PLANNING What You Should Know About... Insurance LIFE INSURANCE DISABILITY INSURANCE LONG-TERM CARE INSURANCE YourMoneyCounts
Like most people, you probably don t live your life expecting the worst to happen. But you do take certain precautions to protect yourself and your loved ones from potential dangers. Just as health insurance provides important protection when you re ill, other types of insurance have a role to play in making you more secure financially. But you may not be sure what kinds of insurance you should have or how much coverage you need. 2005, HSBC North America Holdings Inc. All rights reserved. These are educational materials only, and are not to be used for solicitation purposes. These materials are not a recommendation by HSBC for any product, service, or fi nancial strategy.
Your insurance needs When you buy an insurance policy, you are paying some money now to ensure against financial loss and to provide economic stability for your family. In some cases, you buy insurance hoping that you will never need it. Collision insurance on your new car is one example. No one purchases car insurance with the belief they ll be involved in an accident and have to file a claim. However, the prospect of a bill you would have to pay that could amount to thousands of dollars justifies the cost of the insurance. In other cases, you buy insurance because you know you will need it though you don t know when. The best example is life insurance, which is paid to your survivors when you die. While it s perfectly reasonable to expect that you ll be around for a long time, you also realize that sometimes sad events occur unexpectedly which can have a major impact on your loved ones, including a financial impact. Insurance works because of shared risk. The insurance companies that sell the various policies to you and other customers are willing to commit themselves to pay your potential future claims because they are confident, based on past statistics, that they can make wise investments with your premium payments, to offset future claims, and still make a profit. In part, the premiums you pay are determined based on the level of risk that the insurance company thinks you pose to their having to 3
pay a claim. For example, people with poor driving records tend to be charged more for car insurance than people who have no marks on their records. Required insurance Certain kinds of insurance may be required by law or by your lender. State laws usually require liability insurance if you want to register a car, and mortgage lenders require homeowner s insurance if you have a mortgage on your home. Most states require you to have automobile liability insurance so that if a person or property is injured or damaged in an accident for which you re responsible, there will be money available to cover at least some of the damages. Similarly, lenders who provide mortgages want you to have homeowner s insurance that will repay them what you owe if your home, which you are using as collateral on the loan, is destroyed. Most consumers buy additional insurance to cover their own potential losses as well. Similarly, if you own your own business, you may be required to have workman s compensation insurance to protect your workers or commercial liability insurance to protect the business against claims by clients or customers. Insurance to consider Among the kinds of insurance that you might consider purchasing to protect your financial security and the security of your loved ones are life insurance, disability insurance and long-term care insurance. Life insurance Life insurance can protect your family s finances by providing them, or whomever you choose as the beneficiary of your policy, with a lump sum of cash called a death benefit when you die. Your beneficiary does not owe income tax on the payment, but its value is included in your estate if you own the policy. 4
Why buy life insurance? If your income supports a spouse and child, the payment from a life insurance policy can ensure that they will be able to pay final expenses and routine household expenses during the period immediately following your death. If you anticipate your family s future goals as you begin your insurance planning, your policy may provide enough income to also pay future college expenses or help your survivors meet other important goals. You may also want to buy life insurance if your income goes into a jointly funded household budget. The absence of one income stream could create a similar need for cash in a time of stress. Or your income may be the reason your family enjoys the lifestyle they do something you d rather they could continue to enjoy. Even if you re not earning income, you may still want to consider life insurance. If you stay home with your children or your elderly parents, think about what it would cost your survivors to pay for the value of the homemaking services you provide. But before you buy insurance, be sure you have a clear picture of why you need the coverage, how long you expect to need it, and how much you can afford to pay in premiums. Types of life insurance There are two basic types of life insurance, term and permanent. Term insurance The policy lasts for a certain amount of time, called the term. You pay premiums during that time, and if you die during the term, your beneficiary will receive the amount of the death benefit. Once the term is over, you can either renew the policy or choose to no longer be covered by life insurance. 5
