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INDEXED PRODUCTS TRAINING COURSE

2017 Educational Concepts Unlimited, 3301 W Main St, Belleville, IL 62226PH# 618-233-1228, www.ecuinc.biz, email: [email protected] , Sept 18, 2017

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mailto:[email protected]

Table of Contents

ContentsCHAPTER 1...............................................................................................................................................................2

Introduction to Annuities.........................................................................................................................................2

Types of Annuities................................................................................................................................................3

Chapter 1 Review Questions...........................................................................................................................10

Chapter 2...............................................................................................................................................................11

Annuity Contract Provisions...................................................................................................................................11

Death benefits....................................................................................................................................................17

a. Lump sum pay out..................................................................................................................................17

b. Extended pay out....................................................................................................................................18

Available settlements options........................................................................................................................18

1. Long-term care benefit riders.....................................................................................................................24

2. Guaranteed minimum withdrawal benefit riders.......................................................................................25

3. Guaranteed minimum death benefit riders................................................................................................25

Chapter 2 Review Questions..................................................................................................................26

Chapter 3.............................................................................................................................................................27

Primary Advantages and Disadvantages of Annuities.............................................................................27

Annuity vs CD Chart.....................................................................................................................................35

Effects of Inflation on a Fixed Annuity.................................................................................................36

Income distributions-................................................................................................................................36


Chapter 4...............................................................................................................................................................44

Fixed and Indexed Life Products.............................................................................................................................44

Types of Life Insurance.......................................................................................................................................44

Fixed products................................................................................................................................................44

Policy Specifications........................................................................................................................................57

DEFINITIONS......................................................................................................................................................58

GENERAL PROVISIONS...................................................................................................................................59

Contract...........................................................................................................................................................59

Incontestable..................................................................................................................................................59


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Misstatement of Age or Sex........................................................................................................................59

Minimum Benefits..........................................................................................................................................59

Nonparticipating............................................................................................................................................59

Premium...........................................................................................................................................................59

Premium Taxes..............................................................................................................................................59

Annual Report................................................................................................................................................59

OWNERSHIP.......................................................................................................................................................60

Owner...............................................................................................................................................................60

Rights of Owner.............................................................................................................................................60

Assignment.....................................................................................................................................................60

BENEFICIARY.....................................................................................................................................................61

Beneficiary Designation...............................................................................................................................61

Change of Beneficiary..................................................................................................................................61

DEATH BENEFIT................................................................................................................................................61

Before Annuity Start Date............................................................................................................................61

After Annuity Start Date...............................................................................................................................61

CONTRACT VALUES.........................................................................................................................................61

Policy Value During Term............................................................................................................................61

Accumulation Value......................................................................................................................................62

Policy Value After Term...............................................................................................................................62

Index.................................................................................................................................................................62

Index Value......................................................................................................................................................62

Index Increase................................................................................................................................................62

INCOME BENEFITS...........................................................................................................................................63

Annuity Start Date.........................................................................................................................................63

Amount of Income Payment.......................................................................................................................63

Annuitant’s Adjusted Age............................................................................................................................63

Automatic Monthly Income Option...........................................................................................................63

Evidence that Annuitant is Living.............................................................................................................63

INCOME OPTIONS.............................................................................................................................................64

Selection of Options.....................................................................................................................................64

Option 1...........................................................................................................................................................64


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Life Income......................................................................................................................................................64

Option 2...........................................................................................................................................................64

Life Income with 120 or 240 Monthly Payments Guaranteed..............................................................64

Option 3...........................................................................................................................................................64

Joint Life Income with Two-Thirds to the Survivor...............................................................................64

GUARANTEED ANNUITY TABLES.................................................................................................................65

Monthly Payments for Each $1000 Applied............................................................................................65

Policyholder understanding of indexed life insurance policy performance...................................66


CHAPTER 5.............................................................................................................................................................71

Suitability and Marketing Practices........................................................................................................................71

Importance of determining client suitability for indexed products...................................................72

Table I...........................................................................................................................................................77


CHAPTER 6.............................................................................................................................................................81

Special Issues for Senior Consumers......................................................................................................................81

NASAA Model Act to Protect Vulnerable Adults from Financial Exploitation................................84

Overview......................................................................................................................................................84

1035 Exchange...............................................................................................................................................86

Transfers of Annuity Contracts..............................................................................................................86

Chapter 6 Reviews Questions.........................................................................................................................88

CHAPTER 7.............................................................................................................................................................89

New Developments in Indexed Products...............................................................................................................89

Qualified Longevity Annuity Contract..................................................................................................89

Advantages and Disadvantages of a Longevity Annuity.....................................................................90


Answer Key to Practice Tests..................................................................................................................................92


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Course Objective: This course is designed to cover the various annuities that include fixed, equity-index and variable products. In addition, riders, contract provisions as well as new life insurance products with long term care and annuity benefits. Due the complex nature of index-equity and variable annuities, more time will be spent on them.

Disclaimer: This book is for educational purposes only. It does not provide tax, legal or investment advice. For professional advice the reader should discuss all matters with their own respective advisor. Any laws or regulations cited have been summarized or edited for clarity. Information contented in this book is believed to be accurate but is not warranted. Check with your insurer for changes in product design, provision wording, and benefits.

All rights reserved. The text of this publication, or no part thereof, may not be reproduced in any form without the written approval by the author, Thomas H. Ripperda.

This course was copyrighted in 2011 by Thomas H. Ripperda. First Printing November 2011Second Printing with revisions 2017ISBN: 978-1-4675-0550-5


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CHAPTER 1

Introduction to AnnuitiesThe idea of an annuity goes back to Roman times. The Emperors sold an ”annua” (meaning "annual stipends" in Latin). In exchange of this one-time purchase of the annua, the Roman citizen received a lifetime of annual payments. This funding plan financed the expansion of the Roman Empire with funds used for the army and developing infrastructure.

Annuities served as the funding vehicles for the European wars in the 1700’s. England used them with income passing down through the generations. In 1759, a Pennsylvania insurance company was formed to provide benefits to Presbyterian ministers and their families. The ministers contributed to the fund with the understanding that they would get a lifetime of annual payments in their old age. It was not until the early 20th century that the purchase of annuities became common. The Great Depression led many more Americans to purchase annuities as a “rainy day fund.”

Today, Americans purchase annuities in record amounts because of their features: safety, guaranteed interest rates, tax deferral, and control of the timing of distributions to the annuitant.

Annuity contracts are issued by insurance companies and share some basic features:

Both types of contracts are supervised by state insurance regulators and must follow state laws and regulations. These limit the amount of risk that insurance company can take with premiums collected from contract owners. If the insurance company does invest in riskier investments, they are required to hold higher reserves to cover possible future loss. These reserves hold United States Government bonds or notes because of their safety. United States Government has never failed to pay its’ financial obligations. Because of their safety of funds, the interest rates are lower than other riskier financial instruments.

Permanent life insurance and annuities accumulate funds (cash values) taxed deferred. Both used the term “premiums’ to describe funding of those contracts.

Each has a stated guaranteed interest rate that is the minimum the contract will pay.

If a beneficiary is named the contract, each contract avoids probate and pays out quickly. Probate is the legal process of transferring assets after the death of an individual and requires public notice in the local newspapers of the opening the


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probate process. It is expensive and can take up to nine months before assets can be transferred.

In both types of contracts, there exists an early surrender charge similarity to those charges that banks apply to their certificate of deposits (CD) for early withdrawals. Unlike an annuity with a fixed surrender period, CDs restart their charges after each renewal.

There are four parties to the annuity and life insurance contracts: insurance company, owner, person being covered (insured for life and annuitant for annuity), beneficiary, and premium payer. In many cases the owner, premium payer and insured (annuitant) are all the same person.

Insurance company (insurer) accepts the risk and issues the contract. The owner is the person or organization listed on the contract and has full control of the policy. In many cases, the owner can be the insured/annuitant, premium payer, and in many cases is beneficiary if they are not the insured/annuitant.

The person being covered is underwritten by the insurer which determines the risk level based on medical and other factors. Unless the insured/annuitant is the owner, they have ownership rights.

Beneficiary fall into two categories: primary or contingent. Primary beneficiary’s right is to the collect the contract benefits at the time of the death of the insured/annuitant provided they are living at the death of the insured/annuitant. If the primary beneficiary death occurred before the insured/annuitant, the right to collect contract benefits passes the contingent beneficiary.

Premium payer can be anyone paying the premium. They have not contractual rights in the policy. In most cases, the policy owner would be paying the premiums.

Types of Annuities

Annuities are like insurance; but have special distinctions to those who purchase them. Since both involve written contracts and premiums, the difference between the two is noticeable. When a person purchases life insurance, they pay premiums to meet their insurance needs based on liabilities and responsibilities. This amount will pay in a lump sum or as a stream of income when the insured dies. Life insurance is intended to manage the risk of dying too soon. Annuities, on the other hand, have the individual pay a single premium or a series of premiums and those benefits are paid out while the annuitant is alive. This protects the annuitant against outliving their assets. This benefit is a way to accumulate and protect the individual’s assets. An annuity is a contract of regular income payments made in regular intervals by an insurance company in return


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for a previously paid premium. The most common use of income from an annuity is for retirement. The person receiving the check is the annuitant. An annuity is neither a life insurance (life insurance creates an estate while annuities liquidate funds) nor health insurance policy. It is not a savings account or a certificate of deposit. Annuities pay at the least amount guaranteed interest rate as set by law. Annuities issued before 2000, may have had a guaranteed interest rate of four percent. As the interest rates dropped, insurers reduced the guaranteed rate to three percent. In recent years the state laws changed to a minimum rate of 1 ½ percent over the lifetime of the contract. The growth of funds held in an annuity is income tax deferred. Withdrawals prior to age 59 1/2 are subject to 10% penalty. An annuity should always be considered for long term purposes.

Types of Annuities based on timing of benefits paid out.

1. Immediate annuities- This is the first type of annuities is available as a fixed or variable contract. Immediate annuities are a trade of funds for an income stream. The amount depends on how much is put down with the insurance company, how many years of income you choose, how the money is devoted, and the aggressiveness of the annuitant is they purchase a variable contract. It pays its first payment typically within one month from the purchase date of the annuity and no later than one year after the individual pays the lump sum premium. Annuitants can select to receive their checks monthly, quarterly, semiannually, or once a year. This annuity can only be financed with a lump sum payment. In some cases, funding may come from a 1035 exchange from an existing life insurance policy or annuity. Income payments start no later than one year after the premium has been paid for. Since there is no accumulation period in immediate annuities, these annuities are used for distribution of benefits.

2. Deferred annuities- Deferred annuities have become the most prominent brand of annuities. They allow the annuitants to either choose a short term or long term plan of growth with their money. The annuitants can receive income payments annually; with part of the principal sent out at any given time. Some insurers allow the annuitant to withdraw up to 10 percent of the balance in their annuity without incurring a surrender charges. Some can also elect to have the income payments for deferred annuities begin years later than they originally planned to start drawing benefits. Since the annuitant does not plan to use the accumulated wealth immediately, the annuity grants income for a specific future date. Usually the contract are purchased with flexible premiums, deferred annuities can also be bought with a single premium. This annuity usually has two periods. By funding payments over a period of time, it amasses interest during the accumulation period. The interest is always tax-deferred. The second period has the annuity’s payout to the annuitant furnished with a single one lump sum at the time of


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annuitization. The contract owner can purchase a fixed, equity indexed or variable annuity in a deferred annuity.

3. Split annuities- Split annuities provide immediate income while using unused principal to accumulate to its initial value. Since an immediate annuity capitalizes on short term performance; split annuities are set up to restore principal over the long term. The first annuity is a one-time payout chose over a specific time period. When a person purchases a deferred annuity, it grows to become a greater amount over time with no penalty of a loss from distribution. Often, those who choose split annuities are seeking a tax break, needs current income, or desire a guarantee at the end of the specific period. This concept works well when interest rates are higher. Split annuities lost their attraction when interest rates fell below six percentages.

Annuity type by Funding.

These are two ways to fund an annuity.

1. Single premium annuities- Single premium annuities are contractually written to permit the annuitant to buy an annuity with a single lump sum. Purchasers can elect to pay a one-time premium into a fixed, equity-indexed or variable contract. They choose which resource and which asset to purchase as long as it is made as a cash asset only. The investor can elect an immediate or deferred contract. Investor makes only one deposit in the account; with no more money to be put into this annuity. Immediate or deferred annuities are the only two to choose from.

2. Flexible premium annuities- Different from single premium annuities, flexible premiums are usually situated in variable annuities. Although more money can be entered into the account, flexible premiums support additional money being invested into the contract. The annuitant can choose to pay as much of a premium as they want until the benefits begin. Once the initial premium is made, the annuitant can make more than one deposit into the contract. It is considered fixed because the premium is not obligatory. It is possible for the annuity to have a single premium only option with it. In certain situations, the annuitant may want to move assets from a returned policy or policies or make a lone deposit premium from another resource. Most companies have a minimum initial deposit or minimum annual deposit for the first year. Unlike the fixed-rate annuities, flexible premiums allow the investor to take on the risks.


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Annuity type based on policyowner risk.

1. Variable annuities- These annuities are paid by the insurer in either immediate or deferred payments. The variable annuities differ because the fixed annuities are guarantees and limits on investments. These annuities are based on non-guaranteed equity investments like stocks or bonds. Therefore, the value will fluctuate in response to the stock market. Since variable annuities are intended as investments for meeting continuing objectives, the annuitant will decide how to have the premiums invested. The annuitant’s investments are never guaranteed in a variable contract, therefore the annuitant assumes the risk for higher returns. More often than not, an annuitant will obtain variable annuities when interest rates are high. The premium an annuitant pays is referred to as accumulation pieces and pertains to the accumulation period. During the accumulation period, contributions are paid and a deduction is taken for expenses. The balance is converted to accumulation units and credited to the annuitant’s account. When benefits are paid out, the accumulation units are converted to annuity units. At the initial payout, the annuity unit calculation is made based on an assumed interest rate. The number of annuity units remains the same, however, the value of the annuity units can and does vary from month to month depending upon investment results. Variable annuities tender tax-deferred wealth accumulation, lifetime income options, avoidance of probate, and guaranteed death benefits.

2. Fixed annuities- This is the other type of annuities. As an established source of financial support for millions of Americans, fixed annuities promise a lifetime income that will not outlive the benefits. Their investment options are narrow and clear-cut. The rate of interest, principal, and benefit payments are fixed and guaranteed for a period of time when the contract is written up. This means that the insurance company will assume the risk and limit the market risk to the owner of a fixed annuity contract. No matter how long the annuitant lives, the income will not vary regardless of the unfavorable changes in the insurance company’s investment return and expenses. The annuitant pays a single premium and can select an income for a set number of years only or for their lifetime. In cases where the annuitant wants to retire early before Social Security starts paying a retirement check. The insurer calculates the premium needed to pay the desired income and it ends after a set number of payments to the annuitant. Like the purchase of CD’s, they are inadvertently affected by the current interest rates. As rates fall, fixed annuities are not eye-catching to the consumer. When interest rates are elevated, fixed annuities are solid purchases as a means of lifetime wealth. Like variable annuities, fixed offer tax-deferred wealth accumulation, lifetime income options, avoidance of probate, and assured death benefits.


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a. Declared rate fixed annuities- interest rate is guaranteed for a limited time.

b. Indexed fixed annuities- This is a combination of variable and fixed annuities. It can also be either immediate or deferred. It collects interest from external references and equity indexes while keeping the other part fixed. Linked to equity indexes like the DOW-JONES 30, the SP-500, and NASDAQ, annuitant companies figure the guarantees the minimum and maximum amounts growth of interest .The annuitant cannot lose money even if the market is down. If the index does not move, there will still be a fixed return. If the market does well, the annuitant will do well. The return is limited and the gain can be limited as well

Two Tiered Annuities

A Split Annuity is not an annuity policy but a combination of two annuity products: a fixed period immediate annuity and a single premium tax-deferred annuity. A Split Annuity is structured in such a way as to produce immediate tax-advantaged income for a guaranteed period of time and to restore the original principal at the end of that time period. It’s a contract by which the annuity owner "splits" his or her initial premium into two pieces, and putting part of the premium into a fixed deferred annuity with a guaranteed interest rate for a given term, and putting the other part into an immediate annuity that pays an income for that same term. It is usually structured where the deferred annuity grows back at the end of the guaranteed income from the immediate annuity throughout that same time period.

Dependable Income

The Immediate Annuity may supplement one’s income by providing one with a safe, predictable, and guaranteed cash flow. Depending on one’s income needs, the Immediate Annuity may generate a stream of monthly income anywhere from five to twenty years. For those on a fixed income, certainty of a monthly income is their primary objective. Once the amount money grows back to the start amount, the annuitant will be much older and their “new” immediate annuity payout will be larger.

Tax-Advantaged Income

Since a significant portion of one’s monthly income from the Immediate Annuity is considered a return of one’s original investment, it is tax-advantaged. In our example below, 81% of one’s monthly income payments would be Tax-Free. In some states like Illinois, annuity income is considered retirement funds and it not subject to State Income


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Taxes. Internal Revenue Service allows individuals over age 65 to add a dependent. This reduces the effective income tax rate for seniors.

Tax-Deferred Growth and Principal Preservation

The Deferred Annuity portion of the split-annuity concept offers tax-deferred growth and earns an interest rate that historically has been higher than average CD rates. In addition, the original principal is restored at the end of the guaranteed period that allows the annuitant to start the process over again at prevailing interest rates. The funds placed in the Single Premium Deferred Annuity policy are available for emergencies with limitations.

Plan Limitations

The limits placed on the use of a split annuity are the issue ages of the policies, usually ages 0-85 for nonqualified funds and 0-70 for qualified funds. The immediate income periods range from 3 to 20 years.

Example of a Split Annuity

(Interest Rate Assume is for Illustration Purpose Only and DOES NOT Reflect Current Interest Rates)

$100,000 Total Funds are SPLIT

Immediate Annuity$38,430at 6.25%

Deferred Annuity$61,570at 6.25%

Monthly Income$485.37

will grow to

Annual Income$5,824.48

Yr. 1 $65,418Yr. 2 $69,507

for 8 yearsfor which

Yr. 3 $73,851Yr. 4 $78,466

82%is not taxed

Yr. 5 $83,371Yr. 6 $88,581

Total Income Yr. 7 $94,118


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before Taxes

$46,595.83

Yr. 8 $100,000

Original Principal

Laddering Annuities

Other useful tool is the laddering strategies using multi-year annuities. This strategy is used with Certificates of Deposits and investment grade bonds. Since interest rates change over time, the idea is to stagger the start of each contract and the interest rate available changes. The client has $300,000 to put into annuities. The money would be allocated as follows: $100,000 into any immediate annuity for 3 years, $60,000 into a 4 year deferred annuity and $60,000 into an 8 year deferred and annuity, and $80,000 into a 12 year deferred annuity. The allocation will depend of the client’s age, needed cash flow and interest rate spread. As a general rule, annuities will longer periods before paying out will have higher rates. With this approach, the annuity owner can delay the start date of the annuitization and let the annuity continue to grow.


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Chapter 1 Review Questions

1. The first nationality to use annuities to finance wars wasa. The Britishb. The Greeksc. The Romansd. The Americans

2. Which of the following would not be a feature of an fixed annuitya. Dependable incomeb. Income keeps pace with inflationc. Income tax deferredd. Covered by the State Guarantee Fund for up to $300,000

3. When funding an immediate annuity, which of the following method must be used?

a. Annual premiums paymentb. Fixed quarterly premium paymentsc. Flexible premiums paymentd. Single premium payment

4. Sally inherited $200,000 at age 55 and decides to purchase a single premium annuity with payments to start at age 65. What type of annuity should she purchase?

a. Single premium immediate annuityb. Single premium deferred annuity c. Flexible premium deferred annuityd. None of the above

5. Joe is retiring and looking at options with his 401(k) plan and does not want to outlive his money. Since Social Security will not provide the monthly income to maintain his current lifestyle, what would you recommend?

a. A deferred annuity starting at age 85b. A temporary annuityc. An immediate annuityd. None of the above


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Chapter 2

Annuity Contract Provisions

Common Policy Provisions

Each state establishes laws dealing with annuities.

Interest rates- The interest can vary based on the insurance company practices on interest crediting methods. It is not unusual for insurers to use both methods: portfolio based interest rate or new money based interest rate. In either case, the insured is required to disclose what method is being used at the time of sale with disclosures, brochures and in the contract itself.

Portfolio Based Interest Rates- This type of interest rate reflects the insurers’ income on the entire compilation of securities. Examples would be their stocks, real estate, policy loans to contract owners and bonds that the insurer holds in the general account. Each state sets limitations on the type and percentage of assets held in each class of securities. Whatever the insurance company earns on their general return is averaged into credit to the policy holder. A definite drawback to Portfolio Based Interest Rates is that the rate of return never replicates the actual return on investments being earned at the moment. Each policy owner is credited with a particular compound rate. In this approach, new policy owners are treated equally with old policy holders. When interest rates are rising, the rate of return will not keep up with current market interest and potential clients will look elsewhere for a better interest rate.

New Money Based Interest Rates- The insurance company adjusts its interest rates solely on “new money” it earns. The contract will have a start date for new money that reflects current interest rates. If the interest rates drop, the insurer will stop accepting new money into those contracts and open a ‘new’ money contract period. This approach protects the insured from falling interest rates. These current contracts protected from lower interest because the contract locks in the interest at the higher rate. In the same manner, as interest rates increase, the insurer will stop accepting premiums and open a “new” money contract period that would pay the high interest. Those rates are credited to policy holders on money they have recently made. Insurers are continuing opening and ending contract periods to attract new clients and reduce their exposure to changes in interest rates. Those shopping for an annuity can look into the U.S. 10 year note to see where the interest rates being credited on their “new money” annuity will be paying. The annuity interest rate will be higher than the 10 year U.S. Treasury Note.


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Initial rates- This is an interest rate the insurance company will credit for a set period of time after the purchase of the annuity. Insurance companies guarantee their rates for one year or multiple years once an annuity is purchased. The annuitant is guaranteed a much higher rate than the current interest being offered in current marketplace. Example, insurer offers 8% return on the first year only and all of the following years, the policy minimum rate would apply. Another example, the insurer offers 3% return over the next 3 years and at the end of that period, the interest rate would be adjusted to reflect the current interest environment.

