life insurance 1

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Life InsuranceLife Insurance

Premature DeathPremature Death Financial Impact of Premature Death Financial Impact of Premature Death

on Different Types of Familieson Different Types of Families Amount of Life Insurance to OwnAmount of Life Insurance to Own Types of Life InsuranceTypes of Life Insurance

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Premature DeathPremature Death

The death of a family head with outstanding The death of a family head with outstanding unfulfilled financial obligations can cause unfulfilled financial obligations can cause serious financial problems for the surviving serious financial problems for the surviving family membersfamily members– The deceased’s future earnings are lost foreverThe deceased’s future earnings are lost forever– Additional expenses are incurred, e.g., funeral Additional expenses are incurred, e.g., funeral

expenses, uninsured medical bills, and estate expenses, uninsured medical bills, and estate settlement costssettlement costs

– Some families will experience a reduction in their Some families will experience a reduction in their standard of livingstandard of living

– Noneconomic costs are incurred, e.g., griefNoneconomic costs are incurred, e.g., grief

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Premature DeathPremature Death

Life expectancy has increased Life expectancy has increased significantly over the past centurysignificantly over the past century– Thus, the economic problem of premature Thus, the economic problem of premature

death has declineddeath has declined– Millions of people still die annually from Millions of people still die annually from

heart disease, cancer and strokeheart disease, cancer and stroke The purchase of life insurance is The purchase of life insurance is

financially justified if the insured has financially justified if the insured has earned income and others are earned income and others are dependent on those earnings for dependent on those earnings for financial supportfinancial support

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Financial Impact of Financial Impact of Premature Death on Premature Death on Different Types of FamiliesDifferent Types of Families The need for life insurance varies The need for life insurance varies

across family types:across family types:– Single personSingle person– Single-parent familySingle-parent family– Two income earners with childrenTwo income earners with children– Traditional familyTraditional family– Blended familyBlended family– Sandwiched familySandwiched family

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Amount of Life Insurance Amount of Life Insurance to Ownto Own

Three approaches can be used to estimate Three approaches can be used to estimate the amount of life insurance to own:the amount of life insurance to own:– The human life value approachThe human life value approach

The amount needed depends on the insured’s The amount needed depends on the insured’s human life human life value,value, which is the present value of the family’s share of which is the present value of the family’s share of the deceased breadwinner’s future earningsthe deceased breadwinner’s future earnings

To calculate:To calculate:– Estimate the individual’s average annual earnings over his Estimate the individual’s average annual earnings over his

or her productive lifetimeor her productive lifetime– Deduct taxes, insurance premiums and self-maintenance Deduct taxes, insurance premiums and self-maintenance

costscosts– Using a reasonable discount rate, determine the present Using a reasonable discount rate, determine the present

value of the family’s share of earnings for the number of value of the family’s share of earnings for the number of years until retirementyears until retirement

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Amount of Life Amount of Life Insurance to OwnInsurance to Own

– The needs approachThe needs approach The amount needed depends on the financial needs that The amount needed depends on the financial needs that

must be met if the family head should diemust be met if the family head should die Important family needs must consider:Important family needs must consider:

– An An estate clearance fund:estate clearance fund: cash needed for burial expenses, cash needed for burial expenses, uninsured medical bills, and taxesuninsured medical bills, and taxes

– Income needed for the Income needed for the readjustment periodreadjustment period, a 1-2 year , a 1-2 year period in which the family adjusts to its new living standardperiod in which the family adjusts to its new living standard

– The The dependency perioddependency period is the period until the youngest is the period until the youngest child reaches age 18child reaches age 18

– Life income to the surviving spouse, including income Life income to the surviving spouse, including income during and after the blackout period. The during and after the blackout period. The blackout periodblackout period refers to the period from the time that Social Security refers to the period from the time that Social Security survivor benefits terminate to the time the benefits are survivor benefits terminate to the time the benefits are resumedresumed

– Families should also consider special needs, e.g., funds for Families should also consider special needs, e.g., funds for college education and emergenciescollege education and emergencies

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How Much Life How Much Life Insurance Do You Insurance Do You Need?Need?

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– The capital retention approachThe capital retention approach This approach preserves the capital needed to provide This approach preserves the capital needed to provide

income to the family income to the family – Income-producing assets are preserved for the heirsIncome-producing assets are preserved for the heirs

To calculate:To calculate:– Prepare a personal balance sheetPrepare a personal balance sheet– Determine the amount of income-producing capitalDetermine the amount of income-producing capital– Determine the amount of additional capital needed to meet Determine the amount of additional capital needed to meet

the family needsthe family needs

– Internet-based life insurance calculators produce Internet-based life insurance calculators produce widely-varying results, but may be a good starting widely-varying results, but may be a good starting pointpoint

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Most families own an insufficient amount of life Most families own an insufficient amount of life insuranceinsurance– About one in five households have no life insuranceAbout one in five households have no life insurance

– Consumers procrastinate, and have difficulty in making correct Consumers procrastinate, and have difficulty in making correct decisions about the purchase of life insurancedecisions about the purchase of life insurance

