Chapter 11

How Long Will I Need Life Insurance?

By the time you are 65 at the latest, your need for life insurance and your need to pay the premiums on your life insurance should be gone.

What is a preferred risk policy?

Current assumption whole life insurance is a nonparticipating whole life policy in which the cash values are based on the insurer's current mortality, investment, and expense experience. The policy has an accumulation account that reflects the cash value under the policy. If the policy is surrendered, a surrender charge is deducted from the accumulation account. The policy also has a guaranteed minimum interest rate and a higher interest rate based on current market conditions and company experience. A fixed death benefit and maximum premiums are stated in the policy at the time of issue. Under the low-premium product, premiums are guaranteed only for a fixed period, such as three to five years. After that time, the insurer can change the premiums.

Type B Universal Life

Death benefit fluctuates As cash value grows over time, so does the death benefit The interest rate that is credited is crucial to determining the size of the cash value Insurer guarantees a minimum rate of interest

Type A universal Life

Death benefit is an amount that remains the same while the policy is in force As cash value grows over time, the additional death protection that must be purchased decreases

Identify the various expense charges that policyholders must pay under a variable universal life insurance policy.

Expense charges may include a front-end load, back-end surrender charge, state's premium and federal taxes, investment management fee, mortality and expense (M&E) charges, and administrative fees.

Term Life Insurance Coverage

Issued for a specified period of time or for a particular age. Straight term - not renewable Renewable term- right to buy coverage in the future regardless of your health Each time the policy is renewed, premium goes up to reflect the insured's current age. Conversion option- convertible to a different form of life insurance - regardless of insured's health at time of conversion (+) Limited premium dollars to afford term insurance (+) Preserve right to convert to permanent forms of coverage (+) Young families - need for death protection is great

Important to buy the proper amount

Most clients need a combination of term and whole life.

Explain the situations that justify the purchase of ordinary life insurance.

Ordinary life insurance is appropriate when lifetime protection is desired or additional savings are desired.

Dependency period

Period of time following the readjustment period during which the surviving spouse's children are under age 18 and therefore dependent on the parent.

Explain the meaning of premature death.

Premature death means that a person dies with outstanding unfulfilled financial obligations, such as children to support or a mortgage to be paid off.

Reentry term

Term insurance in which renewal premiums are based on select (lower) mortality rates if the insured can periodically demonstrate acceptable evidence of insurability. Rates are substantially increased if the insured cannot satisfactorily provide satisfactory evidence of insurability.

Explain the situations that justify the purchase of term insurance.

Term insurance is appropriate when income is limited or a temporary need must be met. Term insurance can also be used to guarantee future insurability.

Explain the economic justification for the purchase of life insurance.

The purchase of life insurance can be economically justified if a person has an earning capacity, and someone is dependent on those earnings for part or all of their financial support.

Identify the costs associated with premature death.

There are at least four costs associated with premature death. 1. There is the loss of the human life value; 2. additional expenses may be incurred; 3. because of insufficient income, some families may experience a reduction in their standard of living; 4. and noneconomic costs are incurred, such as the emotional grief of surviving dependents.

How does variable universal life insurance differ from a typical universal life insurance policy?

There are two major differences. First, under a variable universal life policy, the policyholder can invest the cash values in a wide variety of investments; a universal life policy does not have this feature. Second, there is no minimum guaranteed interest rate on the cash values; a universal life policy has a guaranteed minimum interest rate.

Modified Life

a form of whole life with premiums lower for an initial period of time, after that premiums are higher than they would otherwise be (meets the same need or convertible term)

variable universal life

only the cash value varies with the performance of the underlying securities (cash values can be invested in a wide variety of investments) -no minimum guaranteed interest rate Policy owners are given a choice of investment to support the contract, investment risk falls entirely to policy holder -

What Kind of Life Insurance Do I Need?

•Temporary- can be policy purchased for only a few years; cheaper (term insurance) •Permanent - think in terms of 20- to 30-year horizon; in the long run, tends to have less net cost •(whole life - death protection decreases as cash value component increases over the life of the policy holder)

•Three major types of insurance:

•Term •Whole Life •Universal Life

Credit life

•offered in connection with installment loan such as car loans (decreasing term insurance)

Decreasing term

- term life insurance - purchased for a specified purpose, provide cash to pay off the mortgage 30 years mortgage = 30 years decreasing term

Level term

- term life insurance face amount (stated sum of money to be paid to the person)

Increasing term

- term life insurance the face amount goes up periodically on a predetermined basis

Describe the steps in determining the human life value of a family head.

