Chapter 2:
Life Insurance Planning
Objectives
• Identify the purpose of life insurance and
the reasons for buying it.
• Recognize that the need for life insurance
varies over the course of one’s life and
identify the procedures used to calculate
life insurance needs.
Objectives
• Distinguish among the various types of
term and cash-value life insurance policies.
• Describe and explain the purpose of the
major provisions of life insurance policies.
• Discuss important points to consider when
choosing and buying life insurance.
What is the Purpose of
Life Insurance?
• To protect people who depend on you from
financial loss related to your death
– 78% of all American households have it
• To make charitable bequests upon your death
• To save money for retirement or children’s
education
• To leave as part of your estate
• To pay off a mortgage or other debts at the
time of death
The Principle of Life Insurance
• Mortality tables provide
odds on your dying, based
on your age and sex
• Your premium is based on
the projections for the
payouts for persons who die
Determining Your Life Insurance
Needs - Ask Yourself...
• Do you need life insurance?
– do you have people you need
to protect financially?
– does your partner work?
• What are your objectives for life insurance?
– to accumulate money for retirement?
– to provide funds when you die?
– how much can you afford?
Estimating the Amount of
Life Insurance You Need
The Easy Method
– typically, you will need to have enough
insurance to cover 70% of your income for
seven years
The DINK (dual income, no kids) Method
The “Nonworking” Spouse Method
The “Family Need” Method looks at
– employer provided insurance
– Social Security benefits
– income and assets
Determining Life Insurance Needs
1. Multiple-of-Earnings Approach
• The simplest method for estimating your clients’ life insurance needs is
the multiple-of-income approach. The goal of this approach is to replace
the primary breadwinner’s salary for a predetermined number of years.
• Begin by multiplying the client’s current annual income by how many
years they want to provide financial support for their survivors. The
recommendation is to have seven to ten years of life insurance.
• It’s an easy method, but it doesn’t take into account the specific needs of
survivors, other sources of funds — such as the survivors’ income and
investments — or different types of family structures. For example, this
method may work well for a family with one child, but might not work as
well for a family with six children. It also doesn’t take into account
inflation or future salary increases. Using this approach may lead to overinsuring or underinsuring your clients, but it’s a start
Human Life Value Approach
• This method considers your client’s age, gender, occupation, current and
future earnings, and employee benefits. There are several steps to
determining the overall value of the client if they were to die today:
• Estimate the client’s earnings from now until a set point in the future —
typically their expected retirement age. Be sure to factor in future wage
increases as well.
• Subtract the insured’s annual taxes and living expenses from the total. It’s
usually safe to assume 30 percent of their salary will go to taxes.
• Select an assumed rate of return on the remaining total and subtract it
from the gross amount. In other words, subtract the interest you expect
the money to earn.
• Add the cost of additional benefits provided through employment, such as
health care, that will need to be replaced when the client dies. Remember
to account for inflation.
• The primary goal of this method is to replace income lost. It doesn’t
necessarily account for funeral costs, children’s educational expenses, or
other specific future needs.
Capital Need Approach
• The capital needs analysis is the most widely-used approach
for estimating life insurance coverage. In addition to replacing
the client’s salary, it also accounts for other sources of income
and the specific needs of survivors.
• This method factors in:
• Current and future income of both the insured and surviving
spouse
• Immediate lump-sum cash needs upon death, such as funeral
expenses, debt repayment, and mortgage payoff
• Future expenses such as college, weddings, long-term care
expenses, and retirement funding
• Existing family assets, retirement funds, or insurance policies
• Once all future needs are taken into consideration, there are then two
ways to calculate how much insurance the client needs, based on how
they want to utilize the funds in the future.
• Earnings-Only Approach: The survivors will live off only the investment
earnings of the policy without cashing in the principal value. This method
is preferable if the client wants funds to be available for their children
after their spouse has also died. Like any investment, this method is
subject to the risk of changing market interest rates. To provide a sufficient
income stream, the death benefit is usually significantly higher than in the
liquidation approach.
• Liquidation Approach: The surviving beneficiary utilizes a portion of the
principal as well as the investment earnings. There is more risk with this
approach, particularly if the investment earns less than originally
predicted. The surviving spouse may not have sufficient income to live on
for the remainder of their life.
