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RMI Life Insurance Lecture Notes Chapter 5 Premature Death can be defined as the death of a family head with outstanding unfulfilled financial obligation o Can cause serious financial problems for the surviving family members o The deceased s future earnings are lost forever o Additional expenses are incurred e g funeral expenses and estate settlement costs o Some families will experience a reduction in their standard of living o Noneconomic costs are incurred e g grief o Life expectancy has increased significantly over the past century Thus the economic problem of premature death has declined Millions of Americans still die annually from heart disease cancer and stroke o The purchase of life insurance is financially justified if the insured has earned income and others are dependent on those earnings for financial support Financial Impact of Premature Death on Different Types of Families o The need for life insurance varies across family types Single people Single parent families Two income earners with children Traditional families Blended families Sandwiched families life insurance to own The human life value approach o Amount of Insurance to Own three approaches can be used to estimate the amount of The amount needed depends on the insured s human life value which is the present value of the family s share of the deceased breadwinner s future earnings To calculate the amount needed under the human life value approach o Estimate the individual s average annual earnings over his or her productive lifetime o Deduct taxes insurance premiums and self maintenance costs o Using a reasonable discount rate determine the present value of the family s share of earnings for the number of years until retirement Under the needs approach the amount needed depends on the financial needs that must be met if the family head should die The calculation should consider o An estate clearance fund o Income needed for a 1 2 year readjustment period o Income needed for the dependency period until the youngest child reaches age 18 o Life income to the surviving spouse including income during and after the blackout period o Special needs e g funds for college education and emergencies o Retirement needs The capital retention approach preserves the capital needed to provide income to the family To calculate o Prepare a personal balance sheet o Determine the amount of income producing capital o Determine the amount of additional capital needed to meet the family needs o Internet based life insurance calculators produce widely varying results but may be a good starting point Most families own an insufficient amount of life insurance In 2010 only 44 percent of the households in the United States owned any individual life insurance Consumers procrastinate and have difficulty in making correct decisions about the purchase of life insurance o Many families have only a limited amount of discretionary income The purchase of life insurance reduces the amount of discretionary income available for other needs Many families are in debt and have little savings After payment of high priority expenses such as a mortgage food and utilities many families have only a limited amount of income to purchase life insurance Types of Life Insurance Term vs Cash value o Term Life Insurance provides temporary protection Under a term insurance policy protection is temporary protection expires at the end of the policy period unless renewed Most term policies are renewable for additional periods Premiums increase at each renewal To minimize adverse selection many insurers have an age limitation beyond which renewal is not allowed Most term policies are convertible which means the policy can be exchanged for a cash value policy without evidence of insurability Under the attained age method the premium charged for the new policy is based on the insured s attained age at the time of conversion Under the original age method the premium charged for the new policy is based on the insured s original age when the term insurance was first purchased A financial adjustment is also required Yearly renewable term insurance is issued for a one year period Term insurance can also be issued for 5 or more years A term to age 65 policy provides protection to age 65 at which time the policy expires Under a decreasing term insurance policy the face value gradually declines each year Under a reentry term insurance policy renewal premiums are based on select lower mortality rates if the insured can periodically demonstrate acceptable evidence of insurability i e good health Return of premiums term insurance the end of the term period provided the insurance is still in force is a product that returns the premiums at Uses and Limitations of Term Life Insurance Term insurance is appropriate when However o The amount of income that can be spent on life insurance is limited o The need for protection is temporary o The insured wants to guarantee future insurability o Term insurance premiums increase with age at an increasing rate and eventually reach prohibitive levels o Term insurance is inappropriate if you wish to save money for a specific need o Types of Whole Life Insurance a cash value policy that provides lifetime protection A stated amount is paid to a designated beneficiary when the insured dies regardless of when the death occurs Types include Ordinary Life is a level premium policy that provides lifetime protection o Premiums are level throughout the premium paying period o The excess premiums paid during the early years are used to supplement the inadequate premiums paid during the later years of the policy o The insurer s legal reserve is a liability that must be offset by sufficient financial assets o The net amount at risk is the difference between the legal reserve and the face amount of coverage o Cash surrender values A policyholder overpays for insurance protection during the early years resulting in a legal reserve and the accumulation of cash values The policyowner has the right to borrow the cash value or exercise a cash surrender options o An ordinary life policy is appropriate when lifetime protection is needed A major limitation is that some people are still underinsured after the policy is purchased o Limited Payment life the insured has lifetime protection and premiums are level but they are paid only for a certain period The most common limited payment policies are for 10 20 25 or 30 years o A paid up policy at age 65 or 70 is


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FSU RMI 3011 - RMI Life Insurance

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Test 1

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TEST 2

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Chapter 1

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