Chapter 12


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Chapter 12

  1. 1. C HAPTER 12 12-1 Personal Finance Life Insurance Kapoor Dlabay Hughes 7e
  2. 2. An Introduction to Life Insurance <ul><li>Life insurance is obtained by purchasing a policy, with the insurance company promising to pay a lump sum at the time of the policy holder’s death, or sometimes while they are still alive. </li></ul><ul><li>The purpose of life insurance is to protect someone who depends on you from financial loss related to your death. Other reasons are. </li></ul><ul><ul><li>To make charitable bequests upon your death. </li></ul></ul><ul><ul><li>To save money for retirement or for income or education for children. </li></ul></ul><ul><ul><li>To leave as part of your estate. </li></ul></ul><ul><ul><li>To pay off a mortgage or debts at the time of death. </li></ul></ul>12-2
  3. 3. The Principle of Life Insurance <ul><li>Mortality tables provide odds on your dying, based on your age and sex. </li></ul><ul><li>Your premium is based on your life expectancy and the projections for the payouts for persons who die. </li></ul>12-3
  4. 4. Determining Your Life Insurance Needs - Ask Yourself... <ul><li>Do you need life insurance? </li></ul><ul><ul><li>Do you have people you need to protect financially? </li></ul></ul><ul><ul><li>Do you have a partner who works? </li></ul></ul><ul><li>What are your objectives for life insurance? </li></ul><ul><ul><li>How much money do you want to leave your dependents should you die today? </li></ul></ul><ul><ul><li>When do you want to retire, and what income do you think you’ll need? </li></ul></ul><ul><ul><li>How much will you be able to pay for your insurance program? </li></ul></ul>12-4
  5. 5. Estimating Your Life Insurance Requirements <ul><li>The Easy Method. </li></ul><ul><ul><li>Typically, you will need 70% of your salary for seven years while your family adjusts. </li></ul></ul><ul><li>The DINK (dual income, no kids) Method. </li></ul><ul><li>The “Nonworking” Spouse Method. </li></ul><ul><ul><li>Multiply the number of years until the youngest child reaches 18 by $10,000. </li></ul></ul><ul><li>The “Family Need” Method. </li></ul><ul><ul><li>More thorough than the first three because it also considers employer provided insurance, Social Security benefits, and income and assets. </li></ul></ul>12-5
  6. 6. Two Types of Life Insurance Companies <ul><li>Stock life insurance companies are owned by the shareholders. </li></ul><ul><ul><li>95% are of this type. </li></ul></ul><ul><ul><li>Sell non-participating policies. </li></ul></ul><ul><ul><li>If you want to pay the same premium each year, choose a non-participating policy with its guaranteed premiums. </li></ul></ul>12-6
  7. 7. Two Types of Life Insurance Companies <ul><li>Mutual life insurance companies. </li></ul><ul><ul><li>Owned by the policyholders. </li></ul></ul><ul><ul><li>5% of policies are from this type of company. </li></ul></ul><ul><ul><li>With participating policies the premiums are higher than non-participating policies. However, part of the premium is refunded to the policyholders annually. This is called the policy dividend. </li></ul></ul>(continued) 12-7
  8. 8. Types of Life Insurance Policies <ul><li>Term life insurance. </li></ul><ul><ul><li>Protection for a specified period of time. </li></ul></ul><ul><ul><li>If you stop paying premiums, coverage stops. </li></ul></ul><ul><ul><li>A renewability option means that at the end of the term you can renew the policy without having a physical. </li></ul></ul><ul><ul><li>Conversion option allows you to exchange your term policy to a whole life policy without having a physical. </li></ul></ul><ul><ul><li>With decreasing term insurance your premium stays the same, but the amount of coverage decreases as you age. </li></ul></ul>12-8
  9. 9. Types of Life Insurance Policies <ul><li>Whole life insurance is also called straight life. </li></ul><ul><ul><li>You pay a premium as long as you live. </li></ul></ul><ul><ul><li>Amount of premium depends on your age when you start the policy. </li></ul></ul><ul><ul><li>Provides death benefits and accumulates a cash value. </li></ul></ul><ul><ul><li>You can borrow against the cash value or draw it out at retirement. </li></ul></ul><ul><ul><li>Look carefully at the rate of return your money earns. </li></ul></ul>(continued) 12-9
  10. 10. Whole Life Policy Options <ul><li>Limited payment policy. </li></ul><ul><ul><li>Pay premiums for a stipulated period, usually 20 or 30 years, or until you reach a specified age (65). </li></ul></ul><ul><ul><li>Your policy then becomes “paid up” and you remain insured for life. </li></ul></ul><ul><li>Variable life policy. </li></ul><ul><ul><li>A minimum death benefit is guaranteed, but the death benefit can be greater than the minimum depending on earnings of the dollars invested in the separate fund. </li></ul></ul>12-10
  11. 11. Whole Life Policy Options <ul><li>Adjustable life policy. </li></ul><ul><ul><li>A whole life insurance policy, but you can change your policy as your needs change. For example, you can change your premium payments or the period of coverage. </li></ul></ul><ul><li>Universal life - gives you more direct control. </li></ul><ul><ul><li>Lets you pay premiums at any time in almost any amount. The amount of insurance can be changed more easily than a traditional policy. </li></ul></ul><ul><ul><li>The increase in the cash value of the policy reflects the interest earned on short-term investments. </li></ul></ul>(continued) 12-11
