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Slides by Pamela L. Hall
Western Washington University
Life Insurance
Chapter 11
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Why Purchase Life Insurance? If you are single with no dependents, you
may not need any life insuranceBut if you have family members who are
financially dependent on you, reasons include: Cash for immediate needs Re-adjustment funds
Will spouse need time to find work, relocate, etc. Replacement income Special situations
Help pay off the mortgage, finance child’s college, etc.
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Figure 11.2: Estimating Life Insurance Needs
Line Item
Raj
Your Figures
1 Annual living expenses of survivors $60,000
2 Social Security and pension death benefits $20,000
3 Spouse's net income $25,000
4 Annual living expense shortfall $15,000
5 Net real return on assets 4%
6 Capital needed to meet living expense shortfall (line 4 divided by 5)
$375,000
7 Funeral and estate costs $15,000
8 Mortgage and other debts $100,000
9 Spouse education fund, children's education fund, and other needs
$50,000
10 Total capital needed (sum of line 6, 7, 8, and 9) $540,000
11 Investments and savings $100,000
12 Life insurance needed (maximum of 0 or line 10 minus line 11)
$440,000
13 Existing life insurance $200,000
14 Additional life insurance needed (line 12 minus line 13)
$240,000
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How Your Life Insurance Needs Change Over TimeWhen you’re young, may have no need for
life insuranceAs you get married, have children, have a
mortgage payment, etc., your need for life insurance increases
As you get older (and have paid down your mortgage and have substantial investments) your life insurance needs may decrease
DEFINITELY review your needs as you experience major life changes
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Types of Life Insurance Policies
Term insurance Only provides death benefit
Whole-life insurance Combines a savings feature with death
benefits
Universal life insurance Combines a savings feature with death
benefits
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Term InsuranceOffers protection for a specified term
(period of time) and has no value at end of term If policy expires and you don’t die,
insurance company has no further obligation to you
Advantage Inexpensive
Can generally buy 5 to 10 times as much term insurance as other life insurance for same premium
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Term Insurance
Level Term vs. Decreasing Term Level term: Fixed premium and a fixed
amount of coverage Commonly issued for 1, 5 and 10 year terms
Decreasing term: Policy with a declining amount of coverage over time (but premiums remain the same) As you pay off mortgage, children leave
home, etc., need less insurance
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Term InsuranceConversion and Renewable Features
Many term policies offer these features at additional cost Automatic renewal at term end
Can renew for at least one more term w/o another physical exam
Many companies permit renewal as many times as you’d like up to age 70 or so
Term insurance can be converted to another type of life insurance
Usually limited to coverage equal to or less than current coverage
May require that the conversion occur within a certain time period (well before term expires)
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Term InsuranceDeposit Term Insurance
Pay a deposit (about $10 for every $1,000 of coverage) on top of regular premium
Deposit is placed into high-rate, interest-bearing account
If you maintain insurance coverage for term period, you’ll get back deposit plus interest If you let policy lapse, you lose deposit plus interest If you die during term, your beneficiary gets deposit plus
interest and face amount of policy Cheapest form of life insurance, if you keep policy One of most expensive if you let policy lapse
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Whole Life InsurancePurchase for your entire (whole) lifePremiums spent on whole life insurance
are divided between insurance protection and savings Makes whole life more expensive Cost during early years of policy exceeds actual
cost of insurance protection while cost in later years is less than needed Insurance company invests the excess amount
collected in early years of policy to cover increasing risk in later years of policy
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Whole Life InsuranceStraight Life insurance (AKA: continuous
premium whole life insurance or ordinary whole life insurance) Premiums remain same over life of policy
Premiums determined by your age/health at inception of policy
Most life insurance policies are of this type Within first 3 years of policy, begins to build a
cash value (accumulated savings). As time passes, cash value increases You can borrow all or a portion of this cash value at a
relatively low interest rate, which doesn’t have to be paid back (but policy payout upon insured's death is reduced by loan plus interest)
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Whole Life Insurance
Limited-Payment Whole Life Insurance Lasts entire life of policyholder, but
premiums are only paid for a limited number of years—10, 20 or 30 years Premiums are higher, but cash value
increases more rapidly Critics argue why pay higher premiums during
years when your need for living income is greater, whereas by the time you pay off your policy (say 30 years from now), your need for life insurance may be less (or zero)
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Universal Life Insurance
Combines term insurance protection with a savings account Part of each year’s premium is used to buy
low-cost term insurance and remainder placed into high-yield investments Policyholders are not taxed on investment
earnings When policyholder dies, beneficiaries
receive policy amount plus accumulated earnings
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Universal Life Insurance Advantages
Policyholder can vary amount contributed to savings portion once initial premiums are paid
Can adjust (up [assuming good health] or down) the amount of term insurance coverage
Can use cash value to pay part of all of annual premiums or to raise death benefit
Can make tax-free withdrawals from investment portion as long as withdrawal doesn’t exceed total amount already paid in premiums
Disadvantage Much more expensive than term insurance
A 30-year-old spending $200 a year in premiums can buy $250,000 of term insurance and only $50,000 universal life insurance
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Other Life Insurance OptionsGroup Life Insurance
Available at rates lower than rates for most individuals
Often available as a perk with your job If you leave your job, coverage ends
May have option of converting group coverage to individual coverage
Variable Life Insurance Combines a straight life policy with an investment
that could increase the death benefit (but only if the insurance company’s investments perform well) Policy’s cash value can fall from year to year if investments
do poorly
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Other Life Insurance Options
Credit Life Guarantees your debt will be paid off if you die
Protects lender and your family It’s actually decreasing term insurance with the
term equal to the length of loan Very expensive
Some critics view as a rip-off May be worth it if you’re in poor health and find it
difficult to obtain life insurance
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Which Type of Life Insurance is Right for You?
