CH 6. Life premiums and benefits
Which of these is an accurate statement regarding the fixed period settlement option on a life insurance policy?
A portion of the payments paid to the beneficiary comes from interest calculated on the proceeds of the policy
Expense factor (Loading Charge)
Insurance companies are just like any other business. They have operating expenses which need to be factored into the premiums. The expense factor is also known as the loading charge.
Which of these factors does NOT affect life insurance premium rates?
Producer certification Mortality, expenses, and interest are the only factors that determine premium rates.
Who is the beneficiary in a life insurance policy?
The stated person or entity who is designated to receive the death proceeds
Tertiary Beneficiary
The third in line to receive the benefits of a life insurance policy. If no one is named, death benefit will go to insured's estate
Tax treatment of proceeds
► Premiums: Not tax deductible ► Death Benefit: Normally tax-free if taken as a lump sum. Subject to federal estate tax under certain circumstances and normally included in the policyowners gross estate. Death Benefit Installments: Principal is tax free - interest is taxable
Which tax cost is normally associated with death?
Federal estate tax
Which life insurance policy provision prohibits a beneficiary from "commuting, encumbering, withdrawing, or assigning" any portion of the proceeds prior to actual receipt from the company?
Spendthrift clause spendthrift clause prevents a beneficiary from recklessly spending benefits by requiring the benefits to be paid in fixed amounts or installments over a certain period of time.
Switching Life insurance policies without tax consequence is permitted under
Section 1035 rules
Mode of Premium Provision
if policy owner chooses to pay the premium more than one a year (monthly, quarterly, semi-annually) there normally will be an additional charge because the company will have additional charges in billing and collecting the premium payments
Policy surrender
when a policy is surrendered for cash value, some of the cash value received may be taxable if the value was more than the amount of the premiums paid for the policy
cash value
Cash value applies to the savings element of whole life insurance policies that are payable before death. The cash value of a whole life insurance policy during the early policy years typically will be less than the premiums paid.
What would be the disadvantage of naming a trust as beneficiary of a life insurance policy?
Trust administration fees would reduce policy proceeds
The beneficiary of a life insurance policy is normally selected by whom?
Policy owner
Living Beneifts
option to use some of the future death benefit proceeds when they may be most needed, before their death, when the insured has a terminal illness
Single Premium Funding
policy owner pays a single premium that provides protection for life as a paid-up policy normally associated with whole life unsurance
A life insurance beneficiary died after receiving only six payments under the policy's life income settlement option. What happens with the remaining balance of the death proceeds?
Kept by the insurance company Under the life income settlement option, the beneficiary is able to have the benefits converted into an annuity which is based upon the individual's life expectancy and payable as long as the beneficiary is still alive
Viatical Settlements
Viatical Settlement - Allows someone with a terminal illness to sell their existing life insurance policy to a third party for a percentage of the face value. The new owner continues to make the premium payments and will eventually collect the entire death benefit. Note: The original policy owner is called the Viator and the new third party owner is called the Viatical, sometimes called the Viatee.
Per capita
(meaning by the head) Evenly distributes benefits among all named living beneficiaries.
Mortality Factor
A measure of the number of deaths in a given population. Mortality is based on a large risk pool of people and time. Insurance companies use mortality tables to help predict the life expectancy and probability of death for a given group.
Kevin has an existing life insurance policy and assigns it to another insurer for a new contract. How would this transaction be treated for tax purposes?
As a Section 1035 exchange When an existing life insurance policy is assigned to another insurer for a new contract, the transaction may be treated for tax purposes as a Section 1035 exchange.
Which statement is INCORRECT about the interest-only settlement option in a life insurance policy?
Interest on proceeds must be paid by the beneficiary The beneficiary must pay TAXES on any interest paid on the proceeds in an interest-only settlement option. Interest on proceeds is paid by the insurer to the beneficiary
T is covered by an Accidental Death and Dismemberment (AD&D) policy that contains an irrevocable beneficiary. What action will the insurance company take if T requests a change of beneficiary?
