Chapter 10
Financial Planning with Life Insurance
1
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Life Insurance
Chapter Learning Objectives
LO10.1
LO10.2
LO10.3
LO10.4
Define life insurance and determine
your life insurance needs.
Distinguish between the types of life
insurance companies and analyze
various types of life insurance policies
these companies issue.
Select important provisions in life
insurance contracts and create a plan
to buy life insurance.
Recognize how annuities provide
financial security.
10-2
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Learning Objective LO10.1
Define Life Insurance and Determine Your
Life Insurance Needs
Life insurance:
◦ Obtained by purchasing a policy
◦ The insurance company promises to pay a lump
sum to a named beneficiary at the time of the
policy holder’s death (or sometimes while they
are still alive)
Primary Purpose of Life Insurance:
◦ Protect someone who depends on you from
financial loss related to your death
10-3
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Purpose of Life Insurance
Potential Uses of Benefits:
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Pay off a mortgage or debts
Lump-sum endowments for children
Provide an education or income for children
Make charitable donations
Provide retirement income
Accumulate savings
Establish a regular income for survivors
Set up an estate plan
Pay estate and gift taxes
10-4
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The Principle of Life Insurance
Mortality tables provide odds
on your dying, based on your
age and sex.
Premium (the cost of the
policy) is based on your life
expectancy and the
projections for the payouts
for persons who die
10-5
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Do You Need Life Insurance?
Do you have people you need
to protect financially?
Are you single and have a lot of debt?
Do you have parents, relatives, or a charity
that you want to support?
10-6
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Estimating Your Life Insurance
Requirements
The Easy Method
◦ 70% of your salary for seven years while your
family adjusts
◦ Assumes typical family
The DINK Method
◦ Dual income, no kids
◦ Assumes spouse earnings => insured
◦ Cover funeral + ½ debts
10-7
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Estimating Your Life Insurance
Requirements
The “Nonworking” Spouse Method
◦ # years until the youngest child reaches 18 ×
$10,000
The “Family Need” Method
◦ More thorough than the first three
◦ Considers employer provided insurance, Social
Security benefits, income, and assets
10-8
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Learning Objective LO10.2
Types of Life Insurance Companies and
Policies
2 Types of Life Insurance Companies
Type of Company
Owned by
Policy Type
Stock life
Insurance
Shareholders Nonparticipating
Mutual life
insurance
Policyholders
Participating
10-9
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Stock Life Insurance Companies
Owned by the shareholders
95% are of this type
Sell non-participating (non-par) policies
If you want to pay the same premium
each year choose a non-participating
policy with guaranteed premiums
10-10
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Mutual Life Insurance Companies
Owned by the policyholders
5% of policies are from this type of
company
Participating policy premiums are higher
than non-participating policies
◦ Part of the non-participating premium is
refunded to the policyholders annually in the
form of a policy dividend
10-11
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Types of Life Insurance Policies
Term life insurance
Whole Life insurance
Group Life insurance
Credit life insurance
Endowment Life insurance
10-12
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Term Life Insurance
“Term Life”
◦ Protection for a specified period of time
◦ If you stop paying premiums, coverage stops
Many types:
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Renewable term
Multiyear level term
Conversion term
Decreasing term
Return-of-premium term
10-13
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Whole Life Insurance
“Straight Life”
◦ Pay the premium as long as you live
◦ Amount of premium depends on age when you
start the policy
◦ Provides death benefits
◦ 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
10-14
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Whole Life Policy Options
Limited Payment Policy
◦ You pay premiums for a stipulated period
Usually 20 or 30 years, or
Until you reach a specified age (65)
◦ Policy then “paid up” and you remain insured for
life
Variable Life Policy
◦ Minimum death benefit guaranteed
◦ Benefit can be greater depending on earnings of
the dollars invested in the separate fund
10-15
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Whole Life Policy Options
Adjustable Life Policy
Universal Life
◦ Can change premium payments or period of
coverage as your needs change
◦ Term life policy with a cash value
Can borrow against cash value
◦ Premium amount may be changed at any time
without changing coverage
◦ Part of premium goes to investment account
◦ Increase in cash value reflects interest earned on
short-term investments
10-16
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Other Types of Life
Insurance Policies
Group life insurance
◦ Term insurance
◦ Often provided by an employer
◦ No physical required
Credit life insurance
◦ Debt paid off if you die
Mortgage, car, furniture
◦ Also protects lenders
◦ Expensive protection
Endowment Life Insurance
◦ Coverage for specific time, pays to
holder if still living at end of period
10-17
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Comparison of Major Types of Life
Insurance
10-18
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Learning Objective LO10.3
Select important provisions in life insurance
contracts and create a plan to buy life
insurance
Key Provisions in a Life Insurance Policy
◦ Naming your beneficiary and contingent
beneficiaries
◦ Incontestability clause after the policy has
been in force for a specified period, the company
can’t dispute its validity for any reason
◦ Length of grace period for late payments
◦ Reinstatement of a lapsed policy if it has not
been turned in for cash
10-19
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Key Provisions in a Life
Insurance Policy
Non-Forfeiture Clause
◦ Allows you to keep accrued benefits in a whole
life policy if you drop the policy
Misstatement of age provision
Policy loan provision to borrow against
cash value
Suicide clause during first two years
Policy rider
◦ Modifies the coverage by adding or excluding
conditions or altering benefits
10-20
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Key Provisions in a Life
Insurance Policy
Life Insurance Policy Riders
Waiver of premium disability benefit
Accidental death benefit - double indemnity
Guaranteed insurability option
Cost-of-living protection
Accelerated benefits, also called living benefits,
pay to those who are terminally ill before they
die
Second-to-die option, also called survivorship
life, insures two lives
10-21
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Buying Life Insurance
Consider:
◦ Present and future sources of income
◦ Other savings and income protection
◦ Group life insurance
◦ Pension benefits
◦ Social Security benefits
◦ Financial strength of
the insurance company
10-22
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Buying Life Insurance
Determine from whom to buy your policy
◦ Examine both private and public sources
◦ Research the company’s rating by major rating
companies:
A. M. Best
Standard and Poor’s
Duff & Phelps
Moody’s
Weiss Research
◦ Talk to friends or colleagues
10-23
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Choosing Your Insurance Agent
Ask friends, parents, and neighbors for
recommendations
Is the agent available when needed?
