Module 3 Quiz

Which of the following dividend options allows for acquiring additional insurance with no underwriting? A) One-year term B) Reduced premium C) Cash D) Accumulate at interest

The answer is one-year term. With the one-year term dividend option, the dividend is used to purchase additional term death benefit protection with no underwriting required. The paid-up additions and one-year term dividend options both allow the policyowner to acquire more death benefit at no additional cost, other than using the dividend instead of taking it as cash. LO 3.3.2

Which of the following is a dividend option? A) Extended term B) Accumulated at interest C) Variable payment D) Life income

The answer is accumulated at interest. Leaving dividends with the insurance company to accumulate at interest is a dividend option. Extended term is a nonforfeiture option, while variable payment and life income are settlement options. LO 3.3.2

Which of the following is the period during which the owner of a life insurance policy is allowed to pay an overdue premium? A) Grace period B) Waiver of premium period C) Reinstatement period D) Contestable period

The answer is grace period. The insurance remains in force during the grace period. The grace period prevents the policy from lapsing by providing the policyowner with additional time to pay an overdue premium. If the insured dies within the grace period, the company deducts the overdue premium from the death benefit payable to the beneficiary. LO 3.3.1

Under a Section 1035 exchange, which of the following policies may be exchanged on a tax-free basis? An endowment policy exchanged for another endowment policy, in which the beginning date for regular payments is no later than the original contract qualified long-term care contract, or annuity contract One annuity contract exchanged for another annuity contract A life insurance policy exchanged for another life insurance policy (on the same insured), annuity, or endowment contract An annuity contract exchanged for a life insurance policy A) I and IV B) II and III C) I, II, and III D) I and II

Statement IV is not an eligible tax-free exchange under Section 1035. A taxable event occurs if an annuity is exchanged for a life insurance policy or endowment contract. LO 3.5.2

A periodic annuity payment that is guaranteed to pay a set amount is a feature of A) a fixed annuity. B) a variable annuity. C) a deferred variable annuity. D) a deferred annuity.

The answer is a fixed annuity. To guarantee fixed payments to the annuitant, the insurer invests the premiums during the accumulation period in bonds, mortgages, and other fixed-income securities with a guaranteed return. LO 3.6.2

Miguel purchased a $100,000 annuity and, based on his life expectancy, the insurance company determines he could anticipate 20 years of payments of $750 per monthly. What part of each monthly payment is taxable? A) $0 B) $416.67 C) $750.00 D) $333.33

The answer is $333.33. Part of each $750 will be taxable, and part will be a nontaxable return of capital. The nontaxable amount is determined as follows: $750×$100,000($750×12×20)=$750×0.5556=$416.67$750×$100,000($750×12×20)=$750×0.5556=$416.67 For each $750 payment, $416.67 will be a nontaxable return of capital and $333.33 will be taxable. LO 3.6.2

Personal risk exposures that can be covered by life insurance include premature death before a debt is repaid. premature death before children's education is paid. the spouse without a retirement benefit outliving the spouse who is receiving a straight life annuity pension payout. premature death prior to funding the family's financial goals. A) I, II, and III B) I, II, III, and IV C) I and III D) II, III, and IV

The answer is I, II, III, and IV. All of these are personal risk exposures that can be covered by life insurance. LO 3.1.1

Which of the following characteristics of life insurance contracts create favorable tax treatment? Income taxes on investment gains are taxable in the year of the gain. Death benefits paid to a beneficiary are not usually taxable as income. The earnings on the cash value are not taxed during the accumulation period. A) II only B) I and III C) II and III D) I, II, and III

The answer is II and III. Income taxes on investment gains are tax-deferred. LO 3.2.5

Which of the following is an advantage of single-premium immediate annuities (SPIAs)? Investment risk is transferred to the insurer. They protect the principal from creditors. Most benefits increase with inflation. They ensure a lifetime of income, without fear of outliving the principal. A) II and III B) I, II, and IV C) I and IV D) I and II

The answer is I, II, and IV. Statement III is incorrect. Most SPIA benefits are fixed and will not increase with inflation unless the owner has included a cost-of-living adjustment rider. LO 3.6.2

Which of the following regarding policy loans is NOT true? A) With variable products, cash value equal to the amount borrowed is moved to a guaranteed interest rate account. B) A policyholder generally may borrow close to the entire cash value of a policy (less some interest). C) Most insurers charge interest in advance. D) A variable interest rate is generally used with participating policies.

