Life Insurance
Chapter 11
Planning Your Financial Future, 4e
by: Boone, Kurtz & Hearth
Why Purchase Life Insurance?
 If
you are single with no dependents, you may not
need any life insurance
 But if you have family members who are financially
dependent on you, reasons include:


Cash for immediate needs
Readjustment funds
 Will spouse need time to find work, relocate, etc.?


Replacement income
Special situations
 Help pay off the mortgage, finance child’s college, etc.
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Figure 11.1: Estimating Life
Insurance Needs
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How Your Life Insurance Needs
Change Over Time
 When you’re young, you may have no need for life
insurance
 As you get married, have children, have a mortgage
payment, etc., your need for life insurance increases
 As you get older (and have paid down your
mortgage and have substantial investments), your
life insurance needs may decrease
 DEFINITELY review your needs as you
experience major life changes
4
Types of Life Insurance Policies
 Term insurance

Only provides death benefit
 Whole life insurance

Combines a savings feature with death benefits
 Universal life insurance

Combines a savings feature with death benefits
5
Term Insurance
 Offers protection for a specified term (period
of time) and has no value at end of term

If policy expires and you don’t die, insurance
company has no further obligation to you
 Advantage

Inexpensive
 Can generally buy five to ten times as much term
insurance as other life insurance for same premium
6
Term Insurance
 Level term vs. decreasing term

Level term: fixed premium and a fixed amount
of coverage
 Commonly issued for one-, five-, and ten-year terms

Decreasing term: policy with a declining amount
of coverage over time (but premiums remain the
same)
 As you pay off mortgage, children leave home, etc.,
need less insurance
7
Term Insurance
 Conversion and renewable features

Many term policies offer these features at additional cost
 Automatic renewal at term end


Can renew for at least one more term w/o another physical exam
Many companies permit renewal as many times as you’d like up to
age 70 or so
 Term insurance can be converted to another type of life
insurance


Usually limited to coverage equal to or less than current coverage
May require that the conversion occur within a certain time period
(well before term expires)
8
Term Insurance
 Deposit term insurance



Pay a deposit (about $10 for every $1,000 of coverage)
on top of regular premium
Deposit is placed into high-rate, interest-bearing
account
If you maintain insurance coverage for term period,
you’ll get back deposit plus interest
 If you let policy lapse, you lose deposit plus interest
 If you die during term, your beneficiary gets deposit plus
interest and face amount of policy


Cheapest form of life insurance, if you keep policy
One of most expensive if you let policy lapse
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Whole Life Insurance
 Purchase for your entire (whole) life
 Premiums spent on whole life insurance are divided
between insurance protection and savings


Makes whole life more expensive
Cost during early years of policy exceeds actual cost of
insurance protection, while cost in later years is less
than needed
 Insurance company invests the excess amount collected in early
years of policy to cover increasing risk in later years of policy
10
Whole Life Insurance
 Straight life insurance (AKA continuous premium
whole life insurance or ordinary whole life
insurance)

Premiums remain same over life of policy
 Premiums determined by your age/health at inception of policy
 Most life insurance policies are of this type

Within first three years of policy, it begins to build a cash
value (accumulated savings). As time passes, cash value
increases
 You can borrow all or a portion of this cash value at a relatively
low interest rate, which doesn’t have to be paid back (but policy
payout upon insured's death is reduced by loan plus interest)
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Whole Life Insurance
 Limited-payment whole life insurance

Lasts entire life of policyholder, but premiums are only
paid for a limited number of years—10, 20 or 30 years
 Premiums are higher, but cash value increases more rapidly
 Critics argue why pay higher premiums during years when your
need for living income is greater, whereas by the time you pay
off your policy (say 30 years from now), your need for life
insurance may be less (or zero)
12
Universal Life Insurance
 Combines term insurance protection with a
savings account

Part of each year’s premium is used to buy lowcost term insurance and remainder placed into
high-yield investments
 Policyholders are not taxed on investment earnings

When policyholder dies, beneficiaries receive
policy amount plus accumulated earnings
13
Universal Life Insurance

Advantages





Policyholder can vary amount contributed to savings portion once initial
premiums are paid
Can adjust (up [assuming good health] or down) the amount of term
insurance coverage
Can use cash value to pay part of all of annual premiums or to raise death
benefit
Can make tax-free withdrawals from investment portion as long as
withdrawal doesn’t exceed total amount already paid in premiums
Disadvantage

Much more expensive than term insurance
 A 30-year-old spending $200 a year in premiums can buy $250,000 of term
insurance, but only $50,000 universal life insurance
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Other Life Insurance Options
 Group life insurance



Available at rates lower than rates for most individuals
Often available as a perk with your job
If you leave your job, coverage ends
 May have option of converting group coverage to individual
coverage
 Variable life insurance

Combines a straight life policy with an investment that
could increase the death benefit (but only if the insurance
company’s investments perform well)
 Policy’s cash value can fall from year to year if investments do
poorly
15
Other Life Insurance Options
 Credit life

Guarantees your debt will be paid off if you die
 Protects lender and your family


It’s actually decreasing term insurance with the term
equal to the length of loan
Very expensive
 Some critics view as a rip-off
 May be worth it if you’re in poor health and find it difficult to
obtain life insurance
16
Which Type of Life Insurance is
Right for You?
 Do you need or want


Just insurance protection
Insurance protection combined with savings
 Why not pay lower (in some cases, MUCH lower)
term life insurance rates and put the extra money
you’d be saving since you didn’t buy whole life, etc.
into investments yourself ?

