Life and Nontraditional Life Insurance Practice Flashcards

Summary Table of Traditional Whole Life Policy Characteristics

Straight Whole Life
- Premium: Level for life.
- Death Benefit: Predetermined and fixed for the life of the policy (until age $100$ ).
- Cash Value: Yes; it is predetermined, tax-deferred, and guaranteed.
- Policy Loans: Yes, against cash value.
- Partial Withdrawals: No; to receive cash, it must be borrowed.
- Surrender Charges: No.
Limited Pay Whole Life
- Premium: Level for the period selected, then premiums cease.
- Death Benefit: Predetermined and fixed for the life of the policy (until age $100$ ).
- Cash Value: Yes; it is predetermined, tax-deferred, and guaranteed.
- Policy Loans: Yes, against cash value.
- Partial Withdrawals: No; to receive cash, it must be borrowed.
- Surrender Charges: No.
Single Premium Whole Life
- Premium: Predetermined single, lump-sum premium paid at issue.
- Death Benefit: Predetermined and fixed for the life of the policy (until age $100$ ).
- Cash Value: Yes; it is predetermined, tax-deferred, and guaranteed.
- Policy Loans: Yes, but the funds are taxed AND it will be taxable.
- Partial Withdrawals: Yes.
- Surrender Charges: No.

Nontraditional Whole Life Insurance

Modified Whole Life Insurance
- Description: A policy characterized by an initial premium lower than straight whole life for an introductory period.
- Premium Structure: A lower, flat initial premium is paid for the first few years (typically $3$ to $10$ years). After this period, the premium increases once to an amount higher than the original straight whole life premium would have been, then remains level for the life of the policy.
- Purpose: To make the initial purchase of permanent insurance more accessible for individuals with limited financial resources who expect an improved financial position in the future.
- Mechanics: Cash values accumulate with every premium payment. Protection remains in force until death or age $100$ .
Graded Premium Whole Life
- Description: Similar to modified life with lower early premiums, but characterized by more than two fixed premium periods.
- Premium Structure: Premiums increase annually or every year during the initial period. Once the premium reaches its final level (exceeding a standard whole life premium), it remains fixed for the remainder of life.
- Key Difference: Premiums are predetermined but not level in the traditional sense during the initial phase.

Interest-Sensitive and Innovative Whole Life Products

Enhanced Whole Life (Economatic or Extraordinary Life)
- Nature: A low-premium, participating, permanent life insurance policy.
- Operation: The contract's face amount is reduced each year. Dividends are used to purchase either paid-up additions or one-year term insurance equal to the reduction in death coverage.
- Guarantee: Provides a guaranteed death benefit in early years even if dividends are insufficient to maintain level coverage.
Indeterminate Premium Whole Life Insurance
- Description: Offers a low initial premium for a specified period, after which the insurer may increase premiums.
- Adjustments: Future adjustments are based on the insurer's investment performance, mortality experience, and expenses.
- Constraint: While the company can raise or lower premiums, they can never exceed the guaranteed maximum.
Current Assumption Whole Life (CAWL) / Interest-Sensitive Whole Life
- Description: Premiums vary to reflect changing assumptions regarding death, investment, and expense factors. Cash values may exceed guaranteed levels.
- Policyowner Options: If assumptions are favorable, owners can choose lower premiums or higher cash values (resulting in higher death benefits later). If unfavorable, owners may pay higher premiums or reduce the face amount to maintain the current premium.
- Characteristics:
- Uses an accumulation account (Premium minus expense/mortality charges, plus interest at current rates).
- Minimum guaranteed cash value and rate of return.
- Maximum annual premium.
- Fixed surrender charge determined at issue and deducted from the accumulation account to find the surrender value.
- Low-Premium Type: Includes indeterminate premiums and a redetermination provision for refiguring premiums after a set period.
- High-Premium Type: Includes an optional pay-up provision allowing premium cessation once policy values are sufficient.
Equity-Indexed Whole Life Insurance
- Nature: Offers traditional security with interest earnings tied to an equity index (e.g., S&P $500$ ), avoiding direct stock market risk.
- Benefits: Guarantees a minimum interest rate, defers taxes, provides policy loans, and is designed to outpace inflation.

