Using the internet, journals or newspaper, research an article related to Insuring Your Life, and answer the critical thinking question that follows: Summarize the key points from the articl

MG 105 Personal Financial Management

Week 9: Insurance Overview

Welcome to Week 9: This week we will cover Chapters 8, 9 as we review how insurance affects your life.

After reading Chapter 8 and 9, the student should be able to:  Explain the concept of risk and the basics of insurance underwriting  Discuss the primary reasons for life insurance and identify those who need coverage  Calculate how much life insurance you need  Distinguish among the various types of life insurance policies and describe their advantages

and disadvantages  Choose the best life insurance policy for your needs at the lowest cost  Become familiar with the key features of life insurance policies  Discuss why having adequate health insurance is important, and identify the factors

contributing to the growing cost of health insurance  Differentiate among the major types of health insurance plans, and identify major private and

public health insurance providers and their programs  Analyze your own health insurance needs and explain how to shop for appropriate coverage  Explain the basic types of medical expenses covered by the policy provisions of health

insurance plans  Assess the need for and features of long-term care insurance  Discuss the features of disability income insurance and how to determine your need for it

Week 9 Checklist

 Read chapters 8, 9 in your textbook and review resources  Read the lecture notes  Complete week assignment by Sunday – 5 PM  Complete week 9 (chapters 8 and 9) quiz by Sunday – 5 PM

MG105 – PERSONAL FINANCE Chapter 8-Insuring Your Life Chapter 9-Insuring Your Health

PROFESSOR’S CHAPTER INTRODUCTION:

Insurance is one of many financial tools that enable you to protect yourself from the unknown. Specifically speaking, the two Chapters discuss the importance of life insurance and health insurance. While insurance does not prevent an event from occurring, it protects you financially if that event occurs. For example, life insurance will not prevent death; however, it will protect our loved ones financially in case we die. If you think of the responsibilities you take care of while alive, you will find that you pay for the mortgage/or rent, make car payments, school payments, etc. Now imagine if your loved ones who depend on you have to make those payments on their own and without your help. Not all of us are lucky enough to have the ability to continue on our lives without having any financial impact resulting from the death of a loved one who was a major financial supporter of the family. The same goes for health insurance. With the cost of healthcare and emergency care rising, any sudden, unexpected health problem could wipe out years of savings and investing. As a result, health insurance is not just a wise decision to make; it is a necessary part of our financial plans. Read on for more…

CHAPTER 8 OUTLINE

Why Is This Chapter Important for you?

A key ingredient of every successful personal financial plan is adequate life insurance coverage. The overriding purpose of life insurance is to protect the family from financial loss in the event of the untimely death of an income earner. Additionally, some types of life insurance also possess attractive investment characteristics which can further enhance a financial plan if they are chosen correctly. In essence, life insurance is an umbrella for a personal financial plan. The major topics covered in this chapter include:

1. Adequate life insurance acts as protection for the financial goals you have already achieved, and it can also help to attain unfulfilled financial goals.

2. Insurance is based on the idea of recognizing and sharing risk, which includes ways of decreasing risk through loss prevention and control and risk avoidance.

3. The amount of life insurance coverage needed can be determined by assessing your family's needs, subtracting from that amount the resources that will be available after death, and funding the difference.

4. There are three basic types of life insurance policies, which differ from each other by the amount of insurance coverage versus savings element per dollar of premium: term, whole life, and universal.

5. Policy provisions in life insurance policies are very flexible and provide many options to the policyholder and policy beneficiaries.

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6. The best coverage for your purposes means that you consider buying the proper amount and right type of insurance as well as the lowest cost for your needs.

Purpose of Insurance

Basically, insurance is needed to protect you from losing assets you have already acquired and to shield you from an interruption in your expected earnings. Insurance lends a degree of certainty to your financial plans. Life insurance is meant to replace income that you would have earned had premature death not occurred. Enough life insurance means that family financial plans can be achieved, even though family income might be interrupted.

Risk avoidance involves avoiding the act that creates the risk. It is an attractive way to deal with risk when the estimated cost of avoidance is less than the estimated cost of exposure, although it is not always possible to avoid some risks.

Loss prevention is an activity (such as obeying the traffic laws) that reduces the probability that a loss will occur.

