1. 1 Topic 19: Life Insurance  Risk factors Lifestyle Occupation Medical condition Family history  High risk individuals Denied coverage Increased premiums Exclusion of certain risks: skydivers

2. 2 Topic 19: Life Insurance  Concepts Mortality: death rates Morbidity: rates of disability  Expenses: greatest in early years Commissions  Insurable interest Required at time of policy inception Not at the time benefits are paid

3. 3 Topic 19: Life Insurance  Term insurance: temporary Renewable: to age 70 Convertible: to whole life  Whole life: permanent/forced savings Variable: separate account invested based on policy holder’s allocation  Whole life funds go into general account of company  Can increase death benefits/cash value based on investment performance Universal: can change  Premiums: can skip payments  Death benefit Cash value separated from death benefit Variable universal: combine features Survivorship: second to die policy

4. 4 Topic 19: Life Insurance  Contract provisions All language contained in contract Backdating: can be done up to six months Owner may not be insured One month grace period for premium payments Misstate age: adjust death benefit Loans: amount borrowed subtracted from death benefits Assignment: generally policies may be assigned Common disaster: primary beneficiary must outlive insured by 60 – 90 days

5. 5 Topic 19: Life Insurance  Contract provisions Incontestable: insurer has two years to challenge validity of policy Exclusions: suicide (one to two years) and war Settlement options  Lump sum  Annuity Single or joint life; term certain  Interest only

6. 6 Topic 19: Life Insurance  Dividends Cash Accumulate Reduce premiums Buy additional coverage  Interest credits Portfolio method: based on insurer’s earnings of overall portfolio New money method: based on insurer’s earnings on money invested that year

7. 7 Topic 19: Life Insurance  Riders Accelerated death benefits: pay benefits if expected to die within year; in nursing home permanently Long-term care: benefits rider can be added to life insurance policy Waiver of premiums: if disabled Guaranteed insurability: can buy more coverage without showing insurability Double indemnity: twice policy amount if death accidental

8. 8 Topic 19: Life Insurance  Nonforfeiture options After policy has cash surrender value,  Can get cash within six months  Can get a paid-up policy with a reduced face amount  Can get a term policy with the same face amount

9. 9 Topic 19: Life Insurance  Illustrations Projection of financial results  Incorporate present value or just nominal values?  Optimistic assumptions?  Clearly label what is guaranteed?  NAIC model does not apply to variable life/annuities  Policy replacement Regulated by many states  High commissions  May make sense due to reduced mortality charges and in higher interest rate periods

10. 10 Topic 19: Life Insurance  Accelerated death benefits Allow terminally ill insured to obtain funds prior to death tax-free  Pay for custodial care  Preferable to viatical due to discounts on viatical Viatical settlements  Terminally ill insured transfers policy for lump sum payment  Benefits tax-free to insured if: expected to die within two years can’t perform two activities of daily living Life settlement  Sell life insurance policy

11. 11 Topic 20: Income Taxation of Life Insurance  Dividends: whole life policies Not taxable unless total dividends > premiums paid on policy  Loans: whole life policies Not taxable  Withdrawal of cash value Not taxable unless withdrawals > basis If taxable, ordinary income  Surrender Not taxable unless proceeds > basis If taxable, ordinary income

12. 12 Topic 20: Income Taxation of Life Insurance  Death benefit: not taxable  MECs: premiums higher than necessary for insurance. Often single premium policy Then take cash value prior to death Test during first seven years of policy  Is it paid up in seven years? If policy is MEC,  Death benefit is still not taxable  Withdrawals and loans taxed as ordinary income with penalty if under 59 ½

13. 13 Topic 20: Income Taxation of Life Insurance  Transfer for value Sell policy to someone other than related party (business, co-owner, family member)  Seller not taxed if viatical settlement Expected to die within two years  Buyer will be taxed on death benefits if greater than basis (ordinary income) Including premiums paid and purchase price

14. 14 Topic 20: Income Taxation of Life Insurance  Section 1035 exchange Trade an existing policy for a new policy  Good idea???  Mortality/interest rate assumptions Trade a life insurance policy for an annuity  Makes IRS happy Can also trade life insurance or annuity policy for long-term care policy Can not trade an annuity for an insurance policy  Would make the IRS sad

15. 15 Topic 21: Business Uses of Insurance  Buy-Sell Agreements Provides for the sale of business interest on death of owner  Allows heirs to cash out of business  Keeps heirs from becoming co-owners  Keeps ownership with existing owners  Value generally based on formula Valid for estate tax valuation

16. 16 Topic21: Business Uses of Insurance  Buy-Sell Agreements Cross purchase  Owners buy policies on each other Number of policies? Older owner Premiums not deductible Entity  Company buys policy on each owner Premiums not deductible

