Universal Life Insurance (Chapter 4)

Question 1

REVIEW

What’s the difference between Term & Whole Life?

Answer 1

Term provides insurance coverage for a
specified period or term, while Whole Life provides insurance coverage for life.

Question 2

Life Insurance Terminology

Adjusted Cost Basis (ACB)

Answer 2

The amount of money invested.

Question 3

REVIEW

What are the differences in premiums between Term & Whole Life?

Answer 3

• With Term, premiums increase with the age of the life insured.
• With Whole Life, premiums remain constant regardless of the age of the life insured.

Question 4

Life Insurance Terminology

Cash Surrender Value (CSV)

Answer 4

Money that the life insurance policyholder receives for canceling their policy before it matures or they pass away.

Question 5

REVIEW

Name some differences in benefits for Term & Whole Life

Answer 5

• Term does not provide non-forfeiture benefits.
• Death Benefit in term cannot be increased without proof of insurability and additional premiums.
• Whole Life may provide non-forfeiture
  benefits.
• Death benefit in Whole Life can be increased, without providing proof of insurability.

Question 6

Life Insurance Terminology

The difference between Adjusted Cost BASE
& Adjusted Cost BASIS

Answer 6

Adjusted Cost BASE
- Deemed Disposition of capital property.

Adjusted Cost BASIS
- Amount of money invested in an insurance policy, & the calculation of the policy gain.

Question 7

Chapter 4

What is a Universal Life (UL) Policy

Answer 7

UL insurance combines permanent insurance with tax-advantaged investing, within limits.

Question 8

TRUE OR FALSE

Premium Taxes on a UL Policy ranges from 2% to 4%, and it is charged on the entire premium.

Answer 8

TRUE

Question 9

FILL IN THE BLANK

After the premium taxes are applied, the remainder of the premium goes into the policy’s _____________.

a) Investment account(s)
b) Adjusted Cost Basis
c) Dividend Account(s)
d) Exempted Account

Answer 9

After the premium taxes are applied, the remainder of the premium goes into the policy’s Investment account(s)

Question 10

TRUE OR FALSE

If the policyholder were to invest money outside of a policy (ex. mutual funds or GIC), the amount invested would not be subject to premium tax.

Answer 10

TRUE

Question 11

TRUE OR FALSE?

The insurance company adds the mortality costs to the policy’s investment account.

Answer 11

FALSE

The insurance company DEDUCTS mortality costs FROM the policy’s investment account.

Question 12

What are the expenses within a policy premium? (6)

Answer 12

1. Cost of selling the policy (Marketing, salaries & commission to agents)
2. Underwriting
3. Administration
4. Investigating Claims
5. Paying death benefits.
6. Profits sought by shareholders

Question 13

The flexibility of a UL policy results in…

Answer 13

• Timing & amounts of premium
• Face Amount
• Life / lives insured

Question 14

TRUE OR FALSE

Within limits, and amounts of premiums, the insurance company restricts the policyholder from paying maximum premiums due to tax implications that could occur.

Answer 14

FALSE

Within limits, and amounts of premiums, the Policyholder can decide how much to pay in premiums.

Question 15

TRUE OR FALSE

The policyholder can deposit lump-sum premiums at any time.

Answer 15

TRUE

Question 16

Name some key factors that could result in an insufficient account value

Answer 16

• The policy was always minimally funded
• Policyholder made withdrawals from the policy
• Policyholder decreased or stopped premium payments
• The investment returns were negative or lower than anticipated.

Question 17

How is the Modal Factor Calculated in UL Policies?

Answer 17

(1 ÷ number of payments per year).

Question 18

TRUE OR FALSE?

If the policyholder needs additional coverage in the future, he can add that additional coverage to the existing policy on an attained age basis without a Guaranteed Insurability Benefit (GIB) due to the flexibility of the UL policy.

Answer 18

FALSE

Any increase in the face amount of a UL policy will require the insured person to provide evidence of insurability unless the policy includes a rider for a guaranteed insurability benefit.

Question 19

TRUE OR FALSE?

UL policies may allow the policyholder to add or substitute a new life insured under the policy, as long as the new person can provide evidence of insurability.

Answer 19

TRUE

Question 20

FILL IN THE BLANK

The mortality deductions of UL policies are based on______________ .

a) Cash Surrender Value (CSV)
b) Probability of Death
c) Life Expectancy
d) Net Amount at Risk (NAAR)

Answer 20

The mortality deductions are based on the net amount at risk.

