12 LIFE INSURANCE CHAPTER OVERVIEW In this chapter, we explain the meaning of life insurance, outline its history, and describe its purpose. We show how the principle of home insurance discussed in Chapter 10 can be applied to the lives of persons. Then we stress the importance of life insurance companies—mutual and stock—and distinguish between participating and non-participating life insurance policies. Next we describe types of life insurance policies—term life, whole life, modified life, variable life, adjustable life, and endowment policies are discussed in detail. In addition, newer types of life insurance policies, such as universal life, group life, home service life, and credit life insurance are covered. Next we focus on major and important provisions contained in a life insurance contract. We emphasize the need for comparing insurance policy costs and examining a policy before and after the purchase. Finally, we conclude the chapter with a discussion on various settlement options. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: LO12 1 Define life insurance and describe its purpose and principle. Life insurance is a contract between an insurance company and a policyholder under which the company agrees to pay a specified sum to a beneficiary upon the death of the insured. Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. Fundamental to the life insurance principle is the predictable mortality experience of a large group of individuals. LO12-2 Determine your life insurance needs. In determining your life insurance needs, you must first determine your insurance objectives and then use the easy method, the DINK method, the “nonworking” spouse method, or the family need method. The family need method is recommended. You should consider a number of factors before you buy insurance, including your present and future sources of income, other savings and income protection, group life insurance, group annuities (or other pension benefits), and Social Security. LO12 3 Distinguish between the two types of life insurance companies and analyze various types of life insurance The two types of life insurance companies are stock companies, owned by stockholders, and mutual companies, owned by policyholders. In general, stock companies sell nonparticipating policies and mutual companies sell participating policies. The three basic types of life insurance are term, whole life, and 12-1 policies these companies issue endowment policies. Many variations and combinations of these types are available. You should check with both stock and mutual companies to determine which type offers the best policy for your particular needs at the lowest price. Nevertheless, as with other forms of insurance, price should not be your only consideration in choosing a life insurance policy. You should also consider the financial stability, reliability, and service the insurance company provides. LO12 4 Select important provisions in life insurance contracts. The naming of the beneficiary, the grace period, policy reinstatement, the incontestability and suicide clauses, automatic premium loans, the misstatement of age provision, and the policy loan provision are important provisions in most life insurance policies. Common riders in life insurance policies are the waiver of premium disability benefit, the accidental death benefit, and the guaranteed insurability option, and accelerated benefits. LO12 5 Create a plan to buy your life insurance. Before buying life insurance, consider your present and future sources of income, group life insurance, group annuities (or other pension benefits), and Social Security. Then compare the costs of life insurance policies. Examine your policy before and after the purchase. LO12 6 Evaluate the payout options for life insurance. Choose appropriate settlement options based upon the needs of your beneficiary. The most common settlement options are lump-sum payment, proceeds left with the company, limited installment payment, and life income option. Online computer services provide a wealth of information about all topics related to life insurance. An annuity can provide regular payments to your beneficiaries with the life income option. An annuity can also be used to provide you with a regular income for expenses in later years. 12-2 INTRODUCTORY ACTIVITIES • Point out the learning objectives (p. 407) in an effort to highlight the key points in the chapter. • Ask students to comment on the My Life scenario for the chapter (p. 407). • Ask students to share common attitudes toward life insurance. • Discuss methods that a person can use to get basic information on life insurance. • Invite a human resources director from a local company to describe the life insurance coverage offered to company employees. WHAT’S NEW TO THIS EDITION SELECTED TOPICS BENEFITS FOR THE TEACHING AND LEARNING ENVIRONMENT Updated content: Life Insurance Provides updated information on life insurance policies and their face value as of 2012. Revised Exhibit 12-1 Illustrates expectations of life and expected deaths by sex and age in 2010. New Exhibit 12-2: Life expectancy and education New graphic of comparison between life expectancy and education level attained. New Did you Know? Provides information on the amount of hours and equivalent wage of a stay-at-home mom. Expanded content: Online calculators and Apps to calculate life insurance Provides additional methods to calculate insurance needs using updated online calculators and Apps. Revised coverage: Decreasing Term Insurance Describes the use of decreasing term insurance as well as some common alternatives. Revised Did you Know? Updates the average face amount of individual life insurance policies purchased. Revised Exhibit 12-7 Provides updated information for individual, group, and credit life insurance. New Did you Know? Provides information about the most common insurance rider: waiver of premium. New Financial Planning Calculation feature: Describes the effect of inflation on a life insurance policy using Time Value of Money calculations. New information: Underwriting Includes new information about the use of underwriting. Revised Financial Planning Calculation feature: Updated calculations for Determining the cost of insurance. New content: Payout options Includes coverage of payout options for life insurance. New feature: Your Personal Finance Dashboard Provides a graphic of how much insurance is needed based upon various life stages. 12-3 CHAPTER 12 OUTLINE I. Life Insurance: An Introduction A. What Is Life Insurance? B. The Purpose of Life Insurance C. The Principle of Life Insurance D. How Long Will You Live? E. Life Expectancy and Education II. Determining Your Life Insurance Needs A. Do You Need Life Insurance? B. Determining Your Life Insurance Objectives C. Estimating Your Life Insurance Requirements 1. The Easy Method 2. The DINK (Dual Income, No Kids) Method 3. The “Nonworking” Spouse Method 4. The “Family Need” Method D. Online Calculators and Applications (APPS) III. Types of Life Insurance Companies and Policies A. Types of Life Insurance Companies B. Types of Life Insurance Polices C. Term Life Insurance 1. Renewability Option 2. Multi-Year Level Term (or Straight Term) 3. Conversion Option 4. Decreasing Term Insurance 5. Return of Premium D. Whole Life Insurance 1. Limited Payment Policy 2. Variable Life Insurance Policy 3. Adjustable Life Insurance Policy 4. Universal Life E. Other Types of Life Insurance Policies 1. Group Life Insurance 2. Endowment Life Insurance 3. Credit Life Insurance 4. Industrial Life Insurance IV. Important Provisions in a Life Insurance Contract A. Naming Your Beneficiary 12-4 B. The Grace Period C. Policy Reinstatement D. Nonforfeiture Clause E. Incontestability Clause F. Suicide Clause G. Automatic Premium Loans H. Misstatement of Age Provision I. Policy Loan Provision J. Riders to Life Insurance Policies 1. Waiver of Premium Disability Benefit 2. Accidental Death Benefit 3. Guaranteed Insurability Option 4. Cost of Living Protection 5. Accelerated Benefits 6. Second-to-Die Option V. Buying Life Insurance A. From Whom to Buy 1. Sources 2. Rating Insurance Companies 3. Choosing your Insurance Agent B. Comparing Policy Costs C. Obtaining a Policy D. Examining a Policy 1. Before the Purchase 2. After the Purchase 12-5 VI. Life Insurance Proceeds A. Death (or Survivor Benefits) 1. Lump-Sum Payment 2. Proceeds Left with the Company 3. Limited Installment Payment 4. Life Income Option B. Income From Life Insurance Policies C. Switching Policies 12-6 CHAPTER 12 LECTURE OUTLINE Instructional Suggestions I. LIFE INSURANCE: AN INTRODUCTION (p. 408) • Consumer awareness of life insurance has changed very little over the years. Life