Chapter 8 Insuring Your Life
Risk assumption
choice to accept to bear the risk of loss (accepting the risk if choose to not buy health insurance)
What does interest only mean
company keeps proceeds for specified time, beneficiary receives interest payments When there's no current need for principal
Insurance policy
contract between insured and insurer under which insurer agrees to reimburse insured for any losses suffered according to specified terms
What is multiple-of-earnings method
determines amount of life insurance coverage needed by multiplying gross annual earnings by some selected (random) number Rule of thumb: should equal 5 to 10 times current income Fails to consider financial obligations and resources
What does fixed period mean
face amount of policy, with interest earned, is paid to beneficiary over fixed time period
Underwriting
process used by insurers to decide who can be insured and to determine applicable rates that will be charged for premiums
Insurance premium
relatively small certain amount you pay in exchange for promise the insurance company will reimburse you if you suffer a covered loss
Actuarial data
statistical information to estimate the risk of loss for given population
Where do payable death benefits come from
Accumulated pension plans Profit-sharing programs
What are the living benefits
Allows insured to receive a percentage of death benefits form a whole or universal life policy prior to death
Policy loan
An advance, secured by cash value of whole life policy, made by insurer to policyholder Subtracted from the proceeds to the beneficiary
Annual renewable term policy
Annual premium can increase each year for a straight term policy (not popular today) Females pay less than males for coverage Premiums increase sharply with age
How is universal life flexible
Annual premium can increase or decrease cuz cost of death protection may be covered from either annual premium or accumulation account (i.e. cash value) Death benefit can increase or decrease
What if there is a convertibility provision
At stated times allows you to convert term policy into a comparable whole life policy
What are the exclusions
Aviation, war, hazardous occupation or hobby
Key life insurance contract features
Beneficiary clause Settlement options Policy loans Premium payments Grace period nonforfeiture options Policy reinstatement Change of policy
What does fixed amount mean
Beneficiary receives proceeds in regular payments
Social security survivor's benefits
Benefits under social security intended to provide basic, minimum support to families faced with loss of a principal wage earner
What is whole life insurance savings feature
Cash value, results from investment earnings on paid-in insurance premiums Longer insured keeps policy in force, greater cash value
Disadvantages of universal life
Changing premium and protection levels Charges or fees (heavy fees compared to other policies)
Steps in buying life insurance
Compare costs and features Select a large and highly rated financially secure company Choose an agent
Disability clause
Containing a waiver-of-premium benefit alone or coupled with disability income
Types of whole life policies
Continuous premium Limited payment Single premium
Premium payments
Contracts specified when premiums are due
What is Limited payment
Covers entire life but the premium payment is based on a specified period during which you pay a level premium On completion of scheduled payments, insurance remains in force at its face value for the rest of insured's life Can be used as part of savings or retirement plans if have life insurance already in force that is sufficient
Health Insurance
Covers medical costs when sick or become disabled
What is universal life savings feature
Credits cash value at "current" interest rate (current may be higher than guaranteed min rate)
Unbundling
Death protection portion and savings portion are identified separately in its premium
Whole life insurance
Designed to offer ongoing insurance coverage over course of insured's entire life Offers a savings feature (cash value)
How to access family's total economic needs
Determine income needed to maintain adequate lifestyle (monthly amount), extra expenses if income producer dies, special needs of dependents, debt liquidation, and liquidity
What is the Needs Analysis Method
Determines amount of insurance coverage needed by considering a person's financial obligations (needs) and available financial (resources) in addition to life insurance
What is a waiver-of-premium benefit
Excuses payment of premiums on life insurance policy if insured becomes totally and permanently disabled prior to age 60
Benefits of life insurance
Financial protection for dependents Protection from creditors Tax free If it has a cash value, can be a savings vehicle
Advantages of universal life
Flexibility Savings feature
What are extra expenses if income producer dies
Funeral costs Child care Housekeeping
What if term policies offer a renewability provision
Gives you the option to renew policy at its expiration, even if you have become uninsurable due to an accident / other illness during original policy period Premium will increase Renewable at end of each term until insured reaches 65 or 70
Who may tend to use term policies to meet specific coverage needs
Healthy older people with adequate financial resources
Life Insurance
Helps replace lost income if premature death occurs Provides funds so loved ones can help their home Maintain acceptable lifestyle Pay for education and meet other special needs
Assets that can provide proceeds after selling
Home/Real estate, jewelry, stocks, bonds, etc
Determine liquidity
If a high percentage of wealth is in illiquid assets, cash life insurance proceeds can pay bills and maintain assets until they can be sold at fair market value
How to know if you need life insurance
If there are dependents counting on you for financial support, debt, assets, home mortgage, children (suffer the greatest loss),
What is Continuous premium (Straight life)
Individuals pay a level premium each year until they either die or exercise a nonforfeiture right Offers greatest amount of permanent death protection and the least amount of savings per premium dollar If whole life is needed, straight life gets the most of life insurance dollars Once needs are reduced, convert policy to smaller amount of paid-up insurance
Advantage of term life
Initial premiums are lower than other insurance types Economical way to buy large amount of protection over a relatively short period to cover needs that disappear over time
Term life insurance
Insurance that provides only death benefits, for a specified period, does not provide for accumulation of cash value Can be bought for many different time increments (5, 10, 30 years) Premiums can be paid annually, semiannually, or quarterly) (most common is straight and decreasing term)
What is extended term insurance
Insured uses accumulated cash value to buy a term life policy for same face value as the lapsed policy Coverage determined by protection bought by single premium at present age
What does life income mean
Insurer guarantees to pay beneficiary certain amount for rest of life (based on sex, age when benefits start, life expectancy, policy face value, and interest rate assumptions
Nonforfeiture right
Life insurance feature giving whole life policyholder, upon cancellation, the portion of those assets that were set aside to provide payment for future death claims
What are special needs of dependents
Long-term nursing care for disabled or chronically ill children Emergency fund for unexpected financial burdens College education fund for children
A way to keep cost of whole life down
Low-load whole life insurance
What are settlement options (ways of paying proceeds)
Lump sum Interest only Fixed period Fixed amount Life income
What financial resources can be available after death
Money from savings Investments Social security survivor's benefits Proceeds from employer-sponsored group life insurance policies Death benefits payable Proceeds from selling assets Income earned by surviving spouse or children
Two methods to find out how much life insurance is right
Multiple-of-earnings method Needs analysis method
How are the savings rates on whole life policies
Normally fixed and guaranteed to be more than a certain rate Ex. 4 to 6 percent
Disadvantages of term life
Offers only temporary coverage (renewal can be a problem if then have factors that make it difficult to qualify)
Through underwriting, insurance companies try to guard against adverse selection, which happens when..
Only high-risk clients apply for and get insurance coverage (means a disproportionate number of bad risks)
Guaranteed purchase option
Option giving policyholder the right to purchase additional coverage at stipulated intervals without evidence of insurability
Two options of nonforfeiture instead of giving policy's cash value
Paid-up insurance Extended term insurance
What happens to the premium of universal life
Part pays administrative fees and cost of death benefit Remainder is put into cash value (savings) portion, earning a certain return rate Savings portion must have enough to buy death protection at all times When cash value grows, amount of coverage must increase to retain favorable tax treatment
Nonforfeiture options
Pays a cash value policyholder the policy's cash value when a policy is terminated before its maturity (required by all whole, universal, variable policies)
Participation policy
Pays dividends reflecting difference between premiums that are charged and amount of premium necessary to fund actual mortality experience of company
Universal life insurance
Permanent cash-value insurance, combines term insurance (which provides death benefits) with tax sheltered savings/investment account that pays interest (usually competitive money market rates)
Grace period
Permits policyholder to retain full death protection for short period (usually 31 days) after missing a premium payment
Beneficiary (person who receives death benefits of policy) Clause
Policies should have primary beneficiary and various contingent beneficiaries If primary doesn't survive, insurer will distribute benefits to contingent beneficiaries If neither survive, benefits pass to insured's estate
Policy reinstatement
Policyholder may reinstate original policy, usually within 3 to 5 years of lapsing, by paying all premiums back plus interest, so long as whole life policy is under reduced paid-up option or extended term option Must pass a physical examination / other requirements Would buying a new policy be less costly?
What is paid-up insurance
Policyholder uses cash value to buy a new, single premium policy with a lower face value No further premium payments, cash value continues to grow, useful when income and need for death protection decline
What happens if policyholder cancels contract prior to death
Portion of assets set aside to provide payment for death claim is available to him (nonforfeiture right)
Level premium term policy
Premium can remain level throughout policy period for a straight term policy Must requalify at end of each term to retain low premium Cost less than annul renewable term for same period
Advantages of whole life
Premium payments contribute toward building estate Insured can borrow against policy / withdrawal cash value when the need for protection has expired Can budget premium payments over relatively long period Underlying cash value increases much faster Ability to continue coverage after policy lapses cuz premiums weren't paid (nonforfeiture option) Ability to revive older, favorably priced policy that lapsed (policy reinstatement)
What about the changing premium and protection levels for universal life
Premiums must be higher than originally planned in later years to keep policy in force Often premiums never disappear or reappear when interest rates fall
Disadvantages of whole life
Provides less death protection per premium dollar Investment feature provides lower yields Should not be used to obtain max return on investment
Change of policy
Provision that permits insured to switch from one policy to another without penalty
What is Single premium (SPLI)
Purchased with one cash premium payment at inception of contract, buying life insurance coverage for rest of life (limited in usefulness) Appeals to those looking for tax-sheltered investment vehicle Any cash withdrawals/loans taken against its cash value before 59.5 are taxed as capital gains and subject to penalty for early withdrawal
Property Insurance
Reimburses if car or home is destroyed or damaged
What is low-load whole life insurance
Sold directly by insurers to consumers, eliminates sales agents and large commissions from transactions Cash values grow much quicker than traditional policies sold by agents
How to calculate how much life insurance you require
Subtract resources from needs
How is universal life insurance tax treatment
Tax free death benefits Amounts credited to cash value (including investment earnings) accumulate on a tax-deferred basis, prior to insured's death
Decreasing term policy
Term insurance policy maintains a level premium throughout all period of coverage while amount of protection decreases
Straight term policy
Term insurance policy written for a given number of years, with coverage remaining unchanged throughout effective period
Debt liquidation
To leave family relatively debt free, determine average amount needed to pay off outstanding bills, other similar obligations, possibly home mortgage
Multiple indemnity clause
Typically doubles or triples policy's face amount if insured dies in an accident
Suicide clause
Voids contract if insured commits suicide within certain period, normally two years after policy's inception
When is decreasing term policy used
When amount of needed coverage declines over time Ex. homeowner can match coverage with declining balance of mortgage, or families with young children match coverage with declining level of income needed as kids grow and become independent
Who has a high need for death protection
Young families on limited budgets Focus on guaranteed renewable and convertible term insurance, and preserve financial resources for meeting immediate and future consumption and savings goals
Loss control
any activity that lessens severity of loss once it occurs (wearing seatbelt)
Loss Prevention
any activity that reduces probability that a loss will occur (driving speed limit)
Risk Avoidance
avoiding an act that would create risk (not driving to avoid a car accident)