Chapter 11

Life Insurance Overview

Premature Death

• Defined as the death of a family head with outstanding financial obligations.
• "Breadwinner" refers to the family member primarily responsible for financial support.

Costs of Premature Death

• Future Earnings Loss: loss of income that the deceased would have generated.
• Additional Expenses:
• Funeral expenses
• Uninsured medical bills
• Higher childcare costs
• Estate settlement expenses
• Outstanding debts
• Standard of Living: Families may face a reduction in their standard of living.

Who Needs Life Insurance?

• Target Individuals:
• Children
• Single persons without children
• Single parents
• Married couples (with and without children)

Determining Life Insurance Needs

• Factors influencing need include:
• Family size
• Income levels
• Existing financial assets
• Financial goals
• Human Life Value Approach: Calculating the present value of the family's share of the deceased's future earnings.
• Needs Approach: Assess financial needs to be met if the family head dies.

Human Life Value Approach - Steps

1. Estimate average annual earnings over productive lifetime.
2. Deduct taxes and maintenance costs.
3. Calculate present value using a discount rate for earnings until retirement.

Human Life Value Approach Example

• Example: Phil Dunphy, age 30, married with three children, plans to retire in 35 years:

1. Annual earnings: $80,000
2. Annual personal costs: $30,000
3. Net income considered: $50,000
4. Present value of $50,000 annually for 35 years using a 5% discount rate: $818,700.

Disadvantages of Human Life Value Approach

• Ignores other sources of income (e.g., Social Security).
• Assumes constant earnings and expenses.
• Based solely on income rather than assessed need.
• Does not account for inflation impacts.

Needs Approach Calculation Considerations

• Estate Clearing Fund: covers burial, medical bills, debts, attorney fees, taxes.
• Readjustment Period: income support for 1-2 years for family transitions.
• Dependency Period: sustenance for children until they reach adulthood.
• Retirement Needs: considerations for surviving spouse's income.
• Special Needs: funds for education, emergencies, etc.

Needs Approach Example

• Total Needs Calculation for Jennifer Smith:
• Cash needs: $35,000
• Total income needs: $204,000
• Total special needs: $400,000
• Overall needs: $639,000.

Disadvantages of Needs Approach

• Difficult to predict future costs (e.g., college cost).
• Assumption difficulty leading to wide value ranges.
• Variable needs (e.g., in cases of remarriage).

Reasons for Not Purchasing Life Insurance

• Perception that it's too expensive.
• Difficulty making decisions regarding needs.
• Procrastination in action.
• Lack of understanding of its significance.
• Opportunity costs associated.

Types of Life Insurance

• Term Life Insurance:

• Provides death benefits only.

• Coverage is temporary (10, 20, 30 years).

• Cash-Value Life Insurance:

• Includes a death benefit plus a cash-value savings component.

• Policy remains valid for the insured's lifetime.

Term Insurance Features

• Available for various terms (5 to 30 years).
• Premiums are level during the term but may increase upon renewal.
• Policies are usually renewable and convertible to cash-value insurance.

When to Use Term Insurance

• Limited budget for insurance.
• Temporary protection need.
• Desire to ensure future insurability.

Limitations of Term Insurance

• Renewal costs can escalate with age.
• Not ideal for those wishing to save specifically for a purpose.

Term Insurance Premium Examples

• Annual premiums for a $250,000 policy vary widely based on age and gender.

Cash-Value Life Insurance Features

• Provides lifetime protection.
• Accumulates cash-surrender value for early termination.
• Options include Whole Life, Universal Life, and Variable Life.

Advantages of Cash-Value Life Insurance

• Lifetime coverage.
• Savings component accumulation.
• Policyholders can borrow against cash value.

Disadvantages of Cash-Value Life Insurance

• Higher premiums than term.
• Outstanding loans must be repaid.
• Cash-value may not necessarily be guaranteed.

Comparison: Term vs. Cash-Value Life Insurance

• Death Benefit: Both provide level benefits.
• Cash Value: None for term, available for cash-value.
• Premiums: Generally lower for term.

Group Insurance Overview

• Covers many individuals under one contract, often provided through employers.
• Examples: health and life insurance plans.

Group vs. Individual Insurance

• Group: contract between insurer and employer; lower risk due to group nature.
• Individual: contract directly with insurer; higher risk assessment based on individual factors.

Advantages of Group Insurance

• Lower cost for employees.
• Potential tax benefits.
• No evidence of insurability needed to obtain.

Disadvantages of Group Insurance

• Limited flexibility for individuals.
• Coverage is dependent on employment status.