FIN 200: Personal Finance

1. FIN 200: Personal Finance Topic 14-Life Insurance Lawrence Schrenk, Instructor

2. Learning Objectives • Explain the features of life insurance policies. ▪ • Explain and calculate the effect of inflation on financial decision-making.▪

3. Life Insurance

4. Do you need life insurance? • Death Expenses • Funeral Expenses • Ongoing Financial Obligations • Others Dependent on your Income • Others Dependent on your Service • Investment/Savings Vehicle • Bequest

5. How much do you need? • Goal: Maintain Current Standard of Living • Income Method • Rule of Thumb: 7-8 Times Annual Income • Budget Method • Life Insurance Needs Estimator • Be Conservative; More is Better • Adjust for Inflation

6. Terminology • Primary Beneficiary • Contingent Beneficiary • Face Amount/Death Benefit • Cash/Surrender Value

7. Types of Life Insurance • Term (Fixed Period) Life Insurance • Annual Renewable • Fixed-Rate (Lock-In Premium) • Decreasing Term • Permanent Life Insurance • Whole Life • Universal Life • Variable Life • Free (Employer Provided) Life Insurance

8. Term Life Insurance • Cost Factors • Coverage Time • Coverage Amount • Age • Gender • Medical History

9. Permanent Life Insurance • Insurance + Savings Vehicle • Whole Life • Zero Risk Policy • Low (but Guaranteed) Return • Universal Life • More Flexible • Variable returns • Possible Increase in Premium • Variable Life • Various Investment Possibilities

10. Comparison

11. Sources • Agent • Can be necessary for permanent life insurance • Find a good agent • E.g, Certified Life Underwriter (CLU) • Multiple Policy Agent • Financial Planner • Internet • Insure.com

12. Life Insurance as Investment • Rate of Return • Flexibility of Disbursement • ‘Forced Savings’ • Life Insurance Dividends

13. Other Issues • Other Forms of Life Insurance • Mortgage Insurance • Credit Life Insurance • Travel Accident Insurance • Financial Stability of Issuer • Ratings Agencies Rate Insurers • Insure.com Ratings

14. Ratings Example

15. Project Note

16. Ethical Dilemma Steve had a whole life insurance policy that provides $10,000 in life insurance protection and accumulates a cash value of twice his current annual income by age 65. Two years later, after Steve's marriage, he bought a second policy. His agent told him each policy would have a cash value double his annual income. At 65 he was appalled to see that the cash value on the older policy was $17,000 and on the newer policy was only $15,000. a. Was the agent being unethical in now showing Steve the potential impact of inflation on the policies' cash value? b. How much does an insurance agent need to reveal to potential clients? c. What ‘informational’ responsibilities does the buyer have?

17. Inflation

18. Example • Your dream car costs $50,000 and you plan to buy it in 10 years. • You save $273.30/month at 8%, so that you have $50,000.00 at the end of ten year. • What happens to your dream? ▪ • You don’t get it. If inflation were 5%, in 10 years the car would cost $82,350.47. • You are $32,000.00 short! ▪

19. Another Example • You want to be a millionaire by age 50. • You save $546.23/month at 9%, so that you have $1,000,000 at the end of 30 years. ▪ • You are technically a millionaire since you do have $1,000,000 in your investment account. • But, in today’s dollars, that million is only worth $301,795.87 if the inflation rate is 4%. • ‘In Today’s Dollars’–$1,000,000 in 30 years will allow you to buy the same goods that $301,795.87 buys today.▪

20. Real versus Nominal • Inflation–Rise in the General Level of Prices • Nominal Values • ‘Money of the Day’ • Not Adjusted for Inflation • The Dollar Value You Actually Pay • Real Values • Adjusted for Inflation • ‘Current’ Dollars/Today’s Dollars • Constant Consumption Value

21. Historical Inflation

22. Simple Example • A can of soda costs $1.00 today and $1.05 next year. • What is the inflation rate? • At this rate of inflation, what will a can of soda cost in 5 years?

23. Simple Example with Calculator • At 5% inflation, what will a $1.00 can of soda cost in 5 years? • Input 5, Press N (This is annual so N = 5) • Input 5, Press I/Y • Input 1, press +/-, press PV • Press CPT, FV to get $1.28 • Do you recognize this pattern? ▪ • The following two questions are identical: • At 5% inflation, what will a $1.00 can of soda cost in 5 years? $1.28 • At a 5% interest rate, what will be the future value of $1.00 5 years? $1.28▪

24. Another Example (Revisited) • You save $546.23 per month at 9%, so that you have $1,000,000 at the end of 30 years. Inflation is 4% ▪ • How much is that amount worth in today’s dollars? • Change P/Y to 12 • Input 360, Press N (30 x 12 = 360 monthly payments) • Input 4, Press I/Y (use inflation not the interest rate) • Input 1,000,000, press +/-, press FV • Press CPT, PV to get $301,795.87

25. Real versus Nominal Rates • Nominal Interest Rate • This is what we have been using • It does not adjust for inflation. • Real Rate of Interest • The nominal rate adjusted for inflation. • Relationship (Approximation) Real Rate = Nominal Rate – Inflation

26. Another Example (Revisited, Again) • How much do you need to save monthly at 9% to have $1,000,000 (in today’s dollars) in 30 years, if inflation is 4%? • Use the real rate for your calculation Real Rate of Interest = 9% - 4% = 5%. • Change P/Y to 12 • Input 360, Press N (30 x 12 = 360 monthly payments) • Input 5, Press I/Y (use the real interest rate) • Input 1,000,000, press +/-, press FV • Press CPT, PMT to get $1,201.55 (NOT $546.23)

27. Getting your Dream Car! • How much do you need to save monthly at 8% to have $50,000 (in today’s dollars) in 10 years, if inflation is 5%? • Use the real rate for your calculation Real Rate of Interest = 8% - 5% = 3%. • Change P/Y to 12 • Input 120, Press N (10 x 12 = 120 monthly payments) • Input 3, Press I/Y (use the real interest rate) • Input 50,000, press +/-, press FV • Press CPT, PMT to get $357.80 (NOT $273.30)