FI 444 Exam 2
capitilization of earnings method - life insurance needed after tax
(income - taxes - after tax - personal consumption) / (1. risk free rate(discount rate) / 1. inflation rate) to find personal consumption do (after tax income * given personal consumption)
dividend options
1. cash 2. reduced premium 3. accumulate at interest 4. paid up dividend additions 5. one year term
Facts relevant in selecting the proper life insurance
1. client profile 2. client goals and objectives 3. survivors needs 4. estate liquidity 5. risk tolerance 6. existing insurance 7. amount of insurance needed
Single premium deferred annuities/ flexible premium deferred annuities - fixed - disadvantages
1. contract may fail to remain competitive 2. may have to Surender penalty
Types of life insurance - term life insurance - limitations
1. cost prohibitive at older ages - increased premiums based on age -immpractical for old people 2. no savings feature (is found in ordinary whole life policy) 3. No lifetime coverage
Facts relevant in selecting the proper life insurance - estate liquidity, factors that shrink an estate after death
1. decedent's debt 2. probate costs 3. administrative costs 4. federal and estate taxes 5. inheritance tax
advantages of variable annuities
1. diversification 2. guaranteed death benefit 3. riders that protect from downside loss 4. can dollar cost average
advantages of single premium immediate annuitys
1. ensure lifetime of income 2. protect the principal from creditors 3. can include a COLA 4. allows the remaining portfolio to accept higher risk 5. tax is predictable 6. investment risk is transferred to insurance
standard provisions of insurance policies
1. entire contract clause 2. owners rights 3. beneficiary designations 4. grace period 5. suicide clause 6. policy loans 7. reinstatement clause 8. incontestability clause 9. misstatement of age clause
determining life insurance - human life value method - calculation
1. find annual earnings - annual tax by income X tax rate 2. find personal consumption (after tax income X consumption) by (annual earnings - taxes) X consumption % 3. find family share of earnings by income - (income tax +personal consumption) 4. calculate remaining work life expectancy by retirement age - current age 5. FV = 0 PMT = FSE interest rate = ((1.discount rate / 1.inflation rate)-1) N=RWLE find PV
types of life insurance - whole life insurance advantages
1. fixed premiums 2. tax deferred accumulation (no income tax on cash value of policy 3. Lifetime coverage
Types of life insurance - universal life insurance limitations
1. flexible premium - if you miss a premium payment the next one increases 2. fewer guarantees - the value of the policy can go to zero if the right amount of premiums are not paid
Types of life insurance - Universal life insurance advantages
1. flexible premium 2. flexible death benefit 3. current assumptions - is often higher then whole life policy
The next steps of finding life insurance needed
1. identifying goals 2. identify resources 3. identify economic assumptions 4. considering insurability
Types of life insurance -whole life insurance limitations
1. inflexible premiums (premiums are always the same 2. gradual cash value growth (cash value is small at the beginning of the policy) 3. surrender charges 0 insurer can be charged for canceling whole life policy
section 1035 exchange rule
1. life insurance can be changed for another life insurance contract or for an endowment annuity or long term care insurance if the policy is on the life of the same person 2. endowment contracts can be switched when the beginning date for regular payments payments is no later than the original beginning date for regular payments 3. can trade annuity contracts for another one 4.can trade qualified long term care contracts for another
Types of life insurance - term life insurance - advantages
1. maximum coverage per premium dollar 2. meets temporary need for coverage 3. protects insurability - can get a large amount of coverage with limited
disadvantages of single premium immediate annuities
1. most benefits are fixed and do not account for inflation 2. can be more expensive then life only annuities 3. principal not available for emergencies 4. if the insured dies too early they cannot get back their original investment
how important is it for an individual to have life insurance based on their profile? - a person who is married but does not have kids?
1. must see how much extra resources an individual has to help avoid causing a financial hardship to the surviving spouse 2. is the spouse self-supporting enough to maintain satisfactory standard of living (maker her own income) 3. if the spouse needs money, how long will she need it for (how long until they begin to receive social security and other income benefits)
the common goals of life insurance
1. pay off debt 2. replace income 3. Fund college education needs 4. Final expenses (funeral costs, etc.)
disadvantage of annuities
1. tax penalties for early withdrawals 2. bad liquidity 3. fees for managing 4. no long term capital rates.