Loss control is an activity (such as wearing safety belts in a car) that lessens the severity of an injury or loss once an accident occurs.

Risk assumption involves bearing or accepting risk. It can be an effective way to handle many types of potentially small exposures to loss for which the protection of insurance would be too expensive.

With an insurance policy, the policyholder is transferring the risk of loss to the insurance company. You pay an insurance premium in return for a promise from the insurance company that they will reimburse you if you suffer a loss covered by the insurance policy.

These concepts are interrelated in that they are all ways of handling the risk of economic loss. Using each method effectively and in connection with one another will help you protect yourself in the most cost effective manner.

Underwriting is the process by which insurance companies evaluate applications to decide which exposures to loss they can insure and the appropriate rates to charge. Underwriting helps the company guard against adverse selection and establish rates commensurate with the chance of loss. Factors a life insurance underwriter considers include age, sex, occupation, health history and prior problems, driving record and credit rating.

In addition to financial protection for one's family, the benefits of purchasing life insurance include the following:

Protection from Creditors—The purchase of life insurance can be structured in such a way that when death benefits are paid, the cash proceeds do not become part of the estate and, therefore, are protected from creditors. Even if creditors are successful in securing judgments against

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persons while still alive who have substantial accumulations of life insurance cash values, they most often cannot levy any claim on those cash values.

Tax Benefits— Upon the death of the insured, the proceeds of a life insurance policy pass to the beneficiaries free of any state or federal income tax but may have certain death taxes levied, depending on who owned the policy at the time of death. In policies which build cash value, the cash accumulation grows tax free unless it is withdrawn from the policy. If cash values are withdrawn from a policy, income taxes are payable on the amount by which the cash value exceeds the total premiums paid.

Vehicle for Savings—Life insurance can be an attractive medium for savings for some people, particularly those seeking safety of principal. Because life insurance companies have a fairly low failure rate, whole and universal life insurance policies are considered very low risk savings media. As investment vehicles, these policies tend to stack up fairly well when their returns are compared to savings accounts, money fund yields, and returns on T-bills—especially when you factor in the tax shelter provided by the life insurance products.

Reasons people need life insurance are: to provide for those who depend on the insured's income, to eliminate debts, to pay for final expenses, and/or to leave someone a gift. Unless a single college student has one or more of these needs, he or she does not need life insurance. Those college students with student loans, auto loans, or other types of debt would want life insurance to eliminate those debts.

How to Determine Your Insurance Needs

Important events such as marriage, birth of children, divorce, etc., call for careful consideration as to life insurance needs. Of particular importance is the birth of a child, which instantly creates a long-term need for a large amount of life insurance.

The two basic methods for determining a person's life insurance requirements are the multiple earnings approach and the needs approach. The multiple earnings approach is a simple technique in which the amount of insurance to purchase is found by multiplying gross annual earnings by some arbitrarily selected number. Most frequently multiples of three, five, or in some cases, ten, are used.

The needs approach considers the financial resources available in addition to life insurance and the specific financial obligations that a person may have. It involves three steps:

1. Estimating total economic resources needed; 2. Determining all financial resources that would be available at death; and 3. Subtracting the amount of resources available from the amount needed to determine the amount of life insurance required to provide for an individual's financial program.

The most common economic needs that must be satisfied after the death of a family breadwinner are: funds to pay off debts in order to leave his or her family relatively debt-free; income to sustain the family until the children are self-sufficient; income to sustain in full or part the

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surviving spouse; and income to fund any special financial requirements, such as college education for children and/or surviving spouse. Using the needs approach, each of these financial needs should be estimated and viewed in light of available resources to determine life insurance requirements.

Factors a life insurance underwriter considers include age, sex, occupation, health history and prior problems, driving record and credit rating. The company is trying to determine the likelihood of their having to pay a claim if they issue you a policy.

Under the provisions of term life insurance, the insurance company agrees to pay a stipulated sum if the insured dies during the policy period. Common periods of coverage are five years with premiums payable annually or semiannually. Term insurance offers the most economical way to purchase life insurance on a temporary basis for protection against financial loss resulting from death, especially in the early years of family formation.