Bonus rates- Bonus annuities offer an interest rate bonus. This bonus can either be on the initial premium deposit during the first year of the contract or on additional premiums during the term of the contract. This is an extra percent of bonus (interest) that is credited back to the policy holder in the first year. Depending on the contract, bonus rates could be higher initially than later. These are primarily used to attract new annuitants.

Bonus rates can have a negative aspect to them. Insurers can charge for these credits that may overshadow the benefits. Three ways insurers can charge for bonus rates are longer surrender periods, higher mortality risk charges, and higher surrender charges. In the instance of longer surrender periods, the contract may be subjected to longer surrender charges than a similar contract. A typical annuity may have a surrender period of 7-10 years. While the bonus annuity, surrender charges could continue up to 15 years. A higher mortality risk could be deducted from the annuity that pays a bonus rate. Over a long period, this amount adds up to be larger than the bonus rate itself. The third entity that insurers could charge is higher surrender charges. Higher surrender charges often amplify the contract just to pay for the bonus. There are annuity contracts that only pay 87 ½ % of accumulated amount if the annuitant does not live for stated period (example, 15 years).

Premium bonus provides credit for a higher interest rate for the first year and drops down to a much lower rate in successive years. An example, company offers a 10% rate for the first year, 4% for the following three years and 2% in the 5th year on. It is important to understand that the bonus may not be the best deal. Consider comparing it to an annuity that provides a guaranteed 5% for fives. Chart below shows the difference.


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It is clear that a policyholder would be $141.84 ahead by taking the 5% guaranteed rate for 5 years.

Annuitization bonus is offered to those that elect to annuitize their contracts. The insurance company increases the interest credited if annuity does not take a lump sum. This increase percentage or two will be taken back if the policyholder wants to take the lump sum amount at any time.

Renewal Bonus is offered after the initial guarantee period. Under this approach, rate of interest is increased each year at some stated number of basis points. An example, the policy offering 4% per year for two years with a ¼ of a percent increase each year for the next 5 years and after that, the minimum increase credited would be 1 ½ percent. For the policyholder this maybe a great deal if interest rates are failing.

Renewal rates- This is the rate credited by the insurance company after the end of the set time period. Usually the contract will explain how the insurance company sets the renewal rate by indexes or external references.

Minimum guaranteed rates- This is the smallest rate that the annuity will receive. The minimum value of the annuity will be paid if it is higher than the surrender value. The minimum guaranteed interest rate is credited if the indexed interest rate was lower than the guaranteed interest rate.

Issue Guidelines- Each company will set its minimums and maximums premiums permitted. The amount really depends on the type of annuity. A fixed annuity using the portfolio method may require a minimum of $500 in the first year. While another annuity product like an Equity Index Annuity will sets the minimum of $10,000. Under tax qualified plans there are limits on contributions and those reviewed by Internal Revenue Service each year with changes made based on inflation. In addition, there are caught up rules that permit individuals over age 50 to contribute more.


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Year Bonus %

Ending Balance Premium

Bonus

Guaranteed 5% for 5

years

$ 10,000.00 $ 10,000.00

1 10 $ 11,000.00 $ 10,500.00

2 4 $ 11,440.00 $ 11,025.00

3 4 $ 11,897.50 $ 11,576.25

4 4 $ 12.373.50 $ 12,155.06

5 2 $ 12,620.97 $ 12,762.81


Owner’s age- Can be any competent individual age 18 or older. Owner’s age has no effect on the initial issue of the contract. Most companies will issue an annuity contract under age of 85.

Annuitant’s age- The annuitant can be any age. There are tax penalties for early withdrawals before age 59 ½ with several exemptions due to hardship. A tax penalty of 10% applies to withdraw prior to age 59 1/2 for any early withdraws except for hardship. When calculating the benefits at annuitization, the age becomes important. The annuitant age 80 will receive a higher monthly check than the annuitant age 50 for the same contract and contribution. The key reason is life expectancy. If the annuity is being used in a tax qualified plan like an Individual Retirement Annuity (IRA) or Tax Sheltered Annuity (TSA) under a 403(b) plan the last age of issue maybe age 60 or earlier.

Annuity date is the date when the policy is set to start paying an income. That date is subject to change by the policyholder prior to the first check being paid out to the annuitant. Annuitants change the date based on their need for income.

Fixed date- Fixed annuity dates offer liquidity through withdrawal choices or surrender. Liquidity depends on the contract limitations and surrender charges. The fixed dates do not contain any management fees. The date the person obtains their first check based on the annuity option that they elected. If the annuity is as a result of a pension, the date is fixed and benefits begin at that date. Most pensions use age 65 as date for payments to begin.

Optional date- The annuitant can elect a different date for payments to begin at any time prior to getting their first annuity check. If an individual has established their annuitization date at age 65, they could elect to move the annuitization date up if they find a need for income. An example would be if an individual age 55 and their employer have gone bankrupt, because of their current health and prospects of future employment, they can elect to start receiving annuity payments at their current age. These payments would be greatly reduced from the amount they would have gotten at age 65. On the other hand, a person who has plenty of income at age 65 can elect to postpone their annuitization date to age 75 or 80. The advantages of postponing annuitization have two entities. The first part is that the money will continue to grow tax-deferred. The second part is that when it is annuitizing their checks will be much larger because of their age. The other alternate is not to annuitize the contract; therefore, making the amount larger for the annuitant’s beneficiaries.

Withdrawal/Surrender charge waivers- An annuity owner can elect to withdraw from their annuity at any time. The norm is 10% of the annuity balance in any given year provided they are 59 ½ years old or older. This is known as free withdrawal. However,


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when the annuitant withdraws more than 10% of the value, they are charged an early withdrawal. These are called surrender charges. Surrender charges are on a sliding scale. An example would be 7% the first year, 6% the second year, 5% the third year, and 4% the fourth year, etc. Everything above the 10% is subject to early surrender charge. It is calculated based on the amount of money taken out of the annuity. These charges are a percentage of the value of the annuity. Normally there are no extra charges to have withdrawal/surrender charges built into the contract when it is purchased. However, if the contract has a shorter surrender period then the interest being credited will generally be lower.

a. Nursing home waiver- A nursing home waiver will not contain any surrender fees if the annuitant is confined to a nursing facility. Upon certification from a doctor, once a person is placed in a nursing home for 90 days or longer, that individual can withdraw money to pay for the nursing home expenses. The insurance company will waive any penalties for nursing home care. This is an important feature that older annuity contract owners like.

b. Terminal illness waiver- If an individual is deemed terminally ill by a physician, and death is expected between six to twelve months, the insurance company will have a waiver that prompts against withdrawal/surrender charges to help pay associated medical costs. In order to receive these benefits the annuitant must make a written application for benefits and provide written attending physician’s statement. This is a feature that annuity contract owners look for in an annuity.

c. Unemployment waiver- If an individual is unemployed for twelve months or more, the insurance company will waive early withdrawal charges so that the annuitant can preserve a necessary lifestyle. The annuitant could elect to annuitize the contract to receive a lifetime of income or make withdraws as needed. If under age 59 1/2, the Internal Revenue will waiver penalties as well if the amount is taken in a lump sum and used to pay for medical care or medical insurance premiums. The IRS requires the individual to report as regular income any growth in the year it occurs. If a tax qualified plan, all income is considered regular income and is subject to income tax.

Disability waiver- Disability waivers carry a few more requirements than that of those previously mentioned. Typically, these waivers must first have the individual disabled for 90/ 180 days (fixed period of time). It also must conclude that the individual is not able to work or support themselves financially. When these all exist at the same time, the insurance company will waive early withdrawal charges so that the annuitant can maintain a basic lifestyle. If the annuitant returns to work, the free period withdraws will cease.

Premium payments- a. Single premium payments- Single premium payments are a lump sum of money that is used to purchase an annuity. This is a one-time payment to the insurance


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company. No additional payments are ever required. The single premium can come from whichever resource and any asset that the policyholder chooses. It can be as result of a reposition of cash values from an inforce annuity or life insurance policy. Since a transfer of money from an existing annuity or policy is thought as a replacement, it is processed as a 1035 tax-free exchange of policy assets. A 1035 tax-free exchange is taken from the Internal Revenue Code Section 1035 which allows for tax free transfer of cost basis from one policy to another policy. This allows the annuitant to substitute an existing variable annuity contract for a new annuity contract without paying any tax on the income and investment gains. Nearly all fixed rate annuities consist of the single premium payment in place since the owner is placed in a set rate of return for a precise stage of time.

b. Flexible premium payments- The annuitant can pay premiums based on their needs and ability to afford the premium. This option has made flexible premium payments the popular selection of most people. Flexible premiums are established after the first minimum premium payment is made. After that, no required amount or schedule with regard to premium payments is ever in use. They are designed to work best with variable annuities. Provided that the annuitant meets the requirements of the contract, the premiums payments will often vary. It is possible that flexible premiums may also receive a single premium only.

c. Required premium payments- This specific type of premium requires payments on a consistent schedule to meet the contract. Payments are to be made regularly either monthly, quarterly, semi-annually, or annually depending on the contract. These payments are made over a long-term period, typically waiting the retirement of the annuitant.

d. Optional premium payments- Once the initial premium is made, optional premiums can be added by the annuitant. This adds value to the annuity. Optimal premium payments are different from flexible premiums because the annuitant does not have to meet a minimum payment, nor is there a maximum payment. The annuitant can increase their payment without any penalty.

Withdrawal/Surrender charges- Since most insurance companies have a sliding scale; the longer the contract is in place the lower the surrender charge will be. This relates to all annuities. Surrender charges are in affect when the annuitant exceeds their withdrawal limitations of the annuity. These charges offer help aligned with short-term surrender against company assets that have been invested intermediate and long-term investments.

Market Value Adjustments- Market value adjusted annuities (MVA’s) contain funds held in a separate accumulation account. Its values are guaranteed as long as the contract is held for a specific period of time. When surrendered early, the value of the account will be pro-rated on the current market value. Depending on the formula used,


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the cash value may not equal the value of the account. Since the policyholder takes on the risk of interest rate market, a larger interest rate will be accredited to the accumulation account. Market value adjustments will only influence the accumulation account value if amounts withdrawn exceed the amount that the contract will allow. The U.S.Treasury constant maturity index is used to compute the changes on the interest rates on the MVA. This index is compared at the beginning of the contract and then at the surrender date or an excessive withdrawal date. Either date that ends the contact will then have the amount attuned higher or lower based upon contrast of the two.

Contract Administration charges and fees- Since the insurance company accepts all the market and investment risk, the company assumes those risks. Once premiums are paid into a fixed annuity, there are no management or trade costs. Basic fees are not withheld from the premium at the start of the annuity contract. The insurance company uses the spread to make money. An example should explain the process. The insurer invests the money and earns 5% and credits the annuity for 3% and the difference is the spread of 2%. The spread of 2% will cover the insurer’s expenses and provide a profit. Variable annuities do not operate in that manner since the contract owner choses the investments and insurer collects fees and administrative charges.

Withdrawal privilege options- Since most annuities allow the annuitant a definite amount of free withdrawal; almost all monies into the annuity are not tax deductible. Keep in mind that various policies figure withdrawal on a fraction of interest composed or the accumulated amount worth. Earnings are tax deferred until distributions are made. After a certain period of the contract, the annuitant can withdraw up to 10% without suffering any early penalties if the annuitant is under the age of 59 1/2.

Annuitization options- The annuitant choose from two options. The first is lifetime of income, which is described in detail below. The second option is a guaranteed pay-out period. Under this option the individual sets the period of time that the monthly payments can be made. An example would be an individual at age 60, and they have lost their job and need income until age 65 when they qualify for social security. The annuitant payments are spread out in a five year period and ends when the annuitant turns age 65. The annuitant gains because their social security benefits increase at 8% a year for each year that they delay their retirement age. 4.

Death benefits- Upon death of the annuitant most companies will pay out the total account value without fees or penalties. This total account value is the maximum amount, plus any ongoing additions, minus every preceding withdrawal. This money goes strictly to the named beneficiary. The shift of the annuity goes exclusive of tax issues. If the beneficiary is someone other than the spouse, the annuity is taxed as ordinary income. If the beneficiary has passed, no tax ramifications come into play


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either. The death benefit will last until the annuitant ends the contract, annuitize the investment, or the annuitant reaches the specific annuitization age.

a. Lump sum pay out- The annuitant does have the option of receiving the entire value of the annuity in a lump sum. Another approach is to withdrawal a set amount (example 5%) each year. If the annuitant dies before receiving total income at least equal to the premiums paid, the beneficiary receives the difference in a lump sum. If the annuitant lives later than the income paid equals the premiums paid, the insurance company maintains the income payments to the annuitant for as long as they live. This will allow the annuitant to be in charge of the quantity, the distributions, and the tax responsibilities of the annuity.

b. Extended pay out- Instead of taking the lump sum distribution option, the annuitant can elect to take extended payment intervals. If the annuitant does not annuitize the contract they can elect to have payments spread over a 10, 15, or 20 year period.

Available settlements options- During distribution, the annuitant has numerous settlement options. The annuitant can choose from any option of lifetime income with the remaining amount go to their beneficiary. Since most settlements options favor to risk-reward outcomes, the annuitant must keep in mind that fixed return increases will mean lower distribution amounts.

1. Straight Life- Pays the annuitant a guaranteed income for the life of the annuitant. When the annuitant dies, no further payments are made. This form of annuity provides the largest installment payment. Straight life is intended to pay the highest amount of monthly income to the annuitant since it is based on life expectation with no more payments after death. Straight life annuity is not suitable for a married couple; since at the loss of the first partner, income payments stop. The common complaint is the insurer keeps the money, but that is not the case. Since some annuitants live longer than projected the money recovered from early deaths are used to cover those

that live longer than projected.

2. Cash refund- If the annuitant passes away prior to receiving total income at least equal to the premiums paid, the beneficiary will collect the difference in a lump sum. If the annuitant survives after the income paid equals the premiums paid, the insurance company continues to make income payments to the annuitant for life. The cash refund option will forever pay the annuitant an assured income for life. Upon the death of the annuitant, any residual principal will be paid to the beneficiary in one lump sum.

3. Installment refund- If the annuitant dies before getting income at least equal to the premiums paid, a beneficiary receives the difference in installments. If


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the annuitant lives later than the income paid equals the premiums paid, the insurance company continues to make payments to the annuitant for life in periodic installments rather than in a lump sum. This option will always pay the annuitant certain income for life. Upon the death of the annuitant, any outstanding principal will continue to be paid to the beneficiary, in installments, until the total annuity has been paid.

4. Period certain annuity & life thereafter- This particular annuity pays for a lifetime of the annuitant or a specific time (10 years, 20 years etc.) Period certain will promise an agreed number of income payments no matter if the annuitant is alive to collect them. If the annuitant is living after the guaranteed numbers of payments have been made, the income goes on for life. If the annuitant dies in the guarantee period, the balance is paid to a beneficiary. Upon the death of the annuitant, the beneficiary would receive payments until the end of the specific period.

5. Joint and full survivor- Joint and full survivor are elects to have the income payments continue until the death of the first of two or more annuitants. Joint and survivor is suitable for a married couple; since at the death of the first partner, income payments continue. The monthly benefit is lower than with other annuities since income payments end at the second death. Upon the death of the second person, no additional payments are made, or Joint and One Half (upon death of one annuitant, income to surviving annuitant is reduced to half). This is the option that occurs in all pensions. Pensions offered by employers require this option for its retirees. The employee and their spouse must meet with someone from Human Resource to select the annuity options. At that meeting, the spouse must sign off for any other option other than the joint and survivor option.

Principal guarantee- insurers are guaranteed their principal back. If the principal is guaranteed, the insurance company promises to return the amount paid into the annuity without any surrender charges being deducted from the contract. In this case, the early surrender charges would be applied against the interest and not the principal. Not all companies offer this option.

Loan provisions- allows one to borrow up against their principal amount. Each contract is different. The insured is normally charged a fixed interest rate until the loan is repaid. The reason that the annuity charges interest is because the insurance company does not have the use of those funds to invest at a higher rate. Loans on an annuity contract do not make good economic sense because the whole purpose of annuities is for savings for the future and benefits from the tax-deferral growth in the annuity contract. Loans defeat the purpose of annuities

Terminology- Additional contract provisions common to fixed annuities that provide for one or more indexed crediting strategies.


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Cap rates- Since annuities are given an upper limit or cap. The cap is the maximum amount that can be paid on a contract. Not all annuities have cap rates. These rates reflect the maximum interest rates that an annuity can earn. The one time that the maximum rate is achieved, no extra gain is credited to the policy all through the policy year. Caps are hardly ever exercised with asset fees or margin spreads. Certain disadvantages come with cap rates as well. If the economy is doing well during a long period, the indexed interest rate will be high. However, if the economy is slow, the rate will be lower.

Participation rates- The participation rate is the greatest percent of the index that can be accredited to the annuity in every indexing year. This is an actual amount which is multiplied by the gain of the index. Typically guaranteed for at least one year, this approach calculates how much of the increase in the annuity to figure out interest. If the index adjustment is multiplied by the participation rate, the effect is the index interest rate of the annuity. The preliminary participation rate depends on when the policy was issued. When the assured rate ends, the insurance company will subject the annuity a new participation rate. Maximum rate is 100% with no minimum.

Spreads/Asset fees- Margin spreads or asset fees are used to deduct a prearranged percentage from the revisions in the index. This fee may be work with, or take the place of, participation rates. The spread is what the company earns and what they pay out. Asset fees are sometimes used instead of participation rates. If the annuity has an assured minimum rate that would be credited to the account, then the asset fee would only applied if the indexed amount exceeded the minimum rate.

Common Indexed crediting strategies-

1. Fixed interest- Rate is fixed could have built in, most don’t offer this option. A contract could offer a fixed interest rate with any gains above the credited amount would be kept by the insurer. While this provides the annuity with a guaranteed return, it defeats the purpose of equity index annuities.

2. Monthly averaging- By evaluating from one month to the next, rates are given as an average of the two. The index could either occur at the beginning or end the term of the annuity. Some index growth is credited annually and is a sum of all of the monthly percentage changes in the index. These revisions could either be positive or negative. The monthly changes are combined to establish the index for that annual year. Monthly averaging can never have an index credit less than zero. A monthly cap would apply to the change each month and then the participating rate would reduce the return further.


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3. Point to Point- This crediting strategy is used to establish the account’s credit by removing the value of the S&P at the end of the period from the start value. This is based on the difference between the index values from end of, to beginning of the contract. Interest is always added at the end of the contract.

i. Annual point to point- The point to point strategy analyzes the index from the beginning of one year to the end of the year. The difference in the index is used to calculate the indexed rate that will be credited to the policy. The yearend rate will begin the interest rate for the following year. This method of comparing year to year averages will never have a negative rate, if the index declines. If the index does decline in a certain year, the beginning rate would become 0 for the next year. Example:

Starting index is 1000Ending Index is 1,050Cap is 10%, Guaranteed interest rate=0%Participating rate is 80%1050 1000 equals 5% multiple by 80%=4% credited to the account2nd yearStarting Index 1050Ending Index 1030No interest would be credit since the result was a negative

ii. Long term point to point- Under this crediting strategy, the value of the index is set at the policy effective date and again at the end of the policy period. By using the beginning and ending points, the difference is multiplied by the participation rate to conclude the interest rate that is credited to the contract. Participation rates and the rate cap work mutually to establish what the net crediting rate will be. Looks at long term averages. (5 years, 7 years, etc.)

Example:5 Year Point to PointGuaranteed Rate is 0%Cap is 20%Participating Rate is 70%Start Index 1,000End Index 1,500


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(1500-1000=500) divided by 1000=50%multipled by 70%=35%, the contract would be credited for 20%.

High-water mark- Interest is calculated using the highest value of the index. This may create higher interest at uneven levels of the contract. Depending on the contract, rates are reserved at the highest level. The high-water mark is done at the anniversary of the beginning of the policy. All interest is figured on the difference between the index value at the beginning of the term and the highest index value. One disadvantage is that interest is credited to the policy at the end of the policy term. Another disadvantage is that high-water methods may have a lower participation rate to limit the interest that could be earned. In some cases, the contract does not have a participation rate but uses an asset fee.

Combination methods- this is a combination of one or more of the previous examples listed. Consumer choice to allocate/reallocate amongst strategies- Most companies will allow the consumer to choose their own strategy. Over time, the number of reallocation strategies has grown. The more complex the process, the more confusing this product becomes.

Specific issues for index strategy performance

a. Participation Rates fluctuate between companies and products. The insurance company has to cover their cost and met their profit targets. The market indexes changes on a daily basis. Insurance companies operate a certain spread to determine their rates. If, by chance, the rate is 100%, something will always offset it. The way to offset having a 100% participation rate is to reduce the cap or charge an asset fee.

b. Insurance companies must invest in a way to provide the allocation in an indexed strategy. Depending on the participation percentage, insurers take part of their money and put it in a futures contract. This is based on a speculation. The insurer buys a call option on index used in the annuity after setting aside an amount to cover the return of the money invested in case the index is down at some later date. Here is an example, assume the amount needed to provide $1.00 in 10 years is 63 cents and we need 5 cents to cover cost. The 63 cents would be invested in a safe investment like US government securities with a specific rate of interest. The company would use 32 cents (1.00-.68) to buy a call for that period. It would use caps and participating rates to reduce possibility of loses.

******


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Mid-term withdrawals could have on interest credits. If an annuitant takes out money in a certain period of time, the return is reduced substantially. Depending on the market value of the annuity, the annuitant either will not

c. Participation Rates fluctuate between companies and products. The insurance company has to cover their cost and met their profit targets. The market indexes changes on a daily basis. Insurance companies operate a certain spread to determine their rates. If, by chance, the rate is 100%, something will always offset it. The way to offset having a 100% participation rate is to reduce the cap or charge an asset fee.

d. Insurance companies must invest in a way to provide the allocation in an indexed strategy. Depending on the participation percentage, insurers take part of their money and put it in a futures contract. This is based on a speculation. The insurer buys a call option on index used in the annuity after setting aside an amount to cover the return of the money invested in case the index is down at some later date. Here is an example, assume the amount needed to provide $1.00 in 10 years is 63 cents and we need 5 cents to cover cost. The 63 cents would be invested in a safe investment like US government securities with a specific rate of interest. The company would use 32 cents (1.00-.68) to buy a call for that period. It would use caps and participating rates to reduce possibility of loses.