Does the agent advise you to have a financial
plan?
Do you feel pressured?
Does the agent keep current with changes in the
insurance field?
◦ Does the agent belong to professional groups or is a
Chartered Life Underwriter (CLU) who require continuing
education?
Is the agent willing to take the time to answer
your questions and find a policy that is right for
you?
10-24
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Buying Life Insurance
Compare policy costs based on:
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Company’s cost of doing business
Return on company’s investments
Mortality rate among policyholders
Policy features
Competition from other firms
Interest-adjusted index
◦ Used to compare policy costs
◦ Lower index = lower cost policy
10-25
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Obtaining and Examining a Policy
First step = apply
Second step = provide medical history
◦ Usually no physical for a group policy
Read every word of the contract
10-day “free-look” period to change your
mind
Give your beneficiaries
and lawyer a photocopy
10-26
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Choosing Settlement Options
Settlement Options = choices of how the
insurance money is paid out
◦ Lump-sum payment = most common
◦ Limited installment plan
In equal installments for a specific number of
years after your death (10-year certain)
◦ Life income option
Payments to the beneficiary for life
◦ Proceeds left with the company
Pays interest to the beneficiary
10-27
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10 Golden Rules of Buying Life
Insurance
10-28
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Should You Switch Policies?
Switch if benefits exceed costs of getting
another physical, and paying policy set-up
costs
The older you are, the higher the premium
Are you still insurable?
Can you get all the provisions you want?
10-29
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Learning Objective LO10.4
Financial Planning with Annuities
An annuity = a financial contract written by an
insurance company, providing a regular
income
Can supplement retirement income and
shelter income from taxes
Those who expect to live longer than average
benefit most from annuities
Fully fund IRAs, Keoghs and 401(k)s BEFORE
considering an annuity
10-30
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Why Buy Annuities?
Provides retirement income for life
Compounded interest grows tax free
until money withdrawn
No maximum annual contribution (like
IRAs)
Beneficiary guaranteed no less than
amount paid in
10-31
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Types of Annuities
Immediate annuity
Deferred annuity
Fixed annuity
Variable annuity
Index Annuity
Can be included in IRAs and Keogh plans
◦ Income payments begin at once
◦ Payments begin at some point in the future
◦ Annuitant receives fixed amount for life
◦ Amount received depends on investment
performance
◦ Earnings rate based on stock market index
10-32
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Costs of Annuities
Surrender charges
Mortality and expense risk charge
Administrative fees
Fund expenses
◦ Charged if you withdraw money within a certain
period
◦ Usually 1.25% of account value
◦ Flat fee $25-$30 per year
◦ Percentage – usually 0.15% per year
◦ Annual indirect costs imposed by funds
handling underlying investments
10-33
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Tax Considerations of Annuities
Tax Reform Act of 1986
◦ Preserves tax advantage of annuities and insurance
◦ No maximum contribution
◦ Beneficiary guaranteed no less than contributed
Implications of tax deferment
10-34
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Chapter Summary
Learning Objective LO10.1
Life insurance protects the people who
depend on you from financial losses
caused by your death.
Estimation methods:
◦
◦
◦
DINK method
“Nonworking” spouse method
“Family need” method
10-35
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Chapter Summary
Learning Objective LO10.2
Two types of insurance companies:
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Stock insurance companies
Mutual insurance companies
Types of policies:
Nonparticipating
Participating
Two basic types of insurance:
Term life
Whole life
Many variations and combinations
10-36
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Chapter Summary
Learning Objective LO10.3
Most life insurance policies have standard
features.
An insurance company can change the
conditions of a policy by adding a rider to it.
Before buying life insurance, consider all
your present and future sources of income,
then compare the costs and choose
appropriate settlement options.
10-37
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Chapter Summary
Learning Objective LO10.4
An annuity pays while you live, whereas life
insurance pays when you die.
With a fixed annuity, you receive a fixed
amount of income over a certain period or
for life.
With a variable annuity, the monthly
payments vary because they are based on
the income received from stocks or other
investments.
10-38
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