Life Insurance

Life insurance pays a death benefit to beneficiaries upon the death of the insured. The exam focuses on which types are securities, who bears investment risk, cash value mechanics, and the tax treatment of death benefits.

Term Life Insurance

Structure

• Provides a death benefit only for a specified term (e.g., 10, 20, 30 years)
• No cash value component; purely a protection product
• If the insured dies during the term, beneficiary receives the face value (death benefit)
• If the insured survives the term, the policy expires with no payout
• Lowest premium of all life insurance types (for the same death benefit amount)
• NOT a security - no investment component

Variations

Suitability

Young families needing maximum coverage at minimum cost. Temporary insurance needs such as mortgage protection or income replacement during working years.

Exam Tip: Gotchas

• Term life has NO cash value and is NOT a security. If the insured outlives the term, the policy pays nothing. This is pure death benefit protection only.

Whole Life Insurance

Structure

• Provides a death benefit for the entire lifetime of the insured (as long as premiums are paid)
• Level premiums - same premium for the life of the policy
• Guaranteed death benefit at a fixed face amount
• Cash value accumulates in the insurer's general account at a guaranteed rate
• Cash value grows tax-deferred
• Cash value grows slowly in early years; accelerates later
• Surrender value = cash value minus any surrender charges (available if policy is cancelled)
• NOT a security - guaranteed returns, general account investment, no investment risk to owner

Cash Value and Policy Loans

• Cash value grows on a guaranteed schedule (fully predictable)
• Policy loans: Proceeds are not taxable income when taken (it's a loan, not a withdrawal). Interest is charged by the insurer. Outstanding loans reduce the death benefit paid to beneficiaries
• If the policy lapses while a loan is outstanding, the forgiven loan amount becomes taxable income

Death Benefit

• Paid to beneficiaries income-tax-free (Internal Revenue Code (IRC) Section 101(a))
• This is a key distinction from variable annuity death benefits, where the gain portion is taxable as ordinary income
• Life insurance death benefits may be included in the insured's taxable estate for estate tax purposes (if the insured had incidents of ownership)

Suitability

Permanent insurance needs, estate planning, low-risk accumulation, and clients requiring certainty in premiums and death benefit.

Exam Tip: Gotchas

• Policy loan proceeds are NOT taxable income. But if the policy lapses with an outstanding loan, the forgiven loan amount becomes taxable. The exam tests this two-part distinction.
• Whole Life is NOT a security. The insurer bears all investment risk in the general account. No SEC registration or securities license is needed.

Universal Life Insurance

Structure

• Combines a death benefit with a flexible cash value component
• Cash value invested in the insurer's general account (like whole life)
• Key distinction: flexible premiums - owner can increase, decrease, or skip premium payments
• Can also adjust the death benefit amount (subject to underwriting)
• Cash value earns a current interest rate (with a guaranteed minimum)
• If cash value is sufficient, premiums can be paid from it
• If cash value is exhausted and premiums are not paid, the policy lapses
• NOT a security - general account, guaranteed minimum rate, no investment risk to owner

Suitability

Clients wanting permanent coverage with premium flexibility. Variable-income earners who may need to adjust payments.

Exam Tip: Gotchas

• The word "universal" means flexibility - flexible premiums and an adjustable death benefit. Universal life is NOT a security. Only the word "variable" makes a life insurance product a security.

Variable Life Insurance

Structure

• Death benefit and cash value fluctuate based on performance of separate account investments
• Policyholder selects subaccounts (similar to mutual fund portfolios)
• Fixed (level) premiums - unlike universal life, premiums are NOT flexible
• Death benefit has a guaranteed minimum (will not fall below the face amount regardless of separate account performance)
• Cash value has no guaranteed minimum - can decline to zero if investments perform poorly
• IS a security - registered with the SEC; sold by prospectus
• Seller must hold a securities license AND an insurance license

Suitability

Clients who want permanent coverage with a guaranteed minimum death benefit and are willing to accept investment risk for higher potential cash value growth.

Exam Tip: Gotchas

• Variable Life has a guaranteed MINIMUM death benefit, but NO guaranteed minimum cash value. Cash value can drop to zero, yet the death benefit never falls below the stated minimum.

Variable Universal Life (VUL) Insurance

Structure

• Combines features of variable life (separate account investing) and universal life (flexible premiums)
• Cash value invested in separate accounts chosen by the policyholder
• Flexible premiums - can increase, decrease, or skip
• Death benefit and cash value fluctuate with separate account performance
• IS a security - registered with the SEC; sold by prospectus
• Offers the most flexibility of all life insurance products
• Also carries the most risk - if separate account performs poorly and premiums are skipped, policy may lapse

Suitability

Clients seeking maximum flexibility in both premiums and investment choices who are comfortable with market risk to both cash value and death benefit.

Exam Tip: Gotchas

• VUL combines variable (separate account) with universal (flexible premiums). It offers the highest flexibility but also the highest risk among life insurance products.

Life Insurance Comparison

Think of it this way: The word "variable" is the dividing line. Products without "variable" keep your money in the insurer's general account, where the insurer takes the investment risk. Products with "variable" put your money in a separate account, where you take the investment risk. That shift from insurer risk to policyholder risk is exactly what makes variable products securities.

Exam Tip: Gotchas

• "Variable" in the name = separate account = security. The policyholder bears investment risk, and the product requires SEC registration plus a securities license. If there is no "variable" in the name, the insurer bears the risk and it is not a security.