******

Mid-term withdrawals could have on interest credits. If an annuitant takes out money in a certain period of time, the return is reduced substantially. Depending on the get enough or cheat themselves in the long run on the value.

a. Difference between a minimum nonforfeiture interest rate and a minimum annual credited interest rate.

1. Minimum nonforfeiture interest rate- it is the minimum amount that an annuity can earn by contract. It is always a guaranteed rate.


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2. Minimum annual credited interest rate- Could be zero or more. Depending on the participation rate, it is not a guaranteed rate beyond one year.

b. Historical perspective and the realities associated with the following:

1.Hypothetical models- Insurers have to take the interest rates, options, and prices at the time and recreate the participation rates, margins, and cap levels that could have existed. It is impossible to reconstruct participation rates would have been. The economy is continually changing and with it new assumptions. One of the problems of using historical data in a hypothetical is the product may not have existed at the time and may not reflect the results.

2. Actual returns- what the annuity actually does. It does show what it actually did. Variables make the numbers change. NAIC requires illustrations to show for only those years where the annuity has been in place. All others are considered hypothetical.

3. Renewal rates- This is the rate credited by the company after the end of the set time period. Depending on interest rate at the time, it could be lower or higher.

B. Typical riders that are available for annuities.

1. Life insurance riders- Life insurance riders are provisions that have been added to the original contract to give it more benefits and meet the needs of the insured. Usually costing an additional premium, life insurance riders can also be used to take benefits away from the policy. The annuitant is guaranteed a minimum of what one puts in it.

2. Long-term care benefit riders- These specific riders are added to insurance contracts to provide long-term care benefits for skilled nursing home care, custodial care, and home health care. Benefits are paid out in daily, weekly, or monthly intervals


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when the insured cannot perform the critical activities of daily living (ADL’s). These ADL’s include dressing, eating, toileting, and bathing. Any numbers of daily, independent routines are measured as ADL’s. If an annuitant is in a nursing home for 90 days, there will be no penalties on money withdrawn to pay for those nursing care bills.

3. Guaranteed minimum withdrawal benefit riders- this rider sets a minimum withdrawal for each annuity. The limit is generally 10% of the amount in the annuity policy. The reason being the cost of handle the transaction and mailing cost.

4. Guaranteed minimum death benefit riders- in some contracts, the company may pay a death benefit to the beneficiary if you die. This happens before income payments start. Accidental death is a type of rider that provides an additional death benefit if the death is due to an accident. Normally, death must take place within 90 days of the accident for the benefit to be compensated.


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1. Common waiver of surrender charges would bea. Unemploymentb. Terminal Illnessc. Nursing home d. All of these

2. The portfolio method of crediting interest would not includea. Return of all investment held in the general accountb. Return on new investment onlyc. Returns on older bonds with higher ratesd. Returns on all investments with various maturity dates

3. The date when the annuity payments start isa. Date of applicationb. Issue datec. Annuity dated. Maturity date

4. The interest rate that is set at the start of an annuity isa. Initial rateb. Renewal ratec. Minimum rated. Retention rate

5. John wants an income from his annuity to last for at his lifetime and his spouse. What would you recommend that he purchase?

a. Straight life annuityb. Joint and survivor annuityc. Temporary annuityd. period certain and life thereafter


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Chapter 3 Primary Advantages and Disadvantages of Annuities

Guaranteed principal- Age does not affect guaranteed principal. The annuitant will always get whatever money they have put into it less any early surrender charges. Depending on when the fixed annuity contract was issued, the interest rate set by law could have been 4%, 3% and in recent years it is 1 ½ % annually. The most fixed annuity contracts are covered under the State Guaranty Fund that protects the owner from insurer becoming bankrupt for up to $300,000. In the next paragraph, more information on the guaranty fund is provided. For the most conservative individuals, fixed annuities are alternative to certificates of deposit at the banks. Given the restricted investment options for insurance companies, the interest earn is modest. When compared to United States Government Notes, the topical fixed annuity will provide a better interest rate than a 10 year United States Government Note. Insurers do invest in mortgages, real estate that generating rental income and a very limited amount (<5%) in the stock market. Fixed annuities are more suited for those near retirement age or older. Clients at any age wanting a conservative way to save for retirement and looking for tax deferral. Older clients in many cases are looking for a way to pass assets to family members privately without going through probate will want to examine annuities or single premium whole life contracts.

Insurance policyholders and beneficiaries of policies issued by an insurance company that has become insolvent and is no longer able to meet its obligations are covered under the insurance guaranty associations. All states, the District of Columbia, and Puerto Rico have insurance guaranty associations. State law requires Insurance companies to be members of the guaranty association in states in which they are licensed to do business.

There are two types of state guaranty associations: a life and health guaranty association and a property and casualty insurance guaranty association. Annuities, individual and group life insurance policies as well as, long-term care and disability income insurance policies are covered by life and health guaranty associations.

When the assets of an insurance company are insufficient to pay policyholder claims, a guaranty association will assess member insurers that write the same kind of business as the insolvent insurer to fund the shortfall. First the assets of the failing insurer are used and then these assessments are used to pay, up to statutory limits to covered claims of policyholders of the insolvent company. The association will continue coverage for the policyholder until those policies can be transferred to healthy insurers.

In practice the home state of the insurance company will appoint a receiver to gather assets and determine the underfund amount needed to pay claims. Each state association’s coverage of insurance company insolvencies in their state and the funds


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come by way of post-insolvency assessments of the guaranty association member companies. Members’ assessments are based on each their share of premium during the prior three years. The states allow the assessed insurers to take an offset on state premium taxes. This allows insurers a way to recover all or a portion of the assessment.

The National Association of Insurance Commissioners (NAIC) developed a model law with suggested amounts of protection. Each state set amount of coverage provided by the guaranty association by state statute and differs from state to state. Most states enacted the following amounts of coverage:

• $300,000 in life insurance death benefits

• $100,000 in net cash surrender or withdrawal values for life insurance

• $250,000 in present value of annuity benefits, including cash surrender and withdrawal values (payees of structured settlement annuities are also entitled to $250,000 of coverage)

• $300,000 in long-term care insurance benefits

• $300,000 in disability income insurance benefits

An overall cap of $300,000 in total benefits for any one individual with one or multiple policies with the insolvent insurer has been adopted by most states.

Priority is given to claims against the failed insurer where the benefits exceed the above limits. The policyholder may receive additional payments as the insurer’s assets are liquidated. Since each state is different, it would be wise to contact the local Insurance Commissioner or Director.

When employers have used unallocated annuity contract for funding their retirement plans for their employees, most state guaranty associations provide coverage. If the annuities are covered, the limit is typically $5 million for all unallocated group annuity contracts issued to the contract holder. It makes no difference with the number of covered employees is 1 or 1,000. Guaranteed investment contracts (GICs) are not covered in many states.

Each guaranty association is governed by a board of directors and the state’s insurance regulator. All state guaranty associations are members of the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA). When an insolvent life insurer has policyholders in multiple states, the activities of the various guaranty associations are coordinated by NOLHGA. This group provides technical expertise and resources to the state guaranty associations. It also serves as a national forum to discussion issues faced by state guaranty associations.


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With a fixed annuity contract, the insurance company assumes all of the investment risk and the annuitant gets guaranteed and predictable check on a regular basis. If the investment of the insurance company does not hit the interest marks, it is their problem not the annuitant. The annuitant has peace of mind.

Purchase of a fixed annuity simplifies the retirement planning and the same with tax planning. There is no need to hire an investment advisor since the insurance company handles. The annuitant need not worry about declining stock market or dropping interest rates. Since income is predictable, making quarterly income tax deposits are made easier.

Since after-tax dollars are used in most annuities, the owner’s cost basis is the amount paid in. The owner is not required to pay taxes on their cost basis when withdrawals are made. Annuities offer individuals the option for rollovers from qualified plans. This option would be important to those employees who are leaving because disability, retirement, job changes, layoffs or other termination. This option can be helpful to a surviving spouse at the death of the employee.

Assets and Investments1

Assets held by life insurers back the companies' life, annuity, and health liabilities. Accumulating these assets, via the collection of premiums from policyholders and earnings on investments, provides the U.S. economy with an important source of investment capital. At the end of 2014, life insurers had $5.8 trillion invested in the U.S. economy. Life insurers' represent one of the largest investors in U.S. capital markets:

Life insurers are a major source of bond financing for American business, holding 20% of all U.S.corporate bonds. Life insurers invest in American business for the long-term. More than one-third

(37) % of general account bonds held by life insurers had a maturity of more than 20 years at the time of purchase. More than two-thirds had a maturity of more more than 10 years.

Of the $745 billion in government bonds held by life insurers, the overwhelming majority, $713 billion, were in long-term obligations.

Life insurers provide long-term capital to the commercial mortgage market, financing more than $386 billion, or one-eighth, of U.S. commercial mortgages

Variable annuities offer many benefits to purchasers.

1

1


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One key benefit is the opportunity to select investments for their funds. Since insurance companies are limited to where they can invest, this gives the annuity owner the opportunity to greater growth. This opportunity comes with risk because their investment choices may not perform as expected or the market may be down at the time the money is needed.

Variable annuities guarantee payments as long as the annuitant lives because of the mortality guarantee. Insurers charge a mortality expense risk fee from those selected investments held in separate accounts. This mortality fee protects the annuitant and insurer from the risk that the annuitant outlives the expected morality.

Another feature is the expense guarantee. This feature establishes the maximum fees that insurance companies can charge the annuity owner. Just like the mortality expense risk, the expense risk fee is deducted from selected investments held in separate accounts.

Most annuities offer a death benefit in case the annuity owner dies during the accumulation period. This provision offers the beneficiary to select the greater of premiums paid or the accumulated values at the time of the owner’s death.

Since the owner selects investment, those funds are held in separate accounts away from the insurer’s general account and are not subject to recovery in the case of the insurer filing bankruptcy.

Given the returns on stocks over time, the variable annuities offer the owner an opportunity of a lifetime income that is more likely to keep up with inflation. The one thing to keep in mind, the selected investments can decline at the same times of rising inflation if the market is declining.

Variable annuity owners have voting rights that can be exercised in person or by proxy. Those rights involve elections of the board of managers, changes in: investment advisor, custodian, transferring agent, and investment objectives. The votes are based on units which is similar to mutual fund shares. Variable products and mutual funds are governed by the Investment Company Act of 1940.

Variable annuity owners have the right to exchange investments within the family of funds without a sales charge or tax consequences. This allows the owner to change from one separate fund to another. As clients age, they should reduce risk and this option gives them the opportunity to move money from stocks to bonds for example.

There is a qualified retirement plan available to public school employees, hospital workers, and nonprofits {these nonprofits would defined by the IRS as 503(c) (3) employers}. Employer must sponsor the plan and employer contributions are


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optional. The employee can elect to take a salary reduction to fund their contributions. For the employee, they save on social security and income tax by contributing. For the employer, they save on social security, Medicare, unemployment and workers compensation expenses. In 2017, the employee can annually contribute up to $17,500 and if age 50 and older a “catch-up” rule allows an additional $5,500 a year. In addition to fixed and variable annuities, the employee can purchase CDs, mutual funds and other investments. As with other plans, withdrawals prior to age 59 ½ are subject to an IRS penalty of 10% and must be reported as income and is subject to taxes. This is in addition to a surrender charges.

Sales charges on Variable annuities are limited by regulation.o The lifetime maximum charge of 9%.o The level load charges limit charges to 20% of the premiums paid

in any one year with limit sales charges for the first four to not to exceed 16%. After one year, no refunds are available except the Net Asset Value (NAV) less any surrender charges.

o Front end charges limits sales charges a maximum of 50% of the premiums paid. The owner has the right to cancel the contract and receive the Net Asset Value and a refund of sales charges that exceed 15% during the first 18 months of the contract.

There are some disadvantages to look at as well. If a consumer purchases a fixed annuity without a cost of living benefit, they

could see their purchasing power decrease over time. The chart below shows the effect over time and for various inflation rates. Assuming an inflation rate of 3 percent, the annuity providing $40,000 a year in current dollars would only purchase about half of that amount after 22 years. Retirees in their 80’s spend much more on health care. In addition, at some point most retirees hire out tasks that they used to do for themselves.

Taken from ACLI.com website ________________


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Effects of Inflation on Purchasing PowerYear 2% 3% 4% 5%

1 $ 39,200.00 $ 38,800.00 $ 38,400.00 $ 38,000.00

2 $ 38,416.00 $ 37,636.00 $ 36,864.00 $ 36,480.00

3 $ 37,647.68 $ 36,506.92 $ 35,389.44 $ 35,020.80

4 $ 36,894.73 $ 35,411.71 $ 33,973.86 $ 33,619.97

5 $ 36,156.83 $ 34,349.36 $ 32,614.91 $ 32,275.17

6 $ 35,433.70 $ 33,318.88 $ 31,310.31 $ 30,984.16

7 $ 34,725.02 $ 32,319.31 $ 30,057.90 $ 29,744.80

8 $ 34,030.52 $ 31,349.73 $ 28,855.58 $ 28,555.00

9 $ 33,349.91 $ 30,409.24 $ 27,701.36 $ 27,412.80

10 $ 32,682.91 $ 29,496.97 $ 26,593.31 $ 26,316.29

11 $ 32,029.25 $ 28,612.06 $ 25,529.57 $ 25,263.64

12 $ 31,388.67 $ 27,753.69 $ 24,508.39 $ 24,253.09

13 $ 30,760.90 $ 26,921.08 $ 23,528.05 $ 23,282.97

14 $ 30,145.68 $ 26,113.45 $ 22,586.93 $ 22,351.65

15 $ 29,542.76 $ 25,330.05 $ 21,683.46 $ 21,457.59

16 $ 28,951.91 $ 24,570.15 $ 20,816.12 $ 20,599.28

17 $ 28,372.87 $ 23,833.04 $ 19,983.47 $ 19,775.31

18 $ 27,805.41 $ 23,118.05 $ 19,184.13 $ 18,984.30

19 $ 27,249.30 $ 22,424.51 $ 18,416.77 $ 18,224.93

20 $ 26,704.32 $ 21,751.77 $ 17,680.10 $ 17,495.93

21 $ 26,170.23 $ 21,099.22 $ 16,972.89 $ 16,796.09

22 $ 25,646.83 $ 20,466.24 $ 16,293.98 $ 16,124.25

23 $ 25,133.89 $ 19,852.26 $ 15,642.22 $ 15,479.28


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24 $ 24,631.21 $ 19,256.69 $ 15,016.53 $ 14,860.11

25 $ 24,138.59 $ 18,678.99 $ 14,415.87 $ 14,265.70

26 $ 23,655.82 $ 18,118.62 $ 13,839.23 $ 13,695.08

27 $ 23,182.70 $ 17,575.06 $ 13,285.66 $ 13,147.27

28 $ 22,719.05 $ 17,047.81 $ 12,754.24 $ 12,621.38

29 $ 22,264.67 $ 16,536.37 $ 12,244.07 $ 12,116.53

30 $ 21,819.37 $ 16,040.28 $ 11,754.31 $ 11,631.87

At just three percent, the purchasing power of 40,000 has reduced to $21,751 at the end of 20 years. Fixed annuity owners will face reduction in real income at the time their medical expenses are expanding.

Another consideration is that the annuitant does not live to the expected age. Depending on the settlement options selected by the annuitant, there may be no future income and no residual. Once the settlement option is selected, it is irrevocable. That means no adjustment or changes.

Tax-deferred growth- For those under 65, this is more of an important item. Since they are still working, they are still able to add to the value.

a. The difference between taxable returns versus tax-deferred versus tax-free returns is simple. Income tax on annuities is deferred. The annuitant is not taxed on the interest as long as it stays in the annuity. The annuitant is earning interest on their funds plus interest on their interest. Since no income taxes are paid, the annuity owner gets interest on their unpaid income taxes. Over time,


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that tax deferral has an impact on the overall return. Examine the chart below to see the difference. In the first year, both the annuity and certificate of deposit earn 4% or $400.00. At a 30% tax rate, the CD owner nets only $280 (400-120[30% of $400]). The starting amount in the second year to earn interest for the CD is $10,280 and that process continues for the life to the CD. The starting amount for the annuity in the second year is $10,400 and that process continues for the life of the annuity. The owner of the certificate of deposit gets a Form 1099 for the interest earned. The Internal Revenue Service (IRS) treats any interest or earnings that you could have taken, but did not take as income to the taxpayer.

b. The long-term effect of tax-deferred compounding compared to taxable growth results in a 13% advantage for the annuity over the CD. If we assume the client can earn 4% over a 20 year period for an annuity and a CD, the impact is amazing. At the end of 20 years, the CD has grown $17,372.50 in it after taxing income taxes each year and the owner has netted $7,372.50 (17,372.50-10,000.00). The annuity has grown to $21,911.23 in that same period for a gain of $11,911.23 (21,911.23-10,000). That gain has not been taxed. Assuming the owner is still in a 30% tax bracket, income taxes due would amount to $3,573.37 (11,911.23 times 30%) for a net amount after taxes being $8,337.86. The difference between the annuity and CD is $965.36 (8337.86-7,372.50). Annuity outshines the CD by 13% (965.36 divided by 7,372.50)!!! It does matter where a client places their money. For many years, some financial advisers have shied away from annuities because of better returns elsewhere. In a low interest environment, fixed annuities have become more attractive. Safety of funds and reasonable rate of returns guaranteed in annuities are key features today.

Please review the chart on the next page.


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Annuity vs CD Chart For Educational Purposes Only & Does Not Reflect Current Interest Rates

Annuity 4%Certificate of Deposit 4%

Year Start Amount InterestEnd Amount

Start Amount

Interest

Taxes 30% End Amount

1 $ 10,000.00 $ 400.00 $ 10,400.00 $ 10,000.00 $ 400.00 $ 120.00 $ 10,280.00

2 $ 10,400.00 $ 416.00 $ 10,816.00 $ 10,280.00 $ 411.20 $ 123.36 $ 10,567.84

3 $ 10,816.00 $ 432.64 $ 11,248.64 $ 10,567.84 $ 422.71 $ 126.81 $ 10,863.74

4 $ 11,248.64 $ 449.95 $ 11,698.59 $ 10,863.74 $ 434.55 $ 130.36 $ 11,167.92

5 $ 11,698.59 $ 467.94 $ 12,166.53 $ 11,167.92 $ 446.72 $ 134.02 $ 11,480.63

6 $ 12,166.53 $ 486.66 $ 12,653.19 $ 11,480.63 $ 459.23 $ 137.77 $ 11,802.08

7 $ 12,653.19 $ 506.13 $ 13,159.32 $ 11,802.08 $ 472.08 $ 141.63 $ 12,132.54

8 $ 13,159.32 $ 526.37 $ 13,685.69 $ 12,132.54 $ 485.30 $ 145.59 $ 12,472.25

9 $ 13,685.69 $ 547.43 $ 14,233.12 $ 12,472.25 $ 498.89 $ 149.67 $ 12,821.48

10 $ 14,233.12 $ 569.32 $ 14,802.44 $ 12,821.48 $ 512.86 $ 153.86 $ 13,180.48

11 $ 14,802.44 $ 592.10 $ 15,394.54 $ 13,180.48 $ 527.22 $ 158.17 $ 13,549.53

12 $ 15,394.54 $ 615.78 $ 16,010.32 $ 13,549.53 $ 541.98 $ 162.59 $ 13,928.92

13 $ 16,010.32 $ 640.41 $ 16,650.74 $ 13,928.92 $ 557.16 $ 167.15 $ 14,318.93

14 $ 16,650.74 $ 666.03 $ 17,316.76 $ 14,318.93 $ 572.76 $ 171.83 $ 14,719.86

15 $ 17,316.76 $ 692.67 $ 18,009.44 $ 14,719.86 $ 588.79 $ 176.64 $ 15,132.01

16 $ 18,009.44 $ 720.38 $ 18,729.81 $ 15,132.01 $ 605.28 $ 181.58 $ 15,555.71


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17 $ 18,729.81 $ 749.19 $ 19,479.00 $ 15,555.71 $ 622.23 $ 186.67 $ 15,991.27

18 $ 19,479.00 $ 779.16 $ 20,258.17 $ 15,991.27 $ 639.65 $ 191.90 $ 16,439.03

19 $ 20,258.17 $ 810.33 $ 21,068.49 $ 16,439.03 $ 657.56 $ 197.27 $ 16,899.32

20 $ 21,068.49 $ 842.74 $ 21,911.23 $ 16,899.32 $ 675.97 $ 202.79 $ 17,372.50

End of 20 years $ 21,911.23 $ 17,372.50

Basis $ 10,000.00 $ 10,000.00

Growth $ 11,911.23 $ 7,372.50Less Taxes 30% $ 3,573.37 $ -

Gain $ 8,337.86 $ 7,372.50

Difference $ 965.36

% of Gain over CD 13%

Effects of Inflation on a Fixed Annuity

Income distributions- 1. Settlements options-In 1906, the state of New York enacted the first

statutes to permitting settlement options in life and annuity contracts. Some individual insurance companies had been offering contracts with installment options in place of lump sum payments to beneficiaries.

Limitations on Settlement Options Most companies establish some minimums on the method of payments to annuitants and beneficiaries in the interest of economy of operations and efficiency. The limits involve the amounts held and limitations on withdrawals. The contract could require a minimum dollar amount of payouts. For example, the policy states that payments must

be at least $50 before a check will be issued. In the case where the payment from the money held would be $30, the insurer would issue a check every other month for $60.