Do you need or want: Just insurance protection Insurance protection combined with
savings Why not pay lower (in some cases, MUCH
lower) term life insurance rates and put the extra money you’d be saving since you didn’t buy whole-life, etc. into investments yourself?
You’ll probably earn more money in the long run
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Term vs. Whole Life
Most insurance companies argue that term life policyholders will outlive their terms and to obtain a new policy will be very expensive
Experts argue that term insurance is still a good buy for people in their 50s May not need much insurance at this
stage anyway Goal could be to be self-insured by age 60
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The Life Insurance ContractBeneficiary clause
Names the person(s) or organization to receive policy proceeds Proceeds aren’t subject to income taxes but may have
to pay estate taxes Names secondary beneficiaries Can be changed—unless you name an
irrevocable beneficiarySettlement options
Lump sum vs. periodic payments (life income, fixed income, interest only with principal in lump sum at later date)
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The Life Insurance Contract
Premium Payment Clause Premium amount, how often (quarterly,
monthly, annually)
Dividend clause Only with mutual life insurance companies Specifies how dividends are paid
Reducing future premiums May offer various options
Cash, premium reduction, purchase additional life insurance
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The Life Insurance ContractAccidental-Death clause
If policyholder dies by accident, get extra benefit AKA as double- (or triple-) indemnity clause
Restrictions Suicide Riot/insurrection Airplane disaster During commission of a felony
Suicide clause Limits company’s liability within first 2 years of
policy to amount already paid in premiums
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The Life Insurance ContractWaiver-of-Premium Clause
If you become disabled (or lose your job) insurance company may waive premium for some time period so that you don’t lose coverage (and company doesn’t lose client)
Guaranteed insurability clause Policyholder has right to purchase additional
insurance without physical Usually obtainable through age 40 Good idea for younger policyholders who can’t afford
premiums for additional insurance right now
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The Life Insurance Contract Nonforfeiture option
Protects you if policy lapses and your policy has cash value May surrender policy for portion of cash accumulated by your
premium payments May use cash value as a single premium and buy a reduced
amount of paid-up life insurance May use cash value to buy term insurance for as long as the
single premium will provide
Policy Reinstatement Allows policyholders to put a lapsed policy back into effect
if policyholder Offers proof of continued insurability Pays accumulated premiums plus interest May have to meet specified time frame
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Buying Life InsuranceShop around Impossible to compare value of term
insurance to cash-value policiesMake sure you compare similar policies
(amount, term, renewability options, etc.)Rates are usually quoted per $1,000 of
coverage But, rates on larger policies don’t increase in a
linear fashion
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Net Cost Method
With policies having cash valueValue of premiums paid less
accumulated cash value Can even show a negative net cost
(suggesting policy ‘pays for itself’)Ignores interest you could have
earned if you had invested premiumsCompany could assume an abnormally
high investment return on cash value
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Interest-Adjusted Cost Index Method
Considers total premiums paid, accumulated cash value, value of accrued dividends, and what interest buyer could have earned had premiums been invested
You’d like to see this value for different points in time 5-, 10-, 20-years
You should request to see this methodThe lower the index, the cheaper the policy
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Choosing the Right Company and Agent
Check out their financial rating Standard & Poor’s or Best’s Only buy from firm with high rating
Remember, most agents receive a commission Higher the more insurance you buy Higher with cash value policies
Analyze your needs, read up on the policies and buy straight from insurance company—bypass the agent
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Web Links
Information about ratings is available at:
www.ambest.comwww.insure.com/ratings
Quotes are available at:www.quotesmith.com
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Long Term Care InsuranceAbout 40% of all people who recently
turned 65 will need long-term care Odds are higher for women
Long-term care is very expensive Average cost of nursing home is $109 per day
Rising at a rate greater than inflation
Medicare doesn’t pay for extended long-term care
Medicaid does pay, but only after you’ve used up your assets
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Should Long-Term Care Insurance Be Purchased? It is expensiveTypical nursing home stay is fairly short
Highly unlikely a long-term care policy will ever pay for itself Unless you stay in a nursing home for a lengthy time
period and few people do
Medicare will pay the bulk of nursing home bills if certain conditions are met
Medicaid will pay if a person depletes his assets Some nursing homes won’t take Medicaid patients
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Buying the Right Long-Term Care Policy
Relatively new type of insurance Policies and premiums differ widely
Shop around and do your homeworkThe younger you are when you buy the
policy, the cheaper the policy Typical policy doesn’t increase the benefits paid
in tandem with the expected increase in costs Thus the gap between costs and benefits paid will be
greater than younger you are when you buy your policy
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Figure 11.6: The Impact of Inflation on a Long-Term Care Insurance Policy
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Common Sales PitchesYou may not need insurance now but if
you buy it now it will cost less and guarantee future insurability Odds of developing a health problem that
will cause future uninsurability are smallAfter X number of years, you’ll no
longer have to pay a premium Often based on assumption that insurance
company will earn very high interest rates
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Common Sales PitchesYou wouldn’t be able to afford term life
insurance when you’re old May not need life insurance then
A cash value policy is a form of forced savings True, but you’ll probably earn more reinvestment
return if you invest the money yourself
Cash value policies offer tax-deferred savings So does a 401(k) and other retirement plans and will
probably earn higher returns!