Life Insurance Quiz – Episode 226

This transcript was auto-generated and may contain errors.

[00:03] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your hosts, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome to the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, we have bestselling financial author Kim Butler and our co-host with us today. We have a quiz that she has not seen before, so we always love to kind of catch her and see whether her answers match the answers of the quiz. And more importantly, sometimes when they don’t, you have to wonder which answer is correct. How are you, Kim? I’m very fine. Love being set up. It works for me.

[00:56] So full speed ahead. Let’s see how we do. Here we go. Question one. By the way, I guess I should identify this. This is from a site called ProProps, P-R-O-P-R-O-F-S, and it’s a pretty cool site. It’s a custom software that you can buy to build your own flashcards and quizzes. So I was pretty impressed with it. Cool. Which of the following terms best describes a life insurance policy that provides a straight $100,000 of coverage for a period of five years? A, permanent life, B, whole life, C, level term, or D, variable term? I’m going to go for level term, which was C, I believe. Yep. Pretty simple. Is there such a thing as variable term? I don’t think I’ve heard of such a thing. No. Okay. That was an easy one.

[01:55] All the following statements regarding term life insurance are correct, except a three-year renewable policy allows a term policy owner to renew the same coverage for another three years. A three-year renewable policy allows a term policy owner to increase coverage for the next three years. C, an option to convert, provides that a term life insurance policy can be exchanged for a permanent one, or D, both the option to renew and the option to convert relieve the insured from furnishing evidence of insurability. Okay. So I’m going to go with B as being incorrect, that you can increase your term coverage when you renew. Correct. Awesome. A renewable policy allows you to renew, and I think it’s also important to ask,

[02:54] do you renew at the original premium amount? Not typically, nor at the original age. And that’s something that a lot of people get confused about. And I think it’s worth taking a moment to talk about this because converting, which typically you talk about converting to whole life, is different than renewing. Renewing the term insurance is just getting more term insurance. Converting to whole life is taking the term insurance policy and transitioning or converting it to whole life insurance. And a lot of term insurance is not convertible to whole life. It might be convertible, but it would be convertible to universal life. So in our practice, we talk about cheap term, like literally cheap in all its meanings,

[03:44] which is not something that you want to convert. There’s just cheap term that you have for five or 10 or 20 or even 30 years. And your intention is to get rid of it at the end of that term. And then there’s convertible term, which is something that we’re going to convert to whole life down the road, which is more expensive term, but it has the conversion abilities and yet you still are going to be at the older age. But regardless of your health, that’s where that real value comes in, is the convertible term you can convert regardless of your health. And just to clarify, you said something I think that might confuse our listeners just a little bit. You said that renewing is just getting more insurance.

[04:26] Renewing is maintaining the same insurance. You cannot get more, correct? Correct. Yes, thank you. I was going back on the B is the incorrect one. So yes, if you have a hundred thousand dollar term or a million dollar term and you renew that policy, you’re going to get that hundred thousand dollar term again or that million dollar if you had it to begin with again for a new period of time at a different premium based on the age at that time. Now, just so our listeners can understand the advantage of that, what if you’ve had a major change in health circumstances during those three years? Well, if it’s term insurance, you are going to pay for that major change in health. In other words, if you’re converting to whole

[05:14] life, there is no medical issue. But if you are renewing term insurance, it’s basically like starting over again. And so whatever health issues you’ve got, plus the fact that you’re three years older, both of those things will come into play in determining your new life insurance premium. Let’s move to the next one. When level premium insurance is renewed, the premium amount rises to reflect the increased mortality risk of the insured’s older age. What phrase best describes this approach to increasing premiums? A, variable rate, B, targeted rate, C, step rate or D, seniority rate. Holy cow, I’ve not heard of any of those four terms being applied to this. You know, it’s funny, you and I were saying like variable term.