Limits on Amounts Held. It is highly inefficient to make payments in small amounts over a long period of time. Companies will have a stated minimum amount like $50.00

a. Straight Life- The insurance company will pay the annuitant for the largest income for their lifetime. Since the annuitant gets the most out of these payments, this is the life annuity’s major advantage. The life option provides a series of guaranteed payments for as long the annuitant is alive. The life annuity


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does have two distinctive disadvantages. First, once the annuitant dies, no more payments are ever made. If the annuity consists of a left over principal, it is deferred back to the insurance company. Insurers use the balance of those dying early to fund those who beyond their life expectancy. The annuity is included the deceased’s estate for estate tax calculation. This particular option would most likely be used by a person who does not have dependents to financially support. The second disadvantage is that there are never a set number of payments which are definite. This means that no other payments are ever guaranteed.

b. Period certain with life thereafter- In this option, the annuitant chooses a period of years to receive payments (10 years, 20 years). Payments are still completed for those set years even if the annuitant dies. A minimum number of payments will always be made to the annuitant. If the annuitant lives longer than the period certain, they will receive payments until their death. If the annuitant dies during the period certain, the named beneficiary will receive payments until period certain ends. The minimum amount to be paid out is known and the annuitant gets greater protection. Because of this safety feature, the amount of periodic income will be lower than a straight life option would pay. These are chief advantages to purchasing a life with period certain annuity.

However, life with period certain does have its drawbacks. If the annuitant dies after period certain, no more payments will be made to the beneficiary either. Payments to the beneficiary will end after the guaranteed time payment. This additional benefit’s income payment will always be lesser than the life only selection.

c. Joint survivor- Joint survivor annuities major advantage is that the annuity will make payments as long as both the annuitant and spouse are living. Payments will also continue until the last annuitant dies. Joint options are set up to pay a higher income while both individuals are living. If one dies early, then the annuity can be chosen to reduce the amount to the existing member. Joint survivor does have disadvantages as well. Given that living expenses are higher when both are alive. A reduction expenses takes place when one of the annuitants passes away. The survivor’s payments are typically ½ or ¾ the original amount. Annuitants can elect to provide 100% of the amount to the survivor, but doing so will reduce the payments.


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The reason is that the insurer could be paying benefits for a much longer time. Social Security recently reported that a married couple turning 65 in 2017 has a 25% chance of one on them being alive at age 96. This allows for lower income payments to last longer. As the survivor benefit is an added option, every income payment is smaller than the life only option as well.

d. Fixed Period - An individual can elect a settlement option for some fixed period of time. This is a simplest of options. The insurer agrees to retain the proceeds in their general account and make regular payments in equal installments for a period of time decided by the contract owner. An example would be of that of a person who’s 60 who has an annuity contract and wants to retire but cannot start receiving social security benefits until age 62. That person would elect to annuitize their contract to receive payments for the next six years until they file for full social security benefits. Those benefits would be 24% greater than if they started them at the age of 62.

Fixed Years Installment TableII.

Monthly Installments that $1,000 will obtain for number of years elected.

No. of Years Elected

Monthly Installments





1 $ 84.68 11 $ 8.88 21 $ 5.33

2 $ 42.96 12 $ 8.26 22 $ 5.16

3 $ 29.06 13 $ 7.73 23 $ 5.00

4 $ 22.12 14 $ 7.28 24 $ 4.85

5 $ 17.95 15 $ 6.89 25 $ 4.72

6 $ 15.18 16 $ 6.54 26 $ 4.60

7 $ 13.20 17 $ 6.24 27 $ 4.49


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8 $ 11.71 18 $ 5.98 28 $ 4.38

9 $ 10.56 19 $ 5.74 29 $ 4.28

10 $ 9.64 20 $ 5.53 30 $ 4.19

The biggest advantage for choosing fixed period for an income distribution is that the annuitant will receive a monthly check for those years. The annuitant will always be able to depend upon its arrival.

The obvious disadvantage to period certain is that once you use the benefits, the money is no longer available to the annuitant because it has been paid out.

Cash refund- If you don’t draw out the principal, the balance is refunded to the beneficiary. This is a one-time payment. The disadvantage is that the monthly income check will be lower because they have guaranteed a benefit to their survivors.

The advantages and disadvantages of Annuitization options.

Straight Life- The primary advantage is that the annuitant will receive the largest possible check because there is no residual benefit. This means that if the annuitant dies, the contract ends will no additional payments made to anyone. Without survivors, this is the best alternative. Some disadvantages are present also. One is that when the annuitant dies, no additional payments. If there are survivors, and the annuitant has not received enough in payments to break even, the family has lost an asset that cannot be recovered. Another disadvantage is that if the annuitant realizes that they have a terminal illness after the purchase of a single life annuity, they cannot change the contract.

Life with period certain- One advantage is that if one dies early, the remaining principal will go to the beneficiary. One more advantage is that the annuitant is guaranteed to receive all of their money back in full. A disadvantage is that the mount of income is lowered.


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Joint life and survivor- One advantage of joint survivor options is that the payments last the lifetime of both parties. The disadvantage is that there is a reduction in income if one of the parties is to die early.

Fixed Period- One advantage of period certain option is that the annuitant will always get their minimum back. The payments will go to the annuitant or their beneficiary. The drawback is that the amount will be reduced.

Cash refund- An advantage is that the annuitant will get all their money at once. The setback is that once the contract is written, and the annuitant gets their first check, the annuitant cannot change the contract. No more money is available for cash refund.

The tax ramification of Annuitization Non-qualified annuities- The most important tax ramification of non-qualified annuities is that part of what the annuitant gets back is their principal. The remaining balance is interest. The interest is taxable.

Distribution Before Annuity Starting Date From a Nonqualified Plan

If the individual receives a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan (nonqualified plan), it is allocated first to earnings (the taxable part) and then to the cost of the contract (the tax-free part). This allocation rule applies, for example, to a commercial annuity contract you bought directly from the issuer. The taxpayer includes in their gross income the smaller of:

The nonperiodic distribution, or

The amount by which the cash value of the contract (figured without considering any surrender charge) immediately before you receive the distribution exceeds your investment in the contract at that time.

Example. The individual bought an annuity from an insurance company. Before the annuity starting date under the annuity contract, they received a $7,000 distribution. At the time of the distribution, the annuity had a cash value of $16,000 and the investment in the contract was $10,000. The distribution is allocated first to earnings, so the taxpayer must include $6,000 ($16,000 − $10,000) in their gross income. The remaining $1,000 ($7,000 − $6,000) is a tax-free return of part of your investment.

Exception to allocation rule. Certain nonperiodic distributions received before the annuity starting date aren't subject to the allocation rule in the preceding discussion. Instead, the taxpayer includes the amount of the payment in gross income only to the extent that it exceeds the cost of the contract.


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Qualified annuities- The most important issue of qualified annuities is that all the money in the annuity is taxable. All the money earned on what is drawn is taxed.

For this purpose, a qualified retirement plan is: A qualified employee plan (or annuity contract purchased by such a plan), A qualified employee annuity plan, or A tax-sheltered annuity plan (403(b) plan).

The following formula to figure the tax-free amount of the distribution.

Amount Cost of contract Tax-freeReceived X Account balance = Amount

For this purpose, the account balance includes only amounts to which individual has a nonforfeitable right (a right that can't be taken away).

Example. Ann Brown received a $50,000 distribution from her retirement plan before her annuity starting date. She had $10,000 invested (cost) in the plan. Her account balance was $100,000. She can exclude $5,000 of the $50,000 distribution, figured as follows:

$10,000$50,000 X $100,000 = $5,000

Loans Treated as Distributions If an individual borrows money from their retirement plan, the taxpayer must treat the loan as a nonperiodic distribution from the plan unless it qualifies for the exception to this loan as distribution rule explained later. This treatment also applies to any loan under a contract purchased under the retirement plan, and to the value of any part of their interest in the plan or contract that individual pledge or assign (or agree to pledge or assign). It applies to loans from both qualified and nonqualified plans, including commercial annuity contracts an individual purchase directly from the issuer. Further, it applies if the individual renegotiate, extend, renew, or revise a loan that qualified for the exception below if the altered loan doesn't qualify. In that situation, the taxpayer must treat the outstanding balance of the loan as a distribution on the date of the transaction. The individual determines how much of the loan is taxable using the allocation rules for nonperiodic distributions covered earlier. The taxable part may be subject to the additional tax on early distributions. It isn't an eligible rollover distribution and doesn't qualify for the 10-year tax option.

Exception for qualified plan, 403(b) plan, and government plan loans. At least part of certain loans under a qualified employee plan, qualified employee annuity, tax-


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sheltered annuity (403(b) plan), or government plan isn't treated as a distribution from the plan. This exception to the loan-as-distribution rule applies only to a loan that either:

Is used to acquire your main home, or

Must be repaid within 5 years.

If a loan qualifies for this exception, the taxpayer must treat it as a nonperiodic distribution only to the extent that the loan, when added to the outstanding balances all loans from all plans of their employer (and certain related employers, defined later) exceeds the lesser of:

$50,000, or

Half the present value (but not less than $10,000) of their nonforfeitable accrued benefit under the plan, determined without regard to any accumulated deductible employee contributions.

The taxpayer must reduce the $50,000 amount if participant already had an outstanding loan from the plan during the 1-year period ending the day before the participant took out the loan. The amount of the reduction is the highest outstanding loan balance during that period minus the outstanding balance on the date the participant took out the new loan. If this amount is zero or less, ignore it.

Substantially level payments. To qualify for the exception to the loan-as-distribution rule, the loan must require substantially level payments at least quarterly over the life of the loan. If the loan is from a designated Roth account, the payments must be satisfied separately for that part of the loan and for the part of the loan from other accounts under the plan. This level payment requirement doesn't apply to the period in which participant is on a leave of absence without pay or with a rate of pay that is less than the required installment. Generally, this leave of absence must not be longer than 1 year. The participant must repay the loan within 5 years from the date of the loan (unless the loan was used to acquire their main home). The installment payments after the leave ends must not be less than the original payments.

Retirement savings- As a way of a retirement plan, an advantage of having an annuity is it guarantees that there is no loss of your own money. Another advantage affords protection against what a creditor can get at if the annuitant is forced to file bankruptcy. Each state sets their rules involving annuities and creditors. Some states like Illinois and Missouri protect all the funds from creditors. Other states, like Iowa, protect only $15,000 of an annuity value. The major disadvantage is that it the return is severely limited because of its growth.

Potential to avoid probate- Probate literally means to prove the will. Depending on the value of the deceased’s estate, probate can get very expensive. The advantage of


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having an annuity is that they avoid probate and go straight to the beneficiary by contract without exposure to creditors or public notice. The beneficiary can then get access to the money in the annuity. Or they can choose to assume contract ownership and continue the contract themselves. One disadvantage of avoiding probate is that the value of the annuity is still included in the estate of the deceased for federal tax purposes. Although a beneficiary will collect the value tax-free, the annuity’s value is required to be integrated. Another disadvantage of avoiding probate is that if no beneficiary is listed, the annuity value goes back to the estate as an asset and is subject to probate.


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1. Which of the following would be a disadvantage to annuitiesa. Funds grow taxed deferredb. Subject to early withdraw penalty of 10% if under age 59 1/2c. Transfers by contract at deathd. Annuitant elect date to receive income

2. Under state guaranty fund, a fixed annuity would be cover for what amount?

a. $300,000b. $250,000c. $150,000d. $100,000

3. In what case would an annuity be subject to probate?e. Beneficiary is a minorf. Beneficiary lives in other stateg. Second beneficiary dies before contract ownerAnnuitant outlive their beneficiaries

4. Sally purchased an annuity with after tax dollars and paid premiums totaling $10,000 with a current value of $16,500. Sally is age 60 and wants to know how much she can withdrawal before paying income tax.

h. Nothing since all is taxedi. $16,500 since it is after tax dollarsj. $10,000 since she paid in that amountk. She would be subject to a 10% early withdrawal penalty in

addition to taxes on any withdrawals


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Chapter 4

Fixed and Indexed Life Products

Types of Life Insurance

Fixed productsParticipating whole life insurance-This type of life insurance is intended to extend coverage for the insured’s whole life. The insurer assumes that all insureds are dead by age 100. Those living to age 100 will receive the amount equal to their death benefit. To ensure a level premium, the premium at the younger age will always surpass the real cost of protection. The additional premium creates a legal reserve (cash value) combined with the interest earned guarantees the policy has enough reserves to pay out the death benefit at age 100 of those insureds that make it. An actuary takes into account the cost of pure insurance, expected lapse rates, expected rate of returns on investments, operating expenses and a profit factor in coming up with the premium rates. Over a longer phase of time, the calculation will be proven accurate or not.


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If the results of insurance pool are better than calculated by the actuary, insurer will have a larger profit. Policy owners get to share into the profits of the mutual insurance company. Participating whole life policies pay dividends. Dividends are never guaranteed. These dividends come about because the company has experienced a profit. This profit comes from investment earnings, reduction in expenses, or a reduction in the mortality. The reduction in the mortality rate means that the company expects fewer to die in a given year. The result is that they have fewer. An example is that in 1900 the life expectancy was 49 years old. A child born this year has a life expectancy of about 80 years old. For the insurance company, if they calculated on 49 years old, and the insured lives to age 80, the insurer makes a profit which is used to pay for those that die earlier then their life expectancy. The underwriting process is designed to identify those individuals whose health would indicate any early death and price the risk properly. Where insurance companies do a great job of underwriting, those companies tend to be more profitable. That money is invested and continues to grow. In addition, as the population lives longer on average, they are paying premiums longer.

There are four dividend options of whole life: cash, reduction of premiums, accumulation at interest, and paid up additions. A very few companies offer a fifth option to purchase one year term insurance with the cash dividend. Dividends are declared by the insurer’s board of directors and each company has a complex formula to calculate the dividends based on the returns of their general account and client’s share of those profits. At the death of the insured, the insurance company pays a terminal dividend to the beneficiary.

a.) Cash payment is when the insurance company sends the policyholder a check for their dividends (share of profit). Dividends are not at all certain.

b.) The second, reduction of premiums, the dividend is subtracted from the premium, and the annuitant pays the now reduced amount. An example is when the policyholder has a dividend of $300 and their annual premium payments are $1200; the company will bill the difference to the policyholder. The $900 difference is now the reduced amount.

c.) The third dividend option is accumulation at interest. Under this option, the policyholder leaves the dividend with the company and the company credits interest on that amount based on what they earn on their general account. The general account is all the money that the company has invested. The policyholder is credited whatever rate of return the general account returns. That amount is added to accumulation at the end of each policy year. An example is that dividend is $500 and the general account earned an average of 6%. This means that $30 would be added to the dividend. The total $530 is the accumulation of interest. This is generally thought of like a savings account, with its interest income taxable. Each year the dividend is added and each year the policyholder receives a 1099 for the interest earned. When the insured dies, the insurance company pays the death benefit and the total accumulations in the policy to the beneficiary.


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d.)The final dividend option is paid up additions. Paid up additions is additional life insurance based on the amount of the dividend and the current age of the insured. All things being equal, the younger the insured, the more the additional insurance is. This additional insurance is without any sales charges and costs the policyholder nothing. Let us assume that the dividend is $200 and the insured is 24 years old. This $200 dividend would add $600 in additional death benefits. This same $200, but the insured is age 50, now the additional death benefit would only be $300. These paid up additions are added to the face amount of the policy each year. If the insured dies, the face amount plus the paid up additions are paid to the beneficiary. Should the insured elect, they can surrender those dividends for their cash value without affecting the policy that generated the dividends.

Interest Sensitive Whole Life- Interest sensitive whole life allows the insured to allocate earnings differently on interest in order to reflect the current fluctuations in interest levels. This type of insurance is designed to credit the policyholder for more than the guaranteed interest rate. Interest sensitive whole life is modified in two ways. The first has the insurance company determining their premium levels by averaging the lowest mortality rate and highest interest hypothesis. Second, the insurance company uses accumulation funds, undefined premiums and surrender charges to integrate into their averages. Accumulation funds are money that the insurance company has earned on funds in their general accounts. There are two ways to substantiate accumulation funds.

1. The first approach has the insurance company guaranteed fixed rate of return on scheduled, cash values of the policy. Any excess earnings are put into a separate account. The cash value that results is a combination of scheduled cash value plus the separate account.

2. The other approach only has one account. It is credited only on that account. Either instance to determine accumulation funds will end in the similar result.

Universal Life Insurance-This type of insurance is used as an alternative to whole life insurance. The policy can be changed to suit the insured’s financial and insurance needs without issuing a new policy. Universal life even allows the insured to change or skip premium payments easier than other policies. It will also provide one of two death benefits along with cash value account. The first death benefit will allow the beneficiary to receive the face value of the policy. The second death benefit will allow the beneficiary to collect both face amount and the cash value account. The policyholder pays a premium from which the insure deducts an expense charge and a mortality charge. The balance is credited to the cash value account that is invested by the insurer. After initial premium payment, the status of the policy depends upon how often premiums are paid, how much is paid, the amount of interest earned on the cash value


47


and whether the death benefit is changed. Policyholders can increase premium payments, decrease the premium amount, or skip premium payments as long as the cash value account can pay the monthly expenses and mortality charge. If the insured pays less than the planned premium it is very realistic that no cash value will be added to the policy. Withdrawals from the cash value will not affect the death benefit. The interest rate on the cash value account will vary but is usually guaranteed an initial period. Guided by a statutory law if during the first seven years of the policy, the dollar amount in the cash value account increases to be the same or more than the death benefit amount, the insurer will make adjustments to the death.

Term Life Insurance- Term life insurance provides financial protection for a limited period of time. The insurance company is liable for the policy’s face value only if the insurer dies during the period of the contract. If the insurer dies within that period, the face value of the contract is paid to the named beneficiary. If there is no named beneficiary, then the face amount is paid to the estate of the insured. Depending on the selection taken, the policy may be renewed for the stated period for the same coverage but the premiums are based on their current age. This option is guaranteed renewable and the insured is permitted to renew the contract. The insurance company must renew the contract despite the condition of the insured’s health. If the policy does not include the renewal provision, the insurance company can elect not renew the policy. There is a type of term life called reentry term which allows the insured to renew the contract, but in order to qualify for better rates; they must prove that they are insurable If their health is poor, the insurance company can charge a higher premium. Three limitations of term life insurance are that it is a limited period of protection, the premiums steadily increase as the insurer ages, and that they build no equity.

Indexed life- This policy differs from an ordinary whole-life in that the face amount of the contract changes based on a prescribed price index. The most common index is the consumer price index (CPI) and the death benefit increases based on changes in that particular index. The policyholder elects the option of having the index applied either repeatedly or on a voluntary basis. If the policyholder chooses the automatic index increase, the premium remains the same because it has already been factored to reflect the automatic increase. If the policy allows for an optional index increase, an additional premium is charged when this choice is exercised by the policyholder. The increase death benefit would not trigger any more physical examinations or any other proof of insurability. Since the policy factors in the increase in death benefits, the contract will have more fees or reduction in cap or participation rates.

The primary advantage of an indexed life contract is the benefit keeps up with the changes in the consumer prices. As a direct opposite of a indexed life, whole-life contracts provide a constant death benefit that will not change over time.

Certain disadvantages also accompany indexed life policies. The premiums tend to be higher than an ordinary whole-life contract. They also may not of the kind of gains made in variable life contract In addition, if there is no change in the CPI, the death benefits


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would not increase as compared to a dividend paying whole-life contract. Index annuity contracts popular when inflation was at its peak and sales have declined since that time. Variable Life Insurance-- Variable Life Insurance is a whole life insurance policy which provides protection to their beneficiary upon the policyholder’s death. It is considered variable because it grants a return linked to a basic portfolio of securities like bond and stock funds. The portfolio is the collection of mutual funds established by the insurer as an isolated account.

This major advantage allows the policyholder to take part investment alternatives while not being taxed on the earnings. Given that variable life policies do not guarantee any returns, it is possible that the policyholder can lose cash values by selecting a fund that does not do well. Basically, the stockholder assumes all the risks. The policyholder is given some investment advice inchoosing the blend of assets among available funds like common stock, bond, and money market funds, or a combination of thereof. Variable life guarantees fixed premiums and a minimum death benefit. Although the minimum cash value is rarely guaranteed. The better the total return on the investment portfolio, the higher the death benefit or surrender value of the variable life policy

Variable Universal Life- Variable universal life is another form of permanent insurance that builds cash value. It also will pay the death benefit if the annuitant dies at any time as long as there issufficient cash value to pay costs of insurance in the policy. The variable factor in its title refers to its capability to invest in unpredictable investments like mutual funds. The universal factor in its title show the flexibility the owner has to make the premium payments. All the stock investments have generated a higher return than most fixed interest items. Variable life will use part of the premium to cover the current costs of the of the premium to cover the current costs of the insurance protection with the balance invested in additional accounts. The extra interest credited to the cash value account depends on investment results of separate accounts (equities, bonds, real estate, etc.) The policyholder chooses their own accounts into which the premium payments are to be made. However, since this is an equity product, filing with the Securities and Exchange Commission (SEC), an annual prospectus, an audit of separate accounts, and agent registration with the National Association of Securities (NASD) is mandatory. This policy can be considered a replacement for universal life insurance when interest rates of U.S. Treasury issues and other money markets instruments are low. Certain tax advantages accompany Variable Universal Life policies. The first, tax free investment earnings, allows the policyholder to earn gains on their stocks without paying taxes. The second is that the death benefit is paid income tax free. This advantage is in effect once premiums are paid after tax money. The last advantage is that FIFO (first in, first out) the policyholder is able to take out your contributions first without any taxes.

Characteristics of fixed and variable life insurance.


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a. Fixed Life- Fully guaranteed (death benefit and cash values) The vast majority is invested in bonds or mortgage. Because of the safety of those investments, insurance are able to predict with certainty the cash values at some certain date. The investment risk is taken by the insurance company and the insured their death benefit and their cash values. In addition, the policy holder can elect to decide from two other Nonforfeiture values; reduced paid up and extended term. Premiums are locked for the life of the policy. If the insured lives to age 100, the death benefit will be paid to the insured.

b. Variable Life- The insured chooses from an array of funds that would include stocks, bonds, indexes. REITs and other types of investments. The death

benefit is assured as long as the insured pays their required premiums. Unlike whole life insurance, if the policy lapses, the only benefits existing will be the sum of the current value of investments.