Permanent insurance The policy is in effect for your lifetime. You pay premiums for a set amount of time, sometimes throughout your life. When you die, your beneficiary will receive the amount of the death benefit. You also accumulate a cash value account as you pay your premiums. You can borrow against this amount, and, if you cancel or surrender your policy, the company will pay the balance, after fees and charges, as a cash surrender value. If you re uncertain about the best decision to make, you may want to speak with a fee-only insurance consultant who will evaluate your situation and the various policies you are considering. There is a cost, but a fee-only consultant does not sell policies and has no vested interest in the decision you make. Special needs dependents If you have a child, parent or other dependent with special needs, life insurance that funds a special needs trust may help ensure they re provided for even in your absence. In those cases, though, it s very important to work with an experienced lawyer who can help you manage the tax implications and other issues that may arise. Term Insurance Because term life insurance simply provides life insurance, without a cash value reserve, the premiums are generally much lower when compared with a permanent policy with the same death benefit. You can buy the coverage for a single year, or for terms of five or ten years or longer. Most term policies are renewable, which guarantees that you can extend your policy for additional terms without having to prove to the insurance company that you re still in good health. The renewal guarantee is often conditioned, though, on the fact that you ve kept the policy in force by paying your premiums on time. The risk, if you don t renew, is that you won t be covered when you die and your beneficiaries will not receive a death benefit. 6
Renewable policies With level term insurance, you pay the same premium each year during the term and the death benefit remains the same. If you want to renew for an additional term say another five years the annual premium will probably go up. That s because as you get older, the chance you ll die during the new term increases. So the issuing company offsets this increased risk by requiring you to pay more for the coverage during the new term. With annually renewable term insurance, your premium increases each year though the death benefit remains the same. While you ll pay significantly less in the first few years than you would for a level term policy, in most cases your total cost will be higher sometimes much higher. If you re considering both varieties, you ll want to ask for a copy of the increasing rate schedule. By adding the amounts, you ll have a basis for comparison with a level term policy that provides the same benefit. Other term policies If you re concerned about having enough insurance to take care of small children, pay off the mortgage or another responsibility with a fixed time frame, you may consider decreasing term insurance. This type of policy pays the largest death benefit in the first year the policy is in force and a smaller amount in each following year until the policy ends perhaps after 20 years. The premium is level throughout the term. Conversely, if you think you may some day want permanent insurance but find it more costly than you can afford at the moment, you may consider a convertible term policy. That gives you the option of switching to a permanent policy with the same death benefit at some point in the future without having to qualify by passing a health screening exam. To pay for the added flexibility, the annual premiums are more expensive than they would be for a plain vanilla term policy. 7
Term insurance is widely available from a number of insurance companies. You can comparison shop by asking a number of potential providers for their rates and do additional research online. Permanent Insurance Permanent insurance, sometimes called cash value insurance, is designed for lifetime protection. The death benefit is fixed The premiums for coverage remain the same year after year The policy remains in force as long as you continue to pay the premiums Equally important, this type of insurance offers the opportunity for tax-deferred savings. Part of your premium pays for the insurance coverage and the issuing company s expenses in administering the policy. The rest goes into your taxdeferred cash value account. If you surrender, or give up your policy, you re eligible to get some of that accumulated value back. This cash surrender value, as it s known, is a tax-free return of your premiums unless the amount you get back is more than you ve paid in over the years. Then income taxes are due on your gain, or the difference. You can borrow a portion of the money from your cash value account more easily than you might be able to arrange a personal loan from a commercial lender. You re not required to demonstrate financial hardship, as you must before borrowing from your 401(k) or similar plan. There are also no restrictions on how you spend the loan or how fast you pay it back. The risk is that any amount you borrow reduces the death benefit that will be paid to your beneficiaries until that amount has been repaid. Types of permanent insurance Just as there are varieties of term insurance, there are varieties of permanent insurance. Whole life is traditional permanent insurance. Sometimes also called straight life, this type of insurance has a guaranteed death benefit. The total cost of the coverage is guaranteed, but the premiums may be fixed, increasing or decreasing. Increasing premiums are adjusted upward as you grow older and are presumably 8
