Unit 15 - Insurance-based Products
Your client purchased an index annuity from you last year with an investment of $100,000. The particular index tied to this product had an annual return of -4%. If the participation rate is 90% with a cap of 5% and no annual minimum guarantee, the value of the account would be A) $100,000. B) $96,400. C) $96,000. D) $103,600.
A) $100,000. Please note that the return is negative (-4%). An index annuity does not participate in losses of the index, only gains. With no gain, and no guaranteed annual minimum, the account value remains at $100,000.
You have a 37-year-old client whose wife has just given birth to triplets. Because of the added responsibilities, he wants to maximize the amount of life insurance he can acquire. Which of the following types of insurance will give him the greatest amount of coverage for the lowest initial premium? A) Annual renewable term B) Whole life C) Universal life D) Variable life
A) Annual renewable term
Concerning index annuities and their method of crediting interest, which of the following is TRUE? A) High-water mark with look back offers the best return during periods of high volatility. B) Annual reset offers the best return regardless of market fluctuations. C) On average, annual reset has a higher participation rate than point to point. D) Point to point offers the best return when the market has had a single drastic decline during the period.
A) High-water mark with look back offers the best return during periods of high volatility.
A client has been contributing to a periodic payment annuity for 20 years. The M&E charge is 1.25% per year. What happens to that charge when the client annuitizes at attained age 68? A) It ceases B) It continues C) It increases because the client's mortality risk is higher at the older age D) It continues but at a reduced rate
A) It ceases The M&E charge is for mortality and expenses. Once an annuity contract, fixed or variable, is annuitized, that charge no longer applies to the account. There may be an internally computed charge, but unlike the accumulation period, the charge is not broken out separately.
Which of the following is not a type of life insurance policy? A) Variable annuity policy B) Term to 65 policy C) Endowment policy D) Universal life policy
A) Variable annuity policy Although a variable annuity may have a death benefit provision, it is not considered a life insurance policy. One key to that is, among other things, there is no health questionnaire when purchasing an annuity. Perhaps you have never heard of an endowment policy (it is not mentioned in the LEM). This type of situation may come up on the actual exam where one of the choices is something unfamiliar to you. Don't let that cause you to lose your focus. Annuities are issued by life insurance companies, but they are not life insurance policies, so select the correct answer and move on.
You have a 70-year-old client who is in excellent health. Both parents lived into their late 90s and the client is concerned about outliving her money. One product that should be considered to alleviate this concern is A) an annuity. B) an index fund. C) whole life insurance. D) a 30-year term policy.
A) an annuity. One of the unique characteristics of an annuity (variable or fixed) is that it guarantees monthly payments for the life of the annuitant. Life insurance provides a death benefit, but not income. An index fund carries no guarantees.
A variable annuity annuitant bears all of the following risks EXCEPT A) mortality risk B) inflationary risk C) interest rate risk D) market risk
A) mortality risk
If an index annuity has a participation rate of 80%, it means A) the investor's account will be credited with 80% of the growth of the index. B) the investor's account will participate in 80% of the gains and losses of the index. C) the investor's account will never be less than 80% of the initial investment. D) the investor's account will be charged with 80% of the amount lost by the index.
A) the investor's account will be credited with 80% of the growth of the index.
A customer in his 20s, who is not risk averse, is in the market for life insurance. His main worry is that what looks like a generous death benefit today may not be sufficient for a beneficiary 40 or 50 years from now. An investment adviser representative might consider recommending A) variable life insurance B) whole life insurance with the option of purchasing additional coverage C) an aggressive, long-term strategy of investment in small-cap stocks D) term life insurance
A) variable life insurance Variable life insurance has the advantage of offering possible inflation protection for the death benefit. The insured assumes investment risk for this benefit, but pays a fixed scheduled premium for the life of his contract.
Bob, age 60, has invested $17,000 in his nonqualified variable annuity over the years. The total value has reached $26,000. He wishes to withdraw $15,000 to send his son to college. What is his tax consequence on the withdrawal? A) $6,500 is nontaxable; $8,500 is taxable. B) $9,000 is taxable; $6,000 is nontaxable. C) The entire amount is nontaxable. D) The entire amount is taxable.
