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CFP > Risk Management > Flashcards

Risk Management Flashcards

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1
Q

What is the difference between static and dynamic risks?

A

Static - result from factors other than changes in the economy and occur w/ regularity and can be insured
Dynamic - result of economic changes, not typically covered by insurance

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2
Q

what is a fundamental risk?

A

risk that affects a large group of people, possibility of loss/no loss

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3
Q

what is pure risk?

A

involves only the chance of no loss or loss, not a chance of gain

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4
Q

what is speculative risk?

A

involves both chance of loss and gain (gambling)

not insurable

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5
Q

what is the most common element in most definitions of risk?

A

outcome is indeterminate

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6
Q

what are the 4 elements to an insurable risk?

A
  1. sufficiently large and similar sample of individuals or events (homogeneous exposure units) to make the losses reasonably certain
  2. loss produced by risk must be measurable and definite, occurring in a clear time, place, and form. The risk of loss must be uncertain, but the amount of the loss must be certain.
  3. loss must be accidental and not intentional
  4. loss cannot be catastrophic to society
    sometimes 5. the need to avoid adverse selection
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7
Q

what is an insurable interest?

A

relationship in which the person applying for insurance will incur a loss from the destruction, damage, or death of insured subject

In life insurance, insurable interest must exist when the contract was purchased but does not need to exist at the time of death.

Insurable interest for property insurance must exist both when the policy is purchased and at the time of the loss.

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8
Q

what are the insurable interest requirements for life and P&C?

A

P&C - exists at time of contract purchase and time of loss
life - exists at contract inception

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9
Q

What are the 5 steps for the risk management process?

A
  1. clarify objectives
  2. identify risk
  3. measure risk
  4. manage risk
  5. monitor risk
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10
Q

What are the 5 ways to treat risk?

A
  1. risk transfer (insurer)
  2. risk reduction (safety)
  3. risk avoidance (don’t do something)
  4. risk acceptance (self insure)
  5. risk diversification (several alternatives)
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11
Q

What are the 5 elements of a legal contract?

A 
offer acceptance
consideration
legal purpose
signatories w/ legal capacity
legal form
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12
Q

Define indemnity

A

policyowner will be reimbursed by insurer only up to actual loss and cannot make a profit (except life insurance)

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13
Q

Define adhesion

A

policyowner can only accept or reject the contract and cannot modify, alter, or negotiate its terms

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14
Q

what are unilateral contracts?

A

only the insurance company legally promises to perform and there is no legally enforceable promise to pay the premiums by the policyowner

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15
Q

what are aleatory contracts?

A

only insurance company legally promises to perform and the dollars collected by parties are usually unequal

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16
Q

what are contracts of utmost good faith?

A

both parties must disclose all facts truthfully or the contract may either be reformed or rescinded

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17
Q

define subrogation

A

policyowner is required to assign the right of recovery against a third party to the insurance company if the company pays for a loss caused by the third party

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18
Q

define collateral source rule

A

damages assessed against a negligent party should not be reduced simply because the insured party has insurance protecting against the specific peril

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19
Q

what is a tort?

A

private wrong, occurring when a person infringes on the rights of another person in a way that gives the injured person the right to sue for damages

Torts include all civil wrongs not based on contracts and are a broad residual classification of many private wrongs against another person or organization.

Torts occur independently of contractual obligations and can result from intentional acts or omissions, strict liability imposed by law, or negligence.

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20
Q

what is vicarious liability?

A

when a person is liable for the torts committed by someone else
i.e. employer liable for acts of employee

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21
Q

What are the defenses to negligence?

A 
assumption of risk (bars recovery for damages if a person understands and recognizes the danger inherent in a particular activity)
last clear chance
contributory negligence (cannot recover damages if own negligence contributed to other's injuries)
comparative negligence (damages adjusted to extent which injured party's own negligence contributed to injuries)
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22
Q

what is strict liability?

A

holds the party committing a tort liable for damages sustained by their action or products whether or not they were “at fault”

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23
Q

what is a special damage?

A

designed to compensate injured person for measurable losses

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24
Q

what is a general damage?

A

compensate injured person for intangible losses

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25
Q

what are punitive damages?

A

not designed to compensate victim, but to punish wrongdoer (typically when wrongdoer acted intentionally or recklessly)

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26
Q

what duties does the agent owe the principal?

A 
performance
notification
loyalty
obedience
accounting
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27
Q

what duties does the principal have to an agent?

A

compensation
reimbursement and indemnification, if needed
cooperation
safe working conditions

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28
Q

express authority

A

actual authority an insurance company gives to its agents, typically spelled in writing and contained in contract

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29
Q

implied authority

A

authority reasonably necessary for agents to carry out their duties

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30
Q

apparent authority

A

insured led to believe that agent has authority

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31
Q

define the McCarran-Ferguson act of 1945

A

insurance regulated by states through insurance commissioner

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32
Q

what does it mean that an insurer is obligated to compensate the insured only if certain conditions met?

A

conditional

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33
Q

what is a promissory warranty?

A

owner will not do something during the time of the warranty (i.e. not using security system)

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34
Q

what is the test of materiality for an insurance misrepresentation?

A

if the insurer had known the truth, would it have affected the underwriting decision to where the policy would not have been issued?

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35
Q

what are the 3 ways property insurance policies value losses?

A
  1. replacement cost (new material of like kind and quality)
  2. actual cash value (replacement cost minus depreciation)
  3. agreed-upon value
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36
Q

what are the two major types of insurance companies and differences?

A

mutual company - owned by policy holders, participating policies that share in profits of company
stock company - owned by stockholders and offer nonparticipating policies

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37
Q

What are the 3 methods for determining the life insurance needs analysis?

