Unit 2 - Session 8 - Insurance-Based Products

Question 1

Annuity

Answer 1

A contract between an individual and a life insurance company, usually purchased for retirement income

Question 2

Annuitant

Answer 2

An investor who pays the premium in one lump sum or in periodic payments, at which, at some time in the future the annuitant will receive one lump some or regular income distributions that will continue for life

Question 3

Fixed Annuity

Answer 3

Guarantees a fixed rate of return. when the individual elects to begin receiving income, the payout is determined by the account’s value and the annuitant’s life expectancy based on mortality tables. A fixed payment remains constant throughout the annuitant’s life. This is an insurance product, not a security. Must have a life insurance license to sell. Risk is loss of purchasing power due to inflation.

Question 4

Variable Annuities

Answer 4

Money invested into an insurance company’s sub-account, which can include money market securities, and bonds, purchase payments are frequently invested in a stock portfolio, which has a better chance of keeping pace with inflation than fixed-income investments. Greater risk than a fixed annuity, b/c the investor is investing in securities rather than a guarantee from the insurance company, so the security value fluctuates.

Question 5

Combination Annuites

Answer 5

Attempts to provide monthly payout that consists of guarantees fixed amounts as well as a payout that might keep pace with inflation. The investor contributes to both a fixed account and variable account. The result is a guaranteed return on the fixed annuity portion, and a potentially higher return on the variable annuity portion.

Question 6

Index Annuity

Answer 6

Aka equity index annuity, popular among investors seeking market participation but with a guarantee against loss. Overcomes the purchasing power risk of fixed annuities but without the market risk of variable annuity. indexed annuities are credited to the owner’s account. If the index does well, the annuitant is credited with a specified percentage of the growth rate, typically 80-90% of the growth. If over the life of the annuity, the index does poorly, the annuitant may receive the IA’s minimum guaranteed return, typically 3-4%.

Question 7

What are the crediting methods used for indexed annuities?

Answer 7

1. ) Annual reset: Interest is to be credited to the account by comparing the index value at the end of the year to the value at the beginning of the year
2. ) High-water mark: highest value reached by the index between anniversary dates of the annuity is compared to the value at the beginning of the year
3. ) Point-to-Point: interest is computed based on the value of the index at the end of the contract compared to the beginning. A variation is annual point-to-point

Question 8

Accumulation Stage - Annuities

Answer 8

this is the pay-in period. If a payment is missed, the investor is not in jeopardy of losing their preceding contributions. the contract can be terminated at any time during the contract, but usually there is a surrender charge, usually in year 5-10. to discourage termination of contracts, insurance companies often allow contract holders to borrow from their accounts w/o having to cancel the contracts

Question 9

Is there a sales charge maximum for variable annuities?

Answer 9

No - but according to the SEC it must be reasonable and not excessive

Question 10

Annuitizing the contract

Answer 10

Occurs when the investor converts from the accumulation (pay-in) stage to the distribution stage.

Question 11

Life Annuity

Answer 11

Aka straight life/pure life - payout is structured so that the annuitant receives periodic payments (usually monthly) over his lifetime. This option holds the largest periodic payments

Question 12

Life Annuity with Period Certain

Answer 12

Payments for life with a certain minimum period guaranteed. if the annuitant dies before the period certain expires, payments continue to the named beneficiaries for the period. If the annuitant lives beyond the period certain, payments continue until the annuitant’s death

Question 13

Joint Life with Last Survivor Annuity

Answer 13

Annuity covers tow or more people, and payout is conditioned on both lives.

Question 14

Refund Annuity

Answer 14

Aka unit refund annuity, payments continue after death of the insured until the full value of the initial principal has been returned. It can be a lump some or monthly payments

Question 15

Mortality Guarantee and Op Ex Guarantee

Answer 15

Annuity companies guarantee payments for as long as the annuitants live, the insurance company eats the costs if insured annuitant lives longs their anticipated. The company also sets an op ex guarantee to the annuitant’s sub-account

Question 16

Assumed Interest Rate

Answer 16

A basis for determining the distributions from a variable annuity. Estimated conservatively, provides an earnings target for the separate account. The higher the AIR, the higher the projected value of units and the greater the initial payment. the reverse is also true. The AIR does not guarantee a rate of return.