Many families have only a limited amount of Many families have only a limited amount of discretionary incomediscretionary income– The purchase of life insurance reduces the amount of The purchase of life insurance reduces the amount of

discretionary income available for other needsdiscretionary income available for other needs

– Many families are in debt and have little savingsMany families are in debt and have little savings

– After payment of high priority expenses, such as a mortgage, After payment of high priority expenses, such as a mortgage, food and utilities, many families have only a limited amount of food and utilities, many families have only a limited amount of income to purchase life insuranceincome to purchase life insurance

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Types of Life InsuranceTypes of Life Insurance

Life insurance policies can be Life insurance policies can be classified in two general categories:classified in two general categories:– Term insuranceTerm insurance provide temporary provide temporary

protectionprotection– Cash-value life insuranceCash-value life insurance has a savings has a savings

component and builds component and builds cash valuescash values– There are many variations of both types There are many variations of both types

available todayavailable today

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Types of Term Life Types of Term Life InsuranceInsurance

Under a term insurance policy, protection is Under a term insurance policy, protection is temporarytemporary– Protection expires at the end of the policy period, unless Protection expires at the end of the policy period, unless

renewedrenewed– Most term policies are Most term policies are renewable renewable for additional periods for additional periods

Premiums increase at each renewalPremiums increase at each renewal

– Most term policies are Most term policies are convertibleconvertible, which means the policy , which means the policy can be exchanged for a cash-value policy without evidence can be exchanged for a cash-value policy without evidence of insurabilityof insurability

Under the Under the attained-age methodattained-age method, the premium charged for the , the premium charged for the new policy is based on the insured’s attained age at the time of new policy is based on the insured’s attained age at the time of conversionconversion

Under the Under the original-age methodoriginal-age method, the premium charged for the , the premium charged for the new policy is based on the insured's original age when the term new policy is based on the insured's original age when the term insurance was first purchasedinsurance was first purchased

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Types of Term Life Types of Term Life InsuranceInsurance

Yearly-renewable term insuranceYearly-renewable term insurance is issued for a one-year period is issued for a one-year period Term insurance can also be issued for 5 or more yearsTerm insurance can also be issued for 5 or more years A A term to age 65 policyterm to age 65 policy provides protection to age 65, at which provides protection to age 65, at which

time the policy expirestime the policy expires Under a Under a decreasing term insurancedecreasing term insurance policy, the face value policy, the face value

gradually declines each yeargradually declines each year Under a Under a reentry term insurancereentry term insurance policy, renewal premiums are policy, renewal premiums are

based on select (lower) mortality rates if the insured can based on select (lower) mortality rates if the insured can periodically demonstrate acceptable evidence of insurability periodically demonstrate acceptable evidence of insurability (i.e., good health)(i.e., good health)

Under a Under a return of premiums termreturn of premiums term, the premiums are refunded if , the premiums are refunded if the policyowner outlives the term of the policythe policyowner outlives the term of the policy

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Uses and Limitations Uses and Limitations of Term Life Insuranceof Term Life Insurance

Term insurance is appropriate when:Term insurance is appropriate when:– The amount of income that can be spent on life The amount of income that can be spent on life

insurance is limitedinsurance is limited– The need for protection is temporaryThe need for protection is temporary– The insured wants to guarantee future insurabilityThe insured wants to guarantee future insurability

However, However, – Term insurance premiums increase with age at an Term insurance premiums increase with age at an

increasing rate and eventually reach prohibitive increasing rate and eventually reach prohibitive levelslevels

– Term insurance is inappropriate if you wish to Term insurance is inappropriate if you wish to save money for a specific needsave money for a specific need

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Examples of Term Life Examples of Term Life Insurance PremiumsInsurance Premiums

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Types of Whole Life Types of Whole Life InsuranceInsurance

Whole life insuranceWhole life insurance is a cash value is a cash value policy that provides lifetime protectionpolicy that provides lifetime protection– A stated amount is paid to a designated A stated amount is paid to a designated

beneficiary when the insured dies, beneficiary when the insured dies, regardless of when the death occursregardless of when the death occurs

– Types include:Types include:●● Ordinary lifeOrdinary life

● ● Limited-payment lifeLimited-payment life

● ● Endowment insuranceEndowment insurance

● ● Variable lifeVariable life

● Universal life

● Variable universal life

● Current assumption whole life

● Indeterminate-premium whole life

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Ordinary life insuranceOrdinary life insurance is a level-premium is a level-premium policy that provides lifetime protectionpolicy that provides lifetime protection– Premiums are level throughout the premium Premiums are level throughout the premium

paying periodpaying period– The excess premiums paid during the early years The excess premiums paid during the early years

are used to supplement the inadequate premiums are used to supplement the inadequate premiums paid during the later years of the policy. It is paid during the later years of the policy. It is referred to as a referred to as a legal reservelegal reserve

– The insurer’s legal reserve is a liability that must The insurer’s legal reserve is a liability that must be offset by sufficient financial assetsbe offset by sufficient financial assets