Question 21

How do you calculate the Net Amount at Risk ?

Answer 21

• Death Benefit – Investment Account Value

(ex. Pratik owns a UL policy with a death benefit of $500,000 and an account value of $128,000. The current NAAR of his policy is $372,000, calculated as ($500,000 – $128,000).

Question 22

Simplify Yearly Renewable Term (YRT)

Answer 22

• The Cost of Insurance (COI) expressed as a dollar amount per $1,000 of risk.

(Ex. Pratik’s policy has a COI of $18.57. NAAR is $372,000. The insurance company would make a mortality deduction of $6,908 from his account, calculated as ($18.57 × $372,000 ÷ $1,000).

Question 23

TRUE OR FALSE?

Yearly renewable term (YRT) is one-year term insurance that renews at the end of every policy year.

Answer 23

TRUE

Question 24

TRUE OR FALSE?

The annual YRT premium for a specific year is based on the life insured’s risk of death for that year.

Answer 24

TRUE

Question 25

*TRUE OR FALSE?* The cost per $1,000 at risk generally **decreases** each year because the risk of death tends to increase with age (with the exception of the first few years of life).

Answer 25

FALSE The cost per $1,000 at risk generally **INCREASES** each year because the risk of death tends to increase with age (with the exception of the first few years of life).

Question 26

*REVIEW* How do you calculate the mortality cost for term insurance?

Answer 26

Death benefit multiplied by the probability of death.

Question 27

What are the **two** *mortality costing option* for Universal Life Policy?

Answer 27

1. Yearly Renewable Term (YRT) 2. Level Cost of Insurance (LCOI)

Question 28

*TRUE OR FALSE?* For a UL policy based on LCOI, the cost per $1,000 at risk generally remains constant over the duration of the policy.

Answer 28

TRUE

Question 29

*TRUE OR FALSE?* Some policies allow the policyholder to switch **from YRT costing to LCOI** costing after the policy is issued.

Answer 29

TRUE

Question 30

*TRUE OR FALSE?* The policyholder is **permitted** to switch **from LCOI to YRT** costing after the policy is issued.

Answer 30

FALSE The policyholder is NOT permitted to switch from LCOI to YRT costing after the policy is issued.

Question 31

What are the **4 Death benefit options** in a UL Policy?

Answer 31

1. Level Death Benefit 2. Level Death Benefit + Account Value 3. Level Death Benefit + Cumulative Premiums 4. Indexed Death Benefit

Question 32

Name some **Key Points** in Level Death Benefit

Answer 32

- Remain constant at the original face amount. - Beneficiary can receive the policy’s account value once it exceeds the original face amount. - Premiums greater than the minimum will grow the policy's investment account. - least expensive of the death benefit options. - Suitable for clients who do not have an increasing insurance need.

Question 33

What are some **Key Points** for *Level Death Benefit + Account Value?*

Answer 33

- Net Amount at risk (NAAR) remains level over time. - Mortality deductions are greater than Level Death Benefit. - Investment account grows more slowly. - Beneficiary receives original amount of insurance, plus the full account value, as a tax-free death benefit. - Suitable for those who deposit large premiums in excess of the amount required.

Question 34

Name some **Key Points** in the *Level Death Benefit + Cumulative Premiums*

Answer 34

- Most expensive death benefit option - Beneficiary receives the original face amount plus the gross amount of each premium. - Provides a full refund of premiums when the life insured dies. - Suitable for policyholders who intend to maximize their premiums.

Question 35

What are some **Key Points** for *Indexed death benefit?*

Answer 35

- Death benefit equal to the original face amount and indexed for some measure of inflation. - Some policies index the death benefit to the Consumer Price Index (CPI). - Some policies allow the policyholder to choose an indexation rate. - The NAAR for a UL policy with an indexed death benefit will not be level. - Suitable to cover an end-of-life risk that is expected to increase over time (Ex. tax liability on assets that appreciate in value.)

Question 36

Name **3 investment components** within the UL Policy?

Answer 36

- Net Premiums - Tax Deferral - Investment Choices - Impact of investment return

Question 37

**Simplify** Net Premiums

Answer 37

Net premiums are the policy’s investment funds which equals to Gross Premiums — Premium tax — Mortality — Admin expenses

Question 38

*TRUE OR FALSE?* The insurance company may **limit** the policyholder’s net premiums to ensure that the policy remains tax-exempt.

