Series 66: Investment Vehicles (Insurance-Based Products)
Variable life insurance policies are a variety of which of the following?
Whole life insurance policies A variable life insurance policy is a whole life product, but instead of premiums being invested in the insurance company's general account, they are invested in a separate account. Like a whole life policy, the VLI policy has a fixed minimum death benefit. Unlike a whole life policy, the death benefit for a variable life policy can also vary upwards above the minimum death benefit if the separate account performs well. A variable life policy has a fixed annual premium like a whole life policy.
Funds deposited to purchase a fixed annuity contract are invested by the insurance company in its:
general account The insurance company's "general account" of investments collects the premiums paid for traditional insurance policies and fixed annuities and invests them to provide a return that will fund these insurance company obligations. If the underlying investments underperform, the insurance company will not reduce the annuity payment. In contrast, premiums paid for either variable life policies or variable annuity contracts are invested in a legally separate entity called a "separate account." The performance of the securities held in the separate account will determine the amount of insurance benefit or annuity payment - so they will vary.
A customer owns a cash value life insurance policy. Any of the following can result in a taxable event EXCEPT:
taking a loan from the policy Taking a loan is never a taxable event (if this were true, every time you borrowed on MasterCard, you would be taxed!). Because the cash value in a "cash value" life insurance policy (whole life) represents earnings that have never been taxed, when a policy is surrendered or if a partial withdrawal is taken, the portion attributable to the cash value is taxable. Upon death, the amount of the death benefit paid is included in the deceased person's taxable estate (the payment to the beneficiary is not taxable to the recipient, since the estate paid any tax due).
Which statement about variable life insurance is FALSE?
The policy value may be reduced to zero by poor performance of the separate account Variable life gives a guaranteed minimum insurance coverage, regardless of performance in the separate account, making Choice A false. With any life insurance, the policy value is included in the deceased's estate (the only way to remove it is for the individual to put the policy into a non-revocable trust prior to death). With any life insurance, the proceeds go to the beneficiary without tax due. With a variable life policy, the beneficiary can choose to take the death benefit as annuity payments instead of as a lump sum.
Which statement made by a representative when selling an EIA is NOT misleading?
"EIAs are regulated by the State insurance commission" Equity Indexed Annuities are regulated as insurance, so Choice A is true. They do give a minimum guaranteed rate of return, but this adds to the expenses of the product. In a bull market, EIAs are capped to a maximum return of around 9%, so a variable annuity equity separate account will do better. Finally, the only guarantee backing an EIA is that of the issuing insurance company. They are not guaranteed by the Pension Benefit Guarantee Corporation.
When a variable annuity is annuitized, which statements are TRUE? I The annuity units fluctuate II The annuity units remains constant III The unit value fluctuates IV The unit value remains constant
II and III When the separate account interest is "annuitized," the accumulation units are turned into a fixed number of annuity units. Each payment received is the number of annuity units times that unit's current value. Since NAV of the underlying mutual fund is computed daily, the value fluctuates each day.
Which of the following statements describes a universal life insurance policy?
The policy owner can change the schedule of premium payments With a universal life insurance policy, the policy owner can change the schedule of premium payments. After the cash value increases, the owner can skip a premium payment or the policy owner can use the cash value to buy additional insurance. The cash value is not invested in equities, but is invested in the insurer's general account. Whole life offers a fixed death benefit that is guaranteed for the insured's entire life. Term life has low premiums for young insured individuals, but the premiums increase with each renewal as that person ages.
Payments made on fixed annuities are:
the same after annuitization occurs Fixed annuities are an insurance product - they are not defined as a "security." The purchaser will receive a fixed annuity amount. The level payments do not vary with the performance of the investments funding the annuity. Fixed annuities are invested in the insurer's general account, which is required to be invested primarily in fixed income investments.
Which action taken regarding a universal variable life insurance policy will NOT result in tax liability?
Loan of up to 95% Proceeds distributed from a variable life insurance policy are taxable income if there is a distribution of benefits above the amount invested (tax basis) in the separate account. This would include a cash surrender (surrender of the entire policy for its current cash value, terminating the policy) or making a partial withdrawal from the policy. The payment of a death benefit from the policy, while not taxable income to the recipient, is included in the taxable estate of the deceased individual. If the aggregate value of the estate exceeds the estate tax exclusion, there will be estate tax liability. The only way to get cash out of a variable policy without a potential tax consequence is to borrow against the policy. In general, most "cash value" policies only permit a loan of up to 75% of cash value; but if the policy is fully paid, often the loan amount is raised to 95%.
