Chapter 5

Types of Family

Types of Family

Premature Death: death of family head w outstanding unfulfilled financial obligations as: cost of living & education & pay off mortgage.

Cost of Premature Death:

1-PV of family share of future earnings. 2-Cost of funeral, medical bills & tax. 3-Reduction of standard of living. 4-Emotional grief, loss of parental model & children

counseling & guidance.

Chance of Dying Prematurely: 3 reasons: heart disease, cancer & stroke.

Types of FamilyFinancial Impact of Premature Death:

1-Single People: divorced or not married person, need small amount of life insurance to cover burial cost & uninsured medical bills.

2-Single Parent Families: widow, divorced or separated spouse with children need great amount.

3-Two Income Families: a)both wife & husband work without children so, no need for life insurance or they need small amount.

Types of Familyor b)both wife & husband work with children (one outside home), if spouse work outside dies they need large amount of ins. (living cost) & if spouse work inside dies so, larger amount of insurance is needed (cost of living & childcare).

4-Traditional Families: wife & husband with children & one works outside home, they need large amount of life ins. if working spouse dies (cost of living) or larger amount if non-working spouse dies (cost of childcare & cost of living).

Types of Family

5-Blended Families: divorced or widowed spouses w children remarried a spouse w children need large amount if one dies & need the highest amount of insurance if working spouse or both dies.

6-Sandwiched Families : son or daughter with children is supporting one or both parents so, they need huge amount of life insurance.

Types of FamilyAmount of life insurance to own : 3 approaches1-Human life value approach.2-Needs approach.3-Capital retention approach1-Human life value approach: PV of family

share of deceased future earnings & calculated as follows:

a) Calculate average annual earnings. b) Deduct: tax, ins. prem.& his personal needs (1-2= share of family earnings)c) # of years (retirement age – your age)d) Insurance amount = PV of family earnings share.

Types of FamilyEx: Ali, age 40, earns $12,000 annually, tax,

insurance premium & personal needs $4,000 married &

has 3 kids, retired at 60.Solution: Insurance amount = $8,000 x PV of

annuity for 20 years at 8% (8,000 x 10,603599 = $84,829.

Advantage: easy to calculate. Disadvantage: a)Other sources of income not considered. b)Assumed constant earnings & expenses. c)Amount allocated to family isn't constant &

depend on divorce or birth.

Types of Familyd)Ins. amount depends on discount rate which

is difficult to predict. e)Ignored inflation effect.

2-Needs Approach: family needs if family head dies minus existing assets & life ins.

Family Needs: a)Estate clearance fund (burial exp., medical

bills, debts, tax). b)Income during readjustment period (1-2

years after death). c)Income for dependency period (kids=18).

Types of Familyd)Life income to surviving spouse if doesn't

work (income in blackout period from time social security stop until resume, income to supplement social security (60 year)).

e)Special needs: education, mortgage pay off, emergency fund: home & car repair cost.

f)Retirement needs for family's head: in addition to social security, employer retirement benefits (annuities & investments).

Types of FamilyIllustration of Needs Approach:

1-Amount needed to meet: Cash, Income & Special Needs.

2-Present available total assets: Pension, Fund, Ins, Property, Social Security Benefits.

3-Amount of life ins. needed: Total Needs - Total Assets (1-2)

Advantages:

1-Reasonable & accurate.

2-Consider assets & other sources of income

3-Consider needs for disability or retirement.

Types of Family

Disadvantage:

1- Difficult to predict future needs & depends on assumptions.

2- Family needs change (divorce, death, birth) so, must periodically evaluated.

3- Ignore inflation, then ins. amount will be less than actual needs.

4- Ignore preservation of estate assets for heir.

Types of Family3-Capital Retention Approach: produce the capital

needed to provide needed income to the family.

Steps of Calculating Amount of Insurance:

1-Prepare a Personal Balance sheet: Assets (death benefits from: pension, group ins. & other source, investments, property) & Liability (mortgage, auto loan, debts, bills).

2-Determine the Amount of Income-Producing Capital: Amount that produces income to the family=Total Assets –

(Liabilities, Cash Needs: education, emergency & maintenance fund & Non-Income Producing Capital: car, home)

Types of Family

3-Determine the additional needed capital =Additional Needed Capital ÷ Interest Rate

Additional Needed Capital = Needed Income - Available Income (pension, social security).

Advantages: 1-Easy to calculate, understand & preserve capital.

2-Income of emergency & education fund hedge inflation.

3-Consider needs for disability or retirement.

Disadvantage: produce large amount of insurance.

Types of FamilyMethods for Providing Life Insurance

Protection:

1-Yearly Renewable Term Method: provide insurance for 1 year w right to renew it each year without prove of insurability but w higher prem. (bad health renew & good won't-adverse selection), so, it is not practicable for long time protection.

2-Level Premium Method: insured pays equal prem. each year as long as he still alive up to 100. Prem. is more than natural prem. during 1st term & less 2nd term & the differences are called legal reserve.

Types of FamilyPurpose of Legal Reserve: help providing whole

life insurance w level (equal) premium & used in later years to supplement deficiency in prem.

Net Amount at Risk = Ins. Amount – Legal Reserve Insurance Amount = Legal Reserve + Net Amount at

Risk Amount of Insurance = Saving + Protection Element

Cash Value: if insured needs to cancel the policy (surrender), he has the right of legal reserve (surrender value) but after 10-15year