Insurance
A small business owner enters your office with multiple insurance policies issued by many different companies. She has over $600,000 of coverage that expires in five years. Which of the following statements BEST describes the policies? a.) The policies are term life b.) The policies are whole life c.) The policies are variable universal life d.) The policies are variable life
A: A term life policy expires at the end of a period. The other choices are forms of insurance that are permanent and do not have a specific term.
A client wanting only financial protection for her family in case of her premature death should buy: a.) Whole life insurance b.) Term life insurance c.) Universal life insurance d.) Health insurance
B: Term life insurance buys protection at the lowest cost. If the insured does not die within the policy period, the policy expires without any cash value accumulation.
Which of the following is NOT TRUE regarding a viatical settlement contract? a.) The rate of return cannot be determined before the insured dies b.) The inability to accurately calculate the actual life expectancy of the insured c.) An investment in a viatical settlement contract is considered to be liquid d.) If the insured lives longer than expected, the investor is required to pay the premiums to keep the policy in force
C: With a viatical settlement contract, if the insured lives beyond life expectancy, the investor is required to continue to pay the insurance premiums. Since the death of the insured is ultimately unpredictable, the future financial commitment is unknown. A viatical settlement contract is not a liquid investment as there is not a secondary market for such investments.
Which of the following statements are TRUE of both variable life insurance and variable annuities? I. The investment risk is borne by the contract owner. II. The product must be sold with a prospectus. III. Partial surrenders are first treated as a tax-free return of principal. IV. If the contract owner dies, the beneficiary receives any proceeds tax-free.
I & II: Although partial surrenders of variable life insurance policies are first treated as a return of principal up to the amount of basis, variable annuities are subject to interest-first taxation. Only life insurance proceeds pass to beneficiaries tax-free. Beneficiaries of variable annuity contracts are taxed on the proceeds in the same manner as the annuitant.
A whole life insurance policy may be referred to as: I. Permanent life II. Term life III. Ordinary life IV. Straight life
I, III, IV
Five years ago, a registered representative sold a variable annuity to a 65-year-old client. The annuity carries a seven-year surrender fee. The client made a lump-sum investment of $100,000 into a growth-oriented separate account which has grown to $150,000. The RR expects a major market correction in the near future and recommends that the client conduct a 1035 Exchange into a fixed annuity. The RR explains to the client that the surrender fee will be less than the anticipated decrease in account value. This recommendation is: a.) Unsuitable, since there is no benefit in surrendering the annuity due to the other investment options that are available in the separate account. b.) Suitable, since the surrender fees have been disclosed to the client. c.) Suitable, since the RR is acting in the client's best interests. d.) Unsuitable, since the market correction will have little consequence over the short-term.
A: A 1035 Exchange permits the direct transfer of funds in a life insurance policy, endowment policy, or annuity into another policy, without creating a taxable event. However, incurring a surrender fee and then signing a new, long-term contract is not an appropriate recommendation. Since the separate account of a variable annuity will offer numerous investment objectives, the client could move her investment to another offering within the separate account without incurring surrender charges.
If required life insurance premiums are not paid on time, a policy will: a.) Lapse, but will be automatically reinstated b.) Lapse c.) Automatically pay out any existing cash value d.) Continue to honor any stated death benefit
B: The failure to pay life insurance premiums will cause the policy to lapse. Some policies allow policyholders to borrow against their cash value to pay premiums. However, the policyholder is not allowed to skip a payment. Since cash value will not automatically be paid out, it is usually forfeited.
The life insurance policy that allows for the greatest flexibility regarding the payment of premiums is: a.) Decreasing term b.) Universal c.) Variable d.) Split-dollar
B: Universal life allows the policyholder to vary the premium payments. The holder can elect to pay for the entire policy in one payment, allowing the insurance company to withdraw premium payments as required. Premium payments can also be made in specified intervals. However, payments that are too low may cause the policy to lapse if they do not cover the cost of insurance and other policy expenses.
All of the following statements are TRUE of the death benefit of a variable life insurance policy, EXCEPT: a.) It is included in the estate of the deceased b.) It is not taxable to the beneficiary c.) It may be reduced to zero by poor performance of the separate account d.) The beneficiary may elect to receive the death benefit as an annuity
C: Although the death benefit of a variable life policy may increase or decrease due to the performance of the separate account, it will not decrease below a minimum guaranteed amount (the face value of the policy).
Why would an investment adviser perform a capital needs analysis for a client? a.) To determine how much income the client will need at retirement b.) To determine how to best reduce the client's tax liability c.) To determine how much disposable income the client has available to purchase insurance d.) To determine how much insurance the client needs in order to fund future financial goals
D: A capital needs analysis is used to determine the amount of insurance a client needs to purchase today in order to fund her future financial goals. For example, if the client dies prematurely and the value of her investments are not sufficient to pay for her child's college education, life insurance is needed to fund the difference.
Which of the following is NOT a characteristic of whole life insurance policies? a.) The cash value is guaranteed b.) The premiums are deposited into the general account of the insurance company c.) The death benefit is guaranteed d.) The death benefit fluctuates or adjusts to the market
D: In a whole life insurance policy, premium payments are invested in the general account of the insurance company. The insurance company guarantees the owner's cash value and provides a fixed, guaranteed death benefit.
Which of the following choices is NOT a broker-dealer in State B? I. An agent in State A who contacts a client in State B II. A corporation that sells commercial paper every other week in State B III. A broker-dealer registered in State A, where its only office is located, which has only insurance companies as clients in State B IV. A bank trust department that buys and sells securities for its customers
I, II, III, IV: Agents, issuers, and banks are not broker-dealers. Also, a person with no place of business in a state, who deals only with institutional investors, is not a broker-dealer.
