04 - Risk Management and Insurance Planning Flashcards
(102 cards)
1
Q
What is the difference between Moral and Morale hazards?
A
Moral = Dishonest Morale = Carelessness (more "e's" in the definition)
2
Q
What is the difference between “pure risk” and “speculative risk”?
A
Pure risk represents a situation in which only one of two outcomes can occur: loss or no loss.
Speculative risk involves situations in which both gains and losses are present
3
Q
Insurance is used to protect against a pure risk or speculative risk?
A
Insurance is used to protect against pure risk. Insurance is designed to indemnify an insured up to the amount of their economic loss.
4
Q
In terms of insurance, what is “peril”?
A
Peril - A cause of a loss; typical perils include death, flooding, fire, disability, and so on
5
Q
In terms of insurance, what is “physical hazard”?
A
Physical hazard - Something that increases the likelihood of a loss should a peril occur; for example, failing to maintain the brakes on a car
6
Q
In terms of insurance, what is “moral hazard”?
A
Moral hazard - Is present when the use of insurance increases the likelihood that the insured will be dishonest when reporting a loss
7
Q
In terms of insurance, what is “morale hazard”?
A
Morale hazard - Occurs when the presence of insurance causes the insured to become complacent or indifferent to a loss; for example, someone who knows that she is fully insured against theft may not take as many precautions to secure her property
8
Q
Terrell lives in a two-bedroom cottage on the Gulf Coast in Texas. He is reviewing his homeowner’s insurance policy. Terrell wants to make sure that he is covered for losses brought about by a hurricane. When he reviews his policy, he notices that the insurance company uses multiple definitions to refer to different elements of the policy. Under what section of the policy can Terrell find information about hurricane coverage?
A
Terrell can learn about coverage related to hurricane damage under the policy section titled “Perils.” Keep in mind that Terrell’s choice to live on the Gulf Coast is a physical hazard. He can expect to pay higher premiums because the severity of losses associated with hurricane damage tends to increase losses.
9
Q
What are four methods of dealing with pure risks?
A
- Avoiding the risk
- Retaining the risk
- Reducing the risk
- Transferring the risk
10
Q
What concepts help a financial planner determine which risk management strategy is appropriate?
A
The concepts of frequency and severity help financial planners determine which risk management strategy is appropriate
11
Q
In general, when you have a low severity, low frequency risk, what strategy should employed to manage the risk?
A
If the risk is low frequency, low severity, the party should retain the risk
12
Q
In general, when you have a low frequency, high severity risk, what strategy should be employed to manage the risk?
A
If the risk is low frequency, high severity, the party should transfer the risk (e.g. through the purchase of insurance or contract).
13
Q
In general, when you have a high frequency, low severity risk, what strategy should be employed to manage the risk?
A
If the risk is high frequency, low severity, the party should reduce the risk
14
Q
In general, when you have a high frequency, high severity risk, what strategy should be employed to manage the risk?
A
If the risk is high frequency, high severity, the party should avoid the risk
15
Q
What are the four characteristics of an insurable risk (characteristics an insurance company will provide insurance)?
A
An insurable loss is a CHAD:
- Losses cannot be Catastrophic for the insurance company
- The potential pool of insureds must be large and a Homogenous group
- Losses must be Accidental
- Losses must be Determinable and measurable
16
Q
Mabel and Frank were married for 12 years before their divorce last year. When they were first married, Mabel purchased a life insurance policy naming Frank as the insured. She named herself as the policy beneficiary. As a couple, they also owned a homeowner’s insurance policy on their home. The home was titled joint tenants with right of survivorship (JTWROS). Although Frank gave up his interest in the home when they divorced, they did not change these policies.
Unfortunately, a series of negative events has since transpired. Six weeks ago, Frank died. The insurance company paid Mabel the face value of the life insurance policy. Frank’s new wife protested the payment by claiming that Mabel did not have an insurable interest in Frank at the time of death and, as such, Mabel was not eligible to receive payment. Around the same time, Mabel’s home (the one she owned jointly with Frank) burned down. Frank’s new wife filed a claim for Frank’s share of the insurance proceeds. In which situation will the insurance company side with Frank’s new wife?