Similar to most consumer loans, insurers generally charge interest in arrears. The other statements are true. LO 3.3.1

All of the following statements regarding whole life insurance are correct except A) the protection afforded by the whole life insurance contract is permanent. The term never expires, and the policy never has to be renewed or converted. B) whole life insurance pays benefits only if the insured dies during a specified period of years. C) whole life insurance policies issued on a participating basis may return part of the premium in the form of policyowner dividends. D) whole life is considered permanent life insurance.

Whole life insurance provides for the payment of the policy's face amount upon the death of the insured, regardless of when death occurs. LO 3.2.2

In evaluating the replacement of life insurance, which of the following does NOT need to be considered? Spouse's health status New front-end load costs Income tax consequences A) I only B) I and III C) I and II D) II and III

The answer is I only. The client's health status would impact replacement, but the spouse's health would have no impact. All other factors should be considered. LO 3.5.2

Which of the following is an advantage of annual renewable term life insurance? Term life insurance accumulates cash value. Initially, term life insurance has a lower premium than whole life insurance. Initially, term life insurance provides more insurance protection per premium dollar than whole life insurance. A) II and III B) I, II, and III C) III only D) I and II

Term life insurance does not accumulate cash value. Term life insurance provides only temporary protection for a given number of years. In the long run, term life insurance provides less insurance protection per premium dollar than whole life insurance. LO 3.2.1

Your client wants to provide his spouse with $6,000 of additional income adjusted for inflation, paid at the beginning of each month, for 30 years after his death. He wants to use up the entire amount of principal and interest during that period. He expects 3% inflation and 7% net interest on savings and wants the income to be adjusted annually for inflation. Assuming he dies today, how much additional life insurance is required to fund this need? A) $1,256,767 B) $1,260,957 C) $1,274,634 D) $1,278,760

The answer is $1,278,760. The solution to this can be done in a single step. We're looking for the amount it would take today to fund an increasing monthly benefit for 30 years. With the calculator set for BEG mode (SHIFT, MAR), the keystrokes would be 30 × 12 = 360, N; 1.07 ÷ 1.03 = 1.0388 - 1 = .03833 × 100 = 3.8835 ÷ 12 = .3236, I/YR; 6,000, PMT, and solve for PV = 1,278,760. LO 3.4.1

Wanda is considering replacement of her life insurance policy with a new policy issued by another company. Which of the following statements regarding policy replacement is CORRECT? The new policy will have high initial costs relative to the current policy's costs. The new policy's incontestable clause will be waived. A) Neither I nor II B) Both I and II C) II only D) I only

The answer is I only. The majority of a life insurance policy's costs are included in the early years of the policy. At this time, acquisition costs are high. As policies age, the expenses decrease. A new policy will have a new contestable clause, initial expenses, and the potential for a substandard rating, as it will be underwritten at the insured's current age and health. LO 3.5.2

Pauline, age 45, would like to purchase life insurance. She wants a policy that will provide lifetime protection, and she would like to build up a cash value. Pauline has a low risk tolerance and wants the cash value to be invested in the insurance company's general account. She wants the insurance company to assume all the investment risk for the cash value, and she wants a policy that guarantees a minimum cash value at each age. Which of the following policies would best meet Pauline's needs? A) Variable universal life B) Term life C) Whole (ordinary) life D) Variable life

The whole (ordinary) life policy best meets Pauline's needs because it will provide protection for her entire life (if the premiums are paid as agreed) and a guaranteed cash value. In addition, the insurance company assumes all of the investment risk and guarantees a minimum cash value at each age. LO 3.2.2

A client recently annuitized his fixed annuity and selected a life annuity with a 15-year period certain payout option. The income payments from the annuity are currently $2,000 per month. If the client dies after receiving income payments for 10 years, which of the following statements is CORRECT? A) Income payments of $2,000 per month will continue to the beneficiary for 15 years. B) Income payments will stop. C) Income payments will continue to the beneficiary for five years; the amount of the payments will vary depending on the investment returns of the underlying subaccounts. D) Income payments of $2,000 per month will continue to the beneficiary for five years.

The answer is income payments of $2,000 per month will continue to the beneficiary for five years. In a life annuity with period certain payout option, if the annuitant dies before the end of the specified period, payments continue to the beneficiary for the remaining term. In this case, payments continue for five years. Because the client's annuity is a fixed annuity, the payments are not based on the investment performance of subaccounts. LO 3.6.2

Which of the following is a pitfall to avoid when selecting an appropriate type of life insurance? A) Recommending the purchase of term insurance because the client is young B) Establishing client goals C) Comparing the costs of available types of life insurance D) Taking advantage of breakpoints

