Assignment 6 – Life Insurance Policies Practice Exam – Flashcards

Text Explanation: B There are three basic types of life insurance: 1) Whole Life, 2) Term and 3) Endowment. Limited Pay Life policies, such as LP65 and 20-Pay Life, are variations of Whole Life or Straight Life. The premium-paying period has been shortened, but the policy still does not mature until age 100.

Text Explanation: D If we had not mentioned cash accumulation, the answer would have been Term. However, Term has no cash value, so the answer is Whole Life, which is the most inexpensive type of permanent insurance and is required to have a cash value after the third policy year. Although Limited Pay Life is a type of Whole Life, it is incorrect since it is usually quite expensive due to the shortened pay-in period. Annuities have no cash value except the money the annuitant paid in. Since there is no death benefit, no protection is offered.

Text Explanation: C Limited pay whole life (such as a 20 pay life or a life paid up at 65 policy) are variations of traditional whole life insurance. All whole life insurance is designed to reach maturity at the insured's age 100. So, although a 20 pay life policy will be paid up in 20 years from the date it was purchased, it will not reach maturity until age 100. At maturity, the cash value of the policy will equal the face amount of the contract.

Text Explanation: D When taking cash surrender the insured only has to pay tax on the amount withdrawn that exceeds the amount that they paid in. Since premiums for individual life insurance are paid with after tax money, the premiums paid represent the insured's cost basis. When withdrawn, the cost basis is returned to the insured without tax. When taking cash surrender the IRS treats the distribution as return of cost basis first and interest second (First-In-First-Out or FIFO). Since the insured paid $4,000 in premiums and they are withdrawing $5,000 they would have to pay ordinary income tax on the difference ($5,000-$4,000=$1,000). There are never capital gains tax on life insurance cash surrenders.

Text Explanation: D The key words here are "minimum premium." Term is the most inexpensive type of coverage. Since Cheryl's $50,000 loan will be paid off over 20 years and the loan balance will decrease each year, Decreasing Term makes sense. Decreasing Term is not renewable or convertible.

Text Explanation: A Since Whole Life has the longest premium payment period (to age 100), it also has the lowest premium of any policy with a cash value. Limited Pay policies are more expensive, since the premium-payment period has been shortened. Term policies have no cash value. Annuities are the opposite of insurance. There is no Death benefit. They only pay you if you live.

Text Explanation: C Modified whole life modifies the premium, not the face amount. For example, an insurer may modify (discount) the premium for the first 5 years of a new policy in order to attract a client who may be on a limited income because they are in medical school. However, at the end of 5 years, the premium will increase dramatically. Adjustable, universal and variable/universal all permit changes in premiums, which in turn, changes the death benefit (or face amount) of the policy.

Text Explanation: D Limited pay life insurance policies such as Life Paid Up at 65 or 20-Pay Life are simply variations of Whole Life policies. The cash value will equal the face amount of the policy (at least) at the maturity of the policy, which is always age 100 on Whole Life policies. These limited-pay policies are designed so that the insured may pay his or her premiums faster and be "paid up" at a certain age. However, just because the premiums are paid up doesn't mean the policy has matured.

Text Explanation: A Most group policies are purchased by employers who want to pay as little as possible, so most group policies are annual renewable level term contracts. Premiums are based on the average age of the group and often consider past claims experience of the group.

Text Explanation: D Although annuities do not offer insurance protection, they do contain a death benefit which is equal to the contract's cash value at the time of death. Annuities also offer flexible premiums and tax deferred growth at a fixed rate during the accumulation period. Since this is an insurance exam, don't assume they are asking about variable annuities.

Text Explanation: A On Group Life, which is usually written as annual renewable term insurance, the employer is considered to be the Master Policyholder. Covered employees only receive one Certificate of Insurance, summarizing their coverage and listing all covered dependents, if any.

Text Explanation: B Although EXCEPT questions are usually looking for the false answer, this one is looking for the response that is true. Although it will usually take three years for a minimum premium whole life policy to develop a cash value, a single premium whole life policy will develop a cash value right away. Initially, many Universal Life policies were sold to wealthy persons who could afford to pay up the policy by paying a large single premium. Such policies developed an immediate cash value, which earned high rates of tax deferred interest that resulted in rapid cash value accumulation. Eventually, the IRS recognized that such policies were more like investments than life insurance, and reclassified them as Modified Endowments. Please also see the rationale to question #1 of this exam.

