chapter 12 life insurance planning. copyright © houghton mifflin company. all rights reserved.12 |...

Chapter 12

Life Insurance Planning

Copyright © Houghton Mifflin Company. All rights reserved. 12 | 2

Learning Objectives

1. Understand the reasons why you might need life insurance and calculate the appropriate amount of coverage.

2. Distinguish among the types of life insurance.

3. Explain the major provisions of life insurance policies.

4. Apply a step-by-step strategy for implementing a life insurance plan.


Introduction

• There are two primary risks related to longevity and finances:

– The risk of dying too soon

OR– The risk of living too long


How MuchLife Insurance Do You Need?

• The primary reason for buying life insurance is to allow the family members of the deceased to continue with their lives free from the financial burdens that death can bring.

• Beneficiary: The person named in the policy to receive the funds.


What Needs Must Be Met?

• Final expenses: One-time expenses occurring just prior to or after a death. These may also include:

• Income-replacement

• Readjustment-period

• Debt-repayment

• College expense

• Other special needs


What Needs Must Be Met?

• Government benefits can reduce the level of need.

– Social Security survivor’s benefits – Paid to a surviving spouse and dependent children with a payout based on earned income

• Existing insurance and assets reduce the level of need.– Savings account, CD, stocks, bonds and mutual

funds are sources for lost income

– Employer provided life insurance benefit


What Dollar Amount Do You Need?

• The Needs-Based Approach: a recommended approach to estimating life insurance needs considers all factors that affect the level of need.– Final Expenses for funeral, travel and other items

– Income Replacement based on years needed

– Readjustment for employment interruptions

– Debt Repayment for short term period

– College expense for dependents

– Deduct existing insurance and social security

– Result is Life Insurance Amount Needed


Two Basic Types of Life Insurance• Term Life Insurance (or Pure Protection) – Pays

benefits only if the insured dies within the time period that the policy covers. It must be renewed if coverage is desired for another time period.

– Face amount – the dollar value of life insurance protection as listed in the policy and used to calculate the premium.

• Cash-Value Life Insurance – Pays benefits at death and includes a savings/investment component that can provide a reduced level of benefits to the policyholder prior to the death of the insured person.

– Cash-Value: Represents the value of the investment element in the life insurance policy.


Term Life Insurance

• Guaranteed Renewable Term Insurance:

– Protects you against the possibility of becoming uninsurable.

– Maximum number for guaranteed renewable coverage periods may be limited without proving insurability

– The age for renewable guarantee may be limited to 65-70 yrs.

• Level-Premium Term Insurance:

– Premium remains constant over longer time period such as 5 year fixed rate for 10 or 20 years

– Reenter Provision – Requires proof of good health at each period (Ex: Every 5 Yrs.) or higher rate may result

– Caution if coverage needed beyond initial level premium period as rate may increase due to changes in health status


Other Term Life Insurance

• Decreasing Term Insurance – Amount of coverage declines over time as a person ages.

• Convertible Term Insurance – Offers the option of exchanging a term policy for a cash value policy without evidence of insurability.

• Group Term Life Insurance – Issued to people as members of a group rather than individuals. Rates are based on characteristics of group as a whole and do not require proof of insurability.

• Credit Term Life Insurance – Pays remaining credit balance owed on a loan if insured dies before debt repayment. Creditor is beneficiary.


Cash-Value Life Insurance• Some forms of cash-value life insurance pay a fixed

return:– Cash-Value Life – May be borrowed by policy owner

– Permanent Insurance - Renewal is not needed

– Whole (or Straight) Life Insurance – Provides coverage as long as premium is paid

– Limited-Pay Whole Life Insurance – Allows premiums to cease before insured reaches age 100. Ex: Premium payments stop after 20 years or at specified age 65 or “paid up”

– Adjustable Life Insurance – Allows insured to adjust 1) the face value, 2) premium or 3) rate of cash value accumulation without providing new proof of insurability.

– Modified Life Insurance – Reduced premiums early on then gradually increase because term insurance is provided.

– Endowment Life Insurance – Pays face amount of insurance either at time of death OR some predetermined date.


The Essence of Cash-Value Life Insurance

• Cash Value builds overtime offset by decreasing life insurance coverage


Cash-Value Life Insurance

• Some forms of cash-value life insurance pay a variable return:

– Universal life insurance – Provides both the pure protection of term insurance and the cash value buildup of whole life insurance. Initial face amount is $100K+

– Variable life insurance – Allows policy owner to choose investment made with cash value accumulation and to share any gains or losses. Cash value may rise or fall based upon rate of return on the invested funds. Policy face value will not drop below the minimum or original amount.

– Variable-Universal (or Flexible-Premium) life insurance – Gives policyholder some choice in investments with the cash value. (Stocks, bonds, money market mutual funds). Risk of lower return as no minimum guaranteed rate of return. Also, Cash value investment may cover insurance protection if the premium is reduced below the minimum amount needed for coverage.


Comparisons of Three Popular Life Insurance Policies


How All Insurance Policies Are Organized

• Declarations – provide basic descriptive information such as insured person, premium amount, time period, policy limits.

• Insuring Agreements – commits made by insurer to pay the benefit to the beneficiary upon death

• Exclusions – eliminates specific conditions by the insurer when payment will not be made.

