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The Role of Life and Health Insurance


Dread disease and accident insurance. Basic Health Insurance ... types of insurance -- concentrate on making your health coverage as comprehensive as possible. ... – PowerPoint PPT presentation

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Title: The Role of Life and Health Insurance

Chapter 9
  • The Role of Life and Health Insurance

Understanding the Logic Behind Insurance
  • Insurance is an example of risk pooling --
    individuals share their financial risks to reduce
    catastrophic losses from death, accidents, or
    health problems.

Life Insurance Policy Terms
  • Premium -- the monthly cost of the policy
  • Face value -- the benefit due upon death
  • Insured -- the person whose life is covered by
    the policy
  • Policy owner -- the individual or business that
    pays for and owns the policy
  • Beneficiary -- the recipient of the benefit upon
    the death of the insured

Life Insurance May Not Be Necessary for the
  • Single person, without dependents
  • Double-income married couple, without dependents
  • Married, but unemployed, individual without
  • Retired persons

Life Insurance May Be Necessary for Those
  • With dependents
  • Who are a married, single-income couple, with
  • Who are business owners?
  • Whose estate exceeds the estate tax-free transfer
    threshold (675,000 in 2000/2001 and increasing
    to 1M by 2006).

Determine Your Life Insurance Needs Two methods
  • The earnings multiple approach
  • To replace the annual salary stream of a bread
    winner for X years, normally 5 15 times gross
    salary is recommended.
  • The needs approach
  • To meet the needs of the household after the
    death of a breadwinner, both current and in the

The Earnings Multiple Approach
  • Adjust salary down to compensate for the
    reduction in household expenses.
  • Choose the PVIFA i, n yr to match the assumed
    after-tax and after-inflation earnings on the
    policy settlement.
  • The longer the income stream replacement, the
    greater the multiple. The higher the assumed
    earnings, the lower the multiple.

Earning Multiple Approach Formula
  • Life Insurance Needs
  • Income x (1 of income spent on the deceased)
    x PVIFA i, n yr

Assume earning 75,000, less 25,000 for
remaining 30 years at 5 , how much insurance
should one have?
The Needs Approach -- The Seven Funds
  • Immediate needs funds
  • Debt elimination funds
  • Immediate transitional funds
  • Dependency funds
  • Spousal life income funds
  • Educational funds for child or spouse
  • Retirement income funds

The Needs Approach -- The Calculation
  • Add all funding needs to determine total need
  • Subtract current insurance coverage and other
    available assets
  • This determines amount of additional insurance
    coverage necessary

Needs Approach
  • Bill age 35 and Mary age 33 seek your advice on
    the amount of life insurance to purchase. They
    have two children ages six and four.
  • Bill earns 65,000 per year in salary.
  • Their home is worth 150,000 and they have a
    90,000 mortgage.
  • Their savings and investments total 30,000.
  • Mary currently does not work and would find it
    difficult to go to work until the youngest child
    enters first grade in two years.
  • She anticipates she could earn 40,000 after
    taxes at that time which would handle all her
    needs throughout her working life.

Bill and Mary Continued
  • Funeral and administrative expenses would
    approximate 10,000.
  • The family anticipates a current need of 100,000
    to assist the children with college education.
  • Mary acknowledges that she needs an additional
    8,000 per year per child to cover expenses until
    the children are off the nest.
  • Assume 45,000 of Bills salary is devoted to the
    family and 8 is an appropriate rate of return.
  • How much insurance does Bill need?

Major Types of Insurance
  • Term insurance
  • Cash-value insurance

Term Insurance
  • Death benefit coverage for a specific term of
  • Only valid if the insured dies during the term of
  • Least expensive form of insurance

Cash-Value Insurance
  • Provides a death benefit and an opportunity to
    accumulate savings
  • Provides permanent insurance

Types of Cash-Value Insurance
  • Whole life insurance for those who need
    permanent life insurance protection
  • Universal life insurance for those who want a
    flexible policy that combines term protection and
    tax-deferred savings
  • Variable life insurance for those who want to
    take risks and manage their own investments with
    an opportunity for tax-deferred savings.

