Presentation on theme: "Personal Finance: A Gospel Perspective"— Presentation transcript:
1Personal Finance: A Gospel Perspective Insurance: Basics, Life and Disability Insurance
2ObjectivesA. Understand the basics of insuranceB. Understand life insuranceC. Understand disability insurance
3Insurance BasicsInsurance is an important part of becoming financially self-reliant. Elder Marvin J. Ashton said:Appropriately involve yourself in an insurance program. It is most important to have sufficient medical, automobile, and homeowner’s insurance and an adequate life insurance program. Costs associated with illness, accident, and death may be so large that uninsured families can be financially burdened for many years. (Marvin J. Ashton, “Guide to Family Finance,” Liahona, Apr. 2000, 42.)
4Insurance Basics (continued) President N. Eldon Tanner further commented:With rising medical costs, health insurance is the only way most families can meet serious accident, illness, or maternity costs, particularly those for premature births. Life insurance provides income continuation when the provider prematurely dies. Every family should make provision for proper health and life insurance. (N. Eldon Tanner, “Constancy Amid Change,” Ensign, Nov. 1979, 80.)
5Insurance Basics (continued) What is insurance?Insurance is a legal contract between you and an insurance firm whereby the firm agrees for a premium (fee) to pay you compensation for certain kinds of losses or events, i.e., death, sickness, compensation for accidents, loss of ability to work, legal expenses, etc.What are the major types of insurance?Life Insurance, Health Insurance, and Auto, Home, Disability, and Liability Insurance
6Insurance (continued) What is the purpose of insurance?The purpose of insurance is to transfer the risk of certain types of losses or events from yourself to another institution.By transferring risk, it can help you and those you love achieve your specific goals if you die, get sick or become unable to workSpecific goals may include:To take care of your spouse and childrenTo raise children without working outside the homeTo be able to go to college and on missions
7Insurance (continued) How do you eliminate risk?Avoid it. You can take care of yourself, avoid high risk occupations, eat well, and exercise.Reduce it. You can reduce some risks by adding fire extinguishers and burglar alarms, adding airbags, or getting regular medical checkupsAssume it. You can assume the risk through self-insurance. If the costs are not too high, you can assume some risks yourselfTransfer it. You can transfer the risk to others by purchasing insurance. You are paying premiums to transfer the risk to an insurance company.
8Insurance (continued) Should you insure against all losses?No. Some losses are not as critical as others. Insure against the critical or serious lossesCan you classify your risks?Yes. I like two thoughts:Frequency of lossHow often does the loss happen?Severity of lossHow severe are the results if the loss happens?
9Insurance (continued) Frequency of LossLowHighAvoidReduceHighTransferSeverity of LossReduceAssumeReduceAssumeLow
10Insurance (continued) What is the key to insurance?You need to balance the cost of reducing risk with the severity of the lossInsure against high severity losses that rarely occur—those that could have a major impact on the financial condition of you and your familyReduce and avoid those other risks that you can
12Understand Life Insurance Case Study #3. Jonathan is a widower with two children and earns $50,000 per year. His group life insurance policy from work will pay 3 times his salary. He has $70,000 saved in his company 401K, $10,000 in a Roth IRA, and $5,000 in his savings account. He wants to purchase life insurance until is youngest graduates from college in 20 years. He is not concerned about his outstanding mortgage, as his kids could go live with his brother in the event of his death.a. Assuming his brother can earn 3% after-tax and inflation, use the earning multiple approach to calculate his life insurance needs.b. What other information would you need to calculate the needs approach for Jonathan?
13What is life insurance? Why have life insurance? Insurance that provides compensation to your beneficiaries should you die prematurely.This is a high severity riskWhy have life insurance?It transfers the economic loss of death from an individual to a insurance company by way of a life insurance contractIt can help us take care of our own and extended families should we dieDeath is not an excuse for disobedience
14Life Insurance (continued) Other Benefits: Estate PlanningLife insurance products can be helpful in making sure there are sufficient funds for estate tax purposesAn owner has a business worth $3 million. When he dies, he wants the business to pass to his son. How can life insurance help?The owner puts the business in a trust, with the son as trustee, and buys a $750,000 life insurance policy, with his trust as beneficiary.When he dies, the trust takes the $750,000 policy and pays the estate taxes. The son is the beneficiary and now owns the business estate-tax free.