making more money. Decreasing premiums drop off as you grow older because you ve already paid most of the amount that you owe. Universal life offers more flexibility than whole life, but at a greater cost. You can vary your premiums, even skipping some payments if there is enough money in your cash value account to cover what s due. You can also increase or decrease the death benefit if you wish while the policy is in force. Typically the rate at which you earn interest on your cash value account is higher in the first year than it would be on a straight life policy, but that rate can drop as low as the guaranteed floor, or lowest level, in later years. Variable life policies allow you to allocate your cash value account among various investment options that the issuing company offers. The investment return on these choices, which resemble mutual funds or annuity subaccounts in structure, can impact the balance of your cash value account pushing it higher when returns are good and lower when they are disappointing. In some policies, the death benefit is also affected by investment performance. The fees tend to be higher than on the plans without investment choice. Variable universal life, as its name suggests, combines the flexible premiums and death benefit of universal policies with the opportunity variable life provides for investment gains or losses. It is often the most expensive alternative and may not be as widely available as the other types of insurance. Survivorship life, sometimes called a second-to-die policy, insures the lives of two people and pays the death benefit only after the death of the second. It s available in many of the varieties of permanent insurance, and has typically been used by wealthy couples seeking to replace assets that their estate might have been forced to pay for estate taxes. It tends to be expensive compared with other types of insurance. 9
Finding a rider Sometimes you can customize an insurance policy to cover particular needs by adding what s known as a rider. One example, a waiver of premium rider, allows you to suspend premium payments but keep your policy in force if you have a qualifying disability. Remember, though, that as useful as they may be, riders usually increase the cost of the insurance. Pay now or pay later In the few first years that you own a permanent life insurance policy, permanent coverage costs more than you would pay for term insurance with the same death benefit. But with permanent insurance you don t face the prospect of paying more for protection as you grow older. How much insurance? One of the important questions to ask yourself when you re about to buy life insurance is how much coverage you need. The first step is to figure out which expenses you want the policy to cover. The most obvious is providing enough money to pay for your final expenses, including the funeral, any unpaid medical bills and other unexpected costs. Then you can estimate other costs based on what you are spending now, your current net worth and any future financial or life goals your family may have. You can use this informal worksheet as a starting point. You might also want to use an online insurance calculator and discuss your situation with a knowledgeable insurance agent or financial consultant. 10
Worksheet: Calculate your needs Add lines 1, 2 and 3 to determine the immediate and long-term expenses your death benefit should cover. Subtract line 4, which includes other sources of income your survivors will have. Multiply line 5 times line 6, the number of years you expect income to be needed. The result, in line 7, is the death benefit that s needed. 1 Final expenses $ 2 Outstanding debts (excluding mortgage) + $ 3 Annual living expenses + $ Mortgage $ Other living $ Food $ Transportation $ Insurance $ Other $ 4 Dependents income $ Salary $ Investment income $ Social Security $ 5 Additional income needed = $ 6 Number of years income will be needed x $ 7 Death benefit needed = $ If you want to add money to pay off the mortgage or fund one or more college educations, add these amounts to the amount in line 7. While your survivors should invest the money they don t need immediately to provide future income, remember that inflation is likely to drive up the cost of most things. 11