A
Unfortunately for Frank’s new wife, the insurance company will rule against her on both issues. First, an insurable interest in a life insurance contract only needs to exist at the time the policy is issued. Second, at the time of the house fire, neither Frank nor his new wife had an insurable interest in the property. For these reasons, Mabel was entitled to receive the life insurance policy payment and reimbursement for the home fire.
17
Q
What are the six elements that must be in place in order for an insurance contract to be valid?
A
COAL CIL:
- Consideration must be given by one party in the contract to the other. A premium payment is considered an insured’s consideration. The promise to pay in the event of a loss is the insurance company’s consideration.
- There must be an offer. Although it may seem illogical, the offer is made by the person seeking insurance coverage
- There must be an acceptance of the coverage
- The contract must have a lawful purpose
- The parties must be competent
- The person or entity that will receive the proceeds from an insurance policy must have an insurable interest. Insurable interest is a financial or emotional interest.
- The contract must be written in a legal manner that matches state contract law
18
Q
What is an aleatory contract?
A
An aleatory contract is one in which the dollars exchanged between parties is not equal. The owner of a policy typically pays a small premium in relation to the potential amount that could be received with a claim.
19
Q
Dasani works as an insurance agent for a national property and casualty insurance firm. She has been working with a recent college graduate to establish a new automobile and renter’s policy. To whom does Dasani owe a fiduciary responsibility, the insurance company or the client? Would her obligation change if Dasani were an insurance broker?
A
As an agent, Dasani owes her fiduciary responsibility to the insurance firm. Had Dasani been an insurance broker, her duty of care would have changed to that of the policy applicant.
20
Q
Whom does an insurance agent represent? The insurance company or an insurance applicant?
A
An insurance agent represents the insurance company, not the insurance applicant or insured
21
Q
What are the three ways an agent can represent and bind an insurance company?
A
- Express authority - An authority that is specifically granted by the insurer in the agency contract or agreement. Express authority can be either written or oral.
- Implied authority - This is the authority consumers may reasonably believe the agent possesses
- Apparent authority - This authority occurs when an agent oversteps his or her actual authority and the insurer takes no action to counter the impression that such authority exists.
22
Q
Laverne is a single 32-year-old female. Laverne has no dependent children. She is slightly overweight and a smoker. When evaluating her risk exposures, should her financial planner conclude that Laverne’s primary need is life or disability insurance?
A
Several factors come into play when evaluating Laverne’s situation. First, as a young female, her life expectancy is longer than that of a male of a similar age. This means she will need replacement income for a longer period of time, making a compelling case for disability insurance coverage. Second, she is single. Third, she is a smoker, and fourth, she is slightly overweight. The last two personal factors increase Laverne’s chances of needing disability coverage sometime in her lifetime. Given her situation (she has no dependents) and her health factors, the financial planner should recommend disability coverage as a top priority.
23
Q
The number of deaths among a group of people is also known as?
A
The number of deaths among a group of people is known as the “Mortality rate”
24
Q
What is the “Morbidity rate”?
A
The Morbidity rate is the ratio of the occurrence of sickness to the number of healthy persons among a group of people over a given period of time
25
What are some factors to look for that increase the need for disability insurance coverage?
1. Excess body weight
2. Tobacco use
3. Participation in high-risk activities
4. Chronic conditions, including diabetes, high blood pressure, back pain, depression, excessive alcohol consumption, or substance abuse
26
What are the four conditions for negligence to exist?
1. Have a duty to act
2. Engage in a breach of their duty to act
3. Cause injury or damage due to their breach of duty to act
4. The injury/damage must be a direct result of the negligence
If any of these elements are absent, the courts will rule that negligence does not exist and the client will not be liable
27
What is the difference between "strict" and "absolute" liability?
"Strict" liability refers to the accountability of a firm when a product or service is used by consumers. "Absolute" liability arises from a client's dangerous activities
28
What is an "attractive nuisance"?
An attractive nuisance is something owned by a client that may attract children to the person's property and requires the client to use special care to protect trespassers. Some insurance policies will limit the amount of liability coverage for these types of property
29
Mackenzie is a CFP professional. She is in the process of reviewing a client's current homeowner's policy. Under what section of the policy can she find information about the client's responsibilities in case of a claim?
