Life Insurance Chapter 5

Life income joint & survivor

- Annuity is payable to 2 annuitants (in one check) while both are living. Upon the death of the first annuitant, survivor benefits continue, either paying the full amount or reduced to 2/3 or 1/2 for the survivor's income until the survivor dies. Depending on which option is selected, these options may be referred to as Joint and Full Survivor, Joint and 2/3 Survivor, or Joint and ½ Survivor.

Annuity Classifications are based on:

- Method of premium payment (single, flexible, and periodic) - Funding (fixed vs. variable) - When income benefits are payable (immediate vs. deferred) - The payout option selected (Life only vs. -Annuity certain) - Number of lives covered (individual vs. joint)

an annuity may not be sold to a senior if:

-The senior's purpose in purchasing the annuity is to affect Medi-Cal eligibility and either of the following are true: -------The purchaser's assets are equal to or less than the community spouse resource allowance established annually by the State Department of Health Services pursuant to the Medi-Cal Act. ------The senior would otherwise qualify for Medi-Cal. -The senior's purpose in purchasing the annuity is to affect Medi-Cal eligibility and, after the purchase of the annuity, the senior or the senior's spouse would not qualify for Medi-Cal. -Any broker or agent who violates the prohibition against selling annuities to qualify a senior for Medi-Cal is liable for an administrative penalty of $1,000 for the first violation and $5,000 up to $50,000 for subsequent violations and possible suspension of the agent or broker license by the Commissioner.

Long-term care (LTC)

A Long-Term Care rider will permit the owner of the policy to use all or a substantial portion of the annuity cash accumulation value to pay for the expenses of LTC under the same requirements to trigger and pay benefits as a traditional LTC policy.

deferred annuity

A deferred annuity will pay periodic benefits starting at some specified time in the future; benefits begin more than 1 year from the issue date.

annuities and medi-cal eligibility

A life agent who offers for sale, or sells any financial product based on its treatment under the Medi-Cal program must provide, in writing, a disclosure entitled "Notice Regarding Standards For Medi-Cal Eligibility". This notice is a brief description of the Medi-Cal eligibility rules. It is to be clearly separate from any other document, and signed by the prospective purchaser, that person's spouse and legal representative, if any.

single premium

A lump sum payment is made into an annuity.

Qualified vs. Nonqualified Annuities

A qualified annuity is funded with pre-tax dollars, meaning the contribution itself could qualify for a tax deduction, lowering taxable income. The entire distribution from a qualified annuity (contributions and earnings) is subject to ordinary income taxes. Qualified annuities may be used to hold qualified retirement plans such as IRAs or Tax Sheltered Annuities. Contributions are limited by the IRS under these types of plans. A non-qualified annuity is funded with after-tax dollars, meaning taxes on the money were paid before it goes into the annuity. Upon distribution, only the earnings are taxable as ordinary income. Most individual annuities are nonqualified. Exam questions will be about nonqualified annuities unless specifically stated concerning qualified annuities.

Single Premium Immediate Annuity (SPIA)

A single premium (lump sum) is put into an annuity from which the annuitant may immediately begin drawing benefits (within a year of the issue date). A retirement plan rollover, savings account balances or CDs, mutual funds, deferred annuity values, or the death proceeds of a life insurance policy might be used to purchase a SPIA.

Single Premium Deferred Annuity (SPDA)

A single premium (lump sum) is put into an annuity from which the annuitant will draw the benefits at some specified time in the future, more than 1 year from the issue date.

nonforfeiture provisions

An annuity owner will not lose the value accumulated up to the point where they stopped paying into the contract. Nonforfeiture provisions give the owner the rights to the accumulation in the contract. The owner has the right to surrender the contract during the accumulation period. Remember, these provisions only apply to deferred annuities since immediate annuities do not have an accumulation period.

Indexed (or Equity Indexed) annuities

An annuity product with interest rates that are linked to the positive performance of a related index, such as the Standard & Poor's 500 Index. The contract owner enjoys safety of principal and some guaranteed minimum returns. The safety of principal and previously locked-in interest is backed by the insurer's general account. The minimum guarantee can be as low as 0% reflecting that the policy will not be adversely affected by negative stock market index performance. These contracts typically have a fixed account from which funds are transferred into the index selected. They also tend to have higher surrender charges and longer surrender charge periods.