[06:15] What’s that? I’m thinking that actually is maybe what makes the most sense or maybe it’s step rate. I don’t know. What’s the right answer? You got it. It’s step rate. OK, and, you know, if you think about it, it makes sense. Makes sense. Like five years would look just exactly like a staircase. Which of the following statements describing whole life insurance is correct? A, the face amount of the policy gradually increases the longer the policy remains in force. B, the shorter the premium period, the slower the cash value will grow. C, whole life insurance is designed to mature at age 100 or D, the policy’s cash value decreases each year the policy is in force. And I’m supposed to identify which one is correct?

[07:14] Which one is correct? I think I’m going to go with A. Read me that one again real quick. The face amount of the policy gradually increases the longer the policy remains in force. Yes, that is correct. Is that the one they identified? No. Interesting. Talk to me. They are going to, their answer is C, whole life insurance is designed to mature at age 100. And I’m not even sure that’s correct at all anymore. I don’t think so either. So let’s let’s elaborate on this one a little bit. So the word mature is not a good word on their part because that that’s what people do when people die and then the policy matures. That’s what’s happening. And they’re not referring to that right here. They’re referring to the word endow, which is something that whole life

[08:11] insurance has that all other types of life insurance do not have. And what endowment means is that your cash flow and your death benefit are equal. And while it used to be at age 100, so they were in the right ballpark there, it’s actually now at age 121. But you’re still going to see policies. I own policies that are going to endow at age 121. But that’s not maturing. That’s a different term, at least in my English dictionary. And what’s interesting is it is correct that death benefits rise as cash value rises. If you look at any life insurance policy, even one that does not have the maximum pay to petitions rider, the death benefit grows. And we need it to grow because that’s what beats inflation.

[08:58] When we add the maximum pay to petitions rider, it grows even faster. Now, somebody could say, oh, well, if you just look at the guarantees, it doesn’t grow. That’s correct. But the guarantees assume that no dividends are paid ever. And that’s very unlikely, though it is accurate that if no dividends are paid ever, then if you start with a million dollar death benefit, you’re going to end with a million dollar death benefit. But your typical just basic whole life insurance policy without the maximum pay to petitions is going to triple over, say, a 60 to 90 year period of time. If you add the maximum pay to petitions, it’s going to do more than that. I had a question that I saw asked in a chat room, and I’m not sure of

[09:43] the answer, so I’m going to go to you for this one. What they’re saying is is that the insurance industry, particularly the whole life industry, on the previous policies that were written with a endowment age of 100, that when the people are reaching 100, they are paying off the full cash value minus policy loans and canceling the policies so the death benefit is never paid. Yeah, that’s going to happen in universal life. That is improper to use the endowment word with universal life. Again, endowment equals cash value and death benefit, or I should say endowment is cash value is equal to death benefit, which does not happen in universal life, but absolutely happens in whole life. And in whole life, they are not going to pay that policy out.

[10:42] My understanding is that they would hold it, and at that point, it doesn’t matter. Cash value and death benefit are equal, but if they pay it out, it could be a taxable event. And if the insurance company holds it until the person has passed on, and again, we’re talking age 121 now, so that’s out there. But regardless, if the insurance company holds it until the person passes on, then it is going to be paid as a death claim, tax-free as we would have expected. So again, it’s so important, and you’re right. I’ve seen a lot of this coming up as late as well to understand that universal life doesn’t have an endowment and it wouldn’t surprise me at all if the insurance companies start to pay out those cash values

[11:30] as minimal as they are in order to get off the hook for the death claim in the future, but that is not whole life. That is a major difference between the universal lives and the whole lives. If you have a whole life policy written, say, 20 years ago, that endows at age 100 and the new policies endow at age 121, does that retroactively affect yours? Or are you under the terms of the original agreement? You’re under the terms of the original agreement at 100, and then again, my understanding is that they will, if the person is still living, the insurance company will hold that policy until death and then pay the death claim, which would be tax-free at that point. All right, our next question. The cash values of a life insurance policy

[12:21] belong to which of the following? A, the policy owner, B, the insured, C, the insurer, or D, the beneficiary? Absolutely A, the policy owner. No disputes or arguments here. Nope, and we should elaborate on it a little just for fun because it’s a question that comes up in our client base a lot, and that is the owner is sometimes the insured. Like I own my policies and I’m the insured, but the owner can sometimes be a different person than the insured. For example, I own a policy on my son and daughter, Robbie and Kaylee. They’re the insureds, I’m the owner. That cash value is on my balance sheet. And interesting too, it is an asset, and as an asset, there’s not a market for all of them, but there is a market and a possibility for you