– The The net amount at risknet amount at risk is the difference between is the difference between the legal reserve and the face amount of coveragethe legal reserve and the face amount of coverage

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Relationship Between the Net Relationship Between the Net Amount at Risk and Legal Amount at Risk and Legal Reserve (1980 CSO Mortality Reserve (1980 CSO Mortality Table)Table)

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– Another characteristic of ordinary life insurance Another characteristic of ordinary life insurance policies is the accumulation of policies is the accumulation of cash surrender cash surrender valuesvalues

A policyholder overpays for insurance protection during A policyholder overpays for insurance protection during the early years, resulting in a legal reserve and the the early years, resulting in a legal reserve and the accumulation of cash valuesaccumulation of cash values

Because of the loading for expenses and high first-year Because of the loading for expenses and high first-year acquisition costs, cash values are initially below the legal acquisition costs, cash values are initially below the legal reservereserve

The policyowner has the right to borrow the cash value The policyowner has the right to borrow the cash value or exercise a cash surrender optionsor exercise a cash surrender options

– An ordinary life policy is appropriate when lifetime An ordinary life policy is appropriate when lifetime protection is neededprotection is needed

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The major limitation of ordinary life insurance is that The major limitation of ordinary life insurance is that some people are still underinsured after the policy is some people are still underinsured after the policy is purchasedpurchased– A term policy for the same premium would purchase A term policy for the same premium would purchase

substantially more protectionsubstantially more protection Under a Under a limited-payment life insurancelimited-payment life insurance policy, the policy, the

insured has lifetime protection, and premiums are insured has lifetime protection, and premiums are level, but they are paid only for a certain periodlevel, but they are paid only for a certain period– A A single-premium whole lifesingle-premium whole life policy provides lifetime policy provides lifetime

protection with a single premiumprotection with a single premium Endowment insuranceEndowment insurance pays the face amount of pays the face amount of

insurance if the insured dies within a specified insurance if the insured dies within a specified period. If the insured is still alive at the end of the period. If the insured is still alive at the end of the period, the face amount is paid to the policyholderperiod, the face amount is paid to the policyholder

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Insurers have developed a wide variety of whole life Insurers have developed a wide variety of whole life productsproducts

Variable life insuranceVariable life insurance is a fixed-premium policy in is a fixed-premium policy in which the death benefit and cash values vary which the death benefit and cash values vary according to the investment experience of a separate according to the investment experience of a separate account maintained by the insureraccount maintained by the insurer– The premium is levelThe premium is level– The entire reserve is held in a separate account and is The entire reserve is held in a separate account and is

invested in common stocks or other investmentsinvested in common stocks or other investments If the investment experience is favorable, the face amount of If the investment experience is favorable, the face amount of

insurance is increased insurance is increased – Cash surrender values are not guaranteedCash surrender values are not guaranteed

Although the insurer bears the risk of excessive mortality and Although the insurer bears the risk of excessive mortality and expenses, the policyholder bears the risk of poor investment expenses, the policyholder bears the risk of poor investment resultsresults

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Universal Life InsuranceUniversal Life Insurance is a flexible premium is a flexible premium policy that provides lifetime protectionpolicy that provides lifetime protection

– After the first premium, the policyholder decides the After the first premium, the policyholder decides the amount and frequency of paymentsamount and frequency of payments

Most policies have a target premium, but the policyowner is Most policies have a target premium, but the policyowner is not obligated to pay itnot obligated to pay it

– The protection and savings components are The protection and savings components are unbundledunbundled

the policyholder’s statement shows the premiums paid, the policyholder’s statement shows the premiums paid, death benefit, and value of the cash value account death benefit, and value of the cash value account

It also shows the mortality charge and the interest credited It also shows the mortality charge and the interest credited to the cash value accountto the cash value account

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– There are two forms of universal life There are two forms of universal life insurance:insurance: Option A pays a level death benefit during the Option A pays a level death benefit during the

early yearsearly years

– The death benefit increases in later years to meet The death benefit increases in later years to meet the corridor test required by the Internal Revenue the corridor test required by the Internal Revenue CodeCode

Option B provides for an increasing death Option B provides for an increasing death benefitbenefit

– The death benefit is equal to a constant net amount The death benefit is equal to a constant net amount at risk plus the accumulated cash valueat risk plus the accumulated cash value

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Two forms of Universal Life Two forms of Universal Life Insurance Death BenefitsInsurance Death Benefits

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– Universal life provides considerable flexibilityUniversal life provides considerable flexibility Cash withdrawals are permittedCash withdrawals are permitted Policies receive favorable federal income tax Policies receive favorable federal income tax

treatmenttreatment

– Limitations of universal life policies include:Limitations of universal life policies include: Insurers advertise misleading rates of returnInsurers advertise misleading rates of return Policy owner is not given information on how the Policy owner is not given information on how the

expences are allocated between the protection and expences are allocated between the protection and saving components in the policysaving components in the policy

Insurers can increase the current mortality charge Insurers can increase the current mortality charge to recoup expensesto recoup expenses

A policy may lapse because some policyowners do A policy may lapse because some policyowners do not have a firm commitment to pay premiumsnot have a firm commitment to pay premiums

