Life Insurance Practice Exam Preparation Flashcards

Life Insurance Training Overview and Learning Objectives

• The study material is organized into seven primary sections:

  • General Concepts of Life Insurance

  • Temporary Life Insurance Products

  • Permanent Life Insurance Products

  • Alternative Nontraditional Life Insurance Products

  • Securities and Exchange Commission (SEC) Regulated Life Insurance Policies

  • Special Use Life Insurance Products

  • Other Life Insurance Products

• State-Specific Regulation Notice: There is a state-specific portion of the course detailing unique definitions, rules, regulations, and statutes. In the event of a conflict between general content and state law, state law will supersede.

• Learning Objectives:

  • Understand general terminology and concepts used in life insurance contracts.

  • Identify diverse life insurance policies.

  • Identify types, advantages, and disadvantages of term life insurance.

  • Understand whole life insurance concepts, features, and policy variations.

  • Familiarize with nontraditional whole life policies.

  • Understand contract concepts.

  • Distinguish between special-use products (e.g., family plan vs. family income policies).

  • Distinguish between joint life and joint life and survivor policies.

  • Identify nontraditional products and universal life death benefit options.

  • Distinguish between participating and nonparticipating policies.

Core Keywords and Essential Definitions

• Accidental Death Benefit (ADB): A policy providing benefits for accidental death; loss of sight, speech, or hearing; paralysis (loss of use of limbs); or loss of members such as an arm or leg.

• Adjustable Life Insurance: A permanent policy allowing the policyowner to adjust premium amounts and the death benefit. Cash value grows at a guaranteed fixed rate, distinguishing it from Universal Life.

• Attained Age: The current age of the insured as of a specific date. Insurance companies base this on either the nearest birthday or the last birthday. Also called "current age."

• Cash Surrender Value: The cash amount available to the owner if the policy is surrendered before or after maturity.

• Convertible Term Life Insurance: Temporary insurance that the owner can exchange for a permanent whole life policy without providing evidence of insurability.

• Decreasing Term Insurance: Temporary protection where the face amount reduces annually; frequently used for debt or loan protection.

• Endowment Contract: A contract paying a face amount after a fixed period (e.g., $10$, $20$ years, or at age $65$) or upon the insured's death within that period.

• Extended Term Insurance: A nonforfeiture option where the current face amount continues for a specified period after policy surrender.

• Family Income Policy: A combination of whole life and a decreasing term rider providing both a death benefit and monthly income to beneficiaries.

• Joint Life Insurance: Covers two or more people; pays the death benefit and terminates when the first insured person dies.

• Universal Life Insurance: A flexible policy featuring adjustable premiums and death benefits. While the accumulation account has a guaranteed growth rate, insurers often credit a higher rate.

Fundamental Concepts of Life Insurance

• Risk Transfer: Life insurance transfers the risk of death from the policyholder/insured to the insurer.

• Immediate Estate: Because a contract is payable upon death, it instantly creates funds for a beneficiary, creating an immediate estate.

• Policy Diversity: Unlike property and casualty insurance, there are no "standard life insurance policies." Policies are defined by benefit options, coverage length, and funding methods.

• Broad Categories:

  • Permanent (whole life/ordinary) vs. Temporary (term life).

  • Group vs. Individual.

  • Fixed vs. Variable.

  • Industrial, Burial, or Debt insurance.

• Pricing and Age: The risk of death increases statistically with age. Consequently, insurance companies increase policy prices as the insured gets older.

Temporary Life Insurance: Term Life

• Nature of Protection: Term life provides pure or temporary protection. It offers the maximum death benefit for the lowest initial cash outlay.

• Coverage Period: Defined by years (e.g., $1$, $5$, or $20$-year terms) or until a specific age (e.g., term to age $65$ or $70$).

• Expiration: If the insured outlives the specified term, the policy expires with no benefits payable and no cash value returned.

• Scenario Application (Steve): Steve buys a $20$-year, $75,000$ level-term policy for his sister, Amy. Amy receives $75,000$ if Steve dies within the $20$ years. If he lives to year $21$, or if the policy lapses, no benefit is paid.

• Premiums: Premiums are averaged over the term, resulting in fixed/level payments. In early years, the premium exceeds the actual risk cost; in later years, it is lower than the actual risk cost.

Specialized Term Life Insurance Structures

• Decreasing Term Life Insurance:

  • Structure: Death benefit decreases gradually over time while the premium remains level.

  • Example: A $20$-year $50,000$ policy starts at $50,000$, reaches $0$ at the end of $20$ years, with a level premium of $350$ per year.

  • Mortgage Redemption Insurance: A specific decreasing term policy used to pay off a mortgage if the insured dies. Face value decreases as the mortgage balance decreases.

  • Credit Life Insurance: Designed to cover a debtor's loan. The lender is the beneficiary. Usually limited to $10$ years or less. The maximum benefit equals the loan amount. Insurers cannot allow lenders to profit from the death beyond the indebtedness value.

  • Legal Warning: Creditors cannot force a borrower to buy insurance from a specific organization as a condition of a loan; this is considered illegal coercion.