A

capital retention method
human life value method
financial needs or insurance needs analysis method

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38
Q

define capital retention method

A

uses interest or earning only to furnish the continued support of the family. original principal/capital saved by the client still remains at the end of the period

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39
Q

define human life value method

A

uses individual’s income-earning ability as basis for determining the required amount of life insurance

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40
Q

what tax rate should be used for the human life value method calc?

A

effective - true percentage of insured’s income, which must be allocated for taxes

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41
Q

define financial needs analysis method/insurance needs method

A

analyzes all recurring expenses of dependent survivors and any unusual expenses resulting from insured’s death, then funds the difference between current assets and needed assets

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42
Q

what is the social security blackout period?

A

SS benefits cease as youngest dependent child at least 16yrs and surviving spouse not net 60yrs

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43
Q

what is a non-qualified annuity?

A

purchased w/ after-tax dollars

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44
Q

what is a unique characteristic of deferred income annuities?

A

future income start dates are chosen at contract issuance, rather than some point in the future

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45
Q

What are the key provisions of final regulations covering the qualified longevity annuity contracts (QLACs)?

A

maximum age at commencement of income (no later than 85)
maximum allowed investment (use of to 25% of account balance or $125k to buy QLAC)
allowing return of premium death benefit (premiums paid but not received as annuity payments will be returned to their accounts and paid to beneficiaries)
protection against unintentional excess payment of premiums (allowed to correct excess without disqualification)
allowing more flexibility (contract must specifically state it is intended to be QLAC

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46
Q

define superannuation

A

risk of running out of money

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47
Q

what are the 2 main rules to follow when selling a variable annuity?

A

FINRA rule 2111 (suitability)

FINRA rule 2320 (members’ responsibilities regarding deferred variable annuities)

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48
Q

what are the key negative elements from a tax perspective for VA’s vs. mutual fund?

A

taxed as ordinary income w/ 10% penalty if withdrawn before 59.5
no step up in basis at date of death

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49
Q

what is a qualified annuity?

A

that purchased through a retirement plan to satisfy an obligation to provide a pension to the retirement plan participant
distributions treated as ordinary income

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50
Q

what is the exclusion ratio?

A

money invested in nonqualified annuity is recovered tax-free (contribution portion)
(investment in contract / expected return)
every dollar paid under annuity consists of premium payments and earnings of annuity (ordinary income tax)

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51
Q

how are payments beyond projected life expectancy treated for tax purposes?

A

fully taxable

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52
Q

how is annuitant taxed if they die before life expectancy and have not recovered basis?

A

unrecovered basis is deductible on final tax return as misc. itemized deduction (2% AGI floor)

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53
Q

what is the variable annuity exclusion ratio calc?

A

investment in contract /

annuitant’s life

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54
Q

what is the main insurance exchange not allowed under a 1035?

A

variable annuity for life insurance

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55
Q

If the distribution from the nonqualified annuity is not annuitized over the owner/annuitant’s lifetime, what tax rule applies?

A

the last in, first out (LIFO)

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56
Q

The type of annuity that provides the maximum income per dollar of premium is referred to as

A

straight life annuity

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57
Q

what is the main advantage and disadvantage of annual renewable term insurance?

A

no evidence of insurability required to renew

premiums recalculated at end of each year and increase with age of insured

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58
Q

what is the accidental death benefit?

A

life insurance policy rider paying out 2x if insured dies accidentally

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59
Q

what type of insurance was traditionally used as mortgage protection insurance?

A

decreasing term life insurance

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60
Q

is unrecovered basis tax deductible?

A

no

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61
Q

what are paid up additions In life insurance?

A

insurer uses policy dividends to purchase incremental amounts of paid up whole life

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62
Q

what is the net amount at risk?

A

difference between the cash value and the death benefit

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63
Q

what are option A and B death benefits? and what happens to the NAR?

A

A - level (NAR decreases)

B - increasing death benefit (NAR constant)

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64
Q

what is the difference in premiums between variable and UL insurance?

A 
fixed, level premium
flexible premium (as long as the CSV can support the monthly deductions for mortality and admin expenses)
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65
Q

what are the important factors an agent/producer should consider when evaluating an existing insurance policy for replacement?

A

existing policy’s relative fair value
issuing company’s ratings
appropriateness of policy for client’s needs
any possible changes in the client’s insurability
client’s risk tolerance level
financial cost of starting over with new policy

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66
Q

what type of life insurance premiums are generally tax deductible?

A

employer’s paid premiums for group term life provided to employees
premium considered as alimony payments

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67
Q

how are life insurance dividends treated for tax purposes?

A

not taxable to the extent they do not
exceed the premiums paid to date
treated as return of premium and reduces basis in policy
anything in excess would be taxed as ordinary income
if policyowner leaves dividends with insurance company, any interest earned is also taxed as ordinary income in the year earned

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68
Q

how are life insurance withdrawals/loans treated for tax purposes?

A

income tax free until owner’s investment in contract (premiums) has been recovered or paid out

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69
Q

what is the 7 pay test?

A

test used to determine which life insurance policies are modified endowment contracts subject to 10% penalty for withdrawals/loans (if below age 59.5)

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70
Q

What do we know about MECs?

A

once a MEC, always a MEC

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71
Q

What are the 5 instances when transfer of a policy will not result in loss of exclusion treatment?

A

Transfer to:
the insured
a partner of the insured
a partnership in which the insured is a partner
a corporation in which the insured is an officer or shareholder
a transferee whose basis in the policy is determined by reference to the transferor’s basis

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72
Q

what is a viatical settlement

A

sale of life insurance policy by terminally ill person to investor to obtain the cash in the settlement to pay ongoing medical expenses (usually 60-90% of policy’s value)
buyer continues to pay premiums until insured death
proceeds received from sale are tax-free and gain also tax-free if used for long-term care

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73
Q

what are the typical rules investors in viatical settlements use?