Disability insurance While life insurance can financially protect your family if you die, disability insurance can help protect you and your family if you are unable to work because of illness or injury. Most disability policies replace a percentage of your pretax salary, often 50% to 70%, with a cap, or limit on the amount you can receive each month. Making choices You can choose between a policy that covers you for a set period of time, such as one, two or five years, or one that lasts until you are eligible to retire. As with most insurance policies, the longer the coverage period, the more your premiums will be. One thing you should anticipate is that it may take up to four months to start receiving the disability payments once you qualify for the coverage by being considered disabled. The waiting period, known as the elimination period, is typically about 90 days, and the first payment is made at the end of the month after that period ends. You can specify a shorter elimination period when you buy a policy, but that will increase the cost of the insurance. Meeting the test Your insurance company s definition of what it means to be disabled is likely to be rather strict, potentially making it harder to qualify for income payments than you anticipate. Some policies state, for example, that if you can work at any job, even one that pays much less than you were earning, you aren t disabled. More expensive options, called own-occupation policies, will pay benefits if you are unable to do the skilled work for which you have been trained. 12
Before buying a policy, you ll want to read it carefully to be sure you know what it does and does not cover. Many policies, for example, refuse to cover a disability that results from a pre-existing condition. Sources of protection If you re considering disability insurance, you may want to begin by investigating whether there s a policy available through your employer. Group policies tend to be less expensive than those you buy individually, though the drawback to this approach is that if you leave your current job, you probably won t continue to be covered by your former employer s plan. You can also search online to get a sense of what s available through other organizations to which you belong. There is a safety net. You may qualify for Social Security disability coverage, though the standards are rather strict. Job-site injuries may make you eligible for workers compensation. However, that income alone is unlikely to be enough to allow you to live as comfortably as you would like. The bottom line here, as with other types of insurance, is that you ll want to weigh the likelihood of needing disability protection against the cost of that protection. Long-term care As you age, your medical needs are likely to increase. Long-term care insurance (LTC) is designed to cover custodial healthcare costs that Medicare won t cover, such as extended nursing home care or at-home nursing care. Since those costs can be extremely expensive, long-term care insurance is one way to protect your assets. Without the insurance, you might have to spend everything you have to pay the bills. 13
When are you covered? When you qualify as chronically ill, your policy will begin to pay benefits. Some policies allow your doctor to make that decision, while other policies require that the issuing company s medical examiner agree with the diagnosis. In most cases, being chronically ill means either that you re unable to perform a specific number of activities of daily living (ADL) such as eating, bathing or moving around on your own, or you have a cognitive impairment, such as Alzheimer s, that means you depend on another for care. Remember, though, that most policies specify that a certain amount of time, known as the elimination period, must pass between when you begin to need care and when you begin to receive benefits. You can buy a policy with a shorter elimination period, but that will increase the cost of coverage. What you receive Most long-term care policies pay a certain dollar amount, known as the daily benefit, to cover costs of care, though they may place some restrictions on who provides the care. For example, some policies require that providers be certified healthcare professionals. You ll have to pay out-of-pocket for anything the nursing home or other care provider charges above that amount. You may want to investigate a policy that provides inflation protection, as nursing home costs have tended to increase faster than other costs. You don t want to find yourself in a situation where the daily benefit you qualify for is much lower than the real cost of care. 14
You ll continue to receive benefits as long as you continue to qualify as chronically ill. However, there is typically a limit to the dollar amount you can receive, or a cap on the number of years you can receive treatment, so be sure to check what a policy you re considering covers. What it costs The premiums for long-term care insurance vary from policy to policy. In general, the longer the coverage will last and the larger the daily benefit, the more the policy will cost. The cost of coverage also depends on your age when you buy a LTC policy. The older you are and so more likely to need care in the short term the higher your premiums will be. One way to reduce the premiums is to spread the cost over a longer period, which means buying in your 50s or 60s, rather than in your 70s. Using a Checklist If you re considering an LTC policy, here are some questions you may want to ask: 1. What is the elimination period, before payments begin? 2. Is there inflation protection? 3. Is there a waiver of premium, so that you can stop paying premiums during the period you are collecting benefits? 4. Is there a non-forfeiture clause, so that you ll qualify for partial coverage if you have let the policy lapse? 5. Can you receive care at home rather than in a nursing home? 6. Must you have been hospitalized to qualify for benefits? 15