Types of Life Insurance Policies
Term life insurance
– protection for a specified period of time
– if you don’t pay premiums, coverage stops
– renewability option
• at the end of the term you can renew the
policy without having a physical checkup.
Types of Life Insurance Policies
 Term life insurance (continued)
– conversion option
• can change your policy from term to a whole life
policy without a physical check
– decreasing term insurance
• your premium stays the same, but the amount of
coverage decreases as you age
12-8
Types of Life Insurance Policies
(continued)
Whole life insurance
– you pay a premium as long as you live
– amount of premium depends on your age when
you start the policy
– provides death benefits and accumulates a cash
value
– you can borrow against the cash value or draw it
out at retirement
– look carefully at the rate of return your money
earns
Whole Life Policy Options
• Nonforfeiture clause
– if you stop paying premiums you can use the
cash value in a variety of ways.
• Limited payment policy
– pay higher premiums during your earning
years only, keeping lifetime coverage
• Variable life policy
– minimum death benefit guaranteed, but can
be more depending on how your premium
dollars are invested
Whole Life Policy Options
(continued)
• Adjustable
– you can change your premium amount and
thus your coverage
• Universal life
– lets you pay premiums in almost any
amount
– combines term insurance and investment
elements
Decreasing Term Insurance
Comparison of Term vs. Cash Value
Types of Policies Issued in 1994*
Term
22%
Whole Life
45%
Decreasing
2.0%
Variable
2%
Universal
11%
Other
10%
*1997 Insurance Fact Book
Variable Universal
8%
12-12
Other Types of Life Insurance Policies
Group life insurance
– often through an employer
– no physical required
– usually term insurance
Credit life insurance
– debt is paid off if you die
• mortgage, car, furniture
– also protects lenders
– expensive protection
Life Insurance Contract Provisions
• Naming your beneficiary (one or more)
• Length of grace period for late payments
• Reinstatement of a lapsed policy if it has not
been turned in for cash
• Suicide clause during first two years
• Automatic premium loans
– uses the accumulated cash value
to pay the premium if you do not
Life Insurance Contract Provisions
(continued)
• Misstatement of age provision
• Policy loan provision
– can borrow against your cash value
• Rider to add or alter benefits
– cost of living protection
• Waiver of premium disability benefit
• Accidental death benefit
– pays twice the policy face amount
• Guaranteed insurability option
• Accelerated benefits
Buying Your Life Insurance
• Look at your income, savings, group life
insurance, and Social Security benefits
• Compare policy costs which are affected by
– cost of doing business
– return on its investments
– mortality rate among policyholders
– features of the policy
– competition from other companies
Buying Your Life Insurance
(continued)
• Use the interest-adjusted index to compare
policies
– takes into account the time value of money
– helps you make cost comparisons among
insurance companies
• Determine from whom to buy your policy
– examine both private and public sources
– look up the company’s rating
Choosing Your Insurance Agent
• Ask friends, parents and neighbors for
recommendations
• Find out if the agent belongs to professional
groups or is a CLU
• Is the person willing to take the time to answer
your questions and find a policy that is right for
you?
• Do they ask about your financial plan?
• Do you feel pressured?
• Are they available when needed?
Obtaining and Examining a Policy
• Apply and provide
medical history
• Read all of the contract
• After you buy it you
have ten days to change
your mind
• Give your beneficiaries
and lawyer a copy
Choosing Settlement Options
• Options are the choices for how
you want the money paid out
• One lump-sum is most common
• Limited installment plan
– in equal installments for a specific number of
years after your death
• Income for life
– payments to the beneficiary for life
• Proceeds left with the company
– pays interest to the beneficiary
Should You Switch Policies?
• If benefits exceed costs of
getting another physical and
paying policy set up costs.
• Are you still insurable?
• Can you get all the provisions
you want?
Financial Planning with Annuities
• What is an annuity?
– a contract where you pay money in, and at
a certain date get regular payments back during
your lifetime
• Why do people buy annuities?
– to supplement retirement income and to shelter
income from taxes
• How are annuities taxed?
– income deducted and interest earned is not
taxed until you draw the money out