Property and casualty insurance policies share at least five common elements:
```
A declarations section
A definition section
An insurance agreement section
A conditions section
An exclusions section
```
Mackenzie can find information about her client's responsibilities in the conditions section of the policy. Generally, the client must maintain the property prior to a loss. When a loss does occur, the client must take steps to notify the insurance company, protect the damaged property, and provide access for evaluation and repair.
The declarations section provides details about the type and amount of insurance as well as who is insured. The definitions section provides the insurance company's definition of terms such as insured, disability, deductible, and so on. The insurance agreement section describes whether the policy is an all-risk or a named-perils agreement. The exclusion section outlines what is specifically excluded in the policy. Typical exclusions include losses due to flooding and earthquakes.
30
As it relates to insurance, what is an "exclusion"?
An exclusion is a contractual provision in an insurance policy that denies coverage for certain perils, persons, property, or property locations.
31
What are the two factors insurance companies use to price insurance during the actuarial and underwriting process?
Insurance companies use two concepts to price insurance during the actuarial and underwriting processes: estimated maximum possible loss (EMPL) and estimated probable loss (EPL).
32
An indemnity plan is sometimes also called what? What type of healthcare coverage does it provide?
A fee-for-service plan is sometimes called an indemnity plan. This type of health coverage will either pay the medical provider directly or reimburse the client after costs have been filed with an insurance claim for each covered medical expense. With a fee-for-service plan, a client may visit the doctor or hospital of their choice. Typically, this flexibility increases the yearly premium paid for coverage.
33
What is the difference between copayment and coinsurance?
One way to remember the difference between a copayment and coinsurance is to think of a copayment as a fixed expense (fixed dollar amount) and coinsurance as a variable expense (a percentage of a bill). Copayments can be used to meet a plan deductible; coinsurance is paid after a deductible has been met.
34
What is the difference between an HMO and an EPO
A health maintenance organization (HMO) is a health plan that provides care through a network of physicians and hospitals in a particular geographic or service area.. An Exclusive Provider Organization is a health care plan where services are covered only if a client uses doctors, specialists, or hospitals in the plan's network (except in an emergency
35
What is a POS plan?
A point-of-service (POS) plan is one that combines elements of a fee-for-service PPO plan with aspects of a managed care plan
36
What type of plan is an example of a consumer-driven health plan?
A high-deductible health plan (HDHP) is health coverage in which the client pays a deductible of at least $1,300 (individually) or $2,600 (family).
37
What is a health savings accounts?
A health savings account (HSA) generally is available to those who enroll in an HDHP. An HSA allows clients to pay for current health expenses and save for future qualified medical expenses on a pretax basis. Contributions to HSAs are limited to $3,400 for individuals and $6,750 for families in 2017. Those aged 55 or older may increase their contribution by $1,000. Funds deposited into an HSA are not taxed.
38
Lucy is covered by an employer-provided health care plan. She is worried that her coverage will be canceled because over the past two years she has incurred significant medical expenses due to a life-threatening disease. Explain to Lucy how the concepts of guaranteed renewability and noncancellability apply to her situation.
Besides tax and cost benefits, an advantage associated with purchasing health insurance coverage through an employer-provided health plan is that this type of coverage is guaranteed renewable and noncancellable. Guaranteed renewable means that Lucy may renew her coverage without proof of insurability. Noncancellable in this case means that Lucy cannot be singled out based on her health history and denied coverage. Since she is part of a group plan, the insurance company must cover her.
39
What is a HRA?
A health reimbursement arrangement (HRA) is sometimes called a personal care account. These accounts are available to enrollees in HDHPs who are ineligible for HSAs. HRAs are like HSAs except an enrollee cannot make deposits into an HRA, a health plan may impose a ceiling on the value of an HRA, interest is not earned on an HRA, and the amount in an HRA is not transferable if the enrollee leaves the health plan.
40
What is a HCFSA?
A general-purpose health care flexible spending account (HCFSA) is an arrangement a client sets up through an employer to pay for many out-of-pocket medical expenses with tax-free dollars (cafeteria plan). These expenses include insurance copayments and deductibles, and qualified prescription drugs, insulin, and medical devices. In 2017, clients can contribute up to $2,600 from their pay into an HCFSA
41
What is a VEBA?
A voluntary employee's beneficiary association (VEBA) is a mutual association of employees providing certain specified benefits to its members or their designated beneficiaries
42
What are common exclusions from most health insurance policies?
