Universal Life Insurance

Chapter Quizzes

Identify the UL policy's death benefit option that might be appropriate to cover an end-of-life risk that is expected to increase over time.
a) A death benefit plus cumulative premiums

b) A death benefit plus account value

c) A level death benefit

d) An indexed death benefit

d) An indexed death benefit

Rationale: An indexed death benefit might be appropriate to cover an end-of-life risk that is expected to increase over time, such as the tax liability on assets that appreciate in value.

Ref: 4.4.4

Merlin approaches an insurance agent to purchase a life insurance policy for herself. After careful discussion, she decides to purchase a universal life insurance. Identify an advantage of universal life insurance that Merlin is likely to benefit from.

a) Product is simple and easy for the policyholder to understand.

b) Policy performance is not affected by investment performance.

c) Policyholders have a choice of investment products.

d) Investment performance is constant and need not be monitored.

c) Policyholders have a choice of investment products.

Rationale: One of the advantages of universal life insurance is that the policyholder has a choice of investment products. However, the product is complex and may be difficult for the policyholder to understand. The policyholder needs to actively monitor the performance of the investment account, and make adjustments to policy investments as needs change. Policy performance is sensitive to changes in investment performance.

Ref: 4.7

Which of the following statements accurately explains the impact of investment returns on universal life policy viability?
a) If investment returns are negative, then there are chances that the policy would lapse.

b) If the policyholder chooses to base his interest income on index funds, then the investment returns are likely to be positive.

c) If mortality deductions increase, the investment account will grow rapidly in value.

d) If investment returns are higher than expected, then the mortality deductions will erode the account value more quickly.

a) If investment returns are negative, then there are chances that the policy would lapse.

Rationale: While universal life policies unbundle premiums, COI, expenses and investment, this does not mean that these factors operate in isolation. In fact, they are interrelated and must be kept in balance for the long-term viability of the policy. If investment returns are negative, which is a possibility if the policyholder chooses to base his interest income on index funds or mutual funds, then there is a very real possibility of the policy lapsing, unless the policyholder deposits additional premiums.

Ref: 4.5.4

What happens if the universal life policyholder wants access to the capital within the policy but does not want the taxable disposition that would result from a withdrawal?

a) The policyholder can obtain a loan from the insurance company against the cash surrender value of the policy.

b) The policyholder can partially surrender the policy without affecting its long-term viability.

c) The policyholder can surrender the policy, without paying any charges, if the policy has cash value.

d) The policyholder can use the cash surrender value of the policy as collateral for a loan from a third party.

d) The policyholder can use the cash surrender value of the policy as collateral for a loan from a third party.

Rationale: If the universal life policyholder wants access to the capital within his policy but does not want the taxable disposition that would result from either a withdrawal or a policy loan, he may be able to use the cash surrender value of the policy as collateral for a loan from a third party.

Ref: 4.6.5

Sandra is a successful real estate agent. She needs life insurance coverage to ensure financial stability for her family when she dies. On average, her annual earnings allow her to live comfortably, but her income is quite variable and unpredictable on a monthly basis. What is the main reason why a universal life insurance policy would be a good choice for Sandra?
a) Sandra can increase, decrease or even suspend premiums, as long as the policy’s account value can support the mortality and expense deductions.

b) Sandra can choose from a wide variety of investment products for tax-sheltered investing, within limits.

c) Sandra can increase the face amount of the policy as long as she provides evidence of insurability.

d) Sandra can choose between a yearly renewable term (YRT) or a level cost of insurance.

a) Sandra can increase, decrease or even suspend premiums, as long as the policy’s account value can support the mortality and expense deductions.

Rationale: Because Sandra’s income is variable and unpredictable, having fixed premiums, as would be the case with a term or whole life insurance policy, could pose a problem and cause stress. The flexibility of increasing, decreasing or even suspending premiums on a universal life (UL) policy gives Sandra the flexibility she needs considering her variable and unpredictable income. Since she is successful and lives comfortably, this suggests she can afford to pay for the policy, but the timing and amounts she can pay may vary over time. The flexibility of premium payments for a UL policy addresses this issue. It is this feature, which is unique to a UL policy, that makes it a good choice for Sandra.
 