insurance is still more often sold than bought. What Is Life Insurance? (p. 408) • A person joins a risk-sharing group by purchasing a contract. The insurance company promises to pay a sum of money at the time of the policyholder’s death in return for the insured’s agreement to pay it a sum of money (premium) periodically. The Purpose of Life Insurance (p. 408) • Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. The Principle of Life Insurance (p.409) • From records covering many years and including millions of lives, mortality tables have been prepared that show the number of deaths for various age groups during any year. How Long Will You Live? (p. 409) • Life expectancy, shown in Exhibit 12-1, does not indicate the age at which a person has the highest probability of dying. Life Expectancy and Education (p. 409) • Life expectancy appears to have a direct correlation with the level of education attained. • Use PPT slides 12-1 through 12-4. • Discussion Question: Why do people buy life insurance? • Exercise: Have students create situations which point out the different reasons for buying life insurance. • Assignment: Have students survey several other people to determine their reasons for buying life insurance. • Use PPT slide 12-5. • Text Highlight: Point out typical uses that are made of life insurance proceeds. (p. 409) • Discussion Question: What is the relationship between age and the amount a person pays for life insurance? • Assignment: Obtain life insurance rates tables from insurance companies or from mail order insurance sales brochures. Compare the rates charged by different companies and for different age categories. • Text Reference: Point out Exhibit 12-1 that shows male and female mortality rates. (pp. 410) • Text Reference: Point out Exhibit 12-2 that shows life expectancy based upon education level. (pp. 410) • Practice Quiz 12-1 (p. 410) 12-7 II. DETERMINING YOUR LIFE INSURANCE NEEDS (p. 411) • You should consider these factors before you buy insurance. Do You Need Life Insurance? (p. 411) • If your death would cause financial stress for your spouse, children, parents, or anyone you want to protect, then you should consider purchasing life insurance. Determining Your Life Insurance Objectives (p. 411) • Before you consider the types of life insurance policies, answer the following questions: How much money do you want to leave to your dependents? When would you like to be able to retire? How much will you be able to pay for your insurance program? Estimating Your Life Insurance Requirements (p. 411) • These are four general methods for determining the amount of insurance you might need. The easy method: A typical family will need approximately 70 percent of wage earner’s salary for seven years before it adjusts to the financial consequences of wage earner’s death. The DINK method: If you have no dependents and your spouse earns as much or more than you do, you have very simple insurance needs. All you need to do is ensure that your spouse will not be unduly burdened by debts should you die. Nonworking spouse method: To estimate how much life insurance a homemaker should carry, multiply the number of years before the youngest child reaches age 18 by $10,000. The family need method: The first three methods assume that you and your family are “typical” and ignore such factors as Social Security and rate of return on money that you may leave behind. Online Calculators and Applications (APPS) (p. 413) * There are numerous online calculators and apps that can now help you determine the amount of life insurance that you need for your situation. • Use PPT slide 12-6 • Exercise: What personal, social, and financial factors should influence the amount of life insurance a person might desire and the amount the person would have to pay for the insurance? Create a list of these factors. • Use PPT slide 12-7. • Discussion Question: How much life insurance does a person need? • Assignment: Have students talk to life insurance agents to obtain information on the methods they suggest for determining the amount of life insurance a person should have. • Current Example: Insurance News Network will show you what makes a good life insurance needs calculator. Visit their Web site at http://www.insure.com • Discussion Question: Is four to five times annual income a valid guideline for determining the amount of insurance? • Use PPT slides 12-8 and 12-9. • Text Reference: Discuss the values of different methods of determining life insurance amounts; also point out the changing needs for life insurance in various life stages. • Transparency Master 12-1 provides a worksheet to calculate your life insurance needs. • Text Reference: You may want to mention the “Did You Know” feature here (p. 413) • Current Example: Every year in the July issue, Consumer Reports offers advice on choosing the right type of coverage at the best prices for your needs. • Practice Quiz 12-2 (p. 414) 12-8 • III. TYPES OF LIFE INSURANCE COMPANIES AND LIFE INSURANCE POLICIES (p. 415) Types of Insurance Companies (p. 415) • There are two types of insurance companies: * stock life insurance companies owned by stockholders generally sell nonparticipating policies. * mutual life insurance companies, owned by their policyholders, usually sell participating policies. • There has been long and inconclusive debate on whether stock companies or mutual companies offer the least expensive insurance. Types of Life Insurance Policies (p. 415) • Exhibit 12-4 shows common types of policies issued by life insurance companies. • Use PPT slides 12-10 and 12- 11. • Text Reference: Use the material on page 415 to contrast the difference between a mutual insurance company and a stock insurance company. • Assignment: Have students research the differences in premium costs between a mutual company and a stock company. • Discussion Question: What are the benefits of a mutual insurance company compared to a stock company? Term Life Insurance (p. 416) • Term life insurance is protection for a specified period of time, usually 1, 5, 10, or 20 years or up to age 65. * Renewability option: term insurance can be continued if you have a renewable option. * Conversion option: if you have convertible term insurance you can exchange it for a whole life policy. * Decreasing term insurance: term insurance is available in a form that pays less to the beneficiary as time passes. . • Use PPT slides 12-12 and 12- 13. • Transparency Master 12-2 shows major types and subtypes of life insurance. • Supplementary Resource: Life insurance quoting on Insurance News Network. Intelliquote has teamed with INN to offer a term life insurance and annuity pricing service. Visit INN’s state gateway http://www.insure.com) to select your state and a specific kind of insurance, and you will be provided with a list of current sponsors who will provide free insurance quotes. • Supplementary Resource: Contact the American Institute of Economic Research, Division Street, Great Barrington, MA 01230 about obtaining a copy of Life Insurance from the Buyers’ Point of View. • Discussion Question: Why will many insurance agents dissuade you from buying low-cost term insurance? 12-9 Whole Life Insurance (p. 417) • The most common type of permanent life insurance is the whole life policy (also called a straight life policy or an ordinary life policy) in which you pay a specified premium each year for as long as you live. Common features in a whole life policy are: * Cash value is an amount that increases over the years and that you receive if you give up the insurance. * Exhibit 12-5 shows an example of guaranteed cash value on a whole life policy. * Nonforfeiture clause allows you not to forfeit all accrued benefits. • Assignment: Have students obtain premium costs for various types of whole life insurance plans available from insurance agents in your community. • Use PPT slide 12-14. • Several types of whole life insurance policies have been developed to meet different objectives. Popular types are: * Limited payment policy: you pay premiums for a stipulated period, but you remain insured for life. * Variable life insurance policy: the cash values of variable life insurance fluctuate. * Adjustable life insurance policy: you can change such a policy as your needs change. * Universal life: a policy that combines term insurance and investment elements. Universal life is actually a more flexible version of whole life insurance. • Current Example: Track your variable annuity or variable life policy. (http://www.insure.com/articles/ lifeinsurance/) • Use PPT slides 12-15 and 12- 16. • Software: The software that accompanies Personal Finance may be used to calculate life insurance coverage needs. • Discussion Question: What are the benefits of universal life insurance? What are the possible drawbacks of this type of policy? 