B) $9,000 is taxable; $6,000 is nontaxable. Because this is a nonqualified plan, the $17,000 invested is after-tax dollars. Under the Tax Code, the taxable portion is considered to be withdrawn first in any lump-sum distribution. Therefore, the first dollars withdrawn are all taxable until the amount of withdrawal meets or exceeds the growth in the account. Because Bob is over 59½, there is no 10% tax penalty on his withdrawals.
When a customer wants income from an annuity and chooses the option of life with 20-year period certain, how will distributions be taxed? A) As capital gains based on an exclusion ratio B) As ordinary income based on an exclusion ratio C) As capital gains based on LIFO accounting D) As ordinary income based on LIFO accounting
B) As ordinary income based on an exclusion ratio
A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) Fixed annuity B) Variable annuity C) REIT D) Common stock
B) Variable annuity
Which of the following is indicative of the primary difference between variable life insurance and straight whole life insurance? A) Amount of insurance that can be issued B) Way in which the cash values are invested C) Tax treatment of the death proceeds D) Cost of the insurance
B) Way in which the cash values are invested
The death benefit of a variable life policy must be calculated at least A) monthly B) annually C) weekly D) semiannually
B) annually The death benefit must be calculated annually and the cash value, monthly.
Among the reasons to consider investing in a variable annuity would be all of the following EXCEPT A) a guaranteed death benefit for death before annuitization B) capital gains treatment on any realized gains upon withdrawal C) basically, no limit on the amount that can be contributed D) avoiding probate upon the death of the investor
B) capital gains treatment on any realized gains upon withdrawal
A customer has a nonqualified variable annuity. Once the contract is annuitized, monthly payments to the customer are A) 100% taxable B) partially a tax-free return of capital and partially taxable C) 100% tax deferred D) 100% tax free
B) partially a tax-free return of capital and partially taxable
All of the following statements are features of a straight life, fixed, single-premium immediate annuity except A) payments stop when the annuitant dies. B) the income level may drop if the underlying investments go down in value. C) payments do not increase with inflation. D) the annuitant may die before a return of the principal is realized.
B) the income level may drop if the underlying investments go down in value.
A customer purchased a variable annuity from an agent 5 years ago with an initial investment of $200,000. The annuity's surrender fee will expire in year 7, which coincides with the customer's anticipated need for the funds. In the 5th year of the contract, the value of the annuity increased from $300,000 to $375,000. The agent notices that the general market is on the decline and recommends she enter a 1035 exchange of the variable contract for another, thus increasing her death benefit and locking it in at a higher minimum. This recommendation is A) suitable because 1035 exchanges have no adverse tax consequences B) unsuitable because of surrender fees C) suitable because of the increased death benefit D) unsuitable unless the customer agrees with the recommendation
B) unsuitable because of surrender fees
A client who purchased a variable life insurance policy 15 months ago has suffered a stroke. In addition, he has developed adult onset diabetes. When receiving treatment for the stroke, he was diagnosed with lung cancer. He has decided to convert his variable policy to a whole life policy. Which of the following statements is CORRECT? I. He will not be able to convert to a whole life insurance policy because his health has deteriorated to such a severe level. II. The new policy will bear the same issue date and age as the original policy. III. The face amount must remain the same. IV. The premium will be rated because his health has taken a marked turn for the worse. A) II, III, and IV B) I and IV C) II and III D) I, II, III, and IV
C) II and III
A client has purchased a nonqualified variable annuity from a commercial insurance company. Before the contract is annuitized, your client, currently age 60, withdraws some funds for personal purposes. What is the taxable consequence of this withdrawal to your client? A) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn B) A 10% penalty plus the payment of ordinary income tax on funds withdrawn in excess of the owner's basis C) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis D) Capital gains taxation on the earnings withdrawn in excess of the owner's basis
C) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis
One of the features of an index annuity is the ability for the principal value to increase based on the performance of the specified index. Which of the following is NOT used as a method to compute the amount of interest to be credited to the account? A) High-water mark B) Annual reset C) Participation rate D) Point to point
C) Participation rate Although the participation rate is a component of the computation, it is not a method of computing the interest credit. In the annual reset index method, interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the contract year. Interest is added to the annuity each year during the term. Using the high-water mark, the index-linked interest, if any, is decided by looking at the index value at various points during the term, usually the annual anniversaries of the date the annuity was purchased. The interest is based on the difference between the highest index value and the index value at the start of the term. Interest is added to the annuity at the end of the term. And finally, with the point-to-point method, the index-linked interest, if any, is based on the difference between the index value at the end of the term and the index value at the start of the term. Interest is added to the annuity at the end of the term. In each of these, the insurance company will specify the participation rate (what percentage of the increase will be credited) and a cap rate (the maximum amount to be credited).
