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CHAPTER 8: INSURING YOUR LIFE. Basic Purpose of Insurance. To protect you and your dependents from the financial consequences of losing assets or income when an accident, illness, or death occurs. Concept of Risk. Risk is defined as uncertainty with respect to economic loss.

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basic purpose of insurance
Basic Purpose of Insurance

To protect you and your dependents from the financial consequences of losing assets or income when an accident, illness, or death occurs.

concept of risk
Concept of Risk
  • Risk is defined as uncertainty with respect to economic loss.
  • Insurance planning is used to reduce the risk that losses will cause financial devastation.
  • Risk can be dealt with in the following ways:
risk avoidance
Risk Avoidance
  • Not participating in activities that have the risk of loss.

Example—not driving to avoid the risk of an auto accident.

Risk avoidance is not always practical or possible!

loss prevention and control
Loss Prevention and Control
  • Prevention reduces the chance that a loss will occur.

Example: Driving within the speed limit reduces the likelihood of an accident.

  • Controlreduces the severity of a loss once it occurs.

Example: Wearing a seat belt can minimize the effects of an accident.

risk assumption
Risk Assumption
  • You bear the risk of loss yourself.

Example: When your calculator gets stolen, you bear the cost out of pocket.

Transferring Risk

  • Pay someone else to bear your risk of loss.

Example: You transfer the risk to the insurance company when you buy an insurance policy.

insurance
Insurance

An insurance policy is a contract between you and an insurance company in which the insurance company agrees to reimburse you for a loss.

underwriting
Underwriting
  • Process in which the insurance company decides whom to insure and the rate to be charged.
  • Company must guard against adverse selection--a disproportionate number of bad risks.
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Why is it Feasible for Insurance Companies to Assume Risk?

  • Combine the loss experiences of large numbers of people.
  • Calculate probability of frequency of occurrence and amount of loss using past experience.
  • Charge rates in proportion to level of risk.
benefits of life insurance
Benefits of Life Insurance
  • Financial protection for dependents (most important benefit):
    • Provide financial security for those who depend on your income.
    • Prevent a decline in their standard of living.
protection from creditors
Protection from creditors:
  • Before death, cash value in life insurance policies usually protected against legal judgments and bankruptcy proceedings.
  • After death, possible to keep benefits out of estate and away from creditors.
tax benefits
Tax benefits:
  • Savings portion grows tax free unless withdrawn.
  • For taxpayers in higher income brackets, these relatively low returns become more attractive as income taxes take a greater bite from current income and short-term capital gains.
  • Proceeds not income taxable to beneficiaries.
  • Possible to avoid estate taxation on proceeds.
medium for savings
Medium for savings:
  • Provides a means of forced savings for those who would not do so otherwise.
  • Provides preservation of capital for those who desire a relatively safe, conservative investment.
do you need life insurance
Do You Need Life Insurance?
  • Consider life insurance
    • If you have dependents who count on your financial support.
    • If you have debts you would like to clear, like a home mortgage.
  • You may not need life insurance
    • If no one depends on your support.
    • If you are a child.
techniques for estimating life insurance needs
Techniques for estimating life insurance needs:
  • Multiple-of-Earnings Method

Multiply annual earnings by an arbitrary number (usually 5-10)

  • Needs Analysis Method

Estimate needs and examine available resources

how much life insurance is right for you
How Much Life Insurance Is Right For You?
  • Income needed to maintain adequate lifestyle
  • Extra expenses if income producer dies
  • Special needs of dependents
  • Pay off debts
  • Liquidity

Step 1: Assess Family’s Economic Needs

slide18

Step 2: Evaluate Financial Resources

  • Savings and investments
  • Social Security benefits
  • Pension or retirement plans
  • Other life insurance
  • Income of surviving spouse or children
  • Real estate or other assets
slide19

Step 3: Calculate the Difference

  • This is the amount of life insurance needed to provide your family with the desired standard of living.
point to remember
Point to Remember:

Life insurance needs are not static. The amount and type of life insurance you need today will probably differ from the amount and type suitable for you 10 or 20 years from now.

what kind of policy is right for you
What Kind of Policy Is Right for You?
  • Benefit paid if insured dies during the policy period.
  • When time period over, no more protection unless renewed.
  • No savings component.

