Study eight Flashcards
What are the traditional types of permanent insurance?
1) whole life insurance
- the most permanent of the permanent form of life insurance
- provides lifetime coverage, typically at level premiums, and the face value usually remains the constant
- comes with alternative premium payment periods
i) straight life/continuous premium
- as premiums are paid, the policy accumulates CV which earn investment income on a compound basis
- premium payments made until life insured dies
ii) limited-payment policy
- premiums are calculated for a set term, after which the policy is considered to be paid-up/paid in full
- once a policy is paid in full will not require further premiums to be paid
- accelerated payment schedule results in premiums higher than those for equivalent straight life but are payable for a shorter period of time
2) endowment insurance
- allows a policy owner to accumulated specific amount of money by a specified date in the future
- pays the face value of the policy at a pre-determined maturity date, or pays a death benefit equal to the face value if life insured should die prior to maturity date
- provide CSV
- popularity depends on prevailing tax and economic conditions
- not favourable because Income Tax Act does not permit enough tax-deferred accumulation within life ins. policy to allow it to endow prior to age of 85
3) variable insurance
- were developed as a hybrid of whole life
- essentially whole life that transfer risk associated with premium investment from insurer to the policy owner
- policy values are invested into a segregated fund
- policy owner chooses from variety of investment accounts
- CV of policy fluctuates with investment market
- the death benefit is composed of:
i) a guaranteed death benefit
ii) a variable component that responds to market fluctuations
4) adjustable policies
- was designed to allow for changes in premium rate at pre-arranged intervals usually every 3-5 years in reponse to fluctuating interest rates or mortality rates in some cases
- if interest rate increased, insureds premium would be reduced for next interval
- if interest decreased, the insured had the option of either paying higher premiums and maintaining face value of policy or reducing policy’s face value in order to keep premiums constant
- when a sum insured was reduced, it could not be later increased without evidence of insurability
- are seldom marketed today
Explain what a non-participating policy is.
- traditionally life ins. polices were non-participating, meaning that the face amount of ins., policy premiums, guaranteed CSV of policy were all fixed/bundled at time of policy issue, based on estimates of insurers future expenses, investment income, and mortality experience
- if insurer who issues non-part. policy underperforms expectations, no change is made to the policy meaning the insurer absorbs shortfall
- if insurer outperforms expectations, it gets to keep excess profits
- policy owners return on investment in CV tends to be very modest
- because they produce no dividends, premiums are lower than part. policies
Explain what a participating policy is.
- contain a provision whereby the insurer has the option of returning a portion of its operating profits to policy owners in the form of dividends
- dividends are not guaranteed, but are contingent on insurers financial performance and decisions of board of directors
- perm. ins. policies are more likely to be participating polices opposed to term ins.
- offers dividend options
- command higher premium based on relatively conservative loss assumptions
- policy owners net cash outlay is the initial premium- value of policy dividend
List the dividend options within a participating policy.
1) cash dividend
- insurer issues a cheque to policy owner in amount of annual dividend
2) paid-up additional insurance
- allows policy owner to apply dividend to purchase additional perm. life insurance of same type as original policy
- provides for increased death benefits, CSV, loan values
- treated separately from original policy and may be surrendered independently
3) premium reduction
- allows for application of a policy’s dividend to reduce/eliminate policy’s renewal premiums
4) additional term insurance
- dividend is used as a single premium to purchase one-year non-renewable term ins. coverage on insured’s life
5) dividends may be retained by insurer in separate deposit account and allowed to accumulate interest
- fund may be surrendered for its CV or paid out as part of death benefit
6) policy dividends may be held by insurer and invested into segregated fund
Define segregated funds.
- are special investment accounts that are kept separate from an insurers general investment account
- funds are invested into equity markets, or bond and mortgage markets
- performance of fund reflects individual insurers unique investment strategies
What is premium offset/vanishing premiums?
- in the 1980s insurers began marketing their participating policies using an aggressive form of premium reduction option for dividends (aka premium offset)
- concept involved projecting future accumulated policy values, using then-current dividend scales (12% at time), and calculating a present value of those future compound dividends
- the premium offet date referred to when the policy owner might stop paying policy premiums and have the accumulated dividends surrendered to pay the annual premium instead
- unfortunately many brokers/agents marketed the offset as being virtually guaranteed
- in late 1980’s and early 1990’s interest rates dropped resulting in decreases in policy dividend rates and the premium offset set was pushed dramatically into the future (by decades)
- as a resuly many policyowners sued insurance companies successfully
- many insurers no longer market this or have a form that is signed verifying that insured understands is not guaranteed
Describe the universal life concept.