Cost of Living

An inherent risk in a fixed annuity is the loss of purchasing power due to inflation. A Cost of Living rider will increase the annuity payments according to changes in the Consumer Price Index (CPI).

Insurance Aspects of Annuity

Annuities are insurance products based on a mortality table. If a life settlement option is chosen, the insurance company guarantees to provide an income benefit payment as long as the annuitant lives (for example, life only or joint and survivor). Actuarial assumptions based on the law of large numbers allow this to occur. Those who live a shorter life span than expected allow the insurance company to have the reserves in place to be able to pay out guaranteed lifetime income benefit payments to those who live well beyond life expectancy.

Concept of an Annuity

Annuities are used primarily to provide a steady stream of income to an individual typically upon retirement. In theory, an annuity is designed to protect against outliving an individual's retirement income by providing lifetime income. One of the primary functions of an annuity is to liquidate an estate, or to pay benefits until the death of an annuitant. In direct comparison to life insurance, an annuity could be referred to as the opposite of a life insurance policy. Annuities are funded and sold through life insurance companies and require at least a life insurance license to sell.

Employer sponsored qualified retirement plans

Annuities are usually purchased by individuals. They may also be purchased as part of a structured corporate pension plan referred to as a Group Annuity. A Group Annuity is a contract between the insurer and the employer and is set up for eligible employees. Each employee receives a certificate. This is a defined benefit plan under IRS rules. Corporations may use annuities to provide pensions for employees, funding nonqualified deferred compensation plans or qualified retirement plans, and even to structure payments from liability settlements, known as structured settlements. Corporate owned annuities lose the tax-deferral aspect of the policy and interest or gains are taxable as income in the year earned.

Period Certain

Annuity benefit payments are received for a specified period of time. If the annuitant dies with time remaining on the period certain, the named beneficiary receives the balance of the payments. An annuity guaranteed to pay out for a specific number of years (such as a typical, state lottery prize) is called a fixed period.

Life income (pure or straight life)

Annuity is payable for as long as the annuitant lives, and upon death all payments cease. This option provides the highest monthly income than any of the other options.

Life income period certain

Annuity is payable for life, or for a specified period of time, whichever is longer. If the annuitant lives beyond the stated period, benefits continue for life of the annuitant. If the annuitant dies prior to the end of the period certain a beneficiary receives the balance of the payments for the remaining time period.

Life Income with Refund (Installment or Cash Refund)

Annuity is payable for the lifetime of annuitant. Upon death, if an annuitant has not received an amount equal to the total of all payments made into the annuity (not the growth), the balance is refunded to the beneficiary as a lump sum, cash refund, or in installments, sometimes referred to as the installment refund.

joint life

Annuity is payable to 2 or more named annuitants while both are living. Upon the death of the first annuitant, the benefits stop.

Accelerated or Living Benefit

As in life insurance, this rider permits the policyowner to withdraw funds without a surrender charge prior to annuitization in the event of the annuitant's terminal illness diagnosis. Death must be expected within 2 years. Some terminal illness riders also permit withdrawals due to permanent total disability.

General Account vs. Separate Account

As mentioned previously, fixed annuity products require premiums to be invested in the insurer's general account. The general account consists of safe investments that allow the insurer to guarantee a minimum rate of return. Variable annuities require the insurer to maintain a separate account. Performance of the separate account is based on the underlying investments in the stock market and are not guaranteed. Variable annuities are regulated by the SEC and State insurance departments. Annuity payments and cash values fluctuate according to the investment experience of the separate account the contract owner has designated. Payments are based on "units" rather than dollars. While not guaranteed, variable annuities may act as a hedge against inflation. This protects against the purchasing power risk of a fixed payment annuity by providing income that trends toward keeping pace with inflation. The contract owner bears the investment risk and receives the return earned on invested assets, less any charges assessed by the insurer and investment managers. There is no guaranteed return. The premium paid during the accumulation period is invested in separate account; the underlying investment in the separate account is similar to a mutual fund. The investment return varies according to the separate account selected based on the assumed interest rate (AIR). If the actual return is lower than the AIR, the monthly annuity payment will be reduced. If the actual return is equal to the AIR, the monthly annuity payment will remain the same as the previous month. If the actual return is greater than the AIR, the monthly annuity payment will increase from the previous month. Both an insurance license and a securities license (FINRA) are required. This annuity is considered a security, and therefore, must comply with the Federal Securities and Exchange Commission (SEC) rules as well as the state insurance laws. A prospective buyer of a variable annuity must be provided with a document called a prospectus. The prospectus gives detailed information on the separate account available in the annuity. This information provides the contract owner the opportunity to make a better decision based on the historical performance of the separate account. The prospectus must be provided at or before the time of the sale. The premium payments made during the accumulation period may be flexible in amount and frequency limited only to the contract's provisions. Premiums purchase accumulation units of the separate account. These are similar to shares of a mutual fund. Upon annuitization, accumulation units are converted into annuity units. The number of annuity units liquidated remains level, but the unit value fluctuates, based upon the performance of the separate account.

