Free Chartered Life Underwriter (CLU) Insurance and Risk Management Questions and Answers — Questions and Answers
Question 1: A pharmaceutical company conducts research and discovers that a profitable medication has a rare but severe side effect. To eliminate any future liability and potential harm, the company decides to completely halt production and recall the product from the market. Which risk management technique does this action represent?
- Risk Avoidance (Correct answer)
- Risk Retention
- Risk Transfer
- Risk Reduction
Correct answer: Risk Avoidance
Risk Avoidance is a risk management technique that involves ceasing or refusing to undertake an activity that gives rise to a particular risk. By halting production and recalling the product, the company is completely eliminating its exposure to the risk associated with the medication's side effects. Risk transfer would involve shifting the risk to another party (e.g., through insurance), retention means accepting the risk, and reduction would involve modifying the product to make it safer, not ceasing its production.
Question 2: An applicant for a life insurance policy intentionally fails to disclose a history of heart disease, a fact that would have caused the insurer to decline the application or charge a much higher premium. This concealment is a direct violation of which fundamental legal principle of insurance contracts?
- The Principle of Indemnity
- The Doctrine of Adhesion
- The Principle of Utmost Good Faith (Correct answer)
- The Aleatory Contract Principle
Correct answer: The Principle of Utmost Good Faith
The Principle of Utmost Good Faith (uberrimae fidei) requires that both the insured and the insurer act with complete honesty and disclose all material facts relevant to the policy. The applicant's failure to disclose a serious health condition is a breach of this duty. The other principles are distinct: Indemnity aims to restore the insured to their pre-loss financial state, Adhesion means the contract is offered on a 'take-it-or-leave-it' basis, and the Aleatory principle refers to the unequal exchange of value.
Question 3: A highly skilled surgeon sustains an injury that prevents her from performing surgery, but she is still able to work as a university lecturer and medical consultant. Her disability income policy begins to pay her full benefits. Which definition of total disability is MOST likely included in her policy?
- Any-occupation
- Own-occupation (Correct answer)
- Residual disability
- Social Security disability
Correct answer: Own-occupation
An 'own-occupation' definition of disability considers an individual to be totally disabled if they are unable to perform the material and substantial duties of their specific job at the time the disability began, even if they can work in another field. Since the surgeon can no longer perform surgery but can do other work, her policy must have an 'own-occupation' clause. An 'any-occupation' policy would not pay benefits because she is able to work in another capacity.
Question 4: Regarding the federal income tax implications of a non-discriminatory group term life insurance plan, which of the following statements is correct?
- The employer cannot deduct the premiums paid for the plan as a business expense.
- The employee must include the economic benefit of the first $50,000 of coverage as taxable income.
- The cost of coverage in excess of $50,000, determined by an IRS table, must be included in the employee's gross income. (Correct answer)
- The entire death benefit paid to a beneficiary is subject to federal income tax.
Correct answer: The cost of coverage in excess of $50,000, determined by an IRS table, must be included in the employee's gross income.
Under IRC Section 79, an employer can provide up to $50,000 of group term life insurance coverage tax-free to an employee. The economic benefit (imputed cost) of any coverage exceeding $50,000 must be calculated using an IRS-provided table (Table I) and included in the employee's taxable income.
Question 5: A life insurance policy provision states that after the policy has been in force for a certain period (typically two years) during the insured's lifetime, the insurer cannot void the policy or deny a claim based on a material misrepresentation made by the insured in the application. What is this provision called?
- Suicide Clause
- Grace Period Provision
- Reinstatement Clause
- Incontestability Clause (Correct answer)
Correct answer: Incontestability Clause
The Incontestability Clause prevents an insurer from challenging the validity of a life insurance policy after it has been in effect for a specified period, usually two years, except for nonpayment of premiums. This clause protects the beneficiary from a claim denial based on an error or misstatement in the application that the insurer did not discover during the contestable period.
Question 6: A client purchased a non-qualified deferred annuity with an after-tax premium of $120,000. Years later, the annuity's value has grown to $200,000, and the client decides to annuitize the contract to receive lifetime income payments. How is the income from these payments taxed?
- All payments are received tax-free until the $120,000 basis is recovered, after which payments are fully taxable.
- The $80,000 gain is taxed immediately upon annuitization, and all subsequent payments are tax-free.
- Each payment consists of a tax-free return of principal and a taxable portion of the gain, determined by an exclusion ratio. (Correct answer)
- The entirety of each payment is taxed as ordinary income from the very first payment.
Correct answer: Each payment consists of a tax-free return of principal and a taxable portion of the gain, determined by an exclusion ratio.
When a non-qualified annuity is annuitized, the payments are taxed using an exclusion ratio. This ratio determines the portion of each payment that is considered a tax-free return of the principal (cost basis) and the portion that is considered taxable earnings. This method spreads the tax liability over the payment period, rather than taxing the gain upfront or deferring all taxes until the basis is recovered.
Free Chartered Life Underwriter (CLU) Insurance and Risk Management Questions and Answers
A pharmaceutical company conducts research and discovers that a profitable medication has a rare but severe side effect.
To eliminate any future liability and potential harm, the company decides to completely halt production and recall the product from the market.
Which risk management technique does this action represent?