Unit 15: Insurance-Based Products Flashcards
What is an annuity?
generally a contract between an individual and a life insurance company, usually purchased for retirement income
What are the two major types of annuity contracts?
fixed and variable
Fixed Annuities
guarantees a fixed rate of return. Payout is determined by the account’s value and the annuitant’s life expectancy
Is a fixed annuity an insurance product or a security?
Because the insurance company guarantees the return and the annuitant bears no risk, a fixed annuity is an insurance product. Therefor, a salesperson must have a life insurance license to sell fixed annuities but does not need to be securities licensed
What is the risk involved with fixed annuity?
Loss of purchasing power due to inflation
Money deposited in a variable annuity is
directed into one or more subaccounts of the company’s separate account. Purchase payments are frequently invested in a stock portfolio, which has a better chance of keeping pace with inflation than fixed-income investments
What is a separate account?
the contributions that investors make to a variable annuity are kept separate from the insurance company’s general fund
Is a variable annuity an insurance product or a security?
Because the investors bear the risk, a variable annuity is considered to be a security. Therefore, a salesperson must have both a securities license and an insurance license.
A variable annuity offers an investor the opportunity to have
tax-deferred participation in the equity markets, albeit with expenses that are generally higher than for a mutual fund with a similar objective.
Indexed annuities are currently popular among
investors seeking market participation but with a guarantee against loss. If, over the life of the annuity, the index does poorly, the annuitant may receive the IA’s minimum guaranteed return - typically 1 - 3%. However, there are also cap rates.
Participation rate of 80%; cap rate of 8%; and a minimum guarantee of 2%
The purchaser can be offered the following choices as to how growth in the underlying index will credited in the form of interest to the account:
Annual reset, high-water mark, point-to-point, averaging
Annual reset
interest to be credited to the account is computed by comparing the index value at the end of the year to the value at the beginning of year (lower participation rate)
high-water mark
the highest value reached by the index between anniversary dates of the annuity is compared to the value at the beginning of the year (can provide highest gains)
Point-to-point
the interest is computed based on the value of the index at the end of the contract compared to the beginning.
averaging
monthly average and can be the best option when markets are expected to be highly volatile (most common)
Deferred Annuity
purchased with a single lump-sum; referred to as a single-premium deferred annuity
Periodic Payment Deferred Annuity
contract holder can invest money on a monthly, quarterly, or annual basis
Immediate Annuity
the investor deposits a single lump sum and the payouts begin almost immediately, usually within 60 days
Accumulation Stage
the pay-in period for a deferred annuity
Contract holder can terminate the contract at any time during the accumulation stage (although surrender charged likely exist)
Accumulation Units
accounting measure that represents an investor’s share of ownership in the separate account
Bonus Annuities
bonus on top of the investor’s initial contribution
Investing $60,000 into a single-premium annuity with a 5% bonus would result in an initial account balance of $63,000
Usually have surrender charges lasting longer than those without the bonus
Annuity stage
payout period, happens when the owner annuitizes
Annuity Payout Options (Settlement Option)
- Let the money accumulate
- Withdraw a lump-sum
- Withdraw periodically by annuitizing the contract
Life Annuity/Straight Life/Pure Life
Annuitant receives periodic payouts until death, highest monthly payment
Life Annuity with Period Certain
- Payments for life with a certain minimum period guaranteed
- If annuitant dies before the period certain expires, payments continue to the named beneficiaries. Payments to the beneficiary are taxed in the same way. However, there is no 10% penalty.
- If annuitant lives beyond the period certain, payments continue until the annuitant’s death
Joint Life with Last Survivor Annuity
the annuity covers two or more people and payout is conditioned on both (all) lives. Payments cease at the last survivor’s death.
Refund Annuity
Payments will continue after death of the insured until the full value of the initial premium (principal) has been returned
Mortality Guarantee
If annuitants live longer than originally anticipated, the insurance companies assume the increased mortality cost, among the annual charges against the account is that for M&E (mortality and expense).
M&E charge ceases once the contract is annuitized
Annuity Units
a measure of value used only during an annuitized contract’s payout period
Assumed Interest Rate (AIR)
a basis for determining distributions from a variable annuity, provides an earnings target for the separate account. If actual earnings exceed the AIR, payments increase; if they fall short of the AIR, they decrease.
The primary advantage of an annuity as an investment is that:
the tax on interest, dividends, and capital gains is deferred until the owner withdraws money from the contract. In withdrawal, the amount exceeding the investor’s cost basis is taxed as ordinary income.