Annuity Uses

Before determining the use of an annuity, it is important to determine the suitability of the product to the intended purchaser. Suitability describes the steps that must be taken by a producer to ensure that an annuity is addressing a prospective owner's needs and financial objectives at the time of the sale. Additional factors used when determining suitability include the age, income, risk tolerance, and potential use of the annuity.

periodic premium

Continuous premiums paid into the contract. The most common example of a periodic premium is a flexible premium.

Fixed (guaranteed) Annuity

During the accumulation period, the insurer guarantees a minimum fixed interest rate. The fixed amount purchasing power decreases as the cost of living increases. The actual rate of interest created at any one time is based on the earnings rate of the insurer's general account and the insurer bears any investment risk. A life-only insurance license is required in order to sell fixed annuities in California. Some fixed annuities offer a base interest rate plus a bonus interest rate which becomes the current rate credited into the annuity. The current rate is set by the insurance company at the time the contract is issued and is guaranteed for a specific time period.

California Senior Market and Policy Illustrations

Every insurer and life agent offering for sale individual life insurance policies, or individual annuity contracts that are issued for delivery to senior citizens in California with the use of non-preprinted illustrations of non-guaranteed values must disclose on those illustrations, or on an attached cover sheet, the following statement: "This is an illustration only. An illustration is not intended to predict actual performance. Interest rates, dividends, or values that are set forth in the illustration are not guaranteed, except for those items clearly labeled as guaranteed." All preprinted illustrations containing non-guaranteed values must show the columns of any guaranteed values in bold print.

Flexible Premium deferred Annuity (FPDA)

Flexible contributions may be made as often and in whatever amount the contract owner desires. However, most insurers set a minimum and a maximum amount for contributions. Benefits begin more than 1 year from the issue date.

flexible premium

Flexible contributions may be made as often and in whatever amount the contract owner desires. However, most insurers set a minimum and a maximum dollar amount they will accept.

Suitability and taxation

If a life agent offers to sell any life insurance or annuity product to a senior, the agent must advise in writing that the sale of any asset used to fund the purchase of the insurance product may have tax consequences, early withdrawal penalties, or other costs assessed as a result of the sale. The agent may recommend the individual consult independent legal or financial advice before selling assets prior to the purchase of any life or annuity products.

death benefits

In addition to providing a guaranteed income benefit payout for life, an annuity also has another guarantee if the annuitant dies prior to annuitizing the contract. In this case, the policy has a named beneficiary, just like a life insurance policy, whereby the insurer pays out an amount equal to the premiums paid or the account value, whichever is greater.

Free Look and Cancellation

In this section, a senior citizen is defined as an individual who is 60 years of age or older on the date of purchase of the policy. Persons who are 60 years of age or older must be given a 30-day free look period. This allows additional time to seek the counsel of others to assist in the decision to keep or cancel the new policy. Every individual life insurance and annuity contract delivered or issued for delivery to a senior citizen in California must include a notice in 12-point bold print that the policy may be returned within 30 days after receipt of the policy by the owner for a full refund by returning it to the insurance company or agent who sold the policy. The notice must include that if returned after 30 days, cancellation may result in a substantial penalty, known as a surrender charge, unless those penalties or charges do not apply. During the 30 day cancellation period, the premium for variable annuities may be invested only in fixed-income investments and money—market funds, unless the owner specifically directs that the premium be invested in the mutual funds underlying the variable contract. If the policyowner has not directed that the premium be invested in mutual funds, cancellation will void the policy from the beginning and all premiums will be refunded within 30 days. If the owner has directed that the premium be invested in mutual funds, cancellation entitles the owner to a refund of the account value within 30 days. Disclosures of the investment requirement/option and return of premium/fees in case of cancellation must be in 12-point bold print and displayed on the policy cover page. If the insurer fails to refund all the premiums paid in a timely manner during the 30-day free look period, the applicant is entitled to receive interest on the unreturned premium from the date the insurer the returned contract.