Variable universal life
A combination of the features of variable life insurance and universal life insurance under the same contract. Benefits are variable based on the value of equity investments, and premiums and benefits are adjustable at the option of the policyholder.
Non-participating policy
A life insurance policy that is not eligible to receive policy dividends.
Facts relevant in selecting the proper life insurance - existing insurance
If the client currently relies on their employer to cover insurance then it would be wise to consider getting an individual policy that is more permanent but can be expensive
Term life insurance
Insurance that provides financial protection from losses resulting from a death during a definite period, or term. (example, 10 year term, 1 million dollar policy), once that term is over then it can either be ruined or expired
Why get a variable life insurance policy and risk?
Policy holders risk giving up a guaranteed stated cash value in exchange for the possibility of enhanced death benefits and cash values
Facts relevant in selecting the proper life insurance - client goals
What specific sums does the client want to leave to a family member or charity?
dividend options - one year term option
a policy owner can elect to have the annual dividend buy one year term insurance - allows for a small dividend to buy a much larger amount of death benefit protection
Single premium deferred annuities/ flexible premium deferred annuities - fixed - advantages
allows the individual to receive a better fixed return than managing fixed investments in a CD 2.accelerates savings growth due to being tax defered 3. taxed at lower ordinary rates 4.no min floor
Universal life insurance carateristics - flexible premium payments
allows the policy owner to determine when and in what amounts of premium payments to make, can be stopped temporarily and then resumed later
universal life insurance option A
also known as the level death benefit option - pays a level death benefit based on the net amount at risk - here the net amount at risk is the difference between the cash value and the death benefit - when the NAR decreases the cash value increase
tax implications of MEC
any withdrawals from the policy are taxed as ordinary income at a 10% early withdrawal penalty if accessed before 59.5 - but the death benefit remains income tax free
Single premium deferred annuities/ flexible premium deferred annuities
based on the accumulation of funds more than one year rather than immediate payment benefits come in 3 types 1. fixed annuities 2. variable annuities 3. indexed
Facts relevant in selecting the proper life insurance - investment Risk tolerance - if the client has low-to-moderate risk tolerance
client should get either whole (permanent) or universal life insurance
What has in the client profile has a direct affect on determining the cost of life insurance?
clients health
Modified endowment contracts
contract becomes classified as a MEC if the policy owner deposits the equivalent of more than total net annual premium payments at any time during the first seven years - becomes this policy if it fails the seven-pay tests and becomes subject to special taxes and penalties - once a policy qualifies as a MEC it cannot be changed
Joint life policies
covers two or more people can be either first-to-die policies(survivorship polices) or second to die policies
variable annuities
created on the theory that equity market will outperform inflation and fixed interest rates over time - each payment goes into account similar to a mutual fund
Annuities
created to address individuals outliving their money
how to calculate net amount at risk
death benefit - cash value
whole life insurance - variable life insurance
designed to combine the protection and savings functions of traditional life insurance with the growth potential of mutual fund type investments - the cash value is not guaranteed and invested in a separate account - has fixed premiums but cash value relies on the contracts earnings - has a guarentee that the death benefit will never be less than initial face amount - premiums are higher than a normal whole life
whole life insurance - graded premium life
designed to ease people into whole life premiums - premiums begin low in the first year then increase each year for the first five to seven years, at this point it remains level for the life of the insured (level premium becomes similar to traditional whole life policy that could be purchased a year or two before the ultimate premium is reached)
disadvantages of universal life insurance
do to the premiums being flexible, the policy holder runs the risk of the policy lasting by having premium payments be under the cash surrender value and unable to pay thee deposit for additional premium
standard provisions of insurance policies - reinstatement clause
follows the grace period clause - provides that once the policy has lasted, the owner may reinstate it by paying back premiums or reinstating any policy loans that existed at the time of lapse with proof of insurability satisfactory to the company
term life insurance - decreasing term life insurance
form of term life insurance that the premium remains level but the amount of the death benefit decreases - typically 15 or 30 year policies - can be tied to mortgages but are uncommon
Universal life insurance
gives policy owners the ability to adjust premium, death benefit, and cash value to meet their financial goals - does not have a structured premium requirement -
The next steps of finding life insurance needed - identifying goals
goals can include 1. providing liquidity at death for the estate 2. establishing an income fund for the dependents 3. establishing an education fund 4. accounting for final expenses 5. providing an adequate emergency fund
variable annuities - guaranteed minimum income benefit
guarantees a minimum income to the annuity owner
guaranteed min withdrawal benefit
guarantees that their will be a return on principle or protected systematic withdrawals over a specific time period
Single premium deferred annuities/ flexible premium deferred annuities - fixed
has a fixed payment with a guaranteed fixed interest rate minimum and pays an excess current rate based on market conditions - has annual fees and the ability to make withdrawals with a 10% penalty fee
Why is it good to have term life insurance?
