Domain 2 - Insurance Planning and Risk Management
Domain 2 - Insurance Planning and Risk Management
Items here test the risk-management sequence, the choice among treatments, policy mechanics, and the tax rules that make one product or design preferable to another.
The treatment matrix
Avoid, reduce, retain (deductibles, self-insurance), transfer (insurance), share (group coverage and coinsurance). Retain risk when losses are frequent and small; transfer when severity is high and frequency low.
Life insurance
- Needs analysis (capital retention / DIME) funds survivors' specific goals; human life value capitalizes the insured's earnings. They answer different questions and rarely produce the same number.
- Term, whole life, universal (rising cost of insurance, no-lapse guarantees), variable (separate account, registered as a security), indexed (caps, participation rate, floor).
- IRC §101(a): the death benefit is generally income-tax free; cash value grows tax-deferred; withdrawals are FIFO to basis; policy loans are not income while the policy remains in force. A modified endowment contract (failed 7-pay test) taxes gain on distribution plus a 10% penalty before age 59½.
- A §1035 exchange carries over basis; a transfer-for-value forfeits the exclusion, subject to exceptions (partner, corporation, insured's estate).
- Group term coverage above $50,000 creates imputed income measured by Table I rates.
Disability and long-term care
Own-occupation versus any-occupation is the decisive definition. Compare elimination period, benefit period, residual/partial benefits and COLA riders. Employer-paid premiums make benefits taxable; individually paid premiums do not.
Property and liability
Replacement cost versus actual cash value; coinsurance clauses; deductibles; personal umbrella layered over homeowners and auto; HO-3 covers the dwelling on an open-perils basis while HO-5 extends open perils to contents.
Worked example. Survivors need $60,000 a year in real terms for 25 years beginning immediately; mortgage $250,000; education $100,000; final costs $15,000; existing life insurance $300,000; investable assets $400,000. At a 5% real return the annuity-due factor is 14.80, so income capital = $888,000. Total need = $888,000 + $250,000 + $100,000 + $15,000 = $1,253,000; less $700,000 of existing resources = $553,000 of additional coverage.
Traps. Treating the death benefit as taxable; ignoring imputed income on group term; forgetting the three-year lookback when transferring a policy into an ILIT; assuming a MEC is prohibited rather than merely taxed harshly; quoting a coinsurance penalty without running the formula.