Term life insurance

Straight Term—the most frequently purchased, it is a term policy written for a given number of years. The face value of the policy remains constant while the cost of the insurance increases along with one’s risk of mortality. With annual renewable term policies, the annual premiums increase each year reflecting one’s increased likelihood of dying each year. With level-premium term policies, the premiums remain constant for a specified period of years. The cost of insurance still increases each year, but with level-premium policies, the costs for the given period are averaged so that for the first few years of the policy, the insured is overpaying for the cost of insurance, and for the last few years, he or she is underpaying.

Decreasing Term—a term policy that maintains a level premium throughout all periods of coverage, while the face amount decreases. As the insured gets older, the cost of insurance goes up reflecting the greater chance of death occurring. If the premium remains constant but the cost is increasing, then the amount of coverage has to decrease. This type policy is often used to provide for mortgage or other debt repayment in the event of death. The face amount decreases along with the amount of outstanding debt.

In addition, term insurance is often written with renewability and convertibility provisions. The first provision basically allows the insured to renew his or her policy for another term without providing proof of insurability; in contrast, the second provision allows the insured to convert his or her policy to whole life without providing proof of insurability.

The primary advantage of term life insurance is that it offers an economical way to purchase a large amount of protection against financial loss resulting from death, especially during the childbearing years. The guaranteed renewable and convertible options allow the insured to continue coverage throughout his or her life. The most commonly cited disadvantage of term insurance is that the rates increase as the insured ages. People frequently discontinue coverage for this reason.

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Whole Life Insurance

Whole life insurance is designed to offer financial protection for the entire (whole) life of an individual, and the premiums are calculated assuming lifetime protection for the insured. (Term life insurance premiums are calculated based on the probability of death during the given time of the term only.) In addition to death protection, whole life insurance has a savings element called cash value. The life insurance company sets aside assets to be used to pay the claims expected to result from the policies they issue. If policyholders decide to cancel their contracts prior to the death of the insured, that portion of the assets set aside to provide payment for the death claim which did not take place is available to them for use in their retirement years, for example. Whole life policies, therefore, either pay accumulated cash values to the policyholder if canceled or pay their face value to the beneficiaries at the death of the insured.

The three major types of whole life policies, based on premium frequency, are:

1. Continuous premium whole life policies, which require a level premium payment each year until the insured dies. 2. Limited payment whole life policies, which offer coverage for the entire life of the insured but schedule the payments to end after a limited period. The period may be a stated number of years, such as 20-year life, or until a specified age, such as paid-up at age 45. 3. Single premium whole life policies, which are purchased on a "cash basis." One premium payment upon inception of the contract buys life insurance coverage for the insured for the remainder of his or her life.

One advantage of whole life is that the premium payments contribute toward building an estate, regardless of whether the insured lives or dies. It also permits individuals who need insurance for an entire lifetime to budget their premium payments over a relatively long period, thus eliminating the problems of unaffordability and uninsurability often encountered in later years with term insurance. Disadvantages most often cited are that more death protection for the same amount of money can be purchased with term insurance and higher yields can be obtained on other investments.

Universal and Variable Life Insurance

Universal life insurance is a blended product that combines the features of an investment that earns current money market interest rates with a term life insurance policy. It offers policyholders a product that blends the favorable features of a whole life policy with the higher yields that money market and bond funds pay.

Universal life insurance is a type of whole life insurance because the policy provides both death protection and a savings element. However, unlike whole life, universal life separates the insurance protection portion from the savings portion and offers the insured greater flexibility in paying premiums and in changing the level of the benefit. You can increase or decrease both your premium payments and death benefits as long as there is currently enough to pay the cost for the death protection element.

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Variable life is like universal life in that a death benefit provision is combined with a savings/investment plan. The big difference is that the consumer can select and periodically change the type of investment vehicle—money market funds, bond funds, and even stock funds —used with his or her variable life policy. Another difference between variable life and whole or universal life is that the amount of death benefits provided will vary with the profits (or losses) generated in the investment account.

As its name implies, variable universal life insurance is a variation of variable life that includes flexible premiums, like universal life policies, and a choice of investment vehicles, like variable life insurance. The administrative costs are typically higher, which may undermine some of the higher investment returns, and there are few guarantees concerning the rate of investment return or the level of benefit.

