California free look periods and life insurance replacement

California's free look rules depend on the buyer's age and the product, and replacements add their own notice and refund rules.

Questions and answers, explained

All 12 questions above, with the correct answer and why it is correct. Everything here is on california free look periods and life insurance replacement.

1. Under Insurance Code section 786, how long an examination period must an individual disability policy sold to a 70-year-old Californian provide?

   • A30 days after receiptCorrect
   • BOne year after purchase
   • CNone for disability policies
   • D10 days after receipt, the same as for any younger buyer

   Why: Section 786 requires all individual and group disability policies and certificates, and group life policies and certificates, offered to people 65 or older in California to provide a 30-day examination period after receipt; returning the policy voids it from the beginning with a full premium refund.

   Reference Cal. Ins. Code 786 — CA objectives I.C2.24

2. A 45-year-old Californian buys an individual life policy. Under Insurance Code section 10127.9, the right-to-return period stated on the cover must be:

   • AAt least 60 days
   • BNot less than 10 days nor more than 30 daysCorrect
   • CWhatever the agent chooses
   • DExactly 30 days, the same period required for every buyer regardless of age

   Why: Section 10127.9 requires individual life policies and annuities to print a cover notice of the right to return the policy for a period of not less than 10 nor more than 30 days after receipt. For buyers 60 or older, section 10127.10 requires at least 30 days.

   Reference Cal. Ins. Code 10127.9 — CA Life objectives II.D.1.b

3. A 72-year-old buys a variable annuity in California and gives no investment direction. During the 30-day cancellation period, where may the premium be invested under Insurance Code section 10127.10?

   • AIt may not be invested; it must sit in cash
   • BOnly in the insurer's general account at a guaranteed 10 percent
   • CIn any of the underlying stock funds, chosen by the agent to maximize growth during the period
   • DOnly in fixed-income investments and money-market fundsCorrect

   Why: Under section 10127.10, during a senior's 30-day cancellation period the premium for a variable life policy or variable annuity may be invested only in fixed-income investments and money-market funds unless the owner specifically directs investment in the underlying mutual funds.

   Reference Cal. Ins. Code 10127.10 — CA Life objectives II.C, II.D.1.a

4. Under Insurance Code section 10232.7, how long does an applicant for an individual long-term care policy have to return it for a full refund?

   • AOne year
   • B10 days after delivery, the same period as most individual health policies
   • CThere is no right to return
   • D30 days after deliveryCorrect

   Why: Section 10232.7 gives an applicant for a long-term care policy or certificate (other than certain group certificates) the right to return it within 30 days of delivery for any reason, voiding it from the beginning, with all premiums refunded within 30 days of the return.

   Reference Cal. Ins. Code 10232.7 — CA A&H objectives V

5. A 66-year-old buys an individual life insurance policy in California. Under Insurance Code section 10127.10, how long is her right to return it for cancellation?

   • ANot less than 30 days after she receives itCorrect
   • B90 days
   • C10 days from the date the application was signed, the same as for younger buyers
   • DSeniors have no right to return a life policy

   Why: Section 10127.10 requires every individual life policy and annuity delivered to a senior (60 or older) to state on the cover a right to return it within a period of not less than 30 days after receipt. A returned nonvariable policy is void from the beginning and all premiums are refunded.

   Reference Cal. Ins. Code 10127.10 — CA Life objectives II.D.1.a

6. Before recommending an annuity, what should a California agent gather about the consumer?

   • AFinancial situation, objectives, liquidity needs, risk tolerance and time horizonCorrect
   • BNothing; suitability applies only to securities
   • COnly the consumer's age and the amount available to invest, since annuities suit almost everyone
   • DThe consumer's credit score

   Why: California's annuity rules (Insurance Code 10509.910 and following) require a recommendation to be in the consumer's best interest, based on reasonable inquiry into the consumer's financial situation, insurance needs, objectives, liquidity needs, risk tolerance and time horizon, with surrender charges and penalties disclosed.

   Reference Cal. Ins. Code 10509.910 et seq. — CA Life objectives II.C

7. A dentist who co-owns a practice tells her agent she needs three separate things funded if she becomes disabled: (1) replacement of her own take-home pay, (2) money to keep paying the office lease and her hygienist's wages, and (3) cash for her co-owner to buy out her share if the disability proves permanent. Which combination correctly matches products to needs?

