CLU Life Insurance Legal Aspects 5 — Questions and Answers
Question 1: The legal doctrine of subrogation, as it applies to life insurance, differs from property insurance because:
- Subrogation applies equally to both life and property insurance
- Life insurance is not a contract of indemnity, so subrogation generally does not apply (Correct answer)
- Subrogation in life insurance is triggered only by wrongful death suits
- Life insurers always waive subrogation rights by statute
Correct answer: Life insurance is not a contract of indemnity, so subrogation generally does not apply
Because life insurance pays a stated sum rather than indemnifying an actual loss, it is not a contract of indemnity and subrogation rights do not apply—the beneficiary keeps both the proceeds and any wrongful death award.
Question 2: Under the Uniform Transfers to Minors Act (UTMA), when a minor is named as a life insurance beneficiary, proceeds paid to a custodian under UTMA must be distributed to the minor at the latest by age:
- 18 in all states
- 21 in all states
- 18 to 25, depending on state law (Correct answer)
- 30, if the custodian so elects
Correct answer: 18 to 25, depending on state law
UTMA allows states to set the distribution age anywhere from 18 to 25, so the age at which a minor must receive custodial assets varies by state.
Question 3: Which provision in a life insurance policy requires the insurer to notify the policyowner before a policy lapses for non-payment of premium?
- The grace period provision
- The reinstatement clause
- The notice of lapse (or advance notice) provision (Correct answer)
- The automatic premium loan provision
Correct answer: The notice of lapse (or advance notice) provision
Many states require insurers to send advance notice of an impending lapse to the policyowner (and sometimes a designee) before the policy terminates for non-payment.
Question 4: In the context of life insurance policy replacement, NAIC Model Regulation 187 primarily requires that:
- Replacement is prohibited within the first two policy years
- Replacing agents compare the existing and proposed policies and provide a signed comparison to the applicant (Correct answer)
- The replacing insurer obtain a court order before issuing the new policy
- The original insurer has a right of first refusal to match the new policy's terms
Correct answer: Replacing agents compare the existing and proposed policies and provide a signed comparison to the applicant
NAIC Model Regulation 187 requires replacing producers to conduct a needs analysis, provide a signed comparison of existing and proposed coverage, and document that the replacement is in the client's best interest.
Question 5: For federal income tax purposes, life insurance death benefits paid to a named beneficiary in a lump sum are generally:
- Fully taxable as ordinary income to the beneficiary
- Excluded from the beneficiary's gross income under IRC Section 101(a) (Correct answer)
- Subject to capital gains tax to the extent they exceed premiums paid
- Taxable only if the policy was purchased as an investment
Correct answer: Excluded from the beneficiary's gross income under IRC Section 101(a)
IRC Section 101(a) excludes life insurance death benefits from the gross income of the beneficiary when received because of the insured's death, subject to limited exceptions.
Question 6: The 'transfer for value' rule under IRC Section 101(a)(2) provides that if a life insurance policy is transferred for valuable consideration, the death benefit in excess of the consideration paid is:
- Excluded from income if the transfer was to a business partner
- Excluded from income only if the policy was a term policy
- Includible in the transferee's gross income at the insured's death (Correct answer)
- Subject to gift tax at the time of transfer
Correct answer: Includible in the transferee's gross income at the insured's death
Under the transfer for value rule, a policy sold or transferred for valuable consideration loses its income-tax exclusion on the amount of proceeds exceeding the consideration paid plus subsequent premiums, with limited exceptions.
Question 7: Under the Omnibus Budget Reconciliation Act (OBRA) and related regulations, employer-provided group term life insurance coverage exceeding which amount results in taxable imputed income to the employee?
- $10,000
- $25,000
- $50,000 (Correct answer)
- $100,000
Correct answer: $50,000
IRC Section 79 excludes the cost of the first $50,000 of employer-provided group term life insurance from the employee's gross income; coverage above that threshold creates imputed income taxed using IRS Table I rates.
CLU Life Insurance Legal Aspects 5
The legal doctrine of subrogation, as it applies to life insurance, differs from property insurance because: