CSR 342 Quiz 8 Study Guide
What is "hidden information"?
-Adverse selection -People buying the insurance know more about their risk than the insurance company -Ex. someone buying life insurance bc they know they are about to fall terminally ill
Living benefits
-Allow the insured to receive a portion of benefits prior to death
How can you borrow from a life insurance policy?
-Can borrow from accumulated savings -No set repayment schedule -Cash value backup serves as collateral if you don't pay back loan -IR may be slightly higher than market rates -Can borrow an amount equivalent to full cash value accumulated in your account
Guaranteed purchase option
-Enable the insured to purchase additional coverage without providing evidence of insurability
Participating policies
-Enable the policyholder to receive dividends that reflect the difference between premiums charged and the actual amount needed to fund the mortality experience of the company
what is a "moral hazard"?
-Hidden action -When policyholders change their behavior after purchasing insurance that makes them more risk to insure -Ex. someone takes up skydiving after purchasing insurance
What are the adverse tax consequences of borrowing from a life insurance policy?
-If the cash value of your policy is less than the balance outstanding on your loan, you either have to pay the difference of the insurance company will report to the IRS a taxable income based on the paper profit you have made since you took out the loan
Who needs life insurance?
-If you have any dependents that rely on you for financial support and whose financial health you want to protect after you die
Multiple indemnities
-Increases the face value of the policy by a multiplier (usually 2 or 3) if the insured dies in an accident
Policy loan provisions
-Loans secured by the cash value of the policy
Disability clause
-May include a waiver of premium benefit and/or a disability income portion
What is a vatical settlement?
-Occurs when a life insurance policyholder sells that policy before it matures -Involve policyholders with a shortened life expectancy -The company that purchases the policy pays amount between premiums paid and face value (AKA at a discount) -Policyholder can use proceeds for medical expenses
Whole life insurance
-Part insurance, part savings account -Each year, portions of premium goes to fund death benefit and tax-deferred savings account -If you die, beneficiary receives face value comprised of savings account and payment from insurance company -Relatively inflexible, little control/ transparency -Constant payment amounts -Insured has right to cash value of policy if canceled (nonforfeiture) -Types: continuous premium (level premiums paid until death or cancellation), limited payment (level premiums paid for specified number of years, insurance remains until death), single premium (lifetime coverage with one premium)
Grace period
-Permits the policyholder to retain full coverage for a short period of time after missing a due date for a premium payment
Change of policy provision
-Permits the policyholder to switch policy forms
What is underwriting?
-Process by which an insurance company decides who to insure and the rate to charge that person -Have to protect themselves from adverse selection and moral hazard
Nonforfeiture options
-Provide a cash value life insurance policyholder with some benefits, even when the policy is terminated prior to its maturity
Term life insurance
-Provides coverage for a specific number of years, pay premiums and beneficiary receives fave value of policy only if you die during the term -Best for young families -Gets more expensive as you grow older -No savings component -Types: straight term (coverage remains same while premiums increase) or decreasing term (premiums remain same while coverage decreases) -Renewability: allows insured to renew policy without evidence of insurability -Convertibility: allows insured to convert Whole Life policy without evidence of insurability
How can you calculate your life insurance needs?
1. Calculate current monthly expenses 2. Estimate expenses that would be eliminated if one spouse died 3. Estimate increased monthly expenses you might have if one spouse died 4. Record income each spouse contributes to the family budget, determine how much income would be lost if one spouse died 5. Estimate each spouse's monthly expenses and income if the other spouse died, subtract expenses from income, if negative need life insurance 6. Multiply the gap by number of months you expect gap to continue to determine how much insurance you need 7. Or calculate annual need for long-term insurance and account for TVM
Whole life- Advantages and Disadvantages
Advantages: -Savings vehicle -Cash value can be borrowed agains -Premiums remain constant -Cash value accumulates tax free Disadvantages: -Less death protection than term insurance -Lower returns than other savings vehicles -Loans must be repaid with interest -Tax penalties on cash values withdrawn early -If you have loan outstanding when you die, amount subtracted from face value
When shopping for life insurance what should you consider?
-Quality of the insurance company itself; ratings by AM Best -How much coverage you might need; designed to fill gap between financial resources your family would have if you died and what they would need -Determine amount of coverage you need, compare costs between companies, select large/highly rates company, select reputable agent
Policy reinstatement
-Revives the original contractual relationship between the insurance company and the insured
How can you deal with risk?
-Risk Avoidance -Risk Control -Risk Assumption -Risk Transfer
Variable universal life insurance
-Similar to universal life, but investment portion much more flexible -Get a range of investment options ranging from safe to risky -Cash buildup cannot be predicted -More fees because theres investment and insurance companies/agents that need to be paid
Universal life insurance
-Similar to whole life but with more transparency -Spell out how much of each year's premium goes to mortality fees and how much is invested -Offers options if you can't make your payment -Can adjust death benefit during life of policy -Invested potion handles by insurance company, buys low-risk low-return bonds -Premiums are "unbundled" into two separate accounts -Savings grow at constant IR -Provides flexibility in premiums paid/death benefit
Suicide clause
-Specifies that benefits will not be paid if the insured commits suicide within a specified amount of time after policy inception
Beneficiary clause
-Specifies the person(s) who will receive benefits after the death of the insured
Settlement options
-Specifies the way that benefits will be paid after the death of the insured
Payments of premiums
-Specifies when premium payments are due
Exclusion
-Stipulates circumstances in which benefits will not be paid
What are the types of life insurance?
-Temporary: Term life insurance -Permanent: Whole life, universal life, and variable universal life insurance
What are the differences between the different types of life insurance?
-Term: provides coverage for specific number of years -Whole life: part insurance, part savings account -Universal life: more transparency, rigid investment options -Variable universal life: more investment options, higher fees
What insurance mistakes do you need to avoid?
-That life insurance proceeds are free of tax -Beneficiary of life insurance policy will receive face value without having to pay income tax, but may have to pay estate taxes of the insured person owned the policy at the time of their death
What is the goal of insurance?
-To be protected from very large losses which have a very small likelihood of occurrence -Losses are incredibly expensive when they do happen -Expected loss = dollar loss * probability of loss occurring
What is a risk?
-Uncertainty with respect to loss -Probability of occurrence of an adverse event