Indexed Life and Indexed Annuities Common Features and Differences.

Similarities/ Terminology- There are 3 basic components – the index, the interest crediting rate cap and the participation rate.

a.) The index is tied to the market. It protects principal when market goes down. During down markets, indexes are protected from losses; no gains, no losses. In the 1990’s index annuities had huge growth and value. In late 1990’s, when market was down, the owners of index annuities suffered no losses and had no return on their money. The policyholder is able to lock in previous gains. Most indexes use so type of averaging or reset. Index contract are more tax efficient because they are not involved in any active trading of underlining securities. Each contract has a reset point, which could be each month or many years. At reset the value of the contract is adjusted to changes to the underlining index.

Interest crediting rate cap uses a prearranged cap for the return on an index. The most common are 100 percent, 90 percent, etc. If for example the index is up 20 percent and the policy has a 10 percent cap, the contract is credited 10 percent. These values are adjusted at the end of that period. That affects all of the money in the account.


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b) The participation rate is a rate that is applied to the index rate. Most common rates are 100 percent, 90 percent, etc. Under this method, the rate of growth of the index is multiplied by the participation rate. An example if the participation rate is 80 percent, and there is no cap, and if the index grew by 15 percent, the contract would be credited for 12 percent (80 multiplied by 15=12 percent). They grow income tax deferred. The basic similarity between the two is that they both use an indexing method to determine the amount of change in the index. There are tax-deferred interest earnings. Earnings are not taxed until they are withdrawn. The equity indexes links interest to the stock market. That means that if stock market goes up, the contract for a greater return than the minimum guaranteed rate. The contract owner has admission to the cash value at any time.

c.) Indexed Crediting strategies- This is one index methods used by both life and annuities. The crediting strategy commonly refers to the monthly, annual, or actual averaging of the index.

i. Mechanics- Under equity indexes, a portion of each of the premiums goes into a call option of some type of index. This call option, gives the company the right to buy the index at some future date when the option contract expires. The much larger part of the contract is invested in government or high quality corporation bonds. This provides the guaranteed returns in the contract. This feature reduces the inherent risk of investments while permitting the contract owner to share any gains in the market.

ii. Indices- The most common index used are the Standard and Poor’s 500. The S&P 500 is a market basket of individual stocks the representing the top 500 companies in the country. It is not 500 individual stocks. It is a weighted average where companies like General Electric and Citicorp account for about 3 ½ percent of this index each. Another index used is the Dow Jones 30.The Dow Jones 30 is made up of the largest 30 publicly traded companies in the country with each sector having a different weight. This index is over 100 years old. Its beginnings were originally made up of large manufacturers like those of the railroad, steel and coal mining. The Dow Jones 30 is a much narrower gauge of the health of the


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overall economy. Some of the newer indexes being used today are the Russell 1000, the Russell 2000, and the Russell 5000.These newer indexes are much broader to the economy since they take in smaller companies in the country.

Differences- In a variable life contract the face amount and cash value are adjusted based on the changes of the stock market. Life insurance also has a minimum interest rate. Even if the stock market goes down, the cash value is still credited for that annual year. In addition, because the face amount is tied to market returns, the insured can benefit in increases in the face amount or coverage.Since life insurance death benefits are not income taxable, if paid to named beneficiary, the insured is able to take market gains the insured is able to get income benefits to the beneficiary. If the annuitant withdraws money to 59 ½, those withdraws are subjected to 10 percent penalty. By contrast, the life contract allows the policy to borrow the cash value without any income tax consequences. Shouldthe policy owner to make a loan or surrender the contract, those withdrawals thatexceed the cost basis are subject to income tax at time of surrender.

Periodic premiums versus single premiums- Terminology associated with multiple segments or buckets. Multiple segments/buckets are best described as this: The contract owner allocates their investment into different segments/buckets. Those segments would be guaranteed contracts in government bonds or high-quality corporate bonds. The investor can also choose to put their money into riskier segments like junk bonds, energy funds, and international accounts. These riskier segments are usually tied to any number of indexes. At time of reset the contract owner gets the right to reallocate their funds between various segments.

Timing of premium allocation to indexed annuity strategies- Most index annuity allow for a one time only investment of a fixed amount. The least amount allowable is $5,000. Several companies do consent to additional minimum deposits starting at $100 or more. The best time to make the initial deposit is as early as possible before the reset date. Say there is an annual rest of December 31st every year, the best time to make a deposit or payment would be in January of that year. The benefit would be the growth from January until December 31st of that same year.

Annual premium payments-Under the annual approach, the annuity is credited annually. Numerous insurance companies reset the index each year on December 31st. The disadvantage is that the index could have changed a number of times during that year and this credited only from the start to the finish.

Monthly premium payments- Under the monthly premium payment approach; the contract is reset every month. Increases can be magnified as compared to an annual crediting. The notable disadvantage is that when there is a down market there will not be increases to credit because there is no increase in the index.


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Monthly deductions- Explanation of life insurance policy changes-Should the contract owner make changes in the contract, The contract owner’s elects to increase the face amount of the contract and there would be additional charges for the increased coverage.

Premium loads- Premium loads will include the administrative costs for index life. This administration fee is usually a flat amount; e.g. $30/ $40 annually to maintain the contract. Mailings of statements, premium notices, and other customer related services are deducted from the funds. Another approach could be that the company takes 2.5% of the account to pay for the above expenses.

Cost of insurance charges- In index life, the cost of insurance is based on the “at risk amount”. The “at risk amount” is the death benefit minus the amount of money that is already in the account. The cost of insurance is based on the insured’s current age. As the account increases, the amount December 31st of that same year of “at risk” should decrease because of the build-up in the account.

Expense charges- These are separate from the administration charges previously mentioned. The usual range is from 1% to 3% of the account amount. These charges would cover state premium taxes and other expenses of the company. Examples would be investments fees and advisor fees.

Alternative approaches to handling monthly deductions- Some companies will bill the client for administrative fees once a year. The client has the ability to pay those fees from other sources like their personal checking account. This allows the money would have reduced the account to grow income tax-deferred.

Impact on indexed interest credits when deducted from indexed crediting strategies- Equity index annuities contain a minimum guarantee interest that applies to the account value. Most companies will guarantee a 3% interest on 90% on the premium paid less any withdrawals or surrenders. Other companies will offer a 3% minimum on 87.5% of the premiums paid. This would also have a reduction from withdrawals and surrender charges. While others may offer a guarantee of 3% on all the premiums paid, this value would be adjusted at the end of the indexing period. Another approach would be the insurance company offers a floating rate based on all the premiums paid.

Underlying guarantees- The underlying guarantees of the index annuity is that the premiums paid in are protected against losses if the indexes were to go down.

Terminology- Both index life and annuities use caps, participation rates and a floor interest rate. In most index universal life contracts, the floor rate (minimum guaranteed interest rate) is set at zero. If the insurer offers a higher guarantee interest rate, the offset is a lower cap or participating rate shown in the policy provisions. With the


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traditional fixed Universal Life contract, the interest rate is higher and held in the general account of the insurance company

In some cases, insurers will offer a first year bonus interest rate to encourage clients to purchase an annuity. In the second year, the interest rate drops to a much lower rate. Other companies reward clients by way of a bonus for keeping the contract inforce for some fixed number of years. Generally if the bonus is paid to the client, it is offset by lower future interest rates or longer surrender charges.

Liquidity- Liquidity is generally known as the ability to make withdrawals from the account values which can be turned into cash quickly. The policyholder is able to get at their money through the values of the annuity without loss of principal. Depending on their age and basic adjustments, withdrawing early will affect the total liquidity of the annuity. With any annuity, the insurance company has agreed to buy back the annuity at any time from the policyholder for a known amount listed in the contract. Annuities are far more liquid than stocks or bonds. Since one does not have to find a buyer for the product because the insurance company will buy it back. This option guarantees that the client will get back part or all of their money.

Cash or surrender value surrender charges- Typically, when the annuitant gives up a full surrender of the annuity, its surrender value is in place. Most annuity contracts permit surrender of the policy for its scheduled surrender value. This value is the premium paid in, plus interest, less withdrawals and surrender charges. No matter what, the investor must be able to get at least 90 percent of what was invested along with 3 percent per year. There is always a minimum guarantee surrender value.

Transfer provisions- The policyholder is allowed to transfer money between various indexes without incurring additional expenses and sales charges. An example would be that the 60% of their money in an S&P 500 index account. They believe the market will go down. They can then elect to move part or all of their money that is in the S&P 500 account into a safer fund that guarantees 3% interest.

Withdrawals- Annuities occasionally consent to a definite amount of free withdrawal yearly. Depending on the contract, annuities will let the policyholder withdraw 10 percent of the premium each year. Be aware though, those under 59 ½ could be subjected to taxed penalties.

Tax treatment- Like other annuities, index annuities develop tax-deferred buildup of interest earnings in anticipation of being withdrawn. This is a fixed annuities biggest upside. Depending if the annuity meets the provisions of the IRS, interest received on the annuity is not taxed at the time it was accredited. The great benefit of tax-deferred interest is that it permits the policyholder to grow interest on their money that would work towards their retirement without taxes. In a regular taxed account the account


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holder must pay taxes on the growth each year. With annuities the policyholder does not have to pay taxes until they withdraw funds. Tax-deferral will also occur when the policyholder annuitizes their contract. Once the policyholder annuitizes the contract, part of that payment will return of premiums paid (tax-free) and part will be the gain or growth of those funds which are taxable to the annuitant. This allows the client to avoid paying a lump sum tax and permits them to spread the income tax liability over the annuity period. If the insured lives past the period certain, they still will pay the taxes on the gain.

Impact on death benefit- Since taking a withdrawal on the annuity could affect the death benefit provisions; a lump sum payout is an option to the beneficiary. If the beneficiary is the surviving spouse, they can transfer the annuity contract into their name provided the contract has not been annuitized. If the beneficiary is not the surviving spouse, that beneficiary has 5 years to withdraw all of the funds. They can avoid paying the full taxes by annualizing the contract within 60 days of receipt of the annuity payout. If they do not, the full amount will be taxable. All death benefits are passed to the beneficiary without going through the probate process. Lump sum is an option for the beneficiary but taxes must be paid at the time the distribution is made. Some contracts allow for a series of periodic payments over a minimum five-year period for annuitants over a certain age.

Impact on indexed interest credits- Another benefit of being able to defer taxes on interest credited to the annuity is that they allow that interest to be free of being included in the current income. Annuity interest is not incorporated as income for the intention of determining taxes on social security benefits. Therefore, they lessen the annuitant’s general income. That interest must be included sooner or later, but it is at the policyholder’s choosing.

Policy loans- Most annuity contracts allow policy loans. The annuitant is permitted to take out part of the annuity as a loan. If loans are taken out before the age 59 1/2, they may be subject to a 10% early withdrawal penalty from the IRS.

Types- fixed rate and variable rate-Fixed rate annuities have a guaranteed interest rate for the loans. The policyholder does not have to qualify for a loan and uses their annuity as collateral for the loan. If the policyholder does not repay the loan or pay the interest, the insurance company will deduct the interest from the amount in the annuity and the annuity contract will end when there is no value left in the annuity. Variable rate loans are another approach used in annuities. The policyholder is charged interest on the loans based on a market basket of commercial loans or based on the prime interest rate plus 2 points. Another way to figure variable loan rates would be the use of some U.S. treasury rates like a thirty year note or treasury bills.


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Tax treatment- The IRS treats loans as withdrawals and subject to income tax once the amount receives the policyholder’s cost basis. If withdrawals are made before the age of 59 1/2, the policyholder is subjected to a 10% penalty. Those over the age of 59 1/2, they are taxed on any gains. These gains are the account balance less premiums paid into the annuity. They are taxed at ordinary income tax rates.

Impact on death benefit- Under indexed life, while the death benefit is not subjected to income tax, the loan maybe subject to taxation. If the loan is less than the policyholder’s cost basis (premiums paid in), then there will be no income taxes taken out. If the loan is for more than the cost basis, then the gain will be subjected to ordinary income taxes. This gain will be considered income to the decedent. The estate of the deceased will be responsible for the income taxes and the beneficiary will not be obligated to pay those taxes. Under the indexed annuity, there will be no tax consequences for the annuitant prior to annuitizing the contract; since it was taxed when the loan was made. Prior to annuitization, the amount payable on the annuity would be reduced by outstanding loans and those proceeds would be paid to a named beneficiary if living. If not beneficiary survives, the money will be paid to the estate of the decedent.

Impact on indexed interest credits- Under indexed life, the interest on the loan will be deducted from the returns made on the index. If the returns were negative for the period, then the interest will be deducted from the principal in the index annuity. The death benefit of the indexed life would be reduced in the periods that the underlying investments were down. When the underlying investments have growth, the loan interest will reduce the credit for the growth. An example would be that the underlying investments had a 10% growth and if the interest rate on the loan was 7%, the indexed life contract would only grow by 3%. The indexed annuity is generally like that of the indexed life on how growth and loans are treated. The major difference is that if the underlying index is down, the loan interest will reduce the principal accordingly. This reduction in principal is in direct accordance to what the market does and if there is a loan on it. An example is that if the underlying index was negative, the principal would be reduced by 7%; or the current loan/interest rate.

Riders

Accelerated death benefit- This particular rider is planned by insurance companies to offer a cut-rate value of the death benefit to be paid in the event of certain unforeseen events. An instance of these events would be the onset of a terminal illness Terminal illness could either be death of the insured within one year by contracting a disease or lasting residence in a nursing facility. Accelerated death benefits riders will reduce the value of the policy. This rider allowed the insured to receive up to half the death benefits. In order to receive those benefits they must file a written request and provide an attending physician’s statement of terminal illness.


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Waiver of surrender charges upon confinement. In indexed life policies, if the insured is confined for 90 days or more in a nursing home, the insurance will waive all future premiums as long as the insured is confined. Normally the cutoff age for this benefit is 60. However, insurance companies can use a later age if they elect to. The contract will continue to grow in value while the insurance company is paying the premiums. If the insured is discharged from the nursing facility, they resume the premium payments. If the annuitant is resident of a nursing home for at least 90 days, the index annuity will waive any surrender and early withdrawal charges. The annuity owner must make a written request and the insured must approve it. Money in the annuity can be used for nursing home care.

Other riders- Under an index life contracts, a second insured could be added to the policy. This rider will allow for two people to be covered under one contract. There is a premium charge to add the second insured person.


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SAMPLE INDEX POLICY

XYZ Insurance Company

Policy Specifications

Annuitant: John S. Doe Policy Number 123456789Issue Date January 1, 2016Issue Age 30Sex Male

Annuity Start Date January 1, 2051

Single Premium $20,000

Index Standard & Poor’s 500*

Index Value at Issue Date xxx.xx

Participation Rate xx%

Term 10 years

*Standard & Poor’s® and Standard & Poor’s 500 are trademarks of the McGraw-Hill companies, Inc. and have been licensed for use by XYZ Insurance Company. This policy is not sponsored, endorsed, sold or promoted by Standard & Poor’s and Standard & Poor’s makes no representation regarding the advisability of purchasing this policy.

NONPARTICATIONG INDIVIDUAL SINGLE PREMIUM DEFERRED ANNUITY


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DEFINITIONS

Annuity Start Date The date that income payments are scheduled to begin.

Business Date A day in which the New York Stock Exchange is open for trading.

In Force The policy is in effect.

Issue Date The date this policy was issued

Participation Rate The percentage used to calculate the index increase. We will declare the participation rate on a basis which does not discriminate unfairly within a class of policies. Its value for the term is shown on the Policy Specifications page.

Policy The third page of the policy.Specification Page

Policy Year Twelve month periods measured from the issue date.

Term The number of policy years, as shown on the Policy Specification page, used to calculate the index increase. The term starts at the issue date. The end of the term is always the last business day before an anniversary of the issued date.


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GENERAL PROVISIONS

ContractThis policy and the attached application are the entire contact. We will consider all statements in the application to be representatives and not warranties.

IncontestableWe will not contest this policy after the date of issue.

Misstatement of Age or SexIf the Annuitant’s age or sex has been misstated, we will adjust the benefits provided by this policy to reflect the correct age or sex. After the annuity state date any adjustment for underpayment will be paid immediately. Any adjustment for overpayment will be deducted from future payments.

Minimum Benefits Benefits available under this policy are not less than the minimums required by the law of the state in which this policy is delivered.

NonparticipatingThis policy is nonparticipating. It does not share in our surplus.

PremiumThe single premium for this policy must be paid on or before the issue date of the policy.

Premium TaxesWe will charge you an amount to cover the applicable premium tax for any funds subject to premium tax.

Annual ReportWe will send you a report of the policy value at least once a year.


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OWNERSHIP

OwnerThe Annuitant is the owner of this policy unless:1. Another person is named as owner in the application; or2. The current owner names a new owner as provided below

Rights of OwnerDuring the lifetime of the Annuitant all rights and privileges granted by this policy belong to the owner. Before the annuity start date the owner may:1. Change the beneficiary or owner.2. Change the annuity start date.3. Select the income option.4. Select the person to receive the income payments.5. Assign or surrender the policy.6. Withdraw funds from the policy.

After the annuity start date the owner may change:1. The Beneficiary2. The person to receive the income payments.We must receive a signed request to exercise any ownership rights.

AssignmentWe are not bound by an assignment unless duplicate signed forms are filed with us. We are not responsible for the validity of any assignment.Transferability of Qualified Plans, TSAs or IRAsIf this policy is part of a Qualified Plan, as defined in Internal Revenue Code Section 401a, a Tax Sheltered Annuity (TSA), as defined in IRC Section 403b, or an Individual Retirement Annuity (IRA), as defined in IRC Section 408b, it is nontransferable. This policy cannot be sold, assigned, discounted, used as collateral for a loan, or as security for the performance of any obligation.If this policy is owned by a trust as part of a Qualified Plan, the trustee may transfer ownership to the Annuitant.


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BENEFICIARY

Beneficiary DesignationThe beneficiary is the person or persons named to receive any death benefit payable. The beneficiary is as named in the application or as changed by your most recent

If no beneficiary is living at the time of the Annuitant’s death, we will pay any death benefit to you or your estate.

Change of BeneficiaryYou may change the beneficiary by sending us a signed request. The change will take effect on the date it was signed, subject to any action taken by us before we receive the request.If you have named a beneficiary irrevocably, any change must be signed by both you and the beneficiary.

DEATH BENEFIT

Before Annuity Start DateSEE ENDORSEMENTWhile this policy is in force and before the annuity start date, a death benefit will be payable at the earlier of:1. your death, or2. if you are not the Annuitant, the death of the Annuitant.The death benefit will be the greater of the single premium less withdrawals or the policy value as of the date of death if the Annuitant dies. The death benefit will be the policy value as of the date of death if you die and you are not the Annuitant. Payment will be made to the beneficiary upon receipt of due proof of death. The payment will be in a single sum unless the beneficiary elects otherwise.This policy will end at the payment of the death benefit.

After Annuity Start DateIf the Annuitant dies after the annuity start date, we will pay any remaining guaranteed payments to the beneficiary as provided by the income option selected.If the owner is not the Annuitant and the owner dies while the Annuitant is still living, we will continue to pay the income payments for the lifetime of the Annuitant in the same manner as before the owner’s death.

CONTRACT VALUES

Policy Value During TermThe policy value on the issue date is 90% of the single premium.


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The policy value at any time during the term is equal to:1. the policy value on the issue date; less2. any amounts withdrawn; plus3. daily interest at the rate of 3% per year, compounded annually. For amounts withdrawn, daily interest will be paid up to the date of withdrawal.

Accumulation ValueThe accumulation value at the end of the term is equal to the larger of the policy value at the end of the term or:1. the single premium less any amounts withdrawn; plus2. the index increase; less3. any applicable premium tax.

Policy Value After TermThe policy value after the term is equal to:1. the accumulation of value at the end of the term; plus2. daily interest at the rate of 3% per year, compounded annually after the term. We may declare interest rates no more often than annually which are higher than this guaranteed rate.

IndexThe accumulation value of this policy is calculated using the index, which is guaranteed to apply during the term unless publication of the index is discontinued or the calculation of the index is changed substantially. In that case, we will substitute a suitable index and notify you. The index is shown on the Policy Specifications page and excludes dividends.

Index ValueThe index value is the published value of the index. The issue date index value will be the value as of the close of business on the last business day before the issue date. The end of term index value will be the average index value as of the close of business on the last business day of four quarterly intervals ending with the last business day of the term.

Index IncreaseThe index increase is calculated only at the end of the term. The index increase at the end of the term equals A times B times C.A equals the single premium less any amounts withdrawn during the term.B equals the percentage change in the index value between the issue date index value and the end of term index value.C equals the participation rate shown on the Policy Specifications page.


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INCOME BENEFITS

Annuity Start DateWe will begin to make income payments on the annuity start date. This date is shown on the Policy Specifications page. You may change the date by sending us a signed request at least 60 days before the annuity start date.

Amount of Income PaymentThe policy value as of the annuity start date will be used to determine the payment.To calculate the guaranteed minimum monthly payment from the Guaranteed Annuity Tables: 1. Select a monthly income option.2. Determine the adjusted age of the annuitant or joint annuitants.3. Multiply the number of thousands of policy value by the amount shown in the Annuity Tables.If the monthly payment would be less than $50, we will change the frequency of payments to provide payments of at least $50.

Annuitant’s Adjusted AgeThe adjusted age is determined from the calendar year of the first income payment and the actual age on that date. Use the chart below to calculate the adjusted age.Calendar Year of 1st Income Payment Adjusted Age1990-1999 Actual age2000-2009 Actual age, minus 12010-2019 Actual age, minus 22020-2029 Actual age, minus 32030-2039 Actual age, minus 42040 and after Determined by us

Automatic Monthly Income OptionIf you have not selected an income option by the annuity start date, we will provide a monthly income for the lifetime of the Annuitant with 120 monthly payments guaranteed (Option 2).

Evidence that Annuitant is LivingWe have the right to require satisfactory proof that the Annuitant is living on the date of any income payment.


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INCOME OPTIONS

Selection of OptionsYou may select any of the options shown below or any other payment method we agree upon. You may change your selection at any time before the annuity start date by sending us your signed request at least 60 days in advance.