A

insured owns policy for 2+ years to avoid contestability
insured must be terminally ill with life expectancy 2- yrs
insured signs release of medical record access to investor
insured signs waiver releasing investor of any liability associated w/ changing beneficiary designations

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74
Q

why is traditional net cost method of life insurance policy cost comparison not recommended?

A

does not take into account TVM

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75
Q

how is the increase in cash value of a life insurance policy treated?

A

not taxable as long as it remains in the policy

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76
Q

how is basis of cash value life insurance calculated?

A

total premiums paid - outstanding loans - dividends received

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77
Q

how is gain of cash value life insurance calculated?

A

net cash value - basis

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78
Q

how are loans from modified endowment contracts treated?

A

LIFO basis recovery, meaning loans considered to consist of taxable earnings until all taxable earnings have been withdrawn

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79
Q

how are dividends from participating life insurance policies treated?

A

considered return of premium and not taxable

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80
Q

what is a main disadvantage of a HMO plan?

A

cost of medical care generally not covered if subscriber uses outsider provider

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81
Q

what is a health reimbursement arrangement?

A

participating employee is reimbursed medical expenses by an employer
employees do not need to be covered by any other health insurance plan
unused amounts may be carried forward for reimbursement in later years and contributions are unlimited
deposits are deductible by employer
reimbursements tax free by employees
not allowed for self-employed persons

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82
Q

how are health insurance premiums paid by an employer through a group plan treated for tax purposes?

A

deductible business expense to employer

benefits not included in employee’s gross income

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83
Q

how may an employee who itemizes deductions deduct medical/dental expenses?

A

to extent they pay their own health insurance premiums and other eligible medical/dental expenses, these can be deductible to extent they exceed 10% of AGI

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84
Q

how are costs of health insurance treated for self-employed tax purposes

A

deductible from AGI for federal tax

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85
Q

what is COBRA?

A

program where employer must continue to offer health insurance coverage to employee for certain period after qualifying event (18 mo. for termination) and the former employee only liable for up to 102% of previous cost of coverage with employer
continuation of coverage must be elected by terminating employee (includes individuals who leave on their own accord too)
employers must provide if 20+ employees (govt and church exempt) - 1/2 time employees count as 1/2 person for this total

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86
Q

What is HIPAA (health insurance portability and accountability act of 1996)

A

preexisting medical condition clause unenforceable if:
an employee covered by prior employer’s health insurance plan for at least 12 mo.
fewer than 63 days have elapsed since the loss of coverage under prior employer’s plan

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87
Q

how does HIPAA define a preexisting condition?

A

medical condition treated/diagnosed within 6 mo before enrolling in new group health plan

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88
Q

what are main components of patient protection and ACA?

A

dependents on plan until 26
essential health care benefit coverage lifetime and annual limits prohibited
preventive services must be provided without charging deductible, copay, coinsurance
coverage cannot be cancelled after insured gets sick
higher coverage expenses cannot be applied for emergency services provided out of network
plans must provide in network OBGYNs and pediatricians
cannot discriminate based on employee’s pay or preexisting conditions for children under 19
credits for low income earners
state based health insurance exchanges

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89
Q

what is the penalty for not having health insurance coverage?

A

2.5% of annual household income above tax filing threshold

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90
Q

who is covered under medicare?

A

65 yrs +
individuals receiving SS disability benefits for at least 24 mo
individual on kidney dialysis and in end-stage renal failure
railroad retirement program individuals

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91
Q

what are the 4 parts of medicare?

A

A - hospital insurance
B - medical insurance
C - Medicare Advantage Plans
D - outpatient prescription drug coverage

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92
Q

How is the medicare program financed?

A

2.9% payroll tax - 1/2 paid by employee, other 1/2 paid by employer
FICA not deductible by employee, but deductible by employer as necessary and ordinary business expense
Additional .9% tax levied to employee share for higher earners ($250k MFJ, $200k S)
No cap on tax paid

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93
Q

what is included with medicare part A?

A

hospital care limited to 90 days/yr
lifetime reserve of 60 additional hospital care days
skilled nursing care (only if condition expect to improve)
home health services (80% paid by insurance, 100 visits covered)
care in hospice for terminally ill (life expectancy < 6 mo, 210 days covered)
cost of blood (after first 3 pints paid for by insured)

typically do not pay premium if they or spouse have 40+ quarters of medicare-covered employment

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94
Q

what is the main advantage of medicare pt. C?

A

allows individuals to chose alternatives and have a single inclusive packaged plan which processes all of their health insurance claims

95
Q

which medigap policy is least expensive and provides least coverage?

A

policy A
may not include pre-existing conditions
must be guaranteed renewable
cover some copays and deductible from medicare part A and B

96
Q

who is Medicaid provided to?

A

indigenous and impoverished (133% of poverty level)

administered by states, partially funded by federal govt

97
Q

what is the lookback provision for Medicaid?

A

Medicaid law that looks back 60 months for assets transferred to others to make the insured seem improverished and qualify for nursing home care under Medicaid
ineligible for amount of assets transferred divided by cost of care per month

98
Q

what is the health insurance breakpoint?

A

The breakpoint is the dollar amount of covered expenses after which the insurer begins paying 100% of covered expenses and is the sum of the deductible and stop-loss limit.

99
Q

what are the HSA qualifications?

A

For 2018, a high-deductible single-coverage health plan must have a deductible of at least $1,350 and a maximum out-of-pocket of $6,750.

For 2018, a high-deductible family-coverage health plan must have a deductible of at least $2,700 and a maximum out-of-pocket of $13,500.

