Bảo hiểm - Chapter 11: Life insurance

Chapter 11Life InsuranceAgendaPremature DeathFinancial Impact of Premature Death on Different Types of FamiliesAmount of Life Insurance to OwnTypes of Life InsuranceVariations of Whole Life InsuranceOther Types of Life InsurancePremature DeathThe death of a family head with outstanding unfulfilled financial obligations can cause serious financial problems for the surviving family membersThe deceased’s future earnings are lost foreverAdditional expenses are incurred, e.g., funeral expenses, uninsured medical bills, and estate settlement costsSome families will experience a reduction in their standard of livingNoneconomic costs are incurred, e.g., griefPremature DeathLife expectancy has increased significantly over the past centuryThus, the economic problem of premature death has declinedMillions of Americans still die annually from heart disease, cancer and strokeThe purchase of life insurance is financially justified if the insured has earned income and others are dependent on those earnings for financial supportFinancial Impact of Premature Death on Different Types of FamiliesThe need for life insurance varies across family types:Single personSingle-parent familyTwo income earners with childrenTraditional familyBlended familySandwiched familyAmount of Life Insurance to OwnThree approaches can be used to estimate the amount of life insurance to own:The human life value approachThe amount needed depends on the insured’s human life value, which is the present value of the family’s share of the deceased breadwinner’s future earningsTo calculate:Estimate the individual’s average annual earnings over his or her productive lifetimeDeduct taxes, insurance premiums and self-maintenance costsUsing a reasonable discount rate, determine the present value of the family’s share of earnings for the number of years until retirementAmount of Life Insurance to OwnThe needs approachThe amount needed depends on the financial needs that must be met if the family head should dieImportant family needs must consider:An estate clearance fund: cash needed for burial expenses, uninsured medical bills, and taxesIncome needed for the readjustment period, a 1-2 year period in which the family adjusts to its new living standardThe dependency period is the period until the youngest child reaches age 18Life income to the surviving spouse, including income during and after the blackout period. The blackout period refers to the period from the time that Social Security survivor benefits terminate to the time the benefits are resumedFamilies should also consider special needs, e.g., funds for college education and emergenciesExhibit 11.1 How Much Life Insurance Do You Need?Amount of Life Insurance to OwnThe capital retention approachThis approach preserves the capital needed to provide income to the family Income-producing assets are preserved for the heirsTo calculate:Prepare a personal balance sheetDetermine the amount of income-producing capitalDetermine the amount of additional capital needed to meet the family needsInternet-based life insurance calculators produce widely-varying results, but may be a good starting pointAmount of Life Insurance to OwnMost families own an insufficient amount of life insuranceAbout one in five households have no life insuranceConsumers procrastinate, and have difficulty in making correct decisions about the purchase of life insuranceMany families have only a limited amount of discretionary incomeThe purchase of life insurance reduces the amount of discretionary income available for other needsMany families are in debt and have little savingsAfter payment of high priority expenses, such as a mortgage, food and utilities, many families have only a limited amount of income to purchase life insuranceTypes of Life InsuranceLife insurance policies can be classified in two general categories:Term insurance provide temporary protectionCash-value life insurance has a savings component and builds cash valuesThere are many variations of both types available todayTypes of Term Life InsuranceUnder a term insurance policy, protection is temporaryProtection expires at the end of the policy period, unless renewedMost term policies are renewable for additional periods Premiums increase at each renewalMost term policies are convertible, which means the policy can be exchanged for a cash-value policy without evidence of insurabilityUnder the attained-age method, the premium charged for the new policy is based on the insured’s attained age at the time of conversionUnder the original-age method, the premium charged for the new policy is based on the insured's original age when the term insurance was first purchasedTypes of Term Life InsuranceYearly-renewable term insurance is issued for a one-year periodTerm insurance can also be issued for 5 or more yearsA term to age 65 policy provides protection to age 65, at which time the policy expiresUnder a decreasing term insurance policy, the face value gradually declines each yearUnder a reentry term insurance policy, renewal premiums are based on select (lower) mortality rates if the insured can periodically demonstrate acceptable evidence of insurability (i.e., good health)Under a return of premiums term, the premiums are refunded if the policyowner outlives the term of the policyUses and Limitations of Term Life InsuranceTerm insurance is appropriate when:The amount of income that can be spent on life insurance is limitedThe need for protection is temporaryThe insured wants to guarantee future insurabilityHowever, Term insurance premiums increase with age at an increasing rate and eventually reach prohibitive levelsTerm insurance is inappropriate if you wish to save money for a specific needExhibit 11.2 Examples of Term Life Insurance PremiumsTypes of Whole Life InsuranceWhole life insurance is a cash value policy that provides lifetime protectionA stated amount is paid to a designated beneficiary when the insured dies, regardless of when the death occursTypes include:● Ordinary life ● Limited-payment life ● Endowment insurance ● Variable life ● Universal life● Variable universal life● Current assumption whole life● Indeterminate-premium whole lifeTypes of Whole Life InsuranceOrdinary life insurance is a level-premium policy that provides lifetime protectionPremiums are level throughout the premium paying periodThe excess premiums paid during the early years are used to supplement the inadequate premiums paid during the later years of the policy. It is referred