1) are among the most difficult products to categorize and compare
- premium payments are neither ridigly scheduled not guaranteed
- premiums may either be varied by policy owner or increased if insurer’s mortality costs increase, company’s operating expenses inscrease, or policy’s investment earnings decrease
2) are essentially self-directed by policy owner
- insurer’s role is primarily that of an account administrator/manager
3) the amount of death benefit is guaranteed
- however the policy owner must pay sufficient premiums which may be supported with the policy’s investment income, as well as the insurer’s operating expense or the policy will lapse
- any residual amount/overpayment is deposited into the investment portion of the account
- increases to the policys cash value may also be used to cover policy expense deductions to ro reduce/replace future premium payments
What are the elements of a universal life insurance policy?
4) is a blend of term insurance and a flexible, tax-deferred investment vehicle
- a typical uni policy is composed of the following elements:
1) deposits
- premium payments are referred to as deposits because the timing and amount of deposits can be variable at the discretion of the policy owner (with some restrictions)
- allow policy owner to increase/decrease amount of premium paid, or to make periodic lump sum payments
Restrictions include:
i) a minimum required premium for the first few years of policy to ensure that the policy does not lapse
ii) maximum annual premium deposit limit, to ensure that the policy does not forfeit its tax-exempt status
2) provincial premium taxes
- each $ of premium credited to a uni life policy, is sibject to a deduction for prov. premium taxes
- typically in the 2% range
3) account value
- is the sum of the net premiums and income from investment less monthly expense deductions
4) tax exempt and/or taxable investments
- offer a variety of both tax deferred and annually taxable investment options
- in tax-exempt portion of policy, income accrues on a tax-deferred basis which significantly improves compouding potential of taxable investments
- within exempt uni policy interest, dividends, and capital gains are no longer considered to be the above and will simply become part of the policy’s account value
5) investment income
- income earned on investments is credited to account value on a monthly basis
- income includes interest, dividends, and capital gains
6) monthly expense deductions
- each month, deductions are made from policy’s account value to cover:
i) mortality insurance costs
ii) admin costs
iii) a policy fee
iiii) rider costs
NET ACCOUNT VALUE EACH MONTH =
(PREMIUMS DEPOSITED - PREMIUM TAXES) + INVESTMENT INCOME - EXPENSE DEDUCTIONS
7) cash surrender value
- carry back-end loading fees for policies that are surrendered relatively soon after policy issye
- surrender charges usually disappear entirely after 10-15 years
- the policy’s CSV is computed by deducting the current surrender charge from current account value
- CSV may be nil in first years of policy, even though policy has significant account value
CSV= CURRENT ACCOUNT VALUE - SURRENDER CHARGE
What are the feautures of univeral life?
6) death benefit options
i) level death benefit
- death benefit remains level for life of policy unless increased by insurer for income tax purposes
- since the face value remains constant, the amt of insurer’s risk in policy decreases as cash accumulation and account value increases
- mortality monthly deduction is computed by multiplying a table rate of mortality costs times the number of $1000s of risk in the policy
- generally uses YRT mortality deduction option
- the account value is forfeited to the insurer if insured dies
ii) level death benefit plus account value
- death benefit paid out nder policy is equal to initial face amount and the account value of the policy at the time of the death of life insured
- the insurer’s risk in policy always remains level regardless of changes in account value of policy because it is not forfeited to them upon death of life insured
- this option allows policy owner to make overpayments to policy knowing that the money not used for monthly deductions will be returned to beneficiary as part of the death benefit
- may be based on YRT or T-to-100 mortality deduction
iii) level death benefit plus deposits
- whereby death benefit is equal to the initial face amount plus the aggregate value of all premium deposits
iiii) indexed policies
- whereby death benefit is indexed annually on a compound basis
- based on pre-determined rate of CPI
iiiii) level death benefit plus adjusted cost basis
- where an additional layer of death benefit is paid out, equal to the adjusted cost basis of policy at time of death
Explain the use of mortality deductions.