Option 1

Life IncomeWe will pay a monthly income for the lifetime of the Annuitant. The monthly payments will stop with the last payment due before the Annuitant’s death.

Option 2

Life Income with 120 or 240 Monthly Payments GuaranteedWe will pay a monthly income for the lifetime of the Annuitant with the guarantee that we will make at least 120 or 240 monthly payments. You select either the 120 or 240 month guarantee period.If less than 120 or 240 monthly payments have been made at the Annuitant’s death, we will pay the balance of the guaranteed payments to the beneficiary or beneficiaries as monthly payments for the rest of the guaranteed period.If the guaranteed payments have been paid, the monthly payments will stop with the last payment due before the Annuitant’s death.

Option 3

Joint Life Income with Two-Thirds to the SurvivorWe will pay a monthly income during the joint lifetime of two Annuitants. After the death of the first Annuitant, we will continue two-thirds of the monthly payment for the lifetime of the surviving Annuitant. The monthly payments will stop with the last payment due before the death of the last surviving Annuitant.


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GUARANTEED ANNUITY TABLES

Monthly Payments for Each $1000 Applied

Male Female Male Female Male Female50 4.02 3.73 3.99 3.72 3.9 3.6851 4.08 3.79 4.05 3.78 3.95 3.7352 4.15 3.85 4.12 3.83 4 3.7853 4.22 3.9 4.18 3.89 4.06 3.8354 4.3 3.97 4.26 3.95 4.11 3.8855 4.38 4.03 4.33 4.01 4.17 3.9356 4.47 4.1 4.41 4.08 4.23 3.9957 4.56 4.18 4.5 4.15 4.29 4.0558 4.65 4.26 4.58 4.23 4.36 4.1159 4.75 4.34 4.68 4.3 4.42 4.1760 4.86 4.43 4.77 4.39 4.48 4.2461 4.98 4.52 4.88 4.47 4.55 4.362 5.1 4.62 4.98 4.57 4.61 4.3763 5.23 4.73 5.1 4.66 4.68 4.4464 5.37 4.84 5.22 4.77 4.74 4.5165 5.52 4.96 5.34 4.88 4.8 4.5866 5.68 5.09 5.47 4.99 4.86 4.6567 5.84 5.22 5.6 5.11 4.92 4.7268 6.02 5.37 5.74 5.24 4.98 4.7969 6.21 5.52 5.89 5.37 5.04 4.8670 6.42 5.69 6.04 5.51 5.09 4.93

120 Payments Guaranteed

OPTION 2LIFE INCOME

240 Payments GuaranteedADJUSTED

AGE

OPTION 1LIFE INCOME


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Policyholder understanding of indexed life insurance policy performance.

Illustrations- NAIC has developed Life Insurance Illustration Model Regulation and insurer are required to follow those regulations.These general set of rules and regulations used by insurance companies when a life insurance policy has been sold. Basic standards of all illustrations on policies include the following:

1. The illustration must contain the date in which it was prepared.a. Every page must be numbered and show its relationship to the total number of pages in the illustration;b. The understood dates of payment receipt and benefit pay-out in a policy year must be unmistakably identified;c. If the age of the proposed insured is shown as a component of the tabular detail, it shall be issue age plus the number of years the policy is assumed to have been in force;d. The assumed payments on which the illustrated benefits and values are founded shall be recognized as premium outlay or contract premium. Those policies that do not require a contract premium, the illustrated payments shall be identified as premium outlay.e. Guaranteed death benefits and values available upon surrender, for the illustrated premium outlay or contract premium shall be shown and clearly labeled guaranteed.f. If the illustration points out any non-guaranteed elements, they cannot be based on a scale more favorable to the policy owner than the insurer’s illustrated scale at any time.g. The guaranteed elements must be present before corresponding non- guaranteed elements and shall be specifically referred to on any page of the illustration that explains only the non-guaranteed elements

h. The account or accumulation value of the policy must be recognized by the name this value is given in the policy being illustrated and shown in close proximity to the corresponding value available upon surrender.

i. The value offered upon surrender shall be identified by the name this value is given in the policy being illustrated. It must be the amount available to the policyholder in a lump sum after deduction of surrender charges, loans, and policy loan interest.

j. Illustrations can clarify policy benefits and values in charts and graphs; alongside with tabular form.

k. Non-guaranteed elements have to have an added statement establishing that benefits and values are not definite, assumptions on which they were based are subject to change by the insurer, and real results may be more or less favorable.


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The main purpose of the agent to follow the rules and responsibilities of Life Insurance Model Illustration Regulation is to assure that the policyholder is not misinformed about their purchase.

Illustrated rates for indexed crediting strategies- Alternatives approach allows companies to show their results for the period of time the policy has been inforce. As of this writing, the NAIC is studying interest crediting methods to better reflect assumptions going forward. One idea that has some traction is allowing companies to illustrate returns at one percent above the interest rate charges on contract loans. Every illustrations must include a disclaimer regarding use of historical index performance to project future policy values- The disclaimer must state that past performance is not an indication of future performance. This disclaimer is similar to the one developed by the National Association of Securities Dealers (NASD) and not used by FINRA. The illustration makes a basic number of assumptions. This may or may not be true for any given year. If the illustration shows two positive results in the first two years, two negative results in the next two years, and then has positive result the last two years, the illustration would be correct. This would be accurate if it hit the projected results. In the real world, that never happens and the illustration can only be used as a way to explain how index annuities work. The problem with using illustrations is that the future cannot be predicted.

Best practices-Range of results- guaranteed, midpoint, current

assumption- Guaranteed shows the minimum performance of the index life annuity. The guarantee literally means that this is the worst that the policy could possibly do over the life of the contract. Current assumption assumes that the current policy growth will continue over the life of the contract. This assumption obviously will not happen because the market rises and falls over time. Another reason this assumption is not copasetic is that the rate of growth could be more or less than the assumed rate. Midpoint assumes that the return is half of the difference between the guaranteed rate and the current rate of growth. Midpoint tends to be a more realistic approach to projecting the future growth of underlying indexes. An example would be that the guarantee rate is 3% and the current assumed rate is 7%, the midpoint would be 5% growth.

Non-guaranteed elements- Non-guaranteed elements means that the credits, benefits, values, or charges under a policy of life insurance that are not guaranteed or not determined at issue. Since the insurance company uses the current state


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premium tax rate, that rate is not guaranteed. If the state where the policy issued decides to increase the premium tax rate, the performance of this annuity would be greatly reduced. The other factor in non-guaranteed elements is how the federal government may treat the underlying index as far as taxes in the future.

In-force illustrations- In-force illustrations use current rates to project the future returns as long as the policy has been in-force for one year or more.

Annual Statements-Yearly statements are filed by all insurance companies with every state the insurer conducts business in. The insurer must present all policyholders with an annual report on the status of the policy. Most reports should have some key features. a. Key Information- The first, beginning and end date, describes the precise date of the report period. Next is policy values at the end of previous reports. This will let the policyholders compare present end periods with earlier end periods. The third entity in annual reports is the accumulation of items that have either been credited or debited to the policy during the current period. Examples of these are mortality, riders, interest and expenses. The fourth item shown in reports are the current death benefits. Policyholders can compare the end of the report period on every life covered on the policy. The fifth, and last, item shown on annual reports is the amount of outstanding loan and the end of the current period.

b.Timing of annual statements relative to indexed interest crediting- Insurance companies must provide a report to their policyholders, once a year, on either the policy anniversary date or on the day that the index interest is credited. This report must be factual and cannot use any future projections. It must also have the starting balance and the ending balance with additions to the annuity and a list of all deductions for that period of time. The purpose of the annual statement is to provide some transparency to the policyholder.

c. Importance of annual follow-up with policyholder- Typically, the producer calls on the client when the annual


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statement is sent out. The purpose of the follow-up is for the producer to answer any questions that the policyholder may have. If the performance of the annuity is not what the policyholder had expected, and then the producer can recommend changes in the index being used or the allocation between different indexes. The producer may also suggest that the insurer increase their current contributions.

Full Contract Disclosure- The client needs to understand what their money is working towards. They must know all the various fees, expenses, and charges that apply to their contract.

a. Excess interest credits- The policyholder is generally guaranteed 3% of 90% of the money they place in a indexed annuity. The other 10% of their money is invested in hedge funds or in option contracts. Hedge funds are basically a gamble that the stock market is moving up or down. If the consumer believes the market is going up, they would choose a fund whose philosophy is exactly the same. If the hedge experiences a 20% growth, with no cap in interest rates, and is 100% participating, the investor would experience excess earnings of 17%. This would be credited as a result.

b. Death benefit- The death benefit generally is the cost basis or the current account balance, or whichever is higher. There is no early surrender charges applying to the death

benefit. The death benefit is exactly laid out in the disclosure as what the insurance company will pay upon death.

c. Liquidity- The insurance company must disclose to the consumer how they can withdraw their funds and what charges and fees must apply for those early withdrawals. Insurance companies are permitted to use a table showing a projected illustration of growth less any fees. The listed illustration below shows a basic table that insurance sometimes use.

d. Signed illustration- Every illustration must be signed by the proposed insurer indicating that the illustration has been explained in detail to them. Their signature proves their acknowledgement that it has been made clear to their satisfaction. The producer also signs the illustration and states that they have explained, in detail, that they have discussed the illustration to the consumer.


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1. Which of the following statements is untrue concerning dividends on a life policy?a. Dividends are a return of premiumb. Dividends are guaranteedc. Dividends are not subject to income taxd. Interest on dividends held to accumulated is subject to income tax

2. An index life policy guaranteed interest rate isa.0%b.1 ½%c.4%d.5% .

3. Under the NAIC Model Illustration law, which of the following is required?a. Projections based on Guaranteed valuesb. Projections based on Current Returnsc. Projections based a midpoint (difference between current and guaranteed)d. All of the above

4. Investment options in a variable product would not include:a. Bonds and preferred stocksb. Common stockc. Mutual fundsd. Real Estate Investment Trust


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CHAPTER 5

Suitability and Marketing Practices

The buyers of Equity Index Annuities should be made aware of high surrender charges. Indexed annuities typically do not have an up-front sales charge. There are often significant surrender and other charges that the annuitant must pay for access to their money before the surrender period ends. Index annuities are sold as a “no fee product”. There are cost to own these products Gannon. In a study conducted in 3rd Quarter of 2015 by Beacon Research and Fidelity Life Insurance Company, shows the surrender fees for the 10 top-selling indexed annuities averaged 11.25% in the first year. Here is an example of surrender charges: 1st year-12%, 2nd year-11%, 3rd year-10%, 4th year-9%, 5th year-8%, 6th year-7%, 7th year-6%, 8th year-5%, 9th year-4%, 10th year-3%, 11th year-2%, 12th year-1% and finally in the 13th year-0%. In some cases, the insurer pays the minimum guaranteed rate in place of the interest rate credited.

EIA can lose money Many insurance companies only guarantee that the annuity owner receive 87.5% of the premiums paid in, plus 1 to 3 percent interest. The owner doesn’t receive any index-linked interest and could lose money on the investment. If the market index moves down, the annuity owner would not be credited any interest above the guaranteed amount (in many cases, it is 0%). When the owner elects to surrender the contract before the maturity date, the owner will not be credited by many insurance companies for any index-linked interest.

Equity Index Annuity (EIA) MisconceptionCustomers for some reason believe that the EIA will mirror the results of the index. Let’s take a look at the S&P 5002. Over the 10 year period ending Dec. 31, 2015, the S&P 500 average annual return was 7.31%. Not counting the dividends reduced the return to 5.05%, In the same time, an EIA with an 8% first bonus and a cap of 10% with an 80% participating rate returned only 3.14% annually.3 In the typical EIA, the indexes exclude dividends. Since 1930, dividends have made up approximately 40% of the S&P 500's average annual total return.4

2 Trademark of Standard & Poor’s3 Fidelity website: Index Annuities: Look before you leap, updated July 20164. Source: Morningstar® EnCorr®; FMRCo, as of 12/31/2015


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Costs controlled by Insurance CompaniesInsurers have the right to change spreads, caps, participation rates and other fees. Each change can reduce the returns for the purchaser after the annuity is issued. The client should be made aware of these possibilities.

NAIC Suitability in Annuities Transactions Model Act- The National Association of Insurance Commissioners (NAIC) adopted this model in 2003. It was initially directed at the unsuitable sales of annuities to seniors 65 and older. Its direct goal was to ensure the suitability of annuities and the ceasing of taking advantage of seniors. Feeling that annuity products are complicated to everyone, the NAIC adopted a new model in 2006. This newest model, Suitability in Annuities Transactions Act, pertains to all consumers at every age. The National Association of Insurance Commissioners (NAIC) is a coalition of state insurance commissioners who perform as regulators in the insurance field. They strive to advance equality of state guidelines and legislation as it concerns the insurance trade. Their goals include defending the public interest, promote competitive markets; support the fair and impartial treatment of insurance consumers, endorse the solidity, and maintain and advance state guidelines of insurance.

Importance of determining client suitability for indexed productsa.) Identify the need for gathering information prior to making

recommendations and for using the information to make only suitable recommendations- The Suitability Model is a tool that is used to shield consumers from unsuitable sales practices. There are three recommendation standards. The first is for the insurer to make every attempt to obtain relevant information from the consumer before recommending an annuity transaction. The second standard is that the insurer must make recommendations only appropriate to the consumer. The recommendations should assist the consumer’s financial and insurance needs. The third standard forces the insurer, and their producer, to not make any suggestions to the consumer until they act in accordance with state guidelines, procedures, and standards.

b.) The consumer’s financial status- Insurance companies need to acquire the needed information to understand the important facts about the client. This enables the insurance company to suggest only those services or financial implements required. While it is not mandatory when providing optional portfolio management services, the insurance company is not required to relay such information to other financial institutes.


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Income- Sources of income, including their yearly income. Consumer's job, profession. The importance of this is that NAIC has establishes for consumers. The consumer’s income must be at a certain level to purchase the necessary products. Index annuities are a sophisticated product. They require a certain level of investment knowledge. The product is designed for sophisticated investors. The type and amount of income will indicate whether this is the right product for the client.

Liquid assets- This is the consumer’s their cash, CD’s and all other assets that can be transferred into cash. Liquid assets are the safety net for the family. The more liquid assets they have, the better financial shape they are in. The usual rule is four to six months income on hand. Since emergencies do happen, liquid assets are required.

The consumer’s tax status- The consumer’s tax status must be taken in consideration because if they have all of their investment and/or income is currently being taxed, they

may want to consider tax-deferred growth those annuities offer. This can have an important effect on their return over time. Generally the tax payer in the highest income tax bracket will benefit the most by use of tax-deferred products. Listed below is a chart illustrating the differences between current taxed and tax-deferral approaches.

The consumer’s investment objectives, risk tolerance and time horizon- The insurance must take investment objectives into consideration. They should know the three main objectives of the client. The first objective is length of time to keep the investment. Insurance companies must recognize how long the client wants to invest for; short-term or long-term. The second objective is to establish the policyholder’s preference of taking risks. Since the consumer is accepting the risks, the insurance company must aid the client in their decision about those risks. Having their capital secure, while avoiding risk, determines their gains and losses. Usually higher risks often lead to higher profits. The third investment objective is the purpose of the investment. Understanding objectives will guide the insurance company in the accurate direction in how to care for their


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policyholder.

Other information to be used or considered relevant Age (pre-retirement or post-retirement) - The

consumer’s age must be taken into account for suitability. Those who are under age 60, indexed annuities are a way to get greater market return and safety. During this accumulation period, the client needs to maximize their return for retirement. Index annuities are a part of that maximization. The older policy purchaser needs indexed annuities to protect themselves against inflation. Since the older clients cannot go out and earn more income, they need to maximize their return while keeping the underlying assets safe. Index annuities will allow the client to do both.

ii. Financial concernsa. Social security- Social security is a safety

net for most Americans. The average Social Security check is about $1200 (SSA.GOV) a month. This amount is obviously not adequate to provide living expenses for a senior. With proper planning by use of equity indexed annuities, the client can grow their assets and supplement their Social Security income. An example would be $100,000 in an indexed annuity could provide $645 a month for a male aged 65 for his lifetime,

under a life-only option. The other item to consider, in regards to Social Security, is what the client’s retirement plan at work is. If their retirement plan is adequate, combined with Social Security, and provides a comfortable living, the client can use the index annuity to shelter those assets. This will allow the client to provide assets to their loved ones by naming them as beneficiaries on the contracts.

Retirement plan distribution- Depending on when the insured would like their benefits to start, will determine if they want to start receiving benefits under their retirement plan. Many times is not unusual for an annuitant to annuitize their annuity contract early and provide benefits for a fixed period.


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The advantage of this is that each year the person postpones their retirement age, it increases their benefits substantially. The difference of three years would worth 24- 25% more in benefits because of the delaying the start of benefits. An example would be if a person postpones their Social Security until age 70, the benefits would go up 8% per year until retirement payment begins. Timing is the key to good retirement planning.

Investing retirement assets- Investing retirement assets are vital because the chief responsibility under the Prudent Man rule is safety of the principal. With that being the focus, no unusual risks should ever be taken. It would not be appropriate to place retirement income for someone age 60 into investments like foreign currency options.

Health- If the client is in poor health, they should not annuitize the contract. The annuity is designed to provide an income over their lifetime. If they are not in good health, buying the contract would not make feasible sense. It may be a way for a person who is unhealthy to pass assets on to their heirs by avoiding probate. This makes sense since beneficiaries are not known to anyone else besides the insurance company. Wills and probate are public records, annuity beneficiaries would be sheltered from the disclosure of the assets and who receives them. If a person is in excellent health, they may want to look at a number of options discussed previously.

Access to account value Required minimum distributions- If an

indexed annuity is used in a tax-qualified product or plan, the minimum distribution rules do apply. The annuitant must start receiving the minimum distribution benefits by April 1st following their 70 ½ birthday. If they fail to take the minimum distribution by that time, they are subject to a 15% penalty


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of the amount that is in the annuity. The second payment must be taken by December 31st of that same year. The retiree was born on May 28, 1945. They would turn age 70 ½ on November 28, 2015. The account balance of December 31, 2015 is used as the starting point. The account balance is divided by the factor. In this case, the life expectancy factor is 17 according

to the IRS Table 1. Assuming that the retiree takes the next distribution after their 71st birthday, the life expectancy factor would be 16.3.The remaining balance would be divided by 16.3. This would continue each year until the age 111 or the retiree’s death whichever comes first rules do apply. The annuitant must start receiving the minimum distribution benefits by April 1st following their 70 ½ birthday. If they fail to take the minimum distribution by that time, they are subject to a 15% penalty of the amount that is in the annuity.

December 31st of that same year.

Example:

The retiree was born on May 28, 1947. They would turn age 70 1/2 on November 28, 2017. The account balance of December 31, 2017 is used as the starting point. The account balance is divided by the factor. In this case, the life expectancy factor is 17 according to the IRS Table 1. Assuming that the retiree takes the next distribution after their 71st birthday, the life expectancy factor would be 16.3.The remaining balance would be divided by 16.3. This would continue each year until the age 111 or the retiree’s death whichever comes first.

A chart is listed below with examples:


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Table I(Single Life Expectancy)

(For Use by Beneficiaries) Life Expectancy Life ExpectancyAge Factor Age Factor56 28.7 84 8.1 Age 701/2 by 4/157 27.9 85 7.6 IRA Totals $100.00058 27.0 86 7.1 1st Ck 100,000/1759 26.1 87 6.7 or $5,883.00 by 4/160 25.2 88 6.3 2nd ck 100,00061 24.4 89 5.9 less 5,883 62 23.5 90 5.5 94,118/ 16.363 22.7 91 5.2 or $5,774 by 12/3164 21.8 92 4.9 until all gone65 21.0 93 4.666 20.2 94 4.367 19.4 95 4.168 18.6 96 3.869 17.8 97 3.670 17.0 98 3.471 16.3 99 3.172 15.5 100 2.973 14.8 101 2.774 14.1 102 2.575 13.4 103 2.376 12.7 104 2.177 12.1 105 1.978 11.4 106 1.779 10.8 107 1.580 10.2 108 1.481 9.7 109 1.282 9.1 110 1.183 8.6 111 and over 1.0

Free withdrawals, withdrawal in excess of the free amount and full surrender- Under free withdrawals, provided that the annuitant is at least 65, they are entitled to a 10% free withdrawal without penalty. They do not exercise the free withdrawal, it may or not be lost. Some companies will permit the annuitant to accumulate free withdrawals. These choices are shown in the contracts in greater detail

Annuitization- Once annuitization begins, the annuitant is unable to withdraw any additional funds because those funds have purchased the income stream. The funds are no longer available to the annuitant.


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The need for full contract disclosure-The NAIC has developed a model to meet the needs of full contract disclosures. In the Model Life Insurance Disclosure Regulation by National Association of Insurance Commissioners, the NAIC firmly ascertains that all consumers must be given written information concerning their policies. This information must be presented in a buyer’s guide and a policy summary. Certain information must be included. The first requirement is a written amount needed to purchase the appropriate amount of life insurance. The second requirement is that there must be comparisons of the costs associated with the purchase of similar life insurance policies. The third, and final, requirement is that there are many types of life insurance policies that are also available to fit the prospective insured’s needs.

As well as the information about their policy, consumers should anticipate the name and address of their insurance company listed on the policy. The insurance company must also put the insurance policy’s generic name. To guarantee that the consumer is informed with the cost and benefits, full contract disclosure must enclose critical requirements. These requirements are mandatory for each year for the initial five-year policy period. There are four elements to be disclosed in the policy. The first is the amount of premiums to be paid each year. The second are cash values at the end of each year. The third item that has to be disclosed are dividends. Depending on if the policy is a participating policy, all dividends at the end of each year must be clearly stated. The fourth, and final, requirement is the policy’s death benefit.

Needs-based selling for life insurance- The need approach is a personal insurance method that is used to analyze the amount necessary to maintain a family in its customary lifestyle. This approach is planned to make a family’s well-being promising if the principal wage earner passes away. There are five items to consider under the needs approach.

