8-1 copyright 2002 by harcourt, inc. all rights reserved. chapter 8: insuring your life clip art ...

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Copyright 2002 by Harcourt, Inc. All rights reserved.

CHAPTER 8:

INSURING YOUR LIFE

Clip Art 2001 Microsoft Corporation. All rights reserved.

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Basic Insurance Concepts

Basic purposes of insurance:

Protect you and your dependents from losing the assets that you’ve already acquired.

Shield you and your family from an interruption in your expected earnings.

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Insurance Planning Needs: Auto & Homeowners Insurance

– Reimburses for damage or destruction to existing assets

Life Insurance– Replaces income lost due to premature

death

Disability Insurance – Replaces income lost due to disability

Hospitalization & Health Insurance – Covers medical costs from illness or

accident

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Concept of Risk

Risk is defined as uncertainty with respect to economic loss.

Insurance planning is used to reduce the risk that losses will cause financial devastation.

Risk can be dealt with in the following ways:

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Risk Avoidance:

Not participating in activities that have the risk of loss.

Example—not driving to avoid the risk of an auto accident.

Risk avoidance is not always practical or possible!

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Loss Prevention and Control: Prevention reduces the chance that a

loss will occur.

Example: Driving within the speed limit reduces the likelihood of an accident.

Control reduces the severity of a loss once it occurs.

Example: Wearing a seat belt can minimize the effects of an accident.

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Risk Assumption: You bear the risk of loss yourself.

Example: When your calculator gets stolen, you bear the cost out of pocket.

Transferring Risk: Pay someone else to bear your risk of loss.

Example: You transfer the risk to the insurance company when you buy an insurance policy.

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Underwriting

Process in which the insurance company decides whom to insure and the rate to be charged.

Company must guard against adverse selection, a disproportionate number of bad risks.

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Combine the loss experiences of large numbers of people.

Calculate probability of frequency of occurrence and amount of loss using past experience.

Charge rates in proportion to level of risk.

It is economically feasible for insurance companies to assume risk because they:

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How Much Life Insurance?

Enough to provide financial security for those who depend on your income and prevent a decline in their standard of living.

Life insurance needs change throughout your life.

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Other Benefits of Life Insurance:

Protection from creditors–Before death, cash value in life

insurance policies usually protected against legal judgments and bankruptcy proceedings.

–After death, possible to keep benefits out of estate and away from creditors.

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Medium for savings:

–Provides a means of forced savings for those who would not do so otherwise.

–Provides preservation of capital for those who desire a relatively safe, conservative investment.


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Tax benefits:–Savings portion grows tax free unless

withdrawn.

– For taxpayers in higher income brackets, these relatively low returns become more attractive as income taxes take a greater bite from current income and short-term capital gains.

–Proceeds not income taxable to beneficiaries.

–Possible to avoid estate taxation on proceeds.

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Techniques for estimating life insurance needs: Multiple Earnings Approach

multiply annual earnings by an arbitrary number

Needs Approach

estimate needs and examine available resources

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Assessing Economic Needs Family income

Additional expenses

Pay off debts

Surviving spouse’s income

Special financial needs

Liquidity


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Types of Life Insurance

Benefit paid if insured dies during the policy period.

No savings component.

Economical way for young families to purchase large amounts of life insurance.

1. Term insurance:

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Types of Term Insurance:

Straight term

coverage remains the same while premiums increase

Decreasing term

premiums remain the same while coverage decreases

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Important features to look for in term insurance: Renewability

allows insured to renew policy without evidence of insurability

Convertibility

allows insured to convert to whole life policy without evidence of insurability

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2. Whole life insurance:

Provides death protection plus a savings feature called cash value.

If policy canceled prior to death, insured has right to cash value; this is the nonforfeiture right.

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How the cash value accumulates in a $200,000 whole life policy:

$200,000

$100,000

$030 40 50 60 70 80 90 100

CashValue

Age of insured

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Types of Whole Life Insurance: Continuous premium (straight life)

level premiums paid until death or cancellation of policy

Limited payment

level premiums paid for a specified number of years; insurance remains in force until death

Single premium

lifetime coverage purchased with a single premium

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Advantages of Whole Life

Provides a savings vehicle.

Cash value can be borrowed against.

Premiums remain constant.

Cash value accumulates tax-free until redeemed.

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Disadvantages of Whole Life

Dollar for dollar provides much less death protection than term insurance.

Lower returns than other savings vehicles. Loans must be repaid with interest or— Tax penalties may be assessed on cash

values withdrawn early. If you have a loan outstanding when you

die, that amount is subtracted from the face value of your policy.

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3. Universal life insurance: Provides death protection plus a

savings feature.

Premiums are “unbundled” into 2 separate accounts.

Savings grow at the current interest rate vs. guaranteed minimum rate.

Provides flexibility in premiums paid and death benefit.

Understand the risks before you buy!

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4. Other Types of Life Insurance: Variable and variable universal life

Insurance on multiple lives

Group life insurance

Credit and mortgage life insurance

Industrial life insurance

Special-purpose policies

Deferred-premium life insurance

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Key Life Insurance Contract Features

Beneficiary clause Settlement options Policy loan provisions Payment of premiums Grace period Nonforfeiture options Policy reinstatement Change of policy

Multiple indemnity Disability clause Guaranteed

purchase options Suicide clause Exclusions Participating

policies Living benefits

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Buying Life Insurance

Know the amount and type of coverage you need.

Compare costs.

Select a large, highly rated, financially secure company.

Select a reputable agent.

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THE END!

8-1 copyright 2002 by harcourt, inc. all rights reserved. chapter 8: insuring your life clip art ...

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