Group life insurance is an arrangement under which one master policy is issued, and each eligible member of the group receives a certificate of insurance. It is nearly always term insurance, and the premium is based on the characteristics of the group as a whole rather than those related to any specific individual. Group insurance is commonly offered as a fringe benefit to employees. Because of its temporary nature and relatively low face amount (often equal to one year's salary or less), it should fulfill only low-priority insurance needs. However, the employee may be allowed to purchase additional insurance for himself as well as his dependents. This is a very attractive feature when employees intend to stay with the same employer for an extended period. For individuals and their dependents who may be virtually “uninsurable” because of health problems, etc., this may be about the only way they can obtain insurance.

a. Credit life insurance assures the borrower's beneficiaries that, upon death of the borrower, the stated debt will be repaid. Most often this type of insurance is a term policy with a face value that decreases at the same rate as the balance on the loan and is one of the most expensive ways to buy life insurance. Contrary to popular belief, a lender cannot legally reject a loan if the potential borrower chooses not to buy credit life insurance from them.

b. Mortgage life insurance is a form of credit life designed to pay off the mortgage balance upon the death of the borrower. This need can usually be met less expensively by shopping the open market for a suitable decreasing term policy. The high cost of mortgage life insurance is attributable to the fact that the lender selling such insurance receives a commission, and, therefore, is not sensitive to cost factors.

c. Industrial or home service life insurance is whole life or endowment insurance issued in policies with small face values and is sold by agents who call on policyholders weekly or monthly to collect the premiums. The small size of its policies coupled with the high collection costs makes this insurance more expensive per dollar of coverage than whole life or endowment policies. It is rarely sold and accounts for less than 1% of the total amount of life insurance in force in the U.S.

The first and most important step involved in shopping for and buying life insurance is developing an estimate of your future financial needs and then selecting the types of policies that will best satisfy those needs. Life insurance must be evaluated in conjunction with other financial

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goals. A person should also become familiar with the various provisions that life insurance contracts typically include.

Next, a person should select companies and agents to contact based on their reputations (financial and otherwise), cost of their policies, and agents' experience, training, and personality. Once these decisions have been made, the individual(s) should discuss their needs with their agent and capitalize on his or her expertise. They should learn the details of the various policy alternatives and select the most cost-effective policy that best serves their coverage needs.

A.M. Best, Moody's, Fitch, and Standard & Poor's all rate insurance companies according to their underlying financial strength. These firms look at the financial solvency of insurance companies and assess the ability of the insurer to pay future claims to their policyholders. They look at the insurance company's investment portfolio (especially its holding of high risk real estate and junk bonds), its debt structure and the adequacy of its capital to absorb financial shocks, and even its pricing practices and management strategies. From such in-depth analysis, the rating agencies then assign letter ratings that designate the financial integrity of the insurance company—the higher the rating, the more financially secure the company.

Obviously, it is important to know how an insurance company is rated (financially) because you are depending on them to stand behind a very sizable financial obligation (a life insurance policy that could easily run into six figures) at some unknown time in the future. Because of this, you would probably want to stick with insurance companies that receive one of the top two or three grades from the rating agencies (A++ to A from Best; Aaa to Aa2 from Moody's; and AAA to AA from S&P); equally important, look for companies that receive one of these top grades from all of the major rating agencies. Important factors to consider in choosing an insurance agent include his or her level of competence, knowledge of the insurance industry and the various insurance products, willingness to listen to you and his or her attentiveness in determining the most appropriate insurance products to meet your needs. You also want an agent who is known to be dependable and capable of working with other professionals in carrying out your insurance planning needs.

A beneficiary is the person or persons who receive the death benefits of the policy if the insured person dies. A contingent beneficiary is a person or persons to whom benefits of the policy would go in the event that the insured outlives the primary beneficiary or that they both died at the same time. It is essential to name a beneficiary. Otherwise, the policy proceeds would be payable to the estate of the deceased and might be subject to prolonged legal and other procedures associated with estate settlement.

Settlement Options

There are five basic settlement options available for payment of life insurance proceeds upon the death of the insured.

Lump sum—The entire death benefit is paid to the beneficiary in a single amount.

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Interest Only—The policy proceeds are left on deposit with the insurance company for a given period of time. In exchange, the insurer guarantees to make interest payments to the beneficiary during the time it holds the funds. The beneficiary may or may not be permitted to withdraw the proceeds, depending on the agreement.