1. Term insurance:

types of term insurance
Types of Term Insurance:
  • Straight term

Coverage remains the same while premiums increase.

  • Decreasing term

Premiums remain the same while coverage decreases.

important features to look for in term insurance
Important features to look for in term insurance:
  • Renewability

Allows insured to renew policy without evidence of insurability.

  • Convertibility

Allows insured to convert to whole life policy without evidence of insurability.

advantages of term
Advantages of Term:
  • Economical way for young families to purchase large amounts of life insurance.
  • Provides for needs that will disappear over time.

Disadvantages of Term:

  • Premiums become more costly as you get older.
  • Does not build cash value.
2 whole life insurance
2. Whole life insurance:
  • Provides death protection plus a savings feature called cash value.
  • If policy canceled prior to death, insured has right to cash value; this is the nonforfeiture right.
types of whole life policies
Types of Whole Life Policies:
  • Continuous premium (straight life)

Level premiums paid until death or cancellation of policy.

  • Limited payment

Level premiums paid for a specified number of years; insurance remains in force until death.

  • Single premium

Lifetime coverage purchased with a single premium.

advantages of whole life
Advantages of Whole Life:
  • Provides a savings vehicle.
  • Cash value can be borrowed against.
  • Premiums remain constant.
  • Cash value accumulates tax-free until redeemed.
disadvantages of whole life
Disadvantages of Whole Life:
  • Dollar for dollar provides less death protection than term for young people.
  • Relatively low return on savings.
  • Loans must be repaid with interest.
  • Tax penalties may be assessed on cash values withdrawn early.
  • If you have a loan outstanding when you die, that amount is subtracted from the face value of your policy.
3 universal life insurance
3. Universal life insurance:
  • Provides death protection plus a savings feature.
  • Premiums are “unbundled” into 2 separate accounts—death protection portion and savings portion
  • Savings grow at the current interest rate vs. guaranteed minimum rate.
  • Provides flexibility in premiums paid and death benefit.
  • Carries heavy fees compared to other policy types
4 other types of life insurance
4. Other Types of Life Insurance:
  • Variable life insurance
    • Provides death protection plus a savings, or cash value, feature.
    • Cash value can be invested in a variety of mutual funds for greater possible return.
    • Returns not guaranteed and actual death benefit can vary.
  • Variable universal life insurance
    • Combines the flexibility of premium payment feature of universal with the investment choices offered by variable.
slide35

Group life insurance

    • Usually term insurance that is offered through employers.
    • Premiums usually lower than those on individually purchased policies.
    • Benefit equal to about 1 year’s salary
slide36

Type of decreasing term insurance.

    • Pays off outstanding loan balance if borrower dies before loan is repaid.
    • Usually a costly form of coverage.
    • Consider increasing your regular term insurance coverage instead.
  • Industrial life insurance
    • Whole life policies with small face amounts.
    • For low-income families.
  • Credit and mortgage life insurance
buying life insurance
Buying Life Insurance
  • Know the amount and type of coverage you need.
  • Compare costs and features—should be similar in terms of provisions and amounts.
  • Select a large, highly rated, financially secure company (in business for more than 25 years and annual premium volume in excess of $50 million).
  • Select a reputable agent.
insurance rating agencies
Insurance Rating Agencies

Their purpose is to evaluate the company’s claim paying ability (ability of company to pay future claims).

  • A.M. Best Company
  • Moody’s Investor Service
  • Standard & Poor’s Corporation
  • Fitch Inc.
  • Weiss Ratings, Inc.
key life insurance contract features
Key Life Insurance Contract Features
  • Beneficiary clause
  • Settlement options
  • Policy loans
  • Premium payments
  • Grace period
  • Nonforfeiture options
  • Policy reinstatement
  • Change of policy
  • Multiple indemnity
  • Disability clause
  • Guaranteed purchase options
  • Suicide clause
  • Exclusions
  • Participation
  • Living benefits
  • Viatical Settlement