QBank Questions: Course 102 Ch. 3

Which of the following statements concerning term life insurance is (are) CORRECT? 1. Term life insurance is a type of life insurance in which the death proceeds are payable if the insured dies during a specified period and nothing is paid if the insured survives to the end of that period. 2. Term life insurance generally provides no cash value, savings, or investment component. A) Both I and II. B) II only. C) I only. D) Neither I nor II.

A. Both statements I and II are correct. (QB.102.3)

Whole life insurance nonforfeiture options allow a policyowner to: 1. Surrender a whole life insurance policy and receive the net cash value (cash value less any applicable surrender charges and/or outstanding policy loans). 2. Stop paying premiums on a whole life insurance policy and receive a similar type of permanent life insurance policy in exchange for the cash value, but it is a reduced paid-up single-premium permanent life insurance policy. 3. Stop paying premiums on a whole life insurance policy and use the net cash value as a single premium to purchase a paid-up term life insurance policy with a face amount equal to the face amount of the original policy for a specified period. A) 1, 2, and 3. B) 2 and 3. C) 3 only. D) 1 and 2.

A. Nonforfeiture options mean that the policyowner does not forfeit or give up certain policy benefits. There are 3 nonforfeiture options available when surrendering or discontinuing premium payments on a whole life insurance policy that has been in force for more than 1 year. The policyowner can surrender the policy in return for receiving the cash surrender value of the policy (total cash value less any policy loans or premiums due plus any dividends). The second option is to leave the cash value with the company and receive a smaller amount of fully paid-up insurance. The third option is to leave the cash value with the insurance company in exchange for retaining the full amount of the original policy's death benefit, but as a term policy for a guaranteed period. (QB.102.3)

Charles was the beneficiary of his father's life insurance policy. The face amount of the policy was $500,000, and there was an outstanding policy loan of $25,000 when Charles's father died earlier this year. The settlement option for the policy was interest only, payable annually. This year, Charles receives his first payment of $14,250 from the insurance company. Which of the following statements regarding this arrangement is (are) CORRECT? 1. The death benefit payable under the policy was $475,000. 2. The payment of $14,250 consists partly of interest and partly of principal. 3. Charles must include $475,000 in this year's gross income. 4. Charles must include $14,250 in this year's gross income. A) 1 and 4. B) 2 and 4. C) 1 only. D) 2 and 3.

A. Statement 1 is correct. The outstanding policy loan of $25,000 reduces the death benefit payable under the policy to $475,000. Statement 2 is incorrect. Because the settlement option was interest only, the entire payment of $14,250 consists of interest and the $475,000 principal amount remains on deposit with the insurance company. Statement 3 is incorrect because the principal amount of a life insurance death benefit is income tax free. Statement 4 is correct; Charles must include $14,250 in this year's gross income because the payment consists entirely of interest. In addition, the $14,250 of taxable income may be subject to the 3.8% Medicare surtax. (QB.102.3)

Which of the following statements with regards to life insurance policy riders are CORRECT? 1. The disability waiver of premium rider prevents the policy from lapsing as a result of nonpayment of premiums during the insured's disability. 2. The guaranteed insurability rider allows the insured to purchase additional insurance up to a certain age; regardless of insurability. 3. The accidental death benefit rider usually pays 3 times the face amount of the policy if the insured dies accidently. 4. The accelerated death benefit rider allows the policyowner to receive a portion of the policy's death benefit during the insured's lifetime if the insured contracts a terminal illness. A) 1, 2, and 4 B) 1, 2, 3, and 4 C) 1 and 2 D) 1, 2, and 3

A. The accidental death benefit rider (sometimes referred to as the double indemnity clause) pays an additional death benefit if the insured dies accidentally (e.g., in a plane crash). (QB.102.3)

Carolyn was the beneficiary of her husband's life insurance policy with a face amount of $1 million. She elected the single life annuity settlement option. The settlement option will pay her $4,500 per month, and her life expectancy is 30 years. How much of each monthly payment is taxable to Carolyn? A) $1,722.15. B) $3,033.95. C) $0. D) $2,777.85.