While it is true that with a UL policy Sandra will be able to choose from a wide variety of investment products, increase the face amount of the policy, and choose the type of cost of insurance, there is nothing in this scenario to suggest any of these options would be the most appealing feature to her. 

Ref: 4.2

Suzanne has a UL policy, where her cash value is invested in guaranteed investment accounts (GIAs). As Suzanne’s GIAs mature, they are reinvested into GIAs at the current rate. What benchmark is used to set the current rate?

a) Government of Canada bond

b) Government of Canada T-bill

c) Bank rate

d) Prime rate

a) Government of Canada bond

Rationale: Guaranteed investment accounts (GIAs) offer a fixed interest rate for 1-, 3-, 5-, 10-, or even 20-year terms, and they operate similarly to guaranteed investment certificates (GIC). As a GIA matures, the proceeds are rolled over into the policy’s active investment account, unless the policyholder requests that they roll over to a new GIA of the same term. GIAs typically guarantee a minimum interest rate that is based on a specified benchmark. A benchmark is set by a product, performance or service that is a leader in its industry. For instance, the yield of Government of Canada bonds sets a benchmark.

Ref: 4.5.3.2

Russel was discussing life insurance with his friends and heard about the tax benefits associated with a UL policy. He contacts his insurance agent to learn more about this product. 
Which of the following statements about the tax advantages of a UL policy is true?

a) The investment income earned in the UL investment account is not taxed as long as it remains in the policy, and if the account value is paid as part of the death benefit, it will not be taxed.

b) The investment income earned in the UL investment account is not taxed and withdrawals from the policy are tax-free.

c) The investment income earned in the UL investment account is not taxed and premiums paid in the policy are tax-deductible, just like RRSP contributions.

d) The investment income earned in the UL investment account and side account, which is used for excess that may accumulate in the investment account, is not taxable.

a) The investment income earned in the UL investment account is not taxed as long as it remains in the policy, and if the account value is paid as part of the death benefit, it will not be taxed.

Rationale: A UL policy offers a tax-sheltered environment for investments, but there are limits. The investment income earned within a UL investment account is tax-sheltered and if the account value is paid as part of the death benefit, it will not be taxed. However, if the policyholder makes a partial or full withdrawal from the investment account (partial or full surrender of the policy), it could trigger income tax if the withdrawal results in a policy gain. Withdrawals from a UL are not automatically tax-free.
UL premiums are not tax-deductible like RRSP contributions, even though both vehicles offer a tax shelter for investment income.

In order to keep the UL policy “tax exempt”, the investment account value cannot exceed a certain limit, which is determined during an annual exemption test. If there is an excess, it will be transferred to a side account. This side account, or side fund, is non-exempt and the investment income earned within it is taxable annually.
 
Ref: 4.7, 4.5

Agatha decides to purchase a universal life insurance policy for herself. She opts for the level cost of insurance costing option. How is she likely to benefit from it?

a) The mortality cost deductions are lesser during the early years.

b) The short-term policy fund values are high initially.

c) She can switch to yearly renewable term costing option anytime.

d) She will be locked into a level rate for life.

d) She will be locked into a level rate for life.

Rationale: Agents should consider the client’s goals when helping them choose between yearly renewable term (YRT) and level cost of insurance (LCOI) costing. If a client is looking for greater short-term policy fund values, she would likely be better off choosing the YRT costing option, at least initially. If a client is looking for longer-term policy values, she would likely be better off choosing the LCOI costing option, because it locks her into a level rate for life.

 

Ref: 4.3.4

Harrison’s UL policy has an annual mortality cost of $3,000 and administrative expenses of $150. He pays an annual premium of $5,000 into his policy. In Harrison’s province, the premium tax is 3%.