Lump sum structured settlements

Lump sum payments from lawsuits, lottery winnings, or an inheritance can be used to purchase a structured settlement in the form of an annuity. The annuity can then be used to provide guaranteed lifetime income to the annuitant.

Relevant information that should be obtained by a producer in order to present practical and affordable products includes the customer's:

Occupation and occupational status (still working or retired) Marital status Age Number/type of dependents Sources of income Yearly income Existing insurance Insurance needs/objectives Ability to pay for the proposed contract Source of premium payment Investment savings Liquid net worth Tax status Need for tax advantages Investment experience Concern for preservation of capital Product time horizon

Annuity (benefit) payments

Once a contract is annuitized, the insurance company takes ownership of funds in the account. In return, the annuitant is entitled to a guaranteed income stream based on the terms of annuitization. Depending on the option chosen, the annuitant may be able to name a beneficiary to receive any remaining benefits available upon the annuitant's death. Annuity income is based on annuity tables which are similar to mortality tables used for life insurance. Other factors that determine the income include the accumulation amount, interest rate return, age and gender of the annuitant, and the payment option selected. The available payment options includ

tax - deferred growth

Since an annuity is an insurance contract, the accumulation value grows tax deferred. Deferred annuities allow for the naming of a beneficiary to receive any policy values if the annuitant dies prior to annuitizing. Withdrawals prior to age 59½ are subject to income tax and generally a 10% tax penalty as well. Systematic withdrawals are allowed as a way to access the policies values without having to elect a settlement option.

Tax- Sheltered Annuities (TSAs)

Tax-Sheltered Annuities (TSA) are qualified annuity plans benefitting employees of public schools under the Internal Revenue Code Section 403(b), as well as other nonprofit organizations qualified under Section 501(c)(3). Employees of nonprofit organizations may have an arrangement with the employer where the employer agrees with each participating employee to reduce the employee's pay by a specified amount and invest it in a retirement fund or contract for the employee. Employees do not make direct payments to the retirement fund. These accounts are owned by the employee and are nonforfeitable and will be paid upon death, retirement, or termination of the employee. Contributions are pre-tax and interest earned grows tax deferred.

Life Insurance and Annuity Suitability for Seniors in California- Ethical Practices

The California Insurance Code defines a senior, or elder, as someone age 65 or older. All insurers, brokers, and agents engaged in the transaction of insurance owe a prospective insured who is 65 years of age or older, a duty of honesty, good faith, and fair dealing. This duty is in addition to any other duty that may exist. As adopted into California law, the NAIC's "2010 Model Suitability in Annuity Transactions Model Regulations" require all producers to document that an annuity sold to a person age 65 or older is suitable for that person's needs and objectives. Insurers must use suitability questionnaires to gather the required information and producers must receive product-specific training for each annuity they market to seniors before they may even market the annuity. Factors which must be considered prior to the sale of an annuity include, but not are not limited to, the purchaser's financial status, tax status, and investment objectives. The agent must understand the need for consumer awareness of liquidity limitations or surrender charges.

Pre-meeting (scope of Appointment) notice

The Insurance Code requires producers who meet with prospective clients age 65 and older in their homes for the purpose of transacting life insurance, annuities, or disability insurance products to provide a written notice of the first meeting at least 24 hours in advance. The notice includes information about the products that will be discussed, and the insurance license numbers of those attending the meeting. The notice also explains that they may have any other persons—family members or advisers of their choosing—at the meeting, and that they have the right to terminate the meeting at any time. The notice may be delivered in person, by mail, fax, or email. Producers must retain a copy of notices in their files for a minimum of 5 years. Established clients may be given the notice at the time of an appointment.

Annuity Riders

The addition of several different types of riders may make annuities more desirable. As in life insurance, riders extend or enhance the benefit of the annuity contract.