• Increasing Life Insurance:

  • Structure: Death benefit increases at periodic intervals. This is usually a percentage of the original amount or tied to the Consumer Price Index (CPI).

  • Example: A $30$-year-old physician buys a $100,000$ term-to-age-$65$ policy that increases by $100,000$ every $5$ years. At age $60$, the benefit is $700,000$. At age $65$, if alive, the policy terminates.

• Level Term Insurance:

  • Structure: Provides a constant face amount for the entire duration of the policy. Premiums are also level.

  • Exam Tip: Unless specified otherwise, assume "term policy" refers to level term.

  • Example Q: $30$-year-old woman buys $10$-year level term ($250,000$). Coverage ends at age $40$.

  • Example R: $30$-year-old man buys "Term to Age $65$" ($250,000$). Coverage ends at age $65$.

Flexibility Options: Renewable and Convertible Term

• Renewable Term Life Insurance:

  • Option: Allows renewal before expiration without evidence of insurability. This must be in the original contract.

  • Step-up Premium: Renewal premiums are based on attained age and are always higher than the previous period's premiums.

  • Annual Renewable Term (ART/YRT): The most basic form of life insurance; provides coverage for one year and renews automatically with increasing premiums.

  • Re-entry Term: Offers two renewal options: renew automatically at a standard rate or undergo a medical exam to qualify for lower/discounted rates.

• Convertible Term Life Insurance:

  • Option: Allows exchange of term for permanent (whole life) protection without evidence of insurability. The contract may set age or time limits (e.g., before age $55$).

  • Attained Age Method: New premium is based on the age at the time of conversion. This is the most common method and results in higher premiums.

  • Original Age Method: New premium is based on the age when the original term policy was purchased. This requires an upfront payment of the difference in premiums between the term and whole life cost for the years already passed. It may generate more cash value over time.

  • Interim Term Insurance: A form of convertible insurance where the policy automatically converts to permanent coverage within the first year.

Permanent Life Insurance: Whole Life Fundamentals

• Core Concept: Designed for lifelong protection. Also known as straight life, continuous premium life, permanent life, or ordinary life.

• Primary Features:

  • Fixed, level death benefit.

  • Level premium payments.

  • Cash value accumulation (equity build-up) at a guaranteed interest rate.

• Maturity and Endowment: Traditional whole life is designed to "mature" or "endow" at age $100$. At this point, the cash value equals the face amount, and the insurer pays the face amount to the owner. Newer policies may endow at ages $105$ or $110$.

• The Level Premium Approach: Premiums are calculated based on the span between issue age and age $100$. The shorter the payment period, the higher the premium.

• Bundled Premiums: The insurer is not required to disclose the specific distribution of premium dollars toward mortality, expenses, or commissions.

• Cost Basis: Typically expressed as a rate per $1,000$ of coverage (e.g., $9$ per $1,000$ leads to a $900$ annual premium for a $100,000$ policy).

Cash Value and Living Benefits

• Savings Element: Unlike term insurance, whole life builds cash value. In most policies, accumulation begins after the first $2$ to $3$ years.

• Living Benefit: The cash value belongs to the policyowner, not the beneficiary. It is also called cash surrender value or nonforfeiture value.

• Policy Loans: Owners can borrow against the cash value while the policy remains in force. Interest is charged on these loans.

• Funding Mechanics: In early years, more premium goes toward death protection. As cash value grows, it offsets the death benefit, requiring less of the premium for mortality costs and allowing more to flow into the cash value.

Basic Forms of Whole Life Insurance

• Straight Whole Life: Continuous premiums until death or age $100$. This is the standard definition of whole life.

• Limited Pay Whole Life:

  • Structure: Premiums are paid for a limited period (e.g., $10$-pay, $20$-pay, or Life Paid-up at $65$).

  • Characteristics: Premiums are higher than straight life. Cash value builds more quickly. Protection remains in force until death or age $100$. Use this for clients who want permanent coverage but do not want to pay premiums indefinitely.

• Single Premium Whole Life:

  • Structure: A single lump-sum payment at issue fully pays the policy.

  • Characteristics: Creates immediate cash value. Over the entire life of the contract, it is the least expensive option, though it has the highest upfront cost.

  • Tax Status (MEC): The IRS classifies this as a Modified Endowment Contract. Death benefits are tax-free, but living benefits/loans are treated as taxable distributions (similar to retirement assets).

Summary of Policy Characteristics

• Level Term: Level death benefit; fixed premium (no cash value, no loans, no withdrawals).

• Renewable Term: Level death benefit; premium increases each renewal (no cash value, no loans, no withdrawals).

• Convertible Term: Level death benefit; premium fixed until converted, then increases (no cash value/loans until converted).

• Straight Whole Life: Level death benefit; predetermined fixed premium; guaranteed cash value; policy loans available (no partial withdrawals).

• Limited Pay Whole Life: Level death benefit; fixed premium for a set period; guaranteed cash value; policy loans available (no partial withdrawals).

• Single Premium Whole Life: Level death benefit; lump-sum premium; immediate guaranteed cash value; policy loans available but taxed; partial withdrawals not permitted (must borrow to receive cash).