  12. 12. Other Types of Life Insurance Policies <ul><li>Group life insurance. </li></ul><ul><ul><li>Term insurance. </li></ul></ul><ul><ul><li>Often provided by an employer. </li></ul></ul><ul><ul><li>No physical is required. </li></ul></ul><ul><li>Credit life insurance. </li></ul><ul><ul><li>Debt is paid off if you die. </li></ul></ul><ul><ul><ul><li>Mortgage, car, furniture. </li></ul></ul></ul><ul><ul><li>Also protects lenders. </li></ul></ul><ul><ul><li>Expensive protection. </li></ul></ul>12-12
  13. 13. Life Insurance Contract Provisions <ul><li>Naming your beneficiary, and contingent beneficiaries. </li></ul><ul><li>Length of grace period for late payments. </li></ul><ul><li>Reinstatement of a lapsed policy if it has not been turned in for cash. </li></ul><ul><li>Nonforfeiture allows you to keep accrued benefits if you drop the policy. </li></ul><ul><li>Incontestability clause says that after the policy has been in force for a specified period, the company can’t dispute its validity for any reason. </li></ul><ul><li>Suicide clause during first two years. </li></ul>12-13
  14. 14. Life Insurance Contract Provisions <ul><li>Automatic premium loans. </li></ul><ul><ul><li>Uses the accumulated cash value to pay the premium if you do not pay it during the grace period. </li></ul></ul><ul><li>Misstatement of age provision. </li></ul><ul><li>Policy loan provision to borrow against cash value. </li></ul><ul><li>A rider to a policy modifies the coverage by adding or excluding conditions or altering benefits. </li></ul>(continued) 12-14
  15. 15. Life Insurance Contract Provisions <ul><li>Waiver of premium disability benefit. </li></ul><ul><li>Accidental death benefit - double indemnity. </li></ul><ul><li>Guaranteed insurability option. </li></ul><ul><li>Cost of living protection. </li></ul><ul><li>Accelerated benefits, also called living benefits, pay to those who are terminally ill before they die. </li></ul><ul><li>Second-to-die option, also called survivorship, insures two lives. </li></ul>(continued) 12-15
  16. 16. Buying Life Insurance <ul><li>Look at your present and future sources of income, other savings and income protection, group life insurance, pension benefits, and Social Security benefits. </li></ul><ul><li>Determine from whom to buy your policy. </li></ul><ul><ul><li>Examine both private and public sources. </li></ul></ul><ul><ul><li>Look up the company’s rating, in A. M. Best. </li></ul></ul><ul><ul><li>Talk to friends or colleagues. </li></ul></ul><ul><ul><li>Research ratings on the web, </li></ul></ul>12-16
  17. 17. Choosing Your Insurance Agent <ul><li>Ask friends, parents, and neighbors for recommendations. </li></ul><ul><li>Find out if the agent belongs to professional groups or is a Chartered Life Underwriter (CLU). </li></ul><ul><li>Is the person willing to take the time to answer your questions and find a policy that is right for you? </li></ul><ul><li>Do they ask about your financial plan? </li></ul><ul><li>Do you feel pressured? </li></ul><ul><li>Are they available when needed? </li></ul>12-17
  18. 18. Buying Life Insurance (continued) <ul><li>Compare policy costs which are affected by... </li></ul><ul><ul><li>How selective they are in whom they insure. </li></ul></ul><ul><ul><li>Their cost of doing business. </li></ul></ul><ul><ul><li>Return on their investments. </li></ul></ul><ul><ul><li>Mortality rate among policyholders. </li></ul></ul><ul><ul><li>Policy features and competition from other firms </li></ul></ul><ul><li>Use interest-adjusted index to compare policies. </li></ul><ul><ul><li>Takes into account the time value of money. </li></ul></ul><ul><ul><li>Helps you make cost comparisons among insurance companies. </li></ul></ul><ul><ul><li>See sites such as </li></ul></ul>12-18
  19. 19. Obtaining and Examining a Policy <ul><li>The first step is to apply. </li></ul><ul><li>The second step is to provide medical history. </li></ul><ul><li>Usually no physical for a group policy. </li></ul><ul><li>Read every word of the contract. </li></ul><ul><li>After you buy it, you have ten days to change your mind. </li></ul><ul><li>Give your beneficiaries and lawyer a photocopy. </li></ul>12-19
  20. 20. Choosing Settlement Options <ul><li>Options are the choices available for how you can have the life insurance money paid out. </li></ul><ul><li>Lump-sum payment is most common. </li></ul><ul><li>Limited installment plan. </li></ul><ul><ul><li>In equal installments for a specific number of years after your death. </li></ul></ul><ul><li>Life income option. </li></ul><ul><ul><li>Payments to the beneficiary for life. </li></ul></ul><ul><li>Proceeds left with the company. </li></ul><ul><ul><li>Pays interest to the beneficiary. </li></ul></ul>12-20
  21. 21. Should You Switch Policies? <ul><li>Switch if benefits exceed costs of getting another physical, and paying policy set-up costs. </li></ul><ul><li>The older you are the higher the premium will be. </li></ul><ul><li>Are you still insurable? </li></ul><ul><li>Can you get all the provisions you want? </li></ul>12-21
  22. 22. Financial Planning with Annuities <ul><li>An annuity is a financial contract written by an insurance company that provides you with a regular income. </li></ul><ul><li>People buy annuities to supplement retirement income and to shelter income from taxes. </li></ul><ul><li>Those who expect to live longer than average benefit most from annuities. </li></ul><ul><li>Annuities are tax-deferred investment plans. You pay taxes on the interest when you draw the money out. </li></ul>12-22