to as a legal reserveThe insurer’s legal reserve is a liability that must be offset by sufficient financial assetsThe net amount at risk is the difference between the legal reserve and the face amount of coverageExhibit 11.3 Relationship Between the Net Amount at Risk and Legal Reserve (1980 CSO Mortality Table)aTypes of Whole Life InsuranceAnother characteristic of ordinary life insurance policies is the accumulation of cash surrender valuesA policyholder overpays for insurance protection during the early years, resulting in a legal reserve and the accumulation of cash valuesBecause of the loading for expenses and high first-year acquisition costs, cash values are initially below the legal reserveThe policyowner has the right to borrow the cash value or exercise a cash surrender optionsAn ordinary life policy is appropriate when lifetime protection is neededTypes of Whole Life InsuranceThe major limitation of ordinary life insurance is that some people are still underinsured after the policy is purchasedA term policy for the same premium would purchase substantially more protectionUnder a limited-payment life insurance policy, the insured has lifetime protection, and premiums are level, but they are paid only for a certain periodA single-premium whole life policy provides lifetime protection with a single premiumEndowment insurance pays the face amount of insurance if the insured dies within a specified period. If the insured is still alive at the end of the period, the face amount is paid to the policyholderVariations of Whole Life InsuranceInsurers have developed a wide variety of whole life productsVariable life insurance is a fixed-premium policy in which the death benefit and cash values vary according to the investment experience of a separate account maintained by the insurerThe premium is levelThe entire reserve is held in a separate account and is invested in common stocks or other investmentsIf the investment experience is favorable, the face amount of insurance is increased Cash surrender values are not guaranteedAlthough the insurer bears the risk of excessive mortality and expenses, the policyholder bears the risk of poor investment resultsVariations of Whole Life InsuranceUniversal Life Insurance is a flexible premium policy that provides lifetime protectionAfter the first premium, the policyholder decides the amount and frequency of paymentsMost policies have a target premium, but the policyowner is not obligated to pay itThe protection and savings components are unbundledthe policyholder’s statement shows the premiums paid, death benefit, and value of the cash value account It also shows the mortality charge and the interest credited to the cash value accountVariations of Whole Life InsuranceThere are two forms of universal life insurance:Option A pays a level death benefit during the early yearsThe death benefit increases in later years to meet the corridor test required by the Internal Revenue CodeOption B provides for an increasing death benefitThe death benefit is equal to a constant net amount at risk plus the accumulated cash valueExhibit 11.4 Two forms of Universal Life Insurance Death BenefitsVariations of Whole Life InsuranceUniversal life provides considerable flexibilityCash withdrawals are permittedPolicies receive favorable federal income tax treatmentLimitations of universal life policies include:Insurers advertise misleading rates of returnCash-value and premium-payment projections based on higher interest rates are misleading and invalidInsurers can increase the current mortality charge to recoup expensesA policy may lapse because some policyowners do not have a firm commitment to pay premiumsExhibit 11.5 $100,000 Universal Life Policy, Level Death Benefit, Male Age 25, Nonsmoker, 5.5 Percent Assumed Interest (con’t)Exhibit 11.5 $100,000 Universal Life Policy, Level Death Benefit, Male Age 25, Nonsmoker, 5.5 Percent Assumed InterestVariations of Whole Life InsuranceVariable universal life is an important variation of whole life insuranceMost are sold as investmentsSimilar to universal life except that:The policy owner decides how the premiums are investedThe policy does not guarantee a minimum interest rate or minimum cash valueThese policies have relatively high expense charges, including front-end loads for sales commissions, back-end surrender charges, and investment management feesVariations of Whole Life InsuranceCurrent assumption whole life insurance is a nonparticipating whole life policy in which the cash values are based on the insurer’s current mortality, investment, and expense experienceAn accumulation account reflects the cash value under the policyIf the policy is surrendered, a surrender charge is deducted from the accumulation accountA guaranteed interest rate and current interest rate are used to determine cash valuesA fixed death benefit and maximum premium level at the time of issue are stated in the policyTwo forms of current assumption whole life products:Low-premium products, with a low initial premiumHigh-premium products, with a vanishing premium provisionExhibit 11.6 Comparison of Major Life Insurance ContractsVariations of Whole Life InsuranceAn indeterminate-premium whole life policy is a generic name for a nonparticipating policy that permits the insurer to adjust premiums based on anticipated future experienceAfter an initial guaranteed period, the insurer can increase premiums up to the maximum limit if the insurer’s experience is expected to worsenOther Types of Life InsuranceA modified life policy is a whole life policy in which premiums are lower for the first three to five years and higher thereafterPreferred risk policies are sold at lower rates to individuals whose mortality experience is expected to be lower than average (e.g., a non-smoker)Second-to-Die life insurance insures two or more lives and pays the death benefit upon the death of the second or last insuredUsually whole life, but can be termOther Types of Life InsuranceSavings Bank Life Insurance (SBLI) is a type of life insurance that is sold by savings banksPolicies were sold originally by savings banks in Massachusetts, NY and ConnecticutSBLI is also sold over the phone or through WebsitesHistorically, industrial life insurance was a class of life insurance that was issued in small amounts and an agent of the company collected the premiums at the insured’s homeAlso known as home service life insuranceGroup life insurance provides life insurance on a group of people in a single master contract