Learning Objectives 26. What Is Insurance? 3. Coverage Concepts 8. Types of Insurance 10. Types of Insurers 11. Introduction 26

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1 Contents u n i t 1 Introduction to Insurance 1 Introduction 2 Learning Objectives 2 What Is Insurance? 3 Risk 4 Coverage Concepts 8 Types of Insurance 10 Types of Insurers 11 Domicile and Authorization 15 Types of Distribution Systems 16 Producers 18 Summary 20 Unit Test 21 Test 23 u n i t 2 Insurance Regulation 25 Introduction 26 Learning Objectives 26 Regulation of the Insurance Business 27 Summary 54 Unit Test 55 Test 59 u n i t 3 Insurance Law 61 Introduction 62 Learning Objectives 62 Agency Law 63 Formation of a Life or Health Insurance Contract 67 Legal Requirements 71 Summary 76 Unit Test 77 Test 79 iii

2 x Contents U N I T 2 3 Social Health Insurance 497 Introduction 498 Learning Objectives 498 Medicare Parts A and B 499 The Original Medicare Plan 501 Medicare Supplement Insurance 510 Medicare Part C: Medicare Advantage Plans 515 Medicare Part D: Medicare Prescription Drug Plans 517 Medicare and Employer Coverage 518 Medicaid 519 Social Security Disability 520 TRICARE 521 Workers Compensation 521 Summary 526 Unit Test 528 Test 531 U N I T 2 4 Long-Term Care 533 Introduction 534 Learning Objectives 534 History of LTC Coverage 535 Who Needs LTC Insurance? 536 Probability of Needing Care 537 Options Other Than Insurance 537 Rating Factors 538 Types of Benefits 538 Benefit Triggers 543 Qualified Plans 543 Regulation 544 Emerging LTC Issues 544 Marketing LTC Coverage 545 Summary 545 Unit Test 547 Test 549 Common Provisions 539 U N I T 2 5 Health Insurance and Taxation 551 Introduction 552 Learning Objectives 552 Taxation of Health Insurance Policies 552 Disability Income Insurance 554 Medicare Supplement and Long- Term Care Insurance 554 Taxation of Government Health Programs 555 Summary 556 Unit Test 557 Test 559

3 260 Life, Accident, and Health Insurance National License Exam Manual Learning Objectives After completing this lesson, you will be able to: describe and explain the workings of the various types of annuities; list the three types of annuity premium payments; list the five factors used to determine annuity premiums; explain how variable annuities are regulated; and explain how accumulation units and annuity units are calculated Purposes of Annuities Life insurance is designed to protect the insured against premature death. An annuity is designed to protect the annuitant against the risk of living too long and possibly outliving her financial resources during retirement. Annuities offer a benefit unknown to other types of financial vehicles: a payout you cannot outlive. Other investments and savings can be depleted and leave an individual with no other resources in dire financial straits. Annuity payments, however, can be arranged to last for life. Like all insurance, annuities are designed to transfer a risk from consumers to an insurance company. In the case of annuities, the risk being transferred is the risk of outliving your savings. Annuities technically are not life insurance, but because annuities are sold by life insurance companies, a basic understanding of the types of annuity policies available is necessary to qualify for a producer license Distribution of a Lifetime Income Suppose you had a sum of money with which to support yourself for the rest of your life. If you spent too much each month, you would run out of money before you died. If you spent too little, you would not maximize the use of that money you would die before it was all used up. An annuity eliminates this uncertainty by converting a sum of money into a series of period payments that can be guaranteed to last a lifetime, and sometimes longer as we ll see Lump Sum Settlements If an annuitant dies before the annuity fund (the principal) is depleted, a lump-sum cash payment of the remainder is made to the annuitant s beneficiary. Thus, the beneficiary receives an amount equal to the beginning annuity fund less the amount of income already paid to the deceased annuitant.

4 Life, Accident, and Health Insurance National License Exam Manual Accumulation of a Retirement Fund Suppose you don t have a sum of money that will serve as a fund for your retirement. An annuity can be structured to allow for the accumulation of such a fund over time so that when retirement finally arrives, income payments begin. These payments will continue as long as you live and even afterward to your spouse if he survives you Accumulation of Education Funds While annuities are designed to create and accumulate income for retirement, they can be used for other purposes as well. For example, they can be used to create and accumulate funds for a college education. Annuities serve a variety of purposes for which a stream of income is needed for a few years or a lifetime Tax-Deferred Growth Annuity benefit payments are a combination of principal and interest. Accordingly, they are taxed in a manner consistent with other types of income: the portion of the benefit payments that represents a return of principal (i.e., the contributions made by the annuitant) are not taxed; the portion representing interest earned on the declining principal is taxed. The result, over the benefit payment period, is a tax-free return of the annuitant s investment and the taxing of the balance. Though a detailed discussion of how to compute the taxable portion of an annuity payment is beyond the scope of this text, the basics are not difficult to understand. An exclusion ratio is applied to each benefit payment the annuitant receives: Investment in the contract Expected return = Exclusion ratio The investment in the contract is the amount of money paid into the annuity; the expected return is the annual guaranteed benefit the annuitant receives, multiplied by the number of years of her life expectancy. The resulting ratio is applied to the benefit payments, allowing the annuitant to exclude from income a like percentage. Deferred annuities accumulate interest earnings on a tax-deferred basis. While no taxes are imposed on the annuity during the accumulation phase, taxes are imposed when the contract begins to pay its benefits (in accordance with the exclusion ratio just described). To discourage the use of deferred annuities as short-term investments, the Internal Revenue Code imposes a penalty as well as taxes on early withdrawals and loans from annuities. Partial withdrawals are treated first as earnings income (and are thus taxable as ordinary income); only after all earnings have been taxed are withdrawals considered a return of principal. Furthermore, a 10% penalty tax is imposed on withdrawals from a deferred annuity before age 59½. Withdrawals after age 59½ are not subject to the 10% penalty tax, but are still taxable as ordinary income.

