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Chapter 9. The Role of Life and Health Insurance. Understanding the Logic Behind Insurance. Insurance is an example of risk pooling -- individuals share their financial risks to reduce catastrophic losses from death, accidents, or health problems. Life Insurance Policy Terms.

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Chapter 9

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Chapter 9

Chapter 9

The Role of Life and Health Insurance


Understanding the logic behind insurance

Understanding the Logic Behind Insurance

  • Insurance is an example of risk pooling -- individuals share their financial risks to reduce catastrophic losses from death, accidents, or health problems.


Life insurance policy terms

Life Insurance Policy Terms

  • Premium -- the monthly cost of the policy

  • Face value -- the benefit due upon death

  • Insured -- the person whose life is covered by the policy

  • Policy owner -- the individual or business that pays for and owns the policy

  • Beneficiary -- the recipient of the benefit upon the death of the insured


Life insurance may not be necessary for the following

Life Insurance May Not Be Necessary for the Following

  • Single person, without dependents

  • Double-income married couple, without dependents

  • Married, but unemployed, individual without dependents

  • Retired persons


Life insurance may be necessary for those

Life Insurance May Be Necessary for Those

  • With dependents

  • Who are a married, single-income couple, with children

  • Who are business owners?

  • Whose estate exceeds the estate tax-free transfer threshold ($675,000 in 2000/2001 and increasing to $1M by 2006).


Determine your life insurance needs two methods

Determine Your Life Insurance Needs: Two methods

  • The earnings multiple approach

    • To replace the annual salary stream of a bread winner for X years, normally 5 – 15 times gross salary is recommended.

  • The needs approach

    • To meet the needs of the household after the death of a breadwinner, both current and in the future.


The earnings multiple approach

The Earnings Multiple Approach

  • Adjust salary down to compensate for the reduction in household expenses.

  • Choose the PVIFA i%, n yr to match the assumed after-tax and after-inflation earnings on the policy settlement.

  • The longer the income stream replacement, the greater the multiple. The higher the assumed earnings, the lower the multiple.


Earning multiple approach formula

Earning Multiple Approach Formula

Life Insurance Needs =

Income x (1 – % of income spent on the deceased) x PVIFA i%, n yr

Assume earning $75,000, less $25,000 for remaining 30 years at 5 %, how much insurance should one have?


The needs approach the seven funds

The Needs Approach -- The Seven Funds

  • Immediate needs funds

  • Debt elimination funds

  • Immediate transitional funds

  • Dependency funds

  • Spousal life income funds

  • Educational funds for child or spouse

  • Retirement income funds


The needs approach the calculation

The Needs Approach -- The Calculation

  • Add all funding needs to determine total need

  • Subtract current insurance coverage and other available assets

  • This determines amount of additional insurance coverage necessary


Needs approach

Needs Approach

  • Bill age 35 and Mary age 33 seek your advice on the amount of life insurance to purchase. They have two children ages six and four.

  • Bill earns $65,000 per year in salary.

  • Their home is worth $150,000 and they have a $90,000 mortgage.

  • Their savings and investments total $30,000.

  • Mary currently does not work and would find it difficult to go to work until the youngest child enters first grade in two years.

  • She anticipates she could earn $40,000 after taxes at that time which would handle all her needs throughout her working life.


Bill and mary continued

Bill and Mary Continued

  • Funeraland administrative expenses would approximate $10,000.

  • The family anticipates a current need of $100,000 to assist the children with college education.

  • Mary acknowledges that she needs an additional 8,000 per year per child to cover expenses until the children are off the nest.

  • Assume $45,000 of Bill’s salary is devoted to the family and 8% is an appropriate rate of return.

  • How muchinsurance does Bill need?


Major types of insurance

Major Types of Insurance

  • Term insurance

  • Cash-value insurance


Term insurance

Term Insurance

  • Death benefit coverage for a specific term of time

  • Only valid if the insured dies during the term of coverage

  • Least expensive form of insurance


Cash value insurance

Cash-Value Insurance

  • Provides a death benefit and an opportunity to accumulate savings

  • Provides permanent insurance


Types of cash value insurance

Types of Cash-Value Insurance

  • Whole life insurance – for those who need permanent life insurance protection

  • Universal life insurance – for those who want a flexible policy that combines term protection and tax-deferred savings

  • Variable life insurance – for those who want to take risks and manage their own investments with an opportunity for tax-deferred savings.