The Annuity Distribution Period (Pay-Out)

The annuity period begins once the policyowner elects to convert a deferred annuity into an income benefit payment. The settlement option selected can provide a temporary or lifetime payment. If a lifetime benefit is selected, it is an irrevocable election. The cash values go towards paying for the income benefit.

retirement income

The funds accumulated inside an annuity can be used to fund all or part of a consumer's retirement income. The accumulated funds can be used to purchase a settlement option that can provide for a lifetime income stream or an income stream that can end prior to the annuitant's death. The income received will be tax-free as far as the portion of the payment is counted as a return of premium while the balance would be taxable as ordinary income. If premiums were deductible then the entire income received would be subject to tax. The only exception is if the income comes from a Roth IRA annuity whereby the income stream would be tax-free under certain qualifying situations.

immediate annuity

The immediate annuity does not have an accumulation period and is used to generate immediate income within a year of the issue date.

beneficiary

The individual or person named in the contract to potentially receive benefits if the owner and/or annuitant die prior to annuitization or if the settlement option selected offers any residual benefit after the annuitant's death. As with life insurance, annuities may have beneficiaries named and designated by the owner prior to the annuitization or guaranteed payout period. The beneficiary may be named at receipt of the first purchase payment and may only be changed by the owner. The owner's rights begin at the time of purchase. An owner, who may also be the annuitant, may change the annuity date, beneficiary, and payout option. I During the accumulation period, if the contract owner and the annuitant are the same person and the designated beneficiary is the annuitant's spouse, the IRS code allows the spouse to assume ownership of the annuity upon the death of the annuitant. All rights of ownership are assumed to include tax deferment.

owner

The individual who controls the contract and is responsible for making payments into the contract as well as having all of the contractual rights in the policy is the owner.

annuitant

The individual whose life the contract is based upon. Upon a lifetime annuitization, payments will be made to the annuitant according to the annuitant's age, gender, settlement option selected, and dollar amount used to fund the income benefit payments.

Accumulation (pay-in) period

The period of time from the first deposit to the start of the annuity payout is considered the accumulation period, during which taxes are deferred. Accumulation periods are only found within deferred annuities, not immediate annuities.

Market-Value Adjustment (Adjusted) Annuity

This is an annuity product that features fixed interest rate guarantees combined with an interest rate adjustment factor that can cause the surrender value to fluctuate in response to market conditions. Upon withdrawal, the MVA will add or deduct an amount from the annuity or the withdrawal amount. If the interest rates on which the MVA is based are higher than when the annuity was purchased, the MVA will likely be negative, meaning an additional amount may be deducted from either the annuity or the withdrawal amount. If the interest rates on which the MVA is based are lower than when the annuity was purchased, the MVA will likely be positive, meaning money may be added to either the annuity or to the withdrawal amount.

tax penalty

To discourage the use of annuities as short-term tax shelters, a 10% penalty tax is levied against any premature withdrawals prior to 59½ years of age. This discourages withdrawals. The tax penalty does not apply if premature distributions occur due to the death or disability of the contract owner.

Surrender charges

When a contract is fully surrendered, any surrender charges will lessen the contract payout. This is also referred to as a back-end load. Surrender charges diminish over a stated number of years, set by the insurer, until they disappear.

Deferred annuities

are normally purchased to defer taxes on any contract earnings. They are ideal for accumulating a retirement fund. During the accumulation period, only the contract owner can sign the request for surrender of a deferred annuity. During the early part of the accumulation period, the insurer normally assesses a surrender charge.

life insurance vs annuities

life insurance: provides a benefit upon death of the insured, create an estate, pays a death benefit, protects against premature death, owner insured beneficiary, policy annuities: provides steady income until death of the annuitant, liquidates an estate, pays a living benefit, protects against living too long, owner annuitant beneficiary, contract

lump sum vs annuitization

lump sum - The annuitant has the option of cashing out the annuity in a lump sum instead of electing to receive a stream of income. There could be tax consequences and tax penalties depending upon when this occurs. annuitization - The election to receive payments from the annuity for life, or for a specified period depending on the settlement option selected.

personal uses - individual annuities

retirement income lump sum structured settlements

premium payment options

single premium, periodic premium, flexible premium