2.2 Insurance Based Products

All of the following statements regarding scheduled premium variable life insurance are correct EXCEPT: A) better than anticipated results in the separate account could lead to a reduction in annual premium. B) the policy owner has the right to change the selection of sub-accounts. C) premiums are determined based upon age and sex of the insured. D) once selected, the policy owner may change payment modes.

Answer: A Scheduled (fixed) premium variable life premiums are fixed. It is universal life that has flexible premiums.

A variable annuity annuitant bears all of the following risks EXCEPT: A) mortality risk. B) inflationary risk. C) market risk. D) interest rate risk.

Answer: A The insurance company issuing the variable annuity bears mortality risk, or the danger that some annuitants will live to surpass their average life expectancy. The investor in a variable annuity bears inflationary risk, market risk, and interest rate risk.

A fixed-premium variable life insurance contract offers a: guaranteed maximum death benefit. guaranteed minimum death benefit. guaranteed cash value. cash value that fluctuates according to the contract's performance. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: D A fixed-premium variable life contract offers a minimum death benefit and a variable death benefit over the minimum. Its cash value fluctuates with the performance of the separate account. Reference: 2.2.5.4.1 in the License Exam Manual.

In the past 20 years, 55-year-old James has put $27,000 into accumulation units in his nonqualified variable annuity. The current value of his units is $36,000. He wishes to withdraw $16,000 to assist with his grandchild's college education. If he is in the 28% tax bracket, what is his tax consequence on the withdrawal? A) $0.00 B) $2,520.00 C) $4,480.00 D) $3,420.00

Answer: D Because this is nonqualified, the investments are in after-tax dollars. Therefore, any value of the account over the investment is growth. Withdrawals from tax-deferred plans treat the growth as ordinary income for tax purposes. The portion attributable to growth is considered to be withdrawn first under the Tax Code. Here, we have $9,000 worth of growth taxable at 38% (28% + 10% penalty) because James is younger than 59-½. The remaining $7,000 withdrawn is considered a withdrawal of principal and is therefore nontaxable.

Which of the following describe differences between variable and universal variable life insurance? Variable life insurance has a minimum guaranteed death benefit, whereas universal variable life insurance does not. Universal variable life insurance typically provides a higher death benefit than variable life insurance. Variable life insurance provides no inflation protection for the death benefit, whereas universal variable life insurance does. Variable life insurance requires scheduled premium payments, whereas universal variable life insurance permits flexible premium payments. A) I and IV. B) I and II. C) II and III. D) III and IV.

Answer: A Variable life insurance provides a minimum guaranteed death benefit because some of the premium goes into the general account and some goes into a separate account. With universal variable life insurance, the entire premium goes into a separate account, so that no guaranteed death benefit is provided, beyond a very small amount designed to meet funeral expenses. Variable life has a scheduled premium payment for the life of the contract. Universal variable life is far more flexible, though there are minimum payments that must be made. Both provide inflation protection for the death benefit. Reference: 2.2.5.4.2 in the License Exam Manual.

A registered representative presenting a variable life insurance (VLI) policy proposal to a prospect must disclose which of the following about the insured's rights of exchange of the VLI policy? A) The insured may request that the insurance company exchange the VLI policy for a permanent form of life insurance policy, issued by the same company, within two years. The insurance company retains the right to have medical examinations for underwriting purposes. B) Federal law requires the insurance company to allow the insured to exchange the VLI policy for a permanent form of life insurance policy, issued by the same company, for two years, with no additional evidence of insurability. C) The insurance company will allow the insured to exchange the VLI policy for a permanent form of life insurance policy within 45 days from the date of the application or 10 days from policy delivery, whichever is longer. D) Within the first 18 months, the insured may exchange the VLI policy for either a permanent form of life insurance or universal variable policy, issued by the same company, with no additional evidence of insurability.

Answer: B Federal law requires that issuers of variable life insurance policies allow exchange of these policies for a permanent form of life insurance policy, issued by the same company for a period of no less than two years. The exchange must be made without additional evidence of insurability.

A thirty-five year-old client purchases a variable life insurance policy. Under current regulations, the maximum sales charge permitted over the life of the policy is: A) 9% per premium payment. B) 8.5% of total premiums over the life of the plan. C) 9%. D) 8.5% per premium payment.

Answer: C A variable life insurance plan may charge a maximum sales charge of 9% over a period not to exceed 20 years.

Universal variable life policies: have investment risk that is assumed by the investor. do not have a separate account. guarantee the minimum face amount with the opportunity for increases based upon the performance of the separate account. are purchased primarily for their insurance features. A) I and II. B) II and III. C) III and IV. D) I and IV.

Answer: D Universal variable life policies are insurance company products that should be purchased primarily for the insurance features they offer rather than as an investment. Because they have a separate account, the investor assumes the investment risk. Unlike scheduled premium variable life, flexible premium (universal) variable life does not guarantee a minimum death benefit equal to the face amount of the policy.