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Type of Whole Life Type of Whole Life InsuranceInsurance

Variable universal lifeVariable universal life is an important is an important variation of whole life insurancevariation of whole life insurance– Most are sold as investmentsMost are sold as investments– Similar to universal life except that:Similar to universal life except that:

The policy owner decides how the premiums are investedThe policy owner decides how the premiums are invested The policy does not guarantee a minimum interest rate or The policy does not guarantee a minimum interest rate or

minimum cash valueminimum cash value

– These policies have relatively high expense These policies have relatively high expense charges, including front-end loads for sales charges, including front-end loads for sales commissions, back-end surrender charges, and commissions, back-end surrender charges, and investment management feesinvestment management fees

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Current assumption whole life insuranceCurrent assumption whole life insurance is a is a nonparticipating whole life policy in which the cash nonparticipating whole life policy in which the cash values are based on the insurer’s current mortality, values are based on the insurer’s current mortality, investment, and expense experienceinvestment, and expense experience– An accumulation account reflects the cash value under the An accumulation account reflects the cash value under the

policypolicy– If the policy is surrendered, a surrender charge is deducted If the policy is surrendered, a surrender charge is deducted

from the accumulation accountfrom the accumulation account– A guaranteed interest rate and current interest rate are used A guaranteed interest rate and current interest rate are used

to determine cash valuesto determine cash values– A fixed death benefit and maximum premium level at the A fixed death benefit and maximum premium level at the

time of issue are stated in the policytime of issue are stated in the policy– Two forms of current assumption whole life products:Two forms of current assumption whole life products:

Low-premium products, with a low initial premiumLow-premium products, with a low initial premium High-premium products, with a vanishing premium provisionHigh-premium products, with a vanishing premium provision

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Comparison of Major Comparison of Major Life Insurance Life Insurance ContractsContracts

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An An indeterminate-premium whole lifeindeterminate-premium whole life policy is a generic name policy is a generic name for a nonparticipating policy that permits the insurer to adjust for a nonparticipating policy that permits the insurer to adjust premiums based on anticipated future experiencepremiums based on anticipated future experience– After an initial guaranteed period, the insurer can increase After an initial guaranteed period, the insurer can increase

premiums up to the maximum limit if the insurer’s experience is premiums up to the maximum limit if the insurer’s experience is expected to worsenexpected to worsen

A A modified lifemodified life policy is a whole life policy in which premiums policy is a whole life policy in which premiums are lower for the first three to five years and higher thereafterare lower for the first three to five years and higher thereafter

Preferred riskPreferred risk policies are sold at lower rates to individuals policies are sold at lower rates to individuals whose mortality experience is expected to be lower than whose mortality experience is expected to be lower than average (e.g., a non-smoker)average (e.g., a non-smoker)

Second-to-die life insuranceSecond-to-die life insurance insures two or more lives and pays insures two or more lives and pays the death benefit upon the death of the second or last insuredthe death benefit upon the death of the second or last insured– Usually whole life, but can be termUsually whole life, but can be term

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Savings Bank Life InsuranceSavings Bank Life Insurance (SBLI) is a type of life (SBLI) is a type of life insurance that is sold by savings banksinsurance that is sold by savings banks– Policies were sold originally by savings banks in Policies were sold originally by savings banks in

Massachusetts, NY and ConnecticutMassachusetts, NY and Connecticut– SBLI is also sold over the phone or through WebsitesSBLI is also sold over the phone or through Websites

Historically, Historically, industrial life insuranceindustrial life insurance was a class of was a class of life insurance that was issued in small amounts and life insurance that was issued in small amounts and an agent of the company collected the premiums at an agent of the company collected the premiums at the insured’s homethe insured’s home– Also known as home service life insuranceAlso known as home service life insurance

Group life insuranceGroup life insurance provides life insurance on a provides life insurance on a group of people in a single master contractgroup of people in a single master contract

Life Insurance Contractual Life Insurance Contractual ProvisionsProvisions

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Life Insurance Life Insurance Contractual ProvisionsContractual Provisions Under the Under the ownership clauseownership clause, the policyowner , the policyowner

possesses all contractual rights in the policy while possesses all contractual rights in the policy while the insured is livingthe insured is living– Rights include naming beneficiaries and surrendering Rights include naming beneficiaries and surrendering

the policy for its cash valuethe policy for its cash value– The policyholder can designate a new owner by filing an The policyholder can designate a new owner by filing an

appropriate formappropriate form The The entire-contract clauseentire-contract clause states that the life states that the life

insurance policy and attached application insurance policy and attached application constitute the entire contract between the partiesconstitute the entire contract between the parties– Prevents the insurer from making amendments without Prevents the insurer from making amendments without

the policyholder’s knowledgethe policyholder’s knowledge

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Life Insurance Life Insurance Contractual ProvisionsContractual Provisions

