1. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill 12-1 C HAPTER 12 Personal Finance Life Insurance Kapoor Dlabay Hughes 6e

2. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill An Introduction to Life Insurance Life insurance is obtained by purchasing a policy, with the insurance company promising to pay a lump sum at the time of the policy holder’s death, or sometimes while they are still alive. The purpose of life insurance is to protect someone who depends on you from financial loss related to your death. Other reasons are.  To make charitable bequests upon your death.  To save money for retirement or children’s education.  To leave as part of your estate.  To pay off a mortgage or debts at the time of death. 12-2

3. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill The Principle of Life Insurance Mortality tables provide odds on your dying, based on your age and sex. Your premium is based on your life expectancy and the projections for the payouts for persons who die. 12-3

4. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Determining Your Life Insurance Needs - Ask Yourself... Do you need life insurance?  Do you have people you need to protect financially?  Do you have a partner who works? What are your objectives for life insurance?  How much money do you want to leave your dependents should you die today?  When you retire what income do you need?  How much will you be able to pay for your insurance program? 12-4

5. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Estimating Your Life Insurance Requirements The Easy Method.  Typically, you will need 70% of your salary for seven years while family adjusts. The DINK (dual income, no kids) Method. The “Nonworking” Spouse Method.  Multiply the number of years until the youngest child reaches 18 by $10,000. The “Family Need” Method.  More thorough than the first three because it also considers employer provided insurance, Social Security benefits, and income and assets. 12-5

6. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Two Types of Life Insurance Companies  Stock life insurance companies are owned by the shareholders.  95% are of this type.  Sell non-participating policies.  Amount of premium stays the same. 12-6

7. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Two Types of Life Insurance Companies  Mutual life insurance companies.  Owned by the policyholders.  5% of policies are from this type of company.  With participating policies the premiums are higher than non-participating policies. However part of the premium is refunded to the policyholders annually. This is called a policy refund. (continued) 12-7

8. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Types of Life Insurance Policies Term life insurance.  Protection for a specified period of time.  If you don’t pay premiums, coverage stops.  A renewability option means that at the end of the term you can renew the policy without having a physical.  Conversion option allows you to change your policy from term to whole life without a physical.  With decreasing term insurance your premium stays the same, but the amount of coverage decreases as you age. 12-8

9. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Types of Life Insurance Policies Whole life insurance also called straight life.  You pay a premium as long as you live.  Amount of premium depends on your age when you start the policy.  Provides death benefits and accumulates a cash value.  You can borrow against the cash value or draw it out at retirement.  Look carefully at the rate of return your money earns. (continued) 12-9

10. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Whole Life Policy Options Limited payment policy.  Pay premiums for a stipulated period, usually 20 or 30 years, or until you reach a specified age (65).  Your policy then becomes “paid up” and you remain insured for life. Variable life policy.  A minimum death benefit guaranteed, but the death benefit can rise above it depending on yield of the dollars invested in a separate fund. 12-10

11. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Whole Life Policy Options Adjustable.  You can change your policy as your needs change. For example, you can change your premium payments or the period of coverage. Universal life.  Lets you pay premiums in almost any amount.  Combines term insurance and investment elements. (continued) 12-11

12. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Types of Policies Issued 10% 8% Term 22% Whole Life 45% Other Variable Universal Universal 11% Variable 2% Decreasing 2.0% 12-12 1997 Insurance Facts book

13. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Other Types of Life Insurance Policies Group life insurance.  Term insurance.  Often provided by an employer.  No physical is required. Credit life insurance.  Debt is paid off if you die.  Mortgage, car, furniture.  Also protects lenders.  Expensive protection. 12-13

14. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Life Insurance Contract Provisions Naming your beneficiary, and contingent beneficiaries. Length of grace period for late payments. Reinstatement of a lapsed policy if it has not been turned in for cash. Suicide clause during first two years. Automatic premium loans.  Uses the accumulated cash value to pay the premium if you do not pay it during the grace period. Misstatement of age provision. 12-14

15. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Life Insurance Contract Provisions Policy loan provision to borrow against cash value. A rider to a policy modifies it coverage by adding or excluding conditions or altering benefits. Nonforfeiture clause prevents the forfeiture of accrued benefits if you choose to drop the policy. Waiver of premium disability benefit. Accidental death benefit - double indemnity. Guaranteed insurability option. Cost of living protection. Accelerated benefits. (continued) 12-15

16. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Buying Life Insurance Look at your present and future sources of income, savings, group life insurance, and Social Security benefits. Determine from whom to buy your policy.  Examine both private and public sources.  Look up the company’s rating.  Talk to friends or colleagues. 12-16

17. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Choosing Your Insurance Agent Ask friends, parents and neighbors for recommendations. Find out if the agent belongs to professional groups or is a CLU. Is the person willing to take the time to answer your questions and find a policy that is right for you? Do they ask about your financial plan? Do you feel pressured? Are they available when needed? 12-17

18. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Buying Life Insurance (continued) Compare policy costs which are affected by...  How selective they are in whom they insure.  Their cost of doing business.  Return on their investments.  Mortality rate among policyholders.  Policy features and competition from other firms Use interest-adjusted index to compare policies.  Takes into account the time value of money.  Helps you make cost comparisons among insurance companies. 12-18

19. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Obtaining and Examining a Policy The first step is to apply. The second step is to provide medical history. Usually no physical for a group policy. Read every word of the contract. After you buy it you have ten days to change your mind. Give your beneficiaries and lawyer a photocopy. 12-19

20. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Choosing Settlement Options Options are the choices for how you want the money paid out. Lump-sum payment is most common. Limited installment plan.  In equal installments for a specific number of years after your death. Life income option.  Payments to the beneficiary for life. Proceeds left with the company.  Pays interest to the beneficiary. 12-20

21. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Should You Switch Policies? Switch if benefits exceed costs of getting another physical, and paying policy set up costs. Are you still insurable? Can you get all the provisions you want? 12-21

22. © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Irwin/McGraw-Hill Financial Planning with Annuities An annuity is a financial contract written by an insurance company that provides you with a regular income. People buy annuities to supplement retirement income and to shelter income from taxes. Those who expect to live longer than average benefit most from annuities. Annuities are tax-deferred investment plans. You pay taxes on the interest when you draw the money out. 12-22