Answer 38

TRUE

Question 39

*TRUE OR FALSE?* Investment income **earned** within the policy’s tax-exempt investment account are fully **taxable** as long as it remains in the plan.

Answer 39

FALSE Investment income earned within the policy’s tax-exempt investment account is NOT taxable at the time it is earned, much like income earned within a registered retirement savings plan (RRSP) (Tax differed) is not taxable as long as it remains in the plan.

Question 40

*TRUE OR FALSE?* UL policies offer a wide range of fixed income and equity investment choices, giving the policyholder the ability to actively manage the investment mix.

Answer 40

TRUE

Question 41

*TRUE OR FALSE?* The policyholder is **limited** to a single investment choice; he *cannot* have his net premiums divided or spread out to a number of different investment choices due to the Net Amount at Risk.

Answer 41

FALSE The policyholder is **not** limited to a single investment choice; he can have his net premiums divided or spread out to a number of different investment choices.

Question 42

*FILL IN THE BLANK* Daily interest accounts (DIA) usually offer ______________ based on the yield of a specified benchmark, such a percentage of the yield on a 30-day Government of Canada treasury bill. a) a minimum interest rate b) an ETF (Exchange Traded-Fund) c) Advanced Accounts d) Limited Pay T-100

Answer 42

- Daily interest accounts (DIA) usually offer a **minimum interest rate** based on the yield of a specified benchmark, such a percentage of the yield on a 30-day Government of Canada treasury bill. - The absolute minimum return is set at 0%, so the principal is guaranteed.

Question 43

Index options are usually diversified by?

Answer 43

Index options may be diversified by **location, asset mix** (Ex. equity, bond, balanced), **market capitalization** (Ex. large cap, small cap) or **income objective** (Ex. Capital growth vs. income).

Question 44

*TRUE OR FALSE?* UL policyholders can choose to receive interest income based on the performance of a selection of mutual funds.

Answer 44

TRUE

Question 45

*TRUE OR FALSE?* If investment returns are lower than expected in a UL policy, then the mortality deductions will **erode** the account value more quickly.

Answer 45

TRUE

Question 46

*TRUE OR FALSE?* Projections and illustrations of investment returns in a UL policy are **intended** to demonstrate how the policy works, and are a prediction of **guaranteed** or expected performance.

Answer 46

FALSE Projections and illustrations of investment returns are only intended to demonstrate how the policy works, and are **not** a prediction of guaranteed or expected performance.

Question 47

Non-Forfeiture options in a UL policy is commonly known as?

Answer 47

Accumulating fund.

Question 48

What are the **Non-forfeiture options** in a UL policy?

Answer 48

1. Surrendering the policy 2. Policy withdrawals (partial surrender) 3. Premium offsets 4. Policy loans 5. Collateral for third-party loans 6. Leveraging 7. Distribution upon death

Question 49

*FILL IN THE BLANK* Surrender charges are normally charged if the policy is **surrendered** during __________ of coverage. a) Before the 3rd year b) During the accumulation phase c) After 10 years d) First 5-10 years

Answer 49

Surrender charges are normally charged if the policy is surrendered during the **first 5 to 10 years** of coverage.

Question 50

*TRUE OR FALSE?* The surrender charge in a UL policy **can** exceed the value of the investment account especially when funds are withdrawn in the early years.

Answer 50

FALSE - The surrender charge would never exceed the value of the investment account. - The policyholder doesn’t have to pay a surrender charge if the policy does not have a cash value.

Question 51

*TRUE OR FALSE?* Surrendering a UL policy **will** result in a taxable policy gain.

Answer 51

TRUE

Question 52

*FILL IN THE BLANK* A **withdrawal** in a UL Policy is considered to be_____________. a) Full Surrender b) a Paid-Up policy c) Partial Surrender b) Cancellable policy

Answer 52

A withdrawal in a UL policy is considered to be a **partial surrender**.

Question 53

*TRUE OR FALSE?* Withdrawals in a UL policy doesn’t affect the growth of the investment account because they are tax-deferred and held in a reserve.

Answer 53

FALSE Withdrawals in a UL policy will **impede** the growth of the investment account, and may affect the long-term viability of the policy.

Question 54

*TRUE OR FALSE?* Participating whole life policies provide the policyholder with the choice of using policy dividends to offset their premiums.