Text Explanation: A Credit life may only be used on loans up to 15 years in duration. However, decreasing term policies may be written for any length of time, often up to 30 years or longer.

Text Explanation: B Adjustable whole life insurance is sold to clients who have fluctuating incomes, such as real estate agents. For example, a 30 year-old realtor buys a $100,000 adjustable whole life policy for an annual premium of $1,000. If his income drops, he could adjust his premium down to $500, which in turn would cause the policy limit to drop to $50,000. If his income increases, he can adjust his premium up to $750, which in turn will adjust his policy limit up to $75,000, without a physical exam. However, he cannot adjust his face amount up to more than the $100,000 he originally purchased unless he can pass a physical exam.

Text Explanation: A On an Endowment policy, the insured's cash value will equal the face amount of the policy at maturity, which is a predetermined time, say age 65, set by the insured when they buy the policy. Whole Life policies always reach maturity at age 100. You could say that a Whole Life policy endows at age 100. A true Endowment policy will always mature earlier than age 100. Endowments are just like Whole Life, except that the maturity is always earlier.

Text Explanation: A Endowment policies are usually sold either for retirement purposes at age 65 or to children to fund their college education. This type of policy reaches maturity at a predetermined time selected by the insured or policyholder. An E65 would reach maturity at 65 and the cash value would equal the face amount. A 15-year Endowment covering a three-year-old would endow at the child's age of 18 and the funds could be used for his/her college education. Of course, if the insured dies during the policy period (before the policy endows) then the company would pay the face amount to the beneficiary. Endowments are always the most expensive type of life insurance. Endowment policies also contain the three non-forfeiture options, since they do have a cash value.

Text Explanation: B Employers sometimes help their employees purchase cash value life insurance in the form of a 'split dollar' plan. The employer pays that part of the premium that is allocated to the cash value and the employee pays the difference. The cash value portion of the policy belongs to the employer, so if the employee terminates employment the employer may surrender the policy for cash. However, if the employee dies during his term of employment, the proceeds of the policy are paid to who ever the employee designated as beneficiary. If the employee works until full retirement age, the employer may assign the policy to the employee who may keep it or surrender it for cash to supplement his retirement. Split dollar plans are not considered to be Group life or Key Person life insurance.

Text Explanation: D Often used to protect home mortgages or for temporary needs, Decreasing Term insurance has no cash values. Usually written for five, 10, 15, or 20 years, the premium remains the same each year. However, since the amount of insurance decreases, you could say that the cost actually is going up each year. Decreasing Term is not renewable but it is usually convertible to Whole Life at the option of the insured without proof of good health.

Text Explanation: D Group life insurance is considered to be an employee benefit, so the employer may tax deduct the premiums paid. However, the proceeds are payable tax free to the beneficiary selected by the employee. The employer is considered to be the Master Policy Holder, and the insured employee receives a Certificate of Insurance summarizing his coverage. Although dependents may be covered, only one Certificate is issued to each covered employee. Group premiums may be contributory or non-contributory. A group may not be formed just to buy insurance. It must exist for some other reason. By law, Group life coverage is convertible to whole life without a physical exam for 31 days after termination of employment. Conversion is based upon the employee's current age.

Text Explanation: B If most Term policies (except Decreasing Term) were not renewable, no one would buy them. This option allows the insured to renew the policy for another term without proving good health. Of course, the insured does not have to renew-it is at his/her option. Annual Renewable Term (ART) is a good example. It must be renewed every year. The rate goes up as the insured gets older, but no proof of good health is required. However, most Term policies are renewable only up to a certain age, usually age 60 or 65, depending on the company.

Text Explanation: D Although limited pay policies are a type of whole life insurance, the premium is paid during a limited period of time, such as 20 years. However, the policy does not reach maturity until age 100. Limited pay policies are very expensive, but build cash values very rapidly.