The answer is recommending the purchase of term insurance because the client is young. Youth, by itself, is not the determining factor in deciding upon the type of policy to be purchased. Specifically, a strong argument can be made that premiums used to purchase term insurance could have been earning a cash value in a more permanent type of insurance. The type of insurance to be purchased should be determined by the factors comprising the client profile. Insurance companies often have breakpoints with regard to pricing. For instance, it is likely a $500,000 policy will cost less than a $490,000 policy. LO 3.5.1

Which of the following statements regarding variable universal life insurance is CORRECT? This policy contains investment options and no minimum guaranteed rate of return. Cash values can decline to zero, causing the policy to lapse unless additional premium payments are made. Planners must have state variable insurance and securities licenses to sell variable universal life insurance. Variable universal life insurance policies are suited for individuals with higher risk tolerances and investment experience. A) I, II, III, and IV B) II, III, and IV C) I and IV D) II and III

All of these statements regarding variable universal life insurance policies are correct. LO 3.2.3

Daniele has a universal life insurance policy with the Option B death benefit. The net amount at risk (NAR) is $500,000, and the current cash value is $225,000. The beneficiary is her son, Richard. If Daniele dies today, what amount will Richard receive as a death benefit? A) $500,000 B) $225,000 C) $275,000 D) $725,000

The answer is $725,000. Under a universal life insurance policy with the Option B death benefit (also known as the increasing death benefit option), the death benefit is the NAR plus the cash value. Richard will receive $725,000 ($500,000 + $225,000). LO 3.2.3

Which of the following clients would be a good candidate for term life insurance? Tina, 21, who wants life insurance for only 20 years until her mortgage is paid off and who does not want to accumulate a cash value Ralph, 40, who wants life insurance only until he and his wife reach age 66 and begin receiving Social Security benefits. He wants the maximum face amount he can obtain for the amount of premium he can afford to pay. Sam, 35, who wants current life insurance protection at a minimal cost. He may or may not want to renew his policy from year to year, and he does not mind if his premiums increase in the future. A) I only B) I, II, and III C) I and II D) II and III

The answer is I, II, and III. All of these clients are good candidates for term life insurance because they have a temporary need for life insurance protection. In addition, term life insurance does not accumulate cash value (making it appropriate for Tina) and provides the maximum face amount of coverage for a given amount of premium (making it appropriate for Ralph). Although premiums typically increase when term life insurance is renewed, this is not a disadvantage for Sam. LO 3.2.1

Whole life insurance nonforfeiture options allow a policyowner to surrender a whole life insurance policy and receive the net cash value (cash value less any outstanding policy loans). stop paying premiums on a whole life insurance policy and exchange the net cash value for a reduced paid-up single premium permanent life insurance policy. stop paying premiums on a whole life insurance policy and use the net cash value as a single premium to purchase a paid-up term life insurance policy with a face amount equal to the face amount of the original policy for a specified period. A) III only B) I and II C) II and III D) I, II, and III

The answer is I, II, and III. There are three nonforfeiture options available when surrendering or discontinuing premium payments on a whole life insurance policy. First, the policyowner can surrender the policy in return for receiving the cash surrender value of the policy. Second, the policyholder leaves the cash value with the company and receives a smaller amount of fully paid-up insurance. With the third option, a policyholder leaves the cash value with the insurance company in exchange for retaining the full amount of the original policy's death benefit, but as a term insurance policy for a guaranteed period. LO 3.5.1

Which of the following statements regarding variable universal life insurance is CORRECT? This policy contains investment options and no minimum guaranteed rate of return. Planners must have state variable insurance and securities licenses to sell variable universal life insurance. Cash values can decline to zero, causing the policy to lapse unless additional premium payments are made. Variable universal life insurance policies are suited for individuals with lower risk tolerances and investment experience. A) I, II, and III B) I, II, III and IV C) I and IV D) II and III

The answer is I, II, and III. Variable universal life insurance policies are suited for individuals with higher, not lower, risk tolerances and investment experience. LO 3.2.5

Which of the following statements concerning term life insurance is CORRECT? The convertible feature of a term life insurance policy permits the policyowner to exchange the term contract for a contract of permanent life insurance within a specified time without evidence of insurability. If the term life insurance policy is converted, the insured's attained age may determine the premium rate. Term life insurance provides life insurance protection for a limited period only. The face amount of the policy is payable if the insured dies during the specified period, and a reduced amount is paid if the insured survives. The premium for term life insurance is initially lower because most term contracts do not cover the period of old age when death is most likely to occur and the cost of insurance is high. A) I, II, and IV B) I and III C) III and IV D) II only

The answer is I, II, and IV. Statement III is incorrect because nothing is paid if the insured survives the period specified in the term life insurance policy. LO 3.2.1