What is the most suitable policy for an individual who wants to earn a higher return from an insurance policy, but does not want to assume market risk? a.) Universal life insurance b.) Whole life insurance c.) Variable life insurance d.) Non-qualified annuity
A: In some cases, universal life insurance will either pay a minimum rate of return or slightly higher. Depending on the contract specifics, the additional rate of return could be pegged to a stock index or interest rate. An individual who purchases a variable annuity assumes the investment (i.e., market) risk of the security. If the separate account performs well, the value of the investment will increase. However, if the securities in the separate account perform poorly, the value of the investment will decline
One element in preparing a financial plan for a client is to determine the appropriate type and amount of life insurance. If a client is conservative, 30 years old, and married with 2 young children, whose income is unpredictable, the IA may recommend what type of life insurance policy? a.) Universal life insurance b.) Whole life insurance c.) Term life insurance d.) Variable life insurance
A: Since the client is conservative, with unpredictable income, universal life may be more suitable, since the premiums can be increased, decreased, or skipped, by using the cash value to fund the policy. The insurance company guarantees a minimum return on the cash value, which can be used to increase the death benefit. With whole life or term life, any premiums not paid may result in a lapse of the policy. Variable life would not be suitable for a conservative client, as the cash value may increase or decline based on the performance of the separate account. If a client is single with no dependents, life insurance may not be a concern for the client when creating the plan.
Which of the following insurance contracts have the elements of term insurance, a cash value that is not market-based, and a flexible death benefit? a.) Whole life b.) Universal life c.) Modified endowment policy d.) Variable life
B: Universal life is an insurance contract that allows the customer to select the amount of coverage and the size of the premium. Additionally, it has a cash value that grows at a minimum guaranteed rate. However, the performance of the cash value is not market-based.
In what way does variable life insurance provide for a death benefit that can keep up with inflation? a.) The death benefit will increase by the same percentage as the CPI b.) The death benefit will increase by a certain percentage of the increase in a specified index c.) The minimum guaranteed death benefit goes up by a fixed percentage every year d.) The earnings in the subaccounts are added to the guaranteed minimum death benefit every year
D: The death benefit will be increased each year by any increase in the value of the subaccounts. If the value of the subaccounts declines, the death benefit will decline but never below the minimum guaranteed amount. A variable life policy would be chosen because the owner feels that the growth in the subaccounts will provide a death benefit that is likely to keep up with inflation over the long run.
Several years ago, Dale purchased a $100,000 lump-sum, nonqualified variable annuity and made the policy payable to his brother Chip. When Dale died, the policy had a market value of $250,000. What are the tax implications for Chip? a.) There are no tax implications since the annuity has a stepped-up cost basis b.) The entire $250,000 is taxable as ordinary income c.) The entire $250,000 is taxable at long-term gains rates d.) An amount of $150,000 is taxable at ordinary income rates
D: Variable annuities are hybrid products that include features traditionally associated with insurance products and mutual fund investments. When a variable annuity owner dies, the value of the contract is paid to a third party. The recipient inherits the cost basis (in this case, $100,000). Anything above that amount is taxable to the recipient as ordinary income. In this case, Chip owes taxes on $150,000, the difference between the $100,000 invested by his brother and the $250,000 value of the policy at the time of Dale's death. There is no stepped-up cost basis for variable annuities.
Which of the following statements is FALSE about universal life insurance policies? a.) Premiums are always invested in a separate account of the insurance company b.) Cash values may vary based on interest-rate fluctuation c.) Policyholders may not choose how premiums are invested d.) Premiums may fluctuate
A: In universal life insurance policies, all premiums are deposited in the insurance company's general account. Variable policies/contracts use a separate account. Universal policies also have flexible premiums that may be increased or decreased over the life of the policy. While universal policies may have a guaranteed minimum rate of return, the return may fluctuate above the minimum.
All of the following statements are NOT TRUE, EXCEPT: a.) Variable life, as with universal life, gives the policyholder the flexibility to change the death benefit and the premium payments b.) Universal life, as with variable life, gives the policyholder flexibility in changing how the cash value is invested c.) Variable life, as with whole life, has fixed premiums and a fixed death benefit d.) Variable life, as with whole life, has fixed premiums paid at fixed intervals
D: While universal life allows the policy owner to change the premiums and/or the death benefit, variable life has fixed premiums and a fixed minimum death benefit. The actual death benefit on a variable life policy is not changed by a decision of the policyholder but, instead, as a result of growth in the subaccounts. Universal life has a minimum interest rate and an actual rate that could be higher, but it is determined by the insurance company, not the policyholder. Variable life and whole life are the same in having fixed premiums paid at fixed intervals.
Jack has a substantial amount of cash value built up in his variable life insurance policy. He would like to use some of it for a home renovation project. Which TWO of the following choices would be used to explain to Jack his options for accessing his cash value? I. If he withdraws some of his cash value, it will be treated as taxable earnings first, then a tax-free return of premiums (LIFO). II. If he withdraws some of his cash value, it will be treated as a tax-free return of premiums first, then taxable earnings (FIFO). III. If he takes a loan against the cash value, it will be taxed as earnings first, then treated as a tax-free return of premiums (LIFO). IV. If he takes a loan against the cash value, it will be tax-free.
II & IV: Any withdrawal of cash value from a life insurance policy is considered a return of premiums first, which would be tax-free. Withdrawals above the amount of premiums paid will be considered interest and, therefore, taxable as income. Policyholders usually prefer to borrow against their cash value, since this would be tax-free. The loan does not need to be repaid, but any amount still outstanding upon the death of the insured will be subtracted from the death benefit.