[13:19] to be able to sell or transfer ownership. Absolutely. All of the following statements regarding basic forms of whole life insurance are correct except, A, generally straight life premiums are payable or leased annually for the duration of the insured’s life. B, the owner of a 30 pay life policy will owe no more premiums after the 30th year the policy is in force. C, limited payment life provides protection only for the years during which the premiums are paid. And D, a single premium life policy is purchased with a large one time only. And I’m identifying the incorrect one, yes? OK, that’s letter C. A limited pay policy, like a 10 pay or a 20 pay, is designed to be what’s called paid up at that point.

[14:25] And again, if it’s whole life, which they’re indicating it is, absolutely without question, that policy is going to exist for the entirety of the person’s life, hence its name, whole life. So you pay premiums for 10 years, but your policy would exist till you die, or you pay premiums for 20 years or 30 years or whatever your limited pay time frame is. And yet, again, the death benefit is going to be in force. The cash value is going to continue to grow slower because it’s not being added to. But those policies will absolutely have coverage or the benefit be available throughout that person’s entire life. All right, quick question. If you buy a 10 pay life policy, do you have the option of continuing premiums

[15:13] after the 10th payment? Not typically, which is why they’re not one of my favorites. It works fine if you’re out there in your 60s and 70s, but to have, for example, a 40-year-old buy a 10 pay life or a life paid up at 65, I think that limits their capability. Because what if at, like let’s say they do a life paid up at 65, well, that’s the whole old retirement kind of thinking, well, what if they’re still working until their 70s and 80s, which they should be doing, and they want to continue to add premiums and paid up additions to that policy? They’re not able to. So if somebody owns one of those policies, I would absolutely have them keep them. I mean, they’re not bad. They’re just limiting.

[15:58] And I don’t like things that set limits, especially arbitrarily limits based on ages that are irrelevant in our society today, like age 65. Super. Which of the following statements regarding modified endowment contracts is correct? A, a 1988 Revenue Act, commonly known as TAMRA, greatly increased the popularity of MECs. B, the Congress has granted the MEC the most favorable tax status among all life insurance policies. C, to avoid being classified as a MEC, a life insurance policy must satisfy the seven pay test. D, according to the T pay test, if the total amount a policy owner pays into a life contract during its first seven years is less than the sum of the net level premiums that would have been payable

[17:00] to provide paid up future benefits in seven years, the policy is a modified endowment contract. Holy cow. All right, which? It’s a lot simpler than what you think. I’m answering the wrong one again. No, no, you haven’t given me a letter yet. Oh, right. Of those four, I’m trying to pick what is wrong. Which is right. Oh my gosh, I’m even more confused. So either run them by me again or help me. I’m lost. In 88, TAMRA made MECs more popular. Correct, that’s not accurate. B, Congress granted the MEC the most favorable tax status. No, that’s not correct. Yep. C, to avoid being classified as a MEC, a life insurance policy must pass to satisfy the seven pay test. Okay, that is correct, kind of. So that’s why I got thrown.

[17:59] And then D, of course, is not correct. Correct, so C is the winner. Yeah, and my understanding is that MEC has two tests. There’s a seven pay test and a one pay test, an annual one. So regardless, for this particular point, clearly it’s the seven pay test that they’re after. And no, it’s not popular. And no, it’s not helpful. But it is what it is and we deal with it. And it has, I think, enabled us as advisors to go find alternative investments for lump sums of money. Because as they’ve indicated, the single pay and D, that’s gonna immediately create a MEC. And so lump sums of money, we tend to use bridge loans and other things that create cash flow for, and then use annual contributions for the life insurance policies.