How much tax will the insurance company send to the province for Harrison’s UL policy?

a) $150

b) $94.50

c) $90

d) $60.50

a) $150

Rationale: In Harrison’s case, the premium tax is 3% and it is charged on the entire premium, not just the portion that covers the mortality cost and not just on the difference between the entire premium paid and the mortality cost. Hence, the insurance company will pay $150 (3% x $5,000) to the province. The remainder of the premium goes into the policy’s investment account(s).

Whenever the policyholder pays a premium into a UL policy, the insurance company passes a percentage of that premium on to the provincial or territorial government, in the form of a premium tax. 

Ref: 4.1.1

Bernard wants to leave a charitable donation of $100,000 to his favourite charity. After discussing with his agent, he decided to purchase a UL policy to cover this donation since the total cost in premiums will be less than donating this amount in cash. Bernard is mindful of costs. He does not want to pay more than he has to for this policy.
Which death benefit option would be best suited for Bernard?

a) Level death benefit

b) Level death benefit plus account value

c) Level death benefit plus cumulative premiums

d) Indexed death benefit

a) Level death benefit

Rationale: There are two factors to consider in this scenario. 
1. Bernard’s insurance need is fixed. He wants to give a donation of $100,000.
2. Bernard is mindful of cost. 
For Bernard, the best death benefit option is the level death benefit because it is the least expensive of the death benefit options, and Bernard does not have an increasing insurance need. Therefore, the UL policy with the level death benefit will fulfill his charitable donation wish at the lowest cost.

Ref: 4.4

Claudia has a UL policy in which she has accumulated a cash value of $6,000. She paid monthly premiums of $750 and the policy’s minimum monthly premium is $400. Claudia just lost her job. She will stop making premium payments until she finds a new job.

Excluding the investment return and 30-day grace period, for how long can Claudia go without paying premiums and have her policy remain in force?

a) 8 months

b) 12 months

c) 15 months

d) 17 months

c) 15 months

Rationale: To keep the policy in force, the minimum premium must be covered by the policy’s investment account. With $6,000 in the investment account, the policy can last for 15 months, calculated as follows: $6,000 ÷ $400 = 15 months.

STUDY REFERENCE:
4.2.1.1 Insufficient account value 

Which of the following allows the policyholder to stop paying the premiums while maintaining the universal life policy in force?

a) Partial surrender

b) Term insurance riders

c) Net premiums

d) Premium offsets

d) Premium offsets

Rationale: Participating whole life policies provide the policyholder with the choice of using policy dividends to offset their premiums. Because of the way the investment account of a universal life policy works, premiums are naturally offset by investment income and the policyholder’s deposits to the investment account. Depending on the premiums deposited into the policy and the investment returns earned within the policy, the investment account can grow to such a size that it can be used to fund future mortality and expense deductions indefinitely. In other words, the policyholder can stop paying the premiums while maintaining his policy in force.

Ref: 4.6.3

Four years ago, Rebecca bought a UL policy with LCOI costing and level death benefit plus the account value option. The annual mortality cost of the policy was $750, but Rebecca paid an annual premium of $1,500. Today, she wishes to surrender her policy. Her current investment account value is $3,500 and the surrender charge percentage is 400% of the mortality cost.

How much will Rebecca receive after surrendering her policy?

a) $500

b) $3,000

c) $3,500 

d) $0

a) $500

Rationale: The cash surrender value (CSV) that Rebecca will receive upon surrendering her policy is the greater of $0 or cash value minus the surrender charge.

The surrender charge multiple or percentage is applied on the mortality cost, not on the total premium paid.

In this situation, the surrender charge is 400% × $750 = $3,000.

Therefore, the CSV is $3,500 – $3,000 = $500.

Ref: 4.6.1

Merlin approaches an insurance agent to purchase a life insurance policy for herself. After careful discussion, she decides to purchase a universal life insurance. Identify an advantage of universal life insurance that Merlin is likely to benefit from.

a) Product is simple and easy for the policyholder to understand.

b) Policy performance is not affected by investment performance.

c) Policyholders have a choice of investment products.

d) Investment performance is constant and need not be monitored.

c) Policyholders have a choice of investment products.