12-10 Other Types of Life Insurance Policies (p. 420) • Group life insurance plans insure a large number of persons under the terms of a single policy. • Endowment life insurance provides coverage from the beginning of a contract to maturity and guarantees payment of a specified sum to the insured. • Credit life insurance is used to repay a personal debt should the borrower die before doing so. • Industrial life insurance is the least popular form and its appeal continues to drop sharply. • Use PPT slides 12-17 and 12- 18. • Discussion Question: Why is credit life insurance frequently criticized as not being a wise use of financial resources, with more traditional types of life insurance recommended instead? • Text Reference: You may want to mention the “Did You Know features on p. 424. • Practice Quiz 12-3 (p. 423) IV. IMPORTANT PROVISIONS IN A LIFE INSURANCE CONTRACT (p. 423) • Here are some of the most common provisions: Naming Your Beneficiary (p. 423) • A beneficiary is a person who is designated to receive life insurance proceeds from someone. The Grace Period (p. 423) • The grace period allows 28 to 31 days to elapse, during which time the premium may be paid without penalty. Policy Reinstatement (p. 423) • A lapsed policy can be put back in force— reinstated—if it has not been turned in for cash. Non-forfeiture Clause (p. 423) • This clause prevents the forfeiture of accrued benefits if you choose to drop the policy. Incontestability Clause (p. 424) • Incontestability Clause is a provision stating that the • Use PPT slides 12-19 through 12-21. • Supplementary Resource: Got a question about life, health, or property/casualty insurance? Call the new National Insurance Consumer Helpline at 800-942- 4242. The staff will answer your questions and refer complaints to the appropriate sources. The Helpline also offers a wide variety of pamphlets on different subjects. 12-11 insurer cannot dispute the validity of a policy after a specified period. Suicide Clause (p. 424) • A suicide clause is a provision stating that if the insured dies by suicide, the death benefit will equal the amount of the premium paid. Automatic Premium Loans (p. 424) • If the insured does not pay the premium within the grace period, the insurance company automatically pays it out of the policy’s cash value if that cash value is sufficient. Misstatement of Age Provision (p. 424) • If the company finds out that the insured’s age was incorrectly stated, it will pay the benefits that the insured’s premiums would have bought if his or her age had been correctly stated. Policy Loan Provision (p. 424) • A loan from the insurance company is available on a whole life or endowment policy after the policy has been in force for specified years. Riders to Life Insurance Policies (p. 424 & 425) • A rider is a document attached to a policy that modifies its coverage. * waiver of premium disability benefit * accidental death benefit * guaranteed insurability option * cost of living protection * accelerated benefits * second-to-die option Text Reference: Financial Planning Calculations shows the effect of inflation on the value of a policy. (p. 426) • Practice Quiz 12-4 (p. 426) 12-12 V. BUYING LIFE INSURANCE (p. 427) • In buying your life insurance, consider your present and future sources of income, other savings and income protection, group life insurance, group annuities, and Social Security. From Whom to Buy? (p. 427) • Buy insurance coverage from financially strong companies with professionally qualified representatives. * Sources. Protection is available from a wide range of private and public sources. (insurance companies, employers, labor unions, professional organization, Medicare and Social Security, and other financial institutions) * Rating insurance companies. Exhibit 12-8 describes the rating system used by A.M. Best and the other big four rating agencies. * Choosing your insurance agent. Agents who belong to a local Life Underwriters Association are often among the more experienced agents. Look for the designation CLU or CPCUs after their names. Comparing Policy Costs (p. 429) • The price of life insurance policies varies considerably among life insurance companies. Ask your agent to give you interest-adjusted indexes. Obtaining a Policy (p. 431) • The insurance company determines your insurability by means of information in your application, the medical examination, and the inspection report. Examining a Policy: Before and After the Purchase (p. 431) • Read every word of the contract and, if necessary, ask your agent for point-by-point explanation of the language. • You have a 10-day “free-look” period. • Use PPT slides 12-22 through 12-23. • Discussion Question: Why would comparing only the cost of life insurance coverage not be a completely valid approach to determining the best policy? • Current Examples: Surf over to Quick-Quote (http://www.quickquote.com), Insure.com (www.insure.com), and InsWeb (http://www.insweb.com). • Current Example: Find Standard & Poor’s ratings, get company information, and subscribe to e-mail ratings alerts. (Insurance Company Guide http://www.insure.com/articlese arch/articleSearch.jsp?page=hea der • Supplementary Resources: Contact the National Insurance Consumer Organization at 414 A Street, SE, Washington, DC 20003 or telephone 202-547- 6426 for comparing policy costs. You may also contact Insurance Information, Inc, at 1-800-472-5800; Term Quote at 1-800-444-TERM; or Select Quote at 1-800-343-1985 for cost comparisons. • Use PPT slides 12-24 through 12-26. • Use PPT slide 12-27. • Text Reference: Use “Financial Planning Calculations” box on page 430 to explain the process of determining the cost of insurance. • Use PPT slide 12-28. • Practice Quiz 12-5 (p. 432) • Text Highlight: Point out the “Financial Planning For Life’s Situations” box on page 433: Ten Golden Rules of Buying Life Insurance. 12-13 • Discussion Question: What factors would influence the type of settlement option selected? VI. LIFE INSURANCE PROCEEDS (p. 432) • A well-planned life insurance policy can do two things. 1) provide fund to beneficiaries upon death of the insured. 2) provide funds to the insured while they are living. Death or Survivor Benefits (p. 432) The most common settlement options are lump-sum payment, proceeds left with company, limited installment payment, and life income option. Income from Life Insurance Policies(p. 433) • An annuity is a financial contract written by an insurance company to provide you with a regular income. As a general rule, annuities are not advisable for persons with poor health. • A prime reason for buying an annuity is to give you retirement income for the rest of your life. • With an annuity, there is no maximum annual contribution. Switching Policies (p. 434) If you already own whole life insurance, think twice if someone suggests that you replace it. • Use PPT slides 12-29 to 12-31. • Exercise: Create a list of situations that would be appropriate for the use of annuities. • Assignment: Have students contact an insurance agent to obtain information on the features and costs of available annuities. • Current Example: Before you decide to take action with your life insurance policy or annuity, find out what will be going into Uncle Sam’s pocket. The interactive tool lets you search the tax consequences of surrenders, exchanges, cash value, dividends, loans, and early payouts. (The insure.com Life Insurance & Annuity Tax Tool) • Supplementary Resource: Contact the American Institute for Economic Research, Division Street, Great Barrington, MA 01230 for information about obtaining a copy of Annuities from the Buyer’s Point of View. • Practice Quiz 12-6 (p. 435) 12-14 CONCLUDING ACTIVITIES • Use the “My Life Stage for Financial Planning” feature (p. 435 & 436) to highlight the main financial planning activities from the chapter for various ages and life situations • Point out the Summary of Learning Objectives (p. 436) and key terms in the text margin. (p. 436 & 437) • Discuss selected end-of-chapter Self-Test Problems, Problems, Financial Planning Activities, Financial Planning Case, and Continuing Case. • Use the Chapter Quiz in the Instructor’s Manual. • Use the end-of-part continuous case as an in-class discussion exercise or as an out-of-class assignment. • Refer students to the Student Web site for Chapter 12. WORKSHEETS FROM PERSONAL FINANCIAL PLANNER FOR USE WITH CHAPTER 12 Sheet 53 Determining Life Insurance Needs Sheet 54 Life Insurance Policy Comparison CHAPTER 12 QUIZ ANSWERS True-False Multiple Choice 1. T (p. 408) 6. C (p. 412 & 413) 2. F (p. 413) 7. B (p. 423) 3. F (p. 