Question 17

How are variable annuity payments determined?

Answer 17

Mortality tables help value the annuitants account. These payments are not guaranteed

Question 18

Taxation of Annuities

Answer 18

Contributions are usually made with after-tax dollars, if not a part of an employer-sponsored plan. Taxes on interest, dividends, and capital gains is deferred until the owner withdraws money from the contract. Upon the withdrawal, the amount exceeding the investor’s cost basis is taxed as ordinary income

Question 19

Taxation of Annuitized Payouts

Answer 19

Typically made monthly, are taxed to an exclusion ratio, which is expresses the percentages of the annuity’s value upon annuitization of the contribution basis to the total. Upon annuitiization, there is never a 10% tax penalty, even if annuitization commences prior to 59 1/2

Question 20

Exclusion Ratio

Answer 20

expresses the percentages of the annuity’s value upon annuitization of the contribution basis to the total

Question 21

Term Life Insurance

Answer 21

Protection for a specific period typically for 1, 5, 10, or 30 years or to be a specified age where the death benefit is only paid if the insured dies during the term of coverage, and they do not accumulate cash value.

Question 22

Whole Life Insurance

Answer 22

Permanent or cash value insurance, WLI provides protection for the whole of life. Coverage begins on the date of issue to the date of the insured’s death, assuming premiums are paid.

Question 23

Cash Value Whole Life

Answer 23

WLI provides both a death benefit with a cash accumulation and savings element. The savings element is know as the policy’s cash surrender value. The insurer were invest typically in conservative investments (bonds, real estate, etc.). Life insurance reserves are held in the insurer’s general accounts.

Question 24

Policy Loans

Answer 24

Once an insured has accumulated cash value, it cannot be forfeited and the insured can cash in the policy anytime. An insured can also take a policy loan against the cash value, which becomes indebtedness against the policy. If the insured dies before the loan is repaid, the indebtedness will reduce the face amount of the policy.

Question 25

Universal Life

Answer 25

Created to pay higher interest rates (8-12%) versus what the whole life was getting (3-5%) in inflationary times. It has death protection and cash value. However, the death protection resembles one-year renewable term insurance and cash value grows according to the current interest rates.

Question 26

Characteristics of Universal Life

Answer 26

1. ) Premium payments are separated first being paid toward the insurance protection, with the remaining balance being used to build cash value
2. ) Policyowner may increase or decrease the death benefit during the policy term, subject to any insurability requirements
3. ) Premium amounts may be changed as long as enough premium is paid to maintain the policy. It is possible to skip premium payments as long as there is sufficient cash value in the policy to keep it in force.
4. ) Interest in cash account will vary, subject to the guaranteed minimum

Question 27

Universal Life Interest

Answer 27

Subject to two interest rates

1. ) Current Annual Rate: varies with current market conditions and may change every year
2. ) Contract Rate: The minimum guaranteed interest rate and the policy will never pay less that the contracted amount

Question 28

Universal Life Death Benefit

Answer 28

1. ) Option 1 - provides death benefit equal to the policy’s face amount; as the policy cash value increases, net death protection decreases over the life of the policy, making the policy similar to a whole life policy. This option keeps the premiums lower for the same amount of death coverage. The tradeoff is that the level death benefit will not keep pace with inflation.
2. ) Option 2 - provides increasing death benefit equal to the policy’s face amount plus the cash account. This contract is more like a combination of level term insurance and increasing cash value than WLI. Cash grows more quickly in this option b/c of the higher initial premium and low initial death benefit, so a greater percentage is paid to the policy cash value, when then grows interest-free in the contract.

Question 29

Use of Universal Life

Answer 29

A form of permanent insurance that can build cash value, hopefully at a rate greater than traditional whole life. The guaranteed minimum interest rate is around 4% which means that, no matter how the investment performs, there will be a known minimum return on the investment. The unique feature is the flexibility to adjust the death benefit as needs change, as well as the flexibility to pay small or larger premiums as financial conditions dictate. However, poor investment results could cause premiums to increase.
Ability to “overfund” the policy. By paying premiums in excess of those required the excess with go the savings portion, increasing the cash value (money that can be borrowed out of the policy without tax consequences if done properly.

