Life Insurance Mock Exam 2
A few years ago, Ann took out a $50,000 policy loan on her whole life insurance policy to
start a business. At that time, the policy's ACB was $40,000 and the CSV was $70,000.
Today, she wants to repay $20,000 of the loan.
How much of her repayment will she be able to deduct for income tax purposes?
a) $5,000
b) $10,000
c) $15,000
d) $20,000 - ANS-(wrong) $20,000
Rationale:
When Ann took out her $50,000 policy loan, it resulted in a policy gain of $10,000 ($50,000 -
$40,000), which was fully taxable.
When a policyholder repays the policy loan in part or in full, they can deduct the repayment
from their taxable income, up to the amount of the policy gain she had to report when she
took out the loan. By repaying $20,000, Ann is able to deduct a maximum of $10,000, which
was the amount of the policy gain when she took out the loan. (Refer to Section 7.5.1)
Allison earns a gross monthly salary of $4,000. She is confident her salary will rise by an
average of 2% every year. She would like to purchase enough life insurance coverage to
replace her increasing income if she dies. It is assumed that a rate of return of 3.5% annually
is achievable.
Using the income replacement approach, calculate the amount of life insurance coverage
she will need.
a) $3,265,306
b) $3,213,963
c) $1,398,857
d) $1,171,429 - ANS-(correct) $3,265,306
,Rationale:
First, the inflation-adjusted rate of return must be calculated as follows:
[(1+ return) ÷ (1 + inflation rate)] − 1 = (1.035 ÷ 1.02) − 1 = 0.0147
Then use the inflation-adjusted rate of return to determine the required life insurance
coverage:
Annual income ÷ rate of return = ($4,000 × 12) ÷ 0.0147 = $3,265,306. (Refer to Section
11.2.2)
An insurance company is reviewing its experience for a group of adjustable whole life
policies. When comparing the experience to its projections made 10 years ago, the company
realizes that the actual investment returns are higher than projected and death benefits paid
are lower than expected.
As a result of this review, what might the insurance company do regarding this group of
adjustable whole life policies?
a) Reduce the premiums and reduce the death benefit
b) Increase the premiums and reduce the death benefit
c) Increase the premiums and increase the death benefit
d) Reduce the premiums and increase the death benefit - ANS-(correct) Reduce the
premiums and increase the death benefit
Rationale:
Because the investment returns are higher, and the mortality experience is better than
expected, the insurance company will adjust their projections to better reflect the group's
experience. These new projections (higher returns, lower death benefit payouts) will result in
either a decrease in the premiums or an increase in death benefits for the adjustable whole
life policies. (Refer to Section 3.2.5)
Andrew's participating life insurance was issued on April 26, 1998. Since then, he has paid
$28,000 in premiums and received $4,000 in cash from policy dividends. The cumulative net
cost of pure insurance (NCPI) is $11,000 and the cash surrender value (CSV) is $50,000.
Assuming Andrew's marginal tax rate is 45%, how much tax will he pay if he fully surrenders
his policy?
a) $9,900
b) $14,850
, c) $16,650
d) $22,500 - ANS-(correct) $16,650
Rationale:
ACB = Total premiums − NCPI − dividends paid to policyholder
ACB = $28,000 − $11,000 − $4,000 = $13,000
Policy gain = Proceeds of disposition − ACB
Policy gain = $50,000 − $13,000 = $37,000
Andrew will have to pay the following amount in taxes: $37,000 × 45% = $16,650. (Refer to
Section 7.1.3)
Ben and Michelle are married and have a son, Terry. Ben is a co-owner of a small company.
He and the other co-owner, Mark, have just completed a buy/sell agreement that is to be
financed by criss-cross life insurance. Ben looks after his 35-year-old brother, Carson, who
lives in a facility for semi-autonomous individuals.
Ben wants to buy life insurance on all of these people. Which of the following individuals is
NOT an insurable interest for Ben?
a) Michelle
b) Terry
c) Carson
d) Mark - ANS-(correct) Carson
Rationale:
It is typically accepted that a person has an insurable interest in his own life, as well as in the
life of:
His child or grandchild (Terry);
His spouse (Michelle);
Any person upon whom he is wholly or partially dependent upon for support or education;
His employee;
Any person in the duration of whose life he has a pecuniary interest (i.e., his business
partner, Mark, with whom he signed a buy-sell agreement).
Although Ben looks after his brother, Carson, he does not depend on Carson financially.
Therefore, he does not have an insurable interest in Carson. (Refer to Section 9.2.2)
Calvin and Rebecca, both aged 36, are common-law partners and have an 8-year-old
daughter. While reviewing their life insurance needs, Calvin indicates that if he dies, he
A few years ago, Ann took out a $50,000 policy loan on her whole life insurance policy to
start a business. At that time, the policy's ACB was $40,000 and the CSV was $70,000.