(1) Estimate the individual's average annual earnings over his or her productive lifetime. (2) Deduct federal and estate income taxes, Social Security taxes, life and health insurance premiums, and the costs of self-maintenance. (3) Determine the number of years from the person's present age to the contemplated age of retirement. (4) Using a reasonable discount rate, determine the present value of the family's share of earnings for the period determined in Step (3).

Straight life

- premiums are payable as long as the insured lives -life insurance

Universal life insurance - cash value

(Earn a market-based rate on cash value) Cash value varies regularly due to: Insurer's investment earnings Mortality experience Expenses Amount and timing of premiums paid by the insured -policy develops an investment or saving element called a cash surrender value which results from the overpayment of premiums during the earlier years -premium payments can be any amount provided there is sufficient cash value to keep the policy in force -under a contract that seperates the protection and savings components -unbundling of protection, savings, and expense components -two forms -considerable flexibility -cash withdrawels are permitted, which reduces the amount of death benefit -favorable income tax treatment -interest rate is credited to the cash value but is tied to a changing market interest rate - minimum interest rate is guaranteed

How Much Life Insurance Do I Need?

-Human life value approach - measures economic value of human life -Needs approach - consider specific needs; education, mortgage -Another approach is to purchase 6 to 8 times your salary -Comparison shop at least three sources Choose a life insurance company with a high A.M. Best Rating (at least A or better)

What are the major limitations of term insurance?

Term insurance has several limitations. 1. Premiums increase with age, 2. term insurance is not suitable for lifetime protection, 3. and because term insurance does not accumulate cash values, it is inappropriate for retirement or saving purposes.

readjustment period

The 1- to 2-year period immediately following the breadwinner's death during which time the family should receive approximately the same amount of income it received while the breadwinner was alive.

Life Insurance

The risk management tool that is most appropriate for dealing with the exposure of premature death is life insurance. •Endorsements attached to a basic level term or permanent insurance policy: •guaranteed insurability rider purchase additional amounts regardless of health. •Cost-of-living increases the amount of protection by the same amount that CPI increases •No evidence of insurability is required if insured accepts and pays for additional amounts when it is offered

What is a variable universal life insurance policy?

Variable universal life insurance allows the policyholder to invest the premiums in a wide variety of investments, such as stock funds, bond funds, or money market funds. There is no minimum guaranteed rate of interest on the cash values, and the cash values are not guaranteed. In addition, the policy has relatively high expense charges and a substantial investment risk.

debt insurance

•Debit insurance - premiums are only a few dollars a week •Collect premiums at insured's homes •Meet burial needs of low income insured •Small face amounts •More expensive because of the high cost of its premium collection method; needs are better served by term or whole life

Do I Really Need Life Insurance?

•Never buy insurance if you don't need protection. Insurance protection should be the primary motivation for choosing to insure. If you are single and have no dependents, you do not need life insurance. •Ask whether surviving family members want or need to maintain a set standard of living. Would they be forced to sell the house, change jobs, go into debt?

Universal Life Insurance

•Cash Value (established deliberately) •Term Insurance and an Investment •(+) Can very premium payments •More expensive in the early years. •(+) Interest earnings accumulate on a tax-deferred basis and increase cash value of policy •(-) Decline in rates and cash value maybe misleading

whole Life insurance

•Cash Value (merely a by-product of the premium payment). •Permanent Insurance •Lasts a person's whole life -Locks in a premium that does not rise, as the insured grows older. (Later in life the policy is initiated, the more expensive the fixed premium is). -Can borrow against a cash surrender value. -(-) If you don't stay with it you lose money. Kept in force for the insured's entire lifetime Matures at age 100 and claim is paid Account for more than half of all life insurance policies sold If terminated prior to insured's death, the cash value is then refunded The face amount remains fixed, but the death protection component decreases and the cash value component increases

Term Insurance

•Premiums tend to increase overtime (Tend to track the mortality curve) •Provides the most death protection per premium dollar spent •No Cash Value Person in 20's pays 1/10 of amount of whole life. 55 year-old pays several times for term vs. whole life started 30 years ago. 1 - Annual renewable premium remains level for a specified period 2 - Level term premiums fixed for 5, 10, 15, 20, 25 years.

Variable life

- death benefit and cash value fluctuate with investment performance of a seperate account. Entire reserve is held in a seperate account and is invested in common stocks or other investments -cash surrender is not guranteed Policyholders can designate the types of investments

The needs approach is widely used for determining the amount of life insurance to purchase. Describe the following needs for a typical family head: Cash needs Income needs Special needs

. (a) An estate clearance fund is immediately needed when a family head dies. Cash is needed for burial expenses, uninsured medical bills, installment debts, estate administration expenses, and estate, inheritance, and income taxes. (b) Income needs include income during the readjustment period, income during the dependency period, and life income to a surviving spouse. (c) Special needs include a mortgage redemption fund, educational fund, and emergency fund.

What is the major limitation of ordinary life insurance?

1. Because of higher premiums that are required, some people may still be underinsured after an ordinary life policy is purchased. 2. For the same premium, substantially higher amounts of term insurance could be purchased.

Briefly explain the basic characteristics of ordinary life policies.

1. Ordinary life insurance provides lifetime protection. 2. The premiums are level and payable for life. 3. The policy develops an investment or savings element called cash surrender values, which result from the overpayment of premiums during the early years.

Briefly explain the basic characteristics of term insurance.

1. Term insurance provides temporary protection . 2. Most term insurance policies are renewable and convertible to some stated age with no evidence of insurance. 3. Term insurance policies do not accumulate cash values.

Identify the major types of term insurance sold today.

1. The major types of term insurance are yearly renewable term, 5, 10, 15, or 20-year term, 2. term to age 65, 3. decreasing term, 4. reentry term, and 5. return-of-premium term.

Other Types of Life InsuranceVariations or combinations of the 3 major types

1. Variable life 2. variable universal life 3. modified life 4. debt insurance 5. Credit life 6. endowment policy

Explain the basic features of second-to-die life insurance and describe a situation in which a policy might be appropriate.

Many life insurers sell life insurance at lower rates to preferred risks whose mortality experience is expected to be lower than average. The insurance is carefully underwritten and is sold only to individuals whose health, history, weight, occupation, and habits indicate more favorable than average mortality experience. Certain minimum amounts of insurance must be purchased.

Explain the financial impact of premature death on the different types of families in the United States.

Premature death can cause considerable economic insecurity if a family head dies in a single-parent family; in a family with two income earners with children; or in a traditional, blended, or sandwiched family. In contrast, if a single person without dependents dies, or an income earner in a two-income family without children dies, financial problems for the survivors are generally lower.

Explain the basic characteristics of universal life policies.

Universal life insurance is another form of whole life insurance. Universal life insurance has the following features: (1) Unbundling of protection, savings, and expense components (2) Two forms of universal life available (3) Relatively higher investment returns (4) Considerable flexibility (5) Cash withdrawals permitted (6) Favorable income tax treatment

Define human life value.

as the present value of the family's share of the deceased breadwinner's earnings. This approach crudely measures the economic value of a human life.

Why does an ordinary life insurance policy develop a legal reserve?

Under the level-premium method, the insured pays more for the insurance protection in the early years than is actuarially needed. The redundant or excess premiums are invested and used to supplement the inadequate premiums that are being paid in the later years of the policy. In recognition of the fact that the redundant premiums paid in the early years will be needed later, the policy develops a legal reserve. As the legal reserve increases, the net amount at risk declines. Thus, lifetime protection is possible

Explain the limitations of universal life insurance.

Universal life insurance has several limitations. 1. The rates of return advertised are gross rates and not net rates and do not reflect the true rate of return on the saving component. 2. In addition, the attractiveness of universal life to consumers may decline as interest rates decline. 3. The insurer also has the right to increase the mortality charge to the maximum permitted under the policy. 4. Finally, because of the flexibility in paying premiums, some policyholders do not have a firm commitment to pay premiums.

Endowment policy

- pays the face amount of policy if insured dies and also pays face if insured survivor -In pricing a life insurance contract, Age Time value of money Insurer's expense and profit loading determining price per thousand dollars of contract

Basic Charactersitics of variable life insurance

1. Variable life insurance is a policy in which the death benefit and cash surrender value vary according to the investment experience of a separate account maintained by the insurer. 2. The entire reserve is held in a separate account and is invested in equities or other investments. 3. The cash surrender values are not guaranteed.

Limited-pay life

life insurance -premiums are paid only for a specified period of time (ex. 20 years); no further premiums are necessary, but coverage remains in effect until the insured's death.