CLU Individual Life Insurance 4 — Questions and Answers
Question 1: A modified premium whole life policy charges lower premiums in the early years and higher premiums later. How does its cash value accumulation compare to a standard whole life policy?
- Cash value accumulates faster in the early years
- Cash value accumulation is slower in the early years but catches up over time (Correct answer)
- Cash value is identical to standard whole life throughout
- Modified premium policies have no cash value
Correct answer: Cash value accumulation is slower in the early years but catches up over time
Because early premiums are lower in modified whole life, less money funds the reserve initially, causing slower early cash value growth, though it typically converges with standard whole life values in later years.
Question 2: What distinguishes variable universal life (VUL) from traditional universal life insurance?
- VUL has no mortality charges
- VUL invests cash value in separate account subaccounts with market risk borne by the policyowner (Correct answer)
- VUL guarantees a minimum rate of return on all subaccounts
- VUL premiums are fixed and cannot be varied
Correct answer: VUL invests cash value in separate account subaccounts with market risk borne by the policyowner
VUL directs cash value into separate account subaccounts (stocks, bonds, money market) where investment gains are not guaranteed and the policyowner assumes all market risk.
Question 3: Under the IRC Section 7702 corridor test, what happens if a life insurance policy's cash value exceeds the limit relative to the death benefit?
- The policy automatically lapses
- The policy is reclassified as a modified endowment contract
- The insurer must increase the death benefit to maintain corridor compliance (Correct answer)
- Premium payments are suspended
Correct answer: The insurer must increase the death benefit to maintain corridor compliance
To comply with IRC 7702's corridor requirement, if cash value grows too large relative to the death benefit, the insurer must increase the death benefit proportionally to keep the policy classified as life insurance.
Question 4: Which of the following best describes a modified endowment contract (MEC)?
- A policy that fails the 7-pay test and loses favorable tax treatment on withdrawals and loans (Correct answer)
- A policy with a guaranteed cash value equal to the face amount at age 100
- A term life policy that converts to whole life automatically
- A policy sold primarily to fund charitable bequests
Correct answer: A policy that fails the 7-pay test and loses favorable tax treatment on withdrawals and loans
A MEC is a life insurance contract that fails the 7-pay test under IRC 7702A; loans and withdrawals are taxed as income first (LIFO) and subject to a 10% penalty before age 59½.
Question 5: An insured dies during the grace period before paying the overdue premium. How does the insurer typically handle the claim?
- The claim is denied because the policy had lapsed
- The full death benefit is paid, and the overdue premium is deducted from the proceeds (Correct answer)
- Only the cash value is paid to the beneficiary
- The claim is deferred until the premium is paid by the estate
Correct answer: The full death benefit is paid, and the overdue premium is deducted from the proceeds
If death occurs during the grace period, the insurer pays the full death benefit minus the unpaid premium, because coverage remains in force during the grace period.
Question 6: Which life insurance concept describes the present value of future premiums expected to be paid, subtracted from the present value of future benefits?
- Net single premium
- Policy reserve (Correct answer)
- Surrender charge
- Modal premium loading
Correct answer: Policy reserve
The policy reserve (legal reserve) equals the present value of future benefits minus the present value of future net premiums, representing the insurer's liability for each in-force policy.
Question 7: A policyowner designates the estate as beneficiary of a life insurance policy. What is the primary disadvantage of this designation?
- The death benefit becomes taxable income to the heirs
- Proceeds must pass through probate and may be delayed or reduced by creditor claims (Correct answer)
- The insurer will not pay the claim without a court order
- The policy automatically converts to an annuity
Correct answer: Proceeds must pass through probate and may be delayed or reduced by creditor claims
Naming the estate as beneficiary causes life insurance proceeds to flow through probate, exposing them to estate administration costs, delays, and claims by the decedent's creditors.
CLU Individual Life Insurance 4
A modified premium whole life policy charges lower premiums in the early years and higher premiums later.
How does its cash value accumulation compare to a standard whole life policy?