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Principles of Risk Management and Insurance - Chapter 13

1.

A factor that can be ignored when determining the cost of life insurance is

- A) time value of money.
- B) premiums paid.
- C) settlement options.
- D) dividends.

Answer: C

2.

Under the traditional net cost method, the net cost of life insurance for a given period (e.g., 20 years) is determined by which of the following formulas?

- A) the total premiums for the period less the policy reserve at the end of the period
- B) the total premiums for the period less the sum of the total dividends received during the period and the cash value at the end of the period
- C) the sum of the total premiums and dividends for the period less the cash value at the end of the period
- D) the sum of the total dividends received during the period and the cash value at the beginning of the period less the total premiums paid for the period

Answer: B

3.

Which of the following statements about the traditional net cost method of measuring the cost of life insurance is (are) true?

- The traditional net cost method does not consider the time value of money.
- The traditional net cost method can show that life insurance has a negative cost.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: C

4.

Which of the following statements about the surrender cost index for measuring the cost of life insurance is true?

- A) It is based on the assumption that the policy will be in force indefinitely.
- B) It takes into account the settlement options available in the policy.
- C) It does not consider the cash value in the policy.
- D) It takes the amount and timing of each dividend into consideration.

Answer: D

5.

Which of the following statements describes how the net payment cost index differs from the surrender cost index?

- A) Dividends are ignored.
- B) The cash value is ignored.
- C) Premiums are not accumulated at a specified interest rate.
- D) Dividends are not accumulated at a specified interest rate.

Answer: B

6.

David purchased a $100,000 participating whole life policy. The annual premium is $2,280. Projected dividends for the first 20 years are $15,624. The cash value after 20 years will be $35,260. If the premiums were invested at 5 percent interest for 20 years, the premiums would grow to $79,156. If the dividends were accumulated at 5 percent interest for 20 years, they would grow to be $24,400. The amount to which $1 deposited annually will accumulate in 20 years at 5 percent interest is $34.719. Based on this information, what is the traditional net cost per thousand per year of David's policy over the 20-year period?

- A) -$1.52
- B) -$2.64
- C) $5.17
- D) $9.75

Answer: B

7.

David purchased a $100,000 participating whole life policy. The annual premium is $2,280. Projected dividends for the first 20 years are $15,624. The cash value after 20 years will be $35,260. If the premiums were invested at 5 percent interest for 20 years, the premiums would grow to $79,156. If the dividends were accumulated at 5 percent interest for 20 years, they would grow to be $24,400. The amount to which $1 deposited annually will accumulate in 20 years at 5 percent interest is $34.719. Based on this information, what is the surrender cost per thousand per year of David's policy over the 20-year period?

- A) $5.62
- B) $13.75
- C) $15.77
- D) $27.38

Answer: A

8.

David purchased a $100,000 participating whole life policy. The annual premium is $2,280. Projected dividends for the first 20 years are $15,624. The cash value after 20 years will be $35,260. If the premiums were invested at 5 percent interest for 20 years, the premiums would grow to $79,156. If the dividends were accumulated at 5 percent interest for 20 years, they would grow to be $24,400. The amount to which $1 deposited annually will accumulate in 20 years at 5 percent interest is $34.719. Based on this information, what is the net payment cost per thousand per year of David's policy over the 20-year period?

- A) $5.62
- B) $13.75
- C) $15.77
- D) $27.38

Answer: C

9.

Which of the following statements about the use of interest-adjusted cost data for comparing life insurance policies is (are) true?

- Using interest-adjusted cost data provides a more accurate measure of the cost of life insurance than is provided if the time value of money is ignored.
- Its use is most appropriate in deciding between policies when the cost variation is very small.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: A

10.

Which of the following statements about the Linton yield is (are) true?

- It is based on the assumption that a cash-value policy can be viewed as a combination of insurance protection and a savings fund.
- It is the average compound annual rate of return required to make the savings deposits in a life insurance policy equal to the policy's guaranteed cash value at the end of a specified period.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: C

11.

Which of the following statements about the yearly-rate-of-return method (also known as the Belth method) of calculating the yearly rate of return for a life insurance policy is (are) true?