In which of the following do investors have investment options available? I Whole life II Variable life III Universal life IV Variable universal life
II & IV only Investment options are available to persons who hold separate account interests. They can choose the type of separate account to fund either variable annuities or variable life policies (e.g., common stock, bonds, money market instruments, and other securities). With these products, the purchaser bears the investment risk. Policies funded by the general account, which are whole life and universal life policies, do not offer investment options. The reason is that these policies guarantee an investment rate of return.
A 60 year old man wishes to receive an annuity payment for himself and his beneficiary for at least 15 years. The recommended payout option is:
life annuity - period certain A life annuity-period certain will pay for one's life, however if that person dies early, the annuity will still pay for a designated period. In this case, the period certain would be 15 years. A life annuity simply pays for one's life. Once that person dies, payments cease. A unit refund annuity pays the remaining balance as a lump sum if the annuitant dies "early." The annuity option that chooses installments for a designated amount allows the annuitant to choose the monthly amount to be received. Payments continue for that amount until the account is exhausted.
A customer owns a perpetuity that pays $400 per month. Assuming that the market rate of return is 6%, the value of the contract is:
$80,000 A perpetuity makes payments forever. To calculate the value of the contract, you take the annual (not monthly) payment received and divide it by the market rate of interest. $4,800 annual payment received / .06 = $80,000
Which statements are TRUE about variable annuity contracts? I The issuer assumes the investment risk II The issuer assumes the mortality risk III The purchaser assumes the investment risk IV The purchaser assumes the mortality risk
II and III With any annuity, the issuer assumes the mortality risk. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Investment risk is the risk that the return on its investments held in the separate account declines. A decline in investment returns will reduce the annuity payments. This risk is borne by the purchaser of a variable annuity contract.
The "AIR" of a variable annuity contract is set when the:
contract is annuitized AIR stands for Assumed Interest Rate. It is a conservative estimate of annual return needed for the insurance company to maintain a constant annuity payment amount. The AIR is chosen by the customer at the beginning of the payout period, based on an interest rate range set by the State. It is an estimated interest rate that the separate account investments must earn to maintain payment amounts. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases.
What is a 10-year period certain annuity?
An annuity that will pay for a stated period of time, regardless of when the purchaser dies Be careful! There is no mention in the question that this is a "Life Annuity with a Period Certain" - in which case the answer would be Choice C. The question is simply asking about a 10-year period certain annuity. This would not be an annuity option in a variable annuity contract. It is an annuity option associated with the purchase of a fixed annuity. It is a type of annuity that can be purchased from an insurance company that only pays for a stated time period - in this case 10 years. These are used most often to bridge a gap between early retirement and when social security payments start. For example, if an individual retired at age 58 and full social security payments started at age 68, he or she could buy this contract to provide payments for that 10-year gap.
An investment would be made in a variable annuity in order to get: I market participation II market risk reduction III tax deferred growth IV tax free income at retirement
I and III The contribution to a variable annuity is not deductible, but the earnings build tax deferred. Income taken at retirement age is taxable on the portion attributable to the never-taxed build-up. Contributions are invested in a separate account holding shares of a designated mutual fund, typically an equity growth fund. If stock prices rise, the mutual fund shares will rise in value, which will increase annuity payments, so the investment offers market participation. On the flip side, equity values can also drop, which would reduce the mutual fund's value, which would reduce the annuity payments - so there is no market risk reduction.
Which of the following annuity payment options will continue payments for a specified time period if the annuitant dies prematurely?
Life Annuity with Period Certain A life annuity-period certain pays for the annuitant's life, but if that person dies prematurely, the annuity will pay a designated beneficiary for a specified minimum time period (usually 10 years).
Which statement concerning variable universal life policies is correct?
Premium and coverage amounts can vary Universal life policies allow the policy owner to change premium payments up or down to buy a higher or lower death benefit. With a variable universal life policy, the insurer invests premium dollars in a separate account to provide the death benefit. These policies offer a minimum guaranteed death benefit; however, the death benefit will increase if the separate account investments perform better than anticipated. Thus, premiums may vary, and the death benefit may vary, depending upon separate account performance.
Which of the following is NOT an advantage of owning a non-qualified variable annuity?
The amounts contributed are tax deductible to the contract holder Contributions to non-qualified variable annuity contracts are not deductible. The other 3 choices are advantages. The purchaser is guaranteed income for life. There is no limit to the amount that can be contributed, Reinvested dividends and capital gains grow tax deferred - tax is due only when distributions commence.