[18:50] And frankly, I think that puts the client in a much more stable position anyway. A lot of advisors, if they don’t have those alternative investments that create cash flow available to them, they’re trying too hard to make the life insurance policy do all of the jobs. And it’s not necessary. Life insurance should just be your emergency opportunity money. It should be added to on an annual or monthly basis. And that’s it. In most cases, I don’t believe that lump sums should go into the life insurance policies. My opinion would be that a MEC is a tool. Most life insurance agents automatically try to avoid it, but there are situations where it’s appropriate. Absolutely, and they can do a decent job,

[19:34] and sometimes policies accidentally get into MEC status, and they’re fine. They’re not gonna hurt anything. They’re not maybe just the most perfect in all situations, but they’re absolutely doable and workable in all situations. I just, it’s kind of funny. I have one of the first policies that I wrote is still on the book. It’s a MEC, has a guaranteed interest rate of 8%, and the lady’s just happy as she can be. Absolutely. Which of the following whole life insurance policies attempts to make insurance premiums more manageable by offering lower premiums during the first few years following issue? A, minimum deposit whole life, B, indexed whole life, C, modified whole life, or D, indeterminate premium whole life.

[20:31] You ever heard indeterminate premium? No, I haven’t, and I have definitely heard of the three other words, but I don’t like the sound of any of them, although I can see, I think, what they’re trying to get at. I’m gonna just guess here. Do they call it minimum deposit? They call it modified whole life, C. Okay, modified whole life enables you to pay lower premiums at the front end than as you have the opportunity later. And that’s, yeah, that’ll work. That’s legit. While we’re on the subject, I wouldn’t want the word indexed combined with the word whole life at all in any format, because indexed is usually combined with universal life, completely different animal. And what was the other word?

[21:16] Minimum deposit whole life. Yeah, so they don’t use that word, apparently. Any whole life, regardless of what the original premium schedule is, as long as there’s sufficient cash value will continue whether the premiums are paid or not, correct? Correct, because yes, the cash value is going to be borrowed against in a format called an automatic premium loan to pay the premium, which then raises the cash value, which then lets you do it again the next year. And while you can’t continue that strategy forever, it has definitely gotten us and a lot of our clients out of a sticky spot financially from a cashflow standpoint, sometimes for two or three or four or five years, sometimes even longer than that, sometimes shorter,

[22:03] depends on the value. What type of policy would be best used when the need for protection declines from year to year? A, level term, B, decreasing term, C, whole life, or D, universal life? So the proper answer is B, decreasing term. And you know, prior to this question, I was going to say, I am really impressed with the questions and the answers and the way that they’re looking at whole life. And unfortunately, all that impression just went out the window because they’re using a concept called need and needs analysis or needs-based insurance is the wrong way to look at life insurance because there’s a guaranteed death or a guaranteed event, I should say, called death. No other insurance works that way

[22:58] and consequently no other insurance operates that way. All the other insurances can operate like insurance is supposed to, which is you buy the amount of insurance for the value of the item that you have. If you have a $50,000 car, you buy $50,000 of insurance for it. You don’t buy only what you need. You only need a $20,000 car to get you to work or whatever your car does. And yet you have a $50,000 car worth $50,000. So that’s what you insure it for. So why on earth do we apply a needs analysis to life? And this old thinking of you don’t quote, need life insurance when you’re retired is wrong, incorrect, inefficient, not helpful. I’ll try to stay off my soap box here, but unfortunately this question is really, really misguided.

[23:52] I would think it would be difficult to find one. Mortgage companies used to offer a decreasing product, but I can’t say that I’ve seen one in 20 years. I think the old A.L. Williams company, Primarker or whatever they’re going, World something, whatever they’re going by now these days, I think they still have a decreasing term. And essentially, if you get credit life at a bank, that’s decreasing term because as you pay your loan down, your life insurance coverage for that loan goes down. All of the following statements about term insurance are correct, except A, it pays a benefit only if the insured dies during a specified period. B, level decreasing and increasing are basic forms of term insurance.