15Life Insurance (continued) Retirement PlanningThe cash-value portion of life insurance grows tax-free, after (lots of) fees and expensesAn investor wants to save for retirement. He has already invested the maximum in his 401k, Roth IRA, and other vehicles. How can life insurance help?A cash value product provides both a death benefit and savings component. The cash value portion grows tax deferred after fees and expensesThe investor can borrow against the cash value in the insurance contract for a low-cost loan. He will pay a specified interest rate for the loan, and if not paid back, the death benefit is reduced
16Life Insurance (continued) Forced SavingsFor those without the discipline, life insurance can be an expensive type of forced savingsThe investor is unable to save for retirement, although he is good at paying his bills. How can life insurance help?The investor purchases a cash-value product with low fees and expenses, and can direct, to a degree, where the assets are invested. This become forced savings to aid in achieving the investor’s goals.The investor, upon retirement (or even before), can then borrow against the account.
17I. Why Life Insurance? Why Life Insurance? Insurance is for emergency planning and control of your lifeWe have been commanded to keep adequate insuranceDeath is not an excuse for not taking care of our families
18II. How does Life Insurance Work? Insurance is an example of risk poolingIndividuals transfer (share) their financial risks with others to reduce catastrophic losses from:DeathAccidents, orHealth problems
19III. Who needs Life Insurance? Not everyone needs life insurance. Those who do include:Single or married with dependents or childrenMarried, single income couple where the spouse has insufficient work skills or savingsBusiness owners who wish to transfer their businesses to the next generationThose whose estate exceeds the estate tax-free transfer threshold
20How much Life Insurance? How do you determine your Life Insurance needs?From the old LDS Handbook for Families it states:Insure the family’s breadwinner first, then others, if desired, as income permits. At a minimum, get enough life insurance to pay for such things as a funeral, taxes, mortgage on the home, car payments, and other debts. The next priority should be to get enough insurance that, supplemented by any government retirement benefits the surviving spouse may be entitled to, there will be sufficient to provide for the family and to make provisions for the children’s education and missions. “Handbook for Families: Preparing for Emergencies,” Ensign, Dec. 1990, 59.
21How much Life Insurance? (continued) There are two different methods of determining how much life insurance.The earnings multiple approachThe goal is earnings replacementIt seeks to replace the annual salary stream of a bread winner for X years, normally 5 – 15 times gross salary is recommended.The lower general interest rates, the higher the multiple needed
22How much Life Insurance? (continued) How is it calculated?1. Adjust salary down to compensate for the reduction in household expenses2. Choose the appropriate interest rate to match the assumed after-tax and after-inflation earnings on the policy settlement.3. Determine the income stream replacement and annuity
23The Needs Approach How is it calculated? 1. Adjust the salary downward 2. Add up all funding needsThe total needs of the beneficiaries includes: immediate, debt elimination, transitional, dependency, spousal life income, education, and retirement funds3. Subtract current insurance coverage and other available assetsThis is additional coverage necessary4. Determine the income stream replacement and calculate the needed annuity
24Life Insurance and Your Investment Plan Cash value: with guaranteed insurability option paid up till age 65. Term: Five-year guaranteed renewable term in $50,000 and $100,000 increments; can add and drop as necessary. Investment: Includes individual and employer sponsored retirement plans
25V. What Kind of Life Insurance? What are the different types of life insurance?Term insuranceCash value (or endowment)Note: All life insurance is term insurance. The difference is that cash-value insurance has a separate investment component that accrues, after fees and expenses (and these may be substantial), without taxes
26Life Insurance Policy Terms PremiumThe monthly cost of the policyFace valueThe benefit due upon deathInsuredThe person whose life is covered by the policyPolicy ownerThe individual or business that pays for and owns the policyBeneficiaryThe recipient of the benefit upon the death of the insured
27Different Types of Life Insurance What is Term Insurance?Insurance protection for the insured over a specific term or time period.What are its advantages?It is the least expensive form of insuranceDeath benefit coverage is for a specific termWhat are its disadvantages?It is only valid if the insured dies during the termInsurance may not be renewed once your term expiresAdvancing age increases the cost of insurance
28Understanding Term Insurance: The Process + Premium PaymentsYour Insurance Policy- Mortality Costs- Expense Costs (very small)
29Term Insurance (continued) What are the different types of Term Insurance?Renewable term insuranceCan be renewed for a specific number of yearsGenerally have a guaranteed maximum premium for some period of timeThe longer the guaranteed premium (.i.e., 10 years), the higher the monthly or annual premium
30Term Insurance (continued) Decreasing term insurancePremiums remain constant while the face amount of coverage decreasesThis takes into account the fact that the mortality cost of term insurance increases in later yearsGenerally for a specific loss coverage, such as mortgage or child dependency where need changesConvertible term life insuranceTerm policy that can be changed to cash-value policy within a specific number of years
31Term Insurance (continued) Why are premiums for term much less than cash-value?You are only paying for insurance for a specific period, i.e. risk is priced one period at a time95% of term policies lapse without paymentIt is generally for a shorter period, i.e years.The longer the period, the more insurance companies must charge higher fees in the early years to offset the more expensive mortality charges and fees in the later yearsTerm is generally easier and cheaper to administerFees and sales charges are less complex
32Term Insurance (continued) Key questions when purchasing term insurance:How long can I keep this policy?What are the renewal terms of the contract?When will my premiums increase?Can I convert my term policy to a permanent or cash-value policy? What are the details?How strong is the company financially?