- taken from account value on a monthly basis
- is a function of the current rate per $1000 applicable to life insured each year, times the # of $1000’s of insurer’s risk in policy
- typically based on two types of term insurance premium structures:
i) yearly renewable term
- rate per $1000 of risk increases year after year, as life insured ages
- usually relatively low in early years of policy, but may become difficult to sustain as life insured approaches life expectancy
- may be preferrable if the policy owner only wants to retain the policy for a few years or wishes to maximize each accum. in policy during early years
ii) Term-to-100 aka level cost of insurance (LCOI)
- charges same mortality rate per $1000 of risk throughout lifetime of policy
- tends to be relatively more expensive in early policy years, but is unlikely to require huge deposit commitments or account value accumulations in later years to prevent policy lapse
- are often only offered with level death benefits plus account value where amount of risk remains level throughout life of policy
- preferrable if policy is going to maintained for a longer period of time and no expectation that funds will have to be drawn upon in early years of policy
MORTALITY DEDUCTION CAN BE EITHER:
i) guaranteed
- t-to-100 are usually guaranteed
- usually preferrable because they reduce variable factors in policy
- rate per $1000 of risk that is guaranteed, not the amount of policys monthly mortality deduction
ii) adjustable
- subject to change by insurer
- a planned MDE is published in policy with the provision that the rate could be subject to an increase in the future
- usually subject to a cap (50-100%) of planned rate
What are the investment options within universal life?
- uni life policies offer the policy owner a diverse selction of investment options, within 2 different income tax environments (tax-deferred, exempt portion of policy and annually taxable side fund).
EXEMPT PORTION
i) guaranteed deposit accounts that pay interest
- range from daily interest, money market accounts, to term deposit-type investments (1,5,10,20 yr)
- accounts pay may interest monthly or annually, or interest may accrue and compound within the deposit
- usually also offer guaranteed minimum investment rate, but is likely to be lower relative to current interest rate
ii) linked accounts
- investment performance is tied to an outside inidicator such as mutual funds, segregated funds, or stock market index
- is also interest bearing but interest paid is based upon the change in value of external investments
- policy owners should be cautioned that values may either go up or down, fluctuating with the underlying investments
- are more like mutual funds then term deposits
- investors capital may be at risk
TAXABLE PORTION
- net income is reported to policy owner annually for income tax purposes
- income is identified as interest, dividends and capital gains
The purposes of a side fund include:
1) as a source of investment that cannot be held within tax-exempt portion of policy (segregated funds)
2) as a parking place for deposit overpayments that cannot yet be invested in tax-exempt portion
3) as a place to deposit funds that must be withdrawn from exempt portion of policy because cash value accum. has exceeded the amount that is permitted under the income tax act
Describe the tax-exempt uni life insurance policy.
- earnings within perm insurance policies generally accrue on a tax-exempt basis until the funds are withdrawn, as long as the policy is acquired primarily for insurance protection and not for investment accum.
- this stipulation is governed by the income tax act
- the act sets limits on the amount of CSV that can accum. within tax-exempt policies
- guidepost for maximum allowable limits is the exemption test policy (theoretical life insurance policy based on assumption that premiums are paid for 20 years and policy endows at age 85)
- as long as policy values do not exceed values in test, the policy remains tax-exempt
- if policy values exceed the limit, the policy is then considered to be non-exempt (primarily an investment vehicle) and annual growth may be subject to taxation
How do insurers attempt to guarantee tax exempt status of uni life policy through features and designs?
1) increases in death benefit to increase the exempt cash value (limited to 8% yearly to comply with tax regulations)
2) excess premiums may be temporarily deposited into a separate account, the taxable side fund
3) insurers may establish rules to limit overfunding of policy (yearly maximum deposit amount)
Explain the implications of unbundling
- uni life policies unbundle 3 premium-pricing components: mortality costs, investment income, and insurer’s operating cost
- as a result they tend to transfer much of the risk from the insurer to the policy owner
- the amt of coverage, amt and frequency of premium deposits and investment returns and account value can all vary over the course of the policy
- affords the policy owner much lattitude in the use and admin. of the policy
What are the advantages and disadvantages of uni life?
A) traditional whole life insurance has a fixed premium payment schedule
B) universal life has flexible premiums
A) whole life policys basic cash value, exclusive of dividends, is based on a predetermined schedule
B) in uni life, value is calculated based on premium paid, policy admin and mortality costs, and investment earnings
- is impossible to predict what the value of the policy will be because of the variable elements
A) whole life, the policys face value is fixed, unless dividends are used to purchase paid-up additions
B) in uni life, the face value can either be a fixed amount or it can increase based on policys CV
A) whole life can only cover one life (with exceptions of joint policies and riders)
B) uni life can cover many lives
A) whole life investments rates are based upon the performance of life insurers portfolio and other factors
B) uni life investment returns are based upon investments that are self-directed by policy owner, from among the many investment options offered by insurer
