Risk Management / Insurance Planning

Question 1

Calculating tax-free portion of annuitization payment (Exclusion Allowance)

Answer 1

Basis (contract investment) ÷ Expected payout*

Expected payout = Annual payment to be received x Life expectancy period

Exclusion allowance ends when all basis has been recovered.

Question 2

Annuity payout methods

Answer 2

1. Withdrawals - taxed as LIFO (earnings first)
2. Annuitization (Life Annuity or Annuity Certain) - exclusion allowance is applied to each payment until basis is recovered

With either payout method, distributed gains (deferred earnings) are subject to a 10% early withdrawal penalty prior to age 59½, except if disabled / death, it’s an immediate annuity, or substantially equal periodic payments for 5 years.

Question 3

What legal premise gives the insurer the right to collect from a third party after paying its insured’s claim?

Answer 3

Subrogation

EXAMPLE: Joe’s car has been badly damaged by another driver who was speeding and ran through a red light. The police found the speeding driver to be at fault. Joe’s insurance company paid for the repairs.

Question 4

MEC

How are cash value living distributions (withdrawals or loans) taxed on a MEC?

Answer 4

With a MEC, regardless of whether the withdrawal is at or below the basis of premiums paid, the earnings get withdrawn first and are taxed on a LIFO basis. And, if distributions are made prior to age 59½, there’s a 10% penalty (like an annuity).

Death benefit retains its tax-free treatment.

Question 5

Which type of homeowners insurance is referred to as “special coverage”

Answer 5

Open-perils

Question 6

Coinsurance Requirement for partial loss

HO Insurance claim: Determining the amount that the policy will pay for partial loss

Answer 6

Insurance I did have ÷ Insurance I should’ve had (80% of the current value (replacement cost)) X the loss minus the deductible = Claim payout for partial loss.

Question 7

Unrelated skip person

Answer 7

At least 37½ years younger than the transferor.

Question 8

Viatical Settlement

For chronically ill ADL claims to qualify, a doctor must certify that the conditions are expected to continue for at least how many days?

Answer 8

90 days

Question 9

What are the three Buy-Sell Agreements?

Answer 9

CROSS-PURCHASE AGREEMENT
* Few owners
* Partners pay premiums on each other [n X (n-1)].
* Stock gets a step-up in basis to the surviving owner (primary advantage of cross-purchase over entity purchase).
* Younger owners will pay considerably more in premiums.

ENTITY or STOCK REDEMPTION AGREEMENT
* Business pays premiums, so DB passes tax-free to business, therefore stock has NO step-up in basis to surviving owners, so surviving owner(s) will have substantially more gains upon sale of business.
* Buy-Sell purchase price is established between the company and the insured/owner at the time the buy-sell agreement is agreed upon.

WAIT-AND-SEE AGREEMENT
* Flexible to both the partners and the business as they can configure as cross-purchase, entity purchase, or hybrid of the two.
After a partner’s death, the sequence of steps is:
1. Step 1: Business has 1st option to purchase deceased owner’s stock.
2. Step 2: If business waives option to purchase or the business purchases less than half of the deceased partner’s stock, surviving partner(s) have the option to purchase deceased owner’s stock.
3. Step 3: If options 1 and 2 are both waived, the business is required to purchase the stock.
Remember Wait & See B.O.B. = Business(1st) → Owner (2nd) → Business (3rd).

Question 10

Formula for Stop-Loss Limit on insurance policy

Answer 10

(MOOP - deductible) ÷ insured’s coinsurance percentage

Question 11

Disability Insurance

If the ER pays the premium but includes the premium as compensation to the EE, what is the tax impact to the EE?

Answer 11

The benefits are tax-free because the EE pays taxes.

