Insurance-based Products
What is a 10-year period certain annuity? A An annuity that will pay for a stated period of time, regardless of when the purchaser dies B An annuity that will pay for the lesser time period of life of the annuitant or a stated number of years C An annuity that will pay for the greater time period of the life of the annuitant or a stated number of years D An annuitant that will pay based on the estimated lifespan of a 10-year old individual
A. 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.
Which of the following would cause payment of a term life policy death benefit claim to be denied? A The insured person commits suicide during the first year of the policy B The insured person died in an aviation accident that is covered by airline-provided life insurance C The policy has completed the contestability period D The policy was in force at the time of death
A. 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.
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 A I and III B I and IV C II and III D II and IV
A. 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.
Investments to fund a fixed annuity contract are held: I by the issuer of the contract II by the purchaser of the contract III in the general account IV in the separate account A I and III B I and IV C II and III D II and IV
A. 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.
Which statement made by a representative when selling an EIA is NOT misleading? A "EIAs are regulated by the State insurance commission" B "EIAs give a minimum guaranteed rate of return at no cost to the purchaser" C "EIAs outperform variable annuities in a bull market" D "EIAs are guaranteed by the PBGC"
A. 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.
A customer, age 60, is looking for an investment that will provide life-long income at retirement. The BEST recommendation would be for the customer to: A purchase a variable annuity and annuitize the separate account at retirement B purchase a variable annuity and take installments of a designated amount at retirement C invest in an income mutual fund and elect not to automatically reinvest distributions D invest in a GNMA fund since GNMAs make monthly payments
A. The benefit of an annuity contract to an older person is the assurance of receiving income for life - however this only happens if the customer annuitizes the contract. If the customer chooses installments, there is no guarantee of payments for life - when the money in the account is depleted, payments stop.
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 A I and III B I and IV C II and III D II and IV
A. The 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.
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 A I and III B I and IV C II and III D II and IV
A. 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 statement about variable life insurance is FALSE? A The policy value may be reduced to zero by poor performance of the separate account B The policy value is included in the estate of the deceased individual C The policy value is not taxable to the beneficiary D In lieu of taking the death benefit as a lump sum, the beneficiary can choose to take it as an annuity
A. 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.
A customer buys an annuity requiring an initial payment of $100,000. The annuity offers a 4% Bonus Credit. This means that: A the insurance company will pay an extra $4,000 into the contract on top of the customer's $100,000 payment B the customer receives a guarantee that the separate account will grow at a minimum 4% rate per year C the insurance company will issue a check to the customer for $4,000 upon acceptance of the contract D the customer will receive a $4,000 credit from the insurance company that can be used to buy an additional life insurance policy offered by that company
A. 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 $100,000, the bonus credit of 4% means that the insurance company will pay an extra 4% of $100,000 = $4,000 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."
Level premium and permanent are terms associated with: A term insurance B whole life insurance C universal life D fixed index universal life
B. Both whole life and universal life are "permanent" insurance policies, meaning that they cannot be canceled as long as the premium is paid. In contrast, term life is only good for the term of the policy and the insurer does not have to renew. Level premium is only associated with whole life - the premium paid is the same annual amount each year. The level premium pays for both the cost of insurance and also includes a portion that is invested by the insurance company to build "cash value." In contrast, a term life premium, which only buys pure insurance without an investment component, increases as the policyholder gets older (greater risk of death). Universal life policies break apart the premium of a whole life policy into the insurance component and the investment component. These are "flexible policies" because if the policyholder pays both parts, the policy operates much like whole life; however, the policyholder can elect to only pay the insurance component, paying a lower amount (for example, when times are tough) and then only buys pure insurance without any funds added to the investment component. The investment component of both whole life and universal life policies is invested in fixed income securities, which are safe. A variation on a universal life policy allows the holder to invest the cash build-up in either a fixed account or an equity index account, such as one that mirrors the S&P 500 Index, or a combination of both. This variant is "FIUL" - Fixed Index Universal Life.