Text Explanation: A The word "term" means time. Time is temporary. A Term policy, since it is the most inexpensive type of insurance, would provide an applicant the greatest amount of protection (face amount) on a temporary basis. However, in the long run, Term may be the most expensive type of insurance.

Text Explanation: C Mutual insurers write 'participating' policies, which means that their policy owners MAY receive dividends, at the discretion of the Board of Directors. If paid, such dividends are not taxable, since the IRS considers them to be a return of a premium overcharge. Remember, premiums are paid with after-tax dollars. Dividends may never be guaranteed. Stock insurers write 'non-participating' policies.

Text Explanation: C Remember, Universal Life is a type of Whole Life insurance and is sometimes referred to on the exam as "interest sensitive" whole life. Universal Life policies have a cash value with a minimum guaranteed interest rate and an excess current interest rate. The return the insured receives on the cash value will vary and is interest rate sensitive. Loans are permitted, and if taken will definitely have an effect on the cash value accumulation. However, death benefit proceeds are not taxable.

Text Explanation:D If a single premium is used to purchase a whole life policy the policy will be paid up for the life of the policy. No further premium need be paid. Whole Life policies can be purchased and paid for a number of different ways. Continuous premium traditional Whole Life policies were originally purchased with periodic premiums that were paid for the life of the insured. However, many people did not want to pay their life insurance premiums over their entire life, so the insurance company created a number of variations of premium payment. The insured can now select to pay their Whole Life policy premium for a specified number of years (Pay Life), or to a certain age (Life Paid-up). The insured can also select to pay the full premium on day one (Single Premium). Remember, the shorter the premium paying period the higher the premium and the faster the cash value will build.

Text Explanation: C Upon death, your life insurance policy will create an immediate estate, which your beneficiary may choose to liquidate by using the policy proceeds to purchase an annuity

Text Explanation: B The re-entry option is a common feature on many term policies that gives the insured the opportunity to pass a physical exam at the end of the term in order to qualify to renew the policy at a lower premium rate than the guaranteed rate available. Of course, if the insured fails the physical, he can always renew at the rate guaranteed in the policy.

Text Explanation: C Credit life is a type of decreasing term insurance written on the life of the debtor. Proceeds from the policy are payable to the creditor to extinguish the debtor's debt. The maximum policy period cannot exceed the life of the loan, and the policy limit cannot exceed the amount owed. It is not unlimited!

Text Explanation: B You can assume that a Joint Life policy is written on a first-to-die basis unless the exam question specifically refers to a Joint Life 'Survivorship' policy, which is set up to pay only when the second insured dies. Survivorship Life insurance is often purchased to pay estate taxes, which are due when the second spouse dies.

Text Explanation: A On Group Life, the Employer is the Master policyholder and the Employee merely receives a Certificate of Insurance indicating how much coverage he has, who his beneficiary is, and whether or not he has dependents' coverage.

Text Explanation: A Whole Life insurance assumes that the insured will pay the premiums until death or until age 100, whichever comes first. If the insured is still alive at age 100, the policy will reach maturity and pay the insured the face amount or cash value, whichever is more. This is because the insurance company's Mortality Table states that everyone has died by their 100th birthday. An insured who would like to retire at age 65, keeping the life insurance in force but discontinuing premium payments, should consider buying an LP65, which is a Whole Life policy with a limited payment period. Of course, the shorter the premium paying period, the higher the premium. An insured buying Straight Whole Life, which matures at age 100, could also stop paying his premiums at age 65 by selecting the Reduced Paid Up Non-forfeiture option. This would result in the insured having a new Whole Life policy paid up to age 100 with a cash value and a death benefit somewhat reduced from his original policy, but no further premium would be due.

Text Explanation: D In this context "pure" protection means coverage for mortality only. Term insurance has no cash value and therefore offers the most pure protection for the lowest cost.