```
Dental care
Eyeglasses
Hearing aids
Elective cosmetic surgery
Workers’ compensation claims
Claims for self-inflicted injury
Long-term care expenses
```
43
What are some items and servies that Medicare does not cover?
1. Long-term care (custodial care)
2. Most dental care
3. Eye examinations related to prescribing glasses
4. Dentures
5. Cosmetic surgery (except in limited cases)
6. Acupuncture
7. Hearing aids and exams for fitting them
8. Routine foot care
44
What are the three parts of Medicare:
1. Part A Hospital Insurance
2. Part B Medical Insurance
3. Part B Prescription Drug Coverage
45
Damion has been promoted to a position of vice president in his firm. With the promotion came a significant increase in income. He is worried that should he become disabled, his family would have a hard time adjusting to his lost income. What definition of “disability” will provide the most advantageous description of disability for Damion to ensure that he will receive benefits in case he is no longer able to work as a vice president?
For some clients, it is considerably more difficult to qualify for benefits when subjected to an any-occupation definition instead of the more lenient own-occupation definition. In Damion's case, he should seek out an own-occupation disability policy. He may be able to negotiate coverage directly with his employer.
46
How long are short-term disability policies and they based on what "occupation definition"?
Short-term disability policies typically have a maximum benefit of two years. Short-term disability income policies usually base benefits on an own-occupation disability definition.
47
How long are long-term disability policies and they are based on what "occupation definition"?
Long-term disability policies have benefits that can last for the remainder of a person's life, although most long-term policies pay benefits until age 65, when the person transitions to Medicare. Long-term disability policies usually base benefits on an own-occupation definition during the first year or two, and then an any-occupation definition if required longer.
48
What are the three primary definitions of disability?
1. Own-occupation
2. Any occupation
3. Split definition
49
What is the definition of Own-Occupation disability coverage
Own-occupation disability coverage provides benefits when an insured is unable to perform the regular and customary duties of their own occupation because of a covered illness or injury. When available, the premium can be as much as 3% to 5% of a client's annual income.
50
What is the definition of Any Occupation disability coverage
Under an any-occupation disability coverage, insured persons generally are considered eligible for benefits only if they are disabled to the extent that they are unable to perform the duties of any occupation for which they are qualified based on their education, training, and prior experience. As the least expensive coverage, clients might pay 1% of their annual income in premium.
51
What is the definition of Split Definition disability coverage
With a split-definition disability coverage policy, an own-occupation definition is used for the first two years of disability. After this period, an any-occupation definition is used to determine if the insured will continue to receive benefits. This type of policy is becoming more popular in the marketplace. The annual premium can range from 1% to 3% of a client's annual income.
52
What is a presumptive disability?
A presumptive disability is a condition stated in the policy contract that, when present, automatically presumes the insured to be totally disabled and automatically renders payment. If a presumption condition is present, the insured is eligible for benefits regardless of whether the person leaves the workforce or continues working. Examples of presumptive conditions include the loss of two limbs or total loss of sight, hearing, or speech.
53
What is an elimination period?
An elimination period is a specified period of time, stated in the policy contract, following the beginning of disability during which expenses must be paid by the insured; that is, the insurance company will not pay benefits during the elimination period. Elimination periods typically range from a few days to several years. For example, a short-term policy may have no elimination period, whereas a long-term policy may have a six-month or one-year elimination period. The elimination period will vary from contract to contract and company to company. Generally, policies with longer elimination or waiting periods have lower annual premiums.
54
What is a policy benefit amount?
A policy benefit amount is the predefined benefit the insured will receive in situations when a disability claim is paid. Keep in mind that few disability policies replace 100% of an insured's annual income. Why? There would be an incentive for an insured to claim disability and remain on disability status rather than return to work. Financial planners do try to replace as much predisability income as possible, given the restraint that the more income replaced, the higher the annual premium.
55
What are terms of renewal?
The terms of renewal stated in a disability policy contract confirm the rights of the insured and the insurance company to renew, cancel, and/or adjust/modify premiums or benefits.
With an employer group plan (or association group plan), the employer (or association) is considered to be the group policyholder. As such, policyholder renewal rights rests with the employer (or association), not with insured employees or members.
56
What is a cost of living adjustment rider?