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 A I and III B I and IV C II and III D II and IV
B. 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. Review
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 0% 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: -4.5% Year 3: +10% At the end of year 3, the customer will have a principal balance of: A $120,000 B $124,000 C $128,000 D $132,000
B. 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 0% floor, there will be no credit. 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 + $0 + $9,000 = $124,000.
Premiums deposited to purchase a variable annuity contract are invested by the insurance company in: A the general account B a separate account C an investment account D an annuity account
B. 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. 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.
All of the following contracts offer the holder investment options EXCEPT a: A variable annuity B universal life policy C variable life policy D variable universal life policy
B. Universal life is a general account product, as is whole life. These do not offer investment options. All of the variable contracts offer the holder a selection of investment options (called sub accounts). These are from the insurance company's separate accounts, which buy shares of a designated mutual fund.
Insurance companies may invest premiums into their general accounts for all of the following types of life insurance policies EXCEPT: A Universal life B Variable universal life C Whole life D Term life
B. 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 statements are TRUE about fixed annuity contracts? I The issuer assumes the investment risk II The issuer assumes the purchasing power risk III The purchaser assumes the investment risk IV The purchaser assumes the purchasing power risk A I and III B I and IV C II and III D II and IV
B. With a fixed annuity, the issuer assumes the investment risk - the risk that the securities funding the annuity perform poorly. If the underlying securities perform poorly, the insurance company will not reduce the monthly annuity payment promised to the purchaser of the contract. 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.
An advantage of a variable annuity over a fixed annuity is: A minimum guaranteed rate of return on investment B the ability to allocate funds across multiple subaccounts C protection of initial investment from potential loss D tax deductibility of investment made into the contract
B. A variable annuity allows the owner to allocate investment to different mutual funds, with each subaccount holding a single mutual fund. The performance of the mutual fund(s) held in the subaccount(s) determines the annuity payment, so it will vary and if the mutual fund(s) lose value, the payments will decrease. In contrast, fixed annuity premiums are invested in the insurance company's general account, which typically holds very safe bond investments. The annuity payment is fixed and guaranteed by the insurance company. This is not the case with a variable annuity. Both fixed and variable annuities are non-qualified retirement plans, so the contribution is not deductible (unless the annuity is purchased in a retirement account).
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: A Futures contracts B Variable annuity C Fixed annuity D Equity Indexed Annuity
B. 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.
A customer buys a variable annuity and elects a payout option of Life Income with a 20 year period certain. This means that: A payments will continue for the annuitant's life, not to exceed 20 years B payments will continue for the annuitant's life, but if he dies before 20 years elapse, payments continue to his heir(s) C payments continue for the life of the annuitant and then cease D payments continue for 20 years to the annuitant or beneficiary
B. An annuity payout option of Life-with Period Certain means that the annuity continues for the customer's life, but if he dies before the "period certain" (20 years in this case) is completed, payments will continue to a beneficiary until the 20 year period is completed.
A client invests in an equity indexed annuity that has a guaranteed 3% annual return, a 10% cap and an 80% participation rate. In a year when the reference index increases by 15%, the investor will be credited with interest at the rate of: A 8% B 10% C 12% D 15%
B. Because of the 80% participation rate, the client would normally be credited 80% of 15% = 12% for this year. However, the cap of 10% overrides this, and only this amount will be credited to the account.
Cash value of a universal life insurance policy is: A premium payments plus cost of insurance B premium payments minus cost of insurance plus interest C premium payments, plus or minus growth or loss in the separate account, plus the cost of insurance D premium payments, plus or minus growth or loss in the separate account, minus the cost of insurance
B. Both whole life and universal life are "cash value" policies. Premiums are invested in the general account (not a separate account, which is the case for a variable life policy, making Choices C and D incorrect). From the premium payments made, the cost of insurance is deducted. The cash balance that is left over earns interest.