Whole Life Insurance and Its Features
  • Permanent protection
  • Fixed premium
  • Fixed death benefit
  • Fixed cash-value that grows tax-deferred
  • Much less death protection than term for the same
  • Yield on cash value portion is not competitive
    with yields on alternative investments

Universal Life Insurance and Its Features
  • Permanent protection
  • Flexible premium payments with unbundling
  • mortality charge or term insurance
  • cash value or savings
  • administrative expenses
  • Flexible death benefits
  • Cash-value fluctuates depending on the amount
    paid into the policy

Universal Life Insurance and Its Features (contd)
  • Returns fluctuate widely
  • Policies often lapse because of the flexibility
    to not make premium payments
  • Savings may not accumulate as expected due to
    fluctuations in return and high expense charges

Variable Life Insurance and Its Features
  • Permanent protection returns are earned on a
    tax-deferred basis
  • Allows for either a fixed (straight variable) or
    flexible (variable universal) premium
  • Flexible death benefit and fluctuating cash
    value, reflecting the mutual fund investment

Determining Which Type of Insurance Is Right for
  • For most, term is the best alternative.
  • Relatively low cost
  • Affordable coverage when life insurance is needed
    the most
  • Can afford to carry the coverage needed
  • Becomes very expensive with age, but may be

Determining Which Type of Insurance Is Right for
  • Cash-value insurance offers tax advantages
  • Savings grow tax-deferred and are passed on
    without incurring estate taxes
  • Other investment plans are better relative to
    cash-value insurance

1. The Beneficiary Provision
  • Allows for the naming of primary and contingent
  • May name an irrevocable beneficiary that cannot
    be changed without permission of the beneficiary.

2. The Grace Period Clause
  • Automatic extension of 30 or 31 days that the
    owner has to pay the premium without the policy

3. The Loan Clause
  • Only exists on policies with a cash value.
  • Allows the owner to borrow against the cash value
    of the policy.

4.The Nonforfeiture Clause
  • Provides options for policy holders to terminate
    their policies early
  • receive the cash value
  • exchange cash value for a paid-up policy with a
    reduced face value
  • exchange cash value for a paid-up term policy
    with the full face value

5. The Policy Reinstatement Clause
  • Option for restoring a lapsed policy within 3 to
    5 years of the expiration
  • Generally requires all past due premiums, loans,
    and interest be paid before reinstatement

6. The Change of Policy Clause
  • Allows the policy holder to change the type of
    policy in effect

7. The Suicide Clause
  • States that the insurance company will not pay
    death benefits if the insured commits suicide
    within 2 years of when the policy took effect.

8. The Payment Premium Clause
  • Explains the options available for the payment of
    the premiums, such as monthly or annually.

9. The Incontestability Clause
  • Declares that the insurance company can not
    dispute the validity of the policy after a
    certain time period has passed, normally 2 years.
  • This clause provides very important protection to
    the beneficiary against policy cancellation.

10. Settlement Options
  • Lump-sum settlement -- one time payout upon death
    of the insured.
  • Interest-only settlement -- periodic payments of
    the interest earned by the principal.

Buying Life Insurance
  • 1. Buyer beware -- a little knowledge goes a long
  • 2. Select a high-quality insurance company based
    on company ratings
  • 3. Select an insurance agent with whom you feel
  • 4. Compare costs of competing policies
  • 5. Consider alternative approaches the net or an

Major Types of Health Care Coverage
  • Basic health insurance
  • Major medical expense insurance
  • Dental and eye insurance
  • Dread disease and accident insurance

Basic Health Insurance
  • Hospital insurance -- covers hospitalization
    expenses including room fees, nursing fees, and
    drug fees.
  • Surgical insurance -- covers only the direct
    costs of surgery including the surgeons fees and
    equipment fees.
  • Physician expense insurance -- covers physicians
    fees including office fees, lab fees, and X-ray

Major Medical Expense Insurance
  • Covers medical costs beyond the basic plan.
  • Normally requires co-payments and deductible
  • Stop-loss provision -- limits the total
    out-of-pocket expenses incurred by the insured to
    a specific dollar amount.
  • Life-time cap -- total amount the insurance
    company will pay over the life of a policy.

See examples in notes
Dental and Eye Insurance
  • Covers the costs of eye exams, glasses, contact
    lenses, dental work, and dentures.
  • Typically prohibitively expensive unless provided
    with an employer plan.

