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10
Financial Planning with Life Insurance
McGraw-Hill/Irwin
Focus on Personal Finance, 2e
Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.
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Life Insurance
Chapter Objectives
1. Define Life Insurance and determine your life
insurance needs
2. Distinguish between the types of life insurance
companies and analyze various types of life
insurance policies these companies issue
3. Select Important provisions in life insurance
contracts and create a plan to buy life
insurance
4. Recognize how annuities provide financial
security
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Objective 1: Define life insurance and determine
your life insurance needs
Life insurance is obtained by purchasing a policy, with the
insurance company promising to pay a lump sum at the time of
the policy holder’s death, or sometimes while they are still alive.
Purpose of Life Insurance
 The purpose of life insurance is to protect someone who depends
on you from financial loss related to your death.
 Other reasons are.
– To pay off a mortgage or debts at the time of death
– Lump-sum payments as endowments for children at a certain
age
– To make charitable bequests upon your death.
– To provide income or education for children.
– Make charitable donations
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Purpose of Life Insurance
Other reasons are
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continued
Provide a retirement income
Accumulate savings
Establish a regular income for survivors
Set up an estate plan
Pay estate and gift taxes
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The Principle of Life Insurance
 Mortality tables provide odds on
your dying, based on your age
and sex.
 Your premium is based on your
life expectancy and the
projections for the payouts
for persons who die.
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Determining Your Life Insurance Needs –
Ask Yourself...
 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, relative, or a charity that you
want to support?
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Estimating Your Life Insurance Requirements
 The Easy Method.
– Typically, you will need 70% of your salary for
seven years while your family adjusts.
 The DINK (dual income, no kids) Method.
 The “Nonworking” Spouse Method.
– Multiply the number of years until the youngest
child reaches 18 by $10,000.
 The “Family Need” Method.
– More thorough than the first three because it also
considers employer provided insurance, Social
Security benefits, and income and assets.
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Objective 2: Distinguish between the types of life insurance companies
and analyze various types of life insurance policies these companies issue
Two Types of Life Insurance Companies
Stock life insurance companies
are 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
its guaranteed premiums.
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Two Types of Life Insurance Companies
(continued)
Mutual life insurance companies.
– Owned by the policyholders.
– 5% of policies are from this type of company.
– With participating policies the premiums are higher
than non-participating policies. However, part of the
premium is refunded
to the policyholders annually. This is called the
policy dividend.
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Types of Life Insurance Policies
 Term life insurance.
– Protection for a specified period of time.
– If you stop paying premiums, coverage stops.
 Many types of Term life insurance
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Renewable term
Multiyear level term
Conversion term
Decreasing term
Return-of-premium term
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Types of Life Insurance Policies
(continued)
 Whole life insurance is also called straight life.
– 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.
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Whole Life Policy Options
 Limited payment policy.
– Pay premiums for a stipulated period, usually 20
or 30 years, or until you reach a specified age
(65).
– Your policy then becomes “paid up” and you
remain insured for life.
 Variable life policy.
– A minimum death benefit is guaranteed, but the
death benefit can be greater than the minimum
depending on earnings of the dollars invested in
the separate fund.
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Whole Life Policy Options
 Adjustable life policy.
(continued)
– A whole life insurance policy, but you can change
your policy as your needs change. For example,
you can change your premium payments or the
period of coverage.
 Universal life - gives you more direct control.
– Lets you pay premiums at any time in almost any
amount. The amount of insurance can be changed
more easily than a traditional policy.
– The increase in the cash value of the policy reflects
the interest earned on short-term investments.
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Other Types of Life Insurance Policies
 Group life insurance.
– Term insurance.
– Often provided by an employer.
– No physical is required.
 Credit life insurance.
– Debt is paid off if you die.
• Mortgage, car, furniture.
– Also protects lenders.
– Expensive protection.
 Endowment Life Insurance
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Key Provisions in a Life Insurance Policy
 Naming your beneficiary, and contingent
beneficiaries.
 Incontestability clause says that 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.
 Nonforfeiture allows you to keep accrued benefits
if you drop the policy.
 Misstatement of age provision.
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Key Provisions in a Life Insurance Policy
(continued)
 Policy loan provision to borrow against cash
value.
 Suicide clause during first two years.
 A rider to a policy modifies the coverage by
adding or excluding conditions or altering
benefits.
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Key Provisions in a Life Insurance Policy
RIDERS TO LIFE INSURANCE POLICIES
(continued)
 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,
insures two lives.
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Buying Life Insurance
 Look at your present and future sources of
income, other savings and income protection,
group life insurance, pension benefits, and Social
Security benefits.
 Determine from whom to buy your policy.
– Examine both private and public sources.
– Look up the company’s rating,
in A. M. Best.
– Talk to friends or colleagues.
– Research ratings on the web,
www.standardandpoor.com.
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Choosing Your Insurance Agent
 Ask friends, parents, and neighbors for
recommendations.
 Find out if the agent belongs to professional
groups or is a Chartered Life Underwriter (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?
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Buying Life Insurance
(continued)
 Compare policy costs which are affected by...
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Their cost of doing business.
Return on their investments.
Mortality rate among policyholders.
Policy features
Competition from other firms
 Use interest-adjusted index to compare policies.
– Takes into account the time value of money.
– Helps you make cost comparisons among insurance
companies.
– See sites such as www.quotesmith.com.
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Obtaining and Examining a Policy
 The first step is to apply.
 The second step is to provide medical
history.
 Usually no physical for a group policy.
 Read every word of the contract.
 After you buy it, you have ten days to change
your mind.
 Give your beneficiaries
and lawyer a photocopy.
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Choosing Settlement Options
 Options are the choices available for how you
can have the life insurance money paid out.
 Lump-sum payment is most common.
 Limited installment plan.
– In equal installments for a specific number of
years after your death.
 Life income option.
– Payments to the beneficiary for life.
 Proceeds left with the company.
– Pays interest to the beneficiary.
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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 will be.
 Are you still insurable?
 Can you get all the provisions you
want?
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Objective 4: Recognize how annuities provide
financial security
Financial Planning with Annuities
 An annuity is a financial contract written by an
insurance company that provides you with a regular
income.
 People buy annuities to supplement retirement income
and to shelter income from taxes.
 Those who expect to live longer than average benefit
most from annuities.
 Annuities are tax-deferred investment plans. You pay
taxes on the interest when you draw the money out.