Insurance Chapter 11: Life insurance

Transcription

1 Insurance Chapter 11: Life Pre-mature death The death of a family head with outstanding unfulfilled financial obligations - Can cause serious financial problems for surviving family members - The deceased's future earnings are lost forever - Additional expenses are incurred (funeral costs) - Some families will experience a reduction in their standard of living - Noneconomic costs are incurred (Grief)... *** The economic problem of premature death has declined because life expectancy has increased... *** The purchase of life is justified if the insured has earned income and others are dependent on those earnings... *** The need for life varies across different types of families: - Single people - Single parent families - Two income earners with children - Traditional families - Blended families - Sandwhiched families Page 1

2 - The human life value approach There are two ways to estimate the amount of life one should own - The needs approach The human life value approach The amount of life needed depends on the insured's human life value which is the present value of the family's share of the deceased breadwinner's future earnings... *** To calculate the amount of life needed using the human life value approach: - Estimate the individual's average earnings over their lifetime - Deduct taxes, premiums and self maintenance costs - Determine the present value of the family's share of earnings for the # of years until retirement using a discount rate The needs approach... The amount of life needed depends on the financial needs that must be met if the family head were to pass away *** To calculate the amount of life needed using the needs approach: Consider: - An estate clearance fund - Income needed for a one or two year readjustment period - Income needed for the dependency period (until the youngest reaches 18) - Life income to the surviving spouse, including income during and after the blackout period Page 2

3 - Special needs and emergencies - Retirement needs You add all these needs up and that is the total amount of life you need... *** The opportunity cost of purchasing life may be too much for many families - The purchase of life reduces the amount of discretionary income available for other needs - Many families are in debt and have little savings... *** 2 general categories of life - Term life - Cash value life Term life Cash value life Term life Life that provides temporary protection Life that has a savings component and builds a cash value Protection is temporary - Protection expires at the end of the policy period unless renewed - Most are renewable for additional periods - The premiums increase at each renewal period - There may be an age limitation where a renewal is no longer allowed... *** Most term life polices are convertible Page 3

4 Meaning that the policy can be exchanged for a cash value policy without evidence of insurability... *** 2 methods for converting a term life policy into a cash value policy - Attained age method - Original age method Attained age method Original age method Yearly renewable term The premium charged for the new policy is based on the insured's attained age at the time of conversion The premium charged for the new policy is based the insured's original age when the term life was first purchased Form of term that is issued for a one year period... *** Term can also be issued for 5 years or more A term to age 65 policy Term life that provides protection until age 65 in which the policy expires Decreasing term The face value of the term gradually declines each year Reentry term Return of premium term The renewal premiums are based on select (lower) mortality rates if the insured can periodically demonstrate acceptable evidence of insurability (good health) Returns the premiums at the end of the term period provided the is still in force... *** Term life is appropriate when: - The amount of income that can be spent on life is limited - The need for protection is temporary - The insured's wants to guarantee future insurability... *** Term premiums increase with age at an increasing rate Page 4

5 Whole life A cash value policy that provides life time protection - A stated amount is paid to the beneficiary when the insured dies, regardless of when the death occurs Ordinary life A level premium policy that accumulates cash value and provides lifetime protection until age Premiums are level throughout - The excess premiums paid during the early years are used to supplement the inadequate premiums in the later years - The insurer's legal reserve is a liability that must be offset by sufficient financial assets - The net amount at risk the difference between legal reserve and the amount of... *** Ordinary life - Has the accumulation of cash surrender values - A policyholder overpays during the early years resulting in a legal reserve and the accumulation of cash values - The policyholder has the right to borrow the cash value or exercise a cash surrender option Limited payment life The insured has lifetime protection and the premiums are level but they are only paid for a certain period - A paid-up policy at age 65 or 70 is also an example of limited payment life - The most common are for 10, 20, 25, or 30 years Page 5

6 ... *** A policy is paid-up when no additional premium payments are required, it matures when the face amount is paid as a death claim or endowment Single premium whole life Endowment Provides lifetime protection with a single premium Pays the face amount of if the insured dies within a specified period - If the insured is still alive at the end of the period, the face amount is paid to the policyholder Variable life Fixed premium policy in which the death benefit and cash values vary according to the investment experience of a separate account, which is similar to a mutual fund maintained by the insurer - The premium is level - The entire reserve is held in a separate account and is invested in common stocks and other investments - Cash surrender values are not guaranteed and there is no mimimum guaranteed cash value Universal life A flexible premium policy that provides lifetime protection - After the first premium the policyholder decides the amount and frequency of payments - Premiums minus expense charges are credited to a cash value account called an accumulation fund - The policy has flexibility - The protection and savings components are separated... ***Universal life : Page 6

7 - Most policies have a target premium but the policyholder is not obligated to pay it - A monthly mortality charge is deducted from the cash value account for the cost of protection - Insurers typically deduct 5-10 % of each premium for expenses - Interest earnings credited to the cash value account depends on the interest rate... *** There are two forms of universal life - Option A: Pays a level death benefit during the early years, and the death benefit increases in the later years to meet the corridor test - Option B: Provides for an increasing death benefit which is equal to a constant net amount at risk plus the accumulated cash value... *** Cash withdrawals are permitted in universal life Indexed universal life A variation of universal life - There is a minimum interest rate guaranteed - Additional interest may be credited to the policy based on investment gains of a specific stock market index - The amount credited is based on a formula and is usually capped Variable universal life Most are sold as investments or tax shelters Page 7

8 -The policyholder decides how the premiums are invested -The policy does not guarantee a minimum interest rate or minimum cash value -These policies have relatively high expense charges, including frontend loads for sales commissions, back-end surrender charges, and investment management fees -The policyholder bears substantial investment risk Page 8