20% penalty if withdrawn before 65 yrs of age or for non-medical use

catch up contribution of $1k if 55-65 yrs old

100
Q

what types of nursing benefits does medicare provide?

A

Medicare provides only limited skilled nursing facility benefits and no custodial care or nursing home care benefits.
covers full cost for first 20 days and partial for next 80 days
physician must certify care is necessary and nursing home must be approved

101
Q

what part of medicare covers hospice care?

A

part A

102
Q

what priority does medicare take if the insured is covered by an employer health plan as well?

A

secondary

103
Q

what is a PPO?

A

contracts negotiated w/ healthcare providers to provide certain services to group members at a reduced rate on a fee-for-service basis
allows members to receive care outside of in-network provider for increased expense

104
Q

What is the definition of own occupation disability?

A

the inability to engage in your own occupation. insured eligible for benefits if they are unable to perform own occupation, even if they can still perform some other occupation

105
Q

what is the definition of modified own occupation disability?

A

closely related to own occupation. the insured cannot be working to claim benefits

106
Q

define “any occupation” disability

A

insured eligible for benefits only if unable to perform duties of any occupation

107
Q

define “modified any occupation” disability

A

the insureds’ inability to engage or perform any occupation for which they are deemed reasonably qualified by education, training or experience

108
Q

what is the social security definition of disability?

A

individual must suffer mental or physical impairment that prevents him from engaging in any substantial gainful employment.
disability must have lasted for 5 months and be expect to last for at least 12 months or result in the death of that individual

109
Q

what is the presumption definition of disability?

A 
included in some policies where the individual is presumed disabled
total blindness
loss of speech/hearing in both ears
loss of both hands
loss of two appendages
110
Q

define residual disability rider

A

if disabled worker returns to work at lesser pay, the policy will pay the difference between the former and current pay for the benefit period
benefit usually payable in proportion to the insured’s reduced earnings in a range

111
Q

define partial disability rider

A

insured unable to perform one or more important duties of own occupation, but is able to perform some duties
policy will pay a partial benefit of total

112
Q

define morbidity rate

A

probability of a person becoming disabled

113
Q

define social insurance substitute (SIS) rider

A

integration of private disability insurance policy with social security disability coverage
operated to reduce disability policy benefit the amount of social security the disabled person is eligible to receive
reduces premium for insured

114
Q

define future increase option rider

A

protects future earnings by allowing policyowner to increase potential monthly benefit as insured gets older and earns more, regardless of health changes

115
Q

define the noncancelable continuation provision

A

guarantees renewal of policy for stated period without any increase in future premiums
most liberal continuation policy

116
Q

define the guaranteed renewable provision

A

right to renew guaranteed, but insurance company permitted to increase premiums if it does the same for the entire group of policyholders
required to renew for specified period regardless of changes in health of the insured

117
Q

define the conditionally renewable provision

A

may not be cancelled by insurance company during policy terms
company may refuse to new policy for subsequent term if certain conditions exist as specified in policy

118
Q

what is the coverage period for ST disability?

A

2 yrs

119
Q

what is the general rule for taxation of benefits for disability contracts?

A

premiums paid 100% by employer = immediate tax deduction
employee pays taxes on 100% of benefit
if premium payment split, portion employee pays is not deductible, but benefits would be tax-free

120
Q

define business overhead expense insurance

A

covers usual and necessary business expenses if the owner becomes disabled
covers ongoing costs of operation, but does not cover salary during this time
premiums are deductible business expense to company, but proceeds taxable income to business

121
Q

what are the key considerations when evaluating LT disability coverage?

A

amount of benefit should be appropriate given insured’s income being replaced
terms should match work-life expectancy
should cover both accident and sickness
elimination period should be covered by emergency fund + 30 days
disability definition should be appropriate
policy should be noncancelable/guaranteed renewable

122
Q

define tax-qualified LT care policies

A

established w/ HIPAA
premiums paid by policy owner are deductible as medical expenses if itemizing, subject to 10% AGI limit up to a certain $ amount depending on age
benefits generally excluded from taxable income
premiums must be paid w/ after-tax dollars if paid by employer

123
Q

to qualify for favorable tax treatment, what are the main features LTC policies must have?

A

guaranteed renewable/noncancelable
cannot pay for expenses reimbursable under medicare
cannot require hospitalization before paying nursing home benefits
preexisting conditions excluded up to a max of 6 mo after contract issuance
The policy cannot provide a cash value
All dividends must reduce future premiums or increase future benefits
cannot exclude specific illness
inflation protection offered

124
Q

what are the two criteria an insured must meet to qualify for LTC benefits? (must meet one of two)

A
  1. insured must be chronically ill (unable to perform, without substantial assistance, 2 of 6 activities of daily living (ADL) for at least 90 days - eating, bathing, dressing, transferring from bed to chair, using toilet, maintaining continence
  2. substantial services required to protect individual from threats to health and safety because of cognitive impairment
125
Q

define pool of money approach for LTC benefits

A

insured entitled to specific dollar amount benefit

benefit period equals however long dollars will last paying for care

126
Q

7 basic services covered by LTC policy

A 
skilled nursing care
intermediate nursing care
custodial care
home health care
assisted living
adult day care
hospice care
127
Q

define partnership LTC insurance

A

programs bring together state govt and private insurance companies with intent of protecting insured’s assets but still allow to qualify for LTC through medicaid

128
Q

what are the 4 alternatives to LTC insurance?

A

viatical settlement
accelerated benefits rider with life insurance policy
Medicaid eligibility
self funding

129
Q

what are the key factors that can be adjusted to reduce LTC insurance premiums?

A 
increase elimination period
decrease years of coverage
decrease daily benefit amount
decline inflation protection
purchase coverage at younger age
130
Q

what are the main perils excluded from HO policies?