Other insurance Because insurance companies regularly develop new products or update existing ones, you can buy insurance to cover almost every risk you face. The key is to weigh each potential risk against the coverage that s available. Health insurance Most people realize the importance of good health insurance, but if you ve never had a serious illness, you may not be aware how expensive medical treatment is. Many people are covered by their jobs, but coverage can vary greatly. For example, some plans allow you to see any doctor, while others pay only for doctors within the plan s network. If you re covered through your job there s probably not a lot you can do to change your policy, but it s worth checking the details of your plan, so if you become ill you understand what s covered. Renters insurance Renters insurance protects your rented living space and possessions against damage or theft. If the apartment or home you rent is damaged by fire or a flood, for example, renters insurance can cover the cost of repairs and any costs that come from having to move into a hotel while your place is unlivable. Renters insurance also protects your possessions, including furniture and electronics, against damage or theft, reimbursing you either for the cost of replacing the items or their fair market value, which is likely to be less. 16
Credit insurance Credit insurance covers the cost of your minimum monthly payments on any lines of credit if you re not able to meet what s due. You pay a premium each month, and if you become disabled or lose your job, the credit insurance kicks in to cover your minimum payments. That protects your credit history from reflecting a time of financial crisis. However, any balance over the minimum payment will continue to accumulate interest, so credit insurance doesn t replace the need for an emergency fund and careful financial planning. And there are many other forms of insurance too, such as identity theft insurance and even pet insurance to cover veterinarian expenses. What s important to you may not be the same as what s important to someone else, so you ll have to carefully consider your own needs and the cost of the coverage when deciding the kinds and amounts of insurance you d like to purchase. Power of attorney While taking precautions and making certain decisions before the unexpected happens is a smart approach, there are certain decisions you can t make now, and you might not be able to make if you become seriously ill. To protect yourself in those situations, you may want to consider creating a legal document known as a power of attorney. In it, you give someone, known as your agent, the power to make financial and legal decisions when you re not able to. There are different powers of attorney you can consider: Ordinary: Power is granted as soon as the document is signed, and lasts either for the duration of a specific event such as the selling of a home or until you become incapacitated. Durable: Power goes into effect as soon as the document is signed and lasts until you revoke it. Unlike an ordinary power of attorney, a durable one is still in effect even if you become ill, disabled or incapacitated. 17
Springing: Power takes effect at a certain point or after a particular event. When creating a springing power of attorney, you choose the event, usually the onset of an illness or incapacity, which puts the document into effect. While you can create any kind of power of attorney on your own, it s a good idea to consult with a lawyer about the specifics of what you re considering. A professional can help make sure you don t inadvertently give someone power you don t want them to have, or, alternatively, that your agent has the authority to act that you intend. Choose carefully You ll want to carefully consider whom you choose to designate as your agent. It should be someone you trust as well as someone who s familiar with the decisions that may need to be made and the particulars of your financial situation. Make sure to ask whether the person is comfortable in the role of your agent, too. 18
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As one of the world s leading fi nancial services companies, HSBC is committed to championing fi nancial education and serving as an advocate for consumers. Our goal is to help consumers acquire an understanding of fi nancial concepts, as well as the tools necessary to make sound fi nancial decisions. The YourMoneyCounts program, managed by HSBC s Center for Consumer Advocacy, furthers our longstanding commitment to fi nancial education, which dates back to 1929 with the establishment of the Money Management Institute. Recognizing that people choose to learn in different ways, we offer the YourMoneyCounts program through multiple channels online, in print and through fi nancial education workshops. Visit us at YourMoneyCounts.com YourMoneyCounts is sponsored and managed by HSBC - North America YourMoneyCounts is developed in conjunction with Lightbulb Press PH00167 (08/05)