A cost-of-living adjustment (COLA) rider is a policy provision that periodically increases the disability benefit amount. Increases are either based on a percentage stated in the policy or based on changes in inflation (most often measured by the Consumer Price Index).
57
What is a future purchase option rider?
A future purchase option rider allows insured persons to increase their benefits on future specified dates in step with increases in their income. This provision is not available once the insured becomes disabled. This is sometimes referred to a guaranteed insurability rider.
58
What is a partial disability rider?
A partial disability rider pays an amount specified in the policy, often 50% of the full disability benefit amount, when the insured can return to work on a limited or part-time basis.
59
What is a residual disability rider?
A residual disability rider provides a benefit if the insured returns to work on a full-time basis but at an income that is less than the predisability earnings. This policy benefit will fill a portion of the income gap. Keep in mind that the amount payable is based on a formula specified in the policy.
60
What is a return of premium rider?
A return-of-premium rider encourages insureds to limit claims made by requiring the insurance company to return a portion (some or all) of the premiums paid if claims are less than expected during a specified period (stated in the policy).
61
What is a waiver-of-premium rider?
A waiver-of-premium rider provides a way for insured people to keep coverage in force without having to make premium payments when they become disabled for a specified amount of time.
62
What is a recurrent-disability rider?
A recurrent-disability rider ensures that an insured person will receive benefits if he or she were to become disabled for a second time because of a previous disability. This is sometimes referred to as a relapse provision. If an insured suffers a relapse (a disability that is related to a prior disability) and if this relapse occurs within six months of return to work, then the second disability is considered a continuation of the initial disability. This provision is beneficial to the insured because it means the insured does not need to meet a new elimination period before receiving benefits.
63
What is a social security rider?
A Social Security rider provides an additional benefit depending on the amount of disability benefits payable by Social Security
64
What are the two formulas insurance companies typically use to determine the amount of disability income an insured will receive?
1. Income benefit formula
| 2. Flat Amount
65
What is the Income benefit formula?
The income benefit formula calculates the amount of benefit to be paid as a percentage of predisability wages, under a disability claim. The percentage varies by insurance company, but the range tends to fall between 50% and 75%.
66
What is a flat amount disability benefit?
A flat amount disability benefit is a predetermined benefit insured people will receive if they become disabled, under a disability claim.
67
Nearly all disability policies contain important exclusions, including these four:
1. Preexisting conditions: An insurance company may deny coverage for claims considered to be a health condition for which a client received medical treatment or exhibited symptoms that usually require medical care within a time period prior to a disability claim.
2. Act of war: Disability and illness resulting from war.
3. Self-inflicted injuries
4. Work-related injuries: Some policies exclude coverage for work-related disabilities that are covered through workers’ compensation.
68
If a client purchases a policy directly and does not deduct the cost of premiums on Form 1040, are the benefits received taxable?
If a client purchases a policy directly and does not deduct the cost of premiums on Form 1040, any benefits received will not be taxable.
69
If a client purchases a policy through a group plan and pays premiums with pretax dollars, are benefits received taxable?
If a client purchases a policy through a group plan and pays premiums with pretax dollars (this is the most common way benefits are purchased), any benefits received will be subject to income tax.
70
If a client is a partnership or S Corp can it deduct the cost of disability insurance premiums?
Partnerships and S corporations may deduct the cost of disability insurance premiums, but in most cases the cost of premiums must be added back to the employee's income. If benefits are received, no income tax is payable.
71
When does one become eligible for social security disability benefits?
A Social Security insured status is required to satisfy eligibility for disability income benefits. The status is based on having paid Social Security taxes in 20 of the 40 calendar quarters ending with the quarter in which a disability claim is submitted.
72
Ruby, a Certified Financial Planner professional, is working with a young client who is just starting her working career. The client has a good job with outstanding promotion opportunities. The client has seen the statistics that she is more likely to become disabled than to die over her working life. She wants to purchase a long-term disability policy. Ruby has identified several possible policies, but each one is costly, especially when compared to the client's annual salary. What can Ruby recommend that will help reduce the policy premiums?