Text Explanation: D A Universal Life (UL) insurance policy actually has two parts: 1) the protection part, which is actually level term insurance; and 2) the cash value part. Since the protection part is term insurance (which costs more each year as the insured grows older), an increasing portion of the premium paid is allocated to cost of the term coverage each year. In theory, the cost of insurance protection could eventually exceed the minimum premium, which would cause either the premium to go up, or the cash value to start going down. However, UL does offer policy owners the advantage of flexible premiums, meaning that the owner may pay in more or less than the required minimum. However, if the owner pays in less or skips a premium payment, the insurer will debit (reduce) the insured's cash value account to make up the difference. If the owner pays in more, the additional premium will be credited to the cash value, which could possibly cause the policy to be reclassified as a Modified Endowment Contract (MEC), since the insurer's risk has diminished. Since UL is not considered to be a security, it does offer a minimum guaranteed rate of return on the cash value. UL is also known as 'interest sensitive' whole life, since the current rate of return may vary year to year above the minimum. As with all cash value life insurance, earnings are tax deferred.

Text Explanation: C A joint life policy is usually written to cover only the first party to die. A survivorship life policy only covers the last party to die and is usually used to pay estate taxes. If both spouses want coverage to apply when either dies, they need separate policies.

Text Explanation: B With the exception of the Endowment policy, which is always the most expensive and always builds cash values the fastest, you can simply remember this truism: The shorter the premium-paying period, the more expensive the premiums and the faster the cash value builds. Since all the policies mentioned are forms of Whole Life, reaching their maturity at age 100, the only thing different is the premium-paying period. A 20-Pay Life requires that all the premiums be paid within 20 years from the day it is purchased. A Whole Life (or Straight Life) policy requires the premiums to be paid to age 100. If Clark is now 30, the assumption is that he would have to pay premium to age 100, or 70 years. Obviously, 20-Pay Life, which would require the premiums to be paid in over three times as fast, would be much more expensive and would also build cash values much faster.

Text Explanation: C Variable life utilizes a separate account that is similar to a mutual fund, which is why an agent also needs an NASD license. Universal life does offer a "current" interest rate, but funds are invested in the insurers "general account" which does have a minimum guaranteed rate of return.

Text Explanation: D The conversion privilege on Group Life extends for 31 days after the insured terminates from the job. He can convert only to a Whole Life (Permanent insurance) policy written by the same company without submitting evidence of insurability. He cannot convert to more coverage than he had on the Group Life policy. He cannot convert to Term, only to Whole Life.

Text Explanation: C The insured is eligible to convert from the group policy to an individual policy issued by the same insurer within 31 days of ineligibility. The insured CANNOT convert to term, but they can convert to a more expensive type of life insurance, such as whole life. There is no underwriting to convert to an individual policy, however the ex-employee would be responsible for paying the entire premium, which is based on their age at conversion (attained age), not age of enrollment in the group. When converting from a group policy the individual can only convert to a face amount that is no higher than that of the group policy.

Text Explanation: B Most term insurance is renewable up to certain ages as stated in the policy. Remember, the word 'term' means time. A 10 year level term policy has a level premium for 10 years, which is based upon the client's average age. At the end of 10 years, the client may renew it by simply paying the premium, which will be based upon the client's average age for the next 10 years. No physical exam is required and neither the suicide clause nor the incontestability clause starts over. Some insurers offer a 're-entry option' upon term renewal. If the insured can pass a physical exam, the insurer will renew the policy at a lower rate than that offered to insured's who either decline to take or fail to pass a physical exam.

Text Explanation: C In this test, Whole Life and Straight Life are interchangeable. As used, either term means "continuous, level-premium Ordinary Life" insurance. A Whole Life policy may never be changed by the company. The premium can never go up. It never has to be renewed or converted. Therefore, it is known as "permanent protection."

Text Explanation: B All Group Life insurance is Term insurance. Actually it is Annual Renewable Term and it is rated on the average age and claims experience of the entire group, which is called "experience rating." Remember, this type of insurance has a 31-day Grace Period and is convertible to Whole Life upon leaving employment. A Contributory Group plan requires that both the employer and the employees pay part of the premium. At least 75% of those eligible must participate, so the group is sure to get most of the healthy employees as well as those that are sick. In a Noncontributory plan, the employer pays 100% of the premiums and 100% of those eligible must participate. There must be at least 10 persons eligible to form a Group plan. If only the sick employees were to enroll, the insurance company would be the victim of "adverse selection" and their loss ratio (claims ratio) could suffer, causing the rates to go up.