A customer, age 63, has made payments into a non-tax qualified variable annuity contract totaling $10,000. The investment in the separate account is now worth $16,000. The customer wishes to withdraw $5,000 from the account. The tax implications of the withdrawal are: I $5,000 is taxable as ordinary income II $5,000 is not taxable III $500 of penalty tax must be paid IV $0 penalty tax must be paid A I and III B I and IV C II and III D II and IV
B. 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 $10,000 was invested; and it built up to $16,000. Thus, the first $6,000 out of the plan is taxable ordinary income; the remaining $10,000 is a non-taxable return of capital. The customer withdrew $5,000, all of which is taxable as ordinary income. Note that no 10% penalty tax is due on the distribution, since the customer is over age 59½.
Which of the following statements comparing fixed and variable annuities is correct? I Fixed annuities pay for the annuitant's lifetime; variable annuities pay for varying lengths of time II Fixed annuities pay the same amount each period; variable annuities pay the same number of annuity units each period III The insurance company guarantees a rate of return for fixed annuities but not for variable annuities IV The insurance company guarantees an increasing payout for variable annuities but not for fixed annuities A I and II only B II and III only C III and IV only D I, II, III, and IV
B. Fixed annuities pay the same amount each period; variable annuities pay the same number of annuity units each period. The payout may increase or decrease with a variable annuity. The insurance company guarantees a rate of return for fixed annuities, but not for variable annuities. Both fixed and variable annuities make payments for the annuitant's lifetime.
An IAR is preparing a financial plan for a young married couple with 2 small children. They both work and have sufficient income to pay their current bills, including the large mortgage on their house. They have a small emergency reserve and, after paying expenses, have an extra $500 per month that they can put towards investments. They currently have no life insurance, and if one dies, the remaining spouse would not have enough income to meet monthly expenses. The IAR recognizes that they need to buy insurance as part of the plan, but the IAR is not a licensed insurance agent in the State. Which statement is TRUE? A The IAR is not permitted to tell the customers about any aspect of insurance because she is not a licensed insurance agent in the State B The IAR cannot prepare a financial plan that includes life insurance needs unless another IAR licensed as an insurance agent in the State co-authors the plan C The IAR must follow the "Don't Ask Don't Tell" rule in this situation; if the clients don't ask about life insurance coverage, she can't talk about it or include it in the plan D The IAR can prepare a plan that includes life insurance, since life insurance is a security Explanation The best answer is B. Life insurance coverage is an important part of any financial plan. Since the IAR is not licensed to sell life insurance in the State, she is not qualified to make the appropriate recommendation. She must consult with a properly licensed insurance agent in the State to make an insurance recommendation (and only the licensed insurance agent can sell the couple the policy!).
B. Life insurance coverage is an important part of any financial plan. Since the IAR is not licensed to sell life insurance in the State, she is not qualified to make the appropriate recommendation. She must consult with a properly licensed insurance agent in the State to make an insurance recommendation (and only the licensed insurance agent can sell the couple the policy!). Review
A client has purchased various insurance policies from different issuers. One policy gives $100,000 of coverage that expires in 5 years. Another gives $100,000 of coverage that expires in 10 years. A third policy also gives $100,000 of coverage and expires in 12 years. The customer has purchased: A variable life policies B term life policies C whole life policies D universal life policies
B. Term insurance has a fixed "term" at which point it expires and must be renewed at a higher premium since the client is now older. It is not permanent insurance, since it can be canceled at the end of the term and not be renewed by the insurance company. In contrast, whole life, universal life and variable life cover the "whole life" of the insured individual and are permanent insurance (as long as the premium is paid).
Which of the following is NOT an advantage of a variable annuity? A Tax-deferred growth B Fixed return C Lifetime retirement payments D Professional management
B. Variable annuity premiums are invested in a separate account that holds an underlying mutual fund and the annuity payment is based on fund performance. Thus, the return is variable - it is not fixed. Variable annuities offer the benefits of tax-deferred growth in the separate account (however the contribution is not deductible); lifetime retirement payments because an annuity contract is being purchased; and professional management of the mutual fund held in the separate account.
Which of the following statements are TRUE regarding payouts from variable annuity contracts? I The payout is determined by the number of annuity units II The payout is determined by the number of accumulation units III When payout commences, unit value is fixed while the number of units varies IV When payout commences, unit value varies while the number of units is fixed A I and III B I and IV C II and III D II and IV
B. When payout is to commence from a variable annuity, the holder's accumulation units are converted into a fixed number of annuity units (based on mortality tables and payout option selected). The monthly payout is determined by taking that fixed number of annuity units times the unit value (which fluctuates as the value of the securities in the underlying separate account fluctuates).