Question 12

Homeowners Insurance

HO policy coverages (A thru F)

Answer 12

Each homeowners insurance policy has 6 parts:
Property (Part I): Coverage A, B, C, D
Liability (Part 2): Coverage E, F

A = address
B = backyard
C = crap (personal belongings)
D = damaged / destroyed (covers the expenses incurred while living somewhere else during home repairs)
E = exposure to litigation
F = funds for fractured femurs

Question 13

Homeowners Insurance

Policy Forms

Answer 13

HO-2 = Basic coverage
HO-3 = a.k.a. an “all risks policy”. It covers all losses except those specifically named as exclusions in the policy. Provides dwelling coverage on an open perils basis and contents coverage on a named perils basis.
HO-4 = Renters (4 rent). Contents only + liability.
HO-5 = Best coverage (covers open perils)
HO-6 = Condo owners “studs in” - not the roof
HO-8 (Modified Coverage) = For very old or historical homes. Less coverage as it’s difficult to replace.
HO-15 = someone has an HO-3 policy but prefers HO-5 coverage, however it’s not available in their area. The HO-15 endorsement puts the content on an open-perils basis.

Question 14

What is Interpolated Terminal Reserve?

Answer 14

Policies where the decedent is the Owner but someone else is the Insured.

This removes the life insurance face value from the owner’s estate.

Question 15

If the insured forgets to pay the premium or decides to end the contract, how many days does the grace period provide to pay the premium without forfeiting any contractual rights and no questions asked?

Answer 15

31 days

Question 16

If a client wants flexibility to adjust premium payments if cash flow is variable, and to change the frequency of payments into the policy, which type of policy should they buy?

Answer 16

Universal Life

Also appropriate for those who are not focused on accumulating cash value.

Question 17

Universal Life - Options A & B

Answer 17

Option A
* Death benefit remains level (A for Always).
* Will accumulate higher cash value than Option B

Option B
* Death benefit is the combined face amount plus cash value.
* Increases the death benefit over time.
* More expensive than Option A.

Question 18

What life insurance policy is appropriate for someone who doesn’t want to pay premiums for the entire life but wants a policy for when they die.

Answer 18

Limited-pay Whole Life

Example: 10-year limited pay whole life policy, which means you fully fund the policy by paying all of the premiums over 10 years.

Question 19

Which life insurance increases the death benefit over time?

Answer 19

Universal Life Option B
Death benefit is the combined face amount plus the cash value.

Paid-Up Additions
Use your Whole Life dividends to buy a small amount more of death benefits over time.

Question 20

Which type of life insurance or annuity is appropriate for someone who wants to direct their own investments?

Answer 20

Variable Life or Variable Annuity

Being variable means the investment responsibility shifts from the insurance company to the policyholder.

Question 21

Which non-forfeiture option is appropriate when an insured wants to maintain their death benefit but stop paying premiums?

Answer 21

Extended Term

It uses cash value as a single premium to pay for Term, but the extension will eventually end as Term policies do, so it may not be sufficient for life expectancy.

Provides the option to be reinstated later.

This is the default option used by the insurance company if you stop paying premiums.

Extend = maintain

Question 22

Which non-forfeiture option helps when the insured’s death benefit needs have decreased but still wants to retain some cash value?

Answer 22

Reduced Paid-up

It uses the cash value to buy a paid-up policy of the same type as the policy that lapsed.

The new policy will have a reduced benefit but will retain a cash value at a reduced growth rate, and can continue earning interest or dividends for the remainder of the policy.

Question 23

What is an alternative to paying premiums that allows a loan against the life insurance cash value?

Answer 23

Automatic Premium Loan

Any unpaid loan plus accrued interest is deducted from the death benefit.

Question 24

With a single-premium immediate annuity, when does the annuitant begin to receive income distributions?

Answer 24

Between one month and one year from the date of purchase.

Question 25

Exaggerated claims

Answer 25

Moral Hazard

Dishonest tendencies, often due to an insured’s weakened financial condition, that are likely to increase loss frequency and/or severity.