Question 30

Variable Life Insurance

Answer 30

Differs from whole life in that the premiums are invested not in the insurance company’s general account, whose investments are determined by the insurance company, but in a separate account, in whose investments the insured has some choice - common stock, bonds, money markets, etc. The point is to allow the customer to assume some investment risk in an attempt to get inflation protection for his death benefit. Cash value is not guaranteed but policies do have a minimum guaranteed death benefit. The death benefit may increase above the minimum amount depending on investment results. These policies require dually licensed (insurance and securities)

Question 31

Scheduled (Fixed) Premium Variable Life

Answer 31

Issued with a minimum guaranteed death benefit and determined at issuance and evidence of insurability is required. Premium is calculated on the insured’s age, sex, the face amount at issue. The policy owner selects the investment account.

Question 32

Flexible Premium Variable Life (Universal)

Answer 32

VLI with flexible premiums (and thus flexible death benefit). Premiums are invested only in a separate account, and there is only a variable death benefit. The insured has the option to increase, skip, or reduce premium payments, though he must maintaine a minimum cash value and the death benefit is adjusted accordingly

Question 33

Deduction from Premium (VLI)

Answer 33

Charges are deducted from the gross premium include: admin fee, sales load, state premium taxes (if any) aka SAS (sales, admin, state) - all other charges come out of the “separate account”
Admin Fee is usually a one-time charge to cover the cost of processing the application
The maximum allowable sales load on VLI is equivalent of an average 9% of premium pery year, computer over a 20 yr. period. The sales charge may be front-end loaded to 50% of the first year’s premium, but must average out to 9% over a 20 yr. period.

Question 34

Deduction from the Separate Account

Answer 34

Mortality Risk Fee - covers the risk thath te insured may live for a period short than assumed
Expense Risk Fee - covers the risk that the costs of administrating and issuing the policy may be greater than assumed
Investment Management Fee - the cost of the management of the chosen separate account subaccounts

Question 35

VLI Death Benefit

Answer 35

1. ) Guaranteed minimum paid provided by the portion of funds invested in the general account
2. ) Variable death benefit provide by those invested in the separate account (this is recalculated annually). With a positive performance in the separate account, the death benefit will increase

Question 36

VLI Cash Value

Answer 36

Policy’s cash value reflect the investments held in the separate account. This can be calculated monthly. The cash value can increase or decrease based on the separate accounts performance. Can go down to zero but can’t be negative, but will grow whenever there is a positive performance in the cash account.

Question 37

Rules for VLI Death Benefit

Answer 37

1. ) If the separate account performance for the year is greater than the AIR, the death benefit will increase
2. ) If the separate account performance for the year is equal to the AIR, the death benefit will stay the same
3. ) If the separate account performance for the year is less than the AIR, the death benefit will decrease (but never below the guaranteed minimum).

Question 38

Calculation Frequency for VLI

Answer 38

1. ) death benefits are calculated annually
2. ) cash value is calculated monthly
3. ) separate account unite values are calculated daily

Question 39

VLI Policy Loans

Answer 39

1. ) minimum of 75% of the cash value must be available for policy loan after the policy has been in force for three year
2. ) insurer is never require to loan 100% of the cash value. Full cash value is obtained by surrendering the policy to insurer
3. ) If the insured dies with a loan outstanding, the death benefit is reduced by the amount of the loan
4. ) if the insured surrenders his contract with a loan outstanding, cash value is reduced by the amount of the loan

Question 40

VLI Contract Exchange

Answer 40

1. ) contract exchange provision must be available for a minimum of 2 years
2. ) no medical underwriting (evidence of insurability) is required for the exchange
3. ) The new policy is issued as if everything were retroactive. That is, the age of the insured as the original date is the age used for premium calculations for the new policy

Question 41

How much is one vote for a VLI

Answer 41

1 vote per $100 of cash value

Question 42

Viatical Settlement

Answer 42

selling life insurance policy (or the right to receive the death benefit) to any person other than the insurance company that issued the policy. This is considered a security.