Adjustable Life Insurance

Definition: Permanent insurance combining traditional fixed premium whole life with the ability to adjust coverage or the face amount.
Adjustment Provision: Permits prospective (future) adjustments to the policy's coverage amount.
Mechanics:
- The premium is fixed for the current policy year.
- If coverage increases, the consumer pays more and must provide evidence of insurability.
- Premiums cannot be waived by the policyowner.
Target Audience: Individuals with fluctuating income or families expecting major life changes (e.g., having children).
Nature of Policy: At any one point, it is a level-premium, level-death benefit policy, but the "level" can be redefined for future years.

Universal Life Insurance

Overview: Also known as Flexible Premium Adjustable Life. It provides the most flexibility compared to traditional plans.
Interest Sensitivity: Uses changing interest rates to determine cash values (not death benefits or future premiums).
Unbundled Premium: Transparent structure describing where costs are allocated (premiums, death benefits, mortality charges, expenses, and cash values).
Cash Value (Accumulation Account):
- May be called a cash savings plan, policy equity, or savings feature.
- Fixed interest rate paid on savings, with glass minimums typically between $2\%$ and $4\%$ (matching or exceeding the $3.5\%$ to $4.5\%$ on traditional whole life).
- Insurers provide an annual statement identifying interest rates, coverage costs, value, and expenses.
Flexible Premium: The policyowner can pay any amount or nothing if the accumulation account is sufficient. If cash is insufficient to pay for death protection, the policy lapses.
Partial Withdrawals: Unlike traditional whole life, owners can make partial withdrawals directly from cash value without a loan (though surrender charges may apply in the first $10$ to $15$ years).
Death Benefit Options:
- Option A (Option One): Level death benefit. The Net Amount at Risk (NAR) is adjusted monthly. As cash value increases, NAR decreases to keep the total benefit level.
- Option B (Option Two): Increasing death benefit. The benefit equals the face amount plus the current cash value.

Universal Life Riders and Taxation

Corridor and IRS Guidelines: For tax-advantaged status, there must be "space" (a corridor) between the death benefit and cash value. If it fails this, it becomes a Modified Endowment Contract (MEC). Option A policies automatically increase the death benefit if the cash value approaches the face amount to maintain this corridor.
Waiver of Monthly Deduction Rider: Waives the "cost of insurance" (mortality, interest, and expenses) if the owner is permanently disabled, but does not waive the portion allocated to cash value.
No-Lapse Guarantee Rider: Prevents lapse by imposing a minimum regular premium schedule. The guarantee period usually ranges from $5$ to $40$ years depending on issue age.

Specialized Universal Life Types

Indexed Universal Life: Non-variable product linking return to a stock index (S&P $500$ ). It offers potential for higher returns with a cap, but protects against market loss (owner loses no cash value if index declines, but earns zero interest).
Guaranteed Universal Life: Focuses on the guaranteed death benefit rather than cash accumulation. Remains in force even if cash value goes to zero, provided minimum premium targets are met. Owners can select coverage periods (e.g., to age $90$ or $120$ ).
Survivorship Guaranteed Universal Life: Also called "second-to-die" insurance. Covers two people and pays only after the second death. More affordable than two individual policies; often used for estate planning/charity.

Variable Insurance Products

Regulation: Regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Producers must hold both a state life insurance license and a securities license.
Variable Life (Variable Whole Life):
- Structure: Fixed premiums and a guaranteed minimum death benefit.
- Investments: Premiums go into a "separate account" where the owner selects pooled investments (stocks, bonds, money market).
- Risk: Policyowner assumes all investment risk; cash value fluctuates and has no guaranteed minimum.
Variable Universal Life (VUL):
- Death Benefit: Similar to Universal Life (not guaranteed if cash value is insufficient).
- Cash Value: Structure of Variable Life (performance-dependent with no guaranteed rate).
- Features: Flexible premiums, flexible expenses, and investment options in separate accounts.