helps to give a higher pay out for a lower premium then whole or permanent life insurance
The next steps of finding life insurance needed - identifying resources
identify the clients available resources to find if the client has adequate cash flow to afford life insurance - by looking at financial statements it can be found how much insurance is needed to pay off debt
policy loan example
if someone borrows 1000 at 8% for a year and interest due is charged in arrears, it will be 80$ at the end of the year.
Modified endowment contract example
if the annual premium is 2,000 dollars on a insurance policy then deposits in year 3 cannot exceed $6,000
standard provisions of insurance policies - misstatement of age clause
if the insured turns out to be older or younger than indicated on the application the benefit will be adjust to provide the amount the premium would have provided at the correct age
Facts relevant in selecting the proper life insurance - client profile
includes age, income, marital status, health, savings, and investment levels
capitilization of earnings method - initial general life insurance needs calculation
income/ risk free rate
qualified longevity annuity contracts
insurance option that ensures retirees have a stream of regular income othoughout their advanced years
whole life insurance
insurance that provides a guaranteed death benefit for the life of the insured that requires payments made until death or policy maturity
Facts relevant in selecting the proper life insurance - estate liquidity, what kind of insurance is best to deal with this?
is insurance needed to provide estate liquidity at death? - there are multiple factors that must be paid in cash that can shrink inheritance and someones estate - because this is such a long term need permanent insurance is the preferred needed
participating policy
life insurance that provides policy dividends; also called a par policy
registered index-linked annuities
like EIAs use a index/call option creeping strategy to determine cash value of the annuity
The next steps of finding life insurance needed - consider insurability
make sure that clients take physical exam for insurance while they are still health to avoid risk of not being approved for life insurance
how important is it for an individual to have life insurance based on their profile? - a person who is single without dependents
may not need insurance if they have enough recourses to pay their final expenses ( including debts, last illness expense, funeral expenses, and probate costs
Universal life insurance carateristics - unbundled sstructure
means the contract is broken down into coronets so that the policy owner knows exactly where premium dollars age going. helps to determine the interest rate on the policies cash value
how important is it for an individual to have life insurance based on their profile? - a person who has people who are economically dependent on them (kids, spouse)
need life insurance to help the dependents
equity indexed annuities
offer growth potential of the stock market with downside protection of a guaranteed annuity - have charactoristics of both fixed and variable annuities - have both fixed guaranteed minimum interest rate and an interest rate tied to an market index - more expensive than index inuities
dividend options - reduced premium
on the policy anniversary the premium will be reduced by the dividend paid
dividend options - cash
paid to the owner in cash by a direct deposit or check
Join life policy - first to die policy
pays one of the two covered people - if it is between two spouses and one dies then the benefit goes to the survivor - helps to cover the risk of 2 people on one contract - is more expensive than the cost of insuring one person but less expensive then 2 polcies
Join life policy - second to die
pays when the last person covered dies - useful in estate tax planing when the unlimited marital deduction has been used - generally lower than the cost of two separate policies - useful when one insured is highly rated and older
Term life insurance - level term
policies premiums are guaranteed to stay the same for a period of time ranging from 5 to 30 years - the longer the guarantee time for the premium, the higher the premium costs
Universal life insurance carateristics -adjustable death benefits
policy owners can increase or decrease the face amount of the policy according to their changing needs
whole life insurance - modified whole life
policy preceded by a period of term insurance - premiums begin low and similar to traditional term life insurance but then increase to be similar to traditional whole life insurance
deferred income annuity
provide an income stream that begins at an advanced age and continues throughout the individuals life
Annually renewable term insurance
provides death protection for one year at a time that can be renewed each year with the payment of the premiums due - premiums begin low and slowly begin to increase with age - policy are normally renewable until age 70
universal life insurance option B
provides for an increasing death benefit which is equal to a constant net amount at risk plus the accumulated cash value - the net amount at risk remains level throughout the term - monthly mortality cost increase with age and requires greater funding then option A
single premium immediate annuity
provides guarantee income for the life of the annuitant through monthly payments
standard provisions of insurance policies - policy loans interest rate
rate can be fixed or variable, normally it is used on a variable rate
Capitialization of earnings method
requires purchase of sufficient life insurance to provide the future need entirely from the investment income without liquidation of the capital - preserves the capital
dividend options - accumulate at interest
similar to a savings account - insurance holds the dividend in a separate account an pays a current rate of interest on the accumulated dividends
determining life insurance needs - multiple of salary method
simplest method - want "six eight or ten times salary" rule - younger clients wants higher multiplier than older
what is always a MEC?