Question 26

Unlocked doors - home or car

Answer 26

Morale Hazard

An indifference to the loss when insurance is in place, which creates carelessness and increases the chance of loss.

Poor morale

Question 27

What type of agreement is formed when a life insurance death benefit payment is predicated by the insured’s death.

Answer 27

Aleatory contract

An agreement under which action is predicated on a specific event. The events are not controlled by either party.

Question 28

What risk type occurs with the death of the family breadwinner?

Answer 28

Static Risk

Losses caused by factors not related to the economy (e.g., death of the family breadwinner). These tend to occur with regularity and can be insured against.

Question 29

A court cannot reduce damages against negiligent party because plaintiff has insurance

Answer 29

Collateral Source Rule

Holds that damages assessed against a negligent party should not be reduced simply because the injured party has other sources of recovery available.

Question 30

What type of liability occurs if your dog bites the mailman?

Answer 30

Absolute Liability

Liability without regard to negligence or fault.

Question 31

Most traffic violations are what type of liabilty?

Answer 31

Strict Liability

Question 32

An electrician wires a home that the town inspector approves, which causes a fire.

Answer 32

Joint & Several Liability

Both can be sued and held jointly and severally liable.

Question 33

Viatical Settlements

A terminally ill individual is someone who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within how many months?

Answer 33

24 months

Settlement is tax-free and they can do whatever they want with the money.

Question 34

Viatical Settlements

What are the conditions for a chronically ill person that must be met to qualify for a viatical settlement?

Answer 34

• Unable to perform 2 of 6 ADLs
• A doctor must certify that the conditions are expected to continue for at least 90 days.

Settlement portion used for qualified long-term care services is tax-free but the remainder is taxable.

ADLs: B-E-D-C-O-T

Question 35

Qualified LTCi

How are policy dividends applied to long-term care insurance?

Answer 35

Policy dividends must be applied as a reduction in future premiums or increase future benefits.

Question 36

Qualified LTCi

Exclusions and limitations to LTCi are prohibited except…

Answer 36

Pre-existing within 6 months of application.

Question 37

Qualified LTCi

When premiums are paid by the ER, how are benefits taxed to the EE?

Answer 37

Benefits are tax-free.

And excluded from taxable income.

Question 38

Life Insurance

Which type of life insurance always guarantees the initial death benefit at a specific premium for life?

Answer 38

Whole Life

Question 39

What are the ways that you can use Whole Life Participating Dividends?

five ways

Answer 39

1. Cash
2. Paid-up additions
3. Increase cash value
4. Reduce premiums (up to basis)
5. Purchase one-year term (“5th dividend”)

These are return of premium paid (basis), so they don’t require the policyholder to pay taxes.

Question 40

Taxation of Life Insurance

If a client owns the policy on his wife with the daughter as the beneficiary, and the wife dies, how are the proceeds taxed?

Answer 40

The proceeds are considered a taxable gift from the client to their daughter. Had the wife owned the policy on her life, the proceeds would have passed to their daughter tax-free.

Question 41

Taxation of Life Insurance

How are dividends taxed?

Answer 41

Dividends represent a return of the insured’s premium up to their basis (premiums paid). Beyond this, dividends are a fully taxable event.

Question 42

With Group Life, what is the taxation to EEs of ER premiums paid?

Answer 42

EE includes in their taxable income if coverage exceeds $50k.

Question 43

Health Savings Accounts (HSA)

What is the federal taxation for HSA distributions not used for qualified medical expenses?

Answer 43

Subject to ordinary income tax plus a 20% penalty tax.

Question 44

Health Savings Accounts (HSA)

What is the HSA last month rule?

Answer 44

If eligible under HDHP on the first day of the last month of tax year (December 1), you may fund HSA as if eligible for the entire year.

Question 45

Which section of the Internal Revenue Code (IRC) provides for a tax-free exchange of an annuity for a long-term care insurance policy?

Answer 45

1035 Exchange

L-E-A-Q