Chapter 8-Settle Agreements, Settlement Options, and Surrender Values

Question 1

What does the Standard Nonforfeiture Law allow?

Answer 1

• Relieves the insurer of the obligation of granting cash surrender values until the end of 3 policy year for ordinary insurance
• Allows the insurer to postpone the payment of a policy owners cash surrender value for up to 6 months
• Limits the amount of extra first year expense allowance that the insurer may use to calculate surrender value

(the adjusted premium is the level annual premium that will amortize the PV of future benefits of the policy and the special first year expense allowance)
(the difference between reserve and surrender value is surrender charges imposed to cover unamortized first year expenses so the larger the extra first year expense, the smaller the surrender value)

Question 2

What is subtracted from policy owner proceeds during a policy surrender?

Answer 2

• Loans

- Accrued and unpaid interest on loans

Question 3

What are the characteristics of a reduced paid-up insurance surrender option?

Answer 3

• If surrendering a limited-payment whole life policy the new policy will be paid-up whole life (same type of policy but with less value)
• The amount of paid-up insurance purchased is based on the insured attained age at the time the option is chosen
• The net single premium to purchase paid-up coverage is calculated as the policy cash value, plus dividend cash value, minus policy loans and interest
• The cash value of the new coverage will gradually grow to reach the new, reduced face amount by the last age in the mortality table

Question 4

What are the characteristics of the extended term insurance surrender option?

Answer 4

• The automatic option of most insurers
• The face amount of the new coverage will be increased by dividend additions and deposits
• The face amount of the new coverage will be decreased by any policy indebtedness
• The new coverage will be purchased on an attained age basis
• Coverage is purchased by means of a net single premium
• The net single premium to purchase paid-up coverage is calculated as the policy cash value, plus dividend cash value, minus policy loans and interest
• Investment element is at its’ peak when the option is chosen (slowly declines to zero when term expires)

Question 5

Under the extended term surrender option, where is indebtedness against the policy subtracted?

Answer 5

• The term coverage purchased

- The surrender value used as the net single premium

Question 6

What is the result of the extended term surrender option when indebtedness is involved?

Answer 6

• Results in a shorter period of term than with no indebtedness
• Results in a lower amount of term than with no indebtedness

Question 7

Why do insurers prefer the extended term over the paid up whole life option?

Answer 7

• Lower expense rate
• More liberal reinstatement
• Reduced problem of tracking policy owners

(Disadvantage of this option is a higher degree of adverse selection than the paid up option)

Question 8

What are the characteristics of the automatic premium loan option?

Answer 8

• Special policy benefits stay in full force ( such as double indemnity)
• Advantage of not lapsing due to occasional nonpayment
• Disadvantage of cash value declining at an increasing rate
• Disadvantage of cash value growing at a slower rate

Question 9

What settlement option fully discharges the insurer of liability?

Answer 9

Lump sum payment

Question 10

What are the characteristics of a typical life settlement agreement?

Answer 10

• Agreement may be decided when the policy takes effect or at a later date
• Policy owner may change settlement option anytime before death
• Beneficiary may have the right to change the settlement agreement after the insured dies
• Agreement may be arranged to provide payments to the insured (such as endowments, surrender values, accelerated benefits, etc)

Question 11

What is the spendthrift clause?

Answer 11

Agreement to protect life proceeds from beneficiary creditors

(may not be chosen by person receiving benefits)

Question 12

Why do life companies deny the beneficiary the right to name a revocable secondary beneficiary for unpaid proceeds?

Answer 12

• The arrangement may legally be viewed as a disposition of property at death
• The arrangement may legally be required to meet the formal requirements of a will

Question 13

What are settlement agreement contract rates?

Answer 13

Guaranteed rates of income to be paid as specified in the settlement agreement

(Insurers may pay more if mortality, expenses, or earnings are more favorable)

Question 14

What is the relationship between contract and current rates?

Answer 14

The insurer’s contract rates may be higher, lower, or the same as current rates

(current rates are recent contract rates)

Question 15

What are the possible beneficiary restrictions when withdrawing principal under the interest only option?

Answer 15

• Minimum withdrawal per transaction
• Maximum withdrawal per transaction
• Maximum withdrawal in a year
• Maximum withdrawal in total
• Frequency limitations on withdrawals

Question 16

What is the right of commutation?

