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CHAPTER 8:
INSURING YOUR LIFE
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Basic Insurance Concepts
Basic purposes of insurance:
Protect you and your dependents
from losing the assets that you’ve
already acquired.
Shield you and your family from
an interruption in your expected
earnings.
Insurance Planning Needs:
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 Auto & Homeowners Insurance
– Reimburses for damage or destruction to
existing assets
 Life Insurance
– Replaces income lost due to premature
death
 Disability Insurance
– Replaces income lost due to disability
 Hospitalization & Health Insurance
– Covers medical costs from illness or
accident
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Concept of Risk
Risk is defined as uncertainty
with respect to economic loss.
Insurance planning is used to
reduce the risk that losses will
cause financial devastation.
Risk can be dealt with in the
following ways:
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Risk Avoidance:
Not participating in activities
that have the risk of loss.
Example—not driving to avoid
the risk of an auto accident.
Risk avoidance is not always
practical or possible!
Loss Prevention and Control:
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 Prevention reduces the chance that a
loss will occur.
Example: Driving within the speed
limit reduces the likelihood of an
accident.
 Control reduces the severity of a loss
once it occurs.
Example: Wearing a seat belt can
minimize the effects of an accident.
Risk Assumption:
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 You bear the risk of loss yourself.
Example: When your calculator gets
stolen, you bear the cost out of pocket.
Transferring Risk:
 Pay someone else to bear your risk of
loss.
Example: You transfer the risk to the
insurance company when you buy an
insurance policy.
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Underwriting
Process in which the insurance
company decides whom to
insure and the rate to be
charged.
Company must guard against
adverse selection, a
disproportionate number of bad
risks.
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It is economically feasible for
insurance companies to assume
risk because they:
 Combine the loss experiences of
large numbers of people.
 Calculate probability of frequency of
occurrence and amount of loss
using past experience.
 Charge rates in proportion to level of
risk.
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Benefits of Life Insurance
Financial protection for
dependents:
– Provide financial security for those
who depend on your income.
– Prevent a decline in their standard
of living.
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Protection from creditors:
– Before death, cash value in life
insurance policies usually
protected against legal judgments
and bankruptcy proceedings.
– After death, possible to keep
benefits out of estate and away
from creditors.
Tax benefits:
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– Savings portion grows tax free unless
withdrawn.
– For taxpayers in higher income brackets,
these relatively low returns become more
attractive as income taxes take a greater
bite from current income and short-term
capital gains.
– Proceeds not income taxable to
beneficiaries.
– Possible to avoid estate taxation on
proceeds.
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Medium for savings:
– Provides a means of forced
savings for those who would
not do so otherwise.
– Provides preservation of
capital for those who desire a
relatively safe, conservative
investment.
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Do You Need Life Insurance?
Consider life insurance
– If you have dependents who count
on your financial support.
– If you have debts you would like to
clear, like a home mortgage.
You may not need life insurance
– If no one depends on your support.
– If you are a child.
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Techniques for estimating life
insurance needs:
Multiple-of-Earnings Method
Multiply annual earnings by an
arbitrary number
Needs Analysis Method
Estimate needs and examine
available resources
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How Much Life Insurance
Is Right For You?
Step 1: Assess Family’s Economic Needs
 Family income
 Additional expenses
 Special needs of
dependents
 Pay off debts
 Liquidity
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Step 2: Evaluate Financial Resources
 Savings and investments
 Social Security benefits
 Pension or retirement plans
 Other life insurance
 Income of surviving spouse or
children
 Real estate or other assets
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Step 3: Calculate the Difference
 This is the amount of life insurance
needed to provide your family with
the desired standard of living.
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What Kind of Policy Is
Right for You?
1. Term insurance:
 Benefit paid if insured dies
during the policy period.
 When time period over, no more
protection unless renewed.
 No savings component.
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Types of Term Insurance:
Straight term
Coverage remains the same
while premiums increase.
Decreasing term
Premiums remain the same
while coverage decreases.
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Important features to look for
in term insurance:
Renewability
Allows insured to renew policy
without evidence of insurability.
Convertibility
Allows insured to convert to
whole life policy without
evidence of insurability.
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Advantages of Term:
 Economical way for young families
to purchase large amounts of life
insurance.
 Provides for needs that will
disappear over time.
Disadvantages of Term:
 Premiums become more costly as
you get older.
 Does not build cash value.
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2. Whole life insurance:
Provides death protection
plus a savings feature called
cash value.
If policy canceled prior to
death, insured has right to
cash value; this is the
nonforfeiture right.
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How the cash value accumulates
in a $200,000 whole life policy:
$200,000
$100,000
$0
30
Cash
Value
40
50
60
70
80
Age of insured
90
100
Types of Whole Life Policies:
 Continuous premium (straight life)
Level premiums paid until death or
cancellation of policy.
 Limited payment
Level premiums paid for a specified
number of years; insurance remains
in force until death.
 Single premium
Lifetime coverage purchased with a
single premium.
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Advantages of Whole Life:
Provides a savings vehicle.
Cash value can be borrowed
against.
Premiums remain constant.
Cash value accumulates tax-free
until redeemed.
Disadvantages of Whole Life:
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 Dollar for dollar provides less death
protection than term for young people.
 Relatively low return on savings.
 Loans must be repaid with interest or—
 Tax penalties may be assessed on cash
values withdrawn early.
 If you have a loan outstanding when you
die, that amount is subtracted from the
face value of your policy.
3. Universal life insurance:
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 Provides death protection plus a
savings feature.
 Premiums are “unbundled” into 2
separate accounts.
 Savings grow at the current interest
rate vs. guaranteed minimum rate.
 Provides flexibility in premiums paid
and death benefit.
 Understand the risks before you buy!
4. Other Types of Life Insurance:
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Variable life insurance
– Provides death protection plus a
savings, or cash value, feature.
– Cash value can be invested in a
variety of mutual funds for greater
possible return.
– Returns not guaranteed and actual
death benefit can vary.
Variable universal life insurance
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– Combines the flexibility of premium
payment feature of universal with the
investment choices offered by
variable.
Group life insurance
– Usually term insurance that is offered
through employers.
– Premiums usually lower than those
on individually purchased policies.
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Credit and mortgage life insurance
– Type of decreasing term insurance.
– Pays off outstanding loan balance if
borrower dies before loan is repaid.
– Usually a costly form of coverage.
– Consider increasing your regular term
insurance coverage instead.
Industrial life insurance
– Whole life policies with small face
amounts.
– For low-income families.
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Buying Life Insurance
Know the amount and type of
coverage you need.
Compare costs and features.
Select a large, highly rated,
financially secure company.
Select a reputable agent.
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Key Life Insurance Contract Features
 Beneficiary clause
 Settlement options
 Policy loans
 Premium payments
 Grace period
 Nonforfeiture
options
 Policy reinstatement
 Change of policy
 Multiple indemnity
 Disability clause
 Guaranteed
purchase options
 Suicide clause
 Exclusions
 Participation
 Living benefits
 Viatical Settlement