Risk Management Flashcards
Buy-Sell : Cross Purchase
business owners buying insurance on each other for death, disability
of policies = N x (N-1) ; N is number of owners
Each owner pays premium to the insurance company for the death benefit for the other owners.
Death benefits are provided to the surviving owners.
Decednet’s company stock goes to his/her family or Estate.
Surviving owners will use the death benefits to buy the stock from family or estate.
Buy-Sell: Cross Pros and Cons
Advantages:
- Increase in basis for the surviving owner
- works best if you have fewer owners
- death benefits pass tax-free to surviving owners
Disadvantages:
- younger owners will pay considerably more in premiums if there are big age differences
- hard to implement with growing number of owners
Buy-Sell: Entity Purchase Agrt - Advantages
Preferred solution for businesses with multiple partners.
Death benefit passes tax-free to business.
Business pays policy premiums.
Buy-Sell: Entity Purchase Agrt - Disadvantages
No increase in cost basis to surviving owner(s).
Surviving owner(s) will have substantially more gains upon sale of business (due to lack of step-up).
What is a stock redemption buy-sell plan
Buy-Sell: Entity Purchase Agreements
If the business entity is a corporation, the plan may be referred to as stock redemption buy-sell plan
Buy-Sell: Entity Purchase Agreements
a method to completely transfer business interests back to the business (i.e., the entity) using life insurance policies.
The business purchases policies (pays premiums) on the owners and uses death benefit proceeds to buy back ownership shares from the decedent’s family or estate upon death of a partner.
Owners agree to establish a binding agreement with the business to buy and sell their respective business interests upon either:
Death,
Disability, or
Retirement
Buy-Sell: Entity Purchase Agreements - # of Policies Needed
The number of policies needed is equal to the number of partners and/or shareholders.
When setting up a buy-sell agreement with a larger number of partners, entity purchase plan is the more efficient method.
What’s more efficient method when setting up buy-sell agreements with large # of owners?
Entity purchase plan
Buy-Sell: Wait & See Agreements - 3 step process (BOB)
Following the death of a business partner, the following sequence of steps is set in motion:
Step 1: Business has 1st option to purchase the deceased partner’s stock.
Step 2: Surviving partner(s) have the option to purchase the deceased partner’s stock.
Applies if the business waives the option to purchase in Step 1, or The business purchases less than half of the deceased partner’s stock.
Step 3: Business is required to purchase the deceased partner’s stock.
Buy-Sell: Wait & See - who pays the premium
Owners take on life insurance policies on each other.
the agreement is to wait and see what to do about purchase of the decedent’s stock - Whether the business should buy it or owners should buy it
What are Living Distributions from Life Insurance Policy
Withdrawals and Loans
How are Living Distributions from MEC Policy treated?
LIFO (gains first)
Distributions are taxed as ordinary income + 10% penaliy for early withdrawals
How are living distro from non-MEC policy treated?
FIFO (Basis First = Premium’s First)
Distributions are considered ordinary income and taxed as such
No penalty for distributions
Taxation of death benefits for life insurance policies
Tax-free
7-Pay Test
Applies for Case Value Life Insurance Policies
policies that take in too much premium during the first 7 policy years, or in 7 years after a material change.
For each policy, a net level premium is calculated. If the total premium actually paid into the policy at any time during the 7-year testing period exceeds the sum of the net level premiums needed to result in a paid-up policy after 7 years, then the policy is a MEC.
Onec a MEC Always a MEC
Annuity Contract
It’s a investment contract for right to receive stream of income in the future
Purchaser can make one or multiple payments to insurance company and in exchange insurance company “guarantees” to pay stream of income in the future
Annuity Payments timeline
Annuity Payments can begin immediately or at a future date and can last for the predetermined time.
Accumulation Annuity
AKA deferred annuity
Accumulates funds and grows wealth over time, through tax deferred growth
Has two phases - accumulation phase and income phase (optional)
Grow tax deferred, can take withdrawals (charges may apply)
Income Annuity
Provide the guarantee of a steady stream of income in retirement
Priority is guaranteed income payments, not wealth accumulation
How do surrender charges work for Annuities?
Surrender penalty applies typically over a 7-to-10-year period (or longer)
Fixed Annuity
guaranteed interest;
minimum and current
Equity Indexed Annuity
linked to an index; often S&P 500
point to point
participation rate
spread
caps
Variable Annuity
provides a variety of separate subaccounts which allow assets to be invested in securities such as stocks, bonds, money market accounts, etc.
The account owner can transfer assets between subaccounts.
Usually contain a fixed account which provides a guaranteed interest rate account.
Which annutization would have highest payout ?
- Single Life (ends at death of the annuitant)
- Joint Life
- Joint & Survivor (full, 2/3, 1/3)
Annuity Guaranteed Minimums
ONLY Applicable to Life Annuity Form of Payment
Refund certain - When annuitant dies before the period, lump sum or installment of guaranteed minimums to beneficiary
Period Certain - For a specified period of time
Immediate vs. Deffered Annuity Payments
Immediate payments = distributions start within 1 year
Deffered = distributions start after 1 year
Flexible-Premium
more than one-time contribution in varying $ amounts
Taxation of non-qualified (i.e. after-tax) Annuity
Payout = basis + gains
Gains distributed from a non-qualified annuity are taxed as ordinary income
If Annuity payout is a Withdrawals: 1. Gain taxed as ordinary income
2. Basis taxed as LIFO (10% apply to gains if before 59 1/2)
If Annuity payout is Annuitization:
1. Gain taxed as ordinary income
2. Exclusion allowance is applied from each payment until the basis is recovered.
No step-up at death, as annuities are income in the respect of a decedent (IRD).