Answer 16

A right to withdraw in a lump sum the PV of remaining installment payments under liquidating options such as life income, fixed period, or fixed amount (not interest only)

Question 17

What are the characteristics of the interest only option?

Answer 17

• Designed as an interim option to postpone the disposition of proceeds
• Must be followed by a lump sum distribution or liquidating option (no more interest only)
• Provides life Income for the primary beneficiary
• Conserve principal for a contingent beneficiary
• Provides flexibility of income to the primary beneficiary by allowing the right of withdrawal
• Most companies are willing to keep proceeds for the beneficiary’s lifetime or 30 years (whichever is longer)
• Most companies will not accumulate interest and require that it is paid out at least annually
• Beneficiary may have limited (cumulative or noncumulative) or unlimited right of withdrawal
• Beneficiary may have right to select a liquidating option
• May have the right to irrevocably name a person to receive unliquidated proceeds

Question 18

When is the primary beneficiary allowed to retain contract rates?

Answer 18

When a liquidating option is chosen within a specified time frame

Question 19

What are the characteristics of the fixed period option?

Answer 19

-Dividends, paid up additions, and loans affect the payment amount (not period of payments)

Question 20

What factors affect the length of time payments would be made under the fixed amount option?

Answer 20

• Policy loans (-)
• Interest earnings (+)
• Dividend additions (+)
• Accidental death benefits (+)

Question 21

What beneficiary rights are possible under the liquidating payout options?

Answer 21

• Right to delay the liquidation period
• Right to increase rate of liquidation
• Right to withdraw some or all proceeds
• Right to transfer remain proceeds to a different liquidating option

Question 22

How does the life income option work?

Answer 22

• The death proceeds are used as a single premium to purchase an immediate life annuity
• highly inflexible
• Income is based on age and gender of the beneficiary at the time of selection
• No substitutions after payment starts
• No right of withdrawal
• No right of commutation

(available options may be straight life-largest amount, period certain, cash refund-lump sum unpaid payout, and installment refund-installment unpaid payout)

Question 23

What affects the periodic payment with the life annuity option?

Answer 23

• Insurer’s mortality assumptions

- Type of life Income option selected

Question 24

What combination creates the installment refund life Income option?

Answer 24

• Decreasing term (Decreasing term provides the installment refund from start of annuity until proceeds have been received)
• Pure immediate life annuity (beneficiary’s life annuity)

Question 25

What are some beneficiary restrictions under the life Income option?

Answer 25

- No substituting beneficiaries after proceed payments begin | - No right to commute proceeds if there are benefits payable under a deferred life annuity

Question 26

What are the policy termination methods?

Answer 26

- Lapse (terminated for nonpayment prior to surrender value) | - Surrender (terminated for nonpayment after policy surrender value is available)

Question 27

What are the characteristics of withdrawing a surrender benefit?

Answer 27

- Should equal contributions minus costs and expenses - Value should be less than the policy asset share - The withdrawal should neither benefit or worsen the policy owner - Surrenders increase when market rates exceed surrender rates - Expenses occur with processing surrender requests (Data does not support the idea that those in better health surrender and the unhealthy stays)

Question 28

What is the law of large numbers about?

Answer 28

The larger the number of policies outstanding, the less the variation in the impact of uncertainty of the group, and the less the variation in policy owner behavior as a group with respect to demand for cash value

Question 29

Can life companies limit surrender benefits?

Answer 29

Yes, benefits should be limited if their payment would jeopardize the company’s solvency

Question 30

What are the characteristics of nonforfeiture laws in the U.S.?

Answer 30

- Each policy must include a statement of the method that will be used for the surrender value - The objective is to provide a method for calculating the minimum surrender value that is independent of the policy reserve - The objective also assured that the surrender value reflects an amount similar to the policy owners accumulated asset share - Early policies provided no refund to policy owners when terminated - The Standard Nonforfeiture Law of all 50 states now require a minimum nonforfeiture value for all surrendering policy owners (laws are designed to assure fair treatment of surrendering policy owners) - The nonforfeiture value required by law is a minimum but the insurer is able to provide a larger amount - Calculated as the net single premium as of valuation age minus the PV of future adjusted premiums as of that age

Question 31

What are the characteristics of the adjusted premium method of determining surrender value?