The The incontestable clauseincontestable clause states that the insurer states that the insurer cannot contest the policy after it has been in force cannot contest the policy after it has been in force two years during the insured’s lifetimetwo years during the insured’s lifetime– Protects the beneficiary if the insurer tries to deny payment Protects the beneficiary if the insurer tries to deny payment

of the claim years after the policy was first issued of the claim years after the policy was first issued – The insurer has two years to detect fraudThe insurer has two years to detect fraud– The insurer can contest a claim after the incontestable The insurer can contest a claim after the incontestable

period if:period if: The beneficiary takes out the life insurance policy with the The beneficiary takes out the life insurance policy with the

intent of murdering the insuredintent of murdering the insured The applicant has someone else take a medical examinationThe applicant has someone else take a medical examination An insurable interest does not exist at the inception of the An insurable interest does not exist at the inception of the

policypolicy

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Life Insurance Life Insurance Contractual ProvisionsContractual Provisions The The suicide clausesuicide clause states that if the insured states that if the insured

commits suicide within two years after the commits suicide within two years after the policy is issued, the face amount of policy is issued, the face amount of insurance will not be paid; there is only a insurance will not be paid; there is only a refund of the premiums paidrefund of the premiums paid– Reduces adverse selection against the insurerReduces adverse selection against the insurer

A life insurance policy contains a A life insurance policy contains a grace grace periodperiod during which the policyholder has a during which the policyholder has a period of 31 days to pay an overdue period of 31 days to pay an overdue premiumpremium– Prevents the policy from lapsing by giving the Prevents the policy from lapsing by giving the

policyowner additional time to paypolicyowner additional time to pay

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The The reinstatement provisionreinstatement provision permits the permits the owner to reinstate a lapsed policyowner to reinstate a lapsed policy– To reinstate, the following requirements must be To reinstate, the following requirements must be

met:met: Evidence of insurability is requiredEvidence of insurability is required All overdue premiums plus interest are paidAll overdue premiums plus interest are paid Any policy loans are repaid or reinstatedAny policy loans are repaid or reinstated The policy was not surrendered for its cash valueThe policy was not surrendered for its cash value

– The policy must be reinstated within a certain The policy must be reinstated within a certain period, usually 3-5 years after the date of lapseperiod, usually 3-5 years after the date of lapse

– Although it may require a large outlay of cash, it Although it may require a large outlay of cash, it may be cheaper to reinstate a lapsed policy than may be cheaper to reinstate a lapsed policy than to purchase a new policy to purchase a new policy

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The The beneficiarybeneficiary is the party named in the is the party named in the policy to receive the policy proceedspolicy to receive the policy proceeds– The The primary beneficiaryprimary beneficiary is the first entitled to is the first entitled to

receive the policy proceedsreceive the policy proceeds– A A revocable beneficiaryrevocable beneficiary means that the means that the

policyowner reserves the right to change the policyowner reserves the right to change the beneficiary designation without the beneficiary’s beneficiary designation without the beneficiary’s consentconsent

– An An irrevocable beneficiaryirrevocable beneficiary is one that cannot be is one that cannot be changed without the beneficiary’s consentchanged without the beneficiary’s consent

– A A specific beneficiaryspecific beneficiary is specifically identified is specifically identified– A A class beneficiaryclass beneficiary is a member of a group, e.g., is a member of a group, e.g.,

children of the insuredchildren of the insured

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Life Insurance Life Insurance Contractual ProvisionsContractual Provisions Under the Under the misstatement of age or sex clausemisstatement of age or sex clause, if the , if the

insured’s age or sex is misstated, the amount payable insured’s age or sex is misstated, the amount payable is the amount that the premiums paid would have is the amount that the premiums paid would have purchased at the correct age and sexpurchased at the correct age and sex

A A change-of-plan provisionchange-of-plan provision allows policyowners to allows policyowners to exchange their present policies for different contractsexchange their present policies for different contracts

Life insurance contracts do not contain many Life insurance contracts do not contain many exclusionsexclusions– Suicide excluded for two yearsSuicide excluded for two years– Insurers might insert a Insurers might insert a war clausewar clause to exclude payment if to exclude payment if

the insured dies as a direct result of warthe insured dies as a direct result of war– Some policies contain aviation exclusionsSome policies contain aviation exclusions

Premiums can be paid annually, semiannually, Premiums can be paid annually, semiannually, quarterly, or monthlyquarterly, or monthly– If premiums are not paid annually, a carrying charge is If premiums are not paid annually, a carrying charge is

appliedapplied

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A life insurance policy is freely assignable A life insurance policy is freely assignable to another partyto another party– Under an Under an absolute assignmentabsolute assignment, all ownership , all ownership

rights in the policy are transferred to a new rights in the policy are transferred to a new ownerowner

– Under a Under a collateral assignmentcollateral assignment, the policyowner , the policyowner temporarily assigns a life insurance policy to a temporarily assigns a life insurance policy to a creditor as collateral for a loan creditor as collateral for a loan