415) 8. D (p. 424) 4. T (p. 416) 9. A (p. 430) 5. T (p. 420) 10. B (p. 432) 12-15 Name ________________________________________ Date____________________________ CHAPTER 12 QUIZ TRUE-FALSE _____1. Consumer awareness of life insurance has changed very little over the years. _____2. The “non-working” spouse method can be used with any number of dependents. _____3. A participating policy has somewhat lower premiums than a nonparticipating policy. _____4. A term insurance policy pays a benefit only if you die during the period that the policy covers. _____5. Universal life insurance is the answer to the “buy term and invest the difference” philosophy. MULTIPLE CHOICE _____6. One of the following is not a method of estimating your life insurance requirements. a. DINK b. Family need c. Hard d. Easy _____7. Which life insurance provision allows you not to forfeit all accrued benefits? a. Double indemnity b. Nonforfeiture clause c. Incontestability clause d. Suicide clause _____8. Which life insurance provision permits the owner of the policy to borrow any amount up to the cash value of the policy? a. Double indemnity b. Nonforfeiture clause c. Incontestability clause d. Policy loan provision 9. Which is a method of evaluating the cost of life insurance by taking into account the time value of money? a. Interest adjusted index b. Consumer price index c. Insurance index d. Cash value index 10. A settlement option that provides for payment of life-insurance proceeds in equal periodic installments for a specified number of years after your death is called a. lump-sum payment. b. limited installment payment. c. life income option. d. interest-principal payment option. 12-16 SUPPLEMENTARY LECTURE: 12-1 What You Should Know About Buying Life Insurance* Your policy may provide for dividends to be paid to you as either cash or "paid-up" insurance. Or it could provide for interest credits that could increase your cash value and death benefit or reduce your premium. Dividends and credits are not guaranteed. Your costs or benefits could be higher or lower than those in the illustration, because they depend on the future financial results of the insurance company. With variable life, your values will depend on the results of the underlying portfolio of investments. However, when figures are guaranteed, the insurance company will honor them regardless of its financial success. Ask your agent which figures are guaranteed and which are not. If the illustration is for a variable life policy, be sure that the interest rate assumed is reasonable for the underlying investment accounts to which you would allocate premiums. For example, a higher interest rate may be warranted if you select a stock account, while a lower rate should be assumed for more conservative alternatives. Is a policy illustration a legal document, like a contract? No, an illustration is not a legal document. Legal obligations are spelled out in the policy itself. What else should I look for in a policy illustration? • Is it based on recent experience? • Is the classification shown appropriate for me (i.e., smoker/nonsmoker, male/female)? • When are premiums due -- annually, monthly or otherwise? • Which amounts are guaranteed and which are not? • Will I be notified if the non-guaranteed amounts change? • Does the policy have a guaranteed death benefit, or could the death benefit change depending on interest rates or other factors? • Does the policy pay dividends or provide for interest credits? Are those figures incorporated into the illustration? • Will my premiums always be the same? Could the premium increase significantly if future interest rates are lower than the illustration assumes? • If the illustration shows that I will not have to make premium payments after a certain period of time, is there any chance I would have to resume payments in the future? • Is the premium level sufficient to guarantee protection for my entire life? * Source: http://www.pueblo.gsa.gov/acli/page10.htm 12-17 SUPPLEMENTARY LECTURE: 12-2 Evaluate Life Insurance* Consumer Federation of America Insurance Group Life Insurance Rate of Return Service How the service works How the service can help you Who performs the service? What we need from you The cost Contact information Evaluate Life Insurance -- How the Service Works: CFA's Rate of Return (ROR) service estimates "true" investment returns on any cash value life insurance policy -- whole life, universal life or variable life. Using the Linton Yield Method, these returns are derived by comparing the cash value policy to the alternative of buying lower premium term insurance and investing the premium savings in a hypothetical alternative investment, such as a bank account or a mutual fund. You receive a computer printout showing average annual RORs for policy holding periods of (usually) 5, 10, 15 and 20 years. We also send a four-page explanation that includes much valuable information relevant to buying or owning cash value life insurance. Evaluate Life Insurance -- How the Service Can Help You: RORs are similar to Annual Percentage Yields (APYs) provided under the federal Truth-in-Savings statute. RORs provide you with a way to compare cash value policies to one another, to term life or to other investments. Armed with the ROR analysis, you can: • Decide whether to buy a cash value policy or term insurance. • Decide among two or more cash value policies you are considering. • Decide whether your existing cash value policy is worth keeping. Evaluate Life Insurance -- Who Performs the Service?: James H. Hunt, a life insurance actuary with 45 years experience and a former insurance commissioner of Vermont, operates the ROR service. He has reviewed thousands of policies since 1984 when he began the service. Because the analysis is highly technical, he adds a personal note to each printout providing his recommendations, which frequently include better alternatives. It is not uncommon for his recommendations to lead to savings in the thousands of dollars. Evaluate Life Insurance -- What We Need From You: If you’re thinking of buying a cash value life insurance policy, ask your agent or company for an illustration, which is a computer projection of future premiums, cash values and death benefits based on the current dividend scale (whole life) or current interest rates and current costs of insurance (universal life). In the case of variable life, the illustration * Source: http://www.consumerfed.org/pdfs/CFARateofReturnServiceRev.pdf 12-18 will be based on a hypothetical investment account earnings rate such as 8% or 10% and current (not maximum) insurance costs. For universal life and variable life, it is preferable to obtain illustrations without riders, such as disability waiver of premium. For policies you already own, ask for a Current Illustration, sometimes called an In-force Illustration, that will show the same kind of information noted above. Your life insurer may have a toll-free customer service telephone number. The illustration should have your personal identifying information, including issue age, sex, smoking status, year of issue and any rider premiums. If uncertain, send us a copy of the page of your policy that provides this information. Unless you indicate otherwise, we will assume you are in excellent health. Illustrations for whole life policies that don’t pay dividends may not be available; give a call first. Evaluate Life Insurance -- Cost: The cost for the analysis is $60 for the first illustration and $45 for each additional illustration submitted at the same time. The cost for variable life policies you’ve already bought (unless within the free look period) and for survivorship (or second-to-die) policies is $75/$45. Send your check payable to CFA/IG, the illustration(s), and an e-mail address or telephone number (and time to call) in case additional information is needed to: Contact Information: James H. Hunt, CFA/IG 8 Tahanto St. Concord, N.H. 03301-3835 [email protected] 603-224-2805 Tel/Fax (eves/wkends OK) When supplied with an address, we reply by email attachments – Acrobat Reader file (.pdf) and Word file (.doc). Let us know if you prefer regular mail. Mr. Hunt subscribes to a term life database; his fee for guiding you by telephone is $30. SUPPLEMENTARY ACTIVITY: 12-1 As individuals move from one stage of the life cycle to another, their changing financial resources, responsibilities, living situations, and life style will have an impact on their financial security. In the chart below, identify the key concerns or questions each person should identify in order to select a life insurance program that will contribute to their financial security now and in the future. Present Key Concerns/ Question in Five Years Key Concerns/ Questions Mark: high school senior, working part- time, plans to go to • married and expecting first child; graduated from college; wife is a full-time homemaker with no 12-19 college plans for a job Sandra: a married woman in her early 20s; free lance artist; husband employed; plans to have a family • two-year-old son; recently divorced; free lances full-time Ed: a married man in his 40s; a teenage daughter; wife works full-time; substantial mortgage and two car loans • daughter has been seriously ill and may be permanently disabled; Ed has recently changed jobs; purchased a vacation home Anne: a widow and in her early 60s; grown children; works, elderly, dependent mother lives with her • retired; elderly mother has died; recently remarried ./ ANSWERS TO CONCEPT QUESTIONS, PROBLEMS, FINANCIAL PLANNING ACTIVITIES, FINANCIAL PLANNING CASE, AND CONTINUING CASE CONCEPT QUESTIONS Practice Quiz 12-1 (p. 410) 1. How can the Internet help you create a life insurance plan? The Internet can help you in determining the amount of insurance needed, understanding the types of insurance policies and their provisions, etc. 2. What is the purpose of life insurance? 