Several years ago, Diego purchased a $400,000 whole life insurance policy on his life. He has paid cumulative premiums over the years of $20,000 and has accumulated a cash value of $25,000. This year, he was diagnosed with a rare liver disease, and, as a result, his life expectancy is only six months. Because of his large medical costs, he is considering selling his policy to a viatical settlement company. The company has offered him $250,000 for the policy. He would also like to explore other ways to generate cash from the policy. Which of the following statements regarding Diego's situation are CORRECT? If Diego sells his policy to the viatical settlement company, he will be taxed on any gain from the sale if he dies more than two years later. If the viatical company collects the death benefit as a result of Diego's death, the proceeds will be tax free to the company. If Diego sold the policy to his cousin for $250,000, his cousin would be subject to ordinary income tax on a portion of the life insurance benefit when Diego dies. If Diego takes a loan from the policy, some or all of the loan will be subject to ordinary income tax if the policy is classified as a modified endowment contract (MEC). A) I and II B) I, II, and IV C) II and III D) III and IV

The answer is III and IV. Because Diego is terminally ill (i.e., expected to die within two years), he will not be taxed on the proceeds received from the viatical settlement company, even if he lives longer than two years. When the viatical settlement company receives the death benefit, part of the death benefit will be taxed at ordinary income tax rates to the company. The sale of the policy to Diego's cousin would be considered a transfer for value. His cousin would be taxed on the death benefit (less any amounts paid) because the transfer-for-value rules cause the death benefit to become taxable. With a MEC, loans or distributions from the policy are taxed on a last in, first out basis, meaning that any earnings in the policy are taxed first. LO 3.2.4

Which of the following definitions best describes a single premium immediate annuity (SPIA)? A) An annuity specifying that, if the annuitant dies before receiving total benefit payments equal to the purchase price of the annuity, the difference will be refunded in the form of continuing benefit payments B) A life annuity that provides a guaranteed minimum number of benefit payments whether the annuitant lives or dies C) An annuity whose benefit payments continue for the lifetimes of two or more beneficiaries D) An annuity whose benefit payments begin one payment interval after the date of purchase

The answer is an annuity whose benefit payments begin one payment interval after the date of purchase. A SPIA is an annuity whose benefit payments begin one payment interval after the date of purchase. LO 3.6.1

Le'Veon wants to purchase a life insurance policy on his own life. He is concerned that the policy may lapse if he inadvertently forgets to pay the premiums. Le'Veon's family has a history of medical issues, and he is concerned that he may become uninsurable in the future. Which of the following policy provisions would best address Le'Veon's concerns? A) Automatic premium loan provision B) Nonforfeiture provision C) Contestability provision D) Reinstatement provision

The answer is automatic premium loan provision. The automatic premium loan provision provides that the premium will automatically be charged against the policy cash value if it is not paid by the due date. A reinstatement provision allows a policyholder to reinstate a policy after it lapses, but only if the insured can prove insurability. A nonforfeiture provision specifies what will happen to the cash value if the policyowner discontinues premium payments, and an incontestability provision prevents the insurer from challenging the validity of a policy after it has been in force for a specific period. LO 3.5.1

Which of the following statements concerning variable universal life (VUL) insurance is CORRECT? VUL insurance incorporates all of the premium flexibility features of the universal life policy with the policyowner-directed investment aspects of variable life insurance. An agent selling a VUL policy must have both a state insurance license and a securities license. A) Both I and II B) Neither I nor II C) II only D) I only

The answer is both I and II. A VUL insurance policy combines the policyowner investment direction element of variable life insurance with the flexible premium, cash value, and death benefit elements of universal life. Accordingly, the attributes of a VUL policy include an increasing or decreasing death benefit and a flexible premium payment schedule. Agents selling VUL policies must have a state insurance license and a securities license. LO 3.2.3

Which of the following statements regarding the income tax treatment of policy loans from modified endowment contracts (MECs) is CORRECT? They are subject to last-in, first-out (LIFO) tax treatment. They may be subject to a 10% income tax penalty if the policy owner is younger than 59½ years. A) II only B) Neither I nor II C) Both I and II D) I only

The answer is both I and II. Policy loans from a MEC may be subject to a 10% income tax penalty if the policy owner is younger than 59½ years. Loans and withdrawals are also subject to LIFO tax treatment. LO 3.2.5

The appropriate amount of life insurance coverage for a client may be affected by his survivors' needs. These needs may include all of the following except A) the client's health status. B) emergency fund. C) regular income. D) education funding.

The answer is the client's health status. This question is asking about beneficiary needs. The client's health status would not affect how much life insurance the client needs. Rather, that would affect whether or not the client can obtain the coverage needed and at what price. LO 3.4.1