Random Withdrawals
taxed under the last in, first out (LIFO) method
Therefore, since earnings are the last to be received in an account, they are the first to be withdrawn and are taxable as ordinary income
Lump-Sum Withdrawals
also uses the LIFO method
If an investor receives a lump-sum withdrawal before age 59 ½ , the earnings portion withdrawn is taxed as ordinary income and is subject to an additional 10% tax penalty under most circumstances
This penalty only applies to the taxable portion.
With annuities, there is never:
a capital gain
Even when the distribution is from a nonqualified annuity, if it is made before the age of 59 ½,
it is subject to the 10% penalty
Exclusion ratio
expresses the percentage of the annuity’s value upon annuitization of contribution basis to the total
Annuitized payments are typically made monthly and are taxed according to an exclusion ratio.
Upon annuitization,
there is never a 10% tax penalty, even if annuitization commences before age 59 ½.
Term Insurance
protection for a specified period, least expensive form of life insurance
Can be either for a certain amount of years or until a specified age
The death benefit is paid only if the insured dies during the term of coverage
Does not accumulate cash value
For exam purposes, younger people with children are better off purchasing
term insurance because the lower premiums allow significantly more protection. For those age 60 and older, the rates are generally prohibitive.
Whole Life Insurance (WLI)
provides protection for the whole of life, premiums can be paid annually, semiannually, quarterly, or monthly
What are the uses of WLI?
Permanent insurance and accordingly can be used to satisfy permanent needs such as the cost of death, dying, and final burial expenses.
What are the disadvantages of WLI?
The premium paying period may last longer than the insured’s income-producing yeats and it does not provide as much protection per dollar of premium as term insurance
Policy Loans
an insured may also borrow a portion of the cash value in the form of a policy loan, but this must be paid back (with interest) to restore policy values
If the insured dies before the loan has been repaid, any indebtedness will reduce the face amount of the policy accordingly, it will be subtracted from any death benefit.
If the policyowner decides to stop paying the premiums, the policyowner may:
- Surrender the policy for its cash value
- Take a reduced paid-up policy where the death benefit is decreased and future premiums are no longer required
- Take extended term insurance which pays the beneficiaries the full face amount if death occurs within a specified time period
Universal Life
introduced in the 1970s to possibly pay higher interest rates during inflationary times, also provides greater flexibility because they allow the policyowners to adjust the death benefits and/or premium payments based on current needs assessment
Current annual rate
varies with current market conditions and may change every year
Contract Rate
the minimum guaranteed interest rate and the policy will never pay less than that amount
Death Benefit Options
Option 1 (Option A) → Premiums are lower but will not keep pace with inflation
Option 2 (Option B) → cash values grow more quickly over time due to higher initial premiums
What are the uses of universal life insurance?
Form of permanent insurance that can build cash values hopefully at a rate greater than with traditional whole life
Variable Life Insurance
- Premiums are invested in a separate account in whose investments the insured has come choice. The purpose is to let the customer assume some investment risk in an attempt to get inflation protection for the policy’s death benefit
- Cash value fluctuates with the performance of the chosen subaccounts
- Provides policy owners with a minimum guaranteed death benefit.
Scheduled (Fixed) Premium Variable Life
issued with a minimum guaranteed death benefit, evidence of insurability is required
Flexible Premium Variable Life (Universal)
type of variable life insurance with flexible premiums and flexible death benefit. The insured has the option to increase, skip, or reduce premium payments, though he must maintain a minimum cash value and the death benefit is adjusted appropriately.
Charges deducted from the gross premium include:
SAS
Sales load
Administrative fee
State premium taxes
Deductions from the Separate Account:
- Mortality risk fee (cost of insurance)
- Expense risk fee
- Investment management fee
Death benefits are calculated
annually
Cash value is calculated
monthly
Separate account unit values are calculated:
daily in the event there is a withdrawal of cash value
It must be emphasized that variable life insurance must be sold as
life insurance
NOT AS AN INVESTMENT
Variable life insurance allows the policyowner to
decide how the cash value is invested through a number of subaccounts.
With a whole life policy, all investment decisions
are made by the insurance company.
Variable Life Policy Loans
A minimum of 75% of the cash value must be available for policy loan after the policy has been in force for 3 years.
The insurer is never required to loan 100% of the cash value. Full cash value is obtained by surrendering the policy to the issuer.
Contract exchange provision:
- The contract exchange provision must be available for a minimum of two years
- No medical underwriting (evidence of insurability) is required for the exchange
- The new policy is used as if everything were retroactive. Tat is, the age of the insured as of the original date is the age used for premium calculations for the new policy.
Variable Life Insurance Voting Rights
1 vote per $100 cash value funded by the separate account