Which of the following are attributes of Equity Indexed Annuities? A Participation rate and market cap B Index crediting method and market cap C Participation rate and floor D Market cap and dividends
C. An "attribute" is a feature or characteristic. Equity Indexed Annuity (EIA) features include interest credited yearly based on the return of a reference equity index (such as the S&P 500 Index), but the annual credit is subject to a cap and a floor. In addition, the interest is credited based on a "participation rate." Say that it is an EIA linked to the S&P 500 Index, with a cap of 10% and a floor is 1%. Assume that the participation rate is 80%. If the S&P 500 Index rises by 5% in a year, the interest earned will be credited at 80% participation = 4%. In a year when the S&P 500 Index declines, there will still be a 1% interest credit because of the floor. Therefore, the participation rate, cap, and floor are all attributes of an EIA. The actual index crediting method used is another attribute of an EIA (such as point-to-point, annual reset, or high-water mark). However, market cap is not an attribute, and since this is in Choices A, B, and D, these must be incorrect answers.
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 A I and II only B II and IV only C III and IV only D II, III, and IV only
C. 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 of the following is associated with fixed annuities? A Voting rights B Federal regulation C Level payments D Equity investments
C. 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. Insurance products such as a fixed annuity are only subject to State regulation. There is no Federal regulation of insurance products. Finally, purchasers of insurance products do not have voting rights; in contrast, purchasers of common stock (a security), including purchasers of mutual fund shares under a variable annuity contract, do have voting rights.
Variable Universal Life Insurance (VULI) policies provide policy owners with: A guaranteed minimum cash values B variable premiums and the guarantees of term insurance C flexibility with respect to premium payments, investment options, and death benefits D the guarantees of whole life insurance plus the investment flexibility of variable life insurance
C. Variable Universal Life Insurance (VULI) is a combination of universal life insurance and variable life insurance. Thus, it provides flexibility in premium payments, investment-funding choices, and flexibility of death benefits based on investment results. VULI does not guarantee minimum cash value like whole life insurance, since investments are made in a separate account and the amount of cash value depends on separate account performance, making Choice (A) incorrect. VULI does not guarantee a fixed insurance amount, as is the case with term insurance. The amount of coverage will vary with the performance of the separate account, though there is a minimum guaranteed insurance amount, so Choice (B) is incorrect. VULI does not guarantee a fixed rate of return, as does a whole life policy, making Choice (D) incorrect.
All of the following statements concerning a variable life insurance policy are correct EXCEPT: A premium payments are level and fixed for the insured's lifetime B the cash value increases based on equity investments C the death benefit is fixed and guaranteed for the insured's entire life D policy loans will reduce the amount paid at death
C. 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 rate. As the general account investment portion grows, the policy builds "cash value" that can be borrowed. Any borrowed funds reduce the benefit payment upon death. 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.
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 A I and III B I and IV C II and III D II and IV
C. 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.
Which of the following annuity payment options will continue payments to another person for their life after the annuitant dies? A Life Annuity B Life Annuity with Period Certain C Joint and Last Survivor Annuity D Unit Refund Annuity
C. A joint and last survivor annuity pays another person (usually a spouse) when the annuitant dies.
A woman has purchased a variable annuity with a 10-year period certain. She names her husband as the first beneficiary; and her brother as the second beneficiary. The husband dies 2 years later. The woman annuitizes the contract upon the death of her husband, and then dies 4 years later. The brother dies 3 years after the woman. Who gets the remaining 3 years' payments? A No one B The immediate relatives of the brother C The estate of the brother D The state in which the contract was issued
C. Because the husband dies, he is no longer a beneficiary. Once the woman annuitizes the contract, it will pay for 10 years regardless - the 10-year period certain. She dies after receiving 4 years of payments, so there are 6 years of payments remaining, and these go to the brother, who was named as the second beneficiary. Since the brother dies after 3 years, the remaining 3 years of payments will go to the brother's estate. And boy, does this family have bad luck!