[24:42] C, cash values bill during the specified period. D, it provides protection for a temporary period of time. So C is the one that is not correct. There are no cash values with term insurance and everything else in that sentence and those answers is correct and kudos to them. Term insurance is a great product for a term of time as long as you understand that that’s what it is. As a lot of our listeners know, we’re big believers in term insurance. You should have some term insurance, most people, and you should have some whole life. It’s not buy term and invest the difference, it’s buy term and whole life and then go invest all of your other monies and alternative investments and stop calling whole life insurance

[25:29] an investment at all. All right, we got to bring in a person’s name now. Bob purchases a $50,000 five-year level term policy. All of the following statements about Bob’s coverage are correct except, A, the policy provides a straight level $50,000 of coverage for five years. B, if the insured dies at any time during the five years, his beneficiary will receive the policy’s face value. C, if the insured dies beyond the specified five years, only the policy’s cash value will be paid. Or D, if the insured lives beyond the five years, the policy expires and no benefits are payable. So C is the incorrect one because again, they’re mixing cash values with term insurance and term insurance has no cash value.

[26:26] Again, everything else in there is correct and accurate and good for them for keeping it straight. Mrs. Williamson purchases a five-year $50,000 level term policy with an option to renew. At the end of the five-year term, she renews the policy. Which of the following statements is correct? A, the premium for the renewal period will be the same as the initial period. B, the premium for the renewal period will be higher than the initial period. C, the premium for the renewal period will be the same as the initial period, but a one-time service charge will be assessed as a renewal. D, the premium for the renewal period will be lower than the initial period. So B is correct. The premium will be higher for the renewal period

[27:19] than the initial period. And that higher premium, just for what it’s worth, will be based not only on her age, but also on her health. All of the following statements about variable insurance policies are correct, except A, sales presentations must be preceded or accompanied by a prospectus. B, state laws protect consumers and promote meaningful communication. C, materials used in selling variable policies must be approved by the state, office of insurance regulation. D, full and fair disclosure must be provided to prospective policy owners. And one of those was supposed to be incorrect? Yep. Okay, you’re gonna have to try me again. It must have been A or B. It says it’s C. I’m not, well, materials used in selling variable policies

[28:18] must be approved by the state, office of insurance regulation. I think because of the variable part, it’s not the state, office of insurance regulation that has to approve it. And who knows, it may not actually be called the state, office of insurance regulation, but we can state, as a verb, that states, as a noun, are typically what regulate life insurance, but you’re absolutely right. If you bring in the variable word, you’re essentially bringing in sub-accounts or mutual fund-like accounts. And so the Securities and Exchange Commission, the SEC, is going to be the one involved in approving any kind of sales material. And you’re right, I’m sure that’s what they’re addressing there. So, okay, see, it is.

[29:01] You got to have the SEC approve your sales material if you have a variable policy. In contrast to traditional whole life insurance policies with variable life insurance products, A, premiums are invested in insurers’ general account, B, investments match the insurer’s contractual guarantees and liabilities, C, contract cash values are not guaranteed, D, the insurer assumes the investment risk. Okay, I lost what we were trying to do. What’s the first part, what’s the setup? Okay, we’re contrasting a traditional whole life policy with a variable life policy. And so all those statements were about the variable? Yes. Okay, so variable is not the one that’s not an asset of the insurance company on the general books,

[30:07] something like that. The correct answer is C, contract cash values are not guaranteed, which is very true in variable life. Yes, so variable has, like I said, the sub-accounts, the mutual fund-like asset that the cash value is invested in. And you’re right, there are typically no guarantees. You can choose from a variety of accounts, but a guaranteed account is not typically one of them, as opposed to whole life, which has the guaranteed cash value, that’s a dollar figure. I think this is a confusing area for a lot of people. It’s the dollar figure that’s guaranteed in whole life, not the interest rate. We can equate it to an interest rate, but it’s an actual dollar figure, but variable doesn’t have anything guaranteed.

