Chapter 2-Basic Principles

Question 1

What are some characteristics of the 1980 and 2001 CSO mortality tables?

Answer 1

• The tables show different rates at each age for men and women separately
• The 1980 CSO mortality table (separates mortality rates for men and women) (has higher mortality rates for some at age 21 than at age 29) (provides 10 year selection factors) (has mortality data for those insured under ordinary life policies, not annuitants)

Question 2

How do most large life insurance companies determine their rates?

Answer 2

-Using their own mortality data

Question 3

What are some characteristics of the assessment plan of life insurance?

Answer 3

• As the assessment plan grows older, the average age of the participants is likely to rise due to difficulties replacing deceased, withdrawing, and aging member with new members
• As the assessment increases in amount and frequency, the death rate among the participants tends to rise due to withdrawing youth
• The assessment plan is rarely used in modern life insurance

Question 4

What are the characteristics of a yearly renewable term (YRT)?

Answer 4

• Widely used in group life insurance
• Typically renewed without evidence of insurability
• Annual premium rises every year
• Renewal limitations at advanced age
• No cash value

Question 5

What are the characteristics of a level premium plan?

Answer 5

• The sum of premium excess in early years is not equal to deficiencies in later years because compound interest is the difference
• Plan causes the buildup of a reserve that is a liability for the insurance company
• Premiums paid in early years are more than sufficient to cover death claims in those years
• Could be ordinary (whole) or term

Question 6

What are the characteristics of a term-to-age-65 policy?

Answer 6

• The reserve rises, then falls back to zero at 65
• Usually not renewable
• Conversion may be offered but age restrictions
• Cash and other surrender values are provided

Question 7

What are the characteristics of an ordinary life policy?

Answer 7

• Based on the assumption that death is certain to occur (when is the question)
• Reserve builds at a faster rate than term
• Loans are not taxed unless a MEC

Question 8

What are the characteristics of a term policy?

Answer 8

-Reserve builds at a slower rate than orders

Question 9

What are some characteristics of all life insurance policies?

Answer 9

• The reserve (savings element/cash value) is payable as part of the face amount of the policy at the insured’s death
• The amount at risk under a policy decreases as the reserve increases
• Insurance (protection element/net amount at risk) decreases as cash value increases
• Net amount at risk plus cash value always equal face value

Question 10

How is the “cost of insurance” determined in a level premium plan?

Answer 10

-Multiply the net amount at risk by the death rate per 1,000 (death rate times 1,000)

Question 11

What is the relationship between the premium paying period and the death benefit

Answer 11

The shorter the premium paying period, the higher the degree of prefunding, which results in a higher proportion of cash value to death benefit

Question 12

When is a death benefit included in income?

Answer 12

-When a policy has been transferred-for-value (except to a corporation the insured was a shareholder or officer, a partner of the insured, a partnership of the insured, or the insured)

Question 13

When is a death benefit option taxable?

Answer 13

When interest earned on the death benefit is paid (not the death benefit, so interest only option is all taxable income but other options are only partially taxable based on the interest received)

Question 14

What changes increase a policy owners basis (non MEC)?

Answer 14

-Premium payments

(Loans and inside buildup have no effect on basis)

(Dividends decreases the basis)

Question 15

What are the relevant concepts regarding the cash surrender of a life policy?

Answer 15

• Basis (premiums paid minus dividends)
• Taxable gain (surrender value minus policy basis)
• Surrender value (net cash value plus policy loans)

(Surrender Value-Basis=Taxable Gain)

Question 16

What are the characteristics of a Modified Endowment Contract (MEC)?

Answer 16

• Larger savings component than whole life
• Subject to LIFO tax treatment on policy loans (income is distributed first)
• During the first 7 years, a loan is not likely to consist entirely of income (any portion of the loan that exceeds the income will not be taxed)
• A taxable loan from the policy will increase the basis
• A 10% penalty tax applies to a taxable loan if the policyowner is under 59 1/2

(Income tax rules do not apply to the death benefit of MECs)
(MECs failed the “corridor test” in 1984)

Question 17

When are life policy premium payments deductible?

Answer 17

• When the premium can be deducted for another reason such as (benefiting charities as a charitable contribution, employers as a business expense for employees, and a spouse payor as alimony in divorce cases)
• The policy benefits an ex spouse and the premiums are alimony
• A charity is the owner and named beneficiary
• The employer pays the premium for the employee and the employee’s beneficiary would receive proceeds

Question 18

What is the maximum gift amount that can be sheltered by exclusion?

Answer 18

$14,000 to each person
(Gift splitting with a spouse can double that amount to $28,000 per person and the gift exclusion applied to any number of donees)
(The value of gifts over the annual exclusion are eligible for a lifetime exemption up to $5.34 million. Annual and lifetime exclusions are adjusted for inflation. The gift of a life policy is eligible for annual and lifetime exclusions. If exemption is not used during lifetime, it could be used to reduce estate tax. The exemption is portable so any portion not used during life or death can be transferred to a spouse).

Question 19

What gift transfer is not taxable?

Answer 19

-Spousal gift transfers
-Charity gifts
-Payments to a medical institution
-Payments to an educational institution
-Gifts to a political organization
(spousal gifts qualify for a marital deduction but children gifts are taxable)

Question 20

According to the Federal estate tax rules, what is included in the value of the gross estate (subject to taxes)?

Answer 20

-Property in the probate estate (property passing under will or state law of intestacy if no will) (additional assets not part of probate may still be subject to Federal tax)
-Property owned jointly with the spouse at the time of death (the joint interest is not calculated in the gross estate)
-Property transferred but a life interest was retained
-Life insurance transferred by gift within 3 years of death (sold policies are not part of the estate)
-Policies that name the estate or executor as beneficiary
(Life insurance on a decedent is an asset subject to Federal estate tax)

Question 21

What are some characteristics of ownership of a life policy?

Answer 21

• Power to name the beneficiary
• Power to take a loan from the policy
• Power to assign the policy
• Power to surrender the policy

Question 22

What are some non taxable returns of premium (reduces basis)?

Answer 22

-Dividends
-Withdrawals
(Loans do not reduce basis)

Question 23

What is a MEC?

Answer 23

• Modified Endowment Contract

- Policy that fails the 7 pay test (policy is paid up in 7 years)

Question 24

What is Section 1035 of the tax code about?

Answer 24

The ability to change one policy for another policy tax-free if it insures the same person.

Question 25

When is the Federal gift tax imposed?

Answer 25

- When there is a completed lifetime transfer of property | - The transfer is for less than the full value of the gift

Question 26

When are gifts inadvertently given?

Answer 26

When the owner, insured, and beneficiary are all different people. (If the wife owns a policy on the husband and makes the child the beneficiary, the policy is seen as being paid to the wife who gifted it to the child)

Question 27

What are some Federal estate tax deductions?

Answer 27

- Property pass to a spouse or charity get a marital and charitable deduction (unlimited amount) - Funeral and burial costs - Estate settlement expenses - Legitimate debts