12-20 Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. That “someone” could be the nonworking spouse and children of a single- income family. It could be the wife or husband of a two-income family. It could be an aging parent. It could be a business partner or a corporation. (p. 408 & 409) 3. What is the principle of life insurance? The principle of home insurance discussed in Chapter 10 can be applied to the lives of persons. From records covering many years and including millions of lives, mortality tables have been prepared that show the number of deaths for various age groups during any years. (p. 409) 4. What do life expectancy tables indicate? The life expectancy tables show the average number of additional years a person of a certain age and sex can expect to live. (p. 409 & 410) Practice Quiz 12-2 (p. 414) 1. How do you determine the need for life insurance? If your death would cause financial stress for your spouse, children, parents, or anyone you want to protect, then you should consider purchasing life insurance. Your stage in the life cycle and the type of household you live in will influence this decision. Single persons living alone or with their parents usually have little or no need for life insurance. (p. 411) 2. What determines your life insurance objectives? Before you consider types of life insurance policies, you must decide what you want your life insurance to do for you and your dependents. First, how much money do you want to leave to your dependents if you should die today? Will you require more or less insurance protection to meet their needs as time goes on? Second, when would you like to be able to retire? What amount of income do you feel you and your spouse would need then? Third, how much will you be able to pay for your insurance program? When you are older, are you most likely to earn more than, the same as, or less than you do now? Are the demands on your family budget for other expenses of living likely to be greater or less as time goes on? When you have considered these questions and developed some approximate answers, you are ready to select the types and amounts of life insurance policies that will help you accomplish your objectives. (p. 411) 3. What are the five methods of estimating your life insurance requirements? Simple as the easy method is, it is remarkably useful. It is based on the rule of thumb that a “typical family” will need approximately 70 percent of the salary for seven years before it adjusts to the financial consequences of the wage earner’s death. The DINK method is useful if you have no dependents and your spouse earns as much as or more than you do. The “nonworking” spouse method assumes that extra costs of up to $10,000 a year may be required to replace the services of a homemaker in a family with small children. The family need method is probably the best method of determining life insurance requirement. 12-21 The first three methods assume that you and your family are “typical” and ignore such important factors as Social Security and the rate of return that your survivors can earn if they invest the life insurance benefits they receive. The family need method does not make these assumptions. The fifth method is the use of online calculators or APPS. These can give you basic insurance information or very detailed calculations based upon the information that you provide. (p. 412-414) Practice Quiz 12-3 (p. 423) 1. What are the two types of life insurance companies? There are two types of life insurance companies: stock life insurance companies, owned by shareholders, and mutual life insurance companies, owned by policyholders. About 75 percent of U.S. life insurance companies are stock companies, and about 25 percent are mutuals. (p. 415) 2. What are the major types and subtypes of life insurance? Assess the following types of insurance policies, and discuss their advantages and disadvantages. a. Term insurance: protection for a stated period. b. Whole life insurance: insurance for the whole of life. c. Limited payment policy: one type of whole life policy, premiums are paid for 20 or 30 years. d. Single payment policy: insured pays only one premium. e. Variable life: the value of the policy fluctuates. f. Adjustable life: one can increase or decrease coverage. g. Universal life: combines term insurance and investment elements. h. Endowment policy: provides payment after a specified number of years. i. Group life: a plan that insures a large number of people under the terms of a single policy. j. Credit life: used to repay personal debt should the borrower die before doing so k. Industrial life insurance: least popular, and its appeal continues to drop rapidly. 3. What are the main differences between whole life and term policies? Whole life policies provide coverage for the entire life of the insured. Whole life policies can be paid in advance and can also include investment components as well as loan components. Term policies are temporary insurance policies that are only in effect if the premium has been paid for that time period. Practice Quiz 12-4 (p. 426) 1. What are the most common provisions in life insurance contracts? Here are some of the most common provisions: naming your beneficiary, the grace period, policy reinstatement, suicide clause, automatic premium loans, misstatement of age provision, policy loan provision, riders, waiver of premium disability benefit, accidental death benefit, and guaranteed insurability option. (pp. 423-424) 12-22 2. What is a beneficiary? An important provision in every life insurance policy is the right to name your beneficiary. A beneficiary is a person who is designated to receive something, such as life insurance proceeds, from someone. In your policy, you can name one or more persons as contingent beneficiaries who will receive your policy proceeds if the primary beneficiary dies before you do. (p. 423) 3. What is a rider? An insurance company can change the provisions of a policy by attaching a rider to the policy. A rider is any document attached to the policy that modifies its coverage by adding or excluding specified conditions or altering its benefits. A whole life insurance policy may include a waiver of premium disability benefit or an accidental death benefit, or both. (p. 424) 4. What is the concept of double indemnity? Accidental Death Benefit. Under this provision, the insurance company pays twice the face amount of the policy if the insured’s death results from an accident. The accidental death benefit is often called double indemnity. Accidental death must occur within a certain time after the injury, usually 90 days, and before the insured reaches a certain age, usually 60 or 65. (p. 425) Practice Quiz 12-5 (p. 432) 1. Why is it important to know the ratings of the insurance company? The ratings of the insurance company will help you determine the financial strength of the insurance company. The ratings can also play a factor in finding more reasonably priced insurance. (p. 427) 2. How do insurance companies price their products? In brief, the price a company charges for a life insurance policy is affected by five factors: the company’s cost of doing business, the return on its investments, the mortality rate that it expects among its policyholders, the features contained in its policy, and competition among companies with comparable policies. The price of life insurance policies varies, therefore, considerably among life insurance companies. Moreover, a particular company will not be equally competitive for all