Answer 54

TRUE

Question 55

*TRUE OR FALSE* In regards to premium offsets in a UL policy, the investment account can grow to such a size that it can be used to fund future mortality and expense deductions indefinitely.

Answer 55

TRUE

Question 56

What's the term that's used when the UL policyholder **obtains a loan** from the insurance company against the cash surrender value of the policy?

Answer 56

Policy Loan

Question 57

*TRUE OR FALSE?* The policyholder is required to **pay back** the loan in UL, because the loan balance plus any accumulated interest affects the insurance companies administrative expenses.

Answer 57

FALSE The policyholder is **not** required to pay back the loan, but the loan balance plus any accumulated interest will **reduce** the death benefit payable under the policy.

Question 58

*TRUE OR FALSE?* A policy loan is also considered to be a *taxable disposition.*

Answer 58

TRUE

Question 59

*TRUE OR FALSE?* UL policyholders may be able to use the **cash surrender value** of the policy as **collateral** for a loan from a third party.

Answer 59

TRUE

Question 60

What's the difference between Collateral Loan & Leveraging Loan in UL policy?

Answer 60

They are both the same however with leveraging, you can obtain series of loans rather than a single loan. | [Ref. 4.6.6]

Question 61

Name **some** ADVANTAGES in a UL Policy

Answer 61

- Offers flexibility to the policyholder. - Policyholder can increase, decrease or suspend premiums. (as long as the policy’s account value can support the mortality and expense.) - Policyholder has a choice of investment products. - Offers the opportunity for tax-sheltered investing, within limits.

Question 62

What are **some** DISADVANTAGES in a UL policy?

Answer 62

- Complex and may be difficult for the policyholder to understand. - Policyholder needs to actively monitor the performance of the investment account. - Policy performance is sensitive to changes in investment performance.

Question 63

What are the *differences* in **Policy dividend** with UL policy and Whole Life?

Answer 63

Policy pays dividends in Whole Life, but doesn't pay dividends in Universal Life.

Question 64

What are the *differences* in **mortality deductions and expenses** with UL policy and Whole Life?

Answer 64

- Mortality deductions and expenses are **deducted from investment account in UL**. Mortality deductions may be based on YRT or LCOI costing. - Mortality deductions and expenses are **taken from policy reserves** in Whole Life.

Question 65

What are the *differences* in **death benefits** with UL policy and Whole Life?

Answer 65

- UL Policyholders have options with respect to the death benefit (Ex. death benefit plus account value, death benefit plus cumulative premiums). - In Whole Life, Death benefit is not affected by the value of the investment account

Question 66

What are the *differences* in **modal factors** with UL policy and Whole Life?

Answer 66

- Modal factors generally are not used in UL. - Modal factors are applied in Whole Life if premiums are paid other than annually.

Question 67

What are the *differences* in **investments** with UL policy and Whole Life?

Answer 67

- **Policyholder** can choose how the investment account is invested in UL. - **Insurance company** chooses how the policy reserves are invested in Whole Life.

Question 68

Who can benefit from Universal Life Policy?

Answer 68

Investment-savvy policyholders who have long-term insurance needs and who are also looking for tax-advantaged investment opportunities.

Question 69

*TRUE OR FALSE?* Leveraging a UL policy can provide a tax-free source of retirement income.

Answer 69

TRUE

Question 70

Abebe has a universal life (UL) policy with a face amount of **$400,000**. When Abebe purchased the policy, his life insurance agent recommended that his policy have **level cost of insurance** (LCOI). The cost of insurance (COI) of the policy has been set at **$23.25**. Last year the value of the **investment account was $98,000** and this year it has **grown to $107,000**. ***Which statement accurately describes the mortality deduction from Abebe’s account?*** a) The mortality deduction last year was $7,022 b) The mortality deduction this year is $6,832 c) The mortality deduction is the same because it is level d) The mortality deduction in the later years is greater

Answer 70

***Step 1 is to calculate the NAAR for both years:*** **NAAR = death benefit − investment account value** *Year 1 = $400,000 − $98,000 = $302,000* *Year 2 = $400,000 − $107,000 = $293,000* ***Step 2 is to calculate the mortality deduction*** **Mortality deduction = (COI × NAAR) ÷ 1000** *Year 1 = ($23.25 × $302,000) ÷ 1000 = $7,021.5 Year 2 = ($23.25 × $293,000) ÷ 1000 = $6,812.25* | [Ref: 4.3.3]