• Conditions – Obligations imposed on both the insurer and insured in the agreement. Includes procedures for filing a claim, rules for cancellation of the policy or changing its terms.

• Endorsements (or riders in life insurance) – amendments and additions to the basic insurance policy that can expand or limit coverage to accommodate specific needs such as higher benefits paid.


Other Policy Terms Unique to Life Insurance

• The Incontestability Clause – 2 year max limit for insurance company to deny a claim due to erroneous statements from an application.

• The Suicide Clause – Allows insurance company to deny coverage if insured commits suicide within first 2 years after a policy is issued.

• Cash Dividends– Insurance Dividends are tax exempt payments to policyholders

when premiums collected exceed costs of insurance coverage.

– Participating Policies pay dividends to policyholders or may reinvest them with insurance company

– Nonparticipating Policies do not pay dividends when premiums collected exceed insurance costs.


Settlement Payout Options

• Lump sum payment

• Interest income only

• Income of a fixed amount over time

• Income for a fixed period instead of amount

• Income for life based on life expectancy


Policy Features Uniqueto Cash-Value Life Insurance

• The Policy Illustration – Charts the projected growth in the cash value for a given rate of return. The two rates quoted are:

– Guaranteed Minimum Rate of Return – Minimum rate by contract the insurance company is legally obligated to pay.

– Current Rate – Rate of return the insurance company has recently paid to policyholders.

• Nonforfeiture Values are paid in the event the policyholder fails to pay the required premium.

– Cash-Surrender Value is the cash value of a policy minus any surrender charges


Policy Features Uniqueto Cash-Value Life Insurance

• Policy loans– Automatic Premium Loan – Allows any premium not paid by

the end of the grace period to be paid automatically with a policy loan if sufficient cash value or dividends have accumulated.

– Living Benefit Clause – Allows the payment of all or a portion of the death benefit prior to death if the insured contracts a terminal illness.

– Viatical Companies – Organizations which specialize in buying life insurance policies from insureds for $0.50 to $0.80 per $1 of death benefit in return for being named beneficiary on the policy.

• Waiver of premium – Sets certain conditions under which an insurance policy would be kept in full force by the company without the payment of premiums.

• Guaranteed Insurability – Permits the cash value policyholder to buy additional amounts of cash value life insurance at stated times in the future without evidence of insurability.


Step-by-Step Strategyfor Buying Life Insurance

1. First ask whether or not, and for how much, your life should be insured.

2. Then properly integrate your life insurance into your overall financial planning.

– For Single individuals, life insurance needs are small

– Married individuals with children greatly increases life insurance coverage

– Parents with grown children see a reduced need for life insurance because of retirement investments

– Retirement reduces need for life insurance further and may be eliminated altogether.

3. Buy term and invest the rest.- Purchase term insurance for face value and invest remaining amount in mutual fund.

• Layering term insurance policies – Buy an increasing amount of insurance coverage as needs grow over time and then gradually adjust coverage as needs decline.


Fair Pricesfor Term Life Insurance

• Male age 36 non-smoker annual premium is $101.50• Good sources to use: http://insure.com

http://quotescout.com http://accuquote.com

http://insure.com/

http://quotescout.com/

http://accuquote.com/


Typical Annual Premiums for Various Types of Life Insurance for

$100,000 Policy

Policy Type Premium At Inception

Renewable Term $80

20-yr. Decreasing Term $160

Whole Life $870

Universal Life $590

Paid-at-65 Whole Life $920


Where and How to Buy Your Life Insurance

• Compare costs among policies:– Net Cost Method calculates the difference between the

premium paid and the cash value accumulation. Results in a negative amount giving false impression the policy will pay for itself.

– Interest-Adjusted Cost Index Method compares the cost of similar life insurance plans taking into account interest that would have been earned had the premiums been invested rather than used to buy insurance. The lower the IACI, the lower the cost of the policy.

– Interest-Adjusted Net Payment Index Method used to measure the cost of the cash-value insurance assuming policy remains in force until death rather than ending after a certain period such as 20 years.


The Top 3 Financial Challengesin Life Insurance Planning

People experience challenges when they do the following:

1. Let their life insurance agent convince them how much and what type to buy.

2. Buy only cash-value life insurance rather than term policies for the bulk of your need.

3. Ignore your changing need for life insurance as your life progresses from adulthood to retirement.


Good Money Habits inLife Insurance Planning

• Calculate your life insurance needs every three years or when major life events occur, such as the birth of a child.

• Avoid being talked into buying types and amounts of life insurance that you do not need.

• Shop for term life insurance on the internet to obtain the lowest possible rates.

• Employ the principle of “buy term life insurance and invest the rest” with guaranteed renewable or level-premium term life insurance.


Good Money Habits inLife Insurance Planning

• Contribute the money saved by purchasing term rather than cash-value insurance into your retirement plan.

• If you decide that you need a cash-value life insurance policy, get one with a guaranteed insurability option.

chapter 12 life insurance planning. copyright © houghton mifflin company. all rights reserved.12 |...

Documents

life insurance policy

life insurance benefit

life insurance planning

income existing insurance

renewable term insurance

special needs slide

long slide

level of need