Text Explanation: B Since an Endowment at age 65 reaches maturity at age 65, rather than age 100, it will be much more expensive than an LP65. Since it is more expensive, it will also build cash values much faster, since the face amount and the cash value must be at least equal by age 65.

Text Explanation: C There are two types of 'joint life' insurance policies. Remember, a joint life policy covers two insureds and would be cheaper than buying separate individual policies on each person. Most joint life policies are set up as 'first to die', meaning that benefits are paid upon the death of the first insured only, with nothing paid when the second party dies. However, a 'survivorship' joint life policy pays nothing when the first party dies. It only pays upon the death of the second insured. Historically, survivorship life insurance was sold to provide proceeds to pay estate taxes, which are due when the second spouse dies.

Text Explanation: D All life insurance policies provide the beneficiary with tax free death benefits. However, Endowments (which are a type of life insurance that reach maturity at a predetermined age prior to age 100) have a fixed, level premium. Variable life also has a fixed, level premium but does not have a guaranteed minimum rate of return since it is considered to be a securities product. Although annuities do have a death benefit during the accumulation period, it is limited to the account value. There is no insurance protection feature on an annuity and no underwriting requirements. However, Universal Life has all these features.

Text Explanation: B Most term insurance is renewable without a physical exam, although the premium goes up as the insured ages. For example, a client buys a 5 year Level term policy, which has both a level face amount and a level premium for 5 years. At the end of 5 years, the policy is renewable, but the renewal premium will be based upon the insured's average age for the next 5 year period, which will be higher. If the insured is still in good health, they may feel that this increase in premium is unfair, so they may let the policy lapse. To solve this problem, some term insurers offer the 'reentry option', which states that if the insured can pass a physical exam prior to renewal, the insurer will renew the policy for a premium that is less than that charged those insureds who either refuse to take or fail a physical exam.

Text Explanation: D Although Group life insurance is convertible for 31 days after termination of employment to whole life without a physical exam, the premium for the new whole life policy is based upon the insured's current age, not their original age.

Text Explanation: A Adjustable Whole Life is marketed to meet an insured's changing needs and ability to pay premiums in an uncertain economic climate. It is the most flexible type of Whole Life insurance. The insured can adjust the premium, face amount or the length of coverage. If the insured increases the premium they pay the cash value will build faster and the face amount of coverage will increase. However, no physical exam is required unless the insured wants to increase the face amount above that which he originally purchased.

Text Explanation: A Since both Tom and Joe are spending the exact same amount on their life insurance ($500), the brother who purchased term (Tom) will be able to purchase a significantly higher amount of protection (face amount) than the brother who purchases whole life (Joe), since whole life is so expensive. Term is considered to be temporary protection since it only provides protection for a limited period of time. Whole life is considered to be permanent insurance since it never has to be renewed and provides protection until the insured dies or reaches age 100, whichever occurs first.

Text Explanation: B Most Joint Life insurance policies are set up as first-to-die. In other words, two people (often husband and wife) are insured on the same policy. The proceeds are payable when the first party dies. Nothing is paid when the second party dies. However, the opposite would be true on a Joint Life Survivorship policy, which are set up as second-to-die.

Text Explanation: B Credit Life insurance is usually a type of decreasing term insurance that is sold by lenders, such as banks and credit unions. The face amount of the policy is limited to the amount of the loan and the policy expiration date must coincide with the maturity date of the loan. Most credit life is sold as Group, with the lender (or creditor) as the Master Policy Holder and the debtor (or borrower) as the insured. The debtor receives a Certificate of Insurance, not a policy. The creditor is the beneficiary and the proceeds are paid directly to them to pay off the loan if the insured dies. Credit Life may not be used as Mortgage Protection Life insurance.

Text Explanation: C Although the premium remains the same each year on Decreasing Term insurance, the face amount decreases, usually straight line each year. So, if you bought a 20-year Decreasing Term policy, after 10 years your face amount would be reduced by half. However, since the premium remains the same, you could say the cost of your insurance had doubled! Decreasing Term has no cash value. It is usually convertible, but not renewable.