A. The total amount Carolyn will receive from the settlement option is $1,620,000 ($4,500 × 360). Her tax basis is $1,000,000, so her exclusion ratio is 0.6173 ($1,000,000 ÷ $1,620,000). Therefore, $2,777.85 of each payment is excluded from gross income ($4,500 × 0.6173) and the remainder ($1,722.15) is taxable. In addition, the taxable income may be subject to the 3.8% Medicare surtax. (QB.102.3)

Sid bought a $250,000 whole life, double indemnity policy on his life on August 1 of the current year (premiums were $200 per month). On September 30 of the following year, Sid committed suicide. What is payable to Sid's beneficiary, assuming the premiums were paid as agreed up to September 1 of the next year? A) $2,800. B) $500,000. C) $250,000. D) $0.

A. The two-year suicide clause will prevent the payment of the face amount of the policy. However, the premiums paid through the date of the suicide will usually be returned (without interest); 14 months × $200 = $2,800. (QB.102.3)

You have a 35-year-old client who is extremely conservative and risk averse. He is an attorney who specializes in entertainment law, and his income for the next ten years will probably be the highest of his entire career. He wants a life insurance policy that has stability and is guaranteed to be in force until age 95. What type of policy would you recommend that he purchase? A) Whole life insurance. B) Modified whole life. C) Annually renewable term. D) Variable universal life.

A. Whole life insurance is the most appropriate type of coverage for this client. Current cost is not an issue and, in the long run, he will end up paying less for the coverage over his life expectancy. In addition, whole life insurance fits his low risk profile. This type of policy has guaranteed costs, a guaranteed death benefit, and guaranteed cash values. Term life insurance will run out at the end of the term and he may not be able to renew the coverage. Term life will also cost him more in the long run. Variable universal life does not have the built in guarantees that whole life insurance provides and is not recommended for a client who is risk averse. Modified whole life is used for individuals who have a long-term insurance need, but cannot initially afford the higher initial cost of traditional whole life. (QB.102.3)

All of the following statements concerning whole life insurance are correct EXCEPT: A) whole life insurance pays benefits only if the insured dies during a specified period of years. B) the nonparticipating version of whole life insurance does not pay any policyowner dividends. C) the protection afforded by the whole life insurance contract is permanent-the term never expires, and the policy never has to be renewed or converted. D) whole life insurance policies issued on a participating basis may return part of the premium in the form of policyowner dividends.

A. Whole life insurance provides for the payment of the policy's face amount upon the death of the insured, regardless of when death occurs. (QB.102.3)

A client just purchased a house and took out a $300,000 mortgage with a repayment term of 15 years. She wants to purchase a life insurance policy that will provide a death benefit equal to the unpaid mortgage balance if she dies during the term of the mortgage. She wants a level premium and does not feel she will need life insurance once the mortgage is paid off. She does not want a policy that provides a cash value. Which of the following life insurance policies best meets the client's needs? A) 30-year level term life insurance. B) Decreasing term life insurance. C) Annually renewable term life insurance. D) Whole life insurance.

B. A decreasing term life insurance policy is the best choice for this client because decreasing term life insurance provides a level premium and a death benefit that decreases over time. Level term life insurance provides fixed premiums, but the face amount remains constant. Annually renewable term life insurance is not appropriate because the premiums increase at each renewal. Whole life insurance is not appropriate because, although the premiums are fixed, the face amount remains constant and the policy provides a cash value. (QB.102.3)

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

B. A whole (ordinary) life policy best meets Pauline's needs because it will provide protection for her entire life (if the premiums are paid as agreed) and a guaranteed cash value. In addition, the insurance company assumes all of the investment risk and guarantees a minimum cash value at each age. (QB.102.3)

Linda was the beneficiary of her aunt's life insurance policy. The face amount of the policy was $500,000, and the selected settlement option was fixed period installments, payable annually over 10 years. This year, Linda received her first payment of $65,000. Which of the following statements regarding this settlement option is (are) CORRECT? 1. The $65,000 payment consists entirely of nontaxable principal. 2. Linda must include $15,000 in her gross income this year. 3. Linda will receive 9 more annual payments under the policy. 4. Linda must include $65,000 in her gross income this year. A) 1 only. B) 2 and 3. C) 1 and 3. D) 3 and 4.

B. Statement 1 is incorrect because each payment consists partly of interest and partly of principal. Statement 2 is correct; the $500,000 principal is paid out in 10 annual installments, so each payment includes $50,000 in principal. Linda must include $15,000 in her gross income this year because $15,000 of the $65,000 payment is interest. Statement 3 is correct; because the settlement option was fixed period installments payable annually over 10 years, Linda will receive a total of 10 annual payments. Statement 4 is incorrect; only $15,000 of the $65,000 payment is taxable. In addition, the $15,000 of taxable income may be subject to the 3.8% Medicare surtax. (QB.102.3)

Under which life insurance settlement option is a life income paid to the beneficiary with a certain number of guaranteed payments? A) Life annuity. B) Life annuity with period certain. C) Joint and survivor annuity. D) Single life immediate annuity.