   • A(1) business overhead expense, (2) individual disability income, (3) key person disability
   • B(1) individual disability income, (2) key person disability, (3) business overhead expense
   • C(1) key person disability, (2) disability buy-sell, (3) business overhead expense
   • D(1) individual disability income, (2) business overhead expense, (3) disability buy-sellCorrect

   Why: Personal income replacement is the job of an individual disability income policy; fixed operating costs such as rent and staff wages are reimbursed by business overhead expense insurance; and a lump sum to transfer ownership is funded by a disability buy-sell policy. Choice B fails on the last two: key person coverage reimburses the BUSINESS for lost production and the cost of finding a replacement, and it does not transfer ownership.

   Reference CA A&H objectives IV and V (Disability income; long-term care)

8. A California agent takes a life application that will replace an existing policy. Under Insurance Code section 10509.4, what must the agent do?

   • ACancel the existing policy himself so the client is not paying for two policies at once
   • BNothing, if the new policy has a lower premium
   • CPresent a Notice Regarding Replacement, signed by applicant and agent and left with the applicantCorrect
   • DNotify the existing insurer by phone within 24 hours

   Why: Section 10509.4 requires the agent to submit a statement signed by the applicant on whether replacement is involved and, when it is, to present the Notice Regarding Replacement no later than at the time of application, signed by both and left with the applicant, list the policies being replaced, and leave copies of the sales materials used.

   Reference Cal. Ins. Code 10509.4 — CA Life objectives II.D.2

9. Under Insurance Code section 10509.6, the replacing insurer must notify the existing insurer of a proposed replacement within what time after receiving the application or issuing the policy, whichever is sooner?

   • ATen working days
   • BOnly after the free look expires
   • CThirty calendar days, so the existing insurer has time to prepare a conservation offer
   • DThree working daysCorrect

   Why: Section 10509.6 requires the replacing insurer to send each existing insurer a written notice of the replacement, with a policy summary or ledger statement, within three working days of receiving the application or issuing the policy, whichever is sooner. A replacement policy also gives the owner a 30-day right to an unconditional refund.

   Reference Cal. Ins. Code 10509.6 — CA Life objectives II.D.2

10. A cash value life insurance policy becomes a modified endowment contract (MEC) when:

    • AIts cash value at any point during the contract exceeds the policy’s stated death benefit
    • BThe policy is exchanged under Section 1035 within seven years of its original issue date
    • CThe owner takes a policy loan against the cash value during the first seven years
    • DPremiums in the first seven years exceed the seven-pay net level premium limitCorrect

    Why: The seven-pay test compares cumulative premiums actually paid in each of the first seven contract years against the seven-pay net level premium; exceeding it at any point makes the contract a MEC. Choice C reverses cause and effect — a loan does not create MEC status, but a loan taken from a contract that is already a MEC is a taxable distribution. Outline IV — taxation of life insurance.

    Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

11. The owner of a modified endowment contract, age 47, borrows $15,000 against the policy. The contract holds $40,000 of gain above its cost basis. What is the tax result of the loan?

    • ANo tax at all; a policy loan is never taxable to the contract owner
    • BThe full $15,000 is ordinary income and also draws a 10% penaltyCorrect
    • COnly the interest charged on the loan is taxable income
    • DThe $15,000 is taxed as a long-term capital gain instead

    Why: Distributions from a MEC — including loans, assignments, and pledges — are taxed last-in, first-out, so they are ordinary income to the extent of gain in the contract, and a 10% penalty applies before age 59½. Choice A states the rule for a non-MEC life policy, where a loan is treated as debt rather than a distribution; MEC status is precisely what removes that treatment. Outline IV.

    Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

12. Three years after a policy became a MEC, the owner reduces his funding so that all future premiums are well inside the seven-pay limit. He dies several years later. Which statement is correct?

    • AThe contract remains a MEC permanently, but the death benefit is still income-tax-freeCorrect
    • BThe contract loses its MEC status as soon as the funding returns to within the limit
    • CThe contract remains a MEC and the entire death benefit is taxed as ordinary income to the heir
    • DThe death benefit is taxable to the extent of the gain in the contract at death

    Why: Once a contract fails the seven-pay test it is a MEC for the rest of its existence, and any contract received in exchange for it is a MEC as well. MEC status changes only the taxation of living distributions — loans, withdrawals, and surrenders — so the death benefit keeps its income tax exclusion, which is why choices C and D are wrong. Outline IV.

    Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

Drill the whole domain

• Senior Health Products (10%)
• Replacement, Cancellation, Taxation and Social Security Disability (5.3%)
• Annuities (5.3%)

Other topics

• California contract law: concealment, representations and warranties
• California licensing, appointments and continuing education
• California's protections for senior insurance buyers
• Covered California and the Affordable Care Act on the exam
• Medicare supplements and California's Medigap rules
• California group health insurance, COBRA and Cal-COBRA
• California's Commissioner, unfair practices and the guarantee association
• Annuities for the California life exam

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