Whole life insurance and its features

Whole Life Insurance and Its Features

  • Permanent protection

  • Fixed premium

  • Fixed death benefit

  • Fixed cash-value that grows tax-deferred

  • Much less death protection than term for the same price

  • Yield on cash value portion is not competitive with yields on alternative investments


Universal life insurance and its features

Universal Life Insurance and Its Features

  • Permanent protection

  • Flexible premium payments with unbundling

    • mortality charge or term insurance

    • cash value or savings

    • administrative expenses

  • Flexible death benefits

  • Cash-value fluctuates depending on the amount paid into the policy


Universal life insurance and its features cont d

Universal Life Insurance and Its Features (cont’d)

  • Returns fluctuate widely

  • Policies often lapse because of the flexibility to not make premium payments

  • Savings may not accumulate as expected due to fluctuations in return and high expense charges


Variable life insurance and its features

Variable Life Insurance and Its Features

  • Permanent protection; returns are earned on a tax-deferred basis

  • Allows for either a fixed (straight variable) or flexible (variable universal) premium

  • Flexible death benefit and fluctuating cash value, reflecting the mutual fund investment performance


Determining which type of insurance is right for you

Determining Which Type of Insurance Is Right for You

  • For most, term is the best alternative.

    • Relatively low cost

    • Affordable coverage when life insurance is needed the most

    • Can afford to carry the coverage needed

    • Becomes very expensive with age, but may be unnecessary


Determining which type of insurance is right for you1

Determining Which Type of Insurance Is Right for You

  • Cash-value insurance offers tax advantages

    • Savings grow tax-deferred and are passed on without incurring estate taxes

    • Other investment plans are better relative to cash-value insurance


1 the beneficiary provision

#1. The Beneficiary Provision

  • Allows for the naming of primary and contingent beneficiaries.

  • May name an irrevocable beneficiary that cannot be changed without permission of the beneficiary.


2 the grace period clause

#2. The Grace Period Clause

  • Automatic extension of 30 or 31 days that the owner has to pay the premium without the policy lapsing.


3 the loan clause

#3. The Loan Clause

  • Only exists on policies with a cash value.

  • Allows the owner to borrow against the cash value of the policy.


4 the nonforfeiture clause

#4.The Nonforfeiture Clause

  • Provides options for policy holders to terminate their policies early

    • receive the cash value

    • exchange cash value for a paid-up policy with a reduced face value

    • exchange cash value for a paid-up term policy with the full face value


5 the policy reinstatement clause

#5. The Policy Reinstatement Clause

  • Option for restoring a lapsed policy within 3 to 5 years of the expiration

  • Generally requires all past due premiums, loans, and interest be paid before reinstatement


6 the change of policy clause

#6. The Change of Policy Clause

  • Allows the policy holder to change the type of policy in effect


7 the suicide clause

#7. The Suicide Clause

  • States that the insurance company will not pay death benefits if the insured commits suicide within 2 years of when the policy took effect.


8 the payment premium clause

#8. The Payment Premium Clause

  • Explains the options available for the payment of the premiums, such as monthly or annually.


9 the incontestability clause

#9. The Incontestability Clause

  • Declares that the insurance company can not dispute the validity of the policy after a certain time period has passed, normally 2 years.

  • This clause provides very important protection to the beneficiary against policy cancellation.


10 settlement options

# 10. Settlement Options

  • Lump-sum settlement -- one time payout upon death of the insured.

  • Interest-only settlement -- periodic payments of the interest earned by the principal.


Buying life insurance

Buying Life Insurance

1.Buyer beware -- a little knowledge goes a long way

2.Select a high-quality insurance company based on company ratings

3.Select an insurance agent with whom you feel comfortable

4.Compare costs of competing policies

5.Consider alternative approaches: the net or an advisor


Major types of health care coverage

Major Types of Health Care Coverage

  • Basic health insurance

  • Major medical expense insurance

  • Dental and eye insurance

  • Dread disease and accident insurance


Basic health insurance

Basic Health Insurance

  • Hospital insurance -- covers hospitalization expenses including room fees, nursing fees, and drug fees.

  • Surgical insurance -- covers only the direct costs of surgery including the surgeon’s fees and equipment fees.

  • Physician expense insurance -- covers physicians’ fees including office fees, lab fees, and X-ray fees.


Major medical expense insurance

Major Medical Expense Insurance

  • Covers medical costs beyond the basic plan.

  • Normally requires co-payments and deductible payments.

  • Stop-loss provision -- limits the total out-of-pocket expenses incurred by the insured to a specific dollar amount.

  • Life-time cap -- total amount the insurance company will pay over the life of a policy.

See examples in notes


Dental and eye insurance

Dental and Eye Insurance

  • Covers the costs of eye exams, glasses, contact lenses, dental work, and dentures.

  • Typically prohibitively expensive unless provided with an employer plan.


Dread disease and accident insurance

Dread Disease and Accident Insurance

  • Covers only specific illness or accidents.