B. Under this option, the payments are guaranteed for a specified period. If the beneficiary dies before the guaranteed number of payments has been made, the remaining payments are paid to a contingent beneficiary. (QB.102.3)

Which of the following clients would be a good candidate for term life insurance? 1. Tina, age 21, who wants life insurance for only 20 years until her mortgage is paid off and who does not want to accumulate a cash value. 2. Ralph, age 40, who wants life insurance only until he and his wife reach age 66 and begin receiving Social Security benefits; he wants the maximum face amount he can obtain for the amount of premium he can afford to pay. 3. Sam, age 35, who wants current life insurance protection at a minimal cost; he may or may not want to renew his policy from year to year and he does not mind if his premiums increase in the future. A) 2 and 3. B) 1 only. C) 1, 2, and 3. D) 1 and 2.

C. All of these clients are good candidates for term life insurance because they have a temporary need for life insurance protection. In addition, term life insurance does not provide a cash value (making it appropriate for Tina) and provides the maximum face amount of coverage for a given amount of premium (making it appropriate for Ralph). Although premiums typically increase when term life insurance is renewed, this is not a disadvantage for Sam. (QB.102.3)

Which of the following statements concerning the incontestable clause of a life insurance policy is (are) CORRECT? 1. Generally, the clause prevents the insurance company from contesting the validity of the policy after it has been in force for 2 years. 2. The validity of the contract cannot be questioned after the stated period except in limited situations. 3. The incontestable clause does not apply if an insurable interest never existed. A) 1 and 2. B) 1, 2, and 3. C) 1 only. D) 3 only.

C. All of these statements are correct. (QB.102.3)

Which of the following statements regarding the misstatement of age clause in a life insurance policy is (are) CORRECT? 1. The face amount of the policy will be adjusted to the amount of insurance that the premium paid would have purchased based on the insured's correct age. 2. In many cases of misstatement of age, insureds understate their age to reduce the premiums. A) Neither I nor II. B) II only. C) Both I and II. D) I only.

C. Both statements I and II are correct. (QB.102.3)

A life insurance contract with low fixed premiums during the first 3 to 5 years and then higher fixed premiums for the remainder of the policy period is called: A) a limited pay whole life policy. B) a variable life policy. C) a modified whole life policy. D) an increasing term policy.

C. Modified whole life policies are designed for individuals, such as young professionals, who want permanent life insurance, but are not yet able to afford the higher premiums of traditional whole life insurance. The increase to an ultimately higher premium should match an anticipated increase in the premium payor's income. (QB.102.3)

Penny is the beneficiary of her father's life insurance policy. The face amount of the policy is $250,000, and Penny selects the single life annuity settlement option. Her life expectancy is 20 years. Assuming Penny lives for only 12 years after payments begin, which of the following statements regarding the payments to Penny under this settlement option is (are) CORRECT? 1. Payments will continue to Penny's designee for an additional 8 years. 2. A portion of each payment Penny receives is includible in her gross income. 3. Any unrecovered tax basis in the settlement option that remained at Penny's death is deductible on Penny's final income tax return. A) 1 and 3. B) 1 only. C) 2 and 3. D) 2 only.

C. Statement 1 is incorrect; under the single life annuity settlement option, the annuity payments stop when the beneficiary dies. Statement 2 is correct; each payment includes a taxable interest component and a nontaxable principal component. Statement 3 is incorrect; a beneficiary of an annuity from a life insurance settlement option who dies before his or her expected life expectancy cannot deduct any unrecovered basis (QB.102.3).

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

C. The insurance remains in force during the grace period. The grace period prevents the policy from lapsing by providing the policyowner with additional time to pay an overdue premium.

If the insured under a life insurance policy becomes totally disabled due to bodily injury or disease before a stated age, all premiums due during the period of total disability are waived under: A) a forfeiture of premium clause. B) an incontestable clause. C) a waiver of premium rider. D) the grace period.