Only certain rights are transferred to the creditorOnly certain rights are transferred to the creditor Purpose is to protect the insurer from paying the Purpose is to protect the insurer from paying the

policy proceeds twicepolicy proceeds twice

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A A policy loan provisionpolicy loan provision allows the policyowner to allows the policyowner to borrow the cash value borrow the cash value – The policyowner must pay interest on the loan to offset the The policyowner must pay interest on the loan to offset the

loss of interest to the insurerloss of interest to the insurer– A policy could lapse if the policyowner does not repay a loan A policy could lapse if the policyowner does not repay a loan

and the total indebtedness exceeds the available cash valueand the total indebtedness exceeds the available cash value Under the Under the automatic premium loan provisionautomatic premium loan provision, an , an

overdue premium is automatically borrowed from the overdue premium is automatically borrowed from the cash value after the grace period expirescash value after the grace period expires– Prevent the policy from lapsingPrevent the policy from lapsing– Policyowner may become lazy and exhaust all cash valuePolicyowner may become lazy and exhaust all cash value

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Dividend OptionsDividend Options If a policy pays dividends it is a If a policy pays dividends it is a participating policyparticipating policy

– Otherwise it is a Otherwise it is a nonparticipating policynonparticipating policy Dividends come from three main sources:Dividends come from three main sources:

– The difference between expected and actual mortality experienceThe difference between expected and actual mortality experience– Excess interest earningsExcess interest earnings– The difference between expected and actual operating expensesThe difference between expected and actual operating expenses

Policyowners have several ways to take dividends:Policyowners have several ways to take dividends:– Take the cashTake the cash– Reduce the next premium coming dueReduce the next premium coming due– Let them accumulate at interest and withdraw laterLet them accumulate at interest and withdraw later– Apply toward the purchase of paid-up whole life insurance under Apply toward the purchase of paid-up whole life insurance under

the the paid-up additions optionpaid-up additions option– Apply toward the purchase of term insuranceApply toward the purchase of term insurance– Convert the policy to a paid-up contract, or mature a policy as an Convert the policy to a paid-up contract, or mature a policy as an

endowmentendowment

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Nonforfeiture OptionsNonforfeiture Options The payment to a withdrawing policyowner is The payment to a withdrawing policyowner is

known as a nonforfeiture value or cash known as a nonforfeiture value or cash surrender valuesurrender value– A policyowner has a right to the policy’s A policyowner has a right to the policy’s

accumulated cash value; all states have standard accumulated cash value; all states have standard nonforfeiture lawsnonforfeiture laws

– Policyowners have three Policyowners have three nonforfeiture optionsnonforfeiture options:: The policy can be surrendered for its cash valueThe policy can be surrendered for its cash value Under the Under the reduced-paid up insurancereduced-paid up insurance option, the cash option, the cash

surrender value is applied as a net single premium to surrender value is applied as a net single premium to purchase a reduced paid-up policypurchase a reduced paid-up policy

Under the Under the extended term insuranceextended term insurance option, the net cash option, the net cash surrender value is used as a net single premium to surrender value is used as a net single premium to extend the full face amount of the policy into the future extend the full face amount of the policy into the future as term insuranceas term insurance

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Settlement OptionsSettlement Options The policyowner can choose among several options The policyowner can choose among several options

for paying the policy proceedsfor paying the policy proceeds– Or, the beneficiary may be granted the choiceOr, the beneficiary may be granted the choice

The most common options include:The most common options include:– Proceeds are paid in a lump sumProceeds are paid in a lump sum– Under the Under the interest optioninterest option, the proceeds are retained by the , the proceeds are retained by the

insurer, and interest is periodically paid to the beneficiaryinsurer, and interest is periodically paid to the beneficiary The beneficiary can be given withdrawal rightsThe beneficiary can be given withdrawal rights

– Under the Under the fixed-period optionfixed-period option, the proceeds are paid to a , the proceeds are paid to a beneficiary over some fixed period of timebeneficiary over some fixed period of time

– Under the Under the fixed-amount optionfixed-amount option, a fixed amount is , a fixed amount is periodically paid to the beneficiary until the principal and periodically paid to the beneficiary until the principal and interest are exhaustedinterest are exhausted

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Settlement OptionsSettlement Options– Under the Under the life income optionlife income option, installment , installment

payments are paid only while the beneficiary is payments are paid only while the beneficiary is alive and cease on the beneficiary’s deathalive and cease on the beneficiary’s death

There is no refund feature or guarantee of paymentsThere is no refund feature or guarantee of payments– Other life income options include:Other life income options include:

Life income with guaranteed period: if the beneficiary Life income with guaranteed period: if the beneficiary dies before receiving the guaranteed number of years of dies before receiving the guaranteed number of years of payments, the remaining payments are paid to a payments, the remaining payments are paid to a contingent beneficiarycontingent beneficiary

Life income with guaranteed total amount: if the Life income with guaranteed total amount: if the beneficiary dies before receiving installment payments beneficiary dies before receiving installment payments equal to the total amount of insurance placed under the equal to the total amount of insurance placed under the option, the payments continue until the total amount option, the payments continue until the total amount paid equals the total amount of insurance paid equals the total amount of insurance

Under the joint-and-survivor settlement option, income Under the joint-and-survivor settlement option, income payments are paid to two persons during their lifetimes, payments are paid to two persons during their lifetimes, such as a husband and wife such as a husband and wife