policies. (p. 429) 3. How do insurance companies determine your insurability? The company determines your insurability by means of the information in your application, the medical examination, and the inspection report. Of all applicants, 98 percent are found to be insurable. (p. 430) 4. What should you do in examining a policy before and after the purchase? Before the Purchase. When you buy a life insurance policy, read every word of the contract and, if necessary, ask your agent for a point-by-point explanation of the language. Many insurance companies have rewritten their contracts to make them more understandable. Remember that these are legal documents and that you should be familiar with what they promise, even though technical terms are used. (p. 431) 12-23 After the Purchase. After you buy new life insurance, you have a 10-day “free look” period, during which you can change your mind. If you do so, the company will return your premium without penalty. (p. 431) Practice Quiz 12-6 (p. 435) 1. What are the four most common settlement options? Lump-Sum Payment. In the lump-sum payment option, the company pays the face amount of the policy in one installment to the beneficiary or to the estate of the insured. This form of settlement is the most widely used option. Limited Installment Payment. This option provides for payment of the life insurance proceeds in equal periodic installments for a specified number of years after your death. Life Income Option. Under the life income option, payments are made to the beneficiary for as long as the beneficiary may live. The amount of each payment is based primarily on the sex and attained age of the beneficiary at the time of the insured’s death. Proceeds Left with the Company. Under this option, the life insurance proceeds are left with the insurance company at a specified rate of interest. The company acts as trustee and pays the interest to the beneficiary. The guaranteed minimum interest rate paid on the proceeds varies among companies. (p. 432) 2. Should you switch policies? Think twice if someone suggests that you replace the whole life insurance you already own. Before you give up this protection, make sure you are still insurable (check medical and any other qualification requirements). Also remember that you are now older than you were when you purchased your policy and that a new policy will cost more because of your age. Moreover, the older policy may have provisions that are not duplicated in some of the newer policies. (p. 434) 3. What is an annuity? An annuity is a financial contract written by an insurance company to provide you with a regular income. Generally, you receive the income monthly, with payments often arranged to continue as long as you live. The payments may begin at once or at some future date. The annuity is often described as being the opposite of life insurance. It pays while you live; life insurance pays when you die. (p. 433) 4. What makes a variable annuity different? Variable annuities offer stepped-up death benefit, a guaranteed minimum income benefit, and sometimes long-term care insurance. (p. 433 & 434) 12-24 FINANCIAL PLANNING PROBLEMS (p. 438) 1. Calculating Life Expectancy. Using Exhibit 12-1, determine the life expectancy of a 40-year old male. Solution: 78.5 years (See Exhibit 12-1) (40 years old + 38.5 expected additional years = 78.5) LO: 12-1 Topic: How Long Will You Live LOD: Easy Bloom tag: Comprehension/Application 2. Calculating Life Expectancy. Using Exhibit 12-1, determine the average numbers of additional years males alive at age 35 may expect to live. Solution: 43.1 years (See Exhibit 12-1) LO: 12-1 Topic: How Long Will You Live LOD: Easy Bloom tag: Comprehension/Application 3. Calculating Life Expectancy. Using Exhibit 12-1, determine the life expectancy of a 60-year-old female. Solution: 84.5 years (See Exhibit 12-1) (60 years old + 24.5 expected additional years = 84.5) LO: 12-1 Topic: How Long Will You Live LOD: Easy Bloom tag: Comprehension/Application 12-25 4. Calculating the Amount of Life Insurance Needed Using the Easy Method. You are the wage earner in a “typical family,” with $50,000 gross annual income. Use the easy method to determine how much life insurance you should carry. Solution: $50,000 × 7 years = $350,000 × .70 = $245,000 LO: 12-2 Topic: Estimating Life Insurance Needs LOD: Easy Bloom tag: Application 5. Calculating the Amount of Life Insurance Needed Using the Easy Method. Suppose that yours is a typical family. Your annual income is $45,000. Using the easy method, what should be your need for life insurance? Solution: $45,000 x 7 years = $315,000; $315,000 x 0.70 = $220,500 LO: 12-2 Topic: Estimating Life Insurance Needs LOD: Easy Bloom tag: Application 6. Estimating Life Insurance Needs Using the DINK Method. You and your spouse are in good health and have reasonably secure jobs. Each of you makes about $38,000 annually. You own a home with an $80,000 mortgage, and you owe $15,000 on car loans, $5,000 in personal debt, and $2,000 in credit card loans. You have no other debt. You have no plans to increase the size of your family in the near future. You estimate that funeral expenses will be $5,000. Estimate your total insurance needs using the DINK method. Solution: One half of mortgage = $40,000 One half of car loan = 7,500 One half of personal debts = 2,500 12-26 One half of credit card loans = 1,000 Funeral expenses = 5,000 Total insurance needs = $56,000 LO: 12-2 Topic: Estimating Life Insurance Needs LOD: Medium Bloom tag: Application 7. Estimating Life Insurance Needs Using the DINK Method. You are a dual income, no kids family. You and your spouse have the following debts: Mortgage = $190,000; Auto loan = $10,000; Credit card balance = $2,000, and other debts of $4,000. Further, you estimate that your funeral will cost $6,000. Your spouse expects to continue to work after your death. Using the DINK Method, what should be your need for life insurance? Solution: One half of mortgage = $95,000 One half of auto loan = 5,000 One half of credit card loans = 1,000 One half of personal debts = 2,000 Funeral expenses = 6,000 Total insurance needs = $109,000 LO: 12-2 Topic: Estimating Life Insurance Needs LOD: Easy Bloom tag: Application 12-27 8. Using the “Nonworking” Spouse Method to Determine Life Insurance Needs. Tim and Allison are married and have two children, ages 2 and 6. Allison is a “nonworking” spouse who devotes all of her time to household activities. Estimate how much life insurance Tim and Allison should carry. Solution: To estimate how much insurance Tim and Allison should carry, multiply the number of years before their youngest child, 2, reaches age 18 by $10,000. Insurance needed = 16 $10,000 or $160,000 LO: 12-2 Topic: Estimating Life Insurance Needs LOD: Easy Bloom tag: Application 9. Using the "Non-working" Spouse Method to Determine Life Insurance Needs. Using the "non- working" spouse method, what should be the life insurance needs for a family whose youngest child is 5 years old? Solution: To estimate the life insurance need, multiply the number of years before their youngest child, 5, reaches age 18 by $10,000. Insurance needed = 13 years x $10,000 = $130,000 LO: 12-2 Topic: Estimating Life Insurance Needs LOD: Easy Bloom tag: Application 10. Using the "Non-working" Spouse Method to Determine Life Insurance Needs. Using the "non- working" spouse method, what should be the life insurance needs for a family whose youngest child is 4 years old? Solution: To estimate the life insurance need, multiply the number of years before their youngest child, 4, reaches age 18 by $10,000. Insurance needed = 14 years x $10,000 = $140,000 12-28 LO: 12-2 Topic: Estimating Life Insurance Needs LOD: Easy Bloom tag: Application 11. Calculating the Effect of Inflation on a Life Insurance Policy. Susan has purchased a whole life policy with a death benefit of $200,000. Assuming that she dies in 10 years and the average inflation has been 3%, what is the value of the purchasing power of the proceeds? Solution: Follow these steps to determine the effect that 3% inflation would have after 10 years: a) Review Exhibit 1-A (page 42), Future Value of $1 after a Given Number of Time Periods. b) Locate the table factor for 3% and 10 years. The factor is 1.344 c) Divide the $200,000 original amount by the 1.344 table factor. a. $200,000 / 1.344 = $148,810 LO: 12-4 Topic: Calculating the Effect of Inflation on a Life Insurance Policy LOD: Medium Bloom tag: Application 12. Calculating the Effect of Inflation on a Life Insurance Policy. Allen has purchased a whole life policy with a death benefit of $150,000. Assuming that he dies in 8 years and the average inflation has been 2%, what is the value of the