A 62-year old man owns a non-tax qualified variable annuity. If this individual makes a lump-sum withdrawal from the plan, this would:
be subject to ordinary income tax with no penalty Distributions from a non-tax qualified variable annuity are taxable as ordinary income, to the extent of the "never-taxed" build up in the account. Any return of contribution dollars in a distribution is not taxed, because these are "after tax" dollars (there was no deduction for the contributions). There is no 10% penalty tax due because this individual is over age 59½. Regarding a "rollover," this can only be done from a "qualified" plan into an IRA to maintain tax-deferred status. The IRS specifies the permitted rollovers. One cannot roll over funds from a non-qualified plan into an IRA without paying tax on the "build-up" portion of the investment.
A customer, age 50, is in the 35% tax bracket. The customer has a non-tax qualified variable annuity separate account to which he contributed $15,000 that has a current market value of $35,000. The customer takes a distribution of $10,000 from the account. The tax that will be due on this distribution is:
$4,500 Distributions from non-tax qualified variable annuity separate accounts are taxed on a LIFO (Last In First Out) basis. The original non-tax deductible contribution of $15,000 was the first in. The tax-deferred build up of $20,000 occurred second. When distributions are taken, the "build-up" portion comes out of the account first and is taxed at regular tax rates. After the build-up is depleted, the original investment of $15,000 comes out of the account and is not subject to tax. The customer is withdrawing $10,000 - which is all counted as "build-up" for tax purposes (last in - first out). This is taxable at 35%, plus the customer must pay a 10% penalty tax on a premature distribution (prior to age 59½). The total tax due is 45% of $10,000 = $4,500.
An insurance company that sells an Equity Indexed Annuity (EIA) would use any of the following methods to credit the change in investment value EXCEPT:
Moving average EIAs base the annuity payments on the performance of a broad-based index, such as the S&P 500 Index. However, the return is capped and there is a minimum guaranteed return, regardless of the performance of the index. The most common methods of measuring index performance are the: Point-to-point method; Annual reset method; and High-water-mark method. Assume that a client buys an EIA that is based on a 7-year return. The "point-to-point" method compares the index value at purchase date to the value at the end date, 7 years later. Any value fluctuations that occur in-between the 2 measurement dates are irrelevant. Another common valuation method is the "annual reset" method, which would measure the return achieved each year over a 7-year life and add interest to the annuity based on the annual reset. The annual interest credit is based on the difference between the year-beginning index value and the year-ending index value. This risk here is that the market dumps at year end, so that the credit only equals the floor amount. The "high water mark" method avoids the "bad timing risk" that you can have with the "annual reset" method. Instead of basing the annual interest credit on year-beginning and year-ending index value, it bases the credit on year-beginning index value and the highest value that it had during that year.
The participation rate formula for an equity indexed annuity:
considers how much of the gain in the index will be credited to the annuity Equity indexed annuities give a return that is tied to the performance of a reference index, such as the S&P 500 index. The participation rate determines how much of the gain is credited to the annuity. For example, if the participation rate is 80% and the S&P 500 index grows by 10%, the annuity will be credited with 8% for that year. Some annuities charge a "spread" or "asset fee" in addition to, or in place of, a participation rate (Choice B). Most EIAs put an interest rate cap on the annual return (Choice C). Finally, Choice D is just a bunch of garbage.
Which of the following statements are TRUE regarding a life annuity? I The shorter the expected annuity period, the larger the monthly payment II The longer the expected annuity period, the larger the monthly payment III A life annuity usually pays the largest amount of all of the annuity payment options IV A life annuity usually pays the smallest amount of all of the annuity payment options
I and III he shorter the time period to "expected death" when the separate account is annuitized, the larger the monthly payment will be; conversely the longer the time period to "expected death" when the separate account is annuitized, the smaller the monthly payment will be. Regarding annuity payment options, this must be looked at from the standpoint of the insurance company, that has a large pool of annuitants to cover. The insurance company can afford to pay a larger payment to those persons who it expects will be paid for the shortest time period; it will make smaller monthly payments when it expects to pay for a longer time period. A life annuity lasts only for that person's life - this is the shortest expected period of the annuity payment options. A life annuity with period certain continues to pay for a fixed time period if the person dies early; a joint and last survivor annuity pays a spouse when one person dies; a unit refund annuity pays a lump sum if a person dies early.
