Personal Finance SIXTH EDITION Chapter 13 Life Insurance Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Chapter Objectives (1 of 2) 13.1 Provide a background on life insurance 13.2 Describe the types of life insurance that are available 13.3 Identify the factors that influence insurance needs 13.4 Review the contents of a life insurance policy Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Chapter Objectives (2 of 2) 13.5 Discuss how to select a life insurance company 13.6 Explain how life insurance fits within your financial plan Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Background on Life Insurance (1 of 2) • Life insurance: insurance that provides a payment to a specified beneficiary when the policyholder dies • Role of life insurance – – • Maintain financial support for dependents Leave money for heirs Psychology behind the life insurance decision – Easier to focus on happy events – Hard to pay ongoing premiums for benefit you might not need Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Background on Life Insurance (2 of 2) • Role of life insurance companies – • Help clients determine the type and amount of insurance they need Applying for life insurance – Application includes medical and lifestyle history Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Types of Life Insurance (1 of 13) • Term insurance: life insurance that is provided over a specified time period and does not build a cash value – Premiums on term insurance Paid monthly, quarterly, semi-annually or annually Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Types of Life Insurance (2 of 13) – Determinants of term insurance premiums The longer the term, the higher the premium The older the policyholder, the higher the premium The greater the amount of insurance coverage, the higher the premium Premiums higher for males than females Premiums higher for smokers Premiums higher for those with medical problems Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Types of Life Insurance (3 of 13) Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Types of Life Insurance (4 of 13) Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Types of Life Insurance (5 of 13) Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Determining the Amount of Life Insurance (1 of 5) • Income method: a method that determines how much life insurance is needed based on the policyholder’s annual income – For example, 10 times your annual income, so, using this method, a person with an annual income of $40,000 would need $400,000 of life insurance coverage – Easy, but doesn’t consider individual circumstances Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Determining the Amount of Life Insurance (2 of 5) • Budget method (needs method): a method that determines how much life insurance is needed based on the household’s expected future expenses – – – – – Annual living expenses Special future expenses Debt Job marketability of spouse Value of existing savings Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Determining the Amount of Life Insurance (3 of 5) – Using the Internet to determine your insurance coverage – Limitations in estimating need Budget method doesn’t consider an unanticipated major illness or disability Family income may not rise Weak economic conditions impact income Inflation could cause you to underestimate needs Debt level could increase Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Determining the Amount of Life Insurance (4 of 5) • Check out the Life Happens Needs Calculator app (by Life and Health Insurance Foundation for Education) • Search for “Life Happens Needs” app on your mobile device • Helps compute the amount of life insurance you may need Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Determining the Amount of Life Insurance (5 of 5) – Distinguishing between needs and dreams Decide what necessities must be covered for the household to survive Consider other preferences such as college educations for children Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Contents of a Life Insurance Policy (1 of 5) • Beneficiary: person named to receive benefits of an insurance policy • Grace period • Living benefits: benefits that allow the policyholder to receive a portion of death benefits prior to death Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Contents of a Life Insurance Policy (2 of 5) • Nonforfeiture clause: allows you to receive the savings you accumulated if you terminate your whole life policy • Loans • Incontestability clause • Renewability option: allows you to renew your policy for another term once an existing policy expires Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Contents of a Life Insurance Policy (3 of 5) • Conversion option: allows you to convert your term insurance policy into a whole life policy that will be in effect the rest of your life • Settlement options: the alternative ways a beneficiary can receive life insurance benefits in the event that the insured person dies Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Contents of a Life Insurance Policy (4 of 5) – Lump-sum settlement: a single payment of all the benefits owed to a beneficiary under a life insurance policy – Installment payments settlement: the payment of the benefits owed to a beneficiary under a life insurance policy as a stream of equal payments over a specified number of years Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Contents of a Life Insurance Policy (5 of 5) – Interest payments settlement: a method of paying the benefits owed under a life insurance policy in which the company retains the amount owed for a specified number of years and pays interest to the beneficiary Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Selecting a Life Insurance Company • The specific policy that you want • Relatively low insurance premiums – • Shop comparable policies Strong financial condition – – Companies rated www.insure.com • Services • Other types of insurance – Discounts may be available Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Financial Planning Online: How Much Life Insurance Do You Need? • Go to http://www.prudential.com and insert the search term “life insurance needs estimator” • This Web site provides a recommendation for the amount of life insurance you should have based on your financial situation Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How Life Insurance Fits Within Your Financial Plan (1 of 3) • Key decisions about life insurance for your financial plan are: – Do you need life insurance? – What type of life insurance is most appropriate for you? – How much life insurance should you plan for in the future? Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How Life Insurance Fits Within Your Financial Plan (2 of 3) EXHIBIT 13.5 How Life Insurance Fits Within Stephanie Spratt’s Financial Plan GOALS FOR LIFE INSURANCE PLANNING Determine whether I need to purchase life insurance If so, determine what type of life insurance to buy Determine whether I should purchase or add to my life insurance in the future ANALYSIS Type of Insurance Plan Benefits Status Term insurance Insurance benefits provided to beneficiary Not needed at this time since I not have a spouse or dependents Whole life insurance Insurance benefits provided to beneficiary, Not needed at this time and policy builds a cash value over time Universal life insurance Insurance benefits provided to beneficiary, and policy builds a cash value over time Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Not needed at this time How Life Insurance Fits Within Your Financial Plan (3 of 3) EXHIBIT 13.5 How Life Insurance Fits Within Stephanie Spratt’s Financial Plan DECISIONS Decision on Whether I Need Life Insurance and Type of Insurance: I decided to purchase term life insurance to provide my two nieces with a college education if I die The policy is small, and so the premium I pay is $120 per year, or only $10 per month My reason for buying life insurance is simply to have insurance, not to build a cash value Term insurance serves my purpose and is much cheaper than whole or universal policies Decision on Insurance Coverage in the Future: In the future, I will need to ensure proper life insurance coverage if I have a family I would want to ensure that my children have sufficient funds to support them and possibly even pay for their college education if I die If I have a child, I will obtain a 20-year term life insurance policy for $300,000 Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved .. .Chapter Objectives (1 of 2) 13. 1 Provide a background on life insurance 13. 2 Describe the types of life insurance that are available 13. 3 Identify the factors that influence insurance needs 13. 4... savings Whole life premiums remain constant Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Types of Life Insurance (13 of 13) • Universal life insurance: life insurance... for life Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Types of Life Insurance (12 of 13) – Comparison to term insurance Whole life has higher premiums Whole life