A 62-year old man owns a non-qualified variable annuity contract. He makes a withdrawal. The amount of the withdrawal is: A not taxable B potentially subject to taxation at capital gains rates C potentially subject to taxation at ordinary income tax rates D not taxable if used to pay for specified medical expenses
C. Distributions from variable annuity contracts that take place after age 59½ are taxable at ordinary income tax rates. These distributions are 100% taxable and represent all of the tax-deferred earnings that have been reinvested and grown over the years. Once these are depleted, the original investment in the contract is returned with no tax due (since there was no deduction for the contribution amount, these are already "after-tax" dollars.)
A representative is making a presentation to a married couple, ages 77 and 81, about their need for continuing income as the expected life spans of the general population have increased. The representative is strongly recommending that the couple buy an equity indexed annuity (EIA). Which statements made by the representative would be misleading and fraudulent? I "EIAs guarantee a minimum rate of return that is equal to the Standard and Poor's 500 Index" II "I do not earn any commissions when I sell you an EIA" III "EIAs are tax qualified, allowing you to reduce your taxable income by deducting any contribution that you make" IV "EIAs provide a minimum guaranteed rate of return that is guaranteed by the issuing insurance company" A I and III B I and II C I, II, III D I, II, III, IV
C. Equity indexed annuities (EIAs) are an insurance product that falls somewhere between a fixed annuity and a variable annuity. They give a return linked to a well-known index, such as the Standard and Poor's 500 Index, but the return is typically capped to a maximum interest rate per year. Thus, if the cap is 10% and the S&P 500 Index grows by 15%, the customer only gets a 10% return for that year. Thus, Choice I is a misleading statement. Technically the salesperson does not earn a commission, but he or she does earn a very steep sales charge, so Choice II is misleading. There is no deduction for contributions to the contract (these are non-qualified plans) making Choice III a misleading statement. Choice IV is true - the contracts have a minimum guaranteed rate of return (like around 4%) that is guaranteed by the insurance company. Of course, if the insurance company fails (which rarely happens, but it has happened), then the guarantee is worthless.
A customer owns a cash value life insurance policy. Any of the following can result in a taxable event EXCEPT: A payment of a death benefit B taking a partial withdrawal from the policy C taking a loan from the policy D surrender of the policy
C. 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 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 A I and III B I and IV C II and III D II and IV
C. 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 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 and a 15% cap. 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: A $100,000 B $105,000 C $115,000 D $120,000
C. 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 this is an insurance product, the customer does not bear investment risk, and the "floor" rate is 0% (unless the product offers a higher floor rate). Because of the 0% floor, even though the index fell in each of the next 2 years, the account value stays at $115,000.
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 and a 15% cap. 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: A $100,000 B $115,000 C $125,350 D $128,620
C. 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 $115,000 balance is worth $115,000 after the first year. Because this is an insurance product, the customer does not bear investment risk, and the "floor" rate is 0% (unless the product offers a higher floor rate). Because of the 0% floor, the balance stays at $115,000 as of the end of year 2. In year 3, the $115,000 balance will grow by 9% (90% of the 10% growth rate) for a balance of $125,350 at the end of year 3.
Which of the following insurance products is developed from the basic design of the whole life insurance policy? A Term life B Fixed annuity C Variable life D Variable universal life
C. Variable life policies are similar to whole life in that they: are permanent insurance policies; have fixed annual premiums: have an investment component that builds cash value against which owners may take policy loans. Unlike whole life, which guarantees a fixed rate of return, variable life does not. The rate of investment return depends on the performance of the securities in the separate account that funds the variable policy. Term life offers no cash buildup - it is a pure insurance product without any investment features. Universal life policies are also similar to whole life, but in a different way. Universal policies allow the holder to increase or decrease the premiums to buy a different death benefit amount. These policies build cash value from the interest income of the insurer's investments. Insurers fund universal policies from their general account - not from a separate account. As with whole life, they guarantee a fixed rate of return. Universal variable life policies invest the premium in a separate account, so they do not guarantee a fixed rate of return. A fixed annuity offers an unchanging annuity payment - there is a guaranteed rate of return. A variable life insurance policy is a whole life product. Like a whole life policy, the VLI policy has a fixed minimum death benefit. The death benefit for a variable life policy will also vary upwards above the minimum if the separate account performs well. A variable life policy has a fixed annual premium like a whole life policy.
