EXAM PRACTICE QUESTIONS Flashcards
Shri purchases a universal life (UL) insurance policy with the paid-up additions (PUA) rider. The rider allows him to buy additional coverage of $20,000 per year for the next 10 years. Which of the following statements about the use of this rider is true?
a) Shri can make lump-sum payments under PUA only at the time specified in the contract.
b) Shri can increase his coverage by $20,000 every year after proving his insurability.
c) Shri can carry forward unused coverage to the next year and obtain $40,000 additional coverage.
d) There are no age restrictions in purchasing additional coverage under the PUA rider.
Shri can make lump-sum payments under PUA on the dates specified in the contract.
The PUA rider is underwritten at the same time as the base policy, so no additional evidence of insurability is required when the policyholder purchases the PUAs. However, the insurance contract usually places limits on the rider, such as:
- The minimum PUA that can be purchased at any one time;
- The maximum PUAs that can be purchased in any one year;
- The cumulative maximum PUAs that can be purchased over the life of the policy;
- When the policyholder can purchase PUAs (e.g., on policy anniversary);
- The maximum age of the life insured at the time of purchase.
Under this rider, the policyholder is permitted to buy additional coverage without proving insurability, by making lump-sum payments. The policyholder is not required to purchase the additional coverage in any one year, but if he does not do so, he cannot carry that purchase forward.
Reference: 5.1.1
Rick and August are equal shareholders of Prime Plus Inc., which is worth $750,000. They meet with their lawyer to do some financial planning and their lawyer suggests that they purchase a criss-cross insurance to fund their cross-purchase buy-sell agreement. When meeting with their insurance agent Abu, he tells them that August’s annual premium will be $985 and Rick’s premium will be $3,245. When they inquire about the vast discrepancy in premiums, Abu tells them that Rick’s premium is higher because he has high blood pressure, is a smoker, and is 20 years older than August.
Who is at a disadvantage in paying higher premiums in this scenario?
a) August
b) Rick
c) Prime Plus Inc.
d) No one
August is at a disadvantage with this arrangement because he will pay the premiums on Rick’s insurance. In a criss-cross insurance policy, each shareholder purchases insurance on the other shareholder. One of the disadvantages of criss-cross insurance is that there may be significant differences in the premiums for the coverage required on each party, depending on their age and health. Since Rick is older, unhealthy, and a smoker, his premiums are higher than that of August, yet he will only pay $985 on August’s life.
[Ref: 8.4.3]
Billy and Christie are meeting with their insurance agent Joel to assess their life insurance needs. They want to make sure that, in the event of their death, their two-year-old twins will be financially secure. Joel has determined that the need would be $2,000 a month until the twins turn 18. They also have a cottage as joint tenants with an FMV of $700,000 and an ACB of $440,000 and would like to insure the tax liability based on a projected value of $800,000 and a marginal tax rate of 50%. Which recommendation is optimal for Billy and Christie?
a) Joint last-to-die term policy for $384,000 payable to the trustee and joint last-to-die whole life policy for $90,000 payable to the estate
b) Joint first-to die whole life policy for $540,000 payable to the surviving spouse
c) Joint last-to-die whole life policy for $450,000 payable to the trustee
d) Joint first-to-die term policy for $360,000 payable to the trustee and whole life policy for $180,000 payable to the surviving spouse
To satisfy the need for $2000 a month for 16 years for the twins, Billie and Christie will need a term policy for $384,000 ($2000 × 12 × 16). This is needed only if something happened to both of them, so last-to-die is optimal.
To satisfy the tax liability that would be payable upon the second death, the insurance need would be:
$800,000 – $440,000 = $360,000
$360,000 × 50% capital gain = $180,000
$180,000 × 50% marginal tax rate = $90,000 tax payable
The estate would be responsible for the tax and should be the beneficiary of the death benefit.
[Ref: 11.5]
Layla has a universal life (UL) insurance policy. Her policy has a face amount of $400,000. The investment account has accumulated a value of $124,000. For the current policy year, the cost of insurance (COI) is $19.52. Calculate the mortality deduction that will be made from Layla’s account.
a) $5,388
b) $7,808
c) $20,492
d) $2,970
The first step is to calculate the net amount at risk (NAAR).
= Death benefit – value of investment account
= $400,000 – $124,000
= $276,000
The second step is to calculate mortality deduction.
= (COI x NAAR) ÷ 1000
= ($19.52 × $276,000) ÷ 1000
= $5,387.52 (rounded off to $5,388).