Answer 31

- The method recognizes that first year loading does not cover first year expenses - First year extra expenses are amortized over the policy’s premium paying period - The concept of the method is that all policies written on the same plan at the same age should pay their own mortality costs and acquisition expenses - The calculation is net single premium as of issue age plus excess first year expenses, divided by the PV of a life annuity due for the premium paying period as if issue age

Question 32

What is the difference between the adjusted premium method for calculating surrender values and calculating the perspective reserve?

Answer 32

- The difference is the amount of excess first year expenses amortized over the premium paying period so the PV of future adjusted premiums will always be larger than the PV of future net level premiums - The PV of future benefits is the same for both methods if mortality and interest assumptions are the same (The methods for both are the same)

Question 33

What is the difference between full net level premium reserves and the calculation of surrender values?

Answer 33

- The difference is unamortized first year expenses - The difference decreases with each payment (Insurers may use any assumptions about mortality and interest to calculate surrender values as long as the result meets exceeds statutory minimums)

Question 34

How is the present value of future adjusted premiums calculated?

Answer 34

Multiplying the adjusted premium by the life annuity due of $1 as of the valuation age for the balance of the premium paying period

Question 35

Why do insurers pay surrender dividends to surrendering policy owners?

Answer 35

To assure equity in treatment of surrendering policy owners when the policy’s asset share exceeds the policy surrender value (the insurer may have recovered the amount of the extra first year expense)

Question 36

What are the characteristics of surrender values in non traditional life policies such as universal life?

Answer 36

- Surrender value is accumulated value minus explicit surrender charge - Surrender charge is 100% of accumulated value at the time of termination during the first policy year - Surrender charge decreases the first few year of the policy and is 0 by the end of the 7th year

Question 37

What surrender options must be provided to a policy owner?

Answer 37

- Cash - Paid up cash value insurance - Extended or paid up term insurance

Question 38

When are reinstatement rights eliminated?

Answer 38

When a policy is surrendered for cash value | paid up insurance or extended term allows for reinstatement with proof of insurability within a certain amount of time

Question 39

What document spells out the insurers liability beyond policy maturity?

Answer 39

Settlement agreement

Question 40

What are the settlement options?

Answer 40

- Interest only - Fixed amount - Fixed period (During policy issue a settlement option and rate is chosen that will be enforced but may perform better and receive a higher amount)

Question 41

What are the right to withdraw types?

Answer 41

- Cumulative (unused maximum can carry over) | - Noncumulative (unused maximum can not carry over)

Question 42

What minimums do insurers place on settlement agreements?

Answer 42

- Minimum amounts to enforce settlement agreements due to high administrative costs - Minimum periodic payments amounts under liquidating options

Question 43

What are the possible treatments for withdrawing policy owners?

Answer 43

- Nothing is paid (inequitable to policy owners of whole life who pay larger premiums that cover costs in earlier years) - Return premiums paid, minus pro rate share of mortality costs for the group for the period of protection, minus premium loading (inequitable for insurance company because first year expenses may not be recovered) - Return surrender benefit, equal to net premiums paid, minus mortality costs for the years the policy is in force and minus expenses the company incurred establishing and maintaining the policy

Question 44

Why is the surrender benefit less than the policy asset share for withdrawing policy owners?

Answer 44

- Adverse mortality selection (unhealthy insured will likely keep their policy increasing the mortality and costs) - Adverse financial selection-(high rate interest periods increase withdrawals and may cause insurers to borrow to pay surrender values) - Contributions to a contingency reserve (for security provided over the years) - Contribution to corporate profits (for the risks taken by the corporation and dividends paid to shareholders) - Surrender costs (expenses for paperwork to process surrenders)

Question 45

What is the surrender value of a life policy under the adjusted premium method?

Answer 45

-Subtract the present value of future adjusted premiums from the present value of future policy benefits

Question 46

How is the present value of future adjusted premiums calculated?

Answer 46

Adjusted premium, multiplied by the present value of a life annuity due of $1 for the remainder of the premium paying period

Question 47

What is the adjusted premium?

Answer 47

Net level premium, increased by the amount required to liquidated the life insurance policy’s initial acquisition expense over the policy’s premium paying period

Question 48

What is the calculation of the prospective reserve?

Answer 48

The same as the surrender value but the reserve uses the net level premium for the policy instead of the adjusted premium (the adjusted premium is larger by the amount needed to amortize the excess first year expenses over the premium paying period).

Question 49

What is the present value of future policy benefits?

Answer 49

Net single premium for the policy benefits at the date of surrender