Ruby can provide at least five recommendations to can help reduce premiums for a long-term disability policy:
1. Extending the elimination period
2. Purchasing a split-definition policy over an own-occupation policy
3. Reducing the income replacement ratio in the policy
4. Integrating the policy with Social Security
5. Purchasing a policy through a group plan rather than the individual marketplace
73
A financial planner's longtime client stopped by the planner's office today to talk about his older widowed mother. Her health has been declining for several years. The client just learned that his mother is unable to get in and out of bed on her own. Additionally, his mother is no longer able to walk; she must use a wheelchair. The client would like to know if his mother should file a claim against her long-term care insurance policy.
In this case, the client's mother would not qualify for long-term care coverage. At this time, she is unable to perform just one activity of daily living (i.e., transferring from bed to chair).
74
LTC (Long term care) includes services designed to aid an individual who is unable to perform two or more activities of daily living, which include:
1. Bathing
2. Dressing
3. Eating
4. Transferring from bed to chair
5. Using the toilet
6. Maintaining continence
75
What data is needed to complete the analysis of a client's LTC?
1. Current annual LTC cost
2. Client's current age
3. Assets to be used in case of LTC need
4. Assumptions - LTC inflation, Length of LTC need, Age of LTC need, Investment asset rate of return
76
In terms of issues to consider for LTC, what is Long-Term Care Insurance
1. Premium cost is greater for older clients who have a higher need
2. Premiums must be paid in order to maintain coverage
3. No guarantee that service costs will not exceed coverage
77
In terms of issues to consider for LTC, what is Personal Savings
1. Service costs may exceed assets
2. Clients may underestimate the asset need
3. Assets not used for services may be distributed to heirs
78
In terms of issues to consider for LTC, what is Family Support
1. Appropriate if family member(s) are willing and able to provide service
2. As needs increase, family support may be insufficient to meet service requirements
79
In terms of issues to consider for LTC, what is Continuing Care Retirement Community
1. Requires a substantial personal and financial commitment and ongoing costs.
2. May reduce assets available for heirs
80
In terms of issues to consider for LTC, what is Insurance with LTC or Chronic Illness Living Benefits Rider
1. With a living benefits provision or rider, a portion of the life insurance benefit is paid to the policyholder if he or she needs long-term care
2. The death benefit then is reduced by the amount paid for long-term care services
3. Benefits for long-term care often are limited by the rider and policy to 50% (or less) of the total benefit
81
In terms of issues to consider for LTC, what is a Viatical Settlement?
1. The client selling the life insurance policy (viator) loses control and ownership of the policy in return for a cash payment that is less than the full amount of the death benefit in the life insurance policy
2. Typically, available only to those who are terminally or chronically ill
82
In terms of issues to consider for LTC, what are Accelerated Death Benefits?
1. May not be available in older life insurance policies.
2. Client may become ineligible for Medicaid or other need-based governmental benefits and the death benefits may be taxable
3. No guarantee that service costs will not exceed settlement
83
In terms of issues to consider for LTC, what is Reverse Mortgage
1. Income may not meet all service costs
2. Processing fees will be imposed to begin mortgage process
3. Possible loss of asset value that could affect legacy plans
84
In terms of issues to consider for LTC, what is Medicare
1. Extremely restrictive for LTC needs
2. Only eligible if patient is eligible for social Security and can realize an improvement in his or her condition
3. Client is responsible for copayments and deductibles; may be offset with Medicare sSupplemental plan
4. Client may be responsible for some uncovered expenses
85
In terms of issues to consider for LTC, what is Medicaid?
1. Limited eligibility based on income and asset situation; typically restricted to very low income households
2. Client may be responisble for some uncovered expenses
86
In terms of issues to consider for LTC, what is Veterans Benefits
1. Limited coverage
| 2. Available only to those who have served in the U.S. armed forces for a predetermined number of years
87
In terms of issues to consider for LTC, what is PACE?
1. Must be Medicare or Medicaid eligible
2. Client will be responsible for expenses that exceed coverage limits.
3. Copayment and deductible expenses apply
88
What are three criteria of a qualified LTC policy?
1. Provides guaranteed renewability
2. Does not provide a cash surrender benefit
3. Does not pay benefits paid by Medicare
89
Are hybrid LTC policies considered qualified LTC insurance policies for income tax deduction purposes?
Because hybrid policies accumulate a cash balance, they are not considered qualified LTC insurance policies for income tax deduction and exclusion purposes.