Request of the change will be refused An irrevocable designation may not be changed without the written consent of the beneficiary.
per stirpes
(meaning by the bloodline) In the event that a beneficiary dies before the insured, benefits from that policy will be paid to that beneficiary's heirs.
Tax treatment of cash values
If cash value is surrendered, the portion that exceeds the premiums paid is taxable. The total of the premiums paid into the policy minus total dividends received in cash or used to offset premiums is referred to as the cost basis. For policies that are not surrendered, the cash value grows tax-free. As long as the cash value stays in the policy, taxes will never be imposed on any portion, not even the amount that exceeds the cost basis.
Premium mode (Mode of Premium Provision)
refers to the policy feature that permits the policyowner to select the timing of premium payments. Insurance policy rates are based on the assumption that the premium will be paid annually at the beginning of the policy year and that the company will have the premium to invest (interest factor) for a full year. If the policyowner chooses to pay the premium more than once per year (example monthly, quarterly, semi- annually) there normally will be an additional charge because the company will have additional charges in billing and collecting the premium payments. This is sometimes referred to as the Mode of Premium provision.
Interest factor
Insurance companies invest the premiums they receive in an effort to earn interest. This interest is one of the ways an insurance company can lower the premium rates.
Death benefits from a life insurance policy are normally considered to be
Exempt from federal income tax Life insurance death proceeds that are paid to a named beneficiary are generally exempt from federal income tax.
Revocable Beneficiary
The policy owner may change the beneficiary at any time without notifying or getting permission from the beneficiary
Primary beneficiary
First in line to receive death benefit proceeds The beneficiary of a life insurance policy is the person or entity designated in the policy to receive the death proceeds. There are few restrictions on who may be named a beneficiary of a life insurance policy. The owner of the policy is the ultimate decision maker and may change the beneficiary at any time, unless designated as irrevocable. However, in the underwriting process, the underwriter may consider the issue of insurable interest. When the policyowner lists themselves as the beneficiary, they will require proof of insurable interest. Problems are more likely to occur when an estate is named as beneficiary of a life insurance policy. Who can be beneficiaries? ►Individuals ► Businesses ► Trust (Provides management of the proceeds; Policy proceeds may be reduced by trust administration fees) ► Estates (Creditors have rights to life insurance policy proceeds when the beneficiary is the insured's estate) ► Charities ► Minors (Guardian may need to be appointed)
Premium payment options
Payment Options: ► Annual ► Semi-Annual ► Quarterly ► Monthly -Note: The higher the frequency of payments, the higher the premiums. This is because the interest earned to the insurer is decreased while the administrative costs are increased. -Level Premium Funding: Policies that have a level premium average premiums over the policy period. The policyowner pays more in the early years for protection to help cover the cost in later years, which allows the premiums to remain level throughout the life of the policy. -Single Premium Funding: The policyowner pays a single premium that provides protection for life as a paid-up policy. Normally associated with whole life insurance.
irrevocable beneficiary
An irrevocable designation can NOT be changed without the written consent of the beneficiary. The irrevocable beneficiary has a vested interest in the policy, therefore the policy owner may NOT exercise certain rights without the consent of the beneficiary.
Class Designations
In naming children as beneficiaries, a class designation is sometimes desirable. Class designations should be used when individuals of a specific group (such as children of the insured person) are to share the policy proceeds equally.
When a policy loan is requested by a policyowner and it requires the consent of the beneficiary, what kind of beneficiary designation is this?
Irrevocable beneficiary the policyowner must obtain the consent of the named beneficiary before taking out a policy loan if the named beneficiary is an irrevocable beneficiary.
Which statement regarding the joint and survivor life insurance settlement option is NOT true?
The amount of each installment is larger than the single life income option
Death benefits
Death benefits are paid out in a variety of ways. These methods are known as settlement options. The policyowner may select a settlement option at the time of the application and may change the option at anytime during the life of the insured. Once selected, the settlement option cannot be changed by the beneficiary.
