RMIN SG Final ChaptersCHAPTER 11-Premature Death: death of a family head with outstanding unfulfilled financial obligationso 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 centuryo Economic justification for life insuranceJustifiable if the insured has income and others are dependent on those earnings-Financial Impact of Premature Deatho Single people: no dependents so do not need a lot of life insuranceo Single-parent families: sole breadwinner so need a lot of life insurancefor their dependentso 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 dieo 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 earningso Estimate average annual earnings over productive lifetimeo Deduct taxes, insurance premiums, cost of self-maintenance What they would’ve taken out of the incomeo Determine # of years from present age to retiremento Using a reasonable discount rate, determine PVo 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= $514,800o Ignores other sources of income like social securityo Occupations not considered, earnings & expenses are assumed to be constanto Amount of money can quickly changeDivorce, child, etco Long run discount rate is critical-Needs Approach: analyze the family needs that must be met if the family headshould dieo 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 familyo 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 renewableo 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 elemento 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 butincrease 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 ifthe 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 expensiveo 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 nowo 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 protectiono 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 underinsuredo 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 insuranceo 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 valueso Universal Life Insurance: flexible premium policy that provides protection under a contract that unbundles the protection and savingscomponents (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