A customer has invested $20,000 in a non-tax qualified variable annuity contract. The investment in the separate account is now worth $30,000. The customer is age 60, and wishes to liquidate $5,000 from the account. LIFO taxation is used. The tax consequence of the withdrawal is:
$5,000 taxable ordinary income Distributions from non-tax qualified retirement plans are accounted for on a LIFO - Last-In; First-Out basis. The first item that went into the plan was the original non-tax deductible contribution. The next item than went into the plan was the reinvestment of dividends, interest, and capital gains over time - all of which have been building tax deferred. When distributions commence, the first dollars out of the plan are accounted for as the return of the "build-up" - which was never taxed. The last dollars out of the plan are the original investment (cost basis) which was made with after-tax dollars and hence is not taxed. Thus, in this plan $20,000 was invested; and it built up to $30,000. Thus, the first $10,000 out of the plan is taxable ordinary income; the remaining $20,000 is a non-taxable return of capital. The customer withdrew $5,000, all of which is taxable as ordinary income. Note that no penalty tax is due on the distribution because the customer is over age 59½.
With a variable annuity, the insurer takes the risk that expenses for administration will not be more than it expected. What is the charge the insurer makes for taking this risk?
Expense risk charge The expense risk charge compensates the insurer for the expenses that it incurs for administering the contract, and these are capped to a maximum percentage. If the expenses exceed this percentage, then the insurance company is responsible for the excess charges; not the purchaser of the annuity.
The purchaser of an immediate 15-year period certain annuity will receive payments for:
a 15-year time frame following annuitization, even if the purchaser dies before the end of the 15-year term The question is simply asking about an immediate 15-year period certain annuity. This would not be an annuity option in a variable annuity contract. It is only available as a fixed annuity. The purchaser makes a lump sum payment, which is immediately annuitized and which will then pay for 15 years. There is no life annuity feature associated with this. It is a type of annuity that can be purchased from an insurance company that only pays for a stated time period - in this case 15 years. These are used most often to bridge a gap between early retirement and when social security payments start. For example, if an individual retired at age 55 and full social security payments started at age 70, he or she could buy this contract to provide payments for that 15-year gap.
A whole life insurance policy is in force for:
the life span of the insured A whole life insurance policy remains "in force" as long as the premiums are paid. It is "in force" for the entire life span of the insured individual. When that individual dies, the insurance benefit will be paid to the policy beneficiary. The lifespan of the beneficiary has nothing to do with the time that the insurance policy is "in force."
During the annuity period of a fixed annuity, the insurance company assumes all of the following risks EXCEPT:
Morbidity In a fixed annuity, the insurance company assumes mortality risk, expense risk and investment risk. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company's expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company's problem. Investment risk is the risk that the insurance company's return on its investments does not keep pace with its payment obligations to fixed annuity holders. If its investments fare poorly, the insurance company does not reduce the amount of the fixed annuity payments. The insurance company does not assume morbidity (the risk of getting sick), which only applies to various types of health insurance.
A customer wants to buy permanent life insurance. He has no desire to participate in the market and may have additional money to add to premiums in the future. The best recommendation for this client is:
Universal life With a universal life insurance policy, the policy owner can change the schedule of premium payments. After the cash value increases, the owner can skip a premium payment or the policy owner can use the cash value to buy additional insurance. The cash value is not invested in equities, but is invested in the insurer's general account. Any cash value policy is "permanent insurance" - the insurer cannot choose to "non-renew" the policy as long as the premiums are paid. Whole life offers a fixed death benefit that is guaranteed for the insured's entire life. Term life has low premiums for young insured individuals, but the premiums increase with each renewal as that person ages. In addition, it is not permanent insurance - the insurance company can choose to renew; or can choose not to renew, at the end of the term policy's life.
A customer has a young disabled child with multiple sclerosis and wishes to invest enough money to provide $5,000 a month in perpetuity to pay for ongoing medical expenses. Upon the death of the disabled individual, the principal amount will be left to a charity searching for a cure for the disease. Assuming that the principal can be invested at a 6% annual rate of return, the required principal amount is:
$1,000,000 A perpetuity is a "perpetual payment" - so it is an annuity that goes on forever. If $1,000,000 is invested at 6%, it gives annual income of 6% of $1,000,000 = $60,000 without eating into the principal amount. $60,000 annual income / 12 months = $5,000 month income. The best way to deal with this type of question is to take 6% of the principal amount given in each choice to get the annual income and divide it by 12 months a year.