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: A $50,000 B $100,000 C $500,000 D $1,000,000
D. 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 grandfather wishes to provide a perpetuity for his 2 grandchildren. He wants to give them the amount of $1,000 a month. How much principal is required assuming that it is invested at a 3% rate of return? A $33,333 B $40,000 C $333,333 D $400,000
D. A perpetuity is a "perpetual payment" - so it is an annuity that goes on forever. If $400,000 is invested at 3%, it gives annual income of 3% of $400,000 = $12,000 without eating into the principal amount. $12,000 annual income / 12 months = $1,000 month income. The best way to deal with this type of question is to take 3% of the principal amount given in each choice to get the annual income and divide it by 12 months a year.
During the annuity period of a fixed annuity, the insurance company assumes which of the following risks? I Mortality II Morbidity III Expense IV Investment A I & II only B II & III only C III & IV only D I, III & IV only
D. 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.
Which of the following risks does the insurer assume in a variable annuity contract? I Investment risk II Mortality risk III Expense risk IV Cash value risk A I and II only B III only C II and IV only D II and III only
D. Variable annuities do not offer guaranteed cash value. If the owner dies before payout begins, the death benefit is the account value, not a guaranteed amount. The insurer does not assume the investment risk because the premiums are invested in a separate account and the performance of the underlying securities held in the separate account determines the amount of the annuity payment. The insurer assumes the mortality risk (the risk that the owner will outlive normal life expectancy and the annuity will be paid for longer than expected), and the expense risk (the risk that the insurer's operating costs will exceed expectations - the expenses that can be charged against the annuity are capped in the contract). There is no such thing as "cash value risk." Certain insurance policies offer a savings feature ("cash value") in addition to an insurance benefit. The policies that offer "cash value" are whole life policies, universal life policies and universal variable life policies.
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 A I and III B I and IV C II and III D II and IV
D. 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.
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: A Term life B Whole life C Variable life D Universal life
D. 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.
The "AIR" of a variable annuity contract is set when the: A prospectus is delivered to the client B purchase contract is completed C surrender period of the contract has been completed D contract is annuitized
D. 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.
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: A $0 taxable/$0 penalty B $0 taxable/$500 penalty C $5,000 taxable/$0 penalty D $5,000 taxable/$500 penalty
D. 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.
A representative is making a presentation to a married couple, ages 75 and 77, about their need for continuing income as the expected life spans of the general population have increased. The representative is strongly recommending that the couple buy an equity indexed annuity (EIA). Which statement made by the representative would NOT be misleading and fraudulent? A "EIAs guarantee a minimum rate of return that is equal to the Standard and Poor's 500 Index" B "EIAs can be redeemed at any time without penalty if you have an emergency cash need" C "EIAs are tax qualified, allowing you to reduce your taxable income by deducting any contribution that you make" D "EIAs provide a minimum guaranteed rate of return that is guaranteed by the issuing insurance company"
D. Equity indexed annuities (EIAs) are an insurance product that falls somewhere between a fixed annuity and a variable annuity. They give a return linked to a well-known index, such as the Standard and Poor's 500 Index, but the return is typically capped to a maximum interest rate per year. Thus, if the cap is 10% and the S&P 500 Index grows by 15%, the customer only gets a 10% return for that year. Thus, Choice A is a misleading statement. If the contract is redeemed early, there are steep surrender charges, making Choice B misleading. There is no deduction for contributions to the contract (these are non-qualified plans) making Choice C a misleading statement. Choice D is true - the contracts have a minimum guaranteed rate of return (like around 3%) that is guaranteed by the insurance company. Of course, if the insurance company fails (which rarely happens, but it has happened), then the guarantee is worthless.