A 
earthquake
flood
neglect
war/nuclear hazard
power failure
intentional loss
131
Q

what should the CFP recommend their clients insure their homes for?

A

ALWAYS 100% replacement cost value

132
Q

what is the amount of insurance required for partial losses to the dwelling (coinsurance clause)?

A

80% of replacement cost

133
Q

if house is not insured for at least 80% replacement cost value, what is the reimbursement in the event of a partial loss?

A

greater of:

  1. actual cash value of part of the dwelling damaged
  2. (insurance carried / insurance required) x amount of loss, less deductible
134
Q

what is the most common HO policy and what is covered?

A

HO-3
real property covered on open-perils basis unless specifically excluded
personal property covered on named-perils basis
structures covered on a actual cash value basis, but endorsement may be added to provide replacement cost coverage

HO-5 is same as 3, except also include open peril coverage for personal property

135
Q

what are the main duties after loss in a HO policy?

A

give notice immediately to insurance company
protect property from further damage
prepare inventory of loss to dwelling/personal property
file written proof of loss with insurance company in a specified time period

136
Q

what are the 3 main losses covered under a personal automobile policy?

A

damage to or loss of insured’s vehicle
injury to insured or family members
legal liability for personal injuries and damages to property

137
Q

what is the difference between a tort liability state and no-fault state for auto insurance?

A

no-fault - insured cannot sue other drivers for damages

138
Q

what is the standard coverage under a personal liability umbrella plan (PLUP)

A

1M

139
Q

what coverage is provided by HO-15

A

The HO-15 provides open peril coverage for personal property owned, used, or worn by the insured.

140
Q

what are the main principles of workers’ compensation laws?

A

employee gives up right to sue employer in exchange for benefits
paid through premiums paid solely by employer
benefits are periodic payments
injured employee not required to prove negligence on part of the employer
benefits are excluded from the employee’s gross income for tax purposes

medical, disability, death, and rehab coverages included

141
Q

what does HO-8 cover?

A

The HO-8: Modified Form (for Older or Historic Home) is designed for an older home whose replacement value exceeds its market value. uses functional equivalent materials to repair/replace

142
Q

what does HO-6 cover?

A

HO-6: Unit Owner Form (for Condominium Owners) covers the personal property of the insured for the same named perils listed in a HO-2 policy, except HO-6 insurance is for people residing in a condominium or cooperative apartment. This type of policy also provides liability protection.

143
Q

what type of coverage does HO coverage E provide?

A

claims from both bodily injury and property damage, typically up to $300k

144
Q

what does coverage D of a HO policy provide?

A

pays living expenses incurred when house is uninhabitable by covered peril
typically limited to 20% of coverage A limit on dwelling

145
Q

what does coverage F of HO policy provide?

A

The medical payments coverage (Coverage F: Medical Payments to Others) under a standard homeowners insurance policy will pay $1,000 of injured person’s medical bills even though the policyowner may not be at fault.

146
Q

what does coverage B of HO policy provide?

A

detached structures
up to 10% of dwelling coverage

land never covered across ANY HO policies

147
Q

what are the special rules for a stock option to qualify for tax-favored status (LT capital gain) as an incentive stock option?

A
  • part of written plan approved by stockholders of corporation
  • exercise date of option cannot exceed 10 years from grant date
  • exercise price cannot be less than market price of stock at date of grant
  • max value of stock w/r/t which ISO may first become exercisable in any one year is $100k
    share received through exercise cannot be sold within 2 yrs of date of option’s grant and 1 yr from date of option’s exercise
148
Q

what are the tax consequences of the nonqualified stock options at grant, exercise, and stock sale dates?

A

no tax
compensation income to employer, deduction for employer
ST/LT gain depending on holding period

149
Q

what is the tax consequence of an incentive stock option at exercise date?

A

AMT adjustment to employee, no deduction for employer

150
Q

what are the Employee stock purchase plan requirements?

A
  1. written plan approved by shareholders
  2. option grant price must not be lesser of 85% FMV on grant date OR 85% of FMV of stock on exercise date
  3. no employee can buy more than $25k of stock/yr
  4. shares acquired must be held by employee at least 2 yrs from date of grant of option and 1 yr from date of exercise (for favorable tax treatment)
  5. outstanding options must be exercise within 3 mo. after leaving company
  6. employees owning 5%+ may not participate
151
Q

which employees are not included in an ESPP?

A

employees w/ less than 2 yrs of employment
highly compensated
part-time/seasonal

152
Q

what is the tax treatment of ESPP’s?

A

employee recognizes ordinary income based on lesser of FMV of stock at grant date less option price, or FMV of stock on disposition date less option price
balance of gain = capital gain
if option price = FMV of stock at date of grant, all gain at disposition will be capital gain
limit of $25k/yr
3 mo to exercise after separation of service

153
Q

when does the substantial risk of forfeiture exist w/ an ESPP?

A 
employee:
not w/ employer for specified period
does not meet sales/performance goals
goes to work for competitor
works for corporation not controlled by immediate family members
154
Q

what is a section 83(b) election (for restricted stock only)?

A

employee receiving restricted stock may elect to recognize W-2 compensation income immediately rather than waiting until substantial risk of forfeiture expires
if made w/in 30 days, employee includes as W-2 income FMV of stock less amount paid for stock
subsequent appreciation = capital gains

155
Q

what are junior class shares?

A

voting and dividends rights subordinate to regular common stock
convertible subject to specified events
taxed deferred until sale of regular shares
sale price - basis is taxed as capital gain

156
Q

what are phantom/shadow stock arrangements?