purchasing power of the proceeds? Solution: Follow these steps to determine the effect that 2% inflation would have after 8 years: a) Review Exhibit 1-A (page 42), Future Value of $1 after a Given Number of Time Periods. b) Locate the table factor for 2% and 8 years. The factor is 1.172 c) Divide the $150,000 original amount by the 1.172 table factor. a. $150,000 / 1.172 = $127,986 LO: 12-4 Topic: Calculating the Effect of Inflation on a Life Insurance Policy LOD: Medium 12-29 Bloom tag: Application 13. Determining the Cost of Insurance. Suppose you are 45 and have a $10,000 face amount, 15-year, limited-payment, participating policy (dividends will be used to build up the cash value of the policy). Your annual premium is $350. The cash value of the policy is expected to be $4,000 in 15 years. Using time value of money and assuming you could invest your money elsewhere for a 7 percent annual yield, calculate the net cost of insurance. Solution: Annual premium (15 years) $5,250 ($350 x 15 years) Time value of money $350 x 25.129= $8,795 (Exhibit 1-B, 15 years, 7%) + $3,545 ($8,795- $5,250) Total cost of policy $8,795 Cash value (end of 15 years) - $4,000 Net cost of insurance $4,795($8,795 - $4,000) At a 7 percent annual yield, your account would have accumulated to $8,795 in 15 years (See Exhibit 1-B on page 43). You have paid $4,795 for 15 years of insurance protection: LO: 12-5 Topic: Determining the Cost of Insurance LOD: Hard Bloom tag: Application 14. Determining the Cost of Insurance. Suppose you are 30 and have a $25,000 face amount, 20-year, limited-payment, participating policy (dividends will be used to build up the cash value of the policy). Your annual premium is $225. The cash value of the policy is expected to be $3,000 in 20 years. Using time value of money, and assuming you could invest your money elsewhere for a 5 percent annual yield, calculate the net cost of insurance. 12-30 Solution: Annual premium (20 years) $4,500 ($225 x 20 years) Time value of money $225 x 33.066= $7,440 (Exhibit 1-B, 20 years, 5%) + $ 2,940 ($7,440- $4,500) Total cost of policy $7,440 Cash value (end of 15 years) - $3,000 Net cost of insurance $4,440 ($7,440 - $3,000) At a 5 percent annual yield, your account would have accumulated to $7,440 in 20 years (See Exhibit 1-B on page 43). You have paid $4,440 for 20 years of insurance protection LO: 12-5 Topic: Determining the Cost of Insurance LOD: Hard Bloom tag: Application 15. Calculating a Mortality and Expense Risk Charge. Your variable annuity has a mortality and expense risk charge at an annual rate of 1.25 percent of account value. Your average account value during the year is $20,000. What are your mortality and expense risk charges for the year? Solution: You will pay $250 in mortality and expense risk charges that year ($20,000 x .0125). LO: 12-6 Topic: Variable Annuities LOD: Easy Bloom tag: Application 16. Calculating Administrative Fees. Your variable annuity charges administrative fees at an annual rate of 0.15 percent of account value. Your average account value during the year is $50,000. What is the administrative fee for the year? Solution: $50,000 x 0.0015 = $75 administrative fee for the year LO: 12-6 Topic: Variable Annuities 12-31 LOD: Easy Bloom tag: Application FINANCIAL PLANNING ACTIVITIES (p. 439) 1. Planning for Life Insurance. Choose a current issue of Money, Kiplinger’s Personal Finance, Consumer Reports, or Worth magazine and summarize an article that provides information on human life expectancy and how life insurance may provide financial security. Student answers will vary, but you may want to take this opportunity to emphasize why most people buy life insurance and what are typical examples of how life insurance proceeds are used. 2. Assessing the Need for Life Insurance. Interview relatives and friends to determine why they purchased life insurance. Prepare an essay summarizing your findings. The Purpose of Life Insurance Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. That someone could be the nonworking spouse and children of a single-income family. It could be the wife or husband of a two-income family. It could be an aging parent. It could be a business partner or corporation. 3. Comparing the Methods of Determining Life Insurance Requirements. Analyze the five methods of determining life insurance requirements. Which method is best and why? Simple as the easy method is, it is remarkably useful. It is based on the rule of thumb that a “typical family” will need approximately 70 percent of the salary for seven years before it adjusts to the financial consequences of the wage earner’s death. The DINK method is useful if you have no dependents and your spouse earns as much as or more than you do. The “nonworking” spouse method assumes that extra costs of up to $10,000 a year may be required to replace the services of a homemaker in a family with small children. The family need method is probably the best method of determining life insurance requirement. The first three methods assume that you and your family are “typical” and ignore such important factors as Social Security and the rate of return that your survivors can earn if they invest the life insurance benefits they receive. The family need method does not make these assumptions. The fifth method is the use of online calculators or APPS. These can give you basic insurance information or very detailed calculations based upon the information that you provide. 4. Determining the Need for Life Insurance. Jake is a 27-year-old single man with no children. He has a younger sister who has a developmental disability. Both his parents are living, though neither parent is in good health. Jake has an auto loan, a $50,000 mortgage on his condominium, and no consumer debt. Is Jake a good candidate for life insurance? If so, what kind and how much life insurance should he buy? 12-32 Issues may include whether Jake’s sister will need help (whether her parents have provided for her through their insurance or wills); how wealthy her parents are; and how soon Jake can pay off the loans. He may need only a short-term policy, a decreasing term policy, or none at all. 5. Calculating Your Life Insurance Needs. Use Exhibit 12-3 to calculate your insurance needs. Student’s answers will vary based upon current income and assets available. 6. Comparing Premiums for Life Insurance Policies. Choose one stock and one mutual life insurance company. Obtain and compare premiums for: a. Term life insurance for $50,000 b. Whole life insurance for $50,000 c. Universal life insurance for $50,000 Prepare a summary table indicating which policy you would consider and why. Students will discover that insurance rates for $50,000 of life insurance will vary for term, whole life, and universal life insurance. A mutual company will have a somewhat higher premium than a stock company, but a mutual life insurance company will refund a part of the premium to the policyholder annually. Let students compare the premiums. 7. Using the Internet to Obtain Information about Various Types of Life Insurance. All major life insurance companies now maintain a Web page on the Internet. Visit a few Web sites of companies such as Metropolitan Life, New York Life, Transamerica Life, Lincoln Benefit Life, or others of your choice. Then prepare a report that summarizes the various types of insurance coverages available from these companies. Student reports of insurance coverage available from different insurance companies will vary. However, all insurance companies offer various blends of whole life, term life, universal life, and group life insurance. All insurance companies have similar provisions such as, the grace period, policy reinstatement, incontestability clause, suicide clause, automatic premium loans, policy loan provision, etc. 8. Comparing the Provisions of Life Insurance Policies. Examine your life insurance policy and life insurance policies of other members of your family. Note the contractual provisions of each policy. What does the company promise to do in return for premiums? Most provisions are likely to be accidental death benefit, beneficiaries, cash value, change of policy, dividends, loans, premiums and reinstatement, waiver of premium right, and transfer of ownership. In return, the insurance company will pay a specified amount to the beneficiaries upon death of the insured. 9. Using the Services Provided by State Insurance Departments. Contact your state insurance department to get information about whether your state requires interest adjusted cost disclosure. Prepare a summary report of your findings. Students will discover that most states require insurance companies to reveal interest adjustment cost so that the consumer may compare the cost of insurance. 