5 262 Life, Accident, and Health Insurance National License Exam Manual Summation Annuities exist to distribute a lifetime income or to accumulate a sum of money if necessary. This accumulation may be used for retirement, as has been described, or for any other purpose perhaps an education fund to pay college expenses. Whatever the reason, the annuity can serve as a means of providing the money How Annuities Work Like an insurance policy, an annuity is a contract between a purchaser and an insurance company. The purchaser pays the premium and generally is the contract owner. The contract owner has certain rights under the contract. Example The contract owner names the annuitant. The annuitant is the insured, the person on whose life the annuity policy has been issued. In most cases, the annuitant is the intended recipient of the annuity payments. Many times, the contract owner and annuitant are the same person, but not always. The contract owner also names a beneficiary, who receives survivor benefits payable under the annuity upon the death of the annuitant. Annuities may be considered a true insurance product because there is an amount at risk. With an insurance policy, the insurer is counting on the insured living long enough so that the premiums paid and interest earned on them will equal or exceed the policy s death benefit. With an annuity, specifically a life annuity that provides benefits for as long as the annuitant lives, the insurer is counting on the annuitant not outliving the principal and interest used to provide payments. From the standpoint of the consumer, it could be said that life insurance offers protection against dying too soon, whereas an annuity offers protection against living too long.

6 Life, Accident, and Health Insurance National License Exam Manual The Accumulation Period The common purpose of all annuities is the distribution of an income. As we ll see, there are different ways an annuity can do this. Nonetheless, to accomplish this purpose, most annuities have an accumulation period. In fact, there will always be an accumulation period unless (1) the purchaser already has a lump sum with which to buy the annuity contract, and (2) the purchaser wants the payout to begin right away. The accumulation period may be initiated by the payment of a single lump sum or the first of a series of premium payments. During this accumulation period, the principal earns interest and grows year by year. A so-called fixed annuity specifies a fixed, guaranteed minimum rate of interest that will be paid on the principal amount invested in the annuity. Under this arrangement, the contract owner knows exactly the minimum return that will be earned during the accumulation period. The insurer simply invests each premium in its general investment account and credits the current interest to the annuity s cash value, but never less than the minimum guaranteed. A variable annuity, as we ll see, offers a variable, nonguaranteed rate of interest that offers the potential but not a promise to act as a hedge against inflation. In all types of annuities, the principal earns interest. The first year s interest is added to the original principal, and the combined sum then earns more interest in the second year. In other words, we earn interest on interest, or compound interest, in the second and every subsequent year, as demonstrated by the following. Accumulation Period Single, Lump-Sum Deposit Compound interest also works when the accumulation is initiated with the first of several periodic deposits. The first deposit earns interest during year one, which is then added to the principal going into year two, along with the second deposit of principal. The entire sum then earns interest in year two, so again we have the compounding of interest, as shown.

7 Life, Accident, and Health Insurance National License Exam Manual 433 U n i t T e s t 1. To receive benefits from a disability income policy for disability due to sickness, the insured must be A. totally disabled B. partially disabled C. either totally or partially disabled D. deceased 2. Social insurance supplements provide disability income A. before workers compensation and Social Security begin payments B. after workers compensation and Social Security end payments C. both A and B D. neither A nor B 3. The benefit that enables a disabled insured to learn to work in another occupation is known as the A. cost-of-living benefit B. rehabilitation benefit C. guaranteed insurability option D. lifetime benefit option 4. The benefit that protects against the erosion of purchasing power for fixed disability benefits is known as the A. cost-of-living benefit B. rehabilitation benefit C. offset rider D. lifetime benefit 5. The rider that provides more benefits during the first 6 months or year of a claim is known as the A. cost-of-living rider B. rehabilitation rider C. additional monthly benefit rider D. lifetime benefit rider 6. The benefit that pays the regular total disability benefit during the elimination period when the insured is hospitalized is known as the A. hospital confinement rider B. rehabilitation benefit C. nondisabling injury rider D. offset rider 7. The option that allows an insured to purchase additional amounts of disability income protection is known as the A. lifetime benefit option B. additional monthly benefit option C. all or nothing option D. future increase option 8. Social insurance supplements provide disability income A. before workers compensation and Social Security begin payments B. after workers compensation and Social Security end payments C. both A and B D. neither A nor B 9. The elimination period may be thought of as A. a dollar amount deductible B. a time deductible C. a dollar amount co-payment D. a time co-payment 10. The longer the benefit period A. the higher the policy s premium B. the lower the policy s premium C. the higher the policy s benefits D. the lower the policy s benefits 11. Which definition of total disability is more favorable to the insured? A. Own occupation B. Any occupation C. They are the same in terms of benefits to the insured D. There is no way to determine from the information provided 12. Occupational disability benefits are often reduced by benefits received A. from Social Security only B. from workers compensation only C. from either Social Security or workers compensation D. before the end of the elimination period only

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