A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate; a 15% cap and a 3% floor. Interest is credited to the contract under the annual reset method and is compounded annually. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+20% Year 2:-5% Year 3:-10% At the end of year 3, the customer will have a principal balance of approximately:
$122,000 The first year increase in the index of 20% with a 90% participation means that 18% would be credited to the account - however, because of the 15% cap, this is the first year credit, so the $100,000 balance is worth $115,000 after the first year. Because of the 3% floor, even though the index fell in each of the next 2 years, the account value increases to $115,000 x 1.03 = $118,450 at the end of year 2; and $118,450 x 1.03 = $122,004 at the end of year 3.
A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate; a 15% cap and a 3% floor. Interest is credited to the contract under the annual reset method using the simple interest method. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+20% Year 2:-5% Year 3:+10% At the end of year 3, the customer will have a principal balance of: approximately:
$127,000 The first year increase in the index of 20% with a 90% participation means that 18% would be credited to the account - however, because of the 15% cap, this is the first year credit of $15,000. ($100,000 principal x .15) Under the simple interest method, the second year interest credit is still based on the $100,000 principal amount (there is no "interest on interest" as is the case with compound interest) and because of the 3% floor, the credit will be $3,000. ($100,000 principal x .03). Under the simple interest method, the third year interest credit is still based on the $100,000 principal amount (there is no "interest on interest"as is the case with compound interest) and because of the 90% participation, 90% of the 10% index increase, or 9% will be credited. The credit will be $9,000. ($100,000 principal x .09). Thus, the principal value after year 3 will be $100,000 + $15,000 + $3,000 + $9,000 = $127,000.
A customer, age 59, has a fixed annuity contract with a value of $16,000. The cost basis in the contract is $10,000. If the customer withdraws $5,000 and the IRS taxes distributions on a LIFO basis, the tax consequence of a withdrawal will be:
$5,000 taxable/$500 penalty Annuity contract contributions are not tax deductible, so the original contribution of $10,000 represents dollars that were already taxed. Any earnings in the account build tax-deferred. So the $6,000 excess value above the cost basis of $10,000 represents the untaxed build-up. IRS rules require that annuity distributions be taxed on a LIFO (Last In First Out) basis - with the build-up portion being the "Last In;" therefore these are the first dollars to be distributed. Thus, all $5,000 will be taxable. In addition, since this individual is under age 59½, the distribution will be subject to a 10% penalty tax for a premature distribution.
As the economy and the stock market fluctuate, which of the following can the holder of a variable annuity expect to occur during the payout years?
Benefits will fluctuate according to the return the separate account earns The benefit payments from a variable annuity contract will fluctuate based on overall economic conditions. Variable annuity separate accounts are most often invested in equities. If economic growth increases, the performance of the equity securities held in the separate account will increase and so, the amount of the annuity payments will increase. In difficult economic times, the reverse is true.
An individual, for a fee, prepares a custom financial plan for a client that includes a section covering life insurance needs. In order to do so, the individual: I must be a licensed insurance agent in the State II is not required to be a licensed insurance agent in the State III must be a licensed investment adviser representative in the State IV is not required to be a licensed investment adviser representative in the State
I and III To prepare customer financial plans for a fee, the individual must be licensed as an investment adviser representative in the State, but this does not cover life insurance! To sell life insurance, a separate State life insurance license is needed.
Which of the following are associated with variable annuities? I Level benefit payments II Variable benefit payments III Benefit payments that will fluctuate based on stock market movements IV Benefit payments that are unaffected by stock market movements
II and III The benefit payments from a variable annuity contract will fluctuate based on overall economic conditions. Variable annuity separate accounts are most often invested in equities. If economic growth increases, the performance of the equity securities held in the separate account will increase and so, the amount of the annuity payments will increase. In difficult economic times, the reverse is true.
A viatical settlement will typically give the policyholder an immediate cash payment that is: I more than 100% of cash surrender value II less than 100% of cash surrender value III more than 100% of policy face value IV less than 100% of policy face value
I and IV In a viatical or life settlement, a policyholder sells his or her life insurance policy to a third party, in return for an immediate cash payment. The third party now makes the life insurance payments and receives the death benefit upon the insured's death. This gives the policyholder cash now, typically used to pay for medical expenses. The cash payment received from selling the policy must be more than the policy cash surrender value in order for the transaction to make financial sense. Otherwise, the policyholder would simply surrender the policy. The policyholder typically gets around 80% of policy face value, but the actual amount paid depends on the expected life of the policyholder and market interest rate levels, among other items.