1.) The first is immediate needs to various expenses. These needs will cover outstanding debts, medical treatments, burial costs, estate and inheritance taxes, and the cost of probate. 2.) The second need for is that of continued income for young children, if any. This will plan to care for children while they are still in school and still depend on family support. 3.) The third need is that of continued income for the surviving spouse. After the children have grown up and no longer depend on the family for an income, this entails continued income for the remaining spouse. 4.) The fourth need is continued income for miscellaneous expenses. Examples of these expenses would be education, emergency, mortgage payments and health care. The final need is for a retirement fund for the surviving spouse.

The needs approach will conclude a final figure to base the amount of life insurance the wage earner should consider. To do that, the total of


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all expenses must be subtracted from all sources of income existing to the surviving spouse. Sources of income include any investments, pensions, group benefit life insurance plans and Social Security.

1. Financial underwriting issues- Under the needs base approach, the insured must prove that they have a need for the amount of insurance in which they are purchasing. The issue at hand is that the insurance company cannot insure someone without having a need to insure them.

2. Insurable interest- There must be financial or emotional attachment in order for there to be an insurable interest. An

ordinary person cannot buy an annuity on someone they have no connection to. The relation between the owner and annuitant must be of love, affection or some business relationship would meet the insurable interest rule.

A few years ago, the insurance industry discovered that some unethical producers were finding investors with the idea of purchasing a variable annuity from very unhealthy individuals. The individual with a terminal disease starts the policy and selects the most aggressive investment offered by the insurance company with the assistance of the unethical producer. Once the policy was issued, it was sold to an investor ,who would contribute a large amount into the contract. At the death of the annuitant, the investor beneficiary would receive the large of the accumulated amount in the contract or the premiums paid in without any surrender charges. The producer earns commission on the premiums paid and there are no chargeback because of the death of the annuitant. Those Producers have had their license revoked, fined and are barred from the insurance industry.


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1. An insurable interest would be present when?a. Father purchases insurance on a childb. A business insures their key employeec. Wife is the owner on her husband’s life insurance d. All of the above

2. Under a needs based approach to life insurance, which of the following would not be a consideration?

a. Debts of the insuredb. Income needs of the familyc. Age of the insured’s parentsd. Funding of education for the spouse or children

3. A common misconception concerning index annuity that use the S&P 500 as a benchmark is:a. Index product will mirror the S&P 500 less dividendsb. Index does not include dividends paid by those companies in the S&P 500 c. The index annuity does mirror the results of the S&P 500d. If the S&P 500 is negative, the index annuity would credit no interest for that period.

4. Which of the following factors would not be a consideration when looking at suitability for a client?

a. Age of their childrenb. Investment experience or knowledgec. Age of the clientd. Their objectives and timeframe


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CHAPTER 6

Special Issues for Senior Consumers

Product complexity- In dealing with senior citizens, or anyone else of any age, the insurance

company must protect the consumer. In most cases, the producers should conduct several interviews with the client to get the person better. It is important to understand their goals, timeframe, risk tolerate, and financial experience before suggesting a solution. Providing adequate explanations in their sales literature and policies allows the customer to feel comfortable with their purchase.

Insurance companies must provide information in an easily, understood format.

Complexity only confuses the consumer. Some insurers have recognized the problem of confusion by older clients and have developed a system where individuals of a certain age or older are called. The caller will ask questions to identify problems of improper sales activity or confusion of the client.

Below is a chart and explanation of a one year total sum performance with monthly caps.

Premiums are place into a strategy that earns interest on an annual basis by comparing the monthly changes in the S&P 500(registered trade mark) Index. The term of the strategy is for one year. The first premium is placed in a segment with the start date being when the funds are placed and each segment ends on the last day of that month.

Each month, the insurance company, calculates the change in the index value and compare it to prior month. Monthly increase as subject to a cap and there is no floor interest rate. This approach works best in a raising market and does not perform well in a declining market. In the example, below there is a 2% monthly cap and a 0% floor.


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Hypothetical Examples for a One Year Total Sum Performance with Monthly Cap Strategy It assumes a 2% Monthly Cap with a 0% Floor. This examples for educational purposes and do not reflect any current results and it assumes no withdrawals were made during this period.

Example 1 Example 2

Month

Changes in Index Value

Changes in Index Value

12% Cap

(4%) 2%2 2% 2%3 -3% -3%4 1% -4%

5 -1% -1%6 0% 0%

72% Cap

(4%) 2%8 -2% -2%9 2%Cap (3%) -2%

10 1.50% 1.50%11 -1% -1%12 2% 2%

Interest Rate to be credited 5.50% 0%

Annuity Value at beginning of Segment $5,000 $5,000

Interest Rate to be credited at end of Segment $275 $0

Annuity Value after interest is credited $5,275 $5,000

This is an example of the complex index products in the market place today. Producers would be wise to have a complete knowledge of their index products and how they perform over time. If the producer does not fully understand the product, they should not be recommending the product. The duty of the producer is to educate the clients on the product and to see if this product fits the client’s needs.


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Buyer competence: The insurance company needs to look after its consumers by making sure they understand the product. The buyer must be able to understand the product before purchasing it. When insurers thoroughly train their producers to properly explain the product, look for signs of mental impairment and perform their duties ethically, the goal of protecting the client is achieved. Usually the insurance company will do a follow-up phone interview with consumer.

This follow-up phone interview is designed to check on the competence of the purchaser on the product. In asking questions, the insurance company is examining the purchaser’s mental state. The types of questions asked deal specifically with dates, places, and times. (i.e Who is the president of United States? What is your address? Where is your favorite grocery store located? Ask the client to use five words in a sentence-ball, basket, bicycle, bear, and baby. This exercise tests short term memory). If the purchaser is not capable of answering these questions, there is a question about their competency.

Another section covered in the phone interview hopes to locate why the consumer wants to purchase the product. Usual questions are used to find out basic things about the consumer’s choice. The interviewer will ask if the consumer if the contract is for short-term gain, long-term gain or protecting assets. Not only will these questions answer if the consumer understands what they are purchasing, it also provides information on suitability. Suitability, as discussed earlier, is the main focus of the insurance company. Unique ethics and compliance issues- Due to the age of the client; the producer must spend more time explaining the product. Signatures are sometimes required on certain forms upon their completion. The first step is to complete the consumer questionnaire. Questionnaires are used to determine the client’s objectives, goals, and desires about their investments. Once the consumer has signed the proper document citing their understanding of the questionnaire, the producer goes to the second step. This step is to explain the product more in detail by the use of illustrations. The illustrations will include information about guarantee values and projections, or possible scenarios, of money being paid in. Like questionnaires, the consumer must sign all of the illustration sheets. The third, step is completion of all suitability forms. The suitability forms will ask questions about assets, income and net worth. Once the producer believes that the contract is suitable to the consumer another signature is required on the application.

After this signature, the producer can then accept a check from the client’s personal bank account. A checklist will accompany the application and necessary forms. This checklist brings together all of the previous forms to meet the requirements. It will also indicate that the consumer has been presented with a buyer’s guide. A buyer’s guide gives generic information about the product that was just purchased.


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NASAA Model Act to Protect Vulnerable Adults from Financial Exploitation

Overview

The North American Securities Administrators Association (NASAA) and FINRA are

working together to protect seniors. Each state is asked to propose legislation to enact

this model act. This NASAA model act provides the industry and state regulators with

new tools to help prevent and detect financial exploitation of vulnerable adults. The act

mandates reporting to a state securities regulator and state adult protective services

agency when an adviser (Qualified individuals) has a reasonable belief that financial

exploitation of a vulnerable individual (eligible adult) has been attempted or has

occurred. A provision of the model act authorizes disclosure to third parties only in

instances where that adult has previously designated the third party to whom disclosure

may be made. Importantly, if the third party is suspected of financial exploitation, the

act directs that no disclosures be made to the third party.

Application

Under the act, “eligible adults” include those age 65 or older and those adults who

would be subject to the provisions of a state’s adult protective services statute.

“Qualified individuals” include broker-dealer agents; investment adviser representatives;

those who serve in a supervisory, compliance, or legal capacity for broker-dealers and

investment advisers; and any independent contractors that may be fulfilling any of those

roles.

Key Provisions

Mandatory Reporting. Qualified individuals who reasonably believe that financial

exploitation of an eligible adult may have occurred, been attempted, or is being

attempted, must promptly notify their State Adult Protective Services and their state

securities regulator.


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Notification. The act authorizes disclosure to third parties only in instances where an

eligible adult has previously designated the third party to whom the disclosure may be

made. Importantly, the model act directs that disclosure may not be made to the third

party if the qualified individual suspects the third party of the financial exploitation.

Delayed Disbursements. The act provides broker-dealers and investment advisers

with the authority to delay disbursing funds from an eligible adult’s account for up to 15

business days if the broker-dealer or investment adviser reasonably believes that a

disbursement would result in the financial exploitation of the eligible adult. If the broker-

dealer or investment adviser delays a disbursement, it must notify people authorized to

transact business on the account (unless these individuals are suspected of the

financial exploitation), notify the state securities regulator and the adult protective

services agency, and undertake an internal review of the suspected exploitation. Under

the model, the securities regulator or adult protective services agency may request an

extension of the delay for an additional 10 business days. Extensions beyond that could

be ordered by a court.

Immunity. The act’s immunity provisions are applicable to the reporting of suspected

financial abuse to governmental agencies, the disclosure of information to designated

third parties, and the decision to delay disbursements. The immunity provisions provide

immunity from administrative and civil liability for qualified individuals, broker-dealers, or

investment advisers who, in good faith and exercising reasonable care, comply with the

provisions of the act.

Records. The act requires that broker-dealers and investment advisers comply with

requests for information from APS agencies or law enforcement in cases of suspected

or attempted financial exploitation. The act further clarifies that the granting of such

access shall not be construed to subject the records of the broker-dealer or investment

adviser to a state’s public records laws.

Mandated Annuity Training Requirement.


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NAIC originally proposed a model law on Annuity Suitability in 2003 and most state adopted it and make it state law. Because of the changing marketplace, the NAIC passed a revised Annuity Suitability Model Law in 2010 strengthening consumer protection. Those revisions were adopted by most states and it includes a new definition for suitability information, additional requirements

for providing information to consumers regarding the annuity, and a five year record keeping retention requirement.

The revised Rules also require agents to complete a one-time approved four hours continuing education course on annuity products to insure producers are knowledge about these products. In addition, insurers are required to train and test producers on their annuity products as well. Producers licensed to sell annuities must complete the required training prior to engaging in the sale of annuities in states where they are licensed.

Producers must complete a four hours approved annuity suitability course in their home state. Non-residents are exempt if they have already completed "substantially similar" training in their home state. Insurers are responsible for verifying that producers have completed the required state annuity suitability training and company annuity training selling prior to selling any annuity product.

1035 ExchangeAn exchange of an annuity contract into a new annuity contract is treated as a tax-free exchange under section 1035 of the Internal Revenue Code. Investment in the contract and basis are allocated according to cash value immediately prior to the exchange using the rules of section 72 of the Internal Revenue Code dealing with insurance.

Transfers of Annuity ContractsIf an owner transfers without full and adequate consideration, an annuity contract issued after April 22, 1987, the owner is treated as receiving a nonperiodic distribution. The distribution equals the excess of:

The cash surrender value of the contract at the time of transfer, or

The investment in the contract at that time.

This rule doesn't apply to transfers between spouses or transfers between former spouses incident to a divorce under a Qualified Domestic Relations Order (QDRO). A QDRO is a judgment, decree, or order relating to payment of child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant in a retirement plan. The QDRO must contain certain specific information, such as the name and last known mailing address of the participant and each alternate


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payee, and the amount or percentage of the participant's benefits to be paid to each alternate payee. A QDRO may not award an amount or form of benefit that isn't available under the plan.

A spouse or former spouse who receives part of the benefits from a retirement plan under a QDRO reports the payments received as if he or she were a plan participant. The spouse or former spouse is allocated a share of the participant's cost (investment in the contract) equal to the cost times a fraction. The numerator of the fraction is the present value of the benefits payable to the spouse or former spouse. The denominator is the present value of all benefits payable to the participant. A distribution that is paid to a child or other dependent under a QDRO is taxed to the plan participant.

Tax-free exchange. No gain or loss is recognized on an exchange of an annuity contract for another annuity contract if the insured or annuitant remains the same. However, if an annuity contract is exchanged for a life insurance or endowment contract, any gain due to interest accumulated on the contract is ordinary income.If the contract owner transfers a full or partial interest in a tax-sheltered annuity that isn't subject to restrictions on early distributions to another tax-sheltered annuity, the transfer qualifies for nonrecognition of gain or loss.

If the owner exchanges an annuity contract issued by a life insurance company that is subject to a rehabilitation, conservatorship, or similar state proceeding for an annuity contract issued by another life insurance company, the exchange qualifies for nonrecognition of gain or loss. The exchange is tax free even if the new contract is funded by two or more payments from the old annuity contract. This also applies to an exchange of a life insurance contract for a life insurance, endowment, annuity, or qualified long-term care insurance contract.

If the owner transfers part of the cash surrender value of an existing annuity contract for a new annuity contract issued by another insurance company, the transfer qualifies for nonrecognition of gain or loss. The funds must be transferred directly between the insurance companies. The owner’s investment in the original contract immediately before the exchange is allocated between the contracts based on the percentage of the cash surrender value allocated to each contract.

Example: Yolanda owns an annuity contract issued by ABC Insurance. She assigns 60% of the cash surrender value of that contract to DEF Insurance to purchase an annuity contract. The funds are transferred directly between the insurance companies. Yolanda doesn’t recognize any gain or loss on the transaction. After the exchange, her investment in the new contract is equal to 60% of her investment in the old contract immediately before the exchange. Her investment in the old contract is equal to 40% of the original investment in that contract.


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Chapter 6 Reviews Questions

1. How many of hours of continuing education are needed to sell annuities?

a. 1 Hour b .6 Hour c. 4 Hour d. 2 Hours

2. How often must a producer complete the required annuity course?

a. Once b. Annually c. Every 2 years d .Every 5 years

3. NASAA Model Act- Protect Vulnerable Adult defines “eligible adults” starts at?

a. 55b. 65c. 70d. 85

4. Under QDRO, the individual receiving the asset has the cost basis is

a .Value at time of transfer b. Fully taxable at transfer c. Never taxable d. Cost basis of the original owner


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CHAPTER 7

New Developments in Indexed Products

In the past, indexed annuities were pegged to the S&P 500. At the present time, they are now associated to many other indexes. Examples of these indexes are the Dow Jones 30, the Russell 5000/ 4000/ 3000/ 2000/ 1000, S&P 400/200/100, or foreign market indexes. Managers of index funds made the decision which index to use. This selection of index is important because not all indexes move at the same rate or at the same time and will affect the growth of invested funds. It is important to remember that index products do not include the dividends paid on the stocks making up the index.

Since smaller companies tend to grow faster than large companies, index managers felt that there was a better potential for growth by incorporating a number of the different indexes. This incorporation allows the investor a greater chance of economic growth and diversification of their assets. The Russell 5000 is an index representing the top 5000 companies in the country. They illustrate a broader view of economic variation within the country. By now using the Russell 5000 index, it reflects the broader economic picture.

In some cases, the index providers are allowing individuals the opportunity to allocated funds between several different indexes. If the contract owner is willing to give up some basis points, the owner can used the best performing index for that time period.

Qualified Longevity Annuity Contract5

A longevity annuity protects the client from outliving your money late in life. They are also known as an advanced life delayed annuity. The idea for this annuity requires the client to delay payments until they reach age 80 but no later than age 85 before receiving a payout. As with all annuities once the payout begins, the annuity provides a regular guaranteed amount of income for the rest of the client’s life.

This is not the first course of action for retirees but as a supplemental retirement investment. Typically the client would reposition a small portion (10-20%) of their retirement nest egg in a longevity annuity and leave the rest in their other retirement accounts.As with any deferred annuity, the client’s money in a longevity annuity grows until payments start. The later they wait to begin your payments, the larger your payments will be.

Advantages and Disadvantages of a Longevity AnnuityClients should think about a longevity annuity like buying a health insurance policy with a very large deductible. The client insures themselves from a catastrophic risk (living too long). The

5


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premium paid is minimum and the benefits are outstanding. For a typical retiree, putting 10% to 15% of retirement savings into a longevity annuity provides roughly the same spending power as devoting 50% to 60% of savings to an immediate annuity. New changes in the IRS rulings, allow an individual to move money from their current retirement plan into a longevity annuity without current income taxes being paid and the amount removed from the retirement account is not counted when figuring the Minimum Required Distribution that must start by April 1 following the retiree’s 70 ½ birthday. “Qualifying Longevity Annuity Contracts” (QLACs), is excluded from the account balance used to determine required minimum distributions. For example, if at age 70 an employee used $100,000 of his or her account balance to purchase an annuity that will commence at age 85, the annuity could provide an annual income that is estimated to range between $26,000 and $42,000 (depending on the actuarial assumptions used by the issuer and the form of the annuity elected by the employee).

The Treasury Department set some parameters: The amount transferred to a QLAC is limited to $125,000 subject to annual review and

adjustment No more than 25% of the account can be moved to a QLAC. Return of Premium (ROP) is permitted Participating annuities that pay dividends are permitted Variable and index annuities are not allowed in a QLAC because they lack contractual

guarantees on income. Only benefit available at the death of the annuitant is a lifetime annuity payable to the

surviving spouse.

If the client dies before starting to receive payouts, the entire balance in the account will be lost unless there is a return of premium rider attached to the annuity contract. In that case the insurance company would take control of the money in the account and use it to pay others that live much longer. As with all tax matters, check with our CPA or other tax adviser for guidance.

Internal Revenue Bulletin: 2014-30


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1. Index products credit the fund

a. Same rate is the same as the index returnb. Index returns include the stock dividendsc. Index returns exclude the stock dividendsd. Without regards to caps

2. Qualified Longevity Annuity Contract (QLAC) has the following benefit except:

a. Purchase deferred annuity that starts at age 80 or 85b. Purchase deferred annuity that is not subject Required Minimum Distributionc. Purchase deferred annuity grows tax deferredd. Purchase deferred annuity where the beneficiary collects if the annuitant dies

3. QLAC has all of the following features except:

a. Transfers into variable and index annuities is permitted b. Transfers are limited to $125,000

c. Limits amount of transfer to no more than 25% of the retirement accountd. Return of Premium is permitted

4. Retirees should consider repositioning what percentage of the retirement funds into QLAC?

a. Less than 5%b.10 to 20%c. 30 to 40%d 50 to 60%


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Answer Key to Practice Tests

Chapter 1 Page 16

1. C 2.B 3.A 4.B 5.C

Chapter 2 Page 341. A 2.B 3.C 4.A 5.B

Chapter 3 Page 51

1. B 2.A 3.A 4.C

Chapter 4 Page 86

1. B 2.A 3.A 4.C

Chapter 5

1. A 2.C 3.C 4.A

Chapter 6 Page

1. C 2.A 3.B 4.D

Chapter 7 Page

1. C 2.D 3.A 4.B


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Appendix AInsurance Terms

Accelerated death benefit: Benefit paid, under clearly defined health-related circumstances, to a policyholder prior to his or her death. Accelerated death benefits are also known as living benefits.

Accidental death benefit: A provision added to a life insurance policy for payment of an additional benefit if death is caused by an accident. Often referred to as double indemnity.

Actuary: A person professionally trained in the technical aspects of insurance and related fields, particularly in the mathematics of insurance such as the calculation of premiums, reserves, and other values.

Accumulation period: The time prior to a deferred annuity’s payout period when money builds up in the annuity contract.

Adjustable life insurance: A type of life insurance that allows the policyholder to change the plan of insurance, raise or lower the policy’s face amount, increase or decrease the premium, and lengthen or shorten the protection period.

Agent: A representative of an insurance company who is authorized to sell and service insurance contracts. Life insurance agents are also known as life underwriters or producers.

Annuitant: The person whose life expectancy is used to determine the payout of an annuity.

Annuitize: To convert the value of an annuity contract into a steady stream of income for life.

Annuity: A financial contract issued by a life insurance company that offers tax-deferred savings and a choice of payout options to meet an owner’s needs in retirement: income for life, income for a certain period of time, or a lump sum.

Annuity certain: A contract that provides an income for a specified number of years, regardless of life or death.

Annuity consideration: The payment, or one of regular periodic payments, that a policyholder makes to an annuity.

Application: A statement of information made by a prospective purchaser that helps the insurer assesses the acceptability of risk.

Assignment: The legal transfer of one person’s interest in an insurance policy to another person.

Assume: To accept the risk of potential loss from another insurer.

Automatic premium loan: A loan provision in a life insurance policy allowing any premium not paid by the end of the grace period (usually 30 or 31 days) to be paid automatically through a policy loan if cash value is sufficient.

Beneficiary: The person or financial entity (for instance, a trust fund) named in a life insurance policy or annuity contract as the recipient of policy proceeds in the event of the policyholder’s death.

Benefit: The amount payable by the insurance company to a claimant, assignee, or beneficiary when the insured suffers a loss covered by the policy.


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Broker (AKA producer): A sales and service representative who handles insurance for clients and generally sells insurance of various kinds from one company or several.

Business life insurance: Insurance purchased by a business on the life of a member of the firm. This insurance protects surviving business partners against loss caused by the death of a partner and reimburses corporations for loss caused by the death of a key employee.

Capacity: The amount of insurance available to meet demand. Availability depends on the industry’s capacity for risk. For an individual insurer, it is the maximum amount of risk it can underwrite based on its financial condition. An insurer’s capital relative to its exposure to loss is an important measure of its solvency.

Captive agent: A person who represents only one insurance company and is restricted by agreement from submitting business to any other company unless rejected first by the captive agent’s company.

Capital stock: The initial book value of stock sold by a company to start its operations.

Cash balance plan: A defined benefit plan that strongly resembles a defined contribution plan. Benefits accrue through employer contributions to employee accounts and interest credits to balances in those accounts. The accounts serve as bookkeeping devices to track benefit accruals.

Cash value: The amount available in cash upon surrender of a permanent life insurance policy. Also known as cash surrender value.

Cede: To transfer the risk of potential loss to another insurer.

