Life Insurance Basics

Agenda Who needs life insurance? How do you calculate the amount needed? What types of life insurance are available?

Life insurance is used to provide a death benefit: a stipulated sum (the face amount of the policy) is paid to a beneficiary upon the demise of the policyholder (who has paid the premiums). Remember: a beneficiary who receives life insurance payments due to the death of the insured pays no income tax on the amount received.

Who Needs Life Insurance? When does one need life insurance? Do you have people you need to protect financially? Consider different types of families Do you have a partner who works? How long are your obligations? Other considerations: How much money do you want to leave your dependents should you die today? How much will you be able to pay for your insurance program?

Amount of Insurance Needed There are some basic “rules of thumb” “the death benefit on your policy should equal five to ten times the amount of your annual salary” There are several more accurate ways to determine the amount of insurance needed: Human Life Value Approach Needs Approach Capital Retention Approach

The Options… Once you determine one has a need for insurance, and the amount of coverage is determined, there are a variety of ways to meet the need… Policies differ on a number of dimensions, as the next slides show.

Because policies are taken out without the insurance company knowing when payment of the policy will be required, companies may issue: participating policies, in which the company shares the costs of coverage with policyholders; if premiums exceed costs, a policy dividend is issued nonparticipating policies, in which the company does not share profit (or loss) with the policyholders; the premiums for these companies tend to be lower

There are 2 types of insurance companies: stock companies are owned by the company stockholders and usually sell nonparticipating policies (example: MetLife Insurance Co.) mutual companies are run by the company policyholders and usually sell only participating policies (example: Massachusetts Mutual Life Insurance Co.)

Industry Strength Life insurer capital, as measured by policyholders surplus, rose from $310.4 billion in 2011 to $328.6 billion in 2012. The industry’s net gain from operations before federal income taxes rose significantly from $28.0 billion in 2011 to $60.5 billion in 2012. Net income rose from $14.4 billion to $40.9 billion during the same period, the highest level in at least dozen years.

LIFE INSURANCE OWNERSHIP Sixty-two percent of all people in the United States were covered by some type of life insurance in 2013, according to LIMRA’s 2013 Insurance Barometer Study. One third of consumers believe they do not have enough life insurance. Life insurance ownership jumps dramatically as young consumers advance in their careers, with over half of consumers aged 25 to 34 owning policies, compared with 18 percent of those under 25. 30 percent of employed consumers own disability insurance. 14 percent of consumers own long-term care insurance.

There are 2 types of life insurance sold: term and permanent. Life insurance is typically used to secure business loans, for partnership buy-sell agreements, and as security for families. There are 2 types of life insurance sold: term and permanent. Term policies provide coverage for a period of years, typically 1 or 5 (but this is changing) policies provide insurance only premium costs increase with age coverage is not offered after age 65 to 70

There are 2 types of term policies: Yearly renewable term has premiums that are initially low; however, the premiums increase substantially as the insured gets older. These policies have diminished in popularity due to the introduction of level premium term life insurance. Level premium term has premiums which remain unchanged over a specified period of time. Coverage is purchased for a period of 5, 10, 15, 20, 25, or even 30 years. After the initial level period expires, the annual premium will increase for the next level (but there is usually a guaranteed maximum increase).

Yearly renewable term insurance premiums increase rapidly with age, whereas level term insurance premiums only change over a period of years (e.g., every 10 or 20 years). Over the 20 years, level term premium costs are about one third those of yearly renewable term.

The newest product in term life insurance is called the “return of premium” (ROP) policy. A level term policy is purchased, usually for 20 or 30 years, and if the policyholder makes it through the 2 or 3 decades, the insurer pays back the premium payments (tax free). So the premium cost is zero. However, the premiums are 30% to 40% higher than with regular level term policies (the 30 year policies have the least increase in cost). And the insured has to “stay the course” for the time period involved.

Permanent insurance policies provide coverage “for a person’s whole life”, hence also the name “whole life”; policies provide both insurance coverage and investment return. The policy premium does not change substantially over time, even though payments can be made for many decades. Also, the policy accumulates cash value that can be borrowed (usually at a set interest rate). So at the death of the insured, both the policy face amount and the cash value are paid to the beneficiary.

There are 3 types of “whole life” coverage: ordinary life—premium payments continue for the policyholder’s whole life; there is usually a modest guaranteed investment return for the cash value limited payment life—premium payments continue to a certain age or for a stated number of years; premiums are higher but cash value accumulates faster because of the reduced years variable life—offers a minimum death benefit, fixed premiums, and investments in stocks, bonds, mutual funds, or money market funds; the value of the policy at death is primarily based on the return on the investments

Universal life insurance provides flexible insurance coverage and investment return, and both can be changed over time as the policyholder wishes. The investment return is usually greater than with ordinary and limited payment life policies; the policyholder may make tax-free withdrawals (up to the amount contributed) or the annual return can be used to pay for coverage, making it self-funding; there is a maintenance fee, but annual statements are provided to explain costs. This is the preferred type of “whole life” policy because of it’s flexibility.

Comparison of premium costs for a $500,000 life insurance policy (nonsmoker): 20 year term policy 20 year cash value -30-year-old male $600 is zero; total cost is -30-year-old female $400 $12,000/$8,000 20 year ROP term policy 20 year ROP is -30 year-old-male $800 $16,000/$11,000; total -30-year-old female $550 cost is zero Whole life policy 20 year cash value -30-year-old male $1,600 is about $25,000; total -30-year-old female $1,300 cost is $7,000/$5,500 Universal life policy 20 year cash value -30-year-old male $2,400 is about $40,000; total -30-year-old female $2,000 cost is $8,000/$6,000

Life insurance coverage may vary from individual to individual, but the usual progression is: begin with term add universal life (can be used to pay for college expenses) the coverage amount should be sufficient to allow the family to adapt after death (typically 5 to 7 years’ equivalent of income)

Life insurance coverage can be supplemented by the use of riders: guaranteed insurability—guarantees periodic increases in coverage accidental death—pays double or triple the face amount (“double indemnity”) disability—pays premiums of a disabled policyholder

There are several payment options; it is left to the policyholder to decide which one to use: lump sum—the total value of the policy is paid to the beneficiary fixed period—payments are made over a set period of years fixed income—payments are made in equal installments interest income—only interest is paid to a (usually) minor beneficiary until a certain age life income (annuity)—payments are made for the life of the policyholder

Life insurance can be converted into an annuity Life insurance can be converted into an annuity. An annuity pays a certain amount each month to the policyholder (“annuitant”) until the policyholder dies; thus it provides a “life benefit”. For example, a policyholder may purchase a single premium immediate annuity (payments begin immediately) or single premium deferred annuity (payments begin in years) for the cash value of the policy.