Which of the following terms describe Equity-Indexed Annuities? I Investment product II Insurance product III Principal protected IV Not principal protected
II and III Equity Indexed annuities are an insurance product and are currently not defined as a "security." They give a return tied to the performance of the Standard and Poor's 500 Index, but this is subject to an annual cap of typically 7-9%. Thus, in a year of sharply rising stock prices, they will not give the return of the index. However, they are protected in a falling market and guarantee a yearly minimum return of 1-3%. Thus, they will give a better return than the Standard and Poor's 500 Index when the market is falling sharply.
Premiums deposited to a variable annuity contract are invested: I in the insurance company's general account II a separate account III primarily in equity securities IV primarily in fixed income securities
II and III The premiums paid for either variable life policies or variable annuity contracts are invested in a legally separate entity called a "separate account." The performance of the securities held in the separate account will determine the amount of insurance benefit or annuity payment - so they will vary. The underlying securities are often shares of a designated mutual fund invested in equities. In contrast, the insurance company's "general account" of investments collects the premiums paid for traditional insurance policies and fixed annuities and invests them to provide a return that will fund these insurance company obligations. If the underlying investments underperform, the insurance company will not reduce the insurance benefit or annuity payments. General account investments are heavily weighted to safer, fixed income securities (bonds and preferred stocks).
Which statements are TRUE about variable annuity contracts? I Variable annuity contracts are regulated only by each State as an "insurance" product II Variable annuity contracts are regulated by the SEC as a "security" product in addition to being regulated by the State as an insurance product III Investment risk is borne by the purchaser of the contract IV Investment risk is borne by the insurance company that issues the contract
II and III With a variable annuity, the insurance company collects a premium from the purchaser and invests it in a "separate account" of investments - and the separate account buys shares of a designated mutual fund. The performance of the investments held in the separate account determines the amount of the annuity to be paid to the purchaser. Thus, the purchaser bears the investment risk - which is the risk that the investment value does not grow as fast as needed to fund the purchaser's future financial needs. This is why a variable annuity contract is defined as a "security" under Federal law. Also note that because insurance companies are regulated separately by each State, their products, including variable annuities, are also subject to State insurance regulation. Essentially, the purchaser of a variable annuity is buying a mutual fund in an insurance company wrapper. Variable annuities must be registered with the SEC and sold with a prospectus.
Which statements are TRUE regarding Equity Indexed Annuities (EIAs)? I In a year of sharply rising stock prices, EIAs will match the positive return of the Standard & Poor's 500 Index II In a year of sharply rising stock prices, EIAs will not match the positive return of the Standard & Poor's 500 Index III In a year of sharply falling stock prices, EIAs will match the negative return of the Standard & Poor's 500 Index IV In a year of sharply falling stock prices, EIAs will not match the negative return of the Standard & Poor's 500 Index
II and IV Equity Indexed annuities are an insurance product and are currently not defined as a "security." They give a return tied to the performance of the Standard and Poor's 500 Index, but this is subject to an annual cap of typically 7-9%. Thus, in a year of sharply rising stock prices, they will not give the return of the index. However, they are protected in a falling market and guarantee a yearly minimum return of 1-3%. Thus, they will give a better return than the Standard and Poor's 500 Index when the market is falling sharply.
Premiums are invested in an insurance company separate account for which of the following policies? I Whole life II Variable life III Universal life IV Flexible-premium variable life
II and IV Variable contracts (either variable life or variable universal life) have the premiums deposited to a separate account. The performance of the separate account determines the ultimate death benefit, so the policyholder bears the investment risk. Flexible premium variable life is another name for variable universal life, which gives policyholders the right to skip a premium payment. Term life, whole life, and universal life premiums are deposited to the insurance company's general account. The death benefit is fixed based upon premium contribution and is not subject to investment risk. The insurance company invests the premiums collected through its general account and bears the investment risk.
Which of the following life insurance policies give the holder investment options? I Whole life II Universal life III Variable life IV Variable universal life
III and IV only Any variable product gives the holder a variable rate of return. The holder selects the type of separate account in which he or she wants to invest. The amount of any payout depends solely on the performance of that separate account. Thus, the holder is assuming the investment risk. As such, SEC rules define variable products as securities and requires their sale under a prospectus. Whole life and universal life give the holder a guaranteed rate of return, with the insurance company determining the type of investments to make in its general account that will fund the future liability. Thus, the insurance company assumes the investment risk. As such, these are not securities, but are insurance products.
Which statement concerning the AIR of a variable annuity contract is TRUE?
It applies only during the annuity period AIR refers to the assumed interest rate used to determine the initial monthly payment to the annuitant - it is set when the contract is annuitized and only applies during the annuity period. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases. The AIR has no meaning during the accumulation period. Also note that the prospectus has an "AIR Illustration" that is an estimate of the annuity to be paid based on a conservative growth estimate, but the actual AIR is not set until the contract is annuitized.
