Hace 3200 1nd EditionExam # 3 Study Guide Lectures: 18-24Lecture 18 - Chapter 9: The Role of Health and Life Insuranceo The Insurance Industry Over one million people are employed by 35,000 insurance companies Almost 1 out of every 12 dollars spent in the US economy goes to pay for insurance. o Insurance In insurance, RISK is defined as uncertainty with respect to economic loss When you have a financial interest in something (life, health, income, property)- you face risk that your budget cannot absorb a decrease or a loss of that itemo Risk The possibility of experiencing harms, suffering, danger, or loss is known as RISKo Risk Aversion Theory 1) Rational people will try to reduce or avoid risk; and 2) Risk is subjective in that individuals define the level of risk and uncertainty they can handleo Probability A person weighing uncertainty and risk is judging the Probability, or likelihood, of a good or a bad outcomeo Ways to deal with risk Risk avoidance- Don’t drive Risk reduction (loss prevention)- Seat belts Risk Assumption- Accept certain level of risk Insurance (share risk)- Economically recover from loss Understanding the Logic Behind Insurance- Insurance is an example of risk pooling—individuals share their financial risks to reduce catastrophic losses from death, accidents, or health problems  Life Insurance Policy Terms- Premium- the monthly cost of the policy - Face value—the benefit due upon death- Insured—the person whose life is covered by the policy - Policy owner—the individual or business that pays for and owns the policy - Beneficiary—the recipient of the benefit upon the death of the insured Life Insurance May Not be Necessary for the following- Single person, no dependents- DINKS- Married, but unemployed, individual without dependents- Retired persons  Insurance may be Necessary for the following individuals- Those with dependents- Married, single-income couple, with children- Business owners- Those estate exceeds the estate tax-free transfer threshold Determine your Life Insurance Needs: Two Methods- The earnings multiple approacho To replace the annual salary stream of a bread winner for Xyears, normally 5- 15 times gross salary is recommended- The Needs Approacho To meet the needs of the household after the death of a breadwinner, both current and in the future- The Earnings Multiple Approacho Adjust salary down to compensate for the reduction in household expenseso Choose the PVA to match the assumed after-tax and after-inflation earnings on the policy settlemento The longer the income stream replacement the greater themultiple. The higher the assumed earnings, the lower the multiple.- Adjust Salary Downo 5 to 4=20% dropo 4 to 3= 22% dropo 3 to 2= 26% dropo 2 to 1= 30% drop- PMT= Income that needs replaced- N= number of years until retirement- i/y= investment interest rate- Cpt PVA= how much you need to insure yourself against this loss of income  The Needs Approach—The Seven Funds- Immediate needs funds- Debt elimination funds- Immediate transitional funds- Dependency funds- Spousal life income funds- Educational funds for child or spouse- Retirement income funds The Needs Approach—the calculation- Add all funding needs to determine total need- Subtract current insurance coverage and other available assets- This determines amount of additional insurance coverage necessary Term Insurance- Death benefit coverage for a specific term of time- Only valid if the insure dies during the term of coverage- Least expensive form of insurance Cash Value Insurance- Provides a death benefit and an opportunity to accumulate savings- Provides permanent insurance  Types of Cash-Value Insurance- 1. Whole life insurance- 2. Universal life insurance - 3. Variable life insurance Whole Life Insurance and Its features- Permanent protection- Fixed premium and death benefit- Fixed cash-value that grows tax-deferred- Much less death protection than term for the same price- Yield on cash value potion is not competitive with yields on alternative investments Universal Life Insurance and Its Features- Permanent protection- Flexible premium payments- Flexible death benefit- Cash-value fluctuates depending on the amount paid unto the policy  Variable Life Insurance and its features- Permanent protection; returns are earned on a tax-deferred basis- Allows for either a fixed or flexible premium- Flexible death benefit and fluctuating cash value; reflecting the mutual fun investment performance  New Slide- Convertible term: can be renewed for an agreed upon period up to a specific age.. in some cases up to age 94- The premium increases each time  Decreasing term- Renewable term where the premium remains constant,, but the face value (death benefit) decreases Group term- Insurance for a specific group of individuals who do not take a physical exam to be coveredo MY UGA POLICY IS THIS New Slide- Mortgage/credit group life:o Required by your creditor to cover the value of the debt, usually the mortgage until you have 20% equity Lecture 19 - Clauseso Beneficiary Provisiono Coverage grace period..unless you pass awayo Loan clause(cash value only)o Nonforfeiture clause(what your choices are if you lapse)o Policy reinstatement clause(3-5 yrs)o Suicide/ incontestability( 2 years)- Riders= additional costo Waiver of premium for disabilityo Accidental death.. ups the death benefito Guaranteed insurability: increase your benefit without examo Cost of living: increases death benefit with inflationo Living benefits: cash value grants early payout for terminally ill- Settlement optionso Lump sum settlement- one time payout upon death of the insuredo Interest-only settlement- periodic payments of the interest earned by the principal - Cont’do Installment-payments settlement- periodic payments, normally for a fixed period, of both the principal and interesto Life annuity settlement- periodic payments of both the principal and interest that continue for the life of the beneficiary o Note: life insurance death benefits are income tax-free; however, in some cases state inheritance taxes may apply- Health Careo $2,600,000,000,000 USA spent on health care 2011- In 2011o Annual premium (what you pay to have health insurance coverage) was $15,073(family)