance & savings
3) has basic premium and option to deposit more called excess premium which goes into savings component
4) has minimum death benefit w/ option to increase DB
5) savings account offers policyholder different investment options
6) accumulated savings (&investments) are tax sheltered and form part of DB (tax-deferred if funds are withdrawn prior to death)
What is Whole Life insurance?
a form of permanent life insurance - typically guarantees premiums, death benefit, and minimum cash surrender values (CSV)
What is the formula for Mortality Costs?
annual mortality cost = face amt X prob of death
What admin expenses are included in WL policy premiums?
1) marketing expenses
2) salaries & commissions to agents
3) processing applications
4) paying for medical exams
5) paying income taxes
6) investigating claims
7) paying death benefits
What is the formula for Modal Factor?
monthly premium = annual premium X modal factor sample modal factors: semiannually = 0.51 to 0.53 quarterly = 0.26 to 0.30 monthly = 0.087 to 0.09
What are the 3 Premium Options available for payment in WL?
1) Ongoing premiums - fixed price on an ongoing basis
2) Single premium - paid at once in a lump sum (eg. paid-up policy)
3) Limited payment - premium payment limited to a set number of years or age
What are the 2 types of WL policies?
1) Guaranteed WL
2) Adjustable WL
What is a Guaranteed WL?
guarantees DB and a set premium
What is an Adjustable WL?
- DB and premiums are guaranteed for only a certain period of time
- at the end of the guarantee period, insurance company will recalculate mortality costs projections vs actual and adjust premiums or DB accordingly
- premiums are typically lower in adjustable WL
- Adjustable policies no longer in common use in Canada
What is the difference between Participating WL and Non-Participating WL?
Participating WL - offers policyholder the option of receiving a share of the insurance company’s surplus revenues in the form of a dividend
Non-Participating WL - policyholder doesn’t receive dividends, insurance company keeps surplus revenues as retained earnings
Are dividends guaranteed for Participating WL?
No. policyholders have the potential to share in revenue surpluses but not guaranteed - therefore premiums are higher than Non-Participating WL
What are the 6 dividend options for WL Par-Policy?
1) cash
2) premium reduction
3) accumulation
4) paid-up addition (PUA)
5) term insurance
6) impact on death benefits & cash values
What is Cash dividend option in WL?
- policyholder can choose to receive dividend in cash
What is Premium Reduction dividend option in WL?
- policyholder can choose to apply dividend directly again premium for following year
- also called Premium Offset
- in earlier years, dividend is less than premium. however in later years, dividend may be more than premium - excess can be paid out or allocated to other dividend options
What is Accumulation dividend option in WL?
- dividends will be deposited into a separate accumulation account called “Side Account” & earns interest
- accumulated dividend in side account is invested to provide additional growth
- growth in Side Account is taxable
- value that accumulates in Side Account can increase DB so long as it is not withdrawn first
- value of Side Account is paid to beneficiary along with DB when policyholder dies
What is Paid-Up Addition (PUA) dividend option in WL?
- policyholder can use dividend as a single premium to buy more WL
- each PUA is its own policy with own DB and CSV
- PUA cost is based on attained age
- PUA is also considered a Premium Offset
- PUA can be used to increase DB without evidence of insurability
What is Term Insurance dividend option in WL?
- policyholder can use dividend as a single premium to pay for 1-yr Term insurance
- Term insurance has own DB, which is paid out if death occurs during that year
- Term insurance cost is based on attained age
- Term insurance doesn’t require evidence of insurability
What is Impact of DB & CV dividend option in WL?
- PUA may increase both the CSV and the DB
- accumulation option may increase DB if accumulated dividend have not been withdrawn
- Term insurance may temporarily increase DB (for 1 yr only)
What is a dividend illustration?
dividend illustration is a chart or graph that an agent uses to help policyholders understand how participating policies work and to visualize the dividends & effect on DB and CSV
- should use at least 2 dividend scales to set overall expectations of low vs high outcomes
What are the 4 Non-Forfeiture Benefits of WL?
1) Cash surrender value (CSV)
2) Automatic premium loan (APL)
3) Reduced paid-up insurance (RPU)
4) Extended term insurance (ETI)
Why use Cash Surrender Value (CSV) non-forfeiture?
- CSV taken will be taxable
- use when the need for insurance coverage has changed
- use when ability to pay for insurance has changed
What are surrender charges?
surrender charges are used against policy’s cash value to discourage from cashing out before insurance company can recover expenses
- fee is deducted from CSV before it is paid out
- surrender charges decrease over time and are eventually eliminated
How do policy loans in WL work?
- up to 90% of the CSV is available to policyholder as a policy loan
- loan doesn’t have a specified repayment schedule
- interest is charged on loan and accumulates until loan is repaid
- loan doesn’t appear in credit reports
- when policy is surrendered, CSV minus loan minus unpaid interest
- when life insured dies, DB minus loan minus unpaid interest
Why use Automatic Premium Loans (APL) non-forfeiture?
- APL occurs automatically when premium goes unpaid or policyholder gives permission for the loan
- APL can be taken from CSV once or many times. interest is charged against each loan
- when policy loan limit is 90%-100% of CSV is reached, plus a 30 day grace period, the policy terminates & residual CSV if any, is paid to policyholder
Why use Reduced Paid-Up (RPU) Insurance non-forfeiture?
- an option for coverage without continuing to pay premiums
- use CSV as a single premium to pay for a new WL with smaller face amount
- amount of coverage is determined by CSV and attained age
- no need for evidence of insurability
Why use Extended Term Insurance (ETI) non-forfeiture?
- use CSV as a single premium to pay for new Term policy with same face amount as original WL
- duration of Term is determined by amount of CSV & Attained age
- no need for evidence of insurability
- results in same DB as well as temp insurance coverage
What is Limited Payment WL?
- WL coverage while limiting the premium payment period to a set number of years or specific age
- once premiums are no longer required, the policy is said to endow (to provide, give to)
What are the Advantages & Disadvantages of Whole Life?
Advantages:
1) premiums are guaranteed for life
2) coverage continues for life; regardless of age or health
3) par-policy may result in dividends. can receive in cash, accumulate (side account), paid-up addition (PUA), or 1-yr Term
4) WL builds up cash surrender value (CSV) over time that policyholder may receive if he cancels or surrenders the policy
5) in later years, WL premiums will likely be less than premiums for Term
6) WL may offer non-forfeiture benefits in addition to CSV: APL, RPU, and ETI
7) may obtain policy load against the CSV
8) lower volatility in the returns
Disadvantages:
1) high initial costs
2) policyholder has little or no choice over how the policy reserve is invested
3) par-policy dividends are not guaranteed
4) theory to buy Term & invest the difference may result in better financial outcome (provided the policyholder is disciplined to invest the difference)
5) the way policy reserves are invested/managed is not entirely transparent to the public