Which statement describes a variable life insurance policy?
The cash value increases based on equity investments Whole life insurance protects the purchaser from increasing premiums as that person ages, and there are no renewals - the policy is good for that person's "whole" life. With a whole life policy, the annual premium is level, and will start out higher than a term life policy. Part of the premium is invested in the insurance company's general account and is guaranteed to grow at a fixed, guaranteed rate. As the general account investment portion grows, the policy builds "cash value" that can be borrowed. Variable life is a variation on whole life where a level annual premium is invested in a separate account, typically invested in equities. Better performance of the securities in the separate account will increase the death benefit, hence the term "variable life," - so the death benefit is not fixed. The policy builds cash value similar to whole life, but the amount of cash value depends on the performance of the separate account. Part (but not all) of this value can be borrowed, since the separate account performance will vary. Any borrowed funds reduce the benefit payment upon death. Universal life gives the policyholder the flexibility to skip some premium payments. Variable life invests premiums in a separate account and typically invests in equities, whereas both whole life and universal life invest premiums in the general account, which must be heavily invested in fixed income securities. Term life has low premiums for a young insured individual, but the premiums increase with each renewal as that person ages.
Which of the following would cause payment of a term life policy death benefit claim to be denied?
The insured person commits suicide during the first year of the policy Life insurance policies have a "suicide clause" that denies a claim payment if the insured person commits suicide within the first 1 or 2 years of the start of the policy. This makes sure that someone does not take out a policy, intending to then kill him- or herself and improve the financial situation of the named beneficiary. In this case, the insurance company will simply refund the premium payments to the estate of the deceased individual. If an individual dies in an airplane accident where the carrier provided life insurance coverage to the passengers, this has nothing to do with the coverage provided by that unfortunate person's own life insurance policy. This will pay as well. Most life insurance policies have an initial "contestability period" where the death benefit will not be paid if the insured dies within the first 1 or 2 years after the policy is issued and the insurance company believes that there was misrepresentation or fraud involved with the issuance of the policy. If death occurs during the contestability period, the insurance company has the right to investigate whether the information provided in the application was accurate. This is done to make sure that someone who is really ill (and who did not disclose this fact on the application) does not take out a policy in anticipation of imminent death, in order to improve the financial situation of the named beneficiary. As long as the premiums are being paid, the policy remains in force and will pay out if the insured individual dies. If premium payments are not made, the policy will lapse and no payment will be made upon the insured's death.
A contract is entered into between an individual and an insurance company under which a lump-sum payment or a series of payments are made, in return for which the insurance company agrees to make periodic payments immediately or at some future date. The purchase payments can be invested in a range of investment options, which are typically mutual funds. The value of the account, and hence the annuity payment amount, is dependent on the performance of the chosen investment options. This describes a:
Variable annuity A variable annuity invests contract payments in a separate account, which holds a designated mutual fund. The performance of the mutual fund will determine the annuity payment - so it will vary. In contrast, an EIA (Equity Indexed Annuity) is an insurance product where the annuity payment is based on the performance of a broad based index, such as the S&P 500 Index. This product does not have a separate account. Also note that EIAs are capped and floored - there is a maximum and minimum annual return; regardless of how well or badly the S&P 500 Index performs.
What type of life insurance policy has fixed premiums, guaranteed cash value, and a guaranteed death benefit?
Whole life Term life, whole life, and variable life all have fixed premiums. Universal life allows the premium payment to vary. Term life has no cash value. Whole life and universal life deposit excess premiums over the cost of insurance to the insurance company's general account, where it is guaranteed to grow at a minimum interest rate. In contrast, variable life premiums in excess of the cost of insurance are deposited to a separate account holding a designated mutual fund. The growth of cash value depends on the performance of the mutual fund held in the separate account. Term life and whole life have a fixed death benefit amount. Variable life can be offered either with a fixed death benefit amount or a death benefit amount equal to the fixed amount plus the cash value that builds in the separate account. Universal life offers a similar death benefit - the choice between either a fixed benefit or the fixed amount plus the cash value that builds in the policy. Therefore, the only policy that has fixed premiums, guaranteed cash value, and a fixed death benefit amount is whole life.