[Ref: 4.3]
Gino has a universal life (UL) policy with an indexed death benefit. He inherited a family cottage and wants to cover the increasing tax liability so that his children can enjoy the cottage without having to sell it to fund the taxes. Which statement best describes how the indexed death benefit impacts Gino’s UL policy?
a) The NAAR increases over time
b) The NAAR decreases over time
c) The mortality deductions decrease over time
d) The NAAR stays level while the investment account increases
The NAAR for a UL policy with an indexed death benefit will not be level. Depending on the growth rate of the investment account and the index rate chosen by the policyholder, the NAAR (and thus the mortality deductions) could be increasing over time.
[Ref: 4.4.4]
John, Joan, and Robert are the three shareholders of a large incorporated financial consulting firm. They each own 100 shares and each share is worth $100,000. They recently entered into a cross-purchase buy-sell arrangement with a share redemption plan.
If Robert dies today and the company pays $10,000,000 to his estate, how many shares do John and Joan own now?
a) 150
b) 100
c) 200
d) 0
A share redemption plan is an additional layer to a cross-purchase buy-sell agreement where the corporation redeems the shares of the shareholder who passed away. John, Joan, and Robert each own 100 shares. When Robert passes away, their corporation buys up his shares, pays $10,000,000 to his estate, and then cancels those 100 shares. The number of outstanding shares drops to 200 and as John and Joan are the only remaining owners, they now each own 100 shares and 50% of the company.
[Ref: 8.4.1]
Carl reviewed his life insurance needs with his life insurance agent. It was determined that in order for his family to maintain the same lifestyle they currently have, Carl should have $1,000,000 of life insurance coverage, before taking into consideration any life insurance coverage he already has in place. Currently, Carl has a $300,000 personal whole life policy on his life and his employer owns a $500,000 key person life insurance on Carl.
In order for his family to maintain their current lifestyle, what amount of life insurance coverage should Carl purchase?
a) $200,000
b) $500,000
c) $700,000
d) $1,000,000
Of the two life insurance policies on Carl’s life, only the $300,000 whole life policy will benefit his family. The $500,000 key person insurance owned by Carl’s employer is for the benefit of the employer. If Carl dies, his family will not receive the $500,000 death benefit.
Therefore, in order for his family to maintain the same lifestyle if he dies, Carl should purchase $700,000 of coverage ($1,000,000 needed - $300,000 already in place).
[Ref. 10.4.2]
Five years ago, Samantha had an insurance needs analysis and set up an insurance policy to meet her needs. Recently, she has had some big life changes that could potentially affect the amount of coverage she needs.
Which of the following changes could affect her financial plan and insurance needs?
a) Samantha’s month-old niece takes up a lot of her time because she cares for her in the evenings.
b) Samantha has been dating her boyfriend for over three years and thinks that they will be engaged soon.
c) Samantha has a two-week trip planned to South America.
d) Samantha recently changed employers so that she could take care of her niece.
The only change in Samantha’s life that has an immediate effect on her current financial plan is her change in employment. She may have changes to her group life insurance plan that would affect her current amount of coverage.
(Refer to Section 12.1.4)
Jaspreet, who is 40 years old, neglected to save money and has accumulated $100,000 in debt. He married recently and decided to cut back on his expenses and to make debt repayment his primary goal, which he predicts would take him five years. He also wants to purchase a life insurance policy that would take care of his wife in the event of his death. However, he cannot afford the high premiums of whole life insurance but would like to consider it when his debts are paid off.
He would still like to purchase a life insurance policy immediately. What is the best policy to suit his need?
a) Five-year, $100,000, decreasing term insurance
b) Five-year term insurance
c) Universal life insurance
d) Convertible term life insurance
Jaspreet should purchase a convertible, term life insurance policy. The premiums on term insurance are inexpensive and since the policy is convertible, he can convert his insurance in the future to life insurance after his debt is paid off and he can spare the money to pay for permanent life insurance. The five-year term insurances do not have the option to convert to a permanent life insurance like he wants to for the future. Universal life insurance is the most expensive of all the permanent life insurances because of its savings component.
[Ref: 2.8]
Sophie and Daniel have three children under the age of 10. Because they both work during the day, they pay for daycare services for their children. The couple figures they will need these services for another 10 years. They also have a mortgage with a remaining amortization of 22 years. Before meeting Sophie, Daniel was married to Veronica. In their divorce agreement, Daniel has to pay spousal support to Veronica in fixed, monthly amounts until she reaches 60 years of age or gets married. Sophie and Daniel want to ensure there is sufficient life insurance to cover their final expenses when they die.