A client purchased an index annuity from you three years ago and made an initial deposit of $100,000. The contract calls for a 90% participation rate with a 15% cap. The index had a return of + 20% in the first year, - 5% the second year, and +10% the third year. The investor's current value is approximately A) $125,350 B) $126,500 C) $128,620 D) $117,829

Answer: A In the first year, the index gained 20%. With a 90% participation rate, the investor might have earned 18%, but was limited by the 15% cap. So, after one year the value was $115,000. In the second year, the index lost money. However, with an index annuity there are never any reductions in a down market so the account remained at $115,000. In the third year, the investor received 90% of the 10% growth and that increased the account value to $125,350. This resulted in an overall gain of 25.35%, or an average return of almost 8.5% per year.

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) Point-to-point C) Participation rate D) Annual reset

Answer: C 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 statements concerning universal life insurance are CORRECT? Universal life has flexible premiums. Universal life is based on the assumption that level annual premiums are to be paid throughout the insured's life. The death benefit can fluctuate, but never below the guaranteed minimum face amount. Cash values can fluctuate and may even fall to zero. A) II and III. B) I and II. C) I and IV. D) III and IV.

Answer: C Universal life features flexible premiums that add to the cash value account although there are no guarantees and the cash value can disappear if insufficient premiums are paid. There is no guaranteed minimum death benefit as there is with fixed (scheduled) premium variable life. The assumption that level annual premiums are to be paid throughout the insured's life is associated only with ordinary whole life and scheduled premium variable life policies.

A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) Fixed annuity. B) REIT. C) Variable annuity. D) Common stock.

Answer: C 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.

Larry purchased a deferred annuity and, at age 65, annuitized the product under a life with 15-year certain option. His wife, Linda, is the beneficiary. Which of the following statements is CORRECT? A) Payments would be made to Larry until his death, then to his wife for another 15 years. B) Payments would be made to Larry until he is 80, then to his wife for the remainder of her life. C) Payments would be made to Larry until he is 80, then cease. D) Payments would be made to Larry as long as he lives.

Answer: D Larry selected the life with 15-year certain option. This pays Larry for his life, regardless of how long, but pays his beneficiary if he dies before the end of 15 years. That is the 15-year certain part.

Which of the following is a possible advantage of variable life insurance over whole life insurance? A) Possible inflation protection for the death benefit. B) Flexibility of premium payments. C) Greater guaranteed cash value. D) Less risk in the underlying investment instruments.

Answer: A Variable life has scheduled, not flexible, premium payments. The distinguishing factor is the variable death benefit. The insured assumes more risk, not less, in exchange for the possibility that the death benefit will provide protection from inflation.

A 45-year-old investor takes a lump-sum distribution from a nonqualified variable annuity. How is the distribution taxed? The entire amount is taxed as ordinary income. The growth portion is taxed as ordinary income. The growth portion is taxed as a capital gain. The growth portion is subject to a 10% penalty. A) II and III. B) III and IV. C) II and IV. D) I and IV.

Answer: C On withdrawals from a nonqualified annuity, taxes are paid only on the amount that exceeds cost basis (the amount paid into the annuity). In this case, the investor is taking a lump-sum distribution before reaching age 59-½ and must pay an additional 10% penalty on the taxable amount.

Flexible premium payments are a feature of: A) variable life. B) whole life. C) term life. D) universal variable life.

Answer: D Only universal and universal variable life policies have flexible premium payments.

Which of the following statements is TRUE concerning variable life separate account valuation? A) Unit values are computed monthly and cash values are computed weekly. B) Unit values are computed daily and cash values are computed monthly. C) Unit values are computed monthly and cash values are computed daily. D) Unit values are computed weekly and cash values are computed monthly.

Answer: B Unit values are computed each day. Policy cash values are a monthly computation.

When discussing the purchase of a scheduled premium variable life insurance policy with a client, it would be CORRECT to state that: A) you will receive a statement of your death benefit no less frequently than semiannually. B) if a policy loan exceeds the policy cash value, the deficiency must be remedied within ten business days to keep the policy from lapsing. C) by surrendering the policy, its cash value may be obtained. D) premiums will vary based upon performance of the separate account.

Answer: C Surrender of the contract requires the insurance company to pay out its cash value. Death benefit is adjusted annually.

Under the exchange provision, within the first 24 months, a variable life policy may be converted into a A) mutual fund shares B) term insurance policy C) permanent form of life insurance policy D) variable annuity

Answer: C The variable life exchange provision allows a policyholder to convert the variable policy into a permanent form of life insurance policy within the first 24 months of variable policy ownership. The insurance company must use the initial contract date and can not require proof of insurability. Reference: 2.2.5.5.1 in the License Exam Manual.