Fixed-period payments—The face amount of the policy, along with earned interest, is systematically liquidated over a selected period of time. The amount of the periodic payment is determined by the face amount of the policy and length of time over which the funds are to be distributed.

Fixed-amount payments—The beneficiary chooses the amount of periodic benefit desired rather than the number of years over which income is to be received. The period over which the payments are received will, therefore, be determined by the amount of policy proceeds and the size of the periodic benefit specified by the beneficiary.

Life Income—The insurer guarantees a certain payment amount to the beneficiary for the remainder of his or her life. The amount is dependent upon the face value of the policy, interest rate assumptions, and the life expectancy of the beneficiary.

With policies which build cash value, policyholders have a right to receive the cash value if they cancel their policies prior to death (i.e., they do not have to forfeit their cash value). Nonforfeiture options give policyholders choices concerning how they wish to receive these benefits in the event that they do cancel their policies. One option, of course, may be to receive cash. With the paid-up insurance option, the policy's cash value is applied to a new, single- premium policy with a lower face value. Under the extended term option, the cash value is used to buy a term life policy of the same face value; the coverage period is based on the amount of term protection that can be purchased for the given amount of cash value for a person of the insured's age.

a. A multiple indemnity clause doubles or triples the face amount of a policy if the insured dies as a result of an accident. This benefit is usually offered to the policyholder at a small additional cost.

b. A disability clause may contain either a waiver of premium benefit or a waiver of premium coupled with disability income. A waiver of premium benefit excuses the payment of premiums on the life insurance policy if the insured becomes totally and permanently disabled prior to age 60 (or sometimes age 65). Under the disability income portion, the insured is entitled to a monthly income equal to five or ten dollars per $1,000 of policy face value. Some policies will continue these payments over the life of the insured; others will terminate them at age 65.

c. A suicide clause voids the contract if an insured commits suicide within two years (sometimes one) after its inception. In such cases, the company returns the premiums that have been paid. If the insured takes his or her life after this initial period has elapsed, the policy proceeds are paid without question.

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The most common exclusions are aviation (piloting a private plane or flying on a military plane) and war. Hazardous occupations or hobbies, such as skydiving, may also be specifically excluded.

With a participating life insurance policy, the policyholder is entitled to receive policy dividends that reflect the difference between the premiums that are charged and the amount of premium necessary to fund the actual mortality experience of the company. A company estimates its base premium schedule and then adds an adequate margin of safety. The premiums charged the policyholder are based on these somewhat overcautious estimates. When the company experience is more favorable than that estimated, policyholders receive policy dividends. The policyholder may accept the dividend as a cash payment, leave it with the company to earn interest, use it to buy additional paid-up coverage, or apply it toward the next premium payment.

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CHAPTER 9 OUTLINE

A sound personal financial plan includes adequate protection against the potentially devastating financial consequences associated with a serious illness or accident. Provisions must be made to meet doctor and hospital bills as well as to replace income lost during periods of extended illness and recuperation. Health care insurance provides a way to meet such costs. It is a vital component of an effective financial plan, because without adequate health care insurance everything that one has accomplished, as well as the likelihood of goal achievement, could quickly be wiped out. Health care insurance is therefore an essential component of financial plans. The major topics covered in this chapter include:

1. The effect of rising health care delivery costs on the need for adequate health care insurance and the importance of including health insurance as a fundamental component of a strong personal financial plan.

2. Types and sources of health care coverage available for covering medical and hospitalization expenses, including indemnity and managed care plans, such as health maintenance organizations, individual practice associations, and preferred provider organizations.

3. The providers of health care coverage, ranging from the federal government's Social Security program to group health insurance policies and individual health coverages.

4. Review of the most important health insurance policy provisions as they relate to terms of payment and terms of coverage.

5. Cost containment provisions commonly found in health insurance plans. 6. Long-term care insurance, including policy provisions and costs. 7. The importance of disability insurance to replace lost wages during periods of extended

illness.

Key Concepts

Recognizing and meeting the need for adequate health care protection is fundamental to effective personal financial planning. Because health care costs are rising faster than the costs of most other consumer products and services, insuring one&apos

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