90
Barbara is a single retiree. Barbara is considering purchasing an annuity to supplement her retirement income. She has no direct dependents; however, she has a niece that she would like to help financially in the future. If Barbara is concerned about receiving a minimum return on her annuity premium and not losing benefits should she die unexpectedly, what type of annuity option should she purchase?
As a single person who is interested in helping her niece financially, if possible, Barbara should consider purchasing a life contingent annuity option with a period certain or a refund feature. This strategy will ensure that either Barbara or her niece will receive payments in the future should Barbara die unexpectedly.
91
What are the two types payments from an annuity?
A fixed annuity provides the annuitant with a predetermined stable payment during the payout period of the annuity. A variable annuity is an insurance contract where the amount of the payment varies based on the performance of an investment account (or some other predetermined factor).
92
What are the pros and cons of a variable annuity?
Variable annuities are used to protect an annuitant from inflation. It is important to note, however, that variable annuities are riskier (in terms of potential downside losses) than fixed annuities.
93
What is a Straight Life Annuity?
With a straight life annuity, the insurer makes periodic payments for the annuitant's lifetime. With this type of annuity, the annuitant cannot outlive the income payments. There is no residual value in the estate upon the annuitant's death.
94
What is a Life Contingent with Period Certain (annuity payment)?
A life contingent with period certain annuity makes periodic payments during the greater of the annuitant's lifetime or a specified period, such as 10 or 20 years. If the annuitant dies before the end of the specified period, a named beneficiary receives the periodic payments for the remainder of the certain period.
95
What is a Life Contingent with Refund Feature (annuity payment)?
A life contingent with refund feature annuity makes periodic payments during the annuitant's lifetime. If the annuitant dies before the sum of the periodic payments made is at least equal to the premium paid, the excess is paid to a named beneficiary either in cash or installments.
96
What is a Joint and Survivor Annuity?
A joint and survivor annuity is a common way for couples to receive periodic payments. With this annuity, periodic payments are made to two annuitants (called joint annuitants) until the death of the second-to-die annuitant. The surviving annuitant's payment may continue at 100% of the original payment, or it may be reduced to 50%, 66.67%, or 75%. The amount of the survivor's annuity is determined at the time of the annuity purchase.
97
What is a Period Certain Annuity?
With a period certain annuity, periodic payments are made for a specified period of time (e.g., 10 or 20 years). The payments are payable to a named beneficiary if the annuitant dies prior to the end of the specified period. Income payments cease at the end of the period regardless if the annuitant is still alive at that time.
98
What are the two types of deferred annuities?
1. Paid-up deferred annuity.
| 2. Accumulation annuity
99
What is a paid-up deferred annuity?
A paid-up deferred annuity is one in which each premium payment purchases a fixed-dollar benefit that will begin on a specified date in the future (e.g., at retirement). These types of annuity contracts have no account value.
100
What is an Accumulation annuity?
An accumulation annuity is a deferred annuity contract in which premiums paid (less fees and expenses) are accrued in an account and the accumulated amount is applied to the purchase of an income annuity that will be paid during the payout phase of the contract.
101
Lamar is 50 years old and considering purchasing an accumulation deferred annuity. He is concerned that if he makes the purchase, he will be forced to annuitize the contract at a future date. He is unsure if he will need the income payout later in life. What are Lamar's payout alternatives if he does purchase the annuity? What are some of the advantages and disadvantages associated with the different alternatives?
Lamar can either take distributions directly from the accumulation account or convert the account to a payout annuity. An advantage associated with taking periodic withdrawals instead of annuitizing is that Lamar will retain access to and control over the account. He can make partial withdrawals as he need funds, and if the distributions are equal to or less than 10% of the account value, he will not pay a surrender charge. Also, by maintaining the account with the insurance company, Lamar will continue to be credited interest or earnings on the amount still in the account. The primary disadvantage associated with not annuitizing is that Lamar could end up depleting the account during his lifetime, which could result in an income shortfall later in life.
102
Jarvis is a single 69-year-old male. He began receiving period payouts from an annuity this year. He will receive $18,000 per year from the insurance company. If Jarvis paid $75,000 into the annuity contract before taking distributions, how much of this year's annual distribution will be excluded from ordinary income taxes?
Jarvis can exclude $5,294 from ordinary income taxes this year. This estimate is based on the exclusion ratio and his IRS life expectancy of 170 months.