The Assumed Interest Rate (AIR) associated with variable annuities is the:
estimated future earnings rate needed to maintain level payments to the annuitant AIR stands for Assumed Interest Rate. It is a conservative estimate of annual return needed for the insurance company to maintain a constant annuity payment amount. The AIR is chosen by the customer at the beginning of the payout period, based on an interest rate range set by the State. It is an estimated interest rate that the separate account investments must earn to maintain payment amounts. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases.Variable annuities do not provide scheduled increases in payment amounts. The insurance company bases payouts on the value of annuity units when it pays them out.
All of the following statements are true about fixed annuity contracts EXCEPT:
investment risk is borne by the purchaser of the contract Fixed annuity contracts promise a fixed monthly payment to the purchaser of the annuity. The performance of the underlying investments that fund the annuity have no effect on the monthly amount to be paid. If the investments perform poorly, the insurance company will not reduce the monthly annuity payment. Thus, investment risk is borne by the insurance company, not by the purchaser of the annuity. Fixed annuities are regulated as an insurance product, not as a security, precisely because the insurance company bears the investment risk. Because the annuity payments are fixed, if there is substantial inflation, this will erode the purchasing power of the fixed monthly payments.
When comparing a fixed annuity to a variable annuity, a variable annuity has:
no fixed rate of return Fixed annuities have a guaranteed fixed income stream, while the payments from a variable annuity are based on the performance of the mutual fund held in the separate account (also called a subaccount). Fixed annuity premiums are invested in the insurance company's general account while variable annuity premiums are invested in a separate account (aka subaccount) that holds a specific mutual fund. Fixed annuities give a fixed rate of return while variable annuity returns will vary depending on the performance of the mutual fund held in the subaccount. Variable annuities have investment risk - payments will go down if the mutual fund held in the subaccount underperforms, while fixed annuities do not have investment risk because the insurance company guarantees to pay a fixed rate of return.
An annuitized account in a variable annuity is most similar to:
pension payments Once a variable annuity separate account interest is "annuitized," the holder gets a fixed number of annuity units. Each month, the holder gets a payment equal to the fixed number of units x the unit value (which varies based upon the performance of the underlying investments). The payments continue for life. Thus, an annuitized account is most similar to pension payments.
During the payout period of a fixed annuity contract, the annuitant assumes:
purchasing power risk In a fixed annuity, the insurance company assumes mortality risk, expense risk and investment risk. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company's expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company's problem. Investment risk is the risk that the insurance company's return on its investments does not keep pace with its payment obligations to fixed annuity holders. If its investments fare poorly, the insurance company does not reduce the amount of the fixed annuity payments. With a fixed annuity, the purchaser assumes purchasing power risk - the risk of inflation. If there is inflation, the monthly annuity payments do not increase, so the annuitant's purchasing power declines over time.
All of the following life insurance policies offer cash values to the policy owners EXCEPT:
term life Term life insurance is pure insurance with no investment element. For the premium paid, the purchaser is buying life insurance coverage for a fixed time period. At the end of that time period, the policy must be renewed to maintain coverage, typically at a higher premium as the insured individual ages (because of the greater mortality risk). When the purchaser of a term life policy is young, the premium is very low; as that person ages, the premium gets higher and higher. Whole life insurance protects the purchaser for his or her whole life from increasing premiums as that person ages. There are no renewals - the policy is good for that person's life. With a whole life policy, the annual premium is level, and will start out higher than a term life policy. Part of the premium is invested in the insurance company's general account and is guaranteed to grow at a fixed rate. As the general account investment portion grows, the policy builds "cash value" - meaning that part of the investment value can be borrowed against the policy. Any borrowed funds reduce the benefit payment upon death. Universal life combines elements of term life and whole life policies. The premium is broken down into an insurance element (the term component) and a savings element that is invested in the insurance company's general account (savings component). The policy owner's account is credited for the interest income earned on the general account. The rate of return can vary from year to year. The policy owner can use cash value to increase the death benefit or to skip some premium payments. Variable life products invest a portion of the premium in a separate account rather than the general account, and the investment return of the separate account will determine the amount of insurance coverage, which can vary.
A customer buys an annuity requiring an initial payment of $10,000. The annuity offers a 5% Bonus Credit. This means that:
the insurance company will pay an extra $500 into the contract on top of the customer's $10,000 payment When a variable annuity contract offers a "bonus credit," the company matches any customer payment made into the contract with an extra payment of anywhere from 1-5% of the amount paid. Since this customer is paying $10,000, the bonus credit of 5% means that the insurance company will pay an extra 5% of $10,000 = $500 into the contract. Usually annuity contracts with a "bonus credit" have higher annual expense ratios - a classic example of the fact that "you don't get something for nothing."