10. Evaluating the Financial Strength of Insurance Companies. Look up the ratings of at least three insurance companies that you are familiar with. 12-33 Ratings agencies such as A.M Best (www.ambest.com) or insure.com (www.insure.com) can be used. 11. Comparing Insurance Payout Options. List the factors that would influence you in selecting the type of settlement option. There are many options of how you would want to determine the settlement option. The most common factors are how the beneficiary will use the money. The insured will need to consider the following: (1) to cover the immediate expenses resulting from the death of the insured and (2) to protect dependents against a loss of income resulting from the premature death of the primary wage earner. Lump-Sum Payment. In the lump-sum payment option, the company pays the face amount of the policy in one installment to the beneficiary or to the estate of the insured. This form of settlement is the most widely used option. Limited Installment Payment. This option provides for payment of the life insurance proceeds in equal periodic installments for a specified number of years after your death. Life Income Option. Under the life income option, payments are made to the beneficiary for as long as the beneficiary may live. The amount of each payment is based primarily on the sex and attained age of the beneficiary at the time of the insured’s death. Proceeds Left with the Company. Under this option, the life insurance proceeds are left with the insurance company at a specified rate of interest. The company acts as trustee and pays the interest to the beneficiary. The guaranteed minimum interest rate paid on the proceeds varies among companies. FINANCIAL PLANNING CASE (p. 439) Life Insurance for Young Married People 1. In your opinion, do Jeff and Ann need additional insurance? Why or why not? As indicated above, yes, Jeff and Ann need additional insurance, because the children are small and the family needs income should Jeff die. 2. What type of policy would you suggest for Jeff and Ann? Why? For most families, the main source of money is the wage earner’s income. If anything should happen to Jeff, it might be very difficult for the rest of the family to get along without Jeff’s income. That is why most families rely on life insurance. It can provide cash when it is needed for expenses directly associated with the death of a breadwinner. While children are young, it is difficult for a parent alone to maintain a home and a job. A monthly income until they finish school will help keep the family together. Since Jeff and Ann have a growing family, Jeff should have at least $50,000 of insurance-- $25,000 in term and $25,000 in whole life insurance. 12-34 CONTINUING CASE (p. 440) Life Insurance Life Situation Financial Data Young married couple Monthly Gross Income $4,600 Shelby, age 28 Living expenses $3,500 Mark, age29 Assets $182,000 Liabilities $118,000 The Lawrences recently had a baby named Blair and are concerned about their life insurance needs. Shelby has $5,000 of coverage while Mark has life insurance coverage equal to approximately six times his annual salary. They need help in determining the appropriate life insurance amount for their family. Questions 1. What are the five general methods for estimating the amount of life insurance that the Lawrences need? Simple as the easy method is, it is remarkably useful. It is based on the rule of thumb that a “typical family” will need approximately 70 percent of the salary for seven years before it adjusts to the financial consequences of the wage earner’s death. The DINK method is useful if you have no dependents and your spouse earns as much as or more than you do. The “nonworking” spouse method assumes that extra costs of up to $10,000 a year may be required to replace the services of a homemaker in a family with small children. The family need method is probably the best method of determining life insurance requirement. The first three methods assume that you and your family are “typical” and ignore such important factors as Social Security and the rate of return that your survivors can earn if they invest the life insurance benefits they receive. The family need method does not make these assumptions. The fifth method is the use of online calculators or APPS. These can give you basic insurance information or very detailed calculations based upon the information that you provide. 2. Explain how Shelby and Mark might use the following Personal Financial Planner sheet for figuring out their life insurance needs. a. Determining Life Insurance Needs 12-35 DAILY SPENDING DIARY (p. 441) Analysis Questions 1. Are there any spending amounts or items that you might consider reducing or eliminating? Student answers will vary. 2. What actions might you consider now or in the future regarding spending on life insurance? Student answers will vary. 12-36 TM 12-1 Alternate Worksheet to Calculate Your Life Insurance Needs Expenses You'll Need to Cover Example Your Family 1. Funeral, estate taxes, etc. $ 5,000 2. Settling of non-mortgage debt 2,500 3. Emergency fund 5,000 4. College fund 76,800 5. Expected living expenses: A. Expected average living expenses 29,000 B. Expected spouse's average annual income after taxes – 22,500 C. Annual social security benefits – 5,000 D. Net annual living expenses (A B C) 1,500 E. Years until spouse is 90 55 F. Investment rate factor* 22 G. Total living expenses (D F) 33,000 6. Total monetary needs (1 + 2 + 3+ 4 + 5G) $ 122,300 7. Total investment assets in hand – 10,000 8. Life insurance needs (6 7) $ 112,300 *Table of Investment Rate Factors Years until spouse is 90 25 30 35 40 45 50 Conservative investment 20 22 25 27 30 31 Aggressive investment 16 17 19 20 21 21 Source: Adapted from a chart by financial advisers Ballard, Biehl & Kaiser, Inc. of San Mateo, California. Originally printed in the April 2, 1984 edition of The Wall Street Journal. 12-37 TM 12-2 Major Types and Subtypes of Life Insurance (Exhibit 12-4) Whole, Straight, Term (temporary) or Ordinary Life Other Types • Limited payment • Group life • Renewable term • Multiyear level term • Convertible term • Decreasing term • Return of premium • Single premium • Credit life • Endowment life • Modified life • Variable life • Adjustable life • Universal life • Variable universal life 12-38 Name ______________________________________ Cha pt er 12: Life I nsur a nce 3. A method of evaluating the cost of life insurance by taking into account the time value of money. 6. A provision stating that if the insured dies by suicide during the first two years the policy is in force, the death benefit will equal the amount of the premium paid. 8. Life insurance that does not provide policy dividends; also called a "nonpar policy." 9. A life insurance agent who has passed a series of college-level examinations on insurance and related subjects. (abbreviation) 10. An insurance plan in which the policyholder pays a specified premium each year for as long as he or she lives; also called a "straight life policy," a "cash-value policy," or an "ordinary life policy." 12. A person designated to receive something such as life insurance proceeds, from the insured. 14. A contract that provides a regular income for as long as the person lives. 15. A whole life policy that combines term insurance and investment elements. 1. Life insurance that provides policy dividends; also called a "par policy." 2. A provision stating that the insurer cannot dispute the validity of a policy after a specified period. 4. Life insurance protection for a specified period of time; sometimes called "temporary life insurance." 5. A benefit under which the company pays twice the face value of the policy if the insured's death results from an accident. 7. A provision that allows the insured not to forfeit all accrued benefits if a policy is dropped. 11. The amount received after giving up a life insurance policy. 13. A document attached to a policy that modifies its coverage. Across Down N O N P A R T I C I P A T I N G P O L I C Y I N C O N T E S T A B I L I T Y C L A U S E I N T E R E S T A D J U S T E D I N D E X P A R T I C I P A T I N G P O L I C Y N O N F O R F E I T U R E C L A U S E W H O L E L I F E P O L I C Y D O U B L E I N D E M N I T Y U N I V E R S A L L I F E T E R M I N S U R A N C E S U I C I D E C L A U S E B E N E F I C I A R Y C A S H V A L U E A N N U I T Y R I D E R C L U 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Instructor Manual for Personal Finance Jack R. Kapoor, Les R. Dlabay , Robert J. Hughes, Melissa M. Hart 9780077861643, 9781260013993
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