- The formula requires the use of benchmark prices per $1,000 of protection.
- The main drawback of the formula is its complexity, necessitating the use of a computer to calculate the rate of return.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: A

12.

Consumer experts typically recommend all of the following rules when buying life insurance EXCEPT

- A) Consider the financial strength of the insurer.
- B) Deal with a competent agent.
- C) Ignore all factors other than cost.
- D) Shop around for a low-cost policy.

Answer: C

13.

Consumer experts typically recommend which of the following rules when purchasing life insurance?

- Avoid policies which pay dividends.
- Purchase life insurance equal to ten times your annual salary.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: D

14.

Why might the use of "grades" assigned by a life insurance company rating organization not be a reliable guide for consumers?

- There may be variations in grades given by different rating organizations.
- They ignore factors such as profitability and quality of investments.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: A

15.

Marshall is interested in determining the cost per thousand of his life insurance policy. Which of the following will provide Marshall the most meaningful measure of the cost per thousand dollars per year of his life insurance?

- A) the needs approach
- B) the traditional net cost method
- C) the human life value approach
- D) the surrender cost index

Answer: D

16.

Lynn calculated the future value of the first twenty premiums she will pay under her nonparticipating whole life insurance policy. Then she subtracted the cash value after 20 years. Next, she divided this value by the future value annuity due factor for 20 years to arrive at an annual cost of insurance. Finally, she divided the annual cost by the number of thousands of dollars of life insurance purchased to arrive at the cost per thousand per year. Lynn calculated the

- A) traditional net cost per thousand per year.
- B) the Linton Yield.
- C) the surrender cost per thousand per year.
- D) the net payment cost per thousand per year.

Answer: C

17.

Which method of analyzing the cost of life insurance does not consider the cash value of the policy in the analysis?

- A) traditional net cost method
- B) net payment cost index
- C) the Linton Yield
- D) the surrender cost index

Answer: B

18.

Mary is interested in comparing life insurance policies. Rather than looking at the cost per thousand, she would like to compare the rate of return earned on the savings portion of the policy. Which of the following would be of the most interest to Mary?

- A) the policy's Linton Yield
- B) the policy's surrender cost
- C) the policy's traditional net cost
- D) the policy's net payment cost

Answer: A

19.

Which of the following statements is (are) true regarding taxation of life insurance?

- Life insurance proceeds paid in a lump-sum to a designated beneficiary are received free of federal income taxes.
- The policyowner must pay taxes annually on the amount by which the cash value of his or her life insurance policy has increased.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: A

20.

The first step in "shopping for life insurance" is to

- A) estimate the amount of life insurance to purchase.
- B) decide whether you want a policy which pays dividends.
- C) determine if you need life insurance.
- D) decide on the best type of life insurance for you.

Answer: C

21.

Lisa does not want her life insurance policy included in her gross estate when she dies. Lisa can remove the life insurance policy from her estate if she does which of the following more than 3 years before she dies?

- A) borrow the cash value of the policy
- B) make an absolute assignment of the policy to someone else
- C) change the beneficiary to someone who does not have insurable interest
- D) select a lump sum settlement option and name her estate the beneficiary

Answer: B

22.

Brad owns a cash value life insurance policy. Last year, the cash value increased by $300. Brad received $100 in policyowner dividends on the policy last year. Brad was the beneficiary named in his grandmother's $50,000 life insurance policy. When she died this past year, Brad received $50,000. How much taxable income relating to life insurance must Brad report for federal income tax purposes?

- A) $0
- B) $100
- C) $400
- D) $50,400

Answer: A

23.

Carl and Carol Williams, a married couple, are doing some estate planning. Upon his death, Carl plans to leave $1,000,000 in property to his wife. This amount will reduce the value of Carl's gross estate and will be taxed later when Carol dies. This reduction of the gross estate is called the

- A) unified tax credit.
- B) taxable estate.
- C) capital gains deduction.
- D) marital deduction.

Answer: D

24.

Paul is shopping for a life insurance policy. An agent asked Paul if he would like to purchase a participating policy. What is a "participating" policy?

- A) a policy which has a cash value
- B) a policy which pays dividends
- C) a policy which invests in common stock
- D) a policy which provides for an increasing death benefit

Answer: B

25.