  • Provides a set dollar amount of reimbursement.

  • Note: Avoid these types of insurance -- concentrate on making your health coverage as comprehensive as possible.


Private health care plans

Private Health Care Plans

  • Fee-for-service or traditional indemnity plans

  • Managed health care

    • health maintenance organizations (HMOs)

    • preferred provider organizations (PPOs)


Fee for service or traditional indemnity plans

Fee-for-Service or Traditional Indemnity Plans

  • Provides greatest flexibility for choosing doctors and hospitals.

  • Coinsurance -- defines the percentage of each claim that the policy will cover.

  • Co-payment or deductible -- defines the amount that you must pay before a claim is eligible for reimbursement.

  • Plans are relatively expensive and require more paperwork.


Managed health care

Managed Health Care

  • Pays for and provides health care services to policy holders.

  • Limits choices to the doctors and hospitals that participate.

  • Requires the policy holder to pay a monthly premium and share the cost of care.

  • Provides the most efficient payment of bills.


Group insurance

Group Insurance

  • Is sold to a group or employer rather than to an individual

  • Normally does not require subscribers to pass a medical exam

  • 15% - 40% cheaper than an individual policy


Government sponsored health care plans

Government-Sponsored Health Care Plans

  • Workers’ Compensation

  • Medicare

  • Medicaid


Workers compensation

Workers’ Compensation

  • Provides insurance to workers injured on the job

  • Provides payment for work-related accidents and illness

  • Coverage is determined by state law and varies by state


Medicare

Medicare

  • Provides medical benefits to the disabled and to those 65 and older

  • Cost is covered through Social Security tax

  • Divided into two parts -- A and B

  • Part A is compulsory and covers hospital expenses


Medicare cont d

Medicare (cont’d)

  • Part B is voluntary, with a monthly premium, and covers doctors’ fees and other medical services

  • Medigap insurance, sold by private companies, provides for gaps in Medicare coverage with Parts A and B


Medicaid

Medicaid

  • Provides health care for low income, blind, or aged persons.

  • Payments may be used to offset the premiums, deductibles, and co-payments incurred with Medicare.


Controlling health care costs

Controlling Health Care Costs

  • Live healthy

  • Use a medical reimbursement or flexible spending account

  • Consider COBRA when changing jobs

  • Choose no health care coverage -- not recommended unless necessary


Medical reimbursement or flexible spending account

Medical Reimbursement or Flexible Spending Account

  • Optional employer-established savings plan funded with pre-tax dollars.

  • Provides an account for paying unreimbursed medical expenses.

  • Use it or lose it!

  • Very flexible, but some expenses are not eligible for coverage.


Cobra and changing jobs

COBRA and Changing Jobs

  • With a company of more than 20 employees, depending on why you leave the company, you can continue health coverage for 18 – 36 months.

  • You pay the premium.

  • Must notify the company within 60 days of leaving.


Important provisions in health insurance policies

Important Provisions in Health Insurance Policies

  • Who’s covered?

  • Terms of payment

  • Preexisting conditions

    • Always maintain coverage to avoid exclusions

  • Guaranteed renewability provision

  • Exclusions

  • Emotional and mental disorders


Disability insurance

Disability Insurance

  • Provides income (67% to 80% of after-tax income) in the event of a long-term illness or injury

  • Anyone who depends on earned income should have disability coverage


Disability insurance cont d

Disability Insurance (cont’d)

  • Sources of disability insurance

    • Workers’ Compensation

    • Social Security

    • Purchase through your employer’s benefit plan

  • Amount of coverage depends on the amount of income to be replaced


Disability insurance features that make sense

Disability Insurance Features That Make Sense

  • Determine the providers’ definition of disability -- make sure it is not too restrictive

  • Residual or partial payments when returning to part-time work

  • Duration of disability benefits

    • short-term disability -- 6 months to 2 years

    • long-term disability -- until age 65 to 70 or for the insured’s lifetime


Disability insurance features that make sense cont d

Disability Insurance Features That Make Sense (cont’d)

  • Waiting (or elimination) period

  • Waiver of premium provision

  • Noncancelable provision

  • Rehabilitation coverage provision


Long term care insurance

Long-Term Care Insurance

  • Provides a daily dollar benefit for the costs of long-term care

  • Expensive, with many exceptions and conditions for coverage (e.g. ADLs)

  • Who needs it?

    • Those with savings to protect.

    • Those with a family history of long-term disabilities.


Important long term care insurance provisions

Important Long-Term Care Insurance Provisions

  • Provisions which control qualification for benefits

  • Type of care covered

  • Benefit period

  • Waiting period

  • Inflation adjustment provision

  • Waiver of premium provision

  • Noncancelability provision


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