Today, she wants to repay $20,000 of the loan.
How much of her repayment will she be able to deduct for income tax purposes?
a) $5,000
b) $10,000
c) $15,000
d) $20,000 - ANS-(wrong) $20,000
Rationale:
When Ann took out her $50,000 policy loan, it resulted in a policy gain of $10,000 ($50,000 -
$40,000), which was fully taxable.
When a policyholder repays the policy loan in part or in full, they can deduct the repayment
from their taxable income, up to the amount of the policy gain she had to report when she
took out the loan. By repaying $20,000, Ann is able to deduct a maximum of $10,000, which
was the amount of the policy gain when she took out the loan. (Refer to Section 7.5.1)
Allison earns a gross monthly salary of $4,000. She is confident her salary will rise by an
average of 2% every year. She would like to purchase enough life insurance coverage to
replace her increasing income if she dies. It is assumed that a rate of return of 3.5% annually
is achievable.
Using the income replacement approach, calculate the amount of life insurance coverage
she will need.
a) $3,265,306
b) $3,213,963
c) $1,398,857
d) $1,171,429 - ANS-(correct) $3,265,306
,Rationale:
First, the inflation-adjusted rate of return must be calculated as follows:
[(1+ return) ÷ (1 + inflation rate)] − 1 = (1.035 ÷ 1.02) − 1 = 0.0147
Then use the inflation-adjusted rate of return to determine the required life insurance
coverage:
Annual income ÷ rate of return = ($4,000 × 12) ÷ 0.0147 = $3,265,306. (Refer to Section
11.2.2)
An insurance company is reviewing its experience for a group of adjustable whole life
policies. When comparing the experience to its projections made 10 years ago, the company
realizes that the actual investment returns are higher than projected and death benefits paid
are lower than expected.
As a result of this review, what might the insurance company do regarding this group of
adjustable whole life policies?
a) Reduce the premiums and reduce the death benefit
b) Increase the premiums and reduce the death benefit
c) Increase the premiums and increase the death benefit
d) Reduce the premiums and increase the death benefit - ANS-(correct) Reduce the
premiums and increase the death benefit
Rationale:
Because the investment returns are higher, and the mortality experience is better than
expected, the insurance company will adjust their projections to better reflect the group's
experience. These new projections (higher returns, lower death benefit payouts) will result in
either a decrease in the premiums or an increase in death benefits for the adjustable whole
life policies. (Refer to Section 3.2.5)
Andrew's participating life insurance was issued on April 26, 1998. Since then, he has paid
$28,000 in premiums and received $4,000 in cash from policy dividends. The cumulative net
cost of pure insurance (NCPI) is $11,000 and the cash surrender value (CSV) is $50,000.
Assuming Andrew's marginal tax rate is 45%, how much tax will he pay if he fully surrenders
his policy?
a) $9,900
b) $14,850
, c) $16,650
d) $22,500 - ANS-(correct) $16,650
Rationale:
ACB = Total premiums − NCPI − dividends paid to policyholder
ACB = $28,000 − $11,000 − $4,000 = $13,000
Policy gain = Proceeds of disposition − ACB
Policy gain = $50,000 − $13,000 = $37,000
Andrew will have to pay the following amount in taxes: $37,000 × 45% = $16,650. (Refer to
Section 7.1.3)
Ben and Michelle are married and have a son, Terry. Ben is a co-owner of a small company.
He and the other co-owner, Mark, have just completed a buy/sell agreement that is to be
financed by criss-cross life insurance. Ben looks after his 35-year-old brother, Carson, who
lives in a facility for semi-autonomous individuals.
Ben wants to buy life insurance on all of these people. Which of the following individuals is
NOT an insurable interest for Ben?
a) Michelle
b) Terry
c) Carson
d) Mark - ANS-(correct) Carson
Rationale:
It is typically accepted that a person has an insurable interest in his own life, as well as in the
life of:
His child or grandchild (Terry);
His spouse (Michelle);
Any person upon whom he is wholly or partially dependent upon for support or education;
His employee;
Any person in the duration of whose life he has a pecuniary interest (i.e., his business
partner, Mark, with whom he signed a buy-sell agreement).
Although Ben looks after his brother, Carson, he does not depend on Carson financially.
Therefore, he does not have an insurable interest in Carson. (Refer to Section 9.2.2)
Calvin and Rebecca, both aged 36, are common-law partners and have an 8-year-old
daughter. While reviewing their life insurance needs, Calvin indicates that if he dies, he