Which of these features are common to both variable annuities and scheduled premium variable life insurance? Income earned in the separate account is tax deferred. Separate account performance below the AIR causes a reduction in cash value. Fixed contributions are required. Contract owners have voting rights. A) III and IV. B) I and IV. C) I and II. D) II and III.

Answer: B All variable products offer tax deferral of earnings in the separate account. Unit holders of a variable annuity vote on the basis of the number of units they own; holders of variable life insurance receive one vote for each $100 of cash value. With variable life insurance, AIR applies only to the death benefit, not to cash value.

The main benefit that variable life insurance has over whole life insurance is: A) an adjustable premium. B) the availability of policy loans. C) the potential for a higher cash value and death benefit. D) a lower sales charge.

Answer: C Premiums of variable life insurance policyholders are invested in the insurer's separate account. This allows the policyholder the opportunity (though there are no guarantees) to enjoy significant returns and substantially higher cash values than are obtainable through a whole life policy. Reference: 2.2.5.4 in the License Exam Manual.

Which of the following is guaranteed by a variable life policy? A) Minimum separate account performance. B) Minimum death benefit. C) Cash value. D) Policy loans after the policy has been in effect for at least 24 months.

Answer: B A variable life policy has a minimum guaranteed death benefit, but there is no minimum guaranteed cash value. There is no performance guarantee on separate accounts and policy loans are required after the policy has been in effect for at least 3 years (36 months).

A policy loan provision must be offered by the insurer after three years, allowing the variable life policy contract holder to borrow at least what percentage of cash value? A) 75% B) 90% C) 100% D) 125%

Answer: A The minimum that must be available in a VLI contract after three years is 75% of cash value.

A customer in his twenties, 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. A registered representative might consider recommending: A) whole life insurance with the option of purchasing additional coverage. B) an aggressive, long-term strategy of investment in small-cap stocks. C) variable life insurance. D) term life insurance.

Answer: C 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.

An individual purchasing a flexible premium variable life contract should know which of the following? Timing and amount of premiums generally are discretionary. The death benefit will generally be higher than that of a comparable whole life policy. The face amount is fixed at the beginning of the contract. The performance of the separate account directly affects the policy's cash value. A) I and III. B) II and III. C) II and IV. D) I and IV.

Answer: D A flexible premium policy allows the insured to determine the amount and timing of premium payments, provided minimums are met. Depending on the policy, the face amount (death benefit) is recalculated each year. It is intended that the death benefit receive some inflation protection, but this cannot be guaranteed. If separate account performance causes the cash value to drop below an amount necessary to maintain the policy in force, the policy lapses unless the requisite amount is received within 31 days.

All of the following statements regarding universal life insurance are correct EXCEPT: A) there are two death benefit options. B) offers the policyowner exceptional flexibility in adjusting the premiums, cash value, and death benefit. C) may include a minimum guaranteed interest rate. D) premiums are fixed for the life of the policy.

Answer: D The single most distinguishing characteristic of universal life is the fact that premiums are flexible and not fixed.

Which of the following would be a difference between a universal life insurance policy and a scheduled premium variable life insurance policy? A) There is a minimum guaranteed death benefit in the variable life while no such minimum applies to a universal life policy. B) The universal life policy will generally outperform the variable life policy during a period of falling interest rates and rising stock prices. C) There is a greater choice of separate account sub-accounts in the variable life policy. D) There is a minimum guaranteed return on the universal life while there is no guaranteed return on the variable.

Answer: A Universal life, including UVL, does not have a minimum guaranteed death benefit. There is no choice of separate account sub-accounts for universal life. Universal life is designed to benefit from periods of high interest rates, not falling ones.

Which of the following statements are TRUE of a variable annuity? The number of annuity units is fixed when payout begins. The value of accumulation units is fixed at purchase. The monthly annuity payment is a variable amount. The annuity payments are not subject to income taxes. A) III and IV. B) I and III. C) I and II. D) II and III.

Answer: B The number of annuity units is fixed when an annuitant starts the payout process, and the monthly payment will vary with the market value of the securities in the separate account portfolio. The value of accumulation units varies with the value of the portfolio, and the growth portion of the monthly payments is subject to income tax.

An individual is deciding between a flexible premium variable life contract and a scheduled premium variable life contract. If she is concerned about maintaining a minimum death benefit for estate liquidity needs, she should choose: A) the flexible premium policy because the contract's face amount cannot be less than a predetermined percentage of cash value. B) the scheduled premium policy because the contract is issued with a minimum guaranteed face amount. C) the flexible premium policy because earnings of the contract directly affect the face value of the policy and earnings can never be negative. D) the scheduled premium policy because earnings do not affect the contract's face amount.

Answer: B A scheduled premium variable life contract is issued with a guaranteed minimum death benefit. If the individual is concerned about having the minimum guarantee, you should recommend the scheduled contract.