Comparative Summary Table: Nontraditional Products

Adjustable Life
- Death Benefit: Level, but changeable by request.
- Premium: Level, but level may change when policy change is requested.
- Cash Value: Predetermined and tax-deferred.
- Withdrawals: No (must take a loan).
- Surrender Charges: No.
Universal Life
- Death Benefit: Flexible (not guaranteed if underfunded).
- Premium: Flexible after the required first-year target.
- Cash Value: Guaranteed minimum interest (e.g., $4\%$ ); variable based on money markets.
- Withdrawals: Yes.
- Surrender Charges: Yes.
Variable Life
- Death Benefit: Guaranteed minimum plus potential increase from performance.
- Premium: Fixed, level, or predetermined.
- Cash Value: No guaranteed minimum; tax-deferred growth in separate accounts.
- Withdrawals: No (must take a loan).
- Surrender Charges: Yes.
Variable Universal Life
- Death Benefit: No guaranteed minimum.
- Premium: Flexible after first-year target.
- Cash Value: No guaranteed minimum; owner controls investment.
- Withdrawals: Yes.
- Surrender Charges: Yes.

Family and Multi-Life Policies

Family Plan Policies:
- Covers all family members; sold in units.
- Whole life on the breadwinner, level term riders on spouse and children.
- Example: Head of family has $\$20,000$ whole life; spouse/children have $\$10,000$ level term.
- Spouses and children can typically convert to whole life without evidence of insurability; future children are added automatically at no cost.
Family Income Policy:
- Combination of whole life and decreasing term insurance.
- Specifically provides monthly income for a period starting from the date of policy issue (e.g., $10, 15, \text{ or } 20$ years).
- If the insured dies after the specified period, only the whole life face value is paid.
Family Maintenance Policy:
- Combination of whole life and level term insurance.
- Provides income for a stated number of years starting from the date of the insured's death.
- Beneficiary receives the whole life face amount after the income period ends.
Joint Life (First-to-Die): Covers two or more lives; pays benefit upon the first death. Surfaces are lower than combined individual policies because ages are averaged.
Survivorship Life (Second-to-Die): Pays benefit only after the last insured dies. Useful for estate taxes.

Juvenile and Industrial Life Insurance

Juvenile Insurance: Insures a minor (usually under age $15$ or $16$ ). Utilizes third-party ownership (adult applicant is owner/payor).
Jumping Juvenile (Junior Estate Builder):
- Face amount "jumps" (typically $5\times$ the initial amount) when the child reaches the age of majority ( $21$ ).
- Increase requires no evidence of insurability and no premium increase.
- Scenario: Buying $\$20,000$ coverage for $\$25/\text{month}$ at age $5$ . At age $21$ , coverage becomes $\$100,000$ while premium remains $\$25/\text{month}$ .
Industrial (Home Service) Life: Small amounts (e.g., $\$1,000$ ) marketed as burial insurance. Premiums are collected weekly/monthly at the policyowner's home by agents assigned to geographic locations called "debits."

Endowments and Modified Endowment Contracts (MEC)

Endowment Policy: Resembles whole life but matures sooner (e.g., $20$ years instead of age $100$ ).
- Standard: Pays at death or maturity.
- Semi-Endowment: Pays $100\%$ at death, $50\%$ at survival.
- Pure Endowment: Pays only if the insured survives.
- Taxation Note: Under the Tax Reform Act of $1984$ , policies maturing before age $95$ no longer receive favorable life insurance tax treatment.
Modified Endowment Contract (MEC): Defined by the Technical and Miscellaneous Revenue Act (TAMRA) of $1988$ .
- Seven-Pay Test: A policy is an MEC if premiums paid in the first $7$ years exceed the amount needed to pay up the policy in $7$ years. All single-premium policies are MECs.
- Taxation of Distributions: LIFO (Last-In, First-Out). Gains/earnings are taxed first.
- Penalties: A $10\%$ penalty tax applies to withdrawals/loans made before age $59\,1/2$ .
- Duration: Once an MEC, it remains an MEC forever unless there is a material change, which restarts the seven-pay test.