Which of the following best describes the death benefit provision of a variable annuity? A) Upon death, the proceeds pass to the beneficiary free of federal income tax. B) Upon death, the beneficiary will receive the benefit as a lump sum. C) The principal amount at death is the greater of the total of premium payments or the current market value. D) If death should occur before age 59½, the 10% early withdrawal penalty does not apply.
C) The principal amount at death is the greater of the total of premium payments or the current market value. The death benefit insures that the investor will never receive back less than the original amount contributed to the account. Unlike life insurance proceeds, with annuities, anything above the cost basis is taxed as ordinary income. Receiving the benefit as a lump sum is only one of the options available to a beneficiary of a variable annuity death benefit. There are others, such as annuitizing the benefit.
Which of the following is designed primarily as a retirement vehicle to help protect contract owners from a decline in purchasing power? A) Life-paid-up-at-age-65 life insurance B) Retirement income life insurance C) Variable annuities D) Flexible premium fixed annuity
C) Variable annuities
A 35 year-old client indicates that he needs $500,000 of life insurance coverage for the next 20 years. The lowest out-of-pocket cost would be if he purchased A) a 20-pay life policy B) a whole life policy C) a 20-year level term policy D) variable annuity with an extended death benefit
C) a 20-year level term policy
When discussing the purchase of a scheduled premium variable life insurance policy with a client, it would be CORRECT to state that A) if a policy loan exceeds the policy cash value, the deficiency must be remedied within 10 business days to keep the policy from lapsing B) you will receive a statement of your death benefit no less frequently than semiannually C) by surrendering the policy, its cash value may be obtained D) premiums will vary based upon performance of the separate account
C) by surrendering the policy, its cash value may be obtained
A variable annuity has A) fixed payments once it has been annuitized B) a high degree of liquidity C) different investment options known as subaccounts D) a guaranteed rate of return
C) different investment options known as subaccounts
A popular vehicle for saving for retirement is the variable annuity. An agent explaining the benefits of this product would probably be in violation of the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents by claiming that variable annuities offer A) the choice of a large number of different subaccounts with varying objectives B) tax deferral on earnings until withdrawn from the account C) lower overall expenses than a mutual fund with similar investment objectives D) the ability to exchange funds between subaccounts without incurring a tax liability under IRS Code Section 1035
C) lower overall expenses than a mutual fund with similar investment objectives
One way in which universal life and variable life are similar is that both A) have a fixed minimum cash value B) have flexible premiums C) permit loans against the cash value D) are considered securities
C) permit loans against the cash value As long as the policy has cash value, loans are permitted. Neither of these has a fixed minimum cash value, and only universal life has flexible premiums. Only variable life is considered a security.
All of the following statements are features of a straight life, fixed, single-premium immediate annuity except A) the annuitant may die before a return of the principal is realized. B) payments stop when the annuitant dies. C) the income level may drop if the underlying investments go down in value. D) payments do not increase with inflation.
C) the income level may drop if the underlying investments go down in value.
Among the special characteristics of a universal life insurance policy is A) early termination could lead to surrender charges B) that policyowners may borrow against the cash value C) the policy may be overfunded D) death benefits may increase above the initial face amount
C) the policy may be overfunded
An investor purchases a single premium deferred index annuity with an initial premium of $200,000. Soon after the purchase, the investor receives a statement from the insurance company showing an initial balance of $210,000. The most likely reason for the $10,000 increase is A) the underlying index has had outstanding performance. B) the insurance company paid a dividend. C) this is a bonus annuity. D) the insurance agent's commission was added to the account.
