Types of Life Policies and Annuities — practice questions

11.5% of the exam ≈15 real questions 19 free questions here

Whole life, universal and variable life, term, and annuities: about 15 of the 130 scored questions. Most are recognition problems where a client's need or a policy's behavior points to one product.

Where people lose points

• Confusing variable universal life (separate account, no floor) with interest-sensitive whole life (general account, guaranteed minimum).
• Picking level term when the need is a shrinking mortgage balance, which is decreasing term.
• Mixing up the accumulation and annuity periods of a deferred annuity.
• Forgetting that joint life pays at the first death and survivorship life at the second.

Questions and answers, explained

All 10 questions above, with the correct answer and why it is correct. Everything here is on types of life policies and annuities.

1. A universal life policy uses death benefit Option A (level). As the policy's cash value grows over time, what happens to the net amount at risk?

   • AIt increases, because the total death benefit rises right along with the cash value.
   • BIt decreases, because the exposure is the specified amount minus the cash value.Correct
   • CIt stays constant, because the net amount at risk is fixed at policy issue.
   • DIt becomes zero once the cash value exceeds half of the specified amount.

   Why: Under death benefit Option A the total death benefit stays level, so the insurer's pure insurance exposure (specified amount minus cash value) shrinks as the cash value builds, and the monthly cost of insurance is charged against that shrinking net amount at risk. Choice A is the closest distractor: a death benefit that rises with the cash value describes death benefit Option B, but even under Option B the net amount at risk stays level at the specified amount rather than increasing. Choice C states the Option B result, not the Option A result.

   Reference Texas outline #124401, general section I (Types of policies)

2. In a universal life policy, the target premium is best described as the premium that:

   • ACovers only the current month’s mortality and expense charges on the contract.
   • BThe insurer calculates as enough to carry the policy to maturity; commission is based on it.Correct
   • CIs the largest amount the contract may accept before it becomes a modified endowment contract.
   • DMust be paid on each due date or the policy immediately lapses without value.

   Why: The target premium is the insurer's suggested funding level, designed so that, under current interest and mortality assumptions, the policy will stay in force for life; it is also the usual base for first-year commission. Option A describes the minimum premium, the closest distractor, which funds only the current period's deductions. Option C describes the seven-pay or guideline premium limits.

   Reference Texas outline #124401, general section I (Types of policies)

3. Why does federal tax law require a universal life policy to maintain a "corridor" between its cash value and its death benefit?

   • ATo keep enough pure insurance in the contract that it qualifies as life insurance.Correct
   • BTo guarantee that the policy can never lapse for insufficient account value.
   • CTo cap the amount the insurer may charge for the monthly cost of insurance.
   • DTo force the insurer to credit at least the guaranteed minimum interest rate each year.

   Why: IRC section 7702 defines what counts as life insurance, and under its guideline premium and corridor test the death benefit must stay a stated multiple of the cash value — 250% for insureds age 40 and under, declining at higher ages — so a heavily funded contract cannot become a tax-sheltered investment wrapper. Option B is the closest distractor but confuses a tax-qualification rule with a policy guarantee; a universal life policy can still lapse if the accumulated value cannot cover its deductions. Cost of insurance ceilings and guaranteed interest floors are contractual terms, not corridor rules.

   Reference Texas outline #124401, general section I (Types of policies)

4. Universal life is described as an "unbundled" policy because:

   • ACoverage may be divided among several different insureds under a single contract.
   • BThe death benefit is always paid out in separate annual installments.
   • CThe insurer may cancel any component of the policy at will each year.
   • DThe annual report separately discloses interest, mortality and expense charges.Correct

   Why: Universal life separates the three pricing elements and reports each one to the owner, unlike traditional whole life, where mortality, interest and expense assumptions are bundled into one indivisible level premium. Option A describes joint or family coverage, not unbundling. The insurer cannot cancel components at will; it may only apply charges within the guaranteed maximums stated in the contract.

   Reference Texas outline #124401, general section I (Types of policies)

5. Which statement correctly distinguishes scheduled-premium variable life insurance from variable universal life?

   • AOnly variable universal life invests its cash value through a separate account rather than the general account.
   • BScheduled-premium variable life is not a security, while variable universal life must be registered with the SEC and sold with a prospectus.
   • COnly scheduled-premium variable life permits the owner to transfer cash value among the available subaccounts.
   • DScheduled-premium variable life has a fixed premium and a guaranteed minimum death benefit; variable universal life has neither.Correct

   Why: Scheduled-premium variable life keeps the fixed premium of whole life and guarantees the death benefit will never fall below the original face amount, while the cash value floats with subaccount results; VUL adds universal life's flexible premium but gives up that death benefit floor. Option A is wrong because both products use the separate account, and both are securities, which makes option B wrong as well. Subaccount transfers are available under both designs.