single premium life policies
dividend options - paid up additions
small amount of insurance is purchased that has a cash value equal to the dividend without any medical or other underwriting required
standard provisions of insurance policies - grace period
states that premiums received within 30 or 31 days after the due date are treated as through received on time, if premiums are not received in that time frame the policy will lapse
standard provisions of insurance policies - entire contract clause
states that the policy and the attached application constitutes the entire contract - changes to the contract must be made in writing and signed by an officer of the company
1035 exchange
switching to a different life insurance policy when a different cash value coverage is needed without triggering a taxable event - can only be used in certain situations
guaranteed renewable
the insured has the right to renew the policy to the age specified in the policy - company does not have the right to change the. premium unless their is a change in policy class - company can't raise rates or discriminate
Facts relevant in selecting the proper life insurance - amount of insurance needed - if need a large amount
they should get term insurance because it is less expensive with higher returns as permanent insurance (whole life) can be expensive, giving less returns and leaves a risk exposure
Facts relevant in selecting the proper life insurance -investment risk tolerance - if the client has moderate to high risk tolerance
they should get variable life insurance or variable universal life insurance because they provide returns that fluctuate according to the performance of underlying sub accounts
Facts relevant in selecting the proper life insurance - personal risk management Risk tolerance - if the client has a moderate to high personal risk management
they want term insurance because they would be willing to assume the risk of being unable to pay increased future premiums
The next steps of finding life insurance needed - identify economic assumptions
to find how much is needed must look at 1. inflation rate 2. and what after-tax rate of return must be determined - must be conservative when making assumptions to avoid risking insolvency
The primary purpose of life insurance
to provide funds to others in the event of the insureds death
standard provisions of insurance policies - policy loans
two types of policy loans can be made against cash value policy 1. stand policy loans and 2. APLs - allows policy owner to borrow the entire cash value of a policy, - an amount that is equal to the interest due on the next policy anniversary
guarantee lifetime withdrawal benefit
used by 70% of annuity buyers - guarantees the right to withdrawal up to a specified percentage each year for life
determine life insurance needs - human life value method
using projected future earnings as the basis for measuring life insurance investment needs - projects income throughout remaining life work expectancy, a discount rate adjusted for inflation using risk free rate, and determine the present value of the persons future earnings
Facts relevant in selecting the proper life insurance - survivors needs
what do they need for 1. an education fund and required amount 2. what level of income is wanted for dependents 3. what retirement income fund do they want for spouse? 4. what is the right amount for postmodern emergency expenses?
whole life insurance - limited pay life insurance policies
whole life insurance policies with a shorter premium-paying premium - premiums can cease at a point while the death benefit continues for life - has higher premiums than traditional whole life products
whole life insurance - single premium whole life
whole life insurance policy with a lump sum payment and no further required premiums
can a policy become a MEC after the first 7 years?
yes, if there is any change on the policy, addition of riders, or increase of coverage the 7 year time limit restarts
