Chapter 12

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CHAPTER 12

Personal Finance

Life Insurance

Kapoor Dlabay Hughes

7e

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An Introduction to Life Insurance Life insurance is obtained by purchasing a policy, with

the insurance company promising to pay a lump sum at the time of the policy holder’s death, or sometimes while they are still alive.

The purpose of life insurance is to protect someone who depends on you from financial loss related to your death. Other reasons are. To make charitable bequests upon your death. To save money for retirement or for income or

education for children. To leave as part of your estate. To pay off a mortgage or debts at the time of death.12-2

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The Principle of Life Insurance

Mortality tables provide odds on your dying, based on your age and sex.

Your premium is based on your life expectancy and the projections for the payouts for persons who die.

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Determining Your Life Insurance Needs - Ask Yourself...

Do you need life insurance? Do you have people you need

to protect financially? Do you have a partner who works?

What are your objectives for life insurance? How much money do you want to leave your

dependents should you die today? When do you want to retire, and what income do you

think you’ll need? How much will you be able to pay for your insurance

program?

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Estimating Your Life Insurance Requirements

The Easy Method. Typically, you will need 70% of your salary for

seven years while your family adjusts. The DINK (dual income, no kids) Method. The “Nonworking” Spouse Method.

Multiply the number of years until the youngest child reaches 18 by $10,000.

The “Family Need” Method. More thorough than the first three because it

also considers employer provided insurance, Social Security benefits, and income and assets.

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Two Types ofLife Insurance Companies

Stock life insurance companiesare owned by the shareholders. 95% are of this type. Sell non-participating policies. If you want to pay the same

premium each year, choose a non-participating policy with its guaranteed premiums.

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Two Types ofLife Insurance Companies

Mutual life insurance companies. Owned by the policyholders. 5% of policies are from this type of

company. With participating policies the premiums are

higher than non-participating policies. However, part of the premium is refunded to the policyholders annually. This is called the policy dividend.

(continued)

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Types of Life Insurance Policies Term life insurance.

Protection for a specified period of time. If you stop paying premiums, coverage stops. A renewability option means that at the end of the

term you can renew the policy without having a physical.

Conversion option allows you to exchange your term policy to a whole life policy without having a physical.

With decreasing term insurance your premium stays the same, but the amount of coverage decreases as you age.

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Types of Life Insurance Policies

Whole life insurance is also called straight life. You pay a premium as long as you live. Amount of premium depends on your age

when you start the policy. Provides death benefits and accumulates a

cash value. You can borrow against the cash value or

draw it out at retirement. Look carefully at the rate of return your money

earns.

(continued)

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Whole Life Policy Options Limited payment policy.

Pay premiums for a stipulated period, usually 20 or 30 years, or until you reach a specified age (65).

Your policy then becomes “paid up” and you remain insured for life.

Variable life policy. A minimum death benefit is guaranteed,

but the death benefit can be greater than the minimum depending on earnings of the dollars invested in the separate fund.

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Whole Life Policy Options Adjustable life policy.

A whole life insurance policy, but you can change your policy as your needs change. For example, you can change your premium payments or the period of coverage.

Universal life - gives you more direct control. Lets you pay premiums at any time in almost any

amount. The amount of insurance can be changed more easily than a traditional policy.

The increase in the cash value of the policy reflects the interest earned on short-term investments.

(continued)

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Other Types of Life Insurance Policies

Group life insurance. Term insurance. Often provided by an employer. No physical is required.

Credit life insurance. Debt is paid off if you die.

Mortgage, car, furniture. Also protects lenders. Expensive protection. 12-12

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Life Insurance Contract Provisions Naming your beneficiary, and contingent

beneficiaries. Length of grace period for late payments. Reinstatement of a lapsed policy if it has not been

turned in for cash. Nonforfeiture allows you to keep accrued benefits

if you drop the policy. Incontestability clause says that after the policy

has been in force for a specified period, the company can’t dispute its validity for any reason.

Suicide clause during first two years. 12-13

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Life Insurance Contract Provisions

Automatic premium loans. Uses the accumulated cash value to pay the

premium if you do not pay it during the grace period.

Misstatement of age provision. Policy loan provision to borrow against cash

value. A rider to a policy modifies the coverage by

adding or excluding conditions or altering benefits.

(continued)

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Life Insurance Contract Provisions Waiver of premium disability benefit. Accidental death benefit - double indemnity. Guaranteed insurability option. Cost of living protection. Accelerated benefits, also called living benefits,

pay to those who are terminally ill before they die. Second-to-die option, also called survivorship,

insures two lives.

(continued)

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Buying Life Insurance Look at your present and future sources of income, other

savings and income protection, group life insurance, pension benefits, and Social Security benefits.

Determine from whom to buy your policy. Examine both private and public sources. Look up the company’s rating,

in A. M. Best. Talk to friends or colleagues. Research ratings on the web,

www.standardandpoor.com.

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Choosing Your Insurance Agent Ask friends, parents, and neighbors for

recommendations. Find out if the agent belongs to professional

groups or is a Chartered Life Underwriter (CLU). Is the person willing to take the time to answer

your questions and find a policy that is right for you?

Do they ask about your financial plan? Do you feel pressured? Are they available when needed? 12-17

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Buying Life Insurance (continued)

Compare policy costs which are affected by... How selective they are in whom they insure. Their cost of doing business. Return on their investments. Mortality rate among policyholders. Policy features and competition from other firms

Use interest-adjusted index to compare policies. Takes into account the time value of money. Helps you make cost comparisons among

insurance companies. See sites such as www.quotesmith.com.

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Obtaining and Examining a Policy The first step is to apply. The second step is to provide medical history. Usually no physical for a group policy. Read every word of the contract. After you buy it, you have ten days to change your

mind. Give your beneficiaries

and lawyer a photocopy.

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Choosing Settlement Options Options are the choices available for how you

can have the life insurance money paid out. Lump-sum payment is most common. Limited installment plan.

In equal installments for a specific number of years after your death.

Life income option. Payments to the beneficiary for life.

Proceeds left with the company. Pays interest to the beneficiary.

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Should You Switch Policies?

Switch if benefits exceed costs of getting another physical, and paying policy set-up costs.

The older you are the higher the premium will be.

Are you still insurable? Can you get all the provisions

you want? 12-21

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Financial Planning with Annuities

An annuity is a financial contract written by an insurance company that provides you with a regular income.

People buy annuities to supplement retirement income and to shelter income from taxes.

Those who expect to live longer than average benefit most from annuities.

Annuities are tax-deferred investment plans. You pay taxes on the interest when you draw the money out. 12-22