C. This rider protects insureds who are unable to pay premiums because of total disability. The policy and benefits will continue as if the premiums have been paid by the premium payer. (QB.102.3)

Under which life insurance settlement option are the proceeds paid to the beneficiary at a set dollar amount per month until all the principal and interest are exhausted? A) Fixed period. B) Interest only. C) Fixed amount. D) Life income.

C. Under the fixed amount option, a fixed amount is paid until both the principal and interest are exhausted. The amount paid remains unchanged, but the period in which the payments are made depends on how much is to be paid each period. (QB.102.3)

Barb is the beneficiary of a $1,000,000 life insurance policy. The insured recently died, and Barb is considering different settlement options. If her primary objective is to avoid paying any income taxes on the amounts received under the settlement option, which of the following settlement options will best meet her needs? 1. Lump-sum. 2. Fixed-amount installments. 3. Fixed-period installments. 4. Single life annuity. A) 4 only. B) 1 and 3. C) 2 and 3. D) 1 only.

D. Life insurance death benefits received in a lump sum are generally excluded from gross income. The payments under the other settlement options include both a taxable interest component and a tax-free principal component. (QB.102.3)

What must a policyowner do to reinstate a life insurance policy that has lapsed due to a nonpayment of premium? A) Pay the past due premium plus a penalty fee. B) Provide a written notarized request to the insurance company. C) Pay the past due premium only. D) Provide evidence of insurability and pay the past due premium with interest.

D. Most companies require evidence of insurability, and, if the company agrees to reinstate the policy, premiums must be brought current to reinstate a lapsed policy. (QB.102.3)

Which of the following statements are CORRECT with regards to disadvantages of annual renewable term life insurance? 1. Term life insurance does not develop cash values or a savings plan. 2. Term life insurance becomes increasingly uneconomical as the policyowner grows older. 3. At the end of a stipulated period of time, the policyowner may be declined for renewal coverage. 4. Initially, term life insurance has a higher premium than whole life insurance. A) 2 and 3. B) 1 and 4. C) 1, 2, 3, and 4. D) 1, 2 and 3.

D. Only statement 4 is incorrect. Initially, term life insurance has a lower premium than whole life insurance. Over time, however, the cost of a term life insurance policy will far exceed that of a whole life policy with the same face amount of coverage. (QB.102.3)

All of the following statements concerning the methods of providing life insurance protection are correct EXCEPT: A) term life insurance is a form of life insurance in which the death proceeds are payable if the insured dies during a specified period and nothing is paid if the insured survives to the end of that period. B) because death rates rise at an increasing rate as the insured ages, the net premium for term life insurance also rises at an increasing rate. C) an insurance company can use 2 approaches to provide life insurance protection; term life insurance, which is temporary, or whole life insurance, which is permanent protection that builds up a cash reserve or savings component. D) term life insurance is a good choice for people who need permanent life insurance protection.

D. Term life insurance may not be appropriate for meeting a permanent need for life insurance because the protection expires at the end of the term. (QB.102.3)

James Thornhill, a successful 40-year-old attorney, has a $500,000 whole life policy that has been in force over 10 years. Due to his high income tax bracket, he enjoys the policy's tax-deferred cash value accumulation and would like to increase that accumulation as much as possible. James's current dividend option is 'reduce premium'. Last year's dividend was $1,300. What can James change in the policy to maximize the amount of tax-deferred cash value accumulation? A) He could change the dividend option to 'accumulate at interest.' B) He could change the dividend option to 'cash.' C) He could pay a higher premium and convert the policy into a modified endowment contract. D) He could change the dividend option to 'paid-up additions.'

D. The best course of action for James is to change the dividend option to 'paid-up additions.' Under this option, the insurer uses the policy dividends to purchase incremental amounts of paid-up whole life insurance on James's life. Whole life policies usually do not allow for premium changes, therefore, James may not have the ability to increase his premium contribution to the policy. If he changed the dividend option to 'cash' that would not increase the cash value of the policy. Changing the dividend option to 'accumulate at interest' would also not accomplish James's goal of maximizing tax-deferred accumulation. Under this method, the insurer retains the dividends and credits a small amount of interest to them; however, even though the dividends are tax free (as long as they don't exceed James's basis in the policy), the interest earned on them is fully taxable in the year earned. (QB.102.3)

Which of the following settlement options offers the greatest flexibility in life insurance policies? A) Fixed period installments option. B) Life annuity option. C) Fixed amount installments option. D) Interest only option.

D. The interest only option allows the beneficiary to receive income from the proceeds, while keeping all other settlement options available. (QB.102.3)