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Settlement OptionsSettlement Options

Settlement options allow for periodic Settlement options allow for periodic payments to the family, restoring their payments to the family, restoring their financial securityfinancial security

Disadvantages include:Disadvantages include:– Interest rates offered by insurers may be Interest rates offered by insurers may be

lower than rates offered elsewherelower than rates offered elsewhere– The settlement agreement may be The settlement agreement may be

inflexible and restrictiveinflexible and restrictive

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Additional Life Insurance Additional Life Insurance BenefitsBenefits

Other benefits can be added to a life insurance Other benefits can be added to a life insurance policy for an additional premiumpolicy for an additional premium– Under a Under a waiver-of-premium provisionwaiver-of-premium provision, if the insured , if the insured

becomes totally disabled, all premiums coming due during becomes totally disabled, all premiums coming due during the period of disability are waivedthe period of disability are waived

In many cases, total disability means that the insured cannot In many cases, total disability means that the insured cannot do any of the essential duties of his or her job for which he or do any of the essential duties of his or her job for which he or she is suited based on schooling, training, or experienceshe is suited based on schooling, training, or experience

– The The guaranteed purchase optionguaranteed purchase option permits the policyowner to permits the policyowner to purchase additional amounts of life insurance at specified purchase additional amounts of life insurance at specified times in the future without evidence of insurabilitytimes in the future without evidence of insurability

The option guarantees the purchase of specified amounts of life The option guarantees the purchase of specified amounts of life insurance in the future even though the insured may become insurance in the future even though the insured may become uninsurableuninsurable

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Additional Life Insurance Additional Life Insurance BenefitsBenefits

The The accidental death benefit rideraccidental death benefit rider doubles the face doubles the face amount of life insurance if death occurs as a result of amount of life insurance if death occurs as a result of an accidentan accident– Also known as double indemnityAlso known as double indemnity

The The cost-of-living ridercost-of-living rider allows the policyowner to allows the policyowner to purchase one-year term insurance equal to the purchase one-year term insurance equal to the percentage change in the consumer price index with percentage change in the consumer price index with no evidence of insurabilityno evidence of insurability

The The accelerated death benefits rideraccelerated death benefits rider allows insureds allows insureds who are terminally ill to collect part or all of their life who are terminally ill to collect part or all of their life insurance benefits before they die insurance benefits before they die – Forms include: a terminal illness rider, catastrophic illness Forms include: a terminal illness rider, catastrophic illness

rider, and long-term care riderrider, and long-term care rider

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Buying Life InsuranceBuying Life Insurance

Determining the Cost of Life Determining the Cost of Life InsuranceInsurance

Rate of Return on Saving Rate of Return on Saving ComponentComponent

Taxation of Life InsuranceTaxation of Life Insurance Shopping for Life InsuranceShopping for Life Insurance

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Determining the Cost of Determining the Cost of Life InsuranceLife Insurance

The cost of a life insurance policy is the The cost of a life insurance policy is the difference between what you pay and what difference between what you pay and what you get backyou get back

When determining the cost of life When determining the cost of life insurance, four major factors must be insurance, four major factors must be considered:considered:

1.1. Annual premiumsAnnual premiums

2.2. Cash valuesCash values

3.3. DividendsDividends

4.4. Time value of moneyTime value of money

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Under the Under the traditional net cost traditional net cost methodmethod, the cash value and , the cash value and expected dividends are expected dividends are subtracted from annual premiums subtracted from annual premiums to obtain a net cost per year to obtain a net cost per year figurefigure– This method does not consider the This method does not consider the

time value of moneytime value of money

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Exhibit 13.1Exhibit 13.1 Traditional Traditional Net Cost Method Net Cost Method

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The The interest-adjusted cost methodinterest-adjusted cost method is is more accurate because it considers the more accurate because it considers the time value of moneytime value of money

Interest-adjusted cost indices come in Interest-adjusted cost indices come in two forms:two forms:– The The surrender cost indexsurrender cost index is useful if the is useful if the

owner expects to surrender the policy after owner expects to surrender the policy after some time periodsome time period

– The The net payment cost indexnet payment cost index is useful if the is useful if the owner expects to keep the policy in forceowner expects to keep the policy in force

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Surrender Cost Index Surrender Cost Index

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Net Payment Cost Net Payment Cost Index Index

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Interest-adjusted cost indices can Interest-adjusted cost indices can be used to compare policies be used to compare policies across insurersacross insurers– There is a wide variation in costs There is a wide variation in costs

indices across insurers – it pays to indices across insurers – it pays to shop around!shop around!

