Life Insurance

Risk

Uncertainty Concerning a potential economic loss (Car Accident)

Risk Avoidance

Avoiding an act that creates the risk (Stop Driving)

Loss Prevention

Activity that reduces the probability that a loss will occur (drive defensively)

Loss Control

Activity that lessens the severity of a loss once it occurs (Wear a seatbelt)

Risk Assumption

Willingness to accept or bear a loss (OK for small things)

Risk Transfer

A contractual arrangement with a third party that will reimburse you if a risk occurs (Insurance Policy)

Underwriting

Insurance will decide who to insure and how much to charge.

• Purpose is to avoid adverse selection (only high-risk customers apply for coverage)

The Law of Large Numbers

• Allows actuaries to accurately predict future losses

Life insurance Benefits

Give financial security to dependents in the death of a bread winner

• Benefits payable to beneficiaries instead of your estate, out of reach of creditors.

How much Life insurance do you need?

Two Methods - Rule of Thumb

• Multiple of Earnings Method

  • Coverage should equal 5 to 10 times your salary 

• Need Assessment

  • Much more detailed examination that looks at the facts and circumstances of each family.

Social Security - Survivor Benefits

Surviving Spouses 

• Must be at least 60 (50 if disabled)

• At full retirement age, 100% of decedents benefit; 75% if caring for child 

Surviving Children

• Must be unmarried, under 18 or 18-19 and full time student or 18+ with disability

• 75% of the decedents benefit

Surviving Dependent Parents

• Must be 62 or older and dependent on the deceased 

• 82.5% (one parent) or 75% each (two parents) benefit amount

Term Life Insurance

Straight Term: 

• Provides a level death benefit only for a specified period of time 

  • Level Premium: premiums are same each year 

  • Annual Renewable: premiums are adjusted each year as the insured gets older

Decreasing Term: 

• Death benefit declines over a specified period of time

Term Life Insurance - Advantages and Disadvantages

Advantages: 

• Lower initial premiums compared to whole life policies

• Purest form of life insurance

Disadvantages

• Temporary coverage 

• If continued coverage is needed, it may not be available or could be very expensive

  • Renewability: option to renew policy at end of term without evidence of insurability 

  • Convertibility: option to convert term to whole life policy at a future time

Whole life Insurance

Key idea

• Whole life is permanent

• Cash value: stated rate of return and grows tax-deferred

• The longer the policy is in-force the larger the cash value will grow

• Participating policies pay dividends

Types of Whole Life Insurance

Types

• Continuous premiums: premiums are fixed for life; offer the highest death benefit and lowest cash value per premium dollar

• Limited payment: premiums end after 20 or 30 years but the policy remains in force for life 

Single premium: One cash premium and coverage for life

Whole Life Insurance - Advantages and Disadvantages

Advantages: 

• Permanent 

• Cash Value: tax-deferred growth with ability to use a collateral for a loan or cash upon termination of policy

Disadvantages: 

• Costs more than term insurance 

• Cash value may be inferior to other investment options available 

• “But term and invest the difference”

Cash Value Policies

Savings account portion of a policy that grows tax-deferred

Common uses of cash value: 

• Take a loan (not required to pay back)

• Make a withdrawal (income tax-free up to premiums paid)

• Automatic premium loan (if you forget to pay)

• Collateral for bank loan 

• Surrender the policy (you lose coverage but keep the cash value)

• Convert to “reduced paid-up”

Dividend-Paying Policy

• Effectively a partial return of premiums paid when company performance exceeds expectations 

Common uses of dividends 

• Purchase paid-up additions 

• Reduce premiums 

• Take cash 

• Accumulate and earn interest 

• Repay outstanding policy loans

Universal Life Insurance

Features

• Permanent cash value insurance 

• Maximum flexibility

• Death protection and cash value are identified separately in its premium 

• Cash value returns vary with market conditions, pay minimum level of interest 

• Policy can remain in force without additional premiums 

Universal Life Insurance - Advantages and Disadvantages

Advantages

• Flexibility 

• Higher interest rate environment will increase the growth the cash value of a minimum interest guarantee provides protection if rates drop dramatically 

Disadvantages 

• High fees compared to other types of live insurance 

• The ability to change premiums and protection levels may be confusing and not fully understood by policy holders

Variable Life Insurance - Other Type

• Whole life policy where cash value is invested in stocks and bonds

Group Life - Other Type

• Policy offered through a group such as an employer. Usually term policy 

Steps in Purchasing Life Insurance

Step 1 - Compare costs and features

Step 2 - Select an Insurance company

Step 3 - Choose an agent

Key Features of Life Insurance

Beneficiary clause: includes a primary and a contingent

beneficiary; absent a designation proceeds go to the estate

Settlement options: lump sum is what is usually elected

Policy loans: uses cash value as collateral and does not

need to be paid back; outstanding balances at the time of

death are reduced from the death benefit

Grace period: retain death protection if premium is late

(typically 31 days)

Non-forfeiture options: Cash, paid-up insurance, or extended term insurance

Policy reinstatement: allows the policy to be reinstated if the paid-up

insurance or extended term insurance options are elected; back

premiums plus interest are owed

Suicide clause: nullifies policy if suicide occurs within 2 years of

inception

Living benefits: allows policy owners to receive a portion of death

benefit while living, typically as a result of a terminal illness

Viatical settlement: insurer sells policy to 3rd party in exchange for

cash