   Reference Texas outline #124401, general section I (Types of policies)

6. An indexed universal life policy uses a 70% participation rate, a 12% cap and a 0% floor. The linked index gains 10% during the crediting period. What interest rate is credited to the cash value?

   • A10%
   • B12%
   • C7%Correct
   • D0%

   Why: The participation rate is applied first: 70% of the 10% index gain equals 7%, which is below the 12% cap, so 7% is credited and the cap never comes into play. Option A ignores the participation rate, the most common error with these products, and option B wrongly credits the cap simply because it appears in the stem. The floor matters only when the index result is negative.

   Reference Texas outline #124401, general section I (Types of policies)

7. An indexed universal life policy uses annual point-to-point crediting with annual reset, a 100% participation rate, a 10% cap and a 0% floor. The index falls 20% in year 1 and rises 15% in year 2. What interest is credited for those two years?

   • A0% in year 1 and 0% in year 2, because the index has not yet recovered its original starting value.
   • B0% in year 1 and 10% in year 2.Correct
   • C-20% in year 1 and 15% in year 2.
   • D0% in year 1 and 15% in year 2.

   Why: The floor limits year 1 to 0% despite the 20% index decline; annual reset then re-establishes the starting index value at the lower level, so the 15% year-2 gain is measured from that new base and is credited up to the 10% cap. Option D is the closest distractor because it applies the reset correctly but forgets the cap. Option A describes a point-to-point method without reset, where the prior loss must be recovered before any interest is credited.

   Reference Texas outline #124401, general section I (Types of policies)

8. An interest-sensitive (current assumption) whole life policy is subject to periodic redetermination. If the insurer's mortality and interest experience deteriorates, what may the policyowner face at the next redetermination date?

   • AAn increased premium, but never above the guaranteed maximum premium stated in the contract.Correct
   • BA reduction of the guaranteed death benefit stated on the policy schedule page at issue.
   • CLoss of the policy’s nonforfeiture options for the entire remainder of the contract term.
   • DA mandatory surrender of the contract at its then-current cash surrender value, with no option to continue.

   Why: Current assumption whole life re-prices at stated intervals using the insurer's then-current mortality, interest and expense results; a bad experience period can push the premium up, but the contract's guaranteed maximum premium caps how far it can go. Option B is the closest distractor and confuses the pricing element with the benefit: the death benefit remains guaranteed, and it is the premium or cash value projection that moves. Nonforfeiture options are guaranteed by the Standard Nonforfeiture Law and cannot be forfeited through redetermination.

   Reference Texas outline #124401, general section I (Types of policies)

9. How does an endowment contract differ from an ordinary whole life policy?

   • AAn endowment pays the face amount to the owner if the insured is living on a stated maturity date.Correct
   • BAn endowment provides no death benefit at all before it reaches its stated maturity date.
   • CAn endowment accumulates no cash value during the years the premiums are being paid.
   • DAn endowment always requires a single premium payment made at the time the contract is first issued.

   Why: An endowment pays the face amount at the insured's death OR to the owner as a living benefit if the insured survives the endowment date — for example, a 20-year endowment issued at 45 matures at 65. Option B is the closest distractor and misses the death protection that runs throughout the endowment period. Because cash value must reach the face amount so quickly, short endowments generally fail the federal definition of life insurance and are taxed unfavorably, which is why they are rarely sold today.

   Reference Texas outline #124401, general section I (Types of policies)

10. Under a life income with cash refund option, what does the beneficiary receive if the annuitant dies before total payments equal the amount paid for the annuity?

    • AA lump sum equal to the difference between the purchase price and the payments already madeCorrect
    • BContinued monthly payments for the beneficiary's lifetime
    • CContinued monthly installments until the remaining balance of the purchase price has been paid out
    • DNothing, because all payments cease at the annuitant's death

    Why: A cash refund option guarantees that at least the purchase price is returned, and it pays the unrecovered balance to the beneficiary in one lump sum. Option C is the closest distractor and describes the installment refund option, which guarantees the same total but continues the periodic payments until the balance is exhausted. Option D describes straight life, which carries no refund guarantee at all.

    Reference Texas outline #124401, general section I (Types of policies)

Drill other domains

• Life Policy Riders, Provisions, Options and Exclusions (11.5%)
• Life Application, Underwriting and Policy Delivery (9.2%)
• Retirement and Other Life Insurance Concepts (6.2%)
• Types of Health Policies (12.3%)
• Health Policy Provisions, Clauses and Riders (11.5%)
• Social Insurance (4.6%)

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