RMIN SG Final Chapters CHAPTER 11 Premature Death death of a family head with outstanding unfulfilled financial obligations o Costs associated with premature death Loss of income funeral and medical expenses reduction in standard of living noneconomic costs grief o Declining problem of premature death life expectancy has increased significantly over the past century o Economic justification for life insurance Justifiable if the insured has income and others are dependent on those earnings Financial Impact of Premature Death o Single people no dependents so do not need a lot of life insurance o Single parent families sole breadwinner so need a lot of life insurance for their dependents o Two income earners with children need substantial amount of life insurance to maintain the standard of living 2 incomes without children do not need much o Traditional families the working parent needs substantial life insurance non employed spouse does also for the amount that will need to be spent on child care services when they die o Blended family divorced and remarried both family heads need substantial life insurance loss of standard of living o Sandwiched 3 generations living in the same home Grandparent parent child Parent takes care of their parents and children need for life insurance is huge because you have even moredependents Human Life Value Approach present value of the family s share of the deceased breadwinner s future earnings o Estimate average annual earnings over productive lifetime o Deduct taxes insurance premiums cost of self maintenance What they would ve taken out of the income o Determine of years from present age to retirement o Using a reasonable discount rate determine PV o EXAMPLE Richard 27 is married with 2 children earms 50 000 year and plans to reture at age 67 20 000 used for taxes insurance and personal needs assume i 5 PV 17 16 Human Life Value 30 000 x 17 16 514 800 o Ignores other sources of income like social security o Occupations not considered earnings expenses are assumed to be constant o Amount of money can quickly change Divorce child etc o Long run discount rate is critical Needs Approach analyze the family needs that must be met if the family head should die o Most important family needs Estate clearance fund Income during the readjustment period Income during the dependent period Before children turn 18 Life income to surviving spouse Retirement needs Special needs Capital Retention Approach preserves the capital needed to provide income to the family o Following steps Prepare a personal B S Determine the amount of income producing capital Determine the amount of additional capital needed if any Term Insurance period of protection is temporary 1 5 10 20 or 30 yrs o Most term policies are renewable o Most term policies are convertible Attained age method insurance offers it to you when you as the age you are when you convert Original age method insurance offers you the policy as if you were the age you were when you purchased the original policy Usually shorter policies 1 5 years o No cash value or savings element o Types of term insurance Yearly renewable don t have to demonstrate insurability but you have a higher premium 5 10 15 20 25 30 year term premiums are level over time but increase when the policy is renewed Term to age 65 Expires at 65 and if want to convert to permanent insurance it must happen before age 65 Decreasing Term as the policy goes on the face amount will decrease but the premium will remain level Reentry Term renew the policy for even lower premiums Renewal premiums are based on select mortality rates if the insured can periodically demonstrate acceptable evidence of insurability To remain at low premium but continually show proof of insurability Return of premium term if you survive the term of the policy the insurance is going to pay you back your premiums Not all the premiums TVM makes it not even Tend to be more expensive o Uses of Term Insurance Limited amount of income to spend on life insurance Need for protection is temporary Use to guarantee future insurability Will convert to permanent later buy cheap term insurance now o Limitations of Term Insurance Premiums increase with age at an increasing rate Inappropriate if you wish to save money for a specific need Whole Life Insurance cash value policy that provides lifetime protection o Ordinary life insurance Level premium policy that provides cash values and lifetime protections to age 121 Premiums are level through the premium paying period Excess premiums paid during early years are accumulated at compound interest legal reserve Used to supplement the inadequate premiums paid during the later years of the policy Net Amount at Risk difference between the legal reserve and face amount of insurance decreasing with policy age Cash surrender values amount paid to a policyholder who surrenders the policy Not the same as legal reserve Uses of ordinary life insurance When lifetime protection is needed Used to save money Limitations of ordinary life insurance Some are still underinsured o Limited payment life insurance is permanent and individual has lifetime protection Premiums are level but only for a certain time period Paid up policy NOT the same as one that has matured Extreme example would be a single premium whole life insurance o Endowment Insurance pays the amount if the insured dies within a specific period If the insured survives to the end of the endowment period they receive the face amount at that time Account for less than 1 of life insurance Variations of Whole Life Insurance o Variable Life Insurance fixed premium policy in which the death benefit and cash values vary according to the investment experience of a separate account maintained by the insurer Entire reserve is held in a separate account invested in common stocks or other investments Cash surrender values are not guaranteed and there are no minimum cash values o Universal Life Insurance flexible premium policy that provides protection under a contract that unbundles the protection and savings components make payments when you wish to do so and it pays into accumulation fund 2 forms level death benefit increasing death benefit considerable flexibility cash withdrawals permitted favorable income tax treatment Limitations of Universal Life Misleading rates of return Decline in interest rates Right to increase the mortality charge Lack o firm commitment to pay premiums o Indexed Universal Life