33Cash-Value Insurance What is cash-value or permanent insurance? It is an insurance contract that is purchased for your entire life with premiums divided between death protection and savings.What are its advantages?Provides insurance that cannot be cancelledCan be used for estate, retirement, and “forced” savingsWhat are its disadvantages?It is very complex and expensiveUnless premiums are paid, it can expire worthlessCertain cash-value products can lose money
34Understanding Cash Value Insurance: The Process + Premium Payments+ Investment Income+ Dividends (if participating)Your Cash-Value Insurance Policy- Mortality CostsA major benefit is to be able to borrow against your policy tax-free- Expense Costs (may be significant)
35Cash-Value Insurance (continued) Different types of cash-value insurance?Whole life. For those who want term protection with a savings elementUniversal life insurance. For those who want a flexible policy that combines term protection and tax-deferred savingsVariable life. For those who want term protection and to manage their own investments with an opportunity for tax-deferred savings.Variable Universal Life. For those who want term protection, full policy flexibility, and to manage their own investments
36Cash-Value Insurance (continued) The differences in cash-value products relate to the goals, types of investments, and flexibilityGoals: The type of return and risk the insured are willing to take with their investments.Types of investments: The types of investment vehicles the non-mortality portion of the premiums are invested in, i.e., long-term bonds, short-term cash, stocks, etc.Investment, premium and face amount flexibility: The ability to change the type of investments, monthly premium amounts, or the face value amount during the life of the contract.
37Cash-Value Insurance (continued) Source: Ben G. Baldwin, The New Life Insurance Investment Advisor, 2nd ed., McGraw Hill, New York, 2002, pp. 31, 50, 77, and 88.
38Cash-Value Insurance (continued) The key is to understand why you want cash-value life insuranceUnderstand your needsUnderstand the individual polices of competing life insurance companies, i.e., the charges and deductions of the insurance company, and fees and expenses of the mutual funds/assets invested inSelect the policy that gives you maximum benefit at the lowest possible cost to you.
39Cash-Value Insurance (continued) Why are cash value premiums higher than term?It is priced for your entire lifeEarlier premiums must be priced higher to take into account that mortality costs increase as you ageIt includes a savings componentThese savings must be fundedIt cannot be terminated by the insurance company95% of all cash-value policies are paidIt is more costly and time consuming to administerThere are more and higher up-front and operating fees, and sales and other charges are higher
40Cash-value Insurance (continued) Watch your expenses carefullyExpenses on a typical Variable Universal Life policy at the account level include:Minimum Average MaximumSales Charges * 0.0% 8.0% 10.0%State Premium Taxes 0.75% 2.0% 5.0%DAC Tax * 0.0% 1.5% 2.0%First-year Expense * $200 $350 $700Administration Fees/month * $4 $6 $15Mortality and Expense 0.4% 0.7% 1.3%Source: Ben G. Baldwin, “The New Life Insurance Investment Advisor,” 2nd ed., McGraw Hill, New York, 2002, p.106.* These expenses will vary among competing insurance policies from different companies.
41Cash-Value Insurance (continued) Expenses at the sub-account level (i.e. the individual investment level) include:Asset ChargesMinimum Average MaximumInvestment Management * 0.4% .8% 2.8%12-b1 Fees * 0.0% 0.0% 0.5%Overall Expense Ratio * 1.0% 1.5% 4.4%Policy Loans as % Contract Surrender Value *,Interest spread 75%,4% 90%,2% 100%,0%Surrender Charges * can be significantSource: Baldwin, p.106* These expenses will vary depending on the mutual funds or assets chosen for the sub-accounts. Mutual fund expenses can be reduced through research on comparable funds and comparison shopping.
