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Lesson 19 FIN 403. Life, Health and Disability Insurance Learning Objectives : To evaluate who needs life insurance and who does not. To determine the amount of life insurance coverage that a family needs by a) the Income Approach and b) the Expense Approach.
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Lesson 19 FIN 403 Life, Health and Disability Insurance Learning Objectives: To evaluate who needs life insurance and who does not. To determine the amount of life insurance coverage that a family needs by a) the Income Approach and b) the Expense Approach. To explain the most common insurance policies sold, including term life and whole life. To describe a method that can compare different life insurance policies. To explain the major features of a typical disability insurance policy.
Review Life is full of risks. Question. What are some of the risks? Answer. Most families do not have the money to pay for replacement costs if their home burns down or the primary breadwinner becomes unemployed or disabled. These risks are referred to as insupportable, because the family does not have the money to financially support themselves if it happens. Question. What can a family do, to minimize the risk? Answer. Find other people to share the risk.
Important Insurance Definitions Insured: the person upon whose death the death benefit (or face value ~ not to be confused with future value) of the insurance policy will be paid. Beneficiary: the person(s) who received the death benefit or face value of the policy upon the death of the insured. Death Benefit or Face Value: the dollar amount that will be paid to the beneficiary if the insured dies. Premium: the dollar amount that must be paid to the insurance company. The premium may be payable in one lump sum, or periodically – monthly, quarterly, semi-annually, or annually.
Owner: the person who pays the premiums. The owner can be the insure, her employer, the beneficiary or other third parties. If you buy life insurance for your child, you are the owner and your child is the insured. Policy Term: the period during which the insurance is in force. The term can range from one year to an entire lifetime. Rate: the cost of each unit of insurance. A rate of $2.50 per $100 unit means that the premium for $10,000 of insurance is equal to ($2.50x100) or $250.
Insurability. The qualification for the insured to be insurable. There are certain requirements that the insured may have to meet before an insurance policy can be bought; for example, the insured may have to pass a medical examination and give blood (blood to test for diseases, drug use, alcohol abuse) which may be compared to results of an autopsy if the death benefit is challenged by the insurance company. Guaranteed Insurability: a rule that allows the insured to buy additional life insurance at certain specified future dates without proof of insurability. Example, without undergoing anew medical exam. Personal example…
Why is insurance important for you to know about, today? Even though you do not need it now, because you are not married and do not have children, your situation will change with your Life Cycle. Question. What are some examples of Life Cycle changes? Answer. Marriage, child birth, disability, retirement. There are many Employment Opportunities as young professionals in area Risk Management, Financial Planning and Insurance. Question. What professional careers would you like to investigate? Question. Would you like to give a 1 minute presentation on that career, to the class?
Question. Should a family have life insurance for their children and for a mother who does not have a job? Why? Answer. Yes. Explanation(s) Funerals can cost $10,000. If the mother dies, how much will it cost to pay someone to do everything that she did for free (cooking, cleaning, child care)? She may have gone back to work when the children were older, contributing to retirement savings. The ultimate test is whether or not the standard of living of the family will be affected by the death.
3 Good Questions Do you need life insurance? You know how to answer this question. What is the answer? Answer. Will the standard of living of the family will be negatively affected by the death. How much life insurance do you need? How can people estimate the correct amount of insurance they should buy? What kind of life insurance are sold in the market? What kind of life insurance should you buy?
Most people do not know how to determine the correct amount of life insurance to buy. Question. How do most of these people (above) make the decision about how much insurance to buy? Answer. Aggressive salesmen who are self motivated to get the highest commission (profit) for themselves and their company. Some employers share the cost of insurance (50/50 or 70/30).
The Income Approach The income approach estimates the Face Value of the life insurance by calculating the present value of the insured’s expected future income. This is equal to the insured person’s Human Capital (the loss of the human asset). Questions to ask ourselves. What is the present discount rate of the insured’s expected future income? How do we handle inflation? The insured’s income may appear to rise every year, but after accounting for inflation, there may not be any increase at all. The income stream of an individual is very uncertain and hence, fraught with risk; income stream of an individual is very uncertain and hence, fraught with risk; income over one’s lifetime may go up or down; indeed, it may become zero if and when the person is unemployed.
Example Max is 35 years old, earns $30,000 yearly / annually and he expects his income to rise at 5% annually and keep up with inflation. Question. What should the face value of his life insurance policy be? Answer. Present value of the insured’s lifetime earnings assuming no growth in real earnings and using the real rate of interest as the discount rate. Two solutions are available. Formula or Table.
The value of an insurance policy to replace $30,000 income at 3% interest for 30 years. Go to the 3% column. Go to 30 years. Take the number 19.60044 and multiply it by $30,000. Solution. 19.60044 X $30,000 = $ 588,013. The insurance policy must have a Face Value of $ 588,013.
Weekly Group Exercise – 5% of Grade FIN 403 in class and group exercise Assigned November 28, 2011; Due Monday December 5th, 2011 Assignment: Your employer has directed you to do an analysis of three existing clients. From among your group members, find and interview 3 family members or friends that have life insurance. You are required to discuss 3 scenarios in this assignment. CONFIDENTIALITY NOTE: Tell the people being interviewed that neither their name or personal information will be shared. The information they provide will be anonymous and their privacy will be protected, even to your group members. Group members will not ask each other about the origin of the data collection. Find out they type of life insurance policy. Describe the kind of policy, amount, limitations, restrictions annuity or face value. Ask them why they bought a life insurance policy. If the person told you their income, do the calculations and determine if it is enough to protect the family’s standard of living. If it is not enough, explain why. If they did not tell you their income, do the calculations and report what their income would be based on the Income Approach. Give your opinion / reasons as to whether their policy is a good one or if you have recommendations to improve the policy.
Group Exercise (continued) Remember that it is their personal choice to determine the type and amount of insurance and that you are simply analyzing the situation as an opportunity to learn about insurance. Do not make judgments about their decisions. Do not assign your values to their life. This assignment requires that you turn in the report looking like a professional document. The paper should be approximately 2 pages in length. The format: All papers must include a cover page with Name, Student Number and email address of each group member. Due date: Monday December 5th, 2011. Hard copy only. No email submissions. The best paper(s) will be read to the class as an example of good work and future expectations.