C) this is a bonus annuity. It is not uncommon to find index annuities offering a bonus added to the premium. In this case, the bonus appears to be 5%. There are no dividends on index annuities and rebating commissions is prohibited.
If a client wishes to purchase a life insurance policy that doesn't invest in the market, but allows the holder to pay additional premium if desired, the recommendation is A) term life. B) index annuity. C) universal life. D) variable life.
C) universal life.
Current IRS regulations permit an unlimited contribution to which of the following tax-deferred plans? A) Roth IRA B) 401(k) C) SEP IRA D) Annuity
D) Annuity
Which of the following best describes the death benefit provision of a variable annuity? A) Upon death, the beneficiary will receive the benefit as a lump sum. B) If death should occur before age 59½, the 10% early withdrawal penalty does not apply. C) Upon death, the proceeds pass to the beneficiary free of federal income tax. D) The principal amount at death is the greater of the total of premium payments or the current market value.
D) The principal amount at death is the greater of the total of premium payments or the current market value.
A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) Fixed annuity B) Common stock C) REIT D) Variable annuity
D) Variable annuity Longevity risk is the uncertainty that one will outlive his money. The only instrument that guarantees a payout for as long as one lives is an annuity. Because the question asks for a security, only the variable annuity is correct, otherwise the fixed annuity would also offer protection.
A popular vehicle for saving for retirement is the variable annuity. An agent explaining the benefits of this product would probably be in violation of the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents by claiming that variable annuities offer A) the ability to exchange funds between subaccounts without incurring a tax liability under IRS Code Section 1035 B) the choice of a large number of different subaccounts with varying objectives C) tax deferral on earnings until withdrawn from the account D) lower overall expenses than a mutual fund with similar investment objectives
D) lower overall expenses than a mutual fund with similar investment objectives In general, variable annuity expenses are higher than those of a mutual fund with similar objectives. That doesn't mean the fund is good and the VA bad, it is that there are guarantees and other features offered by the VA that a fund does not have and they have to be paid for.
A 68-year-old individual, who purchased a single premium immediate fixed annuity, elected monthly payments for life with a 10-year certain settlement option. If the individual lives to the age of 80, A) monthly payments will remain fixed until age 78 and then reduce until death. B) monthly payments will cease at age 78. C) monthly payments will continue to the beneficiary(s) for 10 years after the annuitant's death. D) monthly payments will continue until death.
D) monthly payments will continue until death. When choosing the settlement option, life with 10 years certain, the annuitant will receive payments until the later of death or 10 years.
Among the reasons why deferred variable annuities might not be a suitable investment for seniors are all of the following EXCEPT A) surrender charges B) potential capital fluctuation C) improper subaccount selection D) potential inflation protection
D) potential inflation protection Variable annuities do offer potential inflation protection due to their participation in the equity market. The tradeoff is potential capital fluctuation, particularly if the portfolio selected is too aggressive. In addition, they typically carry high surrender charges.
The main benefit that variable life insurance has over whole life insurance is A) an adjustable premium B) a lower sales charge C) the availability of policy loans D) the potential for a higher cash value and death benefit
D) the potential for a higher cash value and death benefit
Marianne has a fixed-premium variable life policy in which the separate account has been performing extremely well, and the face value has been increasing as a result of the investment performance. However, recently the separate account performance has been negative. If this continues, the face value could decrease A) to 0 B) to the original face value minus any future negative performance C) to 50% of the original face value D) to the original face value
D) to the original face value The face value in an insurance policy is the death benefit. In a variable life policy, the face value will fluctuate with the separate account's performance, but it will never decrease below the original minimum face value.
A widowed customer with no children has a portfolio invested in mutual funds valued at $250,000. The portfolio generates a monthly income of $1,600, an amount that exceeds her living expenses by $300. The investment portfolio is her sole source of income. Her agent recommends she sell $30,000 worth of her mutual funds and purchase a deferred variable annuity to take advantage of the tax deferral and death benefit features. This recommendation is A) suitable because it provides tax deferral features B) suitable because it offers a growth opportunity with a death benefit for a portion of her holdings C) suitable because it provides diversification D) unsuitable
D) unsuitable