42Cash-Value Insurance (continued) It is not uncommon for the deductions and fees to range between 5% and 15% of every dollar you put into some types of cash-value insurance.As such, the cash-value portion of this life insurance grows slower than a term policy with the remainder investedCash-value insurance is not for everyone, but it may be for someKey is to understand your needs and the needs cash-value insurance can fillEstate planning, Retirement planning, after all other tax-deferred vehicles have been filled, and Forced savings (but it is not as good as other savings vehicles)
43Cash-value InsuranceImportant questions to ask about cash-value insurance:Are the premiums within my budget? Are costs reasonable?Can I commit to these premiums over the long-term?On a variable life policy, what is the assumed interest rate in the illustration?Is the classification shown in the illustration appropriate for me (i.e. smoker/non smoker, male/female)Which figures are guaranteed and which are not?Will I be notified if the non-guaranteed amounts change?Is the death benefit guaranteed?Will the premiums always be the same, even if interest rates are lower that the illustration?Is the illustrated premium sufficient to guarantee protection for my entire life?Is the “current rate” illustrated actually the rate paid recently? What was the current rate in each of the last five years?What assumptions have been used regarding company expenses, dividends, and policy lapse rates?Does all my cash value earn the current rate?Is the illustration based on the “cash surrender value” or “cash value?” The cash surrender value is usually lower and reflects what will be paid if the policy is cancelled.
44Cash-value Insurance for Students Key Questions:Can you commit to the premiums over the long-term?How can you, when you may not have a job?Do you need the tax benefits now?A 401k or IRA may be better? Fill those firstAre the rates of return guaranteed?No. Be careful of people selling these products who do not know what they are selling?Do you have a history of medical problems that would preclude your ability to get term insurance?In this case, you “might” look into cash-value or convertible term insurance)
45Determining Which Type of Life Insurance Is Best for You For most, convertible (convertible to a cash-value policy) renewable (up to 30 years) term is the cheapest and best alternative (especially for students)Goal: Income Replacement of breadwinnerRelatively low costAffordable coverage when life insurance is needed the mostCan afford to carry the coverage needed for the time neededWhile it becomes very expensive with age, it may be less necessary as your other assets grow so you may need less insurance in the future
46Which Life Insurance Is Best (continued) Cash-value insurance may be the best choice if you meet very specific criteria:Goal: Medical Insurability. You have a history of medical problems (and if you already have convertible term insurance) you can’t be denied life insurance if you convertGoal: Estate Planning. Your assets are very large, and you have estate planning issues (i.e., you need to shield some of your assets should you die)Goal: Retirement Savings. You have already invested the maximums in your tax deferred accounts (IRA, 401k, Roth, SEP-IRA, etc.) and want additional tax-deferred savings
47Which Life Insurance Is Best (continued) Still unsure of yourself?Consider a renewable convertible term policy.It allows the low cost of term insurance, with the ability to convert to a cash policy in the future within a specific number of yearsIt gives you time to re-evaluate your current situation and still retain coverage for you and your family
48Which Life Insurance Is Best (continued) Note of caution:Because of the complexity and high setup costs for cash-value life insurance, it is very expensive to change. It is therefore of critical importance that you understand why you are buying and what you are buying before you purchase your policy. These contracts are very expensive to changeConsumers lose a significant amount of money each year because they buy policies they don’t understand and then cancel them a few years later.Remember the key principles of insurance
49Steps to Buying Life Insurance 1. Understand what you wantKnow yourselfKnow your goalsKnow your budgetKnow how much insurance you needKnow how much money you want to spend
50Steps to Buying Life Insurance (continued) 2. Compare costs of competing policiesDo your homework and shop around, not just on price, but on benefits, coverage, and exclusions. Possible comparisons:Annual Premiums: Participating or non-participating? If participating, the 5 year dividend history? This year?Total premium cost over the next 10 years (excluding dividends)In 10 years, what will be your cash/loan value? Paid-up conversion value? Extended term conversion value?
51Steps to Buying Life Insurance (continued) Compare costs (continued)Total Premium cost over 20 years?In 20 years, what will be your cash/loan value? Paid-up conversion value? Extended term conversion value?At what interest rate can you borrow against the policy? Is the interest rate guaranteed?