Rationale: One of the advantages of universal life insurance is that the policyholder has a choice of investment products. However, the product is complex and may be difficult for the policyholder to understand. The policyholder needs to actively monitor the performance of the investment account, and make adjustments to policy investments as needs change. Policy performance is sensitive to changes in investment performance.

Ref: 4.7

Sophia’s daughter is gravely ill. Sophia must take an extended unpaid leave of absence from work to take care of her child and must also pay travel costs so that her daughter can receive the necessary specialized care she needs. To help fund these unforeseen extra expenses and income loss, Sophia is looking to make a partial withdrawal from her UL policy’s investment account and forgo paying the planned annual premium of $7,000 for the next year. She expects to be able to resume paying the planned premiums after one year. The details of her UL policy are:
- Face amount of $400,000
- Annual COI of $4,500
- Annual expense deductions of $200
- Current value of the investment account is $30,000
What is the maximum amount Sophia can withdraw from the UL policy’s investment account without causing the policy to lapse and without reducing the policy’s face amount?

a) $25,300

b) $23,000

c) $25,500

d) $29,800

a) $25,300

Rationale: In order for the policy to remain in force without reducing its face amount, there must be a sufficient amount in the investment account to cover the COI and expense deduction for one year. Sophia plans on resuming payment of the planned annual premium after that time. To cover one year of COI and expense deductions, Sophia must leave a total of $4,700 ($4,500 + $200).

The maximum withdrawal that can be made without causing the policy to lapse is: Current value of investment account – COI – expense deduction

Therefore, the maximum amount Sophia can withdraw without causing her policy to lapse is:
$30,000 - $4,500 - $200 = $25,300
 
Ref: 4.6.2

Corey is the owner of a software development company. Corey used to manage the operations of the company but years ago, hired Melissa as director of operations to free up his time and concentrate on business development in order to generate revenue. The company bought a UL policy on Melissa’s life so that, in the event of her death, the death benefit could replace the loss of revenue that would occur during the period that Corey handles the operations until someone new is hired.

Melissa left the company a few weeks ago but, fortunately, a new director of operations, Aaron, was hired. Corey wants Aaron to be insured under a UL policy (key person insurance) but does not want to create a taxable disposition with the UL on Melissa’s life.

What option should Corey consider?

a) Cancel the policy on Melissa’s life and buy a new one on Aaron’s life.

b) Add Aaron to the existing UL policy.

c) Substitute the life insured, changing Melissa to Aaron as the life insured.

d) Take a policy loan and use the money to buy a new UL on Aaron’s life.

c) Substitute the life insured, changing Melissa to Aaron as the life insured.

Rationale: The UL policy may permit a substitution of the life insured, as long as proof of insurability of the new life insurance is given to the insurance company. That way, there will not be a taxable disposition, and the company will pay insurance costs based on the key employee they want to insure.

If the policy is cancelled or if a policy loan is taken, it is considered a disposition and could generate a taxable policy gain. Adding Aaron to the existing policy means that both Melissa and Aaron will be insured. The company does not need to continue to insure Melissa.

STUDY REFERENCE:
4.2.3 Life/lives insured

Pamela pays a monthly premium of $1,000 for her Universal Life policy. On the policy statement, it mentions an annual premium of $12,000.

What is the modal factor for Pamela’s policy?

a) 0.09

b) 0.083

c) 0.12

d) 12

b) 0.083

Rationale: Modal factor for the majority of universal life policies for monthly payments is calculated as follows:

Modal Factor = 1 ÷ 12

0.0833 = 1 ÷ 12

STUDY REFERENCE:
4.2.1.2 Modal Factors for UL policies

Omar has had a UL policy over the last 20 years. During that time, he has accumulated a cash value of $100,000 invested in a balanced index fund. Omar is considering purchasing a rental property with two friends. If he decides to go ahead with this purchase, he wants to withdraw the cash value of his policy. Omar will decide whether he will go ahead with the real estate purchase within the next 6 months. He wants to ensure that he will have access to the full $100,000 if he decides to go forward with the purchase. 
 
