1. Chapter 10 Financial Planning with Life Insurance 1 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2. 10-2 Life Insurance Chapter Learning Objectives LO10.1 Define life insurance and determine your life insurance needs. LO10.2 Distinguish between the types of life insurance companies and analyze various types of life insurance policies these companies issue. LO10.3 Select important provisions in life insurance contracts and create a plan to buy life insurance. LO10.4 Recognize how annuities provide financial security. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

3. 10-3 Learning Objective LO10.1 Define Life Insurance and Determine Your Life Insurance Needs Life insurance: ◦ Obtained by purchasing a policy ◦ The insurance company promises to pay a lump sum to a named beneficiary at the time of the policy holder’s death (or sometimes while they are still alive) Primary Purpose of Life Insurance: ◦ Protect someone who depends on you from financial loss related to your death Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

4. 10-4 Purpose of Life Insurance Potential Uses of Benefits: ◦ Pay off a mortgage or debts ◦ Lump-sum endowments for children ◦ Provide an education or income for children ◦ Make charitable donations ◦ Provide retirement income ◦ Accumulate savings ◦ Establish a regular income for survivors ◦ Set up an estate plan ◦ Pay estate and gift taxes Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5. 10-5 The Principle of Life Insurance Mortality tables provide odds on your dying, based on your age and sex. Premium (the cost of the policy) is based on your life expectancy and the projections for the payouts for persons who die Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

6. 10-6 Do You Need Life Insurance? Do you have people you need to protect financially? Are you single and have a lot of debt? Do you have parents, relatives, or a charity that you want to support? Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

7. 10-7 Estimating Your Life Insurance Requirements The Easy Method ◦ 70% of your salary for seven years while your family adjusts ◦ Assumes typical family The DINK Method ◦ Dual income, no kids ◦ Assumes spouse earnings => insured ◦ Cover funeral + ½ debts Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

8. 10-8 Estimating Your Life Insurance Requirements The “Nonworking” Spouse Method ◦ # years until the youngest child reaches 18 × $10,000 The “Family Need” Method ◦ More thorough than the first three ◦ Considers employer provided insurance, Social Security benefits, income, and assets Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9. 10-9 Learning Objective LO10.2 Types of Life Insurance Companies and Policies 2 Types of Life Insurance Companies Type of CompanyOwned byPolicy Type Stock life Insurance ShareholdersNonparticipating Mutual life insurance PolicyholdersParticipating Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

10. 10-10 Stock Life Insurance Companies Owned by the shareholders 95% are of this type Sell non-participating (non-par) policies If you want to pay the same premium each year  choose a non-participating policy with guaranteed premiums Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

11. 10-11 Mutual Life Insurance Companies Owned by the policyholders 5% of policies are from this type of company Participating policy premiums are higher than non-participating policies ◦ Part of the non-participating premium is refunded to the policyholders annually in the form of a policy dividend Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

12. 10-12 Types of Life Insurance Policies Term life insurance Whole Life insurance Group Life insurance Credit life insurance Endowment Life insurance Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

13. 10-13 “Term Life” ◦ Protection for a specified period of time ◦ If you stop paying premiums, coverage stops Many types: ◦ Renewable term ◦ Multiyear level term ◦ Conversion term ◦ Decreasing term ◦ Return-of-premium term Term Life Insurance Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

14. 10-14 Whole Life Insurance “Straight Life” ◦ Pay the premium as long as you live ◦ Amount of premium depends on age when you start the policy ◦ Provides death benefits ◦ 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 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

15. 10-15 Whole Life Policy Options Limited Payment Policy ◦ You pay premiums for a stipulated period  Usually 20 or 30 years, or  Until you reach a specified age (65) ◦ Policy then “paid up” and you remain insured for life Variable Life Policy ◦ Minimum death benefit guaranteed ◦ Benefit can be greater depending on earnings of the dollars invested in the separate fund Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

16. 10-16 Whole Life Policy Options Adjustable Life Policy ◦ Can change premium payments or period of coverage as your needs change Universal Life ◦ Term life policy with a cash value  Can borrow against cash value ◦ Premium amount may be changed at any time without changing coverage ◦ Part of premium goes to investment account ◦ Increase in cash value reflects interest earned on short-term investments Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

17. 10-17 Other Types of Life Insurance Policies Group life insurance ◦ Term insurance ◦ Often provided by an employer ◦ No physical required Credit life insurance ◦ Debt paid off if you die  Mortgage, car, furniture ◦ Also protects lenders ◦ Expensive protection Endowment Life Insurance ◦ Coverage for specific time, pays to holder if still living at end of period Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

18. 10-18 Comparison of Major Types of Life Insurance Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

19. Learning Objective LO10.3 Select important provisions in life insurance contracts and create a plan to buy life insurance Key Provisions in a Life Insurance Policy ◦ Naming your beneficiary and contingent beneficiaries ◦ Incontestability clause  after the policy has been in force for a specified period, the company can’t dispute its validity for any reason ◦ Length of grace period for late payments ◦ Reinstatement of a lapsed policy if it has not been turned in for cash 10-19 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