You’ll probably earn more money in the long run
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Table 11.1: Comparing the Cost of
Term to Whole Life Insurance
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Term vs. Whole Life
 Most insurance companies argue that term
life policyholders will outlive their terms and
to obtain a new policy will be very expensive
 Experts argue that term insurance is still a
good buy for people in their 50s


May not need much insurance at this stage
anyway
Goal could be to be self-insured by age 60
19
The Life Insurance Contract
 Beneficiary clause

Names the person(s) or organization to receive policy
proceeds
 Proceeds aren’t subject to income taxes but may have to pay
estate taxes


Names secondary beneficiaries
Can be changed—unless you name an irrevocable
beneficiary
 Settlement options

Lump sum vs. periodic payments (life income, fixed
income, interest only with principal in lump sum at later
date)
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The Life Insurance Contract
 Premium payment clause

Premium amount, how often (quarterly, monthly,
annually)
 Dividend clause


Only with mutual life insurance companies
Specifies how dividends are paid
 Reducing future premiums
 May offer various options

Cash, premium reduction, purchase additional life insurance
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The Life Insurance Contract
 Accidental-death clause

If policyholder dies by accident, get extra benefit
 AKA as double- (or triple-) indemnity clause

Restrictions




Suicide
Riot/insurrection
Airplane disaster
During commission of a felony
 Suicide clause

Limits company’s liability within first two years of
policy to amount already paid in premiums
22
The Life Insurance Contract
 Waiver-of-premium clause

If you become disabled (or lose your job), the insurance
company may waive the premium for some time period
so that you don’t lose coverage (and company doesn’t
lose client)
 Guaranteed insurability clause

Policyholder has right to purchase additional insurance
without physical
 Usually obtainable through age 40
 Good idea for younger policyholders who can’t afford premiums
for additional insurance right now
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The Life Insurance Contract
 Nonforfeiture option

Protects you if policy lapses and your policy has cash value
 May surrender policy for portion of cash accumulated by your
premium payments
 May use cash value as a single premium and buy a reduced amount of
paid-up life insurance
 May use cash value to buy term insurance for as long as the single
premium will provide
 Policy reinstatement

Allows policyholders to put a lapsed policy back into effect if
policyholder
 Offers proof of continued insurability
 Pays accumulated premiums plus interest
 May have to meet specified time frame
24
Buying Life Insurance
 Shop around
 Impossible to compare value of
term insurance to
cash-value policies
 Make sure you compare similar policies (amount,
term, renewability options, etc.)
 Rates are usually quoted per $1,000 of coverage

But, rates on larger policies don’t increase in a linear
fashion
25
Net Cost Method
 With policies having cash value
 Value of premiums paid less accumulated cash
value

Can even show a negative net cost (suggesting policy
‘pays for itself ’)
 Ignores interest you could have earned if
you had
invested premiums
 Company could assume an abnormally high
investment return on cash value
26
Interest-Adjusted Cost Index
Method
 Considers total premiums paid, accumulated cash
value, value of accrued dividends, and what
interest buyer could have earned had premiums
been invested
 You’d like to see this value for different points in
time

5-, 10-, 20-years
 You should request to see this method
 The lower the index, the cheaper the policy
27
Choosing the Right Company
and Agent
 Check out their financial rating


Standard & Poor’s or A.M. Best
Only buy from firm with high rating
 Remember, most agents receive a commission


Higher the more insurance you buy
Higher with cash value policies
 Analyze your needs, read up on the policies, and buy

straight from insurance company—bypass the agent
Use an online quotation service

Such as http://www.insurance.com/
28
Web Links
 Information about ratings is
available at:
 http://www.ambest.com/
 http://info.insure.com/ratings
29
Common Sales Pitches
 You wouldn’t be able to afford term life insurance
when you’re old

May not need life insurance then
 A cash value policy is a form of

forced savings
True, but you’ll probably earn more reinvestment return
if you invest the money yourself
 Cash value policies offer tax-deferred savings

So does a 401(k) and other retirement plans and will
probably earn higher returns!
30
Common Sales Pitches
 You may not need insurance now but if
you
buy it now it will cost less and guarantee
future insurability

Odds of developing a health problem that will
cause future uninsurability are small
 After X number of
years, you’ll no longer
have to pay a premium

Often based on assumption that insurance
company will earn very high interest rates
31
Long-Term Care Insurance
 About 40% of
all people who recently turned 65
will need long-term care

Odds are higher for women
 Long-term care is very expensive

Average cost of nursing home is $125 per day
 Rising at a rate greater than inflation
 Medicare doesn’t pay for extended long-term care
 Medicaid does pay, but only after you’ve used up
your assets
32
Should People Purchase LongTerm Care Insurance?
 It is expensive
 Typical nursing home stay is fairly short

Highly unlikely a long-term care policy will ever pay for
itself
 Unless you stay in a nursing home for a lengthy time period and
few people do
 Medicare will pay the bulk of
nursing home bills if
certain conditions are met
 Medicaid will pay if a person depletes his assets

Some nursing homes won’t take Medicaid patients
33
Buying the Right Long-Term
Care Policy
 Relatively new type of

insurance
Policies and premiums differ widely
 Shop around and do your homework
 The younger you are when you buy the policy, the
cheaper the policy

Typical policy doesn’t increase the benefits paid in
tandem with the expected increase in costs
 Thus the gap between costs and benefits paid will be greater
than younger you are when you buy your policy
34
Figure 11.6: The Impact of Inflation on a
Long-Term Care Insurance Policy
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