Each of the following helps to reduce federal estate taxes EXCEPT

- A) the marital deduction.
- B) the applicable unified tax credit amount.
- C) life insurance policies in which the deceased had an incidents of ownership at the time of death.
- D) expenses such as the cost of the funeral, estate settlement costs, and probate costs.

Answer: C

26.

Which of the following statements is (are) true with regard to using interest-adjusted cost data when shopping for life insurance?

- Cost indexes apply to new policies and should not be used to determine whether to replace a policy.
- Cost indexes should only be used to compare similar plans of insurance.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: C

27.

All of the following statements about the income tax treatment of individually-purchased life insurance are true EXCEPT

- A) policyowner dividends are received tax-free.
- B) the annual increase in cash value is not taxable while the policy remains in force.
- C) premiums paid for individual life insurance are a tax deductible expense.
- D) life insurance proceeds paid to a beneficiary in a lump-sum are received tax-free.

Answer: C

28.

Which of the following statements is (are) true about the federal estate tax?

- The gross estate can be reduced by a number of deductions.
- If the person who died had any ownership interest in a life insurance policy at the time of death, the proceeds are included in the gross estate for federal estate tax purposes.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: C

29.

Life insurance policy reserves

- A) are always equal to the policy's cash surrender value.
- B) are a major asset of life insurance companies.
- C) are paid to the beneficiary when the insured dies.
- D) are a major liability of life insurance companies.

Answer: D

30.

Purposes of life insurance policy reserves include which of the following?

- Legal test of the insurer's solvency
- Formal recognition of the obligation to pay future claims
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: C

31.

The difference between the present value of future benefits payable under a life insurance policy and the present value of net premiums for the policy is the policy's

- A) retrospective reserve.
- B) policyholders surplus.
- C) prospective reserve.
- D) admitted assets.

Answer: C

32.

The policy reserve at the end of any given policy year is called the

- A) terminal reserve.
- B) unearned premium reserve.
- C) mean reserve.
- D) initial reserve.

Answer: A

33.

To level a net single premium (NSP), the NSP is divided by

- A) the maximum number of years the premium could be paid.
- B) the ordinary life annuity factor for the premium payment period.
- C) the present value of a life annuity due of $1 for the premium payment period.
- D) the deferred life annuity factor for the premium payment period.

Answer: C

34.

The gross premium is defined as

- A) the net premium plus the loading allowance.
- B) the terminal reserve plus the commission.
- C) the net premium minus expenses.
- D) the sum of all acquisition expenses.

Answer: A

35.

The National Association of Insurance Commissioners (NAIC) has drafted a "Life Insurance Policy Illustration" model law that most states have adopted. Which of the following statements concerning this model law is (are) true?

- The policy illustration must include a narrative summary describing the basic characteristics of the policy.
- The policy illustration must include a numeric summary showing the premium outlay, the value of the accumulation account, the cash surrender value, and the death benefit.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: C

36.

Beth purchased a $50,000 nonparticipating whole life insurance policy. The annual premium was $1,278. The cash value of the policy after 10 years will be $13,740. The future value of $1 deposited at the start of the year for 10 years, assuming 5 percent interest, is $13.207. What is the traditional net cost of this policy, per thousand per year, over the first 10 years the policy is in force?

- A) -$2.86
- B) -$2.14
- C) -$1.92
- D) -$0.88

Answer: C

37.

Beth purchased a $50,000 nonparticipating whole life insurance policy. The annual premium was $1,278. The cash value of the policy after 10 years will be $13,740. The future value of $1 deposited at the start of the year for 10 years, assuming 5 percent interest, is $13.207. If the premiums were invested at 5 percent interest for 10 years, the premiums would grow to $16,878.55. Assuming 5 percent interest, what is the surrender cost of this policy, per thousand per year, over the first 10 years the policy is in force?

- A) $4.48
- B) $4.75
- C) $4.92
- D) $5.16

Answer: B

38.