Withdrawals from annuity
Withdrawals have LIFO tax treatment (i.e. earnings first)
Subject to early withdrawal 10% penalty prior to age 59 ½.
Sec 1035 exchange
A Section 1035 exchange is used primarily to defer current taxation in the exchange of life insurance and annuity contracts.
Annuity may be exchanged tax-free for other annuities (IRC Section 1035)
Exclusion allowance of annuitization payment
tax free portion = exclusion allowance)
= Basis ÷ expected payout over annuity time (monthly payment x # months when payment is expected)
Exclusion allowance ends when all basis has been recovered.
LEAQ (Loved Elizabeth As Queen)
Life Insurance
Endowment
Annuity
Qualified LTCi
LI can be exchanged for LEAQ
Endowment can be exchanged for EAQ
Annuity can be exchanged for AQ
Qualified LTCI can be exchanged for Q
Named Perils coverage
specifies perils or “causes of loss” that are covered. Everything else is not covered
Open Perils coverage
specifies excluded perils or “causes of loss” that will not be paid. Everything else is covered.
HO-03
Special Form
most comprehensive Homeowners Insurance coverage
Covers CONTENT on a NAMED perils basis
DWELLING on an OPEN perils basis
A HO-03 policy can provide open perils coverage for contents by adding a HO-15 endorsement – remember this by 3 x 5 =15.
HO-05
Comprehensive Form
BEST comprehensive Homeowners Insurance coverage
Covers contents on a open perils basis
HO-03 Dwelling and Content Coverage
HO-03 homeowners insurance provides DWELLING coverage on an OPEN perils basis and CONTENTS coverage on a NAMED perils basis.
HO-08
Modified Coverage for older homes
Used for older homes (150+ years old because of the value of wood work, ornamentation, etc)
Reinstatement Provision
opportunity to renew a lapsed policy (under specified conditions)
Health Insurance Continuation under COBRA
The termination of the employee for any reason except gross misconduct. This includes quitting, retiring, or being fired for anything but gross misconduct - 18 months
Disability (Social Security definition) 29 months
36 months
The death of the covered employee
A reduction of the employee’s hours so that the employee or dependent is ineligible for coverage.
The divorce or legal separation of the covered employee and his or her spouse.
For spouses and children, the employee’s eligibility for Medicare.
A child ceasing to be an eligible dependent under the plan.
HO-4
Renter (4 rent) - Contents + liability
HO-6
Condo owners = cabinetry, content, “studs-in”, not the roof or common areas
6 parts of the HO Insurance Policy
A = for address
B = for backyard
C = for crate-crap
D = damaged/destroyed digs
E = exposure to legal action
F = for others (Fractured Femurs)
Collision Insurance
With an inanimate object - another vehicle, light pole, building etc
Exclusions Not Covered By Homeowners Insurance
Flooding
Earthquakes, landslides, and another ground movement
Termites, rats, and other infestations
Mold
Aggressive or dangerous dogs
Poor maintenance or neglect
Power surges or outages
Home-based businesses
Local building ordinance or law requiring you to bring your home up to code
Intentional damage caused by you or another resident family member
Nuclear hazards
War
Government action
Return of Premium Rider
Refunds the premiums paid over a specified term if the insured is alive at the end of the period or
refunds the premiums paid to the beneficiary at the death of the insured.
The insured pays an additional premium for this rider.
Terminal Illness Rider
Allows a portion of the policy death benefit to be paid while the insured is still alive if the insured has been diagnosed with a terminal illness.
Long-Term Care (LTC) Rider
typically allows a portion of the policy death benefit to be paid while the insured is alive and is in need of long term care services
Spouse Term Rider
allows the spouse of the base policy insured to have a term life insurance rider under a permanent policy insuring their spouse.
Child Term Rider
provides a death benefit in case a child dies before a specified age.
After the child reaches maturity, the plan can be converted into permanent insurance, often up to a multiple of the rider amount, perhaps 4-5x, without the need for medical underwriting.
These riders typically insure all children of the insured parent at one premium cost.
Family Income Benefit Rider
pays a monthly income to the beneficiary in addition to the policy face amount for a stated period of time to help with expenses in a transition period after the death of the insured.
Accidental Death Rider
pays out an additional amount if the insured dies as the result of an accident.
Normally, the additional benefit paid out on death due to an accident is equivalent to the face amount of the original policy, which doubles the benefit, sometimes referred to as the “double indemnity rider.
A policy may offer an accidental death benefit rider in higher multiples of the policy face amount.
Guaranteed Insurability Rider
This rider allows you to purchase additional insurance coverage in the stated period without the need for further medical examination.
The option often is structured in a manner such as every 3 years from age 21 to 40 or some other interval
Waiver of Premium Rider
Future premiums are waived if the insured becomes permanently disabled as a result of injury or illness prior to a specified age.
The disability waiver may have an elimination period before premiums are waived, such as 90 days.
Typically, after the elimination period is satisfied, the premiums paid during the elimination period are refunded.