Which of the couple’s needs is NOT covered by decreasing term insurance?
a) Daycare costs
b) Mortgage repayment
c) Daniel’s spousal support obligations
d) Final expenses
Not only are daycare costs, the mortgage, and Daniel’s spousal support obligations temporary in nature, the amount needed to cover these needs decreases over time. Therefore, they can be covered with decreasing term insurance. Final expenses, on the other hand, are permanent in nature and do not decrease. One could argue that this need increases because of the impact of inflation.
(Refer to Section 2.8.2)
Jennifer, a widow, is the sole owner of a cottage by the water that she acquired many years ago for a total cost of $75,000. Today, the property is worth $650,000. It is estimated that the market value of the cottage will increase by 5% each year because of the rising demand for waterfront properties. Jennifer plans on bequeathing her cottage following her death to her only son, Ben. She does not want her son to be forced to sell the cottage to cover the income tax that will have to be paid on the capital gain of the cottage when she dies.
Which type of life insurance would be the best fit to cover this insurance need?
a) Decreasing permanent insurance
b) Increasing permanent insurance
c) Increasing term insurance
d) Decreasing term insurance
Cindy’s life insurance need arises from the taxable capital gain that will be realized upon her death. If the tax liability cannot be satisfied with liquid assets, the cottage may have to be sold, which would not satisfy Cindy’s wishes of leaving the cottage to Carl. With an increasing permanent life insurance, the tax liability will be funded by the insurance and there will be no need to liquidate additional assets. Since the market value of the cottage is increasing, the amount of tax due will also increase. Therefore, an increasing life insurance is the best option.
Cindy also needs the coverage to extend for her lifetime vs a defined period of time and would require permanent insurance instead of term insurance.
[Ref: 2.3.3]
Ann meets with her client, Narinee, to help her apply for some much-needed term insurance. Ann walks her through an insurance application to ensure Narinee understands the importance of answering these questions accurately and completely. Ann confirms Narinee’s identity by examining her passport and spends a lot of time helping her know what to expect during underwriting. Narinee asks to have some more time with the application, to make sure she completes it thoroughly. Ann says she will pick it up tomorrow from Narinee’s mailbox and asks her to ensure it is signed beforehand.
What is the important step Ann missed to fulfill in her role as the advisor?
a) She did not witness Narinee actually sign the contract.
b) She should not have left the application unattended.
c) She should not have accepted the passport as a form of identification.
d) She should not have stressed the importance of answering questions truthfully. Clients should be left to conclude that on their own.
An insurance advisor must act as an agent of the insurance company during the application process. It is important that they be the “eyes” of the insurer.
Witnessing the policyholder and insured’s signature on the application is one of the pertinent requirements of the insurance advisor. Ann did not witness Narinee’s signature, so did not fulfill her responsibilities as the advisor.
[Ref: 9.1.2]
Marissa is married to Victor and they have two children. She is the co-shareholder of a company with the only other shareholder, Joan. They have a buy-sell agreement that ensures that the surviving shareholder will purchase the shares of the deceased shareholder from her estate. Victor works for a meatpacking plant, but he is actively looking to change jobs as he does not like working for his current employer.
During a meeting with her life insurance agent, Marissa reviewed her life insurance needs and it was determined that for her family to maintain the same lifestyle if she dies, she needs a total of $1,500,000 of life insurance coverage, even after taking into consideration the amount her family will receive after the sale of her shares to Joan. She already owns a $500,000 policy with Victor as the beneficiary. There is also a $750,000 life insurance policy on her life, owned by Joan, to finance the buy-sell agreement purchase. Victor is a member of his employer’s group life insurance plan, which offers life insurance coverage for the whole family. The insurance for the employee is convertible to an individual policy, but not the insurance for his family members. With this group plan, Marissa is covered for $20,000.
In order for Marissa’s family to maintain their current lifestyle, what amount of life insurance coverage should Marissa purchase?
a) $230,000
b) $250,000
c) $980,000
d) $1,000,000
The insurance coverage needed to ensure Marissa’s family can maintain their current lifestyle if she dies is $1,500,000. This amount takes into consideration the fact that her family will receive $750,000 for the purchase of Marissa’s shares as stated in the buy-sell agreement. This purchase is funded by the life insurance that Joan owns on Marissa’s life.
The remaining coverage on Marissa’s life is the $500,000 personal life insurance policy and the $20,000 from the group plan. Because there is a good chance that Victor leaves his employer and that the coverage for the family members cannot be converted, we should not take the $20,000 coverage into account when determining how much life insurance Marissa needs.
Therefore, Marissa would need an additional $1,000,000 of life insurance coverage ($1,500,000 needed - $500,000 in place).
