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FSU RMI 3011 - Chapter 5: Life Insurance

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RMI 3011 Test #3 Study Guide 1 RMI 3011 Test #3 Study Guide Chapter 5: Life Insurance Perils - Premature Death - death of a family head with outstanding unfulfilled financial obligations o Costs  The family’s share of the deceased breadwinners earnings is lost forever  Additional Expenses - Funeral - Uninsured medical bills - Estate settlement costs  Reduction in standard of living due to insufficient income o Chance of dying = Economic Justification of life insurance - Old Age - Poor Health - Unemployment Financial Impact for different types of families - Single People o Does not generally need large amounts of life insurance - Single Parents o The need for life insurance on the family head is great - DINKs (Dual Income, No Kids) o Both income earners need substantial amounts of life insurance incase something happens to the other - Traditional (Married w/ Children)- Dad at work, mom stays home o The working parent in the labor force needs substantial life insurance o The non-working spouse actually needs life insurance also  You have to think about what needs to happen when you aren’t home, example, taking care of kids - Blended Family- divorced spouse, with children remarries and the new spouse also has children o The need for life insurance on both family heads is great - Sandwiched Family (Grandparents living with you) o A working spouse in a sandwiched family needs a substantial amount of life insurance  Must be able to provide for their children and aged parentsRMI 3011 Test #3 Study Guide 2 How much is needed? - Adequate insurance covers the below listed o Final Expenses (end of life costs) i.e. funeral, medical bills etc o Estate Liquidity- the persons debts o Survivor (s) income needs- provide enough money for the beneficiaries to live o Mortgages o Education- for deceased’s children o Legacy Giving Other Available income sources… - OASDI (social security) - Savings Investment - Inheritance How long available? - Focus on duration of the need - Avoid “all or nothing” advice (if you can’t get what you need buy what you can afford Characteristics of Life Insurance - Purpose is to replace income o Only unique feature to life insurance - Not a contract of indemnity… or is it? o Cash payment contract - Claims of creditors Protected! o Annuities, 401k plans, IRAs o And in Florida the primary residence is protected - Proceeds are usually income tax free How Much? - Human Life Value Approach o Estimates the family’s share of the deceased Breadwinners Earnings  Deduct the following which will be used to support the family - FICA - Federal Taxes - Retirement Contributions - Self Maintenance o Crude Measurement  Only based on the persons economic worth o Major Defects  Doesn’t consider other sources of incomeRMI 3011 Test #3 Study Guide 3 - Social security survivor benefits - Work earnings are assumed constant and employee benefits are ignored  Discount rate chosen is crucial - Human life value can be substantially increased by assuming a lower rate - Uses present value of all future earnings Needs Approach - Measures Existence and Extent of need o Estate Clearance Fund (or cleanup fund)- immediate cash needed for:  Burial  Uninsured Medical Expenses  Installment Debts  Estate administration expenses  Estate  Inheritance  Income taxes o Readjustment Period (1-2 years)  The family should receive the same amount of income as before the breadwinners death - Gives them time to adjust to different standard of living o Dependency Period (black-out period)  Period until youngest child reaches 18  Family receives income during this period so surviving spouse can remain at home if necessary  Substantially reduced if remaining spouse is already in work force o Life income to surviving spouse  Income during the blackout period  Income to supplement social security earnings after blackout period  Blackout period- period from the time that social security survivor benefits terminate to the time the benefits are resumed - Survivor benefits terminate when youngest child reaches 16 and restart when surviving spouse reaches age 60  Special Needs - Mortgage Redemption Fund - Education Fund - Emergency Fund  Retirement ***Financial Profiles Software***RMI 3011 Test #3 Study Guide 4 Capital Retention Approach - Assumes the Retention of Capital (hence the name) - Prepare a personal Balance Sheet o Lists all assets and liabilities o Include all death benefits from life insurance - Determine amount of income producing capital o What can bring the family income after the breadwinners death - Determine needs o Use the needs approach for this - Determine Additional Capital needed o Extra capital needed based on income shortage for survivors after deducting:  Survivor benefits  Income produced by capital o *** Investment Income/Interest Income*** Yearly Renewable Term - Pure premium o Calculated at each attained age - Low cost…early o Mortality tables - High cost… later o Some adverse selection ***Premium Exponentially Increases*** Level Premium - Financing Plan to Level Mortality Costs o Probability of death increases with age o Term System produces adverse selection - Overpayment in Early Years o Prepayments create policy reserves o Redundant premiums + compound interest o Supplement inadequate premiums later ***Purpose … Lifetime Protection*** ***By-product … Cash Values***RMI 3011 Test #3 Study Guide 5 Chapters 8+9(part I): Life Insurance Contract Provisions Parties to a life insurance contract - Owner o Applies for contract o Responsible for premiums o Exercises contractual rights  The policy owner (not always the insured) possesses all contractual rights while insured is living o Names the Beneficiary o Must have an insurable interest in the life of the insured at the policy’s inception o Can be a person, corporation or trust  i.e. the insured’s employer - Insured o Person whose death causes payment of proceeds (the face amount) o May or may not be the owner  Life insurance through ones job - Beneficiary o Entity that receives proceeds at death of the insured o Interest is contingent until death Types of Beneficiaries - Primary- the beneficiary that is first entitled to receive the policy proceeds on the insured’s death -


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