20. 10-20 Key Provisions in a Life Insurance Policy Non-Forfeiture Clause ◦ Allows you to keep accrued benefits in a whole life policy if you drop the policy Misstatement of age provision Policy loan provision to borrow against cash value Suicide clause during first two years Policy rider ◦ Modifies the coverage by adding or excluding conditions or altering benefits Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

21. 10-21 Key Provisions in a Life Insurance Policy Life Insurance Policy Riders 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 life, insures two lives Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

22. 10-22 Buying Life Insurance Consider: ◦ Present and future sources of income ◦ Other savings and income protection ◦ Group life insurance ◦ Pension benefits ◦ Social Security benefits ◦ Financial strength of the insurance company Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

23. 10-23 Buying Life Insurance Determine from whom to buy your policy ◦ Examine both private and public sources ◦ Research the company’s rating by major rating companies:  A. M. Best  Standard and Poor’s  Duff & Phelps  Moody’s  Weiss Research ◦ Talk to friends or colleagues Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

24. 10-24 Choosing Your Insurance Agent Ask friends, parents, and neighbors for recommendations Is the agent available when needed? Does the agent advise you to have a financial plan? Do you feel pressured? Does the agent keep current with changes in the insurance field? ◦ Does the agent belong to professional groups or is a Chartered Life Underwriter (CLU) who require continuing education? Is the agent willing to take the time to answer your questions and find a policy that is right for you? Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

25. 10-25 Buying Life Insurance Compare policy costs based on: ◦ Company’s cost of doing business ◦ Return on company’s investments ◦ Mortality rate among policyholders ◦ Policy features ◦ Competition from other firms Interest-adjusted index ◦ Used to compare policy costs ◦ Lower index = lower cost policy Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

26. 10-26 Obtaining and Examining a Policy First step = apply Second step = provide medical history ◦ Usually no physical for a group policy Read every word of the contract 10-day “free-look” period to change your mind Give your beneficiaries and lawyer a photocopy Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

27. 10-27 Settlement Options = choices of how the insurance money is paid out ◦ Lump-sum payment = most common ◦ Limited installment plan  In equal installments for a specific number of years after your death (10-year certain) ◦ Life income option  Payments to the beneficiary for life ◦ Proceeds left with the company  Pays interest to the beneficiary Choosing Settlement Options Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

28. 10-28 10 Golden Rules of Buying Life Insurance Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

29. 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 Are you still insurable? Can you get all the provisions you want? 10-29 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

30. 10-30 An annuity = a financial contract written by an insurance company, providing a regular income Can supplement retirement income and shelter income from taxes Those who expect to live longer than average benefit most from annuities Fully fund IRAs, Keoghs and 401(k)s BEFORE considering an annuity Learning Objective LO10.4 Financial Planning with Annuities Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

31. 10-31 Why Buy Annuities? Provides retirement income for life Compounded interest grows tax free until money withdrawn No maximum annual contribution (like IRAs) Beneficiary guaranteed no less than amount paid in Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

32. 10-32 Types of Annuities Immediate annuity ◦ Income payments begin at once Deferred annuity ◦ Payments begin at some point in the future Fixed annuity ◦ Annuitant receives fixed amount for life Variable annuity ◦ Amount received depends on investment performance Index Annuity ◦ Earnings rate based on stock market index Can be included in IRAs and Keogh plans Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

33. 10-33 Costs of Annuities Surrender charges ◦ Charged if you withdraw money within a certain period Mortality and expense risk charge ◦ Usually 1.25% of account value Administrative fees ◦ Flat fee $25-$30 per year ◦ Percentage – usually 0.15% per year Fund expenses ◦ Annual indirect costs imposed by funds handling underlying investments Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

34. 10-34 Tax Considerations of Annuities Tax Reform Act of 1986 ◦ Preserves tax advantage of annuities and insurance ◦ No maximum contribution ◦ Beneficiary guaranteed no less than contributed Implications of tax deferment Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

35. 10-35 Chapter Summary Learning Objective LO10.1 Life insurance protects the people who depend on you from financial losses caused by your death. Estimation methods: ◦ DINK method ◦ “Nonworking” spouse method ◦ “Family need” method Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

36. 10-36 Chapter Summary Learning Objective LO10.2 Two types of insurance companies: ◦ Stock insurance companies ◦ Mutual insurance companies Types of policies: ◦ Nonparticipating ◦ Participating Two basic types of insurance: ◦ Term life ◦ Whole life Many variations and combinations Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

37. 10-37 Chapter Summary Learning Objective LO10.3 Most life insurance policies have standard features. An insurance company can change the conditions of a policy by adding a rider to it. Before buying life insurance, consider all your present and future sources of income, then compare the costs and choose appropriate settlement options. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

38. 10-38 Chapter Summary Learning Objective LO10.4 An annuity pays while you live, whereas life insurance pays when you die. With a fixed annuity, you receive a fixed amount of income over a certain period or for life. With a variable annuity, the monthly payments vary because they are based on the income received from stocks or other investments. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.