Dread Disease and Accident Insurance
  • Covers only specific illness or accidents.
  • Provides a set dollar amount of reimbursement.
  • Note Avoid these types of insurance --
    concentrate on making your health coverage as
    comprehensive as possible.

Private Health Care Plans
  • Fee-for-service or traditional indemnity plans
  • Managed health care
  • health maintenance organizations (HMOs)
  • preferred provider organizations (PPOs)

Fee-for-Service or Traditional Indemnity Plans
  • Provides greatest flexibility for choosing
    doctors and hospitals.
  • Coinsurance -- defines the percentage of each
    claim that the policy will cover.
  • Co-payment or deductible -- defines the amount
    that you must pay before a claim is eligible for
  • Plans are relatively expensive and require more

Managed Health Care
  • Pays for and provides health care services to
    policy holders.
  • Limits choices to the doctors and hospitals that
  • Requires the policy holder to pay a monthly
    premium and share the cost of care.
  • Provides the most efficient payment of bills.

Group Insurance
  • Is sold to a group or employer rather than to an
  • Normally does not require subscribers to pass a
    medical exam
  • 15 - 40 cheaper than an individual policy

Government-Sponsored Health Care Plans
  • Workers Compensation
  • Medicare
  • Medicaid

Workers Compensation
  • Provides insurance to workers injured on the job
  • Provides payment for work-related accidents and
  • Coverage is determined by state law and varies by

  • Provides medical benefits to the disabled and to
    those 65 and older
  • Cost is covered through Social Security tax
  • Divided into two parts -- A and B
  • Part A is compulsory and covers hospital expenses

Medicare (contd)
  • Part B is voluntary, with a monthly premium, and
    covers doctors fees and other medical services
  • Medigap insurance, sold by private companies,
    provides for gaps in Medicare coverage with Parts
    A and B

  • Provides health care for low income, blind, or
    aged persons.
  • Payments may be used to offset the premiums,
    deductibles, and co-payments incurred with

Controlling Health Care Costs
  • Live healthy
  • Use a medical reimbursement or flexible spending
  • Consider COBRA when changing jobs
  • Choose no health care coverage -- not recommended
    unless necessary

Medical Reimbursement or Flexible Spending Account
  • Optional employer-established savings plan funded
    with pre-tax dollars.
  • Provides an account for paying unreimbursed
    medical expenses.
  • Use it or lose it!
  • Very flexible, but some expenses are not eligible
    for coverage.

COBRA and Changing Jobs
  • With a company of more than 20 employees,
    depending on why you leave the company, you can
    continue health coverage for 18 36 months.
  • You pay the premium.
  • Must notify the company within 60 days of leaving.

Important Provisions in Health Insurance Policies
  • Whos covered?
  • Terms of payment
  • Preexisting conditions
  • Always maintain coverage to avoid exclusions
  • Guaranteed renewability provision
  • Exclusions
  • Emotional and mental disorders

Disability Insurance
  • Provides income (67 to 80 of after-tax income)
    in the event of a long-term illness or injury
  • Anyone who depends on earned income should have
    disability coverage

Disability Insurance (contd)
  • Sources of disability insurance
  • Workers Compensation
  • Social Security
  • Purchase through your employers benefit plan
  • Amount of coverage depends on the amount of
    income to be replaced

Disability Insurance Features That Make Sense
  • Determine the providers definition of disability
    -- make sure it is not too restrictive
  • Residual or partial payments when returning to
    part-time work
  • Duration of disability benefits
  • short-term disability -- 6 months to 2 years
  • long-term disability -- until age 65 to 70 or for
    the insureds lifetime

Disability Insurance Features That Make Sense
  • Waiting (or elimination) period
  • Waiver of premium provision
  • Noncancelable provision
  • Rehabilitation coverage provision

Long-Term Care Insurance
  • Provides a daily dollar benefit for the costs of
    long-term care
  • Expensive, with many exceptions and conditions
    for coverage (e.g. ADLs)
  • Who needs it?
  • Those with savings to protect.
  • Those with a family history of long-term

Important Long-Term Care Insurance Provisions
  • Provisions which control qualification for
  • Type of care covered
  • Benefit period
  • Waiting period
  • Inflation adjustment provision
  • Waiver of premium provision
  • Noncancelability provision