Tax treatment of premiums
Premiums paid on individual life insurance policies are generally not deductible. Premiums for life insurance used for business purposes are generally not tax-deductible. Here are the exceptions to these rules: ► Premiums used for a charity are tax-deductible ► Life insurance premiums paid by an ex-spouse as court-ordered alimony are tax- deductible ► Employer-paid premiums used to fund group life insurance for the benefit of employees are tax-deductible
Facility payment
Typically found in industrial policies. It allows the insurance company to pay all or part of the proceeds to someone NOT named in the policy that has a valid right. This is usually done on behalf of a minor
1035 Exchange
when an existing life insruance policy is assigned to another insurer for a new contract, the transaction may be treated for tax purposes as a Section 1035 Exchange. policy exchanges that qualify as this are NOT taxable
Factors affecting premium amount
Expense factor Mortality factor Other factors that impact the premium amount include: -Age: The older the person, the higher probability of death and disability -Sex / Gender: Women tend to live longer than men, so their premiums are usually lower -Health: Poor health increases probability of death and disability -Occupation: Hazardous job increases the risk of loss -Hobbies: High risk hobbies also increase the risk of loss
Premium Mode
policy feature that permits the policyowner to select the timing of premium payments policy rates based on assu,ption that the premium will be paid annually at the beginning of the policy year and that the company will have the premium to invest (interest factor) for a full year
Living Benefit options
Accelerated benefit-- allows someone that a doctor certifies as terminally ill to access death benefit and amount received will be tax free Viatical Settlement-- allows someone with a terminal illness to sell their existing life insurance policy to a 3rd party for a percentage of the face value Life Settlement-- sale of an existing life insurance policy to a 3rd party for more than its cash surrender value, but less than its net death benefit (The amount of money, after subtracting any loan principal, loan interest, or late premiums due, that is paid or due to be paid to a beneficiary when a person insured under a life insurance policy dies.) Tax Treatment of Proceeds: -Premiums-- NOT tax deductible -Death benefit-- normally tax free if taken as a lump sum. Subject to federal estate tax under certain circumstances and normally included in the policy owners gross estate -Death Benefit Installments-- principal (refers to the initial size of a loan; it can also mean the amount still owed on a loan.) is tax free, but interest is taxable
spendthrift clause
Prevents a beneficiary from recklessly spending benefits by requiring the benefits to be paid in fixed amounts or installments over a certain period of time. A spendthrift clause in a life insurance policy would have no effect if the beneficiary receives the proceeds as one lump sum payment. The spendthrift clause is selected at the time of application. ►A spendthrift clause is also a statement in a settlement agreement that indicates that the proceeds of the policy will be free from attachment or seizure by the beneficiary's creditors
Secondary(contingent) beneficiary
Second in line to receive death proceeds
Death benefit settlement options
beneficiary. Death Benefit Settlement Options ► Lump Sum: Death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. The lump sum option is considered the automatic (or "default") option for most life insurance contracts. ► Interest Only: Insurance company holds death benefit for a period of time and pays only the interest earned to the named beneficiary. A minimum rate of interest is guaranteed and the interest must be paid at least annually. ► Fixed Period: Also called period certain, the death benefit proceed is paid in equal installments over a set period of years. Part of the installments paid to a beneficiary consists of interest calculated on the proceeds of the policy. The dollar amount of each installment depends upon the total number of installments. ► Fixed Amount: The fixed amount installment option pays a fixed death benefit in specified installment amounts until the principal and interest are exhausted. The larger the installment payment, the shorter the payout period. ► Life Income: The life income option provides the beneficiary with an income that they cannot outlive. Installment payments are guaranteed for as long as the recipient lives. The amount of each installment is based on the recipient's life expectancy and the amount of principal. This gives the potential for a greater return, or the potential for greater loss, based on how long the insured lives. A joint and survivor option guarantees that benefits will be payed on a life-long basis to two or more people. This option may include a period certain and the amount payable is based on the ages of the beneficiaries.
