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FINANCIAL PLANNING WITH
LIFE INSURANCE
CHAPTER 12
Personal Finance
Finance 235
LIFE INSURANCE
• What is Life Insurance and when should we get it?
– A means for protecting the financial security of those that depend on us for their
safety and economic well being.
– The best time to get it is when you are young and healthy.
– You should have some by the time you marry or partner.
– You are foolish not to have it when you start a family and acquire
property (cars, home, investments, etc.)
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LIFE INSURANCE
• Major Purposes of Life Insurance
– Pay off mortgage or other debts at time of death
– Provide lump sum payments or endowments to beneficiaries
– Provide education or income to children
– Make charitable donations
– Provide retirement income (whole life / endowment policies)
– Estate Planning (paying estate or gift taxes)
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LIFE INSURANCE
• How Much Life Insurance Do You Need?
– The answer depends on your personal life situation
• A young single person – not much
• An older person with family responsibilities – depends
– Number of dependents
– Magnitude of financial liabilities (mortgages, loans, etc.)
– Magnitude of income
– Social Security survivor benefit
– Example #1: Family (spouse, children, household expenses)
• 7 times 70% of yearly income
• More if dependents are under 7 years of age.
– Example #2: Dual Incomes no Kids (DINKs)
• Enough to cover debts
• Provide a financial cushion
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LIFE INSURANCE COMPANIES
• Types of Insurance Companies
– Stock: Owned by the stockholders – sell nonparticipating polices
– Mutual: Owned by the policy holders – sell participating policies
– Participating Policies (Mutual):
• Mutual LICs return a portion of its investment profits as dividend
• Premiums are invested in investment quality bonds and other high
degree of safety investments (function of legal list requirements)
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INSURANCE COMPANIES
• Type of Policies (1)
– Term
• Coverage for a specified number of years.
• After that period, policy may continue but typically with higher
premiums.
• Categories
– Renewable
– Level
– Conversion (to whole life)
– Decreasing
– Return of Premium
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INSURANCE COMPANIES
• Type of Policies (2)
– Whole Life (cash value / straight life / ordinary)
• Permanent premium paid for lifetime of insured
• Accrues cash values
• Cash values can be used as collateral for loans
– Limited Life (paid up after 20 or 30 years)
– Variable Life (value a function of stock market investment performance)
– Universal Life (ability to change premiums based on cash values)
– Group Polices
• Associated with employment or affinity groups
– Credit Life – pay off a debt if you die before debt is paid
– Endowment Life – pays a sum at maturity to policy holder
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SELECTING PROVISIONS
• What are the Key Provisions in a Policy?
– Naming the Beneficiary (ies)
– Incontestability – policy cannot be cancelled after a certain period of time
– Grace Period (limit to late payment) – lapsed policy
– Reinstatement
– Policy loan provision (borrow against cash values)
– Suicide clause (within 1 year – no benefits)
– Typical Riders
• Accidental death (2x)
• Waiver of premium if permanently disabled (age limit)
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BUYING LIFE INSURANCE
• Decision Criteria
– AM Best rating
– Costs and Features
– Availability of local agents
– Recommendations of Friends
– Articles in Kiplinger, WSJ, Money
• Choosing Settlement Options
– Lump-sum
– Installments
– Life income
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FINANCIAL PLANNING WITH ANNUITIES
• What is an Annuity?
– An particular type of insurance plan structured to provide you with a
fixed payment each [month] for a set period of years.
• What are the Principal Types of Annuities?
– Immediate
– Deferred
– Variable [rate]
– Indexed [to a mix of stocks and bonds]
• Why do People Buy Annuities?
– Main reason is to remove market risk.
– There are also certain tax advantages.
• Thoroughly Investigate before you Buy!
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HOMEWORK
A. Questions:
1. What is an Annuity?
2. What are the Principal Types of Annuities?
3. Why do People Buy Annuities?
B. Be Your Own Personal Financial Planner*
1. 1 – Calculating your insurance need (w/s 47)
2. 6 – Set up a layered Term Insurance Program (w/s 48)
* These are simulated situations.
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