[30:50] I think it’s interesting, anytime you see variable or indexed in anything, well, not necessarily indexed, but variable, most people think that the lowest it could go would be zero, but you can actually have negatives, can’t you? Absolutely, so yeah, that’s more on the index side. And when you have zero in your sub-accounts in options or in a mutual fund or in anything, you still have insurance costs. So you can absolutely go negative. And then you get an extra bill, which I have experienced and is not fun. Correct. All of the following statements about variable insurance are correct, except, A, they are considered insurance contracts, B, sellers must hold a state insurance license, C, they are not considered securities contracts,

[31:46] D, sellers must hold a registered representatives license from FINRA. So I think it’s C, they’re not considered securities contracts? Correct. So right, those mutual fund like sub-accounts are not securities, they are sub-accounts inside a structure that while you do have to have the series six license, which is what D is referring to, they’re not actually mutual funds and they’re not actually securities, hence the convoluted description and way that they are dealt with inside the insurance industry. You know, prior to the creation of these, if I would have been involved in the discussion, I would have considered these as probably a good idea, but post-mortem and being able to see how they actually turned out working,

[32:44] it just, it’s not, I would not recommend them. You’re totally right, I own them. I used to think they were the greatest, but the variable life environment, unfortunately is typically combined with variable universal life. And so it’s the universal part that makes them set so detrimental. There are a few variable whole life contracts out there and those have some decency to them. But as a general rule, it’s just so much more efficient and effective to use whole life, use it as the emergency opportunity account that it’s supposed to be and do all of your investing elsewhere with alternative investments or even with the stock market if you want, but don’t try to mix those two, they’re just not a good combination.

[33:28] A policy covering two lives that only pays a death benefit when the second insured person dies is A, joint life policy, B, a family policy, C, a double indemnity policy, or D, a joint and last survivor policy. Well, they threw me with that last one. So I’m gonna go with D, joint and last survivor. You are correct. So what’s a joint life? I could have been very happy with that one too, but there did used to be, I don’t know if it’s in existence anymore, but there actually used to be, we call the joint life, we call them second to die. There used to be a first to die policy. Yeah, it wasn’t used very much. It was great for buy-sell agreements, but it was basically as expensive as just regular whole life

[34:23] because it’s first to die. So the second to die had the supposed benefit, but think about what happens. You have a couple and let’s say they’re both 60 and they buy a second to die or a joint life and survivor policy and one of them dies at 70 and the other one doesn’t die for 20 years later. I mean, that is just not a helpful space in between that cashflow environment. So we’re not big fans of the joint life, second to die style policy. And I’ve heard from just sort of the upper echelons of the various insurance companies that not many of them pay out because the death benefit is really needed at that first death. And while estate tax planning purposes could support putting off the cash coming in on the second death,

[35:15] it just really isn’t helping families. So they’re either cashing out the policies ahead of time or that other person is still alive years and years and years later. Interesting environment. We are now at our last question. And I think probably our listeners are thinking, wow, there’s more to this life insurance stuff than I thought. So I thought this would be an appropriate point for you to maybe point them to a resource that might help them answer some other questions. Absolutely. So we have a booklet called Financial Planning Has Failed and it addresses a lot of these areas around the life insurance arena and how much life insurance can play a role in your life while you’re living, while in addition, of course, helping upon death.

[36:04] So that’s available only at partners4prosperity.com slash ebook. You cannot get it at Amazon. You just opt in partners4prosperity.com slash ebook and get the Financial Planning Has Failed book. We have a couple others as well, but that’s the greatest starting point. And if you have any specific questions you’d like us to answer or you’d like for us to talk about that would best way to do that would be? Email is hello at partners4prosperity.com. That’s the special email for podcast listeners. Hello at partners4prosperity.com. Awesome. All right, our final question. A policy that pays double or triple the face amount if death occurs during a specified period is A, a multiple protection policy,

[36:53] B, a credit life policy, C, a family policy, or D, a joint policy? Yikes, I don’t like any of those. I don’t know. What’s the answer? The answer is a multiple protection policy. Never heard of it. But I have never heard of it either. So that’s just the way we’re gonna go out. So anyway, this is No BS Money Guide for the Prosperity Podcast. Thanks to Kim Butler. Thanks to all of our listeners. And we look forward to talking to you all again real soon. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partners4prosperity.com. If you liked this episode, make sure you subscribe and leave a review.