What should his agent recommend?

a) Move the amount invested to a daily interest account (DIA).

b) Move the amount invested to a guaranteed investment account (GIA).

c) Move the amount invested to a balanced mutual fund.

d) Move the amount invested to a bond index fund.

a) Move the amount invested to a daily interest account (DIA).

Rationale: Because Omar does not want his cash value to decrease before he decides whether to purchase the rental property, it is necessary to remove the possibility of negative performance. With index funds and mutual funds, the possibility of a decline in value is there, even if it is a bond fund or balanced fund.
 
While the GIA offers an absolute minimum return of 0%, a market value adjustment or penalty may apply if the policyholder redeems the GIA prior to maturity. Typically, the minimum duration of a GIA is one-year, yet Omar will possibly need the money within 6 months. This could trigger the market value adjustment or penalty, reducing the cash value below $100,000.
 
Because his time horizon is less than one year, and he wants to eliminate any chance that the amount he withdraws is less than the $100,000 he accumulated, his agent should recommend moving the money to a daily interest account (DIA). The absolute minimum return is set at 0%, so the principal is guaranteed and there is no market value adjustment or penalty, regardless of when Omar withdraws the money.
 
Ref: 4.5.3

In which of the following situations would a UL insurance policy be most appropriate?

a) Eva is an executive at an investment management firm and an avid saver. She has maximized her RRSP and TFSA and is looking for investment options for additional savings. In the past, she used the extra money at hand to repay her debts. She also wants to have enough life insurance coverage to pay the income tax that will be triggered when she dies.

b) Aaron just graduated from medical school. While he is excited to start his career, he is worried about the large amount of debts he has incurred over the year. He does not have any savings and would like to have sufficient life insurance in place to repay his debts if he dies unexpectedly.

c) Carolyn has worked her entire career as a federal government public servant. Her debts are now paid off and she has extra disposable income available to invest. She is a participant in her employer’s defined benefit pension plan, leaving her with little RRSP room. She has little investment knowledge and little interest in being involved in managing investments. She says she likes to “keep things simple” and is uncomfortable with any product that appears somewhat complex.

d) Harrison is a successful entrepreneur who just finished repaying his debts. He now wants to aggressively invest to build his retirement nest egg. He also wants to increase his life insurance coverage to replace his income, which has increased significantly over the last few years, if he dies before retirement. He has $150,000 of RRSP room and $60,000 of TFSA room.

a) Eva is an executive at an investment management firm and an avid saver. She has maximized her RRSP and TFSA and is looking for investment options for additional savings. In the past, she used the extra money at hand to repay her debts. She also wants to have enough life insurance coverage to pay the income tax that will be triggered when she dies.

Rationale: Typically, a UL policy will be most appropriate for people who have some of the following characteristics:

• Investment-savvy policyholder;

• Long-term insurance needs;

• Maxed out RRSP and TFSA, especially if they have a high marginal tax rate;

• Do not have outstanding non-deductible debts.
  

In the situations above, Eva’s has many of these characteristics. She has maxed out her RRSP and TFSA, has repaid all her debts, has extra money to invest, and the life insurance is needed to cover income tax at death, which is a long-term need. It could be assumed that she is investment-savvy because of her job.

Although Aaron will most likely earn a good living as a doctor, his immediate need is to repay his debts and his current life insurance need – repaying his debts if he dies unexpectedly – is temporary. A term life insurance would be a better fit for Aaron, for now, to have the coverage he needs at a more affordable price, leaving him with more disposable income to repay his debts and start saving in his RRSP and TFSA.

For Carolyn, considering that she is not interested in being involved in the management of her investments and that she is uncomfortable with products that are relatively complex, a UL is probably not the best solution for her. Assuming there is a life insurance need, she would most likely prefer the simplicity of a whole life insurance policy with its guaranteed cash values rather than a UL.

Harrison should maximize his RRSP and TFSA before investing in a UL. His life insurance need of replacing his pre-retirement income can be covered by a term insurance.

Ref: 4.9