A

taxed as ordinary income upon payment, deduction for employer
pays benefits in cash
type of unfunded deferred compensation plan
exercise date controlled by employer
tracks actual stock price and pays accordingly upon exercise, without providing ownership

157
Q

what are stock appreciation rights?

A

give employee choice when to exercise right to share in appreciation of closely held company’s stock

158
Q

how is restricted stock taxed upon earning?

A

ordinary income, may not be sold or gifted until future specified date

159
Q

what are the key tax implications of gifting a NQSO to a qualified charity?

A

no gain on transfer
charitable income tax deduction in yr of gift
no ordinary income if charity exercises option after giftor death
ordinary income if exercised while giftor living

160
Q

what is a bargain element and how taxed?

A 
ordinary income (in lieu of salary)
difference between FMV of stock and option's exercise price
161
Q

when are nonqualified deferred compensation plans most helpful?

A

employer wishes to provide deferred comp benefit to executive(s) at fraction of administrative cost

162
Q

what are the main characteristics of a nonqual deferred comp plan?

A 
established anytime
not subject to nondiscrimination rules
flexible
employee deferral of income
deferred employer deduction
taxable as ordinary income
163
Q

what are the 2 ways a nonqual comp plan may be structured?

A 
salary reduction (pure deferred comp)
salary continuation
164
Q

what are the 3 income tax doctrines a nonqualified plan must follow to defer taxable compensation?

A 
constructive receipt (unrestricted access to funds)
economic benefit (greater rights granted to exec on employer's property than general creditors)
substantial risk of forfeiture (no certainty/guaranty of compensation)
165
Q

if nonqualified deferred comp plan is funded, executive is taxed at later of:

A

date employer contributions to trust/escrow fund are made

date there is no longer a substantial risk of forfeiture associated with the fund

166
Q

what are the 2 types of unfunded NQDC plans? (able to defer taxes)

A

pure unfunded - only promise made to pay benefit

informally funded - underlying assets owned by company, rather than exec and subject to claims of creditors

167
Q

what are the 2 ways informal funding of a NQDC plan creates taxation to employer?

A

earnings from underlying assets funding the plan are taxed at corporate income tax rates
set-aside reserve may create additional tax

168
Q

why is COLI a popular funding vehicle for NQDC plans?

A

cash value buildup is not currently taxed to exec
policy purchased on exec’s life and owned by employer to fund benefit
policy provides funds to pay benefit in event of exec’s death before retirement
The employer may not deduct interest paid on loans borrowed from COLI policies, except under limited circumstances.
employer not permitted to deduct premiums paid

169
Q

what is a rabbi trust?

A

employer places asset into irrevocable trust to fund payment of promised deferred comp to execs
assets remain subject to claims of general creditors in event of company’s insolvency or bankruptcy
employer pays tax on typical earnings in trust
(still has substantial risk of forfeiture)

170
Q

what is a secular trust?

A

irrevocable trust for exclusive benefit of exec
funds inside are not subject to claims of general creditors
exec benefitting does not have substantial risk of forfeiture and is tax immediately on employer contribution and on trust earnings annually
employer receives immediate tax deduction
typically popular where corporate marginal tax rates are greater than those for individuals

171
Q

what is an excess benefit plan?

A

nonqualified plan focusing on providing retirement income to execs
lack of security in payment, just based off of promise
unfunded, not subject to nondiscrimination rules or many of the ERISA requirements

172
Q

what is a supplemental executive retirement plan (SERP)?

A

nonqualified salary continuation plan
purely unfunded or informally unfunded
protects from involuntary termination
designed to provided specified % of retirement income without regard to section 415 benefit limit
taxable to exec as ordinary income when paid out

173
Q

what are the main nonqualified plan distribution rules from the AJCA (American jobs creation act)?

A

participant can not determine when they will receive plan distributions, rather this is specified in plan document
distributions payable only upon separation of service, death, disability, change in ownership of the company, or unforeseeable emergency
key employees who leave company cannot take distribution from plan for 6+ months from separation
significant restriction of offshore rabbi trust designed to avoid US income tax

174
Q

what are most appropriate situations to implement a nonqualified plan for exec client?

A

employer wants to provide benefit solely to exec(s)/key employees and above the standard qualified limit
exec wants employer to help with meeting certain financial planning goals
employer wants to recruit, retain, reward execs/key employees

175
Q

define key employee life insurance and benefits

A

life insured applied for, owned by, and payable to business on life of key employee
premiums not deductible, benefits received tax free

176
Q

define split dollar life insurance

A

arrangement between employer/employee with a sharing of the costs and benefits of the life insurance policy

at the employee’s death, the corporation receives back its contributions.

the premiums paid by the corporation are not tax deductible.

they allow discrimination in favor of certain classes of employees.

the employer is named beneficiary to the extent of the policy cash value and the employee has the right to name her own beneficiary for the difference between the total death proceeds payable and the cash value.

the employee’s share of each premium payment is generally the difference between each year’s cash value increase and the amount of the net premium due.

cash value policies are universally used with the employer’s share of the annual premium being measured by each year’s increase in cash value.

each year, employee must pay income tax on economic benefit derived

177
Q

define collateral assignment method of split dollar life

A

employee is owner of policy and responsible for premium payment
employer makes interest-free loans to employee equal to premium amount
upon death, employer recovers loan from death proceeds, remainder of death benefit paid to employee’s designated beneficiary

178
Q

define endorsement method of split dollar life

A

employer owns policy and responsible for all premium payments
when employee dies, employer receives portion of death benefit equal to cash value of policy (or at least portion) with remainder of proceeds payable to employee’s beneficiary (employer is typically beneficiary to extent of premiums paid)
employee must pay income tax each year on economic benefit of plan
premiums not deductible
benefit = tax free
if employer terminates, employer receives entire cash value and insured receives nothing

179
Q

when to recommend endorsement method?

