8-1 Copyright  2002 by Harcourt, Inc. All rights reserved. CHAPTER 8: INSURING YOUR LIFE Clip Art  2001 Microsoft Corporation. All rights reserved.

8-2 Copyright  2002 by Harcourt, Inc. All rights reserved. Basic Insurance Concepts Basic purposes of insurance:  Protect you and your dependents from losing the assets that you’ve already acquired.  Shield you and your family from an interruption in your expected earnings.

8-3 Copyright  2002 by Harcourt, Inc. All rights reserved. Insurance Planning Needs:  Auto & Homeowners Insurance –Reimburses for damage or destruction to existing assets  Life Insurance –Replaces income lost due to premature death  Disability Insurance –Replaces income lost due to disability  Hospitalization & Health Insurance –Covers medical costs from illness or accident

8-4 Copyright  2002 by Harcourt, Inc. All rights reserved. Concept of Risk  Risk is defined as uncertainty with respect to economic loss.  Insurance planning is used to reduce the risk that losses will cause financial devastation.  Risk can be dealt with in the following ways:

8-5 Copyright  2002 by Harcourt, Inc. All rights reserved. Risk Avoidance:  Not participating in activities that have the risk of loss. Example—not driving to avoid the risk of an auto accident. Risk avoidance is not always practical or possible!

8-6 Copyright  2002 by Harcourt, Inc. All rights reserved. Loss Prevention and Control:  Prevention reduces the chance that a loss will occur. Example: Driving within the speed limit reduces the likelihood of an accident.  Control reduces the severity of a loss once it occurs. Example: Wearing a seat belt can minimize the effects of an accident.

8-7 Copyright  2002 by Harcourt, Inc. All rights reserved. Risk Assumption:  You bear the risk of loss yourself. Example: When your calculator gets stolen, you bear the cost out of pocket. Transferring Risk:  Pay someone else to bear your risk of loss. Example: You transfer the risk to the insurance company when you buy an insurance policy.

8-8 Copyright  2002 by Harcourt, Inc. All rights reserved. Underwriting  Process in which the insurance company decides whom to insure and the rate to be charged.  Company must guard against adverse selection, a disproportionate number of bad risks.

8-9 Copyright  2002 by Harcourt, Inc. All rights reserved.  Combine the loss experiences of large numbers of people.  Calculate probability of frequency of occurrence and amount of loss using past experience.  Charge rates in proportion to level of risk. It is economically feasible for insurance companies to assume risk because they:

8-10 Copyright  2002 by Harcourt, Inc. All rights reserved. How Much Life Insurance?  Enough to provide financial security for those who depend on your income and prevent a decline in their standard of living.  Life insurance needs change throughout your life.

8-11 Copyright  2002 by Harcourt, Inc. All rights reserved. Other Benefits of Life Insurance:  Protection from creditors –Before death, cash value in life insurance policies usually protected against legal judgments and bankruptcy proceedings. –After death, possible to keep benefits out of estate and away from creditors.

8-12 Copyright  2002 by Harcourt, Inc. All rights reserved.  Medium for savings: –Provides a means of forced savings for those who would not do so otherwise. –Provides preservation of capital for those who desire a relatively safe, conservative investment. Clip Art  2001 Microsoft Corporation. All rights reserved.

8-13 Copyright  2002 by Harcourt, Inc. All rights reserved.  Tax benefits: –Savings portion grows tax free unless withdrawn. –For taxpayers in higher income brackets, these relatively low returns become more attractive as income taxes take a greater bite from current income and short-term capital gains. –Proceeds not income taxable to beneficiaries. –Possible to avoid estate taxation on proceeds.

8-14 Copyright  2002 by Harcourt, Inc. All rights reserved. Techniques for estimating life insurance needs:  Multiple Earnings Approach multiply annual earnings by an arbitrary number  Needs Approach estimate needs and examine available resources

8-15 Copyright  2002 by Harcourt, Inc. All rights reserved. Assessing Economic Needs  Family income  Additional expenses  Pay off debts  Surviving spouse’s income  Special financial needs  Liquidity Clip Art  2001 Microsoft Corporation. All rights reserved.

8-16 Copyright  2002 by Harcourt, Inc. All rights reserved. Types of Life Insurance  Benefit paid if insured dies during the policy period.  No savings component.  Economical way for young families to purchase large amounts of life insurance. 1. Term insurance:

8-17 Copyright  2002 by Harcourt, Inc. All rights reserved. Types of Term Insurance:  Straight term coverage remains the same while premiums increase  Decreasing term premiums remain the same while coverage decreases

8-18 Copyright  2002 by Harcourt, Inc. All rights reserved. Important features to look for in term insurance:  Renewability allows insured to renew policy without evidence of insurability  Convertibility allows insured to convert to whole life policy without evidence of insurability

8-19 Copyright  2002 by Harcourt, Inc. All rights reserved. 2. Whole life insurance:  Provides death protection plus a savings feature called cash value.  If policy canceled prior to death, insured has right to cash value; this is the nonforfeiture right.

8-20 Copyright  2002 by Harcourt, Inc. All rights reserved. How the cash value accumulates in a $200,000 whole life policy: $200,000 $100,000 $ Cash Value Age of insured

8-21 Copyright  2002 by Harcourt, Inc. All rights reserved. Types of Whole Life Insurance:  Continuous premium (straight life) level premiums paid until death or cancellation of policy  Limited payment level premiums paid for a specified number of years; insurance remains in force until death  Single premium lifetime coverage purchased with a single premium

8-22 Copyright  2002 by Harcourt, Inc. All rights reserved. Advantages of Whole Life  Provides a savings vehicle.  Cash value can be borrowed against.  Premiums remain constant.  Cash value accumulates tax-free until redeemed.

8-23 Copyright  2002 by Harcourt, Inc. All rights reserved. Disadvantages of Whole Life  Dollar for dollar provides much less death protection than term insurance.  Lower returns than other savings vehicles.  Loans must be repaid with interest or—  Tax penalties may be assessed on cash values withdrawn early.  If you have a loan outstanding when you die, that amount is subtracted from the face value of your policy.

8-24 Copyright  2002 by Harcourt, Inc. All rights reserved. 3. Universal life insurance:  Provides death protection plus a savings feature.  Premiums are “unbundled” into 2 separate accounts.  Savings grow at the current interest rate vs. guaranteed minimum rate.  Provides flexibility in premiums paid and death benefit.  Understand the risks before you buy!

8-25 Copyright  2002 by Harcourt, Inc. All rights reserved. 4. Other Types of Life Insurance:  Variable and variable universal life  Insurance on multiple lives  Group life insurance  Credit and mortgage life insurance  Industrial life insurance  Special-purpose policies  Deferred-premium life insurance

8-26 Copyright  2002 by Harcourt, Inc. All rights reserved. Key Life Insurance Contract Features  Beneficiary clause  Settlement options  Policy loan provisions  Payment of premiums  Grace period  Nonforfeiture options  Policy reinstatement  Change of policy  Multiple indemnity  Disability clause  Guaranteed purchase options  Suicide clause  Exclusions  Participating policies  Living benefits

8-27 Copyright  2002 by Harcourt, Inc. All rights reserved. Buying Life Insurance  Know the amount and type of coverage you need.  Compare costs.  Select a large, highly rated, financially secure company.  Select a reputable agent.

8-28 Copyright  2002 by Harcourt, Inc. All rights reserved. THE END!