Certificate: A statement issued to persons insured under a group policy that defines the essential provisions of their coverage.

Claim: Notification to an insurance company that payment of an amount is due under the terms of a policy.

COBRA: (Consolidated Omnibus Budget Reconciliation Act) A federal law under which group health plans sponsored by employers with twenty or more employees must offer continuation of insurance coverage to employees and their dependents after they leave their employment. Under COBRA, coverage can be continued for up to 18 months; the employee pays the entire premium.

Codification: A process undertaken by NAIC to redefine life company statutory accounting to ensure consistency in how companies present their accounts in their annual statements. This process culminated in the 2001 annual statements, the structure of which was noticeably different from the previous years.

Convertible term insurance: Term insurance that can be exchanged, at the option of the policyholder and without evidence of insurability, for another plan of insurance.

Credit disability insurance: Disability insurance issued through a lender or lending agency to cover payment of a loan, an installment purchase, or other obligation in case of disability.

Credit life insurance: Term life insurance issued through a lender or lending agency to cover payment of a loan, an installment purchase, or other obligation in case of death.

Declination: Rejection of an application for insurance coverage by an insurance company, usually due to the applicant’s health or occupation.


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Deductible: The amount of loss paid by the policyholder. Either a specified dollar amount, a percentage of the claim amount, or a specified amount of time that must elapse before benefits are paid. The larger the deductible, the lower the premium charged for the same coverage.

Deferred annuity: A contract in which annuity payouts begin at a future date.

Deferred group annuity: A type of group annuity providing for the purchase each year of a paid-up deferred annuity for each group member. The total amount received by a member at retirement is the sum of these deferred annuities.

Defined benefit plan: A pension plan that specifies the benefits an employee will receive after retirement. Benefits typically are based on length of service and salary, and are usually funded by the employer on behalf of each plan participant.

Defined contribution plan: A pension plan that specifies the contributions made by employees and in many cases the employer, on behalf of each plan participant. These funds accumulate for each participant until retirement, when they are distributed as a lump sum or monthly annuity. Benefits are based on the amount of contributions plus earnings.

Deposit administration group annuity: A type of group annuity that allows contributions to accumulate in an undivided fund, out of which annuities are purchased as each member of the group retires.

Deposit-type contracts: Contracts that do not include mortality or morbidity risks.

Disability: A physical or mental condition that makes an insured person incapable of working.

Disability benefit: The benefit paid under a disability income insurance policy; also a feature added to some life insurance policies providing for waiver of premium, and sometimes payment of monthly income, if the policyholder becomes totally and permanently disabled.

Disability income insurance: Insurance that provides periodic payments, or in some cases a lump-sum payment, based on the insured’s income replacement needs, when the insured is unable to work due to illness or injury.

Dividend: An amount of money returned to the holder of a participating life insurance policy. The money results from actual mortality, interest, and expenses that were more favorable than expected when the premiums were set. The amount of any dividend is set by the insurer based on the insurer’s standards.

Dividend addition: An amount of paid-up insurance purchased with a policy dividend and added to the policy’s face amount.

Earned premium: The portion of premium that applies to the expired part of the policy period. Insurance premiums are payable in advance but the insurance company does not fully earn them until the policy period expires.

Endowment: Life insurance payable to the policyholder on the policy’s maturity date, or to a beneficiary if the insured dies prior to that date.

EQUITY INDEXED UNIVERSAL LIFE: Insurance in which most of the premium (generally 80% to 90%) is invested in traditional fixed income securities. The remainder of the premium is invested in call option contracts tied to a stipulated stock index. In most instances where there is an increase in the market, exercising of the option contracts takes place and a given percentage of the gain is then credited to the policy. Conversely, should the market decline, the option contracts are said to expire worthlessly and the policy is credited with the minimum guaranteed rate. This type of policy may be suitable for that person who has an interest in purchasing a VARIABLE LIFE INSURANCE policy but is not at ease in participating in the equities market. This type of person could have


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the best of both worlds; the potential high returns of the equities market without the risk to the initial investment (principal).

Evidence of insurability: The common requirement by life insurance companies that potential policyholders undergo a physical examination or medical tests, such as blood pressure or cholesterol screening, before the applicant can purchase an individual life insurance policy.

Extended term insurance: A form of insurance available as a non-forfeiture option providing the original amount of insurance for a limited time.

Extra risk: A person possessing a greater-than-average likelihood of loss.

Face amount: The amount stated on the face of a life insurance policy that will be paid upon death or policy maturity. The amount excludes dividend additions or additional amounts payable under accidental death or other special provisions.

Family policy: A life insurance policy providing insurance on all or several family members in one contract. It generally provides whole life insurance on the principal breadwinner and small amounts of term insurance on the spouse and children, including those born after the policy is issued.

Fiduciary: A person or organization authorized to control or manage pension assets to administer a pension plan. Fiduciaries are legally obligated to discharge their duties solely in the interest of plan participants and beneficiaries, and are accountable for any actions that may be construed by courts as breaching that trust.

Fixed annuity: A deferred annuity contract in which the life insurance company credits a fixed rate of return on premiums paid or an immediate annuity in which the periodic amount is fixed.

Flexible premium policy or annuity: A life insurance policy or annuity contract that allows the amount and frequency of premium payments to be varied.

401(k) plan: An employment-based retirement savings plan that allows employees to make tax-deferred contributions from current earnings.

403(b) plan: A retirement savings plan, similar to a 401(k), for employees of charitable and educational organizations.

457 plan: A retirement savings plan, similar to a 401(k), for employees of state and municipal governments.

Fraternal life insurance: Life insurance provided by fraternal orders or societies to their members.

Fraud: Intentional lying or concealment by policyholders to obtain payment of an insurance claim that would otherwise not be paid, or lying or misrepresentation by the insurance company managers, employees, agents, and brokers for financial gain.

General account: An undivided account in which life insurers record all incoming funds. A general account is usually an insurer’s largest, although separate accounts can also be used to fund specific liabilities as well. Dividends are based on earnings of this account.

Grace period: A period of usually a number of days following each insurance premium due date except the first, during which an overdue premium may be paid and the policy be maintained. All policy provisions remain in force during this period.


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Group annuity: A pension plan providing annuities at retirement to a group of people under a master contract, usually issued to an employer for the benefit of employees. Each group member holds a certificate as evidence of his or her annuity.Group life insurance: Life insurance on a group of people, usually issued to an employer for the benefit of employees. Each group member holds a certificate as evidence of his or her insurance.

Guaranty Fund: A state fund that provides a system to pay the claims of insolvent insurers; the money in the guaranty fund comes from assessments collected from all insurers licensed in the state.

Guaranteed interest contract (GIC): A contract offered by an insurance company guaranteeing a rate of return on assets for a fixed period, and payment of principal and accumulated interest at the end of the period. GICs sometimes are used to fund the fixed-income option in defined contribution plans, such as 401(k) s.

HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT (HIPPA): Guarantees employers are not able to impose pre-existing condition limitations in the insurance they offer to new employees who had insurance coverage for at least 12 months with their previous employer.

Home Health: Health care provided in the home of the patient, usually by a private nurse or a state licensed home health care agency. Services are usually limited to part-time or intermittent nursing care and physical or occupational rehabilitation.

Hospital Indemnity: Provides a pre-determined flat benefit for each day of hospitalization regardless of expenses incurred.

Immediate annuity: An annuity contract in which periodic payments begin immediately or within one year of the policy’s issue.

Indemnity reinsurance: A form of reinsurance in which the risk is passed to a reinsurer, which reimburses the ceding company for covered losses. The ceding company retains its liability to and contractual relationship with the insured.Indexed annuity: A type of fixed annuity in which earnings accumulate at a rate based on a formula linked in part to a published equity index, such as the Standard & Poor’s 500 composite Stock Price Index, which tracks the performance of the 500 largest publicly traded securities. Also referred to as equity indexed annuity.

Individual Annuities: A policy that pays a benefit at regular intervals for the life of the annuitant or for a specified period usually beginning at retirement.

Individual life insurance: Life insurance on a person with premiums payable annually, semiannually, quarterly, or monthly.

Individual policy pension trust: A type of pension plan frequently used for small groups and administered by trustees authorized to purchase individual level-premium policies or annuity contracts for each plan member. The policies usually provide both life insurance and retirement benefits.

Individual retirement account (IRA): An account to which a person can make annual contributions of earnings up to a specified dollar limit. These contributions are tax-deductible for workers who are not covered by an employment-based retirement plan, regardless of income, or whose income does not exceed certain taxable income levels.

Insolvency: Insurer’s legal inability to pay its future policyholder obligations. Insurance insolvency standards and the regulatory actions taken vary from state to state. Typically, the first indication of an insurer’s financial stress is its inability to pass the financial tests regulators routinely administer.


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Insurable risk: Risks for which it is relatively easy to get insurance. Such risks meet certain criteria including being definable, accidental in nature, and part of a group of similar risks large enough to make losses predictable. Such conditions make it possible for an insurer to offer insurance at a reasonable rate.

Insurance: A system to make coverage of large financial losses affordable by pooling the risks of many individuals or business entities and transferring them to an insurance company in return for a premium.

Insurance examiner: The state insurance department representative assigned to conduct the official audit and examination of an insurance company’s operations.

INSURED: A person, a business, or an organization whose property, life, or legal liability; covered by an insurance policy.

INSURER: An insurance company.

Joint and survivor annuity: An annuity in which payments are made to the owner for life and, after the owner’s death, to the designated beneficiary for life.

Keogh (H.R. 10) account: A retirement savings account to which a self-employed person can make annual tax-deductible contributions, subject to limitations.

Lapsed policy: An insurance policy terminated at the end of the grace period because of nonpayment of premiums. See non-forfeiture value.

Legal reserve life insurance company: A life insurer operating under state insurance laws that specify the minimum basis for reserves that the company must maintain on its policies.

Level premium life insurance: Life insurance for which the premium remains the same from year to year. The premium is more than the actual cost of protection during earlier years of the policy and less than the actual cost in later years. The initial overpayments build a reserve which, together with interest to be earned, balances the underpayments of later years.

Life annuity: An annuity contract that provides periodic income payments for life.

Life expectancy: The average years of life remaining for a group of persons of a given age, according to a mortality table.

Life insurance in force: The sum of face amounts and dividend additions of life insurance policies outstanding at a given time. Additional amounts payable under accidental death or other special provisions are excluded.

Limited payment life insurance: Whole life insurance on which premiums are payable for a specified number of years, or until death if it occurs before the end of the specified period.

Lump-sum distribution: The non-periodic withdrawal of money invested in an annuity.

Malpractice insurance: Professional liability coverage for physicians, lawyers, and other specialists against lawsuits alleging negligence or errors and omissions that have harmed their clients.

Managed care: An arrangement between an employer or insurer and selected providers to provide comprehensive health care at a discount to members of the insured group and coordinate the financing and delivery of health care.


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Managed care uses medical protocols and procedures agreed on by the medical profession to be cost effective. These protocols are also known as medical practice guidelines.

Market Conduct Regulations: State laws that regulate the practices of insurers concerning four areas of operation: sales and advertising, underwriting, ratemaking, and claim settlement.

Master policy: A policy issued to an employer or trustee establishing a group insurance plan for designated members of an eligible group.

Mediation: Legal procedure in which a third party or parties attempts to resolve a conflict between two other parties. Mediation can be binding or non-binding.

Medicaid: A federal and state public assistance program created in 1965 and administered by the states for people whose income and resources are insufficient to pay for health care.

Medicare: Federal program for people sixty-five years of age or older that pays part of the costs associated with their health care such as hospital stays, surgery, home care and nursing care.

MEDICARE SUPPLEMENT: Provides accident and health expense coverage not covered under Medicare. The various types of standard policy form choices (A through J) are available for Medicare supplemental insurance coverage. Choice “P” means those insured before June 1, 1992 and no longer offered. Choice “O” means “other” and not meeting any of the choices listed.

MENTAL HEALTH: Coverage for professional mental health services; including psychologist, crisis centers, rehabilitative therapy, etc. An emotional or organic mental impairment (usually excluding senility, retardation or other developmental disabilities, and substance addiction); a psychoneurotic or personality disorder; any psychiatric disease identified in a medical manual. (American Psychiatric Association’s Diagnostic and Statistical Manual).

Mortality and expense charge: The fee for a guarantee that annuity payments will continue for life.

Mortality table: A statistical table showing the death rate at each age usually expressed per thousand.

Mutual life insurance company: A life insurance company without stockholders whose management is directed by a board elected by the policyholders. Mutual companies generally issue participating insurance.

Non-forfeiture value: The value of an insurance policy if it is cancelled or required premium payments are not paid. The value is available to the policyholder either as cash or reduced paid-up insurance.

Non-medical limit: The maximum face value of a policy that a given company will issue without a medical examination of the applicant.

Nonparticipating policy: A life insurance policy under which the company does not distribute to policyholders any part of its surplus. Premiums usually are lower than for comparable participating policies. Some nonparticipating policies have both a maximum premium and a current lower premium, which reflects anticipated experience more favorable than the company is willing to guarantee. The current premium may change from time to time for the entire block of business to which the policy belongs. See participating policy.

Occupational Accident: An accident arising out of and in the course of employment and covered by workers’ compensation laws.


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Ordinary life insurance: A life insurance policy that remains in force for the insured’s lifetime, usually for a level premium. Also referred to as whole life insurance. In contrast, term life insurance only lasts for a specified number of years (but may be renewable).

Paid-up insurance: Insurance on which all required premiums have been paid; frequently refers to the reduced paid-up insurance available as a non-forfeiture option.

Partial disability benefit: A benefit sometimes found in disability income policies providing payment of reduced monthly income if the insured cannot work full time or is unable to earn a specified percentage of pre-disability earnings due to a disability.

Participating policy: A life insurance policy under which the company distributes to policyholders the part of its surplus that its board of directors determines is not needed at the end of the business year. Such a distribution reduces the premium that the policyholder had paid. See policy dividend and nonparticipating policy.

Pensions: Programs to provide employees with retirement income after they meet minimum age and service requirements. Life insurers hold some of these funds. Over the last 25 years, the responsibility of funding these retirement accounts has shifted from the employers (who offered defined benefit plans promising a specific retirement income) to employees (who now have defined contribution plans that are financed by their own contributions and not always matched by employers).

Permanent life insurance: Generally, insurance that can stay in force for the life of the insured and accrues cash value, such as whole life or endowment; may also be referred to as ordinary life insurance.

Policy: The printed document that a company issues to the policyholder, which states the terms of the insurance contract.

Policy dividend: A refund of part of the premium on a participating life insurance policy, reflecting the difference between the premium charged and actual experience.

Policyholder/Policy owner: The owner of an insurance policy, who may be the insured, a relative of the insured such as a spouse, or a non-natural person such as a partnership or corporation.

Policy illustration: A depiction of how a life insurance policy will work, showing premiums, death benefits, cash values, and information about other factors that may affect policy costs.

Policy loan: The amount a policyholder can borrow at a specified rate of interest from the issuing company, using the insurance policy’s value as collateral. If the policyholder dies with the debt partially or fully unpaid, the insurance company deducts the amount borrowed, plus accumulated interest, from the amount payable to beneficiaries.

Policy reserves: The funds that a life insurance company holds specifically for fulfilling its policy obligations. Reserves are required by law to be calculated so that, together with future premium payments and anticipated interest earnings, they enable the company to pay all future claims.

Preferred risk: A person considered less of a risk than the standard risk.

Premium: The payment, or one of the periodic payments, that a policyholder makes to own an insurance policy or annuity.

Premium loan: A policy loan for paying premiums.


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Principal: The amount paid into an annuity contract, separate from the earnings that are credited to it; may also be referred to as purchase payments or contributions.

Qualified plan: An employee benefit plan that meets Internal Revenue Code requirements. Employer contributions to such plans are immediately deductible. Contributions to and earnings in such plans are not included in the employee’s income until distributed to the employee; also known as tax-qualified plan.

Rated policy: An insurance policy issued at a higher-than-standard premium rate to cover extra risk, as when the insured has impaired health or a hazardous occupation; also known as extra-risk policy.

Reduced paid-up insurance: A form of insurance available as a non-forfeiture option providing for continuation of the original insurance plan at a reduced amount.

Reinstatement: The restoration of a lapsed insurance policy. The company requires evidence of insurability and payment of past-due premiums plus interest.

Reinsurance: The transfer of some or all of an insurance risk to another insurer. The company transferring the risk is called the ceding company; the company receiving the risk is called the life assuming company or reinsurer.

Renewable term insurance: Term insurance that can be renewed at the end of the term, at the policyholder’s option and without evidence of insurability, for a limited number of successive terms. Rates increase at each renewal as the insured ages.

Reserve: The amount required to be carried as a liability on an insurer’s financial statement to provide for future commitments under policies outstanding.

Return-to-work program: A program that helps persons with activity limitations return to work. Assistance may involve maximizing medical improvement to diminish the effect of limitations, or facilitating job or job-site accommodations, retraining, or other means of taking activity limitations into account.

Rider: An amendment to an insurance policy that expands or restricts the policy’s benefits or excludes certain conditions from coverage. See accelerated death benefit and accidental death benefit.

Risk classification: The process by which a company decides how its premium rates for life insurance should differ according to the risk characteristics of persons insured—their age, occupation, gender, and health status, for example—and how the resulting rules are applied to individual applications. See underwriting.

Roth IRA: An individual retirement account (IRA) in which earnings on contributions are not taxed at distribution, as long as the contributions have been in the account for five years and the account holder is at least age 59 1/2, disabled, or deceased. Contributions to a Roth IRA are not tax-deductible.

Self-insured plan: A retirement plan funded through a fiduciary—generally a bank but sometimes a group of people—which directly invests the accumulated funds. Retirement payments are made from these funds as they fall due. Also known as trusteed plan or directly invested plan.

Separate account: An asset account maintained independently from the insurer’s general investment account and used primarily for retirement plans and variable life products. This arrangement permits wider latitude in the choice of investments, particularly in equities.

Settlement options: The several ways, other than immediate payment in cash, that a policyholder or beneficiary may choose to have policy benefits paid. See supplementary contract.


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Single Premium A single premium contract is paid at the inception of the policy and the policy becomes fully paid.

Standard risk: A person possessing an average likelihood of loss.

Stock life insurance company: A life insurance company owned by stockholders who elect a board to direct the company’s management. Stock companies generally issue nonparticipating insurance.

Straight life annuity: An annuity whose periodic payouts stop when the annuitant dies.

Straight life insurance: Whole life insurance on which premiums are payable for life.

Structured settlement: An agreement allowing a person who is responsible for making payments to a claimant to assign to a third party the obligation of making those payments. An annuity contract is often used to make structural settlement payments.

Substandard risk: A person who cannot meet the normal health requirements of a standard insurance policy. Protection is provided under a waiver, special policy form, or higher premium charge. Also known as impaired risk.

Supplementary contract: An agreement between a life insurance company and a policyholder or beneficiary in which the company retains the cash sum payable under an insurance policy and makes payments according to the settlement option chosen.

Term-certain annuity: An annuity which makes periodic payments over a fixed number of years. See annuity certain.

Terminal funded group plans: The reserves under an annuity contract for benefits accumulated outside of the contract, such as under a defined benefit retirement plan that has been terminated.

Term insurance: Insurance that covers the insured for a certain period of time, known as the term. The policy pays death benefits only if the insured dies during the term, which can be one, five, ten or even twenty years.

Third-party administrator: Outside group that performs administrative functions for an insurance company.

Tort: A legal term denoting a wrongful act resulting in injury or damage on which a civil court action or legal proceeding may be based.

Total disability: The inability of a person to perform all essential functions of his or her occupation or in some cases any occupation, due to a physical or mental impairment.

Underwriting: The process of classifying applicants for insurance by identifying such characteristics as age, gender, health, occupation, and hobbies. People with similar characteristics are grouped together and charged a premium based on the group’s level of risk.

Uninsurable risk: Risks for which insurance coverage may not be available.

Universal life insurance: A type of permanent life insurance that allows the insured, after the initial payment, to pay premiums at various times and in varying amounts, subject to certain minimums and maximums. To increase the death benefit, the insurance company usually requires the policyholder to furnish satisfactory evidence of continued good health. Also known as adjustable life insurance.


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Variable annuity: A contract in which the premiums paid are invested in separate accounts which holds funds, including bond and stock funds. The selection of funds is guided by the level of risk assumed. The account value reflects the performance of the funds that the owner has chosen for investment.

Variable life insurance: A type of permanent insurance providing death benefits and cash values that varies with the performance of a portfolio of investments. The policyholder may allocate premiums among investments offering varying degrees of risk, including stocks, bonds, combinations of both, and accounts that guarantee interest and principal.

Variable-universal life insurance: A type of permanent insurance that combines the premium flexibility of universal life insurance with a death benefit that varies as in variable life insurance. Excess interest credited to the cash value depends on the investment results of separate accounts investing in equities, bonds, real estate, and others. The policyholder selects the accounts to which premium payments are made.

Vesting: The right of an employee to all or a portion of the benefits he or she has accrued, even if employment terminates. Employee contributions, as in a 401(k) plan, always are fully vested. Employer contributions vest according to a schedule defined by the plan and are usually based on years of service.

Viatical settlement companies: Life insurance companies that purchase life insurance policies at a discounted value from a policyholder who is elderly or terminally ill. The companies then assume the premium payments and collect the face value of the policy upon the death of the person originally insured.

Void: Denotes when an insurance policy is freed from legal obligations for reasons specified in the policy contract (i.e., a policy could be voided by an insurer if information given by a policyholder is proven untrue).

Waiver of premium: A provision that sets conditions under which an insurance company would keep a policy in full force without the payment of premiums. The waiver is used most frequently for policyholders who become totally and permanently disabled.

Whole life insurance: The most common type of permanent life insurance, in which premiums generally remain constant over the life of the policy and must be paid periodically in the amount specified in the policy. Also known as ordinary life insurance.

Workers compensation: Insurance that pays for medical care related to on-the-job injuries and physical rehabilitation. Workers compensation helps cover lost wages while an injured worker is unable to work. State laws vary widely on benefit amounts paid and other compensation provisions.


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chapter 1 · web viewthe insurance company uses the spread to make money. an example should explain...

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