A

exec is not majority shareholder
otherwise, ownership of employer could be attributable to employee and policy death benefit may be included in employee’s gross estate at death

180
Q

when to recommend collateral assignment method?

A

exec is majority shareholder

choose to establish ILIT and exclude from employee’s gross estate at death

181
Q

what is a section 162 executive bonus plan

A

employer business pays employee bonus = premiums due on personally owned life insurance policy of employee
employer deducts premium amount as additional compensation to employee
employee reports compensation as ordinary income

182
Q

what is a DBO (death benefit only) plan?

A

NQDC plan where employer corp is owner and beneficiary of insurance policy owned on life of valued exec
death benefit paid from policy is forwarded to exec’s heirs in lieu of compensation previously deferred
payments not included in gross estate (unless exec is 50%> controlling shareholder)
payment of death proceeds constitutes income to heirs

183
Q

when is life insurance allowed in qualified plans?

A
  1. aggregate premiums paid for term/UL policy cannot exceed 25% of employer’s contributions to plan (50% if whole life)
  2. death benefit cannot be more than 100x expected monthly benefit to be paid to employee under the plan
184
Q

when are all premiums paid by company on GTLI included as income to employee?

A

if company discriminates on his behalf and is key employee

185
Q

what is a cafeteria plan?

A

employees may choose the form of benefits (certain number of dollars or credits to spend)
plan must include cash option (in lieu of noncash benefits of equal value) taxable as W2 compensation income
Qualified benefits, which exclude the cash option, are an exception to the constructive receipt rules of income taxation.
most appropriate with varying group needs
key tax-free benefits: scholarships, educational assistance, employee discounts, retirement or nonqualified plan benefits

186
Q

what is an FSA?

A

cafeteria plan funded entirely through employee salary reductions (with no employer contribution)
$2700 health limit
$5k dependent care limit
no income or payroll/FICA tax
typically for companies w/ many employees (not allowed w/ self-employed)
$500 unused amounts can be paid/reimbursed to participant
grace period of 2.5 months

187
Q

what are commonly covered items w/ FSA?

A

deductibles on group health insurance
coinsurance provisions on group health
dependent care expenses

188
Q

what’s included w/ prepaid legal services?

A

bankruptcy assistance, adoption assistance, divorce legal fees assistance, preparation of estate planning docs

189
Q

what are the characteristics of group carve out plans?

A

employer reduces GTLI coverage on highly paid employees to no more than $50k
premium = taxable compensation to employee, deductible by employer
employer pays premium on CV policy that provides death benefits in excess of $50k
permanent policy owned by employee

190
Q

what are key characteristics of voluntary employees’ beneficiary associations (VEBA)?

A

may be used for severance
permit acceleration of employer’s tax deduction in funding future benefits
income may be tax exempt

191
Q

how are payments, including death distributions, from a nonqualified annuity taxed?

A

as ordinary income excluding basis of contract

192
Q

what are the life insurance policy reinstatement requirements?

A

lapse period cannot exceed 3-5 yrs defined in contract
policy must not be surrendered for cash value
acceptable proof of insurability provided
all premiums due from time of lapse must be paid with interest

193
Q

what are the interest-adjusted method of comparing life insurance policy costs?

A

surrender cost index

net payment cost index

194
Q

what is the only coverage required under a personal auto policy?

A

liability

195
Q

what is a modified whole life policy?

A

low fixed premiums for first 3-5 yrs, then higher premium for remainder of life of policy

196
Q

What are the 3 nonforfeiture options available when surrendering or discontinuing premium payments on a whole life insurance policy.

A
  1. The policyowner can surrender the policy in return for receiving the cash surrender value of the policy.
  2. leave the cash value with the company and receive a smaller amount of fully paid-up insurance.
  3. leave the cash value with the insurance company in exchange for retaining the full amount of the original policy’s death benefit, but as a term insurance policy for a guaranteed period.
197
Q

Which HO coverage insures the dwelling and other structures on an open-perils basis?

A

Under HO-3, all direct physical losses are covered, unless specifically excluded.

excluded earthquakes and floods

198
Q

what is covered under a comprehensive liability policy?

A

The policy promises to pay for sums that the insured becomes legally obligated to pay.
The policy covers liability for bodily injury and property damage.
This coverage includes exposure at or away from the residence.
No coverage is provided if the act that caused the injury was intentional.

199
Q

define Negligence per se

A

situation in which the injured party is relieved of the burden of proving negligence because the act itself (e.g., drunk driving) constitutes negligence.

200
Q

define “res ipsa loquitur”

A

“the thing speaks for itself.” The presumption in such situations is that the incident would not have occurred without negligence on the part of someone; therefore, negligence is presumed.

201
Q

what are the coverage limits for personal auto policies?

A

bodily injury for one person / bodily injury for all persons / property damage

202
Q

define legal capacity

A

requires that the parties entering into the insurance contract must be capable of entering into a contract per law and have the ability to understand the terms and conditions. Minors and mentally incompetent individuals are not considered to have sufficient legal capacity to understand the contract. Therefore, the parties must be of majority age and must be mentally competent.

203
Q

The automatic premium loan provision

A

provides that the premium will automatically be charged against the policy cash value if it is not paid by the due date.

204
Q

The pair and set option allows the insurer to

A

repair or replace any part of a set or pair, or pay the insured the difference between the actual cash value (ACV) of the pair or set before and after the loss.

205
Q

The spendthrift clause is usually included in a life insurance policy to

A

protect the policy proceeds and prevent the beneficiary from assigning his interest in those proceeds to someone else.

This clause is often used to protect the proceeds from the beneficiary’s creditors.

The spendthrift clause is only enforceable while the insurance company holds the policy proceeds.