[STUDY REFERENCE: 10.4.2, 10.4.3]
Which of the following forms the basis for a life insurance needs analysis?
a) The life insured’s net income
b) The life insured’s gross income
c) The life insured’s past income
d) The life insured’s potential income
A life insurance needs analysis is normally based on the take-home pay (also known as net income), or the amount that the life insured receives after all deductions, from now until normal retirement age.
[Ref: 10.2.1.1]
What is an example of an administrative cost that would impact life insurance premiums?
a) Advisor’s commission
b) Mortality costs
c) Investment returns
d) MER fees
In relation to the size of a premium, one of the most expensive upfront administrative costs in an insurance company is the advisor’s commission. This is why if a policy cancels within the first one or two years, there is a substantial chargeback. The other options are not administrative in nature. MER fees are charged for segregated fund
[Ref. 9.7.2]
Joseph was born on November 21, 1977. On August 25, 2002, he bought a convertible term life insurance on his life. His insurance company uses the nearest birthday to determine the attained age. On February 15, 2016, Joseph converts his term policy into a permanent policy.
Calculate what would be the age used to determine the permanent insurance’s premiums if conversion is done at the attained age.
a) 24
b) 25
c) 38
d) 39
If the conversion is done at the attained age, Joseph’s attained age at the time of conversion is 38 since his nearest birthday at that moment is November 21, 2015.
The insurance company uses the nearest birthday to determine the attained age, so Joseph’s attained age when he bought his life insurance was 25 (nearest birthday was November 21, 2002). This will also be the original age should the conversion be on an original-age basis.
[Ref: 2.6.2]
Jonathan was insured under a convertible term life insurance policy for nine years before he converted his term policy into a permanent policy under the conversion provision last year. He also had an accidental death rider on his policy. Yesterday, Jonathan committed suicide.
Considering the two-year suicide exclusion period found in life insurance contracts, what will the insurance company do in this situation?
a) Pay the death benefit because the conversion to a permanent policy is treated as an extension of the original policy
b) Not pay the death benefit because the permanent insurance obtained by converting the term insurance is considered as a new contract and the two-year suicide exclusion period applies
c) Reimburse only the premiums paid to date because the death benefit is never paid in full in the event of a suicide
d) Pay the death benefit under the double indemnity rider
A suicide exclusion period is found in every life insurance contract and is usually two years. However, a policy issued as a result of a conversion is treated as an extension of the original policy. Therefore, Jonathan suicide happened after the two-year suicide exclusion period since he had been insured for ten years. In this situation, the insurance company will pay the full death benefit, but not more.
A life insurance policy with an accidental death (AD) rider will provide an extra benefit, over and above the regular death benefit, if the life insured dies as a result of an accident. The most common multiple is two times the death benefit, and as a result, this rider is sometimes referred to as “double indemnity.”
Suicide is not considered an accidental death, so the accidental death rider does not play a role in this situation.
[Ref: 2.6.1]
Penny, age 72, has accumulated a lot of wealth during her lifetime through a variety of conservative and careful investments, as her risk tolerance is low. She would like to begin transferring her wealth during her lifetime but recognizes that upon her death she will still have several properties under her name. Penny has no life insurance but is referred to an insurance advisor named Maurice, at the advice of her family office.
When she meets with Maurice to discuss purchasing a policy, what would an appropriate product recommendation be for Maurice to make?
a) Participating whole life insurance with paid up additions
b) Variable universal life insurance with asset allocation in a foreign exchange index
c) Term 30 insurance
d) Term 10 insurance
When it comes to finding a suitable insurance product for a client, many factors need to be considered, like selecting a suitable investment. At age 72, Leysa does not have a long-time horizon so selecting a variable policy which relies on the performance of a foreign exchange index fund is too aggressive, particularly since she has a low risk tolerance. Properties still under her name would trigger capital gain taxed only at death or disposition, so term insurance would not suffice. At age 72, she is not eligible for Term 30 insurance. A permanent product, with fixed pricing and conservatively managed investments such as participating whole life insurance would be an appropriate option for Maurice to suggest.
[Ref: 10.2.1.1]
Ryan and Carter, residential contractors, have been partners for more than 20 years. They have a house in the suburbs with a mortgage balance of $200,000, which they are paying off regularly. Ryan and Carter are looking for an inexpensive insurance solution that will absorb their debt if one of them were to die prematurely.