– Most consumers use premiums as a Most consumers use premiums as a basis for comparison, but agents will basis for comparison, but agents will supply cost indicessupply cost indices

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Rate of Return on Saving Rate of Return on Saving ComponentComponent The annual rate of return earned on the The annual rate of return earned on the

savings component of a policy is an savings component of a policy is an important consideration if you intend to important consideration if you intend to invest over a long period of timeinvest over a long period of time

The The Linton yieldLinton yield is the average annual rate of is the average annual rate of return on a cash value policy if it is held for a return on a cash value policy if it is held for a specified number of yearsspecified number of years– Current information is not readily available Current information is not readily available

to consumers, so the method has limited to consumers, so the method has limited useuse

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Rate of Return on Saving Rate of Return on Saving ComponentComponent

The The yearly rate of return methodyearly rate of return method is is based on a formula:based on a formula:

The information needed for the The information needed for the calculation is readily available to calculation is readily available to consumersconsumers

1

rpolicy yea theof beginning at the

policy thein availableamount component protection

theof price assumed

rpolicy yea theofend at the

policy theinavailableamount

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Taxation of Life Taxation of Life InsuranceInsurance Life insurance premium paid by an individual qualifies Life insurance premium paid by an individual qualifies

for a deduction under Section 80C of Income Tax Act, for a deduction under Section 80C of Income Tax Act, 1961. An individual can claim deduction from gross 1961. An individual can claim deduction from gross total income on premium paid for a maximum of Rs total income on premium paid for a maximum of Rs 100,000 in each financial year. Amount deductible 100,000 in each financial year. Amount deductible under Section 80C is equal to: under Section 80C is equal to: – 100% of the "qualifying investment", which includes life 100% of the "qualifying investment", which includes life

insurance premium, or insurance premium, or – Rs 100,000, whichever is lower. Rs 100,000, whichever is lower.

The maturity proceeds of life insurance policies are not The maturity proceeds of life insurance policies are not taxable.taxable.

If a person participates in a Unit Linked Insurance Plan (ULIP) If a person participates in a Unit Linked Insurance Plan (ULIP) and then terminates his participation, he will not be entitled and then terminates his participation, he will not be entitled to claim any tax benefits. to claim any tax benefits.

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Shopping For Life Shopping For Life InsuranceInsurance

Annuities and Individual Annuities and Individual Retirement AccountsRetirement Accounts

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Individual AnnuitiesIndividual Annuities An An annuityannuity is a periodic payment that continues for a is a periodic payment that continues for a

fixed period or for the duration of a designated life fixed period or for the duration of a designated life or livesor lives– The person who receives the payments is the The person who receives the payments is the annuitantannuitant

An annuity provides protection against the risk of An annuity provides protection against the risk of excessive longevityexcessive longevity

The fundamental purpose of an annuity is to provide The fundamental purpose of an annuity is to provide a lifetime income that cannot be outliveda lifetime income that cannot be outlived

The major types of annuities sold today include:The major types of annuities sold today include:– Fixed annuityFixed annuity– Variable annuityVariable annuity– Equity-indexed annuityEquity-indexed annuity

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Fixed AnnuitiesFixed Annuities A A fixed annuityfixed annuity pays periodic income pays periodic income

payments that are guaranteed and fixed in payments that are guaranteed and fixed in amountamount– During the During the accumulation periodaccumulation period prior to prior to

retirement, premiums are credited with interestretirement, premiums are credited with interest The The guaranteed rateguaranteed rate is the minimum interest rate that is the minimum interest rate that

will be credited to the fixed annuitywill be credited to the fixed annuity The The current ratecurrent rate is based on current market conditions, is based on current market conditions,

and is guaranteed only for a limited periodand is guaranteed only for a limited period– A bonus annuity pays a higher interest rate A bonus annuity pays a higher interest rate

initiallyinitially– The The liquidation periodliquidation period is the period in which funds is the period in which funds

are paid out, or annuitizedare paid out, or annuitized

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Fixed AnnuitiesFixed Annuities Fixed annuity income payments can be Fixed annuity income payments can be

paid immediately, or at a future date:paid immediately, or at a future date:– An An immediate annuityimmediate annuity is one where the first is one where the first

payment is due one payment interval from the payment is due one payment interval from the date of purchasedate of purchase

Provides a guaranteed lifetime income that cannot Provides a guaranteed lifetime income that cannot be outlivedbe outlived

– A A deferred annuitydeferred annuity provides income payments provides income payments at some future dateat some future date

A deferred annuity purchase with a lump sum is A deferred annuity purchase with a lump sum is called a called a single-premium deferred annuitysingle-premium deferred annuity

A A flexible-premium annuityflexible-premium annuity allows the owner to vary allows the owner to vary the premium paymentsthe premium payments

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Fixed AnnuitiesFixed Annuities

The annuity owner has a choice of annuity The annuity owner has a choice of annuity settlement offerssettlement offers– Most annuities are not annuitizedMost annuities are not annuitized– Under the cash option, the funds can be Under the cash option, the funds can be

withdrawn in a lump sum or in installmentswithdrawn in a lump sum or in installments– A A life annuity option life annuity option provides a life income to the provides a life income to the

annuitant only while the annuitant remains aliveannuitant only while the annuitant remains alive– A A life annuity with guaranteed paymentslife annuity with guaranteed payments pays a pays a

life income to the annuitant with a certain life income to the annuitant with a certain number of guaranteed payments number of guaranteed payments

life insurance 1

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