206
Q

what is included in a CPP - commercial package policy?

A

Covered forms generally include property, general liability, crime, boiler and machinery, inland marine, commercial auto, and farm.

207
Q

The purpose of the grace period is

A

to allow the insurance policy to remain in effect even though the premium payments are in arrears.

208
Q

uninsured motorist coverage characteristics

A

Uninsured motorist insurance is a form of auto insurance that pays for bodily injury caused by a motorist who is not insured.

Payments are made to insureds who would have been entitled to damages if the at-fault driver had carried liability coverage.

Covers insureds struck by uninsured or hit-and-run drivers.

Covers the insured if a driver’s insurance company has become insolvent.

named insured, their family members, and anyone operating the insured vehicle is covered if this coverage is paid for

209
Q

define life annuity with period certain

A

life annuity that provides a guaranteed minimum number of benefit payments whether the annuitant lives or dies.

210
Q

how are life insurance premiums paid by an employer who is not the beneficiary on behalf of employee?

A

deductible to employer

compensation to employee

211
Q

how are annuities purchased before and after 8/14/82 treated for tax purposes?

A

before - FIFO (withdrawals first come from return of basis)

after - LIFO (withdrawals first come from earnings and are taxed)

212
Q

what are the COBRA coverage term limits?

A

termination, reduction in hours - 18 mo
disabled - 29 mo
divorce, medicare, death - 36 mo

coverage must be elected within 60 days from qualifying event and premiums paid 45 days after COBRA election

213
Q

what is the last-month rule with an HSA?

A

if eligible for HSA on Dec. 1st, then eligible for entire year (individual contribution limit of $3500/yr + $1k catchup if 55+ yrs old)

214
Q

When a corporation is both the owner and the beneficiary of the disability policy,

A

premium payments are nondeductible by the corporation and the corporation receives the insurance proceeds income tax-free.

215
Q

what services are covered under medicare pt. B?

A

Physicians’ services
Outpatient hospital services
Diagnostic tests and x-rays

216
Q

what are the eligibility requirements for homeowner’s insurance?

A
  1. must be owner-occupied
  2. 2 families max
  3. each family may have a max of 2 boarders/roomers
217
Q

what is included in HO policy, section 1 part A ?

A

dwelling - attached structures, includes construction supplies

excludes land

218
Q

what is included in HO policy, section 1 part B ?

A

garage and other detached structures
generally insured for 10% of dwelling
does not apply if used for business, rental, or for land

219
Q

what is included in HO policy, section 1 part C ?

A 
personal property (covered worldwide)
generally 40-50% of dwelling
220
Q

what is included in HO policy, section 1 part D ?

A

living expenses or loss of income resulting from loss of use

typically 10-20% of dwelling value, lasting duration it takes to rebuilt/repair dwelling

221
Q

what are the 8 general exclusions in most HO policies?

A 
ordinance/law
earth movement
water damage
power failure
neglect
war
nuclear hazard
intentional loss
222
Q

what are the following HO limits for:
comprehensive personal liability
damage to property of others
medical payments to others

A

$100k
$250-500
$1k

223
Q

what are the basic named perils? (12)

A 
fire
lightning
wind
hail
riot
aircraft
vehicles
smoke
vandalism
explosion
theft
volcanic eruption
224
Q

what are the additional broad named perils? (6)

A

falling objects
weight of ice, snow, sleet
accidental discharge/overflow of water
sudden and accidental tearing, cracking, etc. from within a household appliance
freezing of household appliance
sudden and accidental damage from artificially generated electrical current

225
Q

what are the coverages under dwelling property 1?

A

A - dwelling
B - other structures (i.e. garage)
C - personal property (10% limit)
D - rental value (up to 10% of policy value for loss of rent)

226
Q

what are the 8 auto premium factors?

A 
territory
age, sex, marital status
use of auto
driver ed
good stfudent
number/type of auto
driving record
credit score
227
Q

what are the six parts of a personal auto policy?

A 
A - liability
B - medical payments
C - uninsured motorists
D - damage to your auto
E - duties after accident/loss
F - general provisions
228
Q

what standards must be met to qualify as a LT care policy?

A

a. limited to qualified LT care services only
b. cannot pay for medicare-reimburseable expenses
c. guaranteed renewable
d. no surrender value or money can be borrowed, paid, assigned, or pledged
e. no payouts, refunds of premiums or dividends must reduce future premiums or increase future benefits
f. must meet consumer protection provisions

229
Q

what coverage requirements must a group life and health plan meet to qualify for favorable tax treatment?

A

cover 70% of all employees and 85% of non-key employees

230
Q

when does the employer receive a deduction for the non-qualified deferred compensation granted to an executive?

A

when funds constructively received and must be reported as taxable income by the exec

231
Q

how are NQSO’s treated for tax purposes at:
grant
exercise
sale of securities

A

no tax implication
ordinary income = difference between exercise price and FMV
capital gain/loss = current FMV - FMV at exercise

232
Q

what are the main requirements for ISO’s?

A
  1. written plan approved by stockholders
  2. expiration <10 yrs from date of grant
  3. exercise price cannot be less than market price of stock at time of grant
  4. max value exerciseable in one year is $100k
  5. only granted to employees
  6. non-transferrable during life, but may be through will
  7. must be exercised within 3 mo of retirement or termination
  8. if sold within 2 yrs from date of grant and 1 yr from date of exercise, favorable tax treatment lost (lt cap gain vs. w-2 income)
233
Q

how is personal property covered under an HO-4 policy?

A

only actual cash value (cost - depreciation) minus the deductible

234
Q

what amount of group term life insurance benefits must be included in the employee’s gross income?

A

the cost of the uniform premium amount for excess of $50k of coverage

CFP (6 decks)

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