Which option is suitable for their insurance need?
a) Decreasing term first-to-die life insurance
b) Level term last-to-die life insurance
c) Term buy-sell life insurance
d) Mortgage insurance
Ryan and Carter should purchase a decreasing term first-to-die insurance policy. Decreasing term insurance provides a death benefit that decreases over the course of the term, while the premiums remain level. This is a good option for them as they are paying off their mortgage and reducing the outstanding mortgage balance. A joint first-to-die life insurance coverage is appropriate whenever two or more people share a debt obligation because the benefit will be paid out as soon as one of the life insureds die.
[Ref: 2.3]
Blake is the policyholder of a life insurance policy. He takes out a policy loan that is less than the policy’s adjusted cost basis (ACB).
What will be the likely outcome in this case?
a) The ACB will be increased to the cash surrender value of the policy.
b) He will have a policy gain equal to the amount of the loan, minus the ACB.
c) The ACB of the policy will be reduced to zero.
d) He will not have a policy gain.
If the policyholder takes out a policy loan that is less than the adjusted cost basis (ACB), he will not have a policy gain, but the ACB will be reduced by the amount of the loan.
[Ref: 7.5]
In which of the following situations can an owner of a corporation NOT choose to leave his business interest to someone in his will, such as a spouse or children?
a) When a buy-sell agreement is in place
b) When the owner is a sole proprietor
c) When a split-dollar arrangement is in place
d) When the owner is the key person
If a buy-sell agreement is in place, the owner cannot choose to leave his business interest to someone in his will, such as a spouse or children. Buy-sell agreements typically specify that either the corporation or the other shareholders or partners buy an owner’s business interest if he dies.
[Ref: 10.2.2.4]
Jenay owns a participating whole life policy insuring his husband Sebastian, and their four children are equal beneficiaries of the $2,000,000 death benefit. Janay appointed Sebastian as the contingent owner. Unfortunately, Jenay passes away prematurely. The cash surrender value (CSV) is $350,000, and the adjusted cost basis (ACB) is $250,000.
What gain amount will be reported on Jenay’ final tax return?
a) $0
b) $100,000
c) $350,000
d) $50,000
No policy gain was triggered upon the death of Jenay. The rollover of a policy to a spouse upon death is seen as a policy transfer, and the ACB moves over to the new owner and spouse. In this circumstance, Sebastian would have inherited the policy with an ACB of $250,000
[Ref: 7.9]
Kayla is a Canadian citizen. She is married to Luis who is a Mexican citizen and a permanent resident of Canada. Kayla is a freelance writer and Luis is an electrician and both are in good health. Luis’ family still resides in Mexico and Luis and Kyla visit them frequently. They are meeting with their insurance agent Sam to purchase life insurance. Sam is discussing the application and underwriting process with Kayla and Luis based on their situation.
Which statement best describes the process for Kayla and Luis?
a) Both Kayla and Luis could be rated as a substandard risk.
b) Luis’ coverage will be limited to $2,000,000.
c) Luis is not eligible for life insurance until he becomes a Canadian citizen.
d) Kayla will not be eligible for coverage as she does not have a permanent job.
If the life insured is a frequent traveller, the insurance company may request further details about past travels and future plans, including the countries visited, and the frequency and duration of visits. As a result, the issued policy may have a substandard risk rating (which would result in higher premiums), or it may specify an exclusion for travel to specified countries.
If a permanent resident makes frequent or extended trips back to his country of origin or other countries, he may be rated as substandard risk (which would result in higher premiums), or the policy may include an exclusion for death occurring in the specified country.
A person must be a permanent resident to apply for life insurance. If the person is awaiting residency, their coverage may be limited based on their occupation.
[Ref: 9.4.9, 9.4.10]
Frank and Allison have a participating whole life insurance policy with a paid-up additions dividend option to cover income taxes that will be due after the second death. They are concerned that if they live long enough, the taxes owed after their deaths will be minimal and they will have paid a considerable amount of money into an insurance policy they may no longer need.
How could Frank and Allison access cash from their policy to recuperate some of the money they have paid as premiums?
a) Stop paying premiums and allow the dividends to pay the premiums.
b) Surrender part or all of their policy to receive the cash surrender value and change the dividend option from paid-up additions to cash.
c) Surrender their whole life policy to receive the cash surrender value and apply for a new term policy with a lower premium.
d) Keep only the paid-up additions of their whole life policy and stop paying any premiums immediately.
They could surrender part of the policy to receive the cash surrender value, keeping only what they think they will need to pay their taxes. They could change the dividend option to cash. There is no guarantee that the dividends will be enough to pay the premiums and the face value could still be more than they need. If they surrender the whole policy the cash surrender value may not be enough to purchase a term policy that would cover their taxes and they are unsure of the term that they would be required to purchase.
(Refer to Section 3.4.4, 3.5.1)