17. 17 Topic 21: Business Uses of Insurance  Key Person Life Insurance Insures life of valued employee:  LeBron  Janitor Business is beneficiary  Premiums not deductible  Benefits tax-free

18. 18 Topic 21: Business Uses of Insurance  Split Dollar Life Insurance Employer and employee share cost of premiums  Employer pays cash value portion  Employee pays pure life insurance cost If employer pays entire premium, coverage above $50,000 taxable Endorsement method  Employer owns policy Receives reimbursement for premiums paid Employee gets balance Employer paid premiums income to employee Collateral assignment method  Employee owns policy Again must reimburse business for premiums paid Premiums treated as loans: employee must pay interest

19. 19 Topic 22:Insurance Needs Analysis  Life insurance Anyone financially sad??? Financial needs approach: determine cash needs, income needs, special needs and then subtract net worth  Income replacement  Debt elimination  College education  Less assets available to meet these needs

20. 20 Topic 22:Insurance Needs Analysis  Life insurance Human life value approach:  Present value of insured’s future income  Does not consider assets, liabilities, other sources of income Capital retention approach:  Not only provide present value of future income but capital is maintained also

21. 21 Topic 22:Insurance Needs Analysis  Life insurance Income retention approach:  Based on income needs of survivor rather than income generated by insured  How soon until surviving spouse will accidentally fall in love? Income multiplier approach: five to fifteen times annual income

22. 22 Topic 23:Insurance Policy and Company Selection  Life insurance Temporary needs: term Permanent needs: whole life  Participating: pays dividends when premiums were “too large” Cost analysis  Net cost method per $1,000 of coverage = (total premiums – cash value) / number of years policy held Ignores time value of money

23. 23 Topic 23:Insurance Policy and Company Selection  Life insurance Cost analysis  Surrender cost index = (future value of premiums – dividends – cash value)/fv factor for $1 for n years at i rate) /$1,000 units of coverage  Net payment cost index = Same as surrender cost index but cash value is not subtracted Benchmarks:  Age 30: $2 cost per $1,000  Age 60: $25 cost per $1,000  Age 80: $125 cost per $1,000

24. 24 Topic 23:Insurance Policy and Company Selection  Life insurance Company selection: financial ratings  Companies rated based on financial strength A.M. Best, S&P, Moody’s  Best: insurance companies only  “A+” rating has different meanings  Variable products provide security of subaccounts Company selection: underwriting  Some companies only want certain types of risk

25. 25 Topic 18: Annuities  Types Immediate: payments begin now Deferred: payments begin later Single premium: one payment  Purchase annuity with 401(k) proceeds Periodic premium Single vs. joint and survivor Period certain: benefits continue for a minimum number of years  Even if die before period ends

26. 26 Topic 18: Annuities  Types Fixed: periodic payment known  Turn defined contribution plan into defined benefit plan Variable: periodic payments based on investment performance  Considered securities: must hold Series 6 and insurance license to sell  Oversold/undersold????

27. 27 Topic 18: Annuities  Structured settlements Receive periodic payments instead of lump sum  For auto accident, medical malpractice, etc.  Payments are tax-free if compensatory including pain/suffering/wrongful death/loss of goodwill Effectively makes interest tax-free Punitive, non-physical damages are taxable  Companies buying structured settlements

28. 28 Topic 18: Annuities  Taxation of annuities Noncontributory-qualified plan  All payments ordinary income Contributory-qualified plan  Basis / total expected payments = percent of each payment not taxed  Remainder of payment ordinary income Subject to 10% penalty if not age 59 1/2  After recover entire basis, all taxable If die before deferred annuity payments begin  Refund of premiums paid generally not taxable since payment equals basis  No step-up in basis for annuities

29. 29 Topic 18: Annuities  Taxation of annuities Commercial annuity  Ordinary income and return of capital based on expected payments Corporate annuities  Must recognize income immediately on increase in value of annuity; no deferral

30. 30 Topic 19: Group Term Life Insurance  Must be nondiscriminatory  Amount of coverage usually multiple of salary Cost of coverage above $50,000 is taxable  No evidence of insurability required Even if leave company and convert to individual cash value policy Inexpensive form of life insurance

31. 31 Topic 19: Group Permanent Insurance  Premiums Deductible by employer Taxable to employee GULPs: employees pay for universal life coverage  Advantage Group underwriting Can continue as individual policy after leaving employment  No evidence of insurability required  Must convert to permanent insurance

32. 32 Topic 19: Group Permanent Insurance  Carve Out Insurance Cover top dogs only  Employer’s cost deductible  Top dogs taxed on premiums paid Pay bonus to top dogs so they can pay taxes on premiums so they won’t be sad  Employer paid death benefit Taxable  Not funded by life insurance policy