Premiums, Proceeds & Beneficiaries
How premiums are calculated and funded, how death benefits get paid out and to whom, and how the IRS taxes all of it.
Take a shot at these. Being wrong here is the point — it primes you for the answers, which are all in this lesson.
A beneficiary elects to leave the death benefit with the insurer and receive it in installments. The interest portion of those payments is:
Which factor has the GREATEST impact on the calculation of a life insurance premium?
A buyer plans to surrender his policy for its cash value in about 15 years. Which tool BEST compares his policy choices?
This chapter follows the money through a life insurance policy: the premium going in, the death benefit coming out, and the beneficiary who receives it. The exam leans hard on this material because it's full of look-alike pairs — net vs gross premium, modified vs graded funding, per capita vs per stirpes, viatical vs life settlement. Learn each concept as a contrast with its twin and the questions get much easier.
Life Insurance Premiums & Funding
[2–2.6]The premium is the policy owner's consideration — the "binding force" of the contract — and it's calculated per $1,000 of coverage using three premium factors: mortality, interest, and expenses. Mortality comes from the CSO mortality table, and adding the insurer's expenses (the loading charge) to the net premium gives the gross premium you actually pay. You'll also learn the five whole life premium funding methods (single, level, modified, graded, flexible), the premium-mode rule that more frequent payments cost more, earned vs unearned premium, and the reserves insurers must hold to guarantee future claims.
Which concept does this describe? The amount available in cash upon voluntary termination of a policy before it becomes payable by death or maturity.
Which factor has the GREATEST impact on the calculation of a life insurance premium?
Comparing Policy Costs; Viatical & Life Settlements
[3–4.2]A lower premium doesn't automatically mean a cheaper policy — cost is what you pay minus what you get back. The NAIC requires two interest-adjusted indexes: the surrender cost index (for buyers who care about cash value) and the net payment cost index (for buyers who care about the death benefit), plus the comparative interest rate method — the "buy term and invest the difference" test. This section also covers selling a policy: a viatical settlement requires a chronically or terminally ill seller (the viator), while a life settlement pays more than cash surrender value but less than the death benefit, for any reason at all.
Which concept does this describe? NAIC-required index numbers that let consumers compare policy costs of the same generic type, factoring in premiums, death benefits, cash value, dividends and the time value of money. Two indexes: the surrender cost index and the net payment cost index.
A buyer plans to surrender his policy for its cash value in about 15 years. Which tool BEST compares his policy choices?
Death Benefit Settlement Options
[5–5.2]The death benefit can be paid five ways — the settlement options: lump-sum (the default), interest only, fixed period, fixed amount, and life income. Life income has its own variants: straight life (highest payment, nothing after death), period certain, refund, and joint and survivor. The spendthrift clause shields proceeds held by the insurer from the beneficiary's creditors — but only until the money is actually paid out.
Which concept does this describe? The methods for paying out the death benefit. The five: (1) lump-sum, (2) interest only, (3) fixed period, (4) fixed amount, (5) life income. The owner may pre-select one (the beneficiary then can't change it); otherwise the beneficiary usually chooses at death.
Which concept does this describe? The death benefit paid in a single payment, minus outstanding loans and overdue premiums. The most common and the default option. Received income-tax-free.
Beneficiaries & Death Benefit Distribution
[6–6.7]Naming the beneficiary may be the single most important decision in the contract. You'll learn the order of succession (primary, contingent, tertiary), revocable vs irrevocable designations, and the two change methods (filing vs endorsement). Distribution has its own rules: per capita (the default, per living head) vs per stirpes (by bloodline), plus what happens with estates, minors, and trusts. When the insured and primary beneficiary die together, the Uniform Simultaneous Death Act and the common disaster provision steer the money to the contingent beneficiary instead of the primary's estate.
Which concept does this describe? "Per head" — proceeds divided evenly among all named LIVING beneficiaries. A deceased beneficiary's share does NOT pass to their heirs. This is the default method.
Which concept does this describe? "By the bloodline" — a deceased beneficiary's share passes to their heirs (down the family branch). Makes contingent designations largely unnecessary.
Tax Consequences of Life Insurance
[7–7.5]The basic bargain: premiums are paid with after-tax dollars (not deductible), so lump-sum death proceeds arrive income tax-free — see taxation of proceeds and its exception, the transfer-for-value rule. While the insured is alive, cash value grows tax-deferred; on surrender, only the gain above the cost basis is taxable. Dividends are tax-exempt as a return of premium, policy loans are generally tax-free unless the policy is a MEC (then LIFO taxation plus a 10% penalty before age 59½), and a 1035 exchange lets you swap like-kind contracts without current tax.
Dario surrenders his whole life policy and receives $48,000. He paid $40,000 in premiums and received $3,000 in dividends over the years. How much is taxable?
Which concept does this describe? Total premiums paid into the policy MINUS dividends received in cash or used to offset premiums. The tax-free portion recoverable at surrender.
Chapter Review: Exam Traps & Contrasts
[8]Chapter 6 is contrast-heavy, so finish by drilling the look-alike pairs the exam loves: net vs gross premium, modified vs graded funding, earned vs unearned premium, surrender cost vs net payment index, viatical vs life settlement, per capita vs per stirpes, and the Uniform Simultaneous Death Act vs the common disaster provision. If you can state which twin is which in one sentence each, you're ready for this chapter's questions.
Close your eyes for a moment, then write everything you remember from this chapter — rules, numbers, traps. Recalling first is worth more than rereading.
Recall captured. Compare it against the summary below.
What this chapter covered
- Life Insurance Premiums & FundingMortality has the GREATEST impact on premium calculation — and more frequent payment modes (monthly vs annual) mean a HIGHER total premium, because the insurer earns less interest and spends more on billing.
- Comparing Policy Costs; Viatical & Life SettlementsViatical = must be chronically ill (can't do 2+ ADLs) or terminally ill (≤24 months). Life settlement = NO illness required — that's the distinction the exam tests.
- Death Benefit Settlement OptionsThe death benefit itself is income tax-free, but interest earned on proceeds left with the insurer is taxable in the year earned — even if it isn't paid out that year.
- Beneficiaries & Death Benefit DistributionOn order-of-succession questions, assume the owner made NO beneficiary changes unless the question explicitly says so — don't add facts that aren't there.
- Tax Consequences of Life Insurance1035 exchanges only move 'downhill': life → life/endowment/annuity, endowment → endowment/annuity, annuity → annuity. An annuity can NEVER be exchanged for life insurance — that would turn tax-deferred money tax-free.
- Chapter Review: Exam Traps & ContrastsMortality = frequency of DEATH (life insurance); morbidity = incidence of DISEASE (health insurance). Higher rates of either mean higher premiums.
Lesson complete — every check passed from memory. Your pretest answers above are now revealed.