52Steps to Buying Life Insurance (continued) 3. Select only a high-quality insurance company based on company ratingsPrice is not the only criteria. You also want the company to be around to pay the benefits. Remember, you are looking for a long-term insurance relationshipRatings Companies:A.M. BestFitch RatingsMoody’sStandard & Poor’sWeiss Research
53Steps to Buying Life Insurance (continued) 4. Select an insurance agent with whom you feel comfortable and are not pressuredStudy the agent’s recommendations and ask for a point-by-point explanation if there are items you don’t understandUnderstand how the agent is getting compensatedIf they can’t (or won’t) explain all the costs and benefits, go to someone who canDo your homework
54Steps to Buying Life Insurance (continued) 5. Use wisdom in your decisionsMake sure you check out the insurance company and read your policy when you receive it to ensure it is correct. It must all be in writing!Consider alternative approaches: the net or an advisorMake sure you feel good about the decision before you sign anything or send money. Don’t rush into a decision.Make your check payable to the insurance company, not the agent, and be sure you are given a receipt for all money’s given.
55Steps to Buying Life Insurance (continued) There is a difference between choosing an agent, and being chosen by an agent. The selection decision is up to you—use it wisely.Read your policy carefully during your “free-look” period. Review your insurance policy annually after that.If you are changing policies, make sure you clearly understand the consequences. Surrendering your policy to buy another could be very, very, very (get the hint) costly.If you have a complaint, contact your agent and the state insurance department
56Case Study #3 Answer a. Earnings Multiple Approach Salary $50,000 Expense reduction % reduction (3 to 2)Amount needed ,000Life insurance needed $550,467PMT = 37,000, I = 3%, N = 20Company life insurance ($150,000) or 3 times salaryAdditional needed $400,467Multiple needed: times salary
57Case Study #3 Answer (continued) b. Other information for a needs approach would be funeral expenses, debt elimination, children’s educational expenses, mission expenses, social security benefits, etc. Notice that the earnings multiple approach does not take into account your individual level of savings or your current financial condition.
58QuestionsDo you have any questions on life insurance?
59B. Understand the Key Areas of Disability Insurance What is disability insurance?Disability is similar to life insurance, but is really “earning-power” insuranceInsurance that in the event that income is interrupted due to illness, sickness, or accident, you will still have incomeWho needs disability insurance?Anyone who depends on income from a jobDisability only kicks in if there is a financial catastrophe in the making
60Disability Insurance (continued) What are the sources of disability insurance?EmployersGovernmentPrivate providersIsn’t worker’s compensation sufficient?What about if the accident is not work-related?Coverage is determined by individual states, with wide variabilitySocial Security benefits vary depending on how many years you have paid into the system, your salary, how long the disability is expected to last
61Disability Insurance (continued) How much coverage should I have?You should have enough coverage to maintain your living standard should you no longer be able to workYour investment income will not stop with a disability, but your income from working will stopIf you have sufficient savings, you may not need much insurance, perhaps only 30% of after-tax incomeIf you have little savings, you may need a lot, perhaps 80%
62Disability Insurance (continued) What are the key areas of disability insurance?Definition of disabilityWhat exactly does the policy consider a disability?Stick with a policy that defines disability as an inability to perform your normal job.A combination definition may include “if you can’t perform your normal job for the first 2 years, and afterwards any occupation for which you are reasonably suited” may be acceptable
63Disability Insurance (continued) Residual or part-time payments when returning to work part-timeSome policies offer partial disability payments that allow workers to return to work part-timeThese payments make up the difference between part-time and full-time work
64Disability Insurance (continued) Benefit DurationPolicies state how long the benefits will continueMost policies provide benefits for a maximum period or until the disability ends (or the disabled reaches age 65 or 70).Short-term disability policies generally provide benefits from 6 months to 2 years, after a wait of 8 to 20 daysOnly a long-term policy makes much sense. Your emergency fund protects short-term
65Disability Insurance (continued) Waiting or Elimination PeriodPolicies determine the waiting period before the benefits beginMost policies have waiting periods of between 1 and 6 months.Generally the longer the waiting period, the less-expensive the policy
66Disability Insurance (continued) Waiver of PremiumWhat is the waiver of premium?It is a good idea to have a waiver of premium provision, which waives the premium payments if you become disabledNon cancelableMake sure your policy that cannot be cancelled. This protects you and guarantees your policy is renewable
67Disability Insurance (continued) Rehabilitation CoverageWhat is the rehabilitation coverage?This provides for vocational rehabilitation, allowing the policyholder to be retrained for employment through employment-related educational and job-training programs.Cost of Living RiderThis provides for inflation adjustments to protect you from the impact of inflation