Beth purchased a $50,000 nonparticipating whole life insurance policy. The annual premium was $1,278. The cash value of the policy after 10 years will be $13,740. The future value of $1 deposited at the start of the year for 10 years, assuming 5 percent interest, is $13.207. If the premiums were invested at 5 percent interest for 10 years, the premiums would grow to $16,878.55. Assuming 5 percent interest, what is the net payment cost of this policy, per thousand per year, over the first 10 years the policy is in force?

- A) $12.71
- B) $14.82
- C) $17.24
- D) $25.56

Answer: D

39.

Actuaries at Term Life Insurance Company calculated the net single premium per thousand for a five-year term policy for a man age 32 to be $5.04. To calculate the net level premium for this policy, the net single premium should be

- A) divided by 5.
- B) divided by the future value life annuity due factor for $1 for five years.
- C) divided by the present value life annuity due factor for $1 for five years.
- D) divided by the present value ordinary life annuity factor for $1 for five years.

Answer: C

40.

Which statement is true regarding using interest-adjusted cost data and purchasing life insurance?

- A) Cost indices can help to determine whether a policy should be replaced.
- B) The type of policy you purchase should he based solely on a cost index.
- C) Small variations in cost indices should be ignored.
- D) Cost indices should be used to select an insurer, not an individual policy.

Answer: C

41.

The net single premium for a life insurance policy is

- A) the premium the insurer charges to cover the death benefit and the insurer's expenses.
- B) the future value of the future death benefit.
- C) the present value of the future death benefit.
- D) the face value of the policy discounted back for the number of year the policy will be in force.

Answer: C

42.

According the 2001 CSO mortality table, the yearly probability of dying for a 40 year-old man is .00165. The present value of $1 one year from today, assuming a 5.5 percent interest rate, is .9479. What is the net single premium per $1,000 for a one-year term insurance policy sold to a man at age 40 assuming a 5.5 percent interest rate? Assume the premium is paid at the start of the year and the death benefit is paid at the end of the year.

- A) $1.56
- B) $2.45
- C) $7.18
- D) $952.81

Answer: A

43.

ABC Life Insurance Company is offering a new product. The product is a two-year term insurance policy funded by a single premium at the start of the first year. Death claims are paid at the end of the year in which death occurs. A portion of the appropriate mortality table is shown below. The first number is age, the second is the number alive at the start of the year, and the last number is the number dying during the year.

39 9,693,539 14,928

40 9,678,611 15,970

Using a 5.5 percent interest rate, the present value of $1 one year from today is .9479, and the present value of $1 two years from today is .8985. Assuming a 5.5 percent interest rate, what is the net single premium for a $1,000 two-year term policy issued at age 39?

- A) $1.49
- B) $2.94
- C) $5.67
- D) $12.83

Answer: B

44.

Charles, age 65, owns a paid-up $250,000 whole life policy on his own life. Charles is doing some estate planning and would not like this policy to be included in his gross estate for federal estate tax purposes. Which of the following statements is (are) true regarding the tax treatment of this policy?

- Charles can avoid having the policy proceeds included in his gross estate by naming his estate the beneficiary.
- If Charles makes an absolute assignment of the policy and dies more than three years later, the policy is not counted as part of his gross estate.
- A) I only
- B) II only
- C) both I and II
- D) neither I nor II

Answer: B

45.

The gross premium for life insurance is equal to

- A) the present value of the future death claim plus an expense loading.
- B) the present value of the future death claim less the sum of the premiums paid when death occurs.
- C) the present value of the future death claim less the present value of the expected dividends.
- D) the net premium less the expense loading.

Answer: A

46.

The average annual rate of return on a cash-value policy if it is held a specified number of years is called the policyâ€™s

- A) net present value.
- B) interest-adjusted cost.
- C) benchmark cost.
- D) Linton yield.

Answer: D

47.

All of the following statements about the tax treatment of life insurance purchased by an individual are true EXCEPT

- A) The annual increase in the cash value is currently taxable.
- B) Premium payments are not tax deductible.
- C) Death benefits received in a lump sum are not taxable income.
- D) Policyowner dividends are not considered taxable income.

Answer: A

48.

The net premiums collected by a life insurer for a particular block of policies, plus interest income at an assumed rate, less assumed death benefits paid is called the

- A) cash value.
- B) retrospective reserve.
- C) net amount at risk.
- D) prospective reserve.

Answer: B