Fundamentals of Insurance Planning

1
Fundamentals ofInsurance Planning
Life Insurance Planning and Purchasing Decisions
Chapter 10
2
Chapter 10 Overview

• appropriate amount and type of insurance
• measuring the cost
• illustrations
• replacement substandard coverage

• viatical agreements
• life settlements
• business uses of life insurance
• tax treatment
• life insurance in estate planning

3
multiple of income approach --

• simplistic approach to life insurance planning
  that determines life insurance needs based on the
  clients current annual income

4
financial needs analysis --

• an approach to determining how much life
  insurance a client needs if the principal sum is
  to be liquidated in the process of meeting the
  client's financial objectives for his or her
  survivors

5
capital needs analysis --

• an approach to determining how much life
  insurance is needed to provide a principal sum
  adequate to fund survivors needs while
  preserving the principal

6
typical financial needs --

• lump-sum needs
• final illness costs
• outstanding debt
• estate taxes, if applic.
• probate and legal expenses
• funeral, burial, etc.
• operational expenses
• emergency fund

• ongoing income needs
• readjustment income
• adjusted income while children are dependent
• blackout period
• spouse income with Social Security and pension

7
financial needs analysis --

• identify lump-sum and ongoing income needs
• identify resources
• needs resources deficit
• calculate deficit for each period
• determine NPV of the deficit for each period
  using appropriate discount rate
• life insurance in that amount funds previously
  unfunded objectives

8
example the Stringers --
9
capital needs analysis --

• complete a financial needs analysis to determine
  capital needs
• determine clients net worth
• subtract illiquid assets
• subtract lump-sum needs
• needs resources deficit
• deficit/applicable interest rate
• resulting capital sum will produce enough income
  to meet the deficit without liquidating capital

10
characteristics relevant to choosing appropriate
insurance --

• term features
• temporary coverage
• low initial premium
• rising premium
• margin for adverse selection
• level, increasing, or decreasing death benefits

• appropriate use
• hedge a loan
• offset speculative business investment
• dependent children

11
buy term and invest the difference? consider --

• safety of principal and income
• rate of return
• liquidity
• assurance that saving will be done

12
other considerations relevant to choosing
appropriate insurance --

• length of premium-paying period
• emphasis on saving vs. protection
• when death benefits needed

• desire for inflation protection
• importance of yield vs. safety in savings
• unbundling
• premium flexibility

13
measuring the cost --

• surrender cost index
• estimates the net cost of life insurance on a
  time-value-adjusted basis, assuming the policy
  will be surrendered at a specified time
• net payment cost index
• estimates the net cost of life insurance on a
  time-value-adjusted basis assuming that the death
  benefit will be paid at a specified time period

14
life insurance illustrations --

• tables or graphs depicting a policys performance
  over a period of years
• include nonguaranteed elements
• of limited value for comparing different policies
• NAIC model regulation prohibits inappropriate use
  of illustrations, requires annual reports on
  universal life policies

15
replacement --

• replacing existing life insurance policy with
  another
• to prevent financial harm to the policyowner,
  agents and insurers must follow prescribed
  procedures
• includes 1035 exchanges

16
1035 exchange --

• mitigates tax implications of policy replacement
• old and new contract must cover same insured and
  have same policyowner
• life contract may be exchanged for annuity,
  annuity may be exchange for life insurance, but
  annuity may not be exchanged for life insurance
• must follow certain procedures

17
some issues in policy replacement --

• pay high first-year expenses again?
• higher premium?
• new suicide clause?
• new incontestable clause?
• more or less favorable policy terms?

18
substandard coverage --

• rate-up age method
• bases premium rate and policy values on an age
  older than the actual age
• extra percentage tables
• separate, higher-than-normal mortality rates are
  used in calculating the premium

• flat extra premium
• charging a specified extra premium per 1,000 of
  insurance regardless of age
• lien
• death proceeds are reduced if death occurs within
  the first few years of coverage

19
viator --

• the policyowner who sells a life insurance
  policy to a third party

20
viatical settlement provider --

• the party who purchases a policy from a viator
  under a viatical settlement purchase agreement

21
viatical settlement purchase agreement --

• contract arranging for the sale of a life
  insurance policy by a viator to a viatical
  settlement provider

22
key employee life insurance --

• protects a business against possibility of
  income loss and/or expense increase following a
  key employees death

23
buy-sell agreement --

• a contract binding the owner of a business
  interest to sell the business interest for a
  specified or determinable price at his or her
  death or disability and a designated purchaser to
  buy at that time

24
life settlement --

• transferring ownership of a life insurance policy
  to a third-party investor when the insured is not
  terminally ill
• can raise cash for seniors who need cash but no
  longer need life insurance
• raises ethical issues

25
entity agreement --

• a business buy-sell agreement in which the
  business itself is the designated purchaser of
  the deceased's business interest

26
cross-purchase agreement --

• a business buy-sell agreement in which the
  surviving co-owners will be the purchasers of the
  business interest of a deceased owner

27
Sec. 79 plans

• employer-sponsored group life plans that permit
  the employer to take a tax deduction on premium
  payments for coverage up to 50,000
• coverage above 50,000 is taxable income for
  employees based on premium rates specified in
  Table I by the IRS

28
split-dollar life insurance --

• a plan under which two parties, usually an
  employer and an insured employee, share the
  premium costs, death proceeds, and perhaps cash
  value of a life insurance policy pursuant to a
  prearranged agreement

29
tax treatment of life insurance benefits --

• death benefits
• generally not taxable income to beneficiary
• exceptions
• transfer for value
• failing IRS definition of life insurance

• living benefits
• dividends, withdrawals, policy loans, cash
  surrender, etc.
• returns exceeding policyholders basis generally
  taxable
• inside buildup not taxable
• 1035 exchange not taxable

30
transfer-for-value rule --

• subject to certain exceptions, if a life
  insurance policy is transferred from one owner to
  another for valuable consideration, the death
  proceeds will be subject to federal income
  taxation

31
cash value accumulation test --

• a test to determine whether an insurance policy
  meets the definition of a life insurance policy
  for federal income tax purposes. To qualify as
  such, the cash value must not exceed the net
  single premium that would be needed to fund the
  policy's death benefit.

32
guideline premium and corridor test --

• a two-pronged test to determine whether an
  insurance policy meets the definition of a life
  insurance policy for federal income tax purposes.
  The test relates to both the size of the total
  premium paid and the size of the death benefit
  relative to the cash value.

33
inside buildup --

• the increase in the cash value or investment
  fund of a permanent life insurance policy

34
modified endowment contract (MEC) --

• a life insurance policy that fails to meet the
  Internal Revenue Code's 7-pay test. Distributions
  receive less favorable tax treatment than other
  life insurance contracts receive.

35
gift tax --

• a tax imposed on transfers of property by gift
  during the donor's lifetime

36
gift --

• for federal gift tax purposes, a completed
  transfer and acceptance of property for less than
  full and adequate consideration

37
annual exclusion --

• the amount of a gift exempt from federal transfer
  taxation
• can be doubled if the donor is married and the
  donor's spouse elects to split the gift

38
estate tax --

• a tax imposed by the federal government and many
  states on the right of a person to transfer
  property at death

39
gross estate --

• for federal estate tax purposes, the property of
  a decedent that passes by will and by other
  means

40
incident of ownership --

• any right to the economic benefits of a piece of
  property, such as a life insurance policy

41
estate-planning techniques --

• gifts of life insurance policies
• providing estate liquidity
• use of second-to-die policies