Free CLU Practice Exam

1. Question 1

   A three-owner firm has a binding buy-sell agreement. It is insured using policies issued five years ago for a total purchase obligation of $2 million, but the latest independent business valuation implies a $5 million obligation. Which action best addresses the risk created by the mismatch?

   • A.Keep the current policies and update the agreement's price to the new valuation, because the existing death benefits will cover the higher price.
   • B.Replace the agreement's valuation method with a fixed formula price, because a set price removes the need to review how the purchase will be funded.
   • C.Reconcile the agreement's valuation method, trigger terms, and financing sources; assess additional coverage and noninsurance funding.
   • D.Buy additional coverage sized only to the original $2 million figure, because the original price in the agreement controls the buyout amount.
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   Correct answer: C. Reconcile the agreement's valuation method, trigger terms, and financing sources; assess additional coverage and noninsurance funding.

   A buy-sell price can grow independently of policy death benefits, leaving a funding gap. Reviewing the pricing method, triggers, and funding sources, and adding coverage or other liquidity, reduces the risk of a forced sale.

   • AA. Raising the price to $5 million does nothing to raise the $2 million of fixed death benefits, so a $3 million shortfall remains. The funding has to be reviewed and increased.
   • BB. A fixed formula price does not remove the funding need. The obligation still has to be paid at the triggering event, and a stale formula price can drift far from true value and cause disputes. The funding source still needs to be reviewed.
   • CC. Aligning the price method and triggers with funding, and adding coverage or other liquidity, addresses the mismatch.
   • DD. Adding coverage sized to the outdated $2 million figure repeats the mismatch. The agreement's price should be reconciled with current value, and funding should be sized to the price the agreement will actually produce.

   • Source: Exam outline: The American College CLU designation (courses)
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2. Question 2

   A parent owns stock with a $100,000 basis and a $500,000 value. A child will receive it either by lifetime gift or as an inheritance at the parent's death, with the value unchanged, and then sell it for $500,000. Ignoring estate tax, what is the child's gain in each case?

   • A.Gift: $400,000 gain, because the donor's basis carries over; inheritance: no gain, because basis steps up to date-of-death value
   • B.Gift: no gain, because basis resets to market value at the transfer date; inheritance: $400,000 gain, because stock received at death keeps the donor's basis
   • C.$400,000 gain in both cases, because the parent's basis carries over in each case
   • D.No gain in both cases, because transfers between parent and child are not taxable events
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   Correct answer: A. Gift: $400,000 gain, because the donor's basis carries over; inheritance: no gain, because basis steps up to date-of-death value

   A donee generally takes the donor's basis (IRC 1015), so the child's gain on a gifted asset is $500,000 - $100,000 = $400,000. Property included in a decedent's estate takes a basis equal to date-of-death value under IRC 1014, so a sale at $500,000 produces no gain.

   • AA. Correct. Gift gives carryover basis; inheritance gives stepped-up basis.
   • BB. This reverses the two rules; a gift carries over the donor's basis, while inherited stock receives a basis step-up to date-of-death value.
   • CC. Inherited property receives a basis step-up, so gain is not $400,000 there.
   • DD. The transfer itself may not be taxed, but the later sale triggers gain measured against the recipient's basis.

   • Source: IRC section 1014 (basis of property acquired from a decedent)
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3. Question 3

   Compared to the human life value approach, the capital needs (needs) analysis approach to life insurance planning is generally considered more comprehensive because it additionally accounts for:

   • A.The discount rate used to present-value the insured's future earnings over his or her remaining working lifetime
   • B.The insurer's current dividend scale illustration and the projected cash value growth under the policy being proposed
   • C.The insured's occupational mortality rating and any avocation-related extra premium assessed by the underwriting department
   • D.Specific family objectives such as mortgage payoff, education funding, emergency reserves, and income replacement needs net of other available resources
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   Correct answer: D. Specific family objectives such as mortgage payoff, education funding, emergency reserves, and income replacement needs net of other available resources

   The needs approach builds a customized capital needs analysis that itemizes specific objectives, debt payoff, education, emergency fund, final expenses, and ongoing income replacement, then nets out existing resources such as savings, Social Security survivor benefits, and other insurance already in force. This makes it more tailored than the human life value method, which relies on a single income-replacement formula.

   • AA. Incorrect. Discount rate is a technical input used in human life value calculations too, not a distinguishing feature of the needs approach.
   • BB. Incorrect. Dividend illustrations and cash value projections relate to policy performance, not to the needs-analysis planning method.
   • CC. Incorrect. Occupational mortality ratings and avocation extras are underwriting concepts unrelated to either planning methodology.
   • DD. Correct. Itemized, goal